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Private Wealth Developments and Observations

U.S. Supreme Court Agrees to Hear Cases Regarding the Constitutionality of Same-Sex Marriage Bans

Posted in Estate Planning

The U.S. Supreme Court has agreed to hear four cases from Ohio, Michigan, Kentucky, and Tennessee, respectively, regarding the constitutionality of same-sex marriage bans by the states. While the Court’s decision to hear the cases was anticipated (as previously discussed here), the decision is nonetheless exciting. Arguments are expected to be presented in April of this year, and the U.S. Supreme Court may very well issue a ruling resolving the state-by-state conflict over same-sex marriage by June. Such a resolution to the state-by-state conflict over same-sex marriage would be a welcome development and would bring a great deal more clarity to trust and estate planning for same-sex partners.

For more information, please contact Chad Makuch at (216) 861-7535 or cmakuch@bakerlaw.com.

Still Waiting For Guidance on Material Participation

Posted in Tax

In March 2014, I commented on the US Tax Court decision in the Frank Aragona Trust case. In that case, the tax court disagreed with the Internal Revenue Service’s arguments that a trust was incapable of providing “personal services” to meet the material participation test under IRC § 469 (c)(7).

In November 2013, when the Service issued the final net investment tax rules, it promised to address the material participation dilemma. To date, no guidance other the Service’s arguments in several court cases have been issued.

Most practitioners take the position that a fiduciary’s participation in the activities in question in any capacity should count for purposes of the material participation determination. The American Institute of CPAs (AICPA) has recommended that when there are multiple fiduciaries, material participation by any one fiduciary should be sufficient for purposes of satisfying the material participation test under IRC § 469 (c)(7). The American Bar Association (ABA), in a recent letter to the Service, urged the Service to allow fiduciaries of a trust or estate to use the same tests that individuals use to establish material participation in a trade or business. The ABA’s letter proposed two alternative tests to determine whether an individual materially participated: an objective hours test and a subjective facts and circumstances test. The hours test would be satisfied on the basis of hours invested by an individual with fiduciary duties to the beneficiaries of the trust or estate, if that individual has the decision-making authority and power to act on behalf of the trust or estate in the trade, business or rental activity. The facts and circumstances test would be satisfied by aggregating the participation of all fiduciaries of the trust or estate, their employees, and agents in the trade, business or rental activity. The Service’s position has been that the activities of a fiduciary’s agents and employees are not considered for purposes of material participation; however, the holdings in the Frank Aragona Trust and Mattie Carter Trust cases, along with continued urging from practitioners, might influence any guidance from the Service on these issues.

The waiting continues.

Protecting A Family’s Most Valuable Asset – Privacy

Posted in Privacy

Private-Weatlth-01-06-2015Each day, family offices receive, relay, and manage a family’s private information.  Depending on the family and the role of the family office, the information managed can be voluminous and include financial information, tax identification numbers, account numbers, health and health insurance information, estate planning documents and even home security system information.   Oftentimes, the family office transmits information to family members via various forms of communication.  Younger generations may respond only to text messaging, another generation may prefer e-mail, and older generations may prefer snail mail.  None is immune to a security breach.

A recent New York Times article states “The number of new digital threats has increased 10,000-fold over the last 12 years.  Last year, over 552 million people had their identities stolen and nearly 25,000 Americans had sensitive health information compromised – on a daily basis.” Approximately 47 states now have data breach statutes.  Generally, these statutes define the information covered and the obligations of the “information holder” upon discovery of a breach.

