From revisions to the Build Back Better Act to restrictions on noncompetition agreements, we have recently seen significant developments in estate planning and business law. To ensure that you stay abreast of these legal changes, we have highlighted some noteworthy developments and analyzed how they may impact your estate planning and business law practice.
US House Releases Scaled-Down Build Back Better Act
H.R. 5376, 117th Cong. (2021)
The new version of the Build Back Better Act released on October 28, 2021 includes the following income tax increases:
- a 15 percent minimum tax on corporate profits over $1 billion
- a 1 percent surcharge on corporate stock buybacks
- a 15 percent country-by-country minimum tax on foreign profits of US corporations
- a new 5 percent surtax on income above $10 million for individuals ($5 million for married individuals filing separately) and $200,000 in the case of an estate or trust, and an additional 3 percent surtax on income above $25 million ($12.5 million for married individuals filing separately) and $500,000 in the case of an estate or trust
- an expansion of the 3.8 percent net investment income tax to include any income derived in the ordinary course of business for single filers with more than $400,000 in taxable income ($500,000 for married filing jointly) and undistributed income from separately taxed trusts and estates
Takeaways: The revised bill notably excludes changes in grantor trust rules, restrictions on valuation discounts, and the lower estate and gift tax exemption amount that were included when the bill was initially released in September 2021. More revisions may be coming. As of the date of this writing, the House has not voted on the bill. If passed, these provisions would be effective on January 1, 2022.
Life Insurance Proceeds Used to Redeem Deceased Owner’s Shares Included in Value of Closely-Held Company
Connelly v. United States, No. 4:19-cv-01410-SRC, 2021 WL 4281288 (E.D. Mo. Sept. 21, 2021)
Michael Connelly, President and CEO of Crown C, a closely-held family business, owned 77.18 percent of its shares. His brother, Thomas Connelly, owned the remaining 22.82 percent of Crown C’s shares. The brothers entered into a stock purchase agreement providing that at the death of one of the brothers, the other had the right to buy his shares. If the surviving brother chose not to purchase the shares, Crown C was required to purchase the deceased brother’s shares. Crown C purchased $3.5 million in life insurance policies on both Michael and Thomas to fund its redemption obligation. The stock purchase agreement specified that the brothers would determine the agreed value per share by executing a certificate of agreed value at the end of each tax year, but if they failed to do so, they would determine the appraised value per share by securing two or more appraisals. The brothers never executed a certificate of agreed value.
Michael died on October 1, 2013. Thomas chose not to purchase his brother’s shares, and Crown C used part of the $3.5 million it had received in insurance proceeds to purchase Michael’s shares. Thomas, as executor of Michael’s estate (Estate), and Crown C did not obtain appraisals of Michael’s shares as set forth in the stock purchase agreement. Instead, they entered into a sale agreement pursuant to which the Estate received $3 million in cash; Michael’s son, Michael Jr., received a three-year option to purchase Crown C from Thomas for $4,166,666; and, if Thomas sold Crown C within ten years, he and Michael Jr. would share evenly in any gains from the sale.
Thomas, as executor, filed an estate tax return that valued Michael’s shares at $3 million as of the date of his death. The Internal Revenue Service (IRS) issued a notice of deficiency for $1 million in additional estate taxes based on its assertion that the fair market value of Crown C should have included the $3 million in life insurance proceeds used to redeem Michael’s shares. Thomas paid the $1 million in additional taxes but sought a refund.
The Federal District Court for the Eastern District of Missouri noted that the IRS generally determines the fair market value without regard to a buy-sell agreement (in this case, the stock purchase agreement) unless it meets certain requirements. Internal Revenue Code § 2703(b) imposes three requirements: (1) the buy-sell agreement is a bona fide business arrangement; (2) it is not a device designed to transfer property to the decedent’s family for less than full and adequate consideration; and (3) its terms are comparable to an arm’s length transaction. Additional requirements are set forth in 26 C.F.R. § 20.2031-2(h): (1) the offering price must be fixed and determinable under the buy-sell agreement; (2) the buy-sell agreement must be legally binding on the parties during life and after death; and (3) the agreement must have been entered into for a bona fide business reason, not as a substitute for a testamentary disposition for less than full and adequate consideration—similar to the statutory requirement.
