The question of the rights of inheritance of adopted persons has a long history in this Commonwealth. Until 1855, adoption needed the approval of the state legislature. Then the legislature got out of the adoption business, moving it to the judicial system. The Wills Acts of 1855, 1887, 1889 and 1911 all stated that adopted children had the same rights to inheritance as the adoptive parents’ natural children.

But, what about adopted grandchildren and more remote descendants? What were their rights in regard to inheritance? That question was slow in being addressed. The question of adopted grandchildren’s standing to inherit was raised especially when a child who had no natural children passed away. Often that child’s siblings didn’t want to see this share go "out of the bloodline" to adopted children.

Another issue was how late in life a child could adopt and still have the adopted children considered as issue in "Grandfather’s Estate." The Wills Act of 1917 set a cut-off date of the date of the signing of the Will in question. Any child adopted after the date of the signing of Grandfather’s last Will would be presumed not to be counted among his child’s children or more remote descendants. The idea was to stop this sort of thing: the 65 year old son adopts his 30 year old girlfriend so she would inherit his share.

Relief from that presumption came in a curious way with the Estate of Caves in 1937. With this case, the court ruled that if the decedent dies intestate, grandchildren adopted any time before grandfather’s death were included as issue. This meant that adopted children were given more protection in the case of intestacy than if a Will governed distribution.

This remained the law until the Wills Act of 1947 was passed. The rebuttable presumption became that adopted grandchildren of a testator were assumed to be issue of the testator and therefore inherit along with his or her fellow grandchildren. However, the grandchildren had to be adopted before the death of the testator. This moved the "cut-off date" forward for both the testamentary case and the intestate case, but still left those children adopted after Grandfather’s death out in the cold.

This remained the case until 1972. In January of 1972, the Court agreed to hear the Estate of Tafel. The children of the decedent, Tafel, were enjoying the income of a trust created in his Will, with the remainder to be distributed to his child’s issue, if any, and if none, the remainder was to be given over to the other siblings. One of Tafel’s children, a son, had adopted two children after his father’s death. The law at the time supported the presumed intention of the testator: if the son with the adopted children dies before his trust is distributed, the remaining amount would go to his brothers and sisters. Before the case was decided, a new Wills Act was passed in June of 1972 that eliminated the "cut-off date" of the grandparent’s death. The Court had for years wanted to address this issue, and so the court’s ruling, delayed until November of 1972, made new case law that exists today.

The Court decided that any adopted child, no matter when adopted and no matter how many generations removed from the testator, would share in the inheritance with all issue. The only restriction is that the rule does not apply when the adoptee is an adult (18 or over) when adopted.

All of these laws and cases addressed what should be assumed to be the intent of a decedent if there was no written statement showing his intention to include or exclude adopted children or more remote issue. Many professionally drawn Wills include definitions, either including or excluding adopted children, and such definitions can change the rule about adult adoptees.

A person may change the rule of the statute by specifying in a Will whether adopted children will inherit equally with natural-born children. Inheritance by grandchildren and more remote issue can be similarly specified. If the presumption of today’s law is not what you want, be sure to address it in your next Will or Codicil.

 

2010 is the year with no federal estate tax. George Steinbrenner died in July 2010. His family will be saving about $500 million in estate tax and won’t have to sell the Yankees to pay the tax. Forbes says 5 billionaires died so far in 2010, and the tax their estates would have owed totals $8.7 billion.

Under the tax cut legislation, the estate tax exemption increased to $3.5 million and then in 2010 the estate tax was repealed for the year. If nothing changes, the estate tax will be back January 1, 2011 with a $1 million exemption.

The year with no estate tax was the year to "throw mamma from the train." This year’s estate planning techniques included one-way tickets to Switzerland where euthanasia is legal. Congressman Richard E. Neal, quoted in the New York Times when asked about the expiration or the estate tax in 2010 said, "If you’re at the checkout counter, you might want to expedite things."

Three states – Oregon, Washington and Montana – allow versions of the practice of euthanasia or assisted suicide. Oregon’s law took effect in 1997, and Washington enacted a similar one in 2009. Montana’s Supreme Court recently ruled that nothing in the state constitution prohibited doctors aiding patients with dying, but voters haven’t yet specifically authorized it. Some countries, such as Switzerland and the Netherlands, have long allowed physicians to aid patients in dying. But only Switzerland extends this benefit to foreigners.

