From a taxpayer’s win in a split-dollar life insurance arrangement case to the reinstatement of a Trump-era independent contractor rule, 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.
Taxpayer Win in Split-Dollar Insurance Arrangement Case
Estate of Levine v. Comm’r, 158 T.C. No. 2 (Feb. 28, 2022)
Marion Levine entered a split-dollar life insurance transaction whereby her revocable living trust (RLT) paid the premiums for life insurance policies taken out on the lives of her daughter and son-in-law. The insurance policies were held by separate irrevocable life insurance trusts (ILITs). The ILIT agreed to assign the policies to the RLT as collateral. In addition, the ILIT agreed to pay Marion’s RLT the greater of (a) the total premiums paid for the policies ($6.5 million) or (b) either the policies’ current cash-surrender value upon the death of the last surviving insured or their cash surrender value on the date they were terminated if termination occurred before the insureds’ deaths. Both insureds were still living at the time of Marion’s death.
The question before the court was what amount had to be included in Marion’s taxable estate: the value of her RLT’s right to be repaid in the future or the life insurance policies’ cash surrender value as of the date of her death.
Split-dollar life insurance arrangements are governed by Treas. Reg. § 1.61-22, which defines a split-dollar life insurance arrangement as
any arrangement between an owner and a non-owner of a life insurance contract that satisfies the following criteria:
(i) Either party to the arrangement pays, directly or indirectly, all or a portion of the premiums on the life insurance contract, including a payment by means of a loan to the other party that is secured by the life insurance contract;
(ii) At least one of the parties to the arrangement paying premiums … is entitled to recover (either conditionally or unconditionally) all or a portion of those premiums and such recovery is to be made from, or is secured by, the proceeds of the life insurance contract; and
(iii) The arrangement is not part of a group-term life insurance plan [other than one providing permanent benefits].
Treas. Reg. § 1.61-22(b)(1). The court determined that Marion’s split-dollar arrangement met these requirements. However, it concluded that neither Treas. Reg. § 1.61-22 nor Internal Revenue Code (I.R.C.) § 2042 (which applies only to life insurance policies on a decedent’s own life) governs the estate tax consequences of split-dollar arrangements. As a result, the court turned to the default rules in the I.R.C.’s estate tax provisions to determine the effect of Marion’s split-dollar arrangement on the gross value of her estate. Specifically, the court looked to I.R.C. § 2036, a catchall statute aimed at preventing a taxpayer from avoiding estate tax by simply transferring property prior to death, and I.R.C. § 2038, which “claws back” certain assets transferred before death.
The parties disagreed about whether the property at issue was the insurance policies themselves, the rights under the split-dollar arrangement to receive the greater of the total amount of premiums paid ($6.5 million) or the policies’ cash surrender value on the date they were terminated, or the $6.5 million in cash wired to the ILIT from Marion’s assets. The court determined that the life insurance policies were not the property at issue, as they were purchased by the ILIT so were never owned or transferred by Marion’s RLT. In addition, the receivable itself was also not at issue: it belonged to Marion’s RLT and subsequently to her estate and was retained, not transferred.
The court found that the policies’ cash surrender value was not includible in Marion’s estate because only the ILIT’s investment committee—composed of only Marion’s business partner—had the right to terminate the policies. Further, the investment committee owed fiduciary duties to Marion’s grandchildren in addition to Marion, her daughter, and her son-in-law. The investment committee could not unwind the split-dollar arrangement and surrender the policies for the benefit of the daughter and son-in-law because the grandchildren would then receive nothing under terms of the ILIT. Such a result would amount to a breach of the investment committee’s fiduciary duties to the grandchildren. Therefore, the investment committee’s right to surrender the policies and realize their cash surrender values could not be characterized as a right retained by Marion, either alone or in conjunction with the investment committee, to designate who shall possess or enjoy the property transferred or the income from it. Further, Marion did not have the right to alter, amend, revoke, or terminate any aspect of the split-dollar arrangement.
Because Marion had no contractual right to terminate the policies, she had no right to their cash surrender values, precluding their inclusion under I.R.C. § 2036 or § 2038. Rather, the only property left in her estate was the split-dollar receivable, i.e., the right to receive the greater of the premiums paid or the cash surrender value of the policies when they were terminated. The court held that the value of the receivable, which the parties had agreed was $2,282,195 (representing a 65 percent discount of the $6.5 million receivable) must be included in Marion’s gross estate and that no accuracy-related penalties were applicable. Further, the special valuation rules under I.R.C. § 2703 apply only to property owned by a decedent at death so would not apply to the insurance policies, which Marion had never owned.