The court found that the stock agreement was a bona fide business arrangement but that the Estate had failed to meet its burden of proving that the stock agreement was not simply a testamentary device to pass Crown C shares to members of the Connelly family for less than full and adequate consideration. It noted that Thomas and the Estate had excluded the life insurance proceeds—a significant asset—from the valuation of Crown C, failed to obtain an independent appraisal, and disregarded the appraisal requirement in the stock agreement. Further, the stock agreement did not provide a minority discount for Thomas’s shares or a control premium for Michael’s shares, thus overvaluing Thomas’s shares and undervaluing Michael’s shares. Moreover, the Estate failed to provide any persuasive evidence that the stock agreement was comparable to similar arrangements negotiated at arm’s length.
The court further found that the price of Michael’s Crown C shares was not fixed and determinable because Michael and Thomas never agreed on the value or signed certificates of agreed value. The Estate also failed to obtain an appraised value per share as set forth in the stock agreement and instead merely provided its own ad hoc valuation of $3 million, an amount less than the value of the life insurance proceeds. During Michael’s life, Michael and Thomas did not treat the provisions requiring a certificate of agreed value as binding; and, after Michael’s death, Thomas and the Estate did not treat the price-per-share provisions as binding but instead ignored the pricing mechanism set forth in the agreement despite its mandatory language.
The court rejected the reasoning of the Eleventh Circuit Court of Appeal in Estate of Blount v. Comm’r, 428 F.3d 1338 (11th Cir. 2005), which held that nonoperating assets such as insurance proceeds should not be included in the fair market valuation of a company where there is an enforceable contractual obligation that offsets such assets. The court noted that the fair market value of Crown C must be determined as of the date of Michael’s death, not as of the later date when his shares were redeemed. Further, excluding the insurance proceeds from Crown C’s value “impermissibly treats Michael’s shares as both outstanding and redeemed at the same time, reducing Crown C’s value by the redemption price of the very shares whose value is at issue.” Excluding the insurance proceeds from the fair market value would result in Thomas’s shares being worth 336 percent more than Michael’s shares—a result that a willing seller of Michael’s shares would not accept because it would create a windfall for the buyer.
The court also rejected the Eleventh Circuit’s conclusion in Estate of Blount that 26 C.F.R. § 20.2031-2(f)(2) precluded the inclusion of the insurance proceeds, noting that the regulation instead states that in determining the fair market value of a closely-held corporation, “consideration shall also be given to nonoperating assets, including proceeds of life insurance policies payable to or for the benefit of the company” to the extent they have not been taken into account in determining the company’s net worth. The court held that a redemption obligation is not an ordinary corporate liability that would change the value of the company before the shares are redeemed. Rather, the stock redemption involves a change in the company’s ownership structure. A redemption obligation does not diminish the value of the shares being redeemed. Instead, the company gets something of equal value for the cash spent: the decedent’s share of ownership in the company.
Consequently, the court found that the Eleventh Circuit’s conclusion in Estate of Blount was “demonstrably erroneous” and that there were “cogent reasons for rejecting it.” Accordingly, the court rejected the Estate’s petition for a tax refund on the basis that the $3 million in life insurance proceeds used to redeem Michael’s shares must be included in the fair market value of Crown C and of Michael’s shares.
Takeaways: At the time of writing, no appeal has been filed. If the decision is appealed and affirmed by the Eighth Circuit Court of Appeals, the conflict with the Eleventh Circuit could ultimately be determined by the United States Supreme Court.
Estate Planning Attorney’s Testimony Is Key Evidence of Decedent’s Mental Capacity and Absence of Undue Influence
Matter of Varrone, 72 Misc. 3d 1201 (N.Y. Surr. Ct. June 17, 2021)
Cynthia Varrone passed away on July 4, 2018. She had five children, but her last will and testament left her entire estate, including her real property, to her son John and specifically disinherited her other children. In addition, Cynthia transferred her real property to John during her life: first, through the execution of a deed dated April 21, 2010, which transferred the property from her sole ownership to herself and John as joint tenants with rights of survivorship, and then by a deed dated October 15, 2013—the same date Cynthia signed her will—transferring full ownership of the property to John and divesting herself of any interest in it.
Another son, Charles, as limited administrator, filed a petition seeking return of the real property to Cynthia’s estate. He asserted that Cynthia suffered from dementia and lacked the capacity to transfer the property to John and that John had exerted undue influence over Cynthia to induce her to execute the deeds. John filed a motion for summary judgment seeking the dismissal of the petition.
Because John had not provided any consideration for the inter vivos gift of the property, the court held that he was required to prove three elements by clear and convincing evidence: (1) the donor’s intent to make a present transfer; (2) actual or constructive delivery of the gift to the donee sufficient to divest the donor of dominion and control over the property; (3) acceptance on the part of the donee.