In a recent news story in Wyoming, Representative Cynthia Lummis claimed some of her Wyoming constituents are so worried about the reinstatement of federal estate taxes that they plan to discontinue dialysis and other life-extending medical treatments so they can die before Dec. 31. She didn’t name names, but gave the example of a rancher on dialysis seriously considering termination of treatment to let the end come and, thus, escape the estate tax due to come back two months hence.

This news article generated page after page of comments on the internet. Many took the approach that if a person has enough money to have to pay federal estate tax, they ought to be able to pay a professional to minimize or even eliminate the transfer taxes at death. True, good planning can minimize the impact of taxes, but it can’t eliminate them.

Some commentators advocated stealth gifts to the family, or selling the farm to the kids for one hundred dollars. These approaches don’t work. These are do-it-yourself techniques that just create problems. The IRS is anything but naive. A transfer of a $5 million dollar ranch in a $100 dollar sale is really a $4.999900 million gift. Doing this could actually result in more tax due, not to mention penalties and interest. The gift tax exclusion is only $1 million, but the estate tax exclusion might be as much as $5 million next year.

All this said, one enlightened responder to the posting, an estate planning lawyer named Emil Blatz quoted a study showing this "hurry up and die" mentality to be a recurring phenomenon. He quotes research stating that "academic researchers have known for years that death rates are influenced by major changes in estate-tax law. A 2003 paper published in the prestigious Review of Economics and Statistics looked at 13 major estate-tax changes in the U.S. – following the creation of the tax in 1916 – and found they had a small but statistically significant effect on death rates. "Among those wealthy enough to be affected by the changes, the chance of dying increased slightly in the two weeks before rates went up and decreased in the two weeks after an estate-tax cut, a phenomenon the authors have dubbed death elasticity."

As one elderly gentleman put it, with sardonic humor, "In 2010 I’m not going to linger too long at the top of any stairways."

Soon we will have some much needed changes to Pennsylvania’s Probate, Estates and Fiduciaries Code which will clarify rights of inheritance when a divorce is pending, interpret funding clauses dependent on the federal estate tax, and curtail some abuses prevalent in the use of powers of attorney.

As of October 14, 2010, Senate Bill 53 had been approved by both the Pennsylvania House and the Senate and had been sent to the governor for his signature. The governor is expected to sign it in due course. Here are a few of the provisions:

 Formula Clauses for Federal Estate Tax

As has been discussed in this column before, estate plans that contain "formula clauses" that divide the decedent’s estate into two parts based on the amount of the exemption from the federal estate tax ran aground this year. There is no federal estate tax in 2010, so the question arises: how to interpret these formula clauses? I recommended to my clients that they amend their plans to answer this question because it very fundamentally determines "who gets what." If you did not do that, the legislature will now answer it for you, and here is their answer: a will, trust, or other instrument for a decedent who dies after December 31, 2009 and before January 1, 2011, that contains a formula clause will be "rebuttably presumed to be interpreted pursuant to the Federal Estate Tax and Generation-Skipping Transfer Tax laws applicable to estate of decedent dying on December 31, 2009." In other words, the formula will be interpreted under the federal estate tax as it existed in 2009. There is an exception: the rule of the new law does not apply (1) if the will, trust or other instrument was executed after December 31, 2009 or indicates that a different rule should apply, or (2) there is a federal estate tax or generation-skipping tax that applies to the decedent who dies in 2010 (which would take some fast action by Congress or else a very controversial and probably unconstitutional retroactive application of an estate tax or generation skipping tax).

 Agent Under a Power of Attorney

With regard to the agent’s power to engage in insurance transactions, the law is amended to provide that an agent or a named beneficiary of a life insurance policy "shall be liable, as equity and justice require, to the extent that a beneficiary designation made by the agent is inconsistent with the known or probable intent of the principal." In other words, the agent cannot name himself as beneficiary if that is not the principal’s intent. This is aimed at situations such as when an agent under a power of attorney changes a beneficiary designation to him or herself.

A similar provision is made for an agent’s change of beneficiaries on a retirement plan. Further, an agent cannot designate himself a beneficiary of a retirement plan unless the agent is the spouse, child, grandchild, parent, brother or sister of the principal.

