From sweeping legislative changes to decisive judicial decisions—we’ve seen some impactful developments in estate planning and business law this year. To ensure that you close out the year successfully, we’ve highlighted six noteworthy developments of 2019 and analyzed how they may impact your law practice.
Supreme Court Weighs In on State Taxation of Trusts
North Carolina Department of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust (Kaestner)
On June 21, 2019, in a narrow ruling in N.C. Dep’t of Revenue v. Kaestner 1992 Family Trust,1 the U.S. Supreme Court found that application of General Statutes of North Carolina section 105-160.2 to the trust in question violated the Fourteenth Amendment’s Due Process Clause. For tax years 2005 through 2008, North Carolina assessed more than $1.3 million against the Kimberley Rice Kaestner 1992 Family Trust (the Trust) because its beneficiaries were residents of the state. North Carolina asserted that its law allowed it to tax any trust income that “is for the benefit of” a state resident. During the tax years in question, the beneficiaries did not receive any income from the Trust; had no right to demand Trust income or otherwise control, possess, or enjoy Trust assets; and had no guarantee of receiving any income from the Trust in the future. Additionally, the Trust situs, Trustee, and assets were all in other states.
The Court was careful to highlight the narrow application of its holding by stating, “In limiting our holding to the specific facts presented, we do not imply approval or disapproval of trust taxes that are premised on the residence of beneficiaries whose relationship to trust assets differs from that of the beneficiaries here.”2 Further, in footnote 8, the Court stated, “We do not decide what degree of possession, control, or enjoyment would be sufficient to support taxation.”3 Although North Carolina argued that ruling in favor of the Trust would “undermine numerous state taxation regimes,”4 the Court stated that its “ruling will have no such sweeping effect. North Carolina is one of a small handful of States that rely on beneficiary residency as a sole basis for trust taxation, and one of an even smaller number that will rely on the residence of the beneficiaries regardless of whether the beneficiary is certain to receive trust assets.”5
Practitioners hoping for additional guidance from the Court regarding state taxation of trusts may have been disappointed when the Court one week later denied a petition for a writ of certiorari in Bauerly v. Fielding.6 In Fielding, the Minnesota Department of Revenue asked the Court to overturn a Minnesota State Supreme Court case holding that the state could not impose a tax on trust income based on the residency of the trust’s grantor at the time the trust became irrevocable. The trust’s connections to the state in Fielding differed significantly from those in Kaestner.
On July 2, 2019, the North Carolina Department of Revenue published a notice stating that affected taxpayers who had filed a notice of contingent event had until December 21, 2019, to file an amended return, and those who had not filed a notice of contingent event would have until the end of the regular statute of limitations to file an amended return. According to Steve Akers, at least 400 protective claims for refund have been filed in North Carolina.7
Takeaways: As noted by the U.S. Supreme Court in Kaestner, “Settlors who create trusts in the future will have to weigh the potential tax benefits of such arrangements [i.e. trusts that provide no income to beneficiaries, no right to demand income, and uncertainty about future distributions] against the costs to the trust beneficiaries of lesser control over trust assets.”8
Connecticut and Illinois Become Latest States to Adopt Version of Uniform Trust Code
On July 12, the governors of Illinois and Connecticut signed legislation for their respective states revamping their trust codes, joining thirty-two other states and the District of Columbia that have adopted a version of the Uniform Trust Code (UTC). The new trust codes in both states take effect January 1, 2020.
The new Illinois Trust Code largely conforms with the UTC. Trustees will need to pay attention to new notice and reporting requirements. Additionally, the standard for modifying or terminating a noncharitable irrevocable trust will change. Other updates include changes to Illinois’s previous decanting requirements and provisions regarding the use of trustee exculpation clauses.
Takeaways: Although Connecticut’s new law is titled the Connecticut Uniform Trust Code (CUTC), the new law includes changes that extend well beyond the UTC. In addition to implementing a version of the UTC, the CUTC includes a version of the relatively new Uniform Directed Trust Act (which was also adopted by seven other states in 2019), allows for domestic asset protection trusts, and expands Connecticut’s rule against perpetuities to 800 years. Widely hailed as a welcome change to Connecticut’s trust laws, the CUTC should make the state a more attractive venue for trusts.
Tax-Affecting Allowed for Valuations of Pass-Through Entities
Two notable tax cases came out this year that may have a big impact on valuations of pass-through entities, because both holdings allow tax-affecting, which the IRS has taken a strong stance against since 1999 based on the holding in Gross v. Commissioner.9 When tax-affecting is used in a valuation of a pass-through entity, adjustments are made to the entity’s earnings based on differences between pass-through entities and C corporations. First, in Kress v. U.S.,10 both the taxpayer’s and government’s experts tax-affected the earnings of an S corporation, and the court followed this approach. Although the Kress decision was notable, its precedential value was limited to the Eastern District of Wisconsin. Then in August, the United States Tax Court issued its opinion in Estate of Jones v. Commissioner,11 in which Judge Pugh accepted tax-affecting in the valuation of both a partnership and an S corporation.
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Takeaways: Practitioners working with clients who have taxable estates and closely held business entities should take note of the new precedent allowing tax-affecting in valuations. Hiring an appraiser who understands how to appropriately use tax-affecting in a valuation prior to making large gifts of business interests, or prior to filing an estate tax return, could lead to gift or estate tax savings. Prior to hiring an appraiser, asking the appraiser’s opinion of these two cases and whether they think tax-affecting would be appropriate for your client’s business valuation would be a great tool to assist with vetting the appraiser’s qualifications.