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U.S. Supreme Court Now Likely to Rule on Constitutionality of Same-Sex Marriage Bans

Posted in U.S. Supreme Court

Justice_453626233To date, the U.S. Supreme Court has declined to rule on the constitutionality of state laws banning same-sex marriage. Even in the U.S. Supreme Court’s landmark decision in U.S. v. Windsor (discussed here), the U.S. Supreme Court left to the states the authority to define and regulate marriage. In addition, as recently as October 6, 2014, the U.S. Supreme Court issued orders declining to review appeals regarding same-sex marriage in five states (Indiana, Oklahoma, Utah, Virginia, and Wisconsin). Consequently, same-sex married couples and state-sanctioned partners have been left to navigate a complex legal environment in which their marriage or partnership is recognized in some states (albeit an ever-growing number of states) and not others. Such irregular treatment among the states gives rise to complex estate and income tax planning and, at times, is so detrimental that it limits the states in which it is financially advisable for such couples to live.

Justice Ruth Bader Ginsburg publicly commented that the U.S. Supreme Court has not ruled to this point on the constitutionality of same-sex marriage, in part because the courts of appeals have not split on the issue. That is, until now.

Earlier this month, the U.S. Court of Appeals for the Sixth Circuit became the first federal appeals court to uphold same-sex marriage bans. Specifically, the Sixth Circuit’s decision upholds same-sex marriage bans in Ohio, Michigan, Kentucky, and Tennessee, and thereby marks a stark split from the decisions of federal appeals courts in the Fourth, Seventh, Ninth, and Tenth circuits, each of which has struck down similar bans on same-sex marriage.

Given this split in the courts of appeal (and assuming the Sixth Circuit decision is appealed directly to the U.S. Supreme Court), the Supreme Court will likely review the Sixth Circuit decision and rule on the constitutionality of same-sex marriage bans by the states once and for all.

For more information regarding the Sixth Circuit’s decision, please contact Chad Makuch at (216) 861-7535 or cmakuch@bakerlaw.com.

Tax Court Rules Corporate Merger of Family-Owned Businesses Results in Substantial Taxable Gift

Posted in Tax

In September, the Tax Court issued its opinion in Cavallaro v. Commissioner, T.C. Memo 2014-189, holding that a merger of two family-owned businesses resulted in a $29.6 million gift from Mr. and Mrs. Cavallaro to their three sons.

Background

Mr. Cavallaro started a tool manufacturing company called Knight Tool Co. (“Knight”). Knight was co-owned by Mr. and Mrs. Cavallaro. As his sons became adults, all three were  involved in the business. In the 1980s, Knight developed what turned out to be a valuable technology for applying liquids during the manufacturing process. In the late 1980s, the sons formed Camelot Systems, Inc. (“Camelot”), which would exclusively sell Knight’s products. The Cavallaro sons each owned one-third of Camelot.

In the mid-90s, due to the rise in value of the technology, Mr. and Mrs. Cavallaro sought estate planning advice. The Cavallaros sought advice from their CPA and an estate planning attorney. Both advisors separately recommended merging Knight and Camelot. After the merger, the Cavallaros would own the surviving company, with each shareholder’s ownership proportionate to his or her relative ownership and the value of the shares owned in Knight and Camelot, respectively.

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IRS Attempts to Simplify the Application Process for Certain 501(c)(3) Organizations, but is “EZ” Better?

Posted in Tax

On July 1, 2014, the Internal Revenue Service (“IRS”) released Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code (“Code”).

Form 1023-EZ is an abbreviated version of the twelve page Form 1023 (which can be supplemented by as many as seven schedules) and is intended to streamline the application for recognition of exemption under Code §501(c)(3) for certain organizations.  Such organizations are those with gross receipts of $50,000 or less and assets of $250,000 or less and are otherwise eligible to file the Form by being a public charity described in Code §§170(b)(1)(A)(vi) or 509(a)(2), a private foundation, or an organization seeking reinstatement of exempt status pursuant to section 4 or 7 of Revenue Procedure 2014-11 following automatic revocation of such status for failure to file required annual returns or notices for three consecutive years. Continue Reading

Keep Your Collection Away from the Collectors: Tax Planning for Fine Art

Posted in Estate Tax, Tax

Artwork Tax PlanningAppreciation of fine art can create challenging tax issues, but with proper planning collectors can minimize the estate, gift, and income tax consequences of their collections.