Death while Divorce is Pending

Prior PA law provided that a spouse who for one year or more before death has willfully neglected or refused to support the spouse, or who for one year or more has deserted the spouse, shall have no right to claim a share of the deceased spouse’s estate.

The Omnibus Amendment would add that a surviving spouse shall have no right or interest in the estate of the deceased spouse if the spouse died domiciled in Pennsylvania during the course of divorce proceedings, no decree of divorce has been entered, and grounds have been established.

Similarly, wills are modified not only by a divorce but also by a pending divorce where grounds have been established. The surviving spouse in a pending divorce is deemed to have predeceased when the will is interpreted.

A pending divorce where the grounds have been established will also void a beneficiary designation of a life insurance policy, annuity contract, pension or profit-sharing plan.

Uniform Trust Act

Various technical corrections and clarifications are made to the Uniform Trust Act. These changes will be most helpful to practitioners as they work with the new law which requires notice to trust beneficiaries and provides for ways to modify trusts by agreement.

The IRS estimates that U.S. taxpayers under report and underpay about $400 billion in taxes each and every year. The IRS operates a Whistle blower Program where the agency will give monetary awards to individuals who provide information that results in the collection of significant un-reported tax dollars.

The IRS Whistleblower Office was established by the Tax Relief and Health Care Act of 2006. There were ways to turn in alleged tax cheats before that, but since 2006 there are specific procedures. Now, if the IRS uses information provided by the whistleblower; it can award the whistle blower up to 30% of the additional tax, penalty and other amounts it collects.

The information must be specific and credible, and it must result in the actual collection of taxes, penalties and interest from the noncompliant taxpayer. The information must be detailed. They are not interested in speculation and unsubstantiated accusations about your ex-husband or former employer.

There are two types of awards for whistleblowers: (1) If collected taxes, penalties and interest exceed $2 million, the IRS will pay at least 15 but not more than 30%. This is the major change in the program that was made by the 2006 law. These awards are no longer discretionary. The new law says that the whistleblower shall receive 15 to 30% of the collected proceeds. The IRS’s determination on this award is appealable by the whistleblower. If the taxpayer is an individual, his or her gross income must exceed $200,000. (2) If tax is less than $2 million or the alleged cheat’s annual income is less than $200,000, there are also awards. These can be up to a maximum of 15%, and the IRS’s determination is not appealable.

If you decide to submit information, use IRS Form 211, Application for Award for Original Information. You must provide specific and credible information regarding the taxpayer that you believe has failed to comply with tax laws and that will lead to the collection of unpaid taxes. Attach all supporting documentation (for example, books and records) to substantiate the claim. If documents or supporting evidence are not in your possession, you must describe these documents and their location. You must also describe how the information which forms the basis of the claim came to your attention, including the date(s) on which this information was acquired, and a complete description of your relationship to the taxpayer. The IRS emphasizes that under no circumstance do they expect or condone illegal actions taken to secure documents or supporting evidence.

If you chose to file Form 211, the process could take several years. There must be an audit or investigation resulting in the collection of proceeds. The taxpayer’s appeal rights must be expired and all sums collected before any award is paid to the whistleblower.

A person who reports under the IRS Whistleblower Act does not have the right to prosecute it. A whistleblower cannot compel the IRS to investigate a claim nor may a whistleblower file a private cause of action if the IRS declines to pursue an investigation.

Will the alleged tax cheat know you turned them in? The IRS will protect the identity of the whistleblower to the fullest extent permitted by the law (whatever that is). If the whistleblower is an essential witness in a judicial proceeding, it may not be possible to pursue the investigation or examination without revealing the whistleblower’s identity. The IRS will inform the whistleblower before deciding whether to proceed in such cases.

Offshore accounts are an increasing priority for the IRS and the Whistleblower Program has helped in uncovering these situations. As reported by Janet Novack and William P. Barrett for Forbes, "In June 2007, Bradley C. Birkenfeld–motivated in large part, he now acknowledges, by the new reward law–came to U.S. officials with documents in hand and laid out how his former employer, UBS AG, helped wealthy Americans hide money offshore. So far the investigation he triggered has produced a $780 million payment to the U.S. government from UBS, Switzerland’s largest bank; an unprecedented agreement by the Swiss to finger 4,450 U.S. taxpayers with secret UBS accounts; and criminal investigations of more than 150 American UBS clients."

