Appeal from the Circuit Court of Livingston County; the Hon.
William T. Caisley, Judge, presiding.
JUSTICE TRAPP DELIVERED THE OPINION OF THE COURT:
Flanagan State Bank (the trustee), as executor and trustee under the will of John W. Albrecht, deceased, brought this action in the circuit court of Livingston County, to reform the provisions of the trust (1) to allow for annual distribution of income, (2) to avoid classification as a private foundation, and (3) to obtain a finding that the consent of BroMenn Healthcare (BroMenn) (former Mennonite Hospital) a contingent beneficiary, was not necessary in order to amend the trust. BroMenn filed a counterclaim, seeking to set aside the trustee's designation of The Sisters of The Third Order (The Sisters) as the beneficiary of the trust. The circuit court allowed the amendments to the trust, set aside the trustee's designation of The Sisters as beneficiary, and imposed certain requirements for the selection of the beneficiaries of the trust. The trustee, The Sisters, and the Attorney General appeal. BroMenn cross-appeals.
John W. Albrecht, the decedent, was a lifelong resident of Livingston County. His only marriage was of short duration, ending in divorce, and he had no children. The decedent died November 23, 1977, leaving a last will dated September 5, 1961, and a codicil thereto dated March 14, 1974. The Flanagan State Bank was appointed executor. The decedent's estate had a fair market value of $8,892,000 as of the date of his death and consisted principally of farmland.
The decedent's will and codicil thereto provide for the establishment of a charitable trust. Pursuant to the terms of the trust, the income is to be accumulated for 20 years and added to the principal. The terms of the trust further provide that the real estate shall be retained by the trustee for 20 years following the decedent's death. The will provides for the disposition of the trust estate as follows:
"I direct that my said trustee shall within fifteen years from the date of my death select a charitable organization or trust which qualifies as a charitable deduction for Estate Tax under U.S. Internal Revenue Laws and qualifies as a charitable deduction under Inheritance Tax laws of the State of Illinois, said charitable organization or trust to be one which operates a hospital in Livingston County or Woodford County, Illinois, or a charitable organization or trust, one of the purposes of which is to operate a hospital in Livingston County or Woodford County, Illinois. I further direct that twenty-one years after my death this trust shall terminate and the net proceeds of sale of my trust estate shall be paid by my said trustee to said charitable organization or trust selected as herein provided by my trustee.
I further direct that said charitable organization or trust shall use said net proceeds as it sees fit, provided said proceeds shall only be used to purchase, build, repair, remodel, maintain or operate a hospital at the location and in accord with selection made by Trustee as herein authorized, said net proceeds or hospital to be known as `John W. Albrecht Memorial Fund' or `John W. Albrecht Memorial Hospital.'
I hereby declare that it is my hope and desire and I direct that the hospital established or to be established by the charitable organization or trust selected by my trustee will be located in Livingston County, Illinois, near the Village of Flanagan, Illinois. In the event that my said trustee, at the time of selecting said charitable organization or trust deems it unwise or impractical to so locate said hospital, then I hope and desire and I direct that said hospital established or to be established be located in Woodford County, near Minonk, Illinois, or at such a location as may be selected by my said trustee in either Livingston or Woodford County that my trustee would feel well suited for the service of both of said communities.
In the event that my trustee in its sole discretion feels that it is unwise or impractical to locate said hospital in any of the locations directed hereinabove, then I direct that twenty-one years after my death my said trustee shall pay over said net proceeds to the Mennonite Hospital at Bloomington, Illinois, to be used by it for Hospital purposes as it sees fit."
In the codicil to his will, the decedent authorized the trustee to select a home for aged persons in Livingston or Woodford Counties, rather than a hospital, depending on which is more needed. Mennonite Hospital is identified in the will; it is a party to this proceeding under its present name, BroMenn Healthcare; and is located in McLean County.
The decedent's will was executed on September 5, 1961, prior to the Tax Reform Act of 1969, which began imposing stringent requirements on private foundations. The trust, as established under the terms of the decedent's will, is a private foundation.
Private foundations are broadly defined as all organizations exempted from tax by section 501(c)(3) of the Internal Revenue Code (Code) (religious, charitable, educational, et cetera, organizations), except for four specified exceptions. (26 U.S.C. sec. 509(a) (1982).) Those exceptions are churches, educational institutions, hospitals, certain publicly supported organizations and "supporting organizations" of such publicly supported organizations.
Classification as a private foundation is burdensome. Private foundations, their managers, and certain other persons dealing with the foundation are subject to excise taxes for certain prohibited acts or failures to act. (26 U.S.C. § 4941 (1982).) Private foundations having assets of $5,000 or more must file annual informational tax reports. (26 U.S.C. § 6033 (1982).) Section 4940(a) of the Code imposes an excise tax of 2% on net investment income of private foundations. 26 U.S.C. § 4940(a) (1982).