For taxpayers hoping to keep their works in the family, a recent 5th Circuit Court of Appeals ruling provides some promising precedent for valuation issues. In Estate of Elkins v. C.I.R. [1], a deceased taxpayer had gathered an impressive collection of fine art with a fair market value (“FMV”) of roughly $35 million. Mr. Elkins and his wife, partially motivated by concerns about future estate tax liability, distributed fractional ownership shares in two groups of paintings to their three children. At the time of his death, Mr. Elkins retained a 50% interest in three works of art with a cumulative FMV of approximately $10.5 million and a 73% interest in a group of 61 pieces of artwork with a cumulative FMV of about $24.5 million. This division of ownership is a common tactic for passing assets to family members. The benefit lies in valuations for estate tax purposes, which may include large discounts from FMV to reflect the unenviable position of an unrelated prospective buyer owning a partial stake in a family asset with limited marketability. However, the IRS has seldom applied such discounts to partial ownership interests in pieces of fine art. In Elkins, the Commissioner argued that no discount at all could be permitted while the estate had calculated a discount of 44.75% for the entire collection. The Tax Court found neither argument appealing and instead applied a 10% discount across the board. The Elkins estate appealed the ruling and the 5th Circuit granted the estate a $14 million refund plus interest while applying discounts ranging from 50%-80% to the different ownership shares. The ruling provides some support for wealthy families considering fractional interests for their art collections. But complying with the letter of the law, which requires possession by each owner commensurate with their percentage interest, remains a challenge. In addition to discounted valuations, taxpayers with valuable collections can mitigate estate and gift tax consequences by removing value from their estate within the limits of annual and lifetime gift tax exclusions or by making gifts to an irrevocable trust with Crummey [2]withdrawal powers for the benefit of each of their children and grandchildren. Continue Reading

Colorado Court Leaves Valuation Question Unanswered When Valuing GRAT Appreciation

Posted in Colorado, Estate Planning, GRAT, Uncategorized

On March 20, 2014, the Colorado Court of Appeals, in Malias v. Malias, upheld the trial court’s determination that grantor retained annuity trust (GRAT) remainder interests were “property interests” for property division purposes,  and the corresponding valuation of the GRAT interests for those purposes.  Although the case has not yet been selected for publication, it provides interesting insights for both estate planners and family law practitioners.

In Colorado, determining the disposition of trust property between divorcing parties is a two-step process.  A court must first determine if an interest in trust constitutes a “property interest,” and if so, must then decide whether it is “separate” property or “marital” property.  Colorado statutes provide a rebuttable presumption that all property acquired after the marriage is marital property, except for gifts, inheritance, property acquired in exchange for separate property, and property excluded by agreement between the parties.  Marital property also includes appreciation of, and income earned from, a spouse’s separate property, including gifted property.

Husband and Wife were married in 1999.  In 2003, Husband’s parents created GRATs for the benefit of Husband and his brothers. The GRATs had four year terms and were funded with stock in Husband’s family’s business.  The value reported for gift tax purposes of the GRAT established for the Husband was $2,341.  At the GRAT’s termination, the value distributed to Husband exceeded $7 million. Issues reviewed on appeal, among others, were whether the trial court erred in determining that the GRAT remainder interests were property interests for property division purposes and whether its valuation of those interests was reasonable.

The appellate Court first upheld the trial court’s finding that Husband’s GRAT remainder interests were property interests.  The Court based its decision on the facts that the GRATs were irrevocable and Husband’s remainder interest was subject only to his surviving the GRAT’s four year terms.  Citing Colorado case law, the Court stated that Husband’s remainder interest was a “‘certain, fixed interest’ sufficient to constitute property for purposes of Colorado law.” As a property interest, the GRAT’s appreciation from the initial creation of the GRAT constituted marital property.