However, Birkenfeld tried to conceal his own involvement in the fraud and was prosecuted for a felony for his participation. His prosecution has been roundly criticized. Here is the lesson: If you’re going to blow the whistle, you must "tell all" truthfully. Whistleblowers willing to tell the full truth can usually obtain any protection needed.

The fact the Birkenfeld was prosecuted is not a bar to his award. He is still eligible for the "bounty."

 

Much ink has been spilled on the subject of our President and Congress’s failure to address the federal estate tax in a coherent way. Last year there was a $3.5 million exemption. This year there is no federal estate tax at all. And it looks like there is a good chance there will be an estate tax with a $1 million exemption in 2011.

It’s bizarre. Billionaire George Steinbrenner died in 2010, and his heirs will pay no estate tax at all. If your neighbor who is worth $1 .5 million dies in 2011, his estate will pay the federal government $210,000 in estate tax. Insane.

But it is what it is. Yet in this mess there is an opportunity.

While there is no estate tax in 2010, there is a gift tax. Its lifetime exemption is $1 million and rate is 35% – which is the lowest rate since the 1930’s. This $1 million exemption is in addition to the annual exclusion, which is a free pass of $13,000 per year per donee. Wealthy people are looking at making taxable gifts in 2010.

They are considering paying a 35% gift tax now, because next year the top rate will rise to 55%. That’s a huge increase in the rate. That’s not all. The value of many assets is currently depressed. Stocks, real estate, and interests in businesses are at low market values in the struggle to weather the recession (Is it really over?). Making gifts of these assets now gets them through the transfer tax system at a low value. Any future appreciation will not be subject to gift or estate tax.

When there are steep declines in the market, most folks are understandably concerned about the shrinking value of their assets. The natural urge is to hold them closer. If you are in taxable estate territory – over $1 million in 2011, you need to ask yourself if you really need to hold it all so very close. Wouldn’t it be better to take advantage of low valuation and low rates to pass more property to your beneficiaries?

It gets better. If the donor is making gifts to grandchildren or to a trust for the benefit of grandchildren, there is a major advantage. Usually large gifts to grandchild (or more remote descendants) are subject to an additional tax called the Generation-Skipping Transfer Tax (GSTT). The GSTT applies in addition to the Gift Tax and Estate Tax but in 2010, just like the Estate Tax, there is no Generation-Skipping Tax!If a single donor makes $3,013,000 million gift to one grandchild or a generation-skipping trust, in 2010, there is only a gift tax, and that at the rate of 35% over the $1 million exemption. The 2010 gift tax, after taking the $13,000 annual exclusion for gifts, would be $700,000.

Here is an example.

Contrast that with a gift in 2011, or with a death in 2011. The generation skipping tax after the $13,000 annual exclusion for generation skipping transfers, and the $1,340,000 GST exemption in 2011, would be $912,900. That generation skipping tax is added to the amount of the gift for a total gift of $3,912,900. The gift tax on that amount is $1,447,095. Add to that the $912,900 generation skipping tax, and the total tax due for the gift comes to $2,359, 995. Yikes! Compare that to this years total of $700,000 and you will see why it is such a bargain.

If you are attracted by this planning opportunity, start making plans now. Be cautious, and make sure that you know what Congress is up to this month, but be prepared to act. To take advantage of this opportunity, gifts must be made before year end and a large gift requires careful planning. It shouldn’t be rushed into at the end of the year.

They appear on late night television and on the internet promising to reduce your tax debt, remove tax liens, and settle your unpaid taxes, interest and penalties for pennies on the dollar. Do you really believe you can pay a fee to a tax relief company and reduce your $50,000 tax bill to $2,000?

Apparently a lot of people do believe that. The California Attorney General is suing TV’s Tax Lady, Roni Deutch, for $34 million.

Attorney General Jerry Brown announced the suit last Monday saying "Tax Lady Roni Deutch…promises to significantly reduce [clients’] IRS tax debts, but instead preys on their vulnerability, taking large up-front payments but providing little or no help in lowering their tax bills."

Brown alleges that Roni Deutch regularly violates state law by making false promises about her ability to resolve disputes with the IRS. He says that Deutch overstates her advertised television claims of winning 99% of her tax battles with the IRS while in reality she reduces the amount of money her clients owe in taxes in just 10% of the cases. Most of her clients quit or are terminated by her firm and are denied refunds after her staff bills them for work that wasn’t performed, the lawsuit said.