Because the recording of the deeds gives rise to a presumption of delivery and acceptance, the donor’s intention is paramount in determining whether the transaction was a valid inter vivos gift. Accordingly, it was necessary for John to demonstrate prima facie that Cynthia intended to make an irrevocable present transfer of ownership of the property. In support of his motion for summary judgment, John submitted substantial evidence, including copies of the deeds, Cynthia’s will, and the testimony of Cynthia’s estate planning attorney.
The court held that the deeds themselves were evidence of Cynthia’s donative intent, and that although her will, by its nature, could not serve as evidence of a present intent to give the property to John, it was evidence of her relationship with John at the time of the transaction. In addition, the disinterested deposition testimony of Cynthia’s attorney, Jake Lasala, was further evidence of her donative intent. He testified that he prepared the deeds at Cynthia’s request after discussing the transactions with her. In addition, he personally supervised their execution and arranged for their recording. He repeatedly indicated that Cynthia’s main goal was to ensure that John, who was unmarried, lived with her, assisted her, and would continue to have a place to live. The will, which also devised the real property to John, was prepared to provide Cynthia additional assurance that John would receive the property.
Although the burden was on John to show that Cynthia was competent, the court noted that the law presumes that individuals have capacity, recognizing that those who are elderly and even mentally weak may still be able to comprehend the meaning of a deed or a transfer of property. Further, Lasala provided adequate evidence of her capacity by testifying that at the time of the 2010 and 2013 transfers, there was no indication that Cynthia did not know what she was doing or signing. Lasala also provided prima facie evidence of the lack of undue influence by testifying that he had taken direction solely from Cynthia in relation to the transfers and that they had been executed at her behest.
Takeaways: Based on reported decisions, undue influence claims relating to actions of decedents with dementia are on the rise. The best way to combat them is for the responsible trusts and estates attorney to personally supervise the preparation and execution of the relevant documents and maintain notes of discussions with the client.
California Community Property Presumption Prevails Over Form-of-Title Presumption Only Before Spouse’s Death
Estate of Wall, 68 Cal. App. 5th 168 (Cal. Ct. App., 3rd Dist. 2021)
In 2020, Benny Wall and his second wife, Cindy, decided to purchase a home. Benny took title to the home as “Benny M. Wall, a married man as his sole and separate property.” He used funds from his separate property account for the down payment and obtained a loan for the balance of the purchase price. Benny made mortgage payments from his separate property bank account. In 2013, Benny refinanced the home, but Cindy was not included on the loan, and the deed of trust listed the borrower as “Benny M. Wall, a married man as his sole and separate property.”
Benny died unexpectedly in 2016, apparently intestate (Cindy told Benny’s children she did not find a will). After Benny’s death, Cindy petitioned the court for a determination that the home, titled solely in Benny’s name, was community property. Benny’s children testified that the marriage was not close. Their testimony was echoed by Benny’s sister, who also testified that Benny had told her that Cindy had signed a deed specifying that she did not own an interest in the home and that he wanted to leave his assets to his children. However, Cindy testified that she had written a check to Benny in 2008 intended for the future purchase of a home and that their intention in 2010 was to purchase the home as joint owners. They initially applied for a loan as joint borrowers, but it was denied because Cindy had a mortgage on a home from her previous marriage. Upon the suggestion of their mortgage broker, Benny applied for a loan solely in his name. The broker testified that Benny and Cindy agreed that Cindy’s name would be added to the title later. Their real estate agent also testified that his understanding was that they were purchasing the home together. Cynthia testified that several days after she and Benny signed documents at the title company, the escrow officer told her to sign another document, but did not explain that it was a quitclaim deed or what it meant. She signed the quitclaim deed, but Benny told her that she was an owner of the home and continually referred to the residence as their home. Cindy invested time and money making improvements to the home and helped pay household expenses. She testified that Benny’s actions caused her to believe that she was helping to pay the mortgage and that she was an owner of the home. Nevertheless, Cindy’s name was never added to the title.
Benny’s children from his first marriage objected to Cindy’s petition, but the probate court found that the home was community property, ruling that in an action between spouses, the community property presumption (Cal. Fam. Code § 760) rather than the form-of-title presumption (Cal. Evid. Code § 662) applied—and that although the present action was not between spouses, the children “essentially stood in the shoes of the decedent.” In addition, the probate court found that where an interspousal transaction advantages one spouse over another, a presumption of undue influence arises (Cal. Fam. Code § 721). The probate court concluded that neither the community property presumption nor the undue influence presumption had been rebutted.