Takeaways: The court distinguished prior decisions involving split-dollar life insurance arrangements, including Estate of Cahill v. Comm’r, 115 T.C.M. (CCH) 1463 (2018), which involved an agreement that could be terminated during the insured’s lifetime by the unanimous written consent of the decedent or decedent’s agents and the ILIT’s independent trustee. Because the arrangement required the decedent’s approval to terminate the arrangement (unlike the present case), the taxpayer in Cahill was viewed as standing on both sides of the transaction. Split-dollar life insurance arrangements must be carefully designed to avoid including the cash surrender value of the life insurance policies in the decedent’s estate and to enable the estate to substantially discount the value of the receivable due to the taxpayer.
Notwithstanding the taxpayer’s victory, the Levine transaction may still have income tax implications. Repaying the receivable (which was included in Marion’s estate) will result in income tax.
Trust Modification to Add Formula General Power of Appointment Had No Adverse Generation-Skipping Transfer Tax Consequences and Could Limit Appointive Assets
I.R.S. P.L.R. 202206008 (Feb. 11, 2022)
In P.L.R. 202206008, the Internal Revenue Service (IRS) addressed whether a generation-skipping transfer (GST) tax grandfathered trust could be judicially modified pursuant to a court-approved settlement agreement to add a formula testamentary general power of appointment. Adding the power of appointment would allow the remainder beneficiaries to benefit from a new basis in the trust’s assets upon the death of the primary beneficiary, who would be the power holder.
In its ruling, the IRS stated that adding the power of appointment would not result in a transfer of property subject to the GST tax or affect the trust’s GST tax-exempt status. Under Treas. Reg. § 26.2601-19b0(4)(1), modifying a GST tax-exempt trust will not cause the loss of exempt status if (1) the modification would not shift any beneficial interest in the trust to any beneficiary who occupies a lower generation and (2) the modification would not extend the time for vesting of any beneficial interest in the trust beyond the period provided for in the trust. The IRS determined that adding the formula testamentary general power of appointment would comply with the requirements of the regulation and the trust would not lose its GST tax-exempt status or become subject to the GST tax.
In addition, the trustee’s exercise of its discretionary authority to grant the primary beneficiary a testamentary general power of appointment to appoint a defined portion of the trust principal to the primary beneficiary’s estate would include only the desired amount in the beneficiary’s estate. The defined portion would be the largest portion of the trust that could be included without increasing the total amount of transfer taxes payable at death above the amount that would have been payable in the absence of such a provision
Takeaway: When a trust beneficiary has no taxable estate, using a formula testamentary power of appointment to include appreciated trust assets in the beneficiary’s estate can result in substantial income tax savings for the next generation. For low-basis assets subject to the power, the basis will be adjusted to the property’s fair market value at the date of the trust beneficiary’s death, even if the trust beneficiary does not exercise the power. Although a Private Letter Ruling has no precedential value and cannot be relied on by other taxpayers, this Private Letter Ruling suggests that, at least in cases involving similar facts, the IRS’s view is that using this strategy will not affect the GST tax-exempt nature of a grandfathered trust or have other adverse GST tax consequences; and, more significantly, the scope of the power of appointment can be limited by a formula referencing the total amount of transfer taxes, a possibility that some commentators have expressed concern about.
President Biden’s Proposed Budget Calls for “Billionaire Tax” and Increased Corporate Tax Rate
On March 28, 2022, President Biden released his proposed budget for fiscal year 2023, and the Department of the Treasury released its reen Book. The proposal includes several large tax increases, including a 20 percent minimum tax on the income and unrealized capital gains of Americans worth more than $100 million. The proposals also eliminate the carried interest preference and the like-kind exchange real estate preference for those with high incomes. The budget further proposes increasing the corporate tax rate from 21 percent to 28 percent and includes measures to prevent multinational corporations operating in the United States from using tax havens to avoid a proposed global minimum tax.
Takeaways: Congress is likely to make major changes to the plan, as the Democrat-controlled Congress recently rejected both a billionaire tax and a corporate tax rate increase in bills introduced last year.
Trustees Held Personally Liable for Unpaid Estate Taxes
United States v. Allison, No. 1:20-cv-00269-DAD-HBK, 2022 WL 583573 (E.D. Cal. Feb. 24, 2022)
Roger L. Wilson, Sr. created an RLT named the Roger L. Wilson Revocable Trust (the Trust) on November 12, 2005, about two weeks prior to his death on November 27. Diane Allison and Sonja Wilson were named co-trustees for the Trust, to which Roger transferred assets valued at $518,750.