The Court next addressed the trial court’s valuation of the property interest for purposes of determining appreciation.  Each party’s expert testified that the purpose of GRAT planning is to remove any appreciation realized during the term of the GRAT from the grantor’s estate.  Wife’s expert testified that the value reported on Husband’s parents’ 2003 gift tax returns reflected the appropriate value of the GRAT remainder interests gifted to Husband because that value accounted for the uncertainty of any future appreciation. Husband’s expert explained that aggressive planners seek to “zero” out remainder interest values and, therefore, the gift tax values were artificially low compared to the contributed property’s actual value.  But, the Court noted that Husband’s testimony revealed that he disagreed with the gift value only because he did not consider Husband’s remainder interest to be property until the GRAT terminated and Husband received the distribution.  Husband’s expert did not challenge the accuracy of the gift tax values nor did he offer any alternative valuation or valuation methodology.

The Court affirmed the trial court’s decision to value the property interests by utilizing the value reported for gift tax purposes as of the date of the gift.  Specifically stating that the gift tax returns were the only evidence of value available, the Court held that the record supported the trial court’s decision to adopt the values reported for gift tax purposes.  And as a result, almost the entire value distributed to Husband at the GRAT’s termination was appreciation constituting marital property subject to division.

If the Court had been provided with alternatives for valuing the assets on the date of their contribution to the GRATs, would the Court have made the same value determination?

Income Tax Reporting for Decanting

Posted in Estate Planning, Income Tax, Tax, Trust Administration

Decanting refers to the distribution of trust property of one trust (the “first trust”) to another trust (the “second trust”).  Over the past several years, the number of states specifically authorizing decanting by statute has grown rapidly.  As of March 2014, at least twenty-two states have passed or proposed a state decanting statute.

Notwithstanding this proliferation of decanting statutes at the state level, the Internal Revenue Service (the “IRS”) has not provided authoritative guidance regarding the proper tax treatment of decanted trusts.  In Notice 2011-101, the IRS invited comments from the public regarding the income, gift, estate and generation-skipping transfer tax issues arising from decanting.  In response, the IRS received comments from many well-respected national groups but still has not issued guidance.  In fact, to the contrary, the IRS continues to list certain decanting transactions on its “no ruling list” pursuant to Rev. Proc. 2014-3, and has not added decanting to its Priority Guidance Plan, all of which suggests that guidance will not be forthcoming in the near future.  Meanwhile, trustees decanting trusts today must determine with their legal and other tax advisors how to report the distribution of trust assets from the first trust to the second trust without such guidance.

With respect to income tax reporting, one issue all trustees decanting a trust will face is whether the second trust should be treated as a new trust or a continuation of the first trust for income tax purposes. Continue Reading

SEC “Common Trust Fund” Exception Narrowly Construed for Private Trust Companies

Posted in Estate Planning, Trust Administration

Recent years have seen a dramatic increase in the number of Private Trust Companies (“PTCs”) established by wealthy families.  PTCs are used to consolidate the trustee function of multiple trusts within a family, and because these trusts are often invested in family-controlled investment vehicles they implicate various federal securities laws.  For instance, the Investment Company Act of 1940, which regulates mutual funds and other pooled investment vehicles (the “1940 Act”) may require significant review and planning for large families considering considering use of a PTC.  Compliance with 1940 Act registration and ongoing regulatory requirements can be extremely burdensome, and therefore we, as advisers, are often faced with the challenge of navigating the maze of exceptions available under the 1940 Act.

As a general rule, there is an exception to the registration and other requirements of the 1940 Act for investment vehicles (such as partnerships or limited liability companies) which have fewer than 100 investors, or whose owners are all “qualified purchasers” (generally a person with over $5 million of investments).  While the 100 investor limit would seem generous in a family context, it is not out of the question that a multi-generational family could have in excess of 100 investment accounts after counting all trusts and individual family members having separate accounts, and therefore fail to qualify for this exception.  Likewise, it is not often the case that all investors are qualified purchasers.  In these situations, a family must seek another exception from the 1940 Act. Continue Reading