The attorney general’s office says hundreds of Deutch’s clients have filed complaints. In addition to not lowering their debts, consumers says she also refused to refund fees of as much as $4,700 that her firm charged.

The complaint filed against her alleges that she engaged in a scheme to swindle taxpayers, including senior citizens and disabled, who cannot afford to pay their tax debt by enticing them to engage her firm to negotiate a resolution of their tax debt with the IRS. She promises to lower the amount the clients owe the IRS, eliminate interest and penalties, establish a low monthly payment plan, or prevent the IRS from collecting on the tax debt altogether. According to the complaint, she also falsely represents that she is able to immediately stop IRS collection actions such as levies and wage garnishments.

Deutch has faced similar allegations before. In December 2006, she settled a lawsuit filed by New York City’s Department of Consumer Affairs that alleged she misled consumers with her advertising. She agreed to pay $300,000, including $100,000 in fines and $200,000 in restitution to consumers.

A recent MSNBC article cautioned taxpayers against falling for tax resolution promises that sound too good to be true. According to the article, "Instead of describing the long odds [of winning a tax settlement], many tax debt settlement companies sweet talk clients. Then they take large up-front payments — prices start at $3,000 and climb fast from there – but do little or nothing to help with the tax problem."

Most people are frightened when they are in trouble with the IRS. They may have a bill that is larger than anything they ever owed and they are scared stiff. Put yourself in their shoes. There you are, watching late night TV, unable to sleep because you are so worried about your tax problem, and an angry female attorney comes on and tells you she will fight the IRS for you and win! If you call the toll free number, you reach a salesperson whose job it is to get a large up front payment from you on your credit card.

Many tax relief companies make outlandish promises about reducing their tax bill to taxpayers, collect a large fee up front, and then never do anything. They may tell the taxpayer later that they don’t qualify for relief and suggest they call the IRS themselves for a payment plan.

If you are already in debt because of unpaid taxes, you don’t need to pay a big fee for nothing to one of these outfits.

Finding competent help can be challenging. You need to do your homework, and ask lots of questions. Find out about the firm – how long it’s been in business, what kind of complaints have been lodged against it? How many tax attorneys do they have on staff? Ask for references.

If the firm offers you a guarantee. Just say "no thanks" and run away. Nobody can guarantee anything. Does the firm want all its fee up front? If they do, run away. Some money upfront as a retainer is reasonable.

Do they give you a high pressure sales pitch? If they are pushing that hard, that’s a warning sign to stay away. In many cases when you get a sales pitch, you are talking with a salesperson, not a tax attorney or tax resolution specialist who can help you.

In general, when considering hiring any company or person to represent you, look for statements that seem too good to be true, claims of some kind of special advantage, or creating a fear that only they can solve. Be careful out there.

Most of these United States use post-mortem probate. A person’s will is submitted for probate after his or her death. The idea is that after the testator is dead, the will is read and the testator’s estate is distributed in accordance with his wishes.

I always thought there should be some procedure to validate a will before the testator’s death, a "pre-mortem probate." After all, the testator is the best source of evidence about his or her intent. And the best time to assess a testator’s capacity or susceptibility to undue influence is at the time the will is made, right? It seems illogical that these issues have to wait for probate when the best evidence is no longer available.

Probating a will after the decedent’s death brings with it all sorts of family disputes, will contest suits, and other litigation. The worst aspect of the process is that it encourages spurious contests where unhappy beneficiaries bring actions claiming lack of capacity, fraud or undue influence, just to get a settlement. It’s the cost of their going away. Of course, even if a will contest results in no settlement or adverse verdict, the failed challenger has no responsibility to reimburse the estate for all of the costs it has been forced to incur to defend the testator’s intent. As stated by Aloysius A. Leopold and Gerry a Byer in the article, "Ante-Mortem Probate: A Viable Alternative," [T]esting the validity of the instrument after the testator’s death is the most illogical and impractical time for such scrutiny because even the simplest of errors have the unavoidable effect of destroying the validity of a will and upsetting the testator’s interests."

The alternative to a post-death probate is the "Ante-Mortem Probate." A court proceeding is held during the testator’s lifetime to validate the will. The most obvious and striking feature of this approach is that the person who has the best evidence of intention, the testator, is alive and can tell exactly what he or she intends.