On February 27, 2007, Diane and Sonja filed an estate tax return on behalf of Roger’s estate, reporting that the total gross value of the estate was $1,663,242 on the date of Roger’s death. The tax liability reported on the return, $192,425, was paid in full and all of the property held by the trust and in the estate was distributed. On February 9, 2010, Diane and Sonja, as representatives of the estate and trustees of the Trust, agreed to an assessment of additional tax of $98,808 on the estate. However, the trustees disputed some adjustments, and the United States sought partial summary judgment regarding two of them: a $35,000 cashier’s check that the United States asserted should be included in the gross estate and the disallowance of a $25,000 deduction from a settlement that the estate had paid.
The question of whether the $35,000 check should be included in the gross estate turned on whether Roger had an interest in the cashier’s check on the date of his death. The cashier’s check at issue had been purchased with funds from Roger’s account on November 10, 2005—before his death—and was intended to be a gift to his son to settle the son’s child support debt. However, the Department for Child Support Services refused the check, and it was canceled on March 13, 2006—after Roger’s death. To effectuate the gift, the estate issued a check for $29,000 to the Department of Child Support Services and another check for $6,000 to Roger’s son.
The District Court for the Eastern District of California held that the stipulated facts showed that (1) any attempted delivery was rejected when the Department of Child Support Services refused the check; (2) the cancellation of the cashier’s check after Roger’s death established that physical delivery had never occurred before his death; and (3) the reissuance of two new checks with different amounts and recipients was different from what Roger had apparently intended. Because Diane and Sonja presented no evidence establishing the check’s physical delivery to the intended recipient before Roger’s death, Roger retained a property interest in it and it was includible in his gross estate.
In determining whether the $25,000 deduction should be allowed, the court considered whether the settlement payment could be deducted as a claim against Roger’s estate. The settlement ended a lawsuit initiated by Jannise Lazarus and Ashli Tree-Ana Wilson-Bolton against Diane and Sonia as trustees of the Trust, which asserted that certain real and personal property Roger had owned belonged to them rather than to the Trust or Roger’s estate. Pursuant to the settlement agreement, Ashli received $25,000 from the Trust.
To be deductible, the claim must represent Roger’s personal obligation that existed at the time of his death, “whether or not then matured, and interest thereon which had accrued at the time of death.” 26 C.F.R. § 20.2053-4. In contrast, claims to a portion of the estate are not deductible. However, the court found that the state court action that Jannise and Ashli had filed sought an inheritance they believed Ashli was entitled to rather than any amount Roger owed her before his death. In addition, the state court action was predicated on Ashli’s status as both a trust beneficiary and Roger’s heir. Therefore, the $25,000 paid to Ashli pursuant to the settlement agreement was for her claims to a portion of the estate and was not deductible.
Under I.R.C. § 6324(a)(2):
If the estate tax imposed by chapter 11 is not paid when due, then the spouse, transferee, trustee . . . or beneficiary, who receives, or has on the date of the decedent’s death, property included in the gross estate under sections 2034 to 2042, inclusive, to the extent of the value, at the time of the decedent’s death, of such property, shall be personally liable for such tax.
The court found that, under I.R.C. § 6324(a)(2), Diane and Sonja were personally liable for unpaid estate tax liabilities up to the value of the property held in Roger’s Trust at his death.
Takeaways: This case highlights the importance of asset discovery in preparing and filing Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. Personal representatives who fail to reserve sufficient funds to cover the amount ultimately due to the government may be held personally liable to the extent that they render the estate insufficient. The IRS normally has three years after the submission of any tax return to assess it and request payment of any determined deficiency. Nine months after filing the estate tax return, to allow time for processing, personal representatives should request, and wait to receive, an estate tax closing letter before distributing the estate’s assets. The estate tax closing letter informs the authorized recipient that the IRS has accepted the estate tax return and provides information such as the amounts of the net estate tax and any state death tax credit. An acceptable substitute for a closing letter may be an account transcript, available online to authorized tax professionals, showing that Form 706 was accepted and an examination was completed. However, an account transcript may not be sufficient in states with probate laws that require filing estate tax closing letters with the probate court. In addition, an executor representing a decedent’s estate or a fiduciary of a decedent’s trust may use Form 5495 to apply for release from personal liability under I.R.C. § 6905 for income and gift taxes and I.R.C. § 2204 for estate taxes. The IRS has nine months from the filing to inform the executor or fiduciary of any tax due. If the tax has been paid or the IRS provides no notice of any tax due, the executor or fiduciary is relieved of personal liability.
Arbitration Provision in Deed Was a Covenant Running with the Land and Binding on Subsequent Purchasers
Hayslip v. U.S. Home Corp., No. SC19-1371, 2022 WL 247073 (Fla. Jan. 27, 2022)
In 2007, U.S. Home constructed and sold a house, conveying the property by special warranty deed recorded in Lee County, Florida. The deed contained the following arbitration provision:
Grantor and Grantee specifically agree that this transaction involves interstate commerce and that any dispute . . . shall first be submitted to mediation and, if not settled during mediation, shall thