Court Removes Trustee for Self-Dealing and Reduces Inheritance for Incurred Tax Penalties

On November 30, 2020, the Iowa Court of Appeals issued an opinion regarding a trustee’s actions before she was replaced by judicial order. The court affirmed that the trustee’s inheritance should be reduced for tax penalties and interest incurred because she engaged in self-dealing. The court also affirmed a $20,000 trustee fee award and the denial of sanctions.

Background

Before passing away, a farmer created a trust. At the time of his death, the settlor’s estate was worth over $6 million. Under the terms of the trust, his fiancée would receive ten percent of the gross estate and the settlor’s two adult children from a previous relationship would split the remainder. After the settlor passed away, his fiancée became the trustee.

Soon after, the settlor’s children petitioned the court to remove the trustee claiming that she breached her fiduciary duties. The district court found that the trustee delayed trust accounting responsibilities while she petitioned the court claiming to be the settlor’s common law spouse entitled to a one-third spousal share of the estate. Finding no evidence on the common law marriage claim, the court ruled that the trustee had engaged in self-dealing and appointed a bank to replace her.

The bank proposed a distribution for the former trustee’s ten percent share. Believing that the trustee incurred unnecessary charges, the bank deducted these costs from the trustee’s distribution. This greatly reduced the former trustee’s inheritance. The former trustee rejected the plan and submitted her own proposal which included a request for $58,691 for her unpaid work as a trustee. The parties were unable to reach an agreement and the bank filed for sanctions against the former trustee. The settlor’s children intervened as beneficiaries of the trust.

After trial, the district court denied the request for sanctions, but reduced her inheritance to account for the penalties and fees incurred for failing to timely and properly file required tax returns, including the penalty and interest for late filing IRS Form 706. The court also awarded $20,000 in trustee fees. Both parties appealed.

Inheritance Deduction for Self-Dealing

On appeal, the former trustee claimed she should not be liable for the $150,370 in assessed penalties and interest for the untimely filing of Form 706. She claimed that because the trust document limits liability of a trustee, she was not liable for any harm. The district court had noted, however, that trustees do not receive liability protection if they act “intentionally, with gross negligence, in bad faith, or with reckless indifference to the interest of the beneficiary, or for any profit derived by the trustee from the breach.” Iowa Code § 633A.4505(1).

The former trustee claimed she did not have to file a Form 706 because she had a good faith claim that she had a common law marriage. The district court had found that the former trustee engaged in self-dealing that she attempted to justify by an unsupported common law marriage claim. The district court also found evidence of gross negligence and reckless indifference.

In rejecting the former trustee’s claims on appeal, the court noted that there were many instances of self-dealing. By prioritizing her common law marriage claim over the accounting needs of the trust, continuing to occupy the settlor’s home without compensation, and by filing multiple claims for trustee fees in order to increase the chance of earning money from the trust, the former trustee engaged in self-dealing. The court ruled that the district court properly reduced the former trustee’s share in the amount of the tax penalties and interest from the delinquent 706 filings.

Trustee Fees

The bank and the settlor’s children appealed the district court’s $20,000 trustee fee award. The terms of the trust did not specify the amount of compensation for a trustee. The court explained, however, that a trustee is entitled to reasonable compensation “under the circumstances.” Iowa Code § 633A.4109.

While the former trustee submitted several inappropriate charges, the court found evidence that she had performed legitimate work as well. The former trustee marketed and sold crops for the estate, organized a farm auction, dealt with insurance, and paid trust bills. Therefore, the court affirmed the trustee fee award.

Trustee Sanctions

The settlor’s children also appealed the district court’s denial of sanctions. The court found this to be an emotion-driven request. The court stated that a pleading must be grounded in fact and warranted by existing law or a good faith belief for modification of an existing law. See Iowa R. Civ. P. 1.413(1). The purpose of sanctions is to encourage compliance, not provide compensation. The court affirmed that the proper remedy in this case was a reduction in the trustee’s share of the trust distribution, not sanctions.