Questions about the capacity of the testator can be resolved by direct testimony of the testator. The testator is there, thus able to answer questions, explain his or her intentions, correct misapprehensions and eliminate ambiguities. Beneficiaries would have to consider carefully their complaints or contests.

In some jurisdictions, guardian or conservatorship proceedings are used in an attempt to establish a life-time determination of competency and freedom from influence. While these kind of proceedings are not directly related to the validity of a will, they are related to competency issues and can provide current testimony and actual input from the testator to build a legal record. For example, in California, a posthumous challenge to a will was barred because the same issues of capacity and undue influence had already been litigated in a proceeding for guardianship while the decedent was alive. While this may provide some help, the proceeding is expensive and can be embarrassing. There should be another way.

Several states experimented with Ante-Mortem Probate alternatives in the 19th century. The uniform commissioners have considered the matter several times, in the 1930’s, the 1940’s and 1970’s. There is much discussion of the concept in academic literature. Currently, three states, Arkansas, North Dakota and Ohio, allow living probate procedures. In those states the procedure is like a will contest and results in a declaratory judgement.

There are issues that need to be resolved if pre-mortem probate is enacted. Who would receive notice of a scheduled proceeding? What kind of notice should be given? Would the decree bind beneficiaries of prior wills who did not have notice? How many times should a testator be allowed to bring another proceeding if the first probate fails?

Providing for pre-mortem probate is not a panacea. And no one recommends that port-death probate be eliminated. But there should be a way to validate a will while the testator is living to make sure the testator’s property is distributed as he or she intends.

 

If my father promises to give me money to buy a grand piano for my birthday and then reneges, can I sue him for the money? Is a promise to make a gift legally enforceable? In general, no, I cannot sue him to force him to give me the money for the grand piano.

But what if after he makes the promise I go to the piano store and sign a contract with the store to buy the piano? I relied on his promise. When a person reasonably relies to his or her detriment on another’s promise to make a gift, the promise becomes enforceable. Then I can sue him.

The same analysis applies in the context of a pledge to a charity. When we think of a charitable contribution, we think of a contribution that is freely given. However, most courts view charitable pledges as legally enforceable commitments. Whether or not the pledge is enforceable is a matter of state law.

Under general principals of contract law, a charitable pledge is enforceable if it is a legally

binding contract. There must be an agreement between the donor and the charity, and there must be "consideration" given in exchange for the pledge. That is, the charity must agree to do something (or not do something) in exchange for the promised donation.

It is also "consideration" if a charity has relied on a pledge to its detriment even though that reliance was not requested by the donor as consideration. The legal doctrine applied here is called "promissory estoppel." In the law of contracts, the doctrine of promissory estoppel provides that if a party changes his or her position substantially either by acting or forbearing from acting in reliance upon a gratuitous promise, then that party can enforce the promise although the essential elements of a contract are not present.

Actions that constitute such reliance based on the pledge include soliciting other donors, incurring costs, entering into contracts, or borrowing money based on the expectation that the donor’s promise will be kept. Promises by other donors can be the consideration for the pledge that the charity seeks to enforce. Courts have been very liberal in finding reliance such as where there are specific fund-raising goals for pledges or naming opportunities.

In some states, a charitable pledge is enforceable even without consideration or detrimental reliance as a matter of public policy. For example, in Ohio, a pledge is considered to be just like a promissory note.

In Pennsylvania, any written promise is enforceable despite the absence of consideration or reliance if the writing states that the maker intends to be legally bound. (33 P.S.§6)

According to the Financial Accounting Standards Board, unconditional promises must be listed as assets on the charities financial statements and reported as revenue when the pledge is made. Lenders will often use pledges as collateral for a loan to the charity.

The directors of a nonprofit corporation or the trustees of a charitable trust may have a duty to pursue the collection of legally enforceable pledges. In general, directors and trustees have a

fiduciary duty to protect and preserve assets. If a donor has declined to fulfill a pledge and clearly has adequate resources to fulfill the pledge, the charity may have a fiduciary duty to enforce the pledge. A breach of fiduciary liability can result in personal liability for the director or trustee.

There are tax issues as well. Charities enjoy tax exemption granted by the IRS. One of the conditions is that a charity not give its assets away except to another charity. Forgiving a pledge could be construed as a gift back to the donor – obviously an improper action for a charity. Forgiving a pledge could be a prohibited benefit for which sanctions could be imposed on the organization for giving a disqualified person an excess benefit.

