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From an Internal Revenue Service (IRS) win in an individual retirement account (IRA) rollover contribution case involving James Caan, to increased contribution limits for ABLE accounts and updated guidance under the Corporate Transparency Act, we have recently seen significant developments in estate planning, elder and special needs law, 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, elder law, and business law practice.
Estate Planning
IRS Win in James Caan IRA Rollover Contribution Case
In re Estate of Caan v. Comm’r, 2023 WL 7844565, 161 T.C. No. 6 (Oct. 18, 2023)
Actor James Caan, best known for his role in The Godfather, had two individual retirement accounts with the Union Bank of Switzerland (UBS). The first account held cash, mutual funds, and stock in exchange-traded funds. The second held a non-publicly traded partnership interest in the P&A Multi-Sector Fund, considered an alternative asset. For IRAs with alternative assets, the IRA’s trustee or custodian must report the fair market value of the assets annually (I.R.C. § 408(i)). The custodial agreement for the USB IRAs reflected that Caan—who relied on professional wealth management advisors to handle his financial affairs—was responsible for providing UBS with a fair market value of the partnership interest at the end of each year. In 2015, Caan failed to provide a year-end market value for 2014. UBS then declined to continue serving as the custodian of the IRA holding the partnership interest: It sent Caan a notice that it would distribute the partnership interest and issued a Form 1099-R reporting the distribution of the partnership interest to the IRS that reflected the 2013 year-end fair market value of $1,910,903.
Before the distribution, Caan’s financial advisor at UBS moved to Merrill Lynch and persuaded Caan to move both IRAs to Merrill Lynch, where they were transferred to a single IRA through Merrill Lynch’s Automated Customer Account Transfer System (ACATS). Because the partnership interest could not be transferred through ACATS, Caan’s financial advisor directed the P&A Multi-Sector Fund to liquidate it and transfer the proceeds to the IRA held by Merrill Lynch. However, the liquidation of the partnership interest did not occur until nearly one year after UBS had notified Caan that it had distributed the partnership interest.
Caan reported the distribution of the partnership interest on his 2015 tax return but asserted that it was nontaxable. The IRS disagreed and sent a notice of deficiency dated April 30, 2018, in the amount of $779,915 for 2015 and an accuracy-related penalty of $155,983. The IRS denied Caan’s July 27, 2018, request for a private letter ruling asking the IRS to waive the requirement that a rollover of an IRA distribution be made within 60 days from the date of the distribution, on the grounds that the partnership interest was liquidated and the proceeds contributed to the Merrill Lynch IRA.
Caan filed a petition for a redetermination of his 2015 income tax deficiency. After Caan died in 2022, Scott Caan, the trustee of the Jacaan Trust—the sole beneficiary of Caan’s estate—was appointed as the special administrator of Caan’s estate for the purposes of this case only. Caan’s estate asserted that UBS did not distribute the partnership interest to Caan, or if it did, Caan had made a nontaxable rollover contribution (see I.R.C. § 408(d)(3)) of the partnership interest to the Merrill Lynch IRA.
Under I.R.C. § 408(d)(3)(A)(i), when a taxpayer requests an IRA distribution, the distribution is nontaxable if “the entire amount received (including money and any other property) is paid into an [IRA] . . . for the benefit of such individual not later than the 60th day after the day on which he receives the . . . distribution.” If the distribution is of noncash property, that exact property must be contributed to another IRA to qualify as a nontaxable rollover contribution under I.R.C. § 408(d)(3)(A)(i). The court determined that UBS had distributed the partnership interest to Caan and that Caan’s estate’s contention that UBS had not notified him or his financial advisors of the distribution lacked credibility. Furthermore, the estate’s argument that Caan was never in actual or constructive receipt of the partnership interest failed due to evidence that the custodian had relinquished title to the partnership interest and Caan had unfettered control over it.