Setting Every Community Up for Retirement Enhancement (SECURE) Act
Professional advisors have been closely following the SECURE Act’s progression through Congress because, if passed by the Senate, the Act would result in sweeping changes impacting the advice and strategies offered by financial, estate, and business planners. Designed to encourage Americans to save for retirement by improving access to more types of financial products, the Act would create incentives for employers to expand access to 401(k) plans, particularly to employees of small businesses and part-time employees—two groups traditionally ineligible for employer-sponsored retirement plans.
The SECURE Act includes the following key provisions:
- increasing the Required Beginning Date for Required Minimum Distributions from 70 ½ to 72
- repealing the maximum age for contributions to traditional IRAs
- adding exceptions for penalty-free withdrawals by an account owner
- requiring certain beneficiaries to withdraw inherited account balances within 10 years of the account owner’s death
Takeaways: The SECURE Act aims to address a pressing issue—the lack of sufficient retirement savings among a significant percentage of Americans. The Act’s costly incentives and tax credits, which are intended to improve accessibility to and administration of employer-sponsored retirement plans, are to be balanced by other new measures, such as accelerated taxation of inherited IRAs. Trusted advisors should be prepared to speak with clients about the potential impact of the legislation should it pass in the Senate. For now, the SECURE Act’s future is uncertain, with the latest attempt to get the measure passed via unanimous consent failing on November 7, 2019, in the Senate. Stay tuned.
IRS Releases Final Regulations on 199A
In January 2019, the IRS released much-anticipated clarifications regarding Internal Revenue Code Section 199A.12 These Final Regulations offered clarity regarding specified service trade or business (SSTB) guidelines, calculation of qualified business income (QBI), anti-abuse rules, and application of W2 wages and aggregation rules. Below are a few highlights of the Final Regulations.
- Multiple Trusts. The Final Regulations have an additional anti-abuse rule concerning the treatment of multiple trusts that attempt to get around QBI limits. Section 1.643(f)-1 states that, in circumstances where two or more trusts have substantially the same grantor and beneficiaries, the trusts will be treated as a single trust for federal income tax purposes if a principal purpose for establishing the multiple trusts was the avoidance of federal income tax. Estate planners should revisit any plans that may be affected by this rule and carefully document nontax reasons for multiple trusts if they have an impact on the 199A deduction.
- SSTB Guidelines. The Final Regulations clarify which businesses are considered SSTBs. Many types of services or professional businesses can be considered SSTBs, including those providing health care, law, actuarial, and accounting services. Additionally, consultants, performers, and financial advisory service providers are considered SSTBs. Architecture, engineering, and staffing services, however, are not treated as consulting services for the purposes of 199A. The SSTB definition is important because it can limit or even eliminate the 199A deduction. Deductions are limited for SSTB owners who are above the income threshold, and there are no deductions at all for owners with incomes above the phase-in range.
- Calculation of QBI. The Final Regulations contain several important modifications to assist in the calculation of QBI. For example, they stipulate that deductions such as the tax on self-employment income, self-employed health insurance, and contributions to qualified retirement plans (as described in sections 164(f), 162(l), and 404, respectively) are allowable, so long as the business’s gross income is taken into account when calculating the deduction on a proportionate basis.
Takeaways: The Final Regulations are complex and easy to mishandle, and attorneys can thus add significant value to small business clients in this area. Section 199A will remain an important component of business structuring and tax planning in 2020 and beyond.
Fair Workweek Legislation
Over the past three years, the state of Oregon and a number of cities including Seattle, San Francisco, Philadelphia, Chicago, and New York City have passed “fair workweek” legislation that aims to make employees’ schedules more predictable (or compensate employees when their schedules are unpredictable). Other states, including Washington, Connecticut, and Massachusetts, are considering statewide legislation. The laws require that certain companies—most often retail and food service companies employing several hundred people or more—take steps such as posting schedules two weeks in advance, compensating workers if there are last-minute scheduling changes, and allowing sufficient rest time between shifts.
On November 5, Representative Rosa DeLauro announced that she and Senator Elizabeth Warren were reintroducing the federal Schedules That Work Act13 legislation, which calls for protections such as two weeks’ notice of schedules and compensation for schedule changes for employees in food service, cleaning, hospitality, warehouse, and retail occupations. The Schedules That Work Act introduced in 2015 had similar rules, including a requirement to provide schedules two weeks in advance, with compensation if shifts were changed last minute, for employees of retail, cleaning, and food service companies.
Takeaways: Unpredictable scheduling can be extremely stressful for workers and their families. State and federal legislation aiming to assist employees in planning ahead and balancing family and work will be important to many businesses in 2020 and beyond. By requiring advance notice and compensation for last-minute changes, fair workweek scheduling may significantly raise the quality of life for millions of people, but it may also require substantial changes in the way businesses schedule and compensate their workforce. Business law attorneys should continue to monitor further developments and advise clients accordingly.
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1 288 U.S. ___ (2019), 2019 WL 2552488.
2 Id. at *5.
3 Id. at *6 n. 8.
4 Id. at *9.
6 No. 18-664, 139 S. Ct. 2773 (2019).
7 Steve R. Akers, Estate Planning Current Developments and Hot Topics, Bessemer Trust, 63 (Nov. 2019), https://www.bessemertrust.com/sites/default/files/2019-11/Hot%20Topics%20Current%20Developments_11_01_19.pdf.
8 288 U.S. _____ (2019), 2019 WL 2552488, at *9.
9 78 T.C.M. 201 (1999).
10 No. 16-C-795 (E.D. Wis. Mar. 26, 2019).
11 No. 27952-13, T.C. Memo. 2019-101 (2019).
12 Treas. Reg. § 1.199A (2019).
13 H.R. 2942, 115th Cong. (2017).