While charities have the right to sue donors who default on pledges and while the directors owe duties to the charity to conserve its assets, they probably do not have an absolute duty to sue defaulting donors. So far, no court has held a charity liable for refusing to enforce a pledge. The costs of pursuing such legal action and the damage such a lawsuit might do to relationships with other donors are appropriate for the board to consider.

Most charities routinely file claims in a deceased donor’s estate to secure payment of a pledge. This is considered to be routine and is not seen in the same way as a suit against a living donor. Suing living donors in default has pubic relations ramifications.

As with any contract, a charitable pledge will not be enforced if certain defenses to recovery exist such as where the donor was a victim of undue influence or fraud. If a pledge is small or the debtor is in financial trouble, the prudent course may be not to seek to enforce the pledge.

Directors and trustees are placed in the unenviable position of deciding whether to accept a significant write-off of the charitable organization’s assets or putting pressure on donors to honor their pledges which, in turn, may jeopardize future donations.

Retail mutual fund shares are classes A, B and C. They differ in the amounts of internal 12-b1 fees and also on the loads, or sales charges.  Read about it here:  The ABCs of Mutual Funds.  There is another class offered for many funds: Class I, which stands for institutional class. Class I shares are offered only to large investors, typically investment firms and minimum purchases are often more than $500,000. Class I shares’ fees are typically 40% less than those of classes A, B and C.

What does this have to do with you and me? The connection is that our 401(k) managers can make Class I funds available as investment options for our retirement account. Since Class I funds have exactly the same underlying investment positions as the A, B, and C class shares (ABCs), you would expect the fund manager would go with the better deal for us. Wouldn’t you be upset if he were paying higher fees than he had to?

Think about it this way. You want to buy a car. There are two identical cars on the dealer’s lot. One costs $5,000 more than the other. Which one would you buy?

Why would you pay $5,000 for an identical car? Why would a fund dealer provide ABCs which carry a higher fee instead of Class I shares? Maybe carelessness. Or maybe because the additional fee charged benefits the fund manager or plan sponsor. That is exactly what happens when your 401(k) investment manager provides retail (ABCs) mutual funds for you. They call it "revenue sharing". The plan sponsor receives "offsets" from retail mutual funds, that is, the 12-b1 fees. They don’t call it a kickback.

A recent court case should make 401(k) plan sponsors think twice before offering retail funds as investment options in the plan when investment class shares, Class I, are available with lower expenses. In a case in the middle district of California, Tibble vs Edison International, a group of plan participants went to federal court to complain about the plan buying non-institutional shares. Judge Stephen V. Wilson ruled that the company violated its duty of prudence by selecting retail shares instead of Class I shares for three of the funds held by the plan.

The Edison International Trust Investment Committee made retail share classes of three mutual funds available to participants in the Edison 401(k) Savings Plan. In deciding which funds to offer, the committee did not consider, let alone evaluate, other share classes of the funds. However, it did solicit and rely upon the advice of Hewitt Financial Services, an affiliate of the plan’s third-party record keeper. A class of plan participants sued the committee, Edison International, and others seeking damages under ERISA for alleged financial losses suffered by the plan, in addition to injunctive and other equitable relief on account of breaches of fiduciary duty.

Judge Wilson stated, "In light of the fact that the institutional share classes offered the exact same investment at a lower fee, a prudent fiduciary acting in a like capacity would have invested in the institutional share classes."

Daniel Sonin reported this case on dailyfinance.com on July 28. He reported that Edison is not an isolated instance. He asserts that "over ninety percent of the funds he has examined have purchased retail class funds when institutional class funds of the same content were available."

If Class I shares’ fees are typically 40% less than those of classes A, B and C, what would a 40% reduction in fees by offering Class I shares look like? Consider a fund of $200,000. For simplicity, assume no additions or withdrawals. Assume a rate of return of 8% minus annual fees of 2% for a net annual return of 6%. If the fees of 2% were forty percent lower, they would be just 1.2 % per year, allowing the fund to grow at a net 6.8 % per year. After ten years at 6%, it would grow to $358,170. At 6.8 %, it would grow to $386,138, a difference of almost $28,000.

If Judge Wilson is correct and the company is liable for lost income, that would make many fund advisors think twice about recommending retail funds.