Moreover, the court found that because Caan had liquidated the partnership interest, changing the character of the property, he had failed to preserve its tax-deferred status under I.R.C. § 408(d)(3)(A)(i). He had also missed the 60-day deadline for the rollover contribution. Further, the P&A Multi-Sector Fund, after liquidating the partnership interest, had made three transfers within a one-year period rather than the one rollover contribution per year allowed under I.R.C. § 408(d)(3)(B).
The court held that the value of the partnership interest at the time of distribution was $1,548,010, the ending capital account balance reported by the P&A Multi-Sector Fund for tax year 2015, rather than the 2013 year-end fair market value. In addition, the court determined that the IRS did not err in declining to grant a waiver of the 60-day rollover period because the failure of the contribution to meet the “same-property” requirement disqualified the contribution of the cash proceeds from the liquidation of the partnership interest from qualifying as a rollover contribution under I.R.C. § 408(d)(3)(A)(i).
The court further addressed two questions of first impression, holding that (1) it had jurisdiction to review the Commissioner’s denial of a waiver under I.R.C. § 408(d)(3)(I) and (2) the standard to be applied in that review was an abuse of discretion. The court determined that the IRS could not waive Caan’s failure to meet the statutory same-property requirement; therefore, it was not an abuse of discretion for it to “deny a waiver [of the 60-day rollover period] where granting the waiver would not have helped the taxpayer in any way.” In re Estate of Caan v. Comm’r, 161 T.C. No. 6, at *15 (Nov. 14, 2023).
Takeaways: Although the Caan estate succeeded in persuading the court to adopt a reduced value of the partnership interest for tax year 2015, its argument that the contribution of the proceeds of the liquidated partnership interest to the Merrill Lynch IRA qualified as a nontaxable rollover contribution failed. Therefore, the value of the partnership interest was required to be included in Caan’s gross income for 2015. Clients should be reminded that although the IRA may waive the 60-day rollover requirement in certain circumstances, clients must generally roll over a distribution from an IRA or retirement plan to another plan or IRA within 60 days.
Trust Distributions Timely Rolled Over to Surviving Spouse’s IRA Excluded from Income
I.R.S. Priv. Ltr. Rul. 2024-04-003 (Jan. 26, 2024)
On January 26, 2024, the Internal Revenue Service released Private Letter Ruling 2024-04-003, addressing a specific IRA rollover situation. In the factual situation addressed, Spouse 1 established an IRA with a custodian. Spouse 1 and Spouse 2 then created a trust as part of their estate plan and named themselves as co-trustees with the ability to act independently of each other to exercise any of their powers as trustees. They both were authorized to withdraw or distribute property from the trust.
After the establishment of the trust, Spouse 1 rolled over funds from a 401(k) plan to the IRA. Spouse 1 died before reaching the age at which required minimum distributions must be made under I.R.C. § 401(a)(9).
Spouse 1’s IRA was then paid to an inherited IRA established for the trust. The trust was restated to provide that Spouse 2 was the sole trustee with the power to distribute all of the trust assets to herself during her lifetime.
Under Treas. Reg. 1.408-8, Q&A 5, a surviving spouse can elect to treat their deceased spouse’s IRA as their own if they are the sole beneficiary of the IRA and have an unlimited right to withdraw amounts from the IRA. However, “[i]f a trust is named as beneficiary of the IRA, this requirement is not satisfied even if the spouse is the sole beneficiary of the trust.” Id. The IRS determined that because Spouse 1’s IRA was transferred to the trust at death, Spouse 2, as the surviving spouse, was not permitted to treat the IRA as her own because the trust, not Spouse 2, was the named beneficiary of Spouse 1’s IRA.
Nevertheless, the IRS ruled that because Spouse 2 was the sole trustee and primary beneficiary of the trust during her lifetime and had the authority to distribute all trust assets to herself, she was “effectively the individual for whose benefit the account is maintained.” I.R.S. Priv. Ltr. Rul. 2024-04-003 at 3 (Jan. 26, 2024). Therefore, Spouse 2 could roll over distributions of the IRA’s proceeds into one or more IRAs established in her own name (other than amounts that had to be distributed under I.R.C. § 401(a)(9)) within 60 days of receiving the IRA proceeds without being required to include those proceeds as gross income for federal income tax purposes.