On appeal, the California Court of Appeals ruled that the probate court had erred in finding that the community property presumption, rather than the form-of-title presumption, applied in an action that was not between spouses. Despite holding that the form-of-title presumption was applicable postdeath, the court held in an unpublished portion of its opinion that when the form-of-title presumption conflicts with the undue influence presumption, the undue influence presumption prevails and applies in postdeath disputes. The court affirmed the probate court’s judgment granting Cindy’s petition for a determination that the home was community property on the basis that Cindy had presented substantial evidence of constructive fraud to support the probate court’s finding of undue influence.
Takeaways: Winding through a maze of conflicting presumptions, Estate of Wall establishes that if a spouse dies intestate while holding sole title to real estate, the deceased spouse’s heirs can assert the form-of-title presumption to claim an ownership interest in the asset. However, if the surviving spouse provides convincing evidence of breach of a confidential relationship, the breach can constitute constructive fraud supporting the presumption of undue influence, which would prevail when it conflicts with the form-of-title presumption. For another case involving statutory protections against fraudulent behavior by a spouse, see Mohen v. Mohen, No. 835 EDA 2020, 2021 WL 4281296 (Pa. Sup. Ct. Sept. 21, 2021), an unpublished decision in which a Pennsylvania court held that a husband’s transfer of marital property to trusts for their children without the wife’s agreement or involvement and for inadequate consideration prior to their separation was fraudulent and void under 23 Pa. Cons. Stat. Ann. § 3505 and should be charged against the husband in the parties’ equitable distribution scheme.
Trust Provision That Beneficiary’s Interest Be Held in Trust If He Is Married Not an Unlawful Restraint Against Marriage
Rotert v. Stiles, No. 21S-TR-452, 2021 WL 4704622 (Ind. Sup. Ct. Oct. 8, 2021)
Marcille Borcherding executed a revocable living trust in 2009 containing a subtrust for her son Roger with the following provision:
In the event that [Rotert] is unmarried at the time of my death, I give, devise and bequeath his share of my estate to him outright and the provisions of this trust shall have no effect. However, in the event that he is married at the time of my death, this trust shall become effective, as set out below.
Although Rotert had been married to his third wife for eight years, his wife had filed for divorce before Borcherding created the trust. However, the couple reconciled and were still married when Borcherding died in 2016. Rotert sued on the basis that the provision was void as a restraint on marriage.
The Indiana Supreme Court affirmed the trial court’s ruling that the prohibition of restraints against marriage in the probate code, specifically Ind. Code § 29-1-6-3, applies only to dispositions to a spouse made by will, not to dispositions made by trust. The plain language of the statute applies only to devises. Further, Indiana’s trust code does not prohibit conditions in restraint of marriage, and “absent a clear indication from the legislature that trusts are subject to a general prohibition against restraints of marriage, we reject such a view.”
Takeaways: Despite the public policy disfavoring restraints on marriage and the apparent inconsistency between the probate code and the trust code, the Indiana Supreme Court was reluctant to apply such a prohibition in a context in which the legislature had declined to do so.
Sole Director, Officer, and Shareholder Who Was Alter Ego of Corporation Held Personally Liable for Corporation’s Federal Income Taxes
United States v. Lothringer, No. 20-50823, 2021 WL 4714609 (5th Cir. Oct. 8, 2021)
Arthur Lothringer formed a corporation, Pick-Ups, Inc., and was its sole director, officer, and shareholder. The United States sued Lothringer, his wife Janet, and Pick-Ups to collect federal taxes. The district court found that Pick-Ups was Lothringer’s alter ego under Texas law because “there is such unity between corporation and individual that the separateness of the corporation has ceased and holding only the corporation liable would result in injustice.” The court relied on undisputed facts showing that Lothringer exercised complete dominion and control over Pick-Ups, failed to observe corporate formalities, loaned substantial money to Pick-Ups, and made personal loan payments from the corporate bank account. As a result, Lothringer was personally liable for $1,777,047 in federal taxes owed by Pick-Ups.
Takeaways: The $1.7 million judgment against Lothringer is a good reminder that business owners, especially sole shareholders or sole members of single-member limited liability companies, should erect strict barriers between their personal and business affairs and transactions and comply with all corporate formalities to avoid personal liability for business debts and obligations.