Most importantly here, section 4942 of the Code imposes an excise tax on the undistributed income of a private foundation. (26 U.S.C. § 4942(a), (b) (1982).) If a private foundation fails to currently distribute the required amounts, an initial tax and an additional tax are imposed. The initial tax is imposed in the amount of 15% on any part of the distributable amount remaining undistributed at the beginning of the second taxable year (and each succeeding taxable year). If any portion of the distributable amount remains undistributed at the close of the taxable year, an additional tax of 100% of the amount involved is imposed. (26 U.S.C. § 4942(b) (1982).) In order to avoid these confiscatory taxes, reform of the governing instruments is authorized by State statute.
Under "An Act to conform certain charitable trusts to the requirements of the Federal Tax Reform Act of 1969" (Charitable Trust Act) (Ill. Rev. Stat. 1981, ch. 148, par. 51), a trustee of a trust which is a private foundation is directed to annually distribute the income in order to avoid taxes imposed on undistributed income under section 4942 of the Code. (Ill. Rev. State. 1981, ch. 148, par. 51(1)(b).) The Charitable Trust Act also authorizes the trustee to amend the terms of the trust to avoid private foundation status under section 509(a)(3) of the Code. The Act provides that the trustee may "release any power contained in the governing instrument, may reduce or limit the charitable organizations or classes of charitable organizations in whose favor a power to select may be exercised and may appoint new and additional trustees." Ill. Rev. Stat. 1981, ch. 148, par. 51(2)(c).
The amendments to the Albrecht will proposed by the trustee sought to qualify the trust as a "supporting organization," thereby avoiding private foundation status. A supporting organization under section 509(a)(3) is exempt from private foundation status. (26 U.S.C. § 509(a)(3) (1982).) Section 509(a)(3)(B) describes the nature of the relationship which must exist between the organization seeking exemption from private foundation status as a supporting organization and one or more publicly supported organizations. The supporting organization must meet one of the following relationships:
"(1) Operated, supervised, or controlled by,
(2) supervised or controlled in connection with, or
(3) operated in connection with, one or more public charities." Treas. Reg. sec. 1.508(a)-4(f)(2) (1982).
Both of the first two relationships contemplate a common element of control between the supporting organization and the public charities, i.e., the same persons supervise or control both the supporting organization and the public charity. (Treas. Reg. sec. 1.509(a)-4(f)(4) (1982).) The sort of relationship which the trust established under the decedent's will would likely qualify for would be that of "operated in connection with" a public charity. The charitable selection agreement between the trustee and The Sisters provides that the trustee intends that the trust be a supporting organization "operated in connection with" The Sisters.
In order to satisfy the relationship of "operated in connection with" a public charity, the supporting organization must meet both a "responsiveness test" and an "integral part" test. (Treas. Reg. sec. 1.509(a)-4(i) (1982).) The regulations governing the first test provide:
"In order to meet this test, either subdivision (ii) or subdivision (iii) of this subparagraph must be satisfied.
(ii)(a) One or more officers, directors, or trustees of the supporting organization are elected or appointed by the officers, directors, trustees, or membership of the publicly supported organizations;
(b) One or more members of the governing bodies of the publicly supported organizations are also officers, directors or trustees of, or hold other important offices in, the supporting organization; or
(c) The officers, directors or trustees of the supporting organization maintain a close and continuous working relationship with the officers, directors or trustees of the publicly supported organizations; and
(d) By reason of (a), (b), or (c) of this subdivision, the officers, directors or trustees of the publicly supported organizations have a significant voice in the investment policies of the supporting organization, the timing of grants, the manner of making them, and the selection of recipients by such supporting organization, and in otherwise directing the use of the income or assets of such supporting organization.
(iii)(a) The supporting organization is a charitable trust under State law;
(b) Each specified publicly supported organization is a named beneficiary under such charitable trust's governing instrument; and
(c) The beneficiary organization has the power to enforce the trust and compel an accounting under State law." (Emphasis added.) (Treas. Reg. sec. 1.508(a)-4(i)(2)(ii), (iii) (1982).)
In Quarrie Charitable Fund v. Commissioner of Internal Revenue (7th Cir. 1979), 603 F.2d 1274, the court stated that in order to meet the "operated in connection with" relationship, the governing documents of the supporting organization must specify the beneficiary organization by name. See generally B. Hopkins, The Law of Tax-Exempt Organizations 374-81 (3d ed. 1979).
Prior to November 30, 1979, the trustee, then acting as executor, employed A.T. Kearney, Inc., management consultants, to assess the health care needs of Livingston and Woodford Counties. Throughout the period of estate administration, the trustee, cognizant of the tax problems, continued to explore alternative dispositions of the trust property. Approval of the Federal estate return was not received until June 16, 1981.
On October 2, 1982, the trustee petitioned the court to reform the will to qualify as a supporting organization under section 509(a)(3) of the Code. The amendments proposed by the trustee provided for the annual distribution of income to a charitable organization or a trust which operates a hospital or home for aged persons in Livingston or Woodford Counties. The Attorney General, representing the interests of the public, entered his appearance consenting to the amendment. On October 7, 1982, the trustee filed ...