Takeaways: Although private letter rulings do not have precedential value for other taxpayers or IRS personnel, they are instructive regarding the IRS’s position on an issue. This private letter ruling is a taxpayer win: the IRS recognized that Spouse 2 was “effectively” the individual for whose benefit the IRA was maintained and was not required to include in her gross income distributions from the trust of IRA proceeds that were timely rolled over to her own IRA.
Pennsylvania Amends Tax Code to Align with Federal Grantor Trust Rules
S.B. 815, Reg. Sess. (Pa. 2023)
On December 14, 2023, Pennsylvania Governor Josh Shapiro signed S.B. 815, effective February 23, 2024, providing that the grantor or owner of an irrevocable grantor trust, rather than the trust or its beneficiaries, will pay Pennsylvania state income tax on trust income regardless of whether the income is distributed or distributable to the beneficiaries or is accumulated. The changes apply to tax years beginning January 1, 2025.
Takeaways: Under I.R.C. §§ 671–679, the grantor of a trust may be treated as the owner of all or part of a trust for personal income tax purposes, whether the trust is revocable or irrevocable. Under the federal rules, the grantor is subject to tax on the trust’s income and can report trust deductions. S.B. 815 will bring Pennsylvania, the only state that varied from federal grantor trust rules, into alignment with federal grantor trust rules for irrevocable grantor trusts. For tax years beginning January 1, 2025, grantors, rather than trustees or beneficiaries, should make estimated tax payments, if needed, and include trust income on their personal state income tax returns.
Wyoming Supreme Court: Assets that Transfer to Testamentary Trust Via Pour-Over Will Part of Probate Estate for Purposes of Spouse’s Elective Share
In re Estate of Tokowitz, 541 P.3d 446 (Wyo. Jan. 12, 2024)
Neal and Carol Tokowitz were married for 30 years. Neal, who had two children from a previous marriage, died in Arizona in April 2021. His will, which made no provision for Carol, devised all of his property to an unfunded revocable trust to “be held and administered in accordance with the terms of the trust.” The will, which had been executed in 2012, stated that Neal was “now domiciled” in Wyoming. The personal representative of Neal’s estate filed a petition for probate stating that Neal was a resident of Wyoming at the time of his death. Carol asserted her right to the elective share under Wyo. Stat. Ann. § 2-5-101 and to exempt assets under Wyo. Stat. Ann. §§ 2-7-504 and 505. The probate court granted Carol’s elective share and set over the exempt assets. The personal representative and trustee appealed.
The Wyoming Supreme Court rejected the contention of the personal representative and trustee that Neal was not domiciled in Wyoming as required by Wyo. Stat. Ann. § 2-5-101(a) (“If a married person domiciled in this state shall by will deprive the surviving spouse of more than the elective share . . . of the property which is subject to disposition under the will, the surviving spouse has a right of election to take an elective share of that property . . .”). The court noted the well-established distinction between residence and domicile, stating that a “person may have a ‘domicile’ in only one place at a time; however, the same person may be a ‘resident’ of several places at the same time.” In re Estate of Tokowitz, 541 P.3d 446, 451 (Wyo. Jan. 12, 2024) (quoting Wyo. Ins. Guar. Ass’n v. Woods, 888 P.2d 192, 198 (Wyo. 1994)). The court found that Carol had met her burden of establishing that Neal was domiciled in Wyoming: the petition for probate, which only stated that Neal was a resident of Wyoming, had no bearing on whether he was domiciled there, but Neal’s will, which stated that he was domiciled in Wyoming, was unrebutted evidence that he was domiciled there.
The court also rejected the personal representative and trustee’s argument that under the elective share statute, Carol must demonstrate that she was not entitled to one-fourth of the Wyoming estate, including any interest she had in the trust. The elective statute stated that she had a right to take an elective share of “one-fourth (1/4)” of the “property which is subject to disposition under the will.” Wyo. Stat. Ann. § 2-5-101(a). The personal representative and trustee asserted that the relevant inquiry was whether Carol was entitled to more than the elective share under the trust, and that because she was entitled to more than one-fourth of the estate under the trust, she was not entitled to claim an elective share.
To the contrary, the language of Wyo. Stat. Ann.§ 2-5-101(a) (if “a married person domiciled in [Wyoming] shall by will deprive the surviving spouse of more than the elective share . . . of the property which is subject to disposition under the will . . . ,” (emphasis added)) made no reference to property transferred outside of the will, and therefore, “[t]he terms of the trust and [Carol’s] rights under the trust are not relevant to her entitlement to an elective share.” Id. at 453. Because the will made no provision for her, she was deprived under the will of more than her elective share and entitled to the spousal election.
Further, the court rejected the argument that because Neal’s will was a pour-over will and the trust was the sole beneficiary, the property that poured into the trust at his death was not part of the probate estate from which Carol’s spousal share should be determined. Rather, the court took “this opportunity to clarify that any property passing to a trust via a pour-over provision in the will is part of the probate estate until the will is probated. Only after probate does it pass in accordance with [Wyo. Stat. Ann.] § 2-6-103 to the trust to be distributed by the trust terms.” Id. at 454. Therefore, the probate court did not err in its conclusion that Carol was entitled to her elective share.
The court also held that the probate court correctly ruled that it did not have jurisdiction to determine claims arising from the trust, specifically how the trustee should proceed with distributions from the trust once the spousal election had been paid. Rather, in the absence of statutory authority, a probate court does not have jurisdiction to control the trustees of a trust created by a will.
Takeaways: Spousal property rights are governed by state law, so it is important to be familiar with the laws in your state to help your clients achieve their planning goals. Elective share statutes protect a surviving spouse from disinheritance. They typically allow a spouse to elect to inherit a certain percentage—often ranging from 30 to 50 percent—of their deceased spouse’s estate regardless of what the deceased spouse’s will says. In some states, the surviving spouse is only allowed to take their elective share from the probate estate, which excludes money and property that have been transferred to a trust, insurance policies, and retirement or financial accounts that name other beneficiaries.
This is the case in Wyoming: In In re Estate of Tokowitz, the court clarified that to the extent prior case law could be interpreted to hold that property transferred by the pour-over will provision “is not part of the probate estate for purposes of determining the elective share, it is incorrect.” Id. at 454. Note that other states have statutes that include both the probate estate and other accounts or property the deceased spouse owned; these laws provide that the surviving spouse’s elective share can be calculated based on a larger pool of assets called the augmented estate.
Elder Law and Special Needs Law
Annual Limitation on Contributions to ABLE Accounts Increased to $18,000 for 2024
Program Operations Manual System, SI 01130.740 Achieving a Better Life Experience (ABLE) Accounts (Jan. 22, 2024)
Individuals who meet the Social Security Administration’s definition of disabled but have assets exceeding their state’s limit to qualify for government benefits such as Medicaid, Supplemental Nutrition Assistance Program, or Supplemental Security Income are not eligible to receive those benefits. However, under the 2014 ABLE Act, disabled individuals and others can contribute up to $100,000 to a tax-advantaged ABLE account that can be spent on disability-related expenses without impacting their eligibility for public benefits. The total amount that may be contributed per year from all sources is generally limited to the gift tax exclusion amount applicable for each year. For 2024, the annual gift tax exclusion amount—and thus the annual limitation on contributions to ABLE accounts—was increased to $18,000.
Takeaways: The new ABLE account contribution amount reflects an increase over the 2023 contribution limit, which was $17,000, and a significant increase over the period from 2018 to 2021, when the amount was $15,000. This increase, which reflects the high rate of inflation, provides much-needed relief for disabled individuals by increasing the amount of funds available to beneficiaries for disability-related expenses without jeopardizing their eligibility for benefits.
Business Law
Tax Court Rules Functional Analysis Test Applicable to Limited Partner Exception to Self-Employment Tax
Soroban Capital Partners v. Comm’r, 161 T.C. No. 12 (Nov. 28, 2023)
Soroban Capital Partners was a Delaware limited partnership subject to the Tax Equity and Fiscal Responsibility Act (TEFRA) unified audit and litigation procedures (I.R.C. §§ 6221–6234) in tax years 2016 and 2017 (note that TEFRA procedures were repealed and applied only to tax years beginning before January 1, 2018). It reported guaranteed payments made to the limited partners and the general partner’s share of ordinary business income as net earnings from self-employment on its tax returns for 2016 and 2017. Soroban excluded distributions of ordinary income to the limited partners based on the limited partner exception of I.R.C. § 1402(a)(13), which excludes “the distributive share of any item of income or loss of a limited partner, as such” from net earnings from self-employment.
The IRS adjusted Soroban’s net earnings to include the shares of ordinary business income allocated to the limited partners, asserting that they were limited partners in name only. Soroban filed a petition challenging the IRS’s determinations. In a motion for summary judgment, Soroban sought a determination that the limited partners’ ordinary business income was excluded from self-employment tax as a matter of law pursuant to I.R.C. § 1402(a)(13) or that an inquiry into a limited partner’s role could not be resolved in a TEFRA partnership-level proceeding. The IRS also filed a motion for summary judgment asking the court to determine as a matter of law that an inquiry into a limited partner’s role was a partnership item that could be determined in a partnership-level proceeding.
Note: Because a partnership is a pass-through entity that is not subject to income tax and taxation occurs at the partner level (I.R.C. § 701), a TEFRA partnership-level proceeding does not determine the underlying tax liability of a partnership. Instead, a partnership-level proceeding determines the tax treatment of partnership items (I.R.C. § 6221), i.e., “any item required to be taken into account by a partnership under subtitle A that is more appropriately determined at the partnership level plus any legal or factual determination underlying such an item.” Soroban Capital Partners v. Comm’r, 161 T.C. No. 12, *1 (Nov. 28, 2023); I.R.C. § 6231(a)(3).
In a case of first impression, the Tax Court held that a functional analysis test should be applied to determine whether the limited partnership exception applied to limited partners in state law limited partnerships. The court noted that I.R.C. § 1402(a)(13) does not define the phrase “limited partner, as such.” Further, the US Department of the Treasury has not issued a temporary or final regulation defining “limited partner” under I.R.C. § 1402(a)(13) following substantial criticism of proposed regulations issued in 1997 (Prop. Treas. Reg. § 1.1402(a)-2(h)(2), 62 Fed. Reg. 1702 (Jan. 13, 1997)).
Based on the rules of statutory construction, the court ruled that a term that is undefined by a statute should be given its ordinary meaning at the time of enactment and a statute should be interpreted to give effect to every clause and word in the statute. Because Congress included the words “as such,” it made clear that the limited partnership exception does not require state law limited partners to automatically be excluded from self-employment tax. It does not apply to limited partners in name only; rather, the exception applies only to those who are functioning as limited partners.
The court further determined that it had jurisdiction over a TEFRA partnership-level proceeding when the tax-matter partner or other eligible partners timely petitioned the court for a readjustment of partnership items and to redetermine partnership items. It ruled that an inquiry into the roles and activities of the limited partners at Soroban for the purpose of determining whether the limited partnership exception applied was a partnership item. The court explained that I.R.C. § 1402 was found in Subtitle A, which requires a partnership to separately state “the amount of income that would be [net earnings from self-employment] in the hands of the ultimate recipients if those recipients were in fact individuals.” Soroban (quoting Olsen-Smith, Ltd. v. Comm’r, 90 T.C.M (CCH) 64, 66 (2005)).
Further, it is an item identified in Treas. Reg. § 301.6231(a)(3)-1 as a partnership item because it is more appropriately determined at the partnership level. Specifically, Treas. Reg. § 301.6231(a)(3)-1(b) states that “the accounting practices and the legal and factual determinations that underlie the determination of the amount, timing, and characterization of items of income, credit, gain, loss, deduction, etc.” are included in the term “partnership item.” Because a functional inquiry into the roles and activities of Soroban’s limited partners involved factual determinations necessary to determine Soroban’s aggregate amount of net earnings from self-employment, it was a partnership item and was appropriate for a partnership-level proceeding. Accordingly, the court denied Soroban’s motion for summary and granted the IRS’s motion for partial summary judgment.
Takeaways: Minimizing self-employment taxes is an important factor for business planning attorneys and their clients to consider in forming business entities. Although there are still uncertainties and the Tax Court has not yet applied the functional analysis test in the Soroban case, business planning attorneys should assist their clients in evaluating their planning options in light of the court’s decision.
Updated Corporate Transparency Act FAQs Provide Guidance on Identifying Company Applicants
On January 12, 2024, the Financial Crimes Enforcement Network issued several updates to its Frequently Asked Questions (FAQs), including clarifications regarding who is considered a company applicant that must disclose identifying information under the Corporate Transparency Act (CTA). The updates clarified that company applicants may include two individuals: (1) individuals who directly file the document that created or registered a reporting company or (2) individuals who are primarily responsible for directing or controlling the filing.
Company applicants may include attorneys, paralegals, accountants, law firm mailroom employees, corporate service companies, and other entity registration service providers. For example, when an attorney is primarily responsible for overseeing the preparation and filing of a reporting company’s incorporation documents but the paralegal directly files the incorporation documents with the secretary of state, both will be company applicants for the reporting company.
However, automated websites that provide only online tools and software and third-party mailing services that only deliver documents to the secretary of state will not be required to disclose identifying information. In the case of an online automated incorporation service, only an individual who prepares and files the documents using the service’s software or online tools is the company applicant. When a delivery service is used, the individual who requests the service to deliver the documents is the company applicant.
Takeaways: Only reporting companies formed on or after January 1, 2024, must report company applicants. WealthCounsel members may visit our CTA page for new developments, webinars, articles, drafting updates, client handouts, and marketing materials.
Deja Vu All Over Again: DOL Issues Final Rule on Worker Classification under the Fair Labor Standards Act
Employee or Independent Contractor Classification Under the Fair Labor Standards Act, 29 C.F.R. § 780, 29 C.F.R. § 788, 29 C.F.R. § 795 (Jan. 10, 2024)
On January 10, 2024, the Department of Labor released a final rule setting forth a six-factor test to determine the classification of workers as independent contractors under the Fair Labor Standards Act (FLSA) (29 U.S.C. §§ 201–19). Similar to the pre-Trump rule, the following factors should be considered in determining whether a worker is an employee or independent contractor:
- The worker's opportunity for profit or loss and exercise of managerial skill
- The relative investments made by the worker and the potential employer
- The degree of permanence of the work relationship
- The degree of control an employer has over the work
- The extent to which work performed is integral to the employer's business
- The use of a worker's skill and initiative
In contrast to the Trump-era rule (rescinded by the new final rule) that identified five similar factors but placed greater weight on two core factors—the worker’s opportunity for profit or loss and the degree of control an employer has over the work—the new final rule specifies that a “totality of the circumstances economic reality analysis” should be applied to consider the six factors mentioned above, with none of the factors being given more weight than the others. The final rule takes effect on March 11, 2024.
Takeaways: In light of the March 11, 2024, effective date, to avoid potentially substantial penalties for noncompliance with the FLSA, businesses that hire independent contractors should immediately reevaluate their relationships with current workers to ensure that they will be classified properly under the new final rule. Management-level employees should be made aware of the new rule to ensure compliance. In addition, independent contractor agreements should be reviewed to ensure they accurately reflect the nature of the relationship between workers and businesses. Note that some states have their own worker classification rules. In the event of conflicting federal and state rules, the FLSA provides that employers must comply with the standard that provides the highest degree of protection to workers (29 U.S.C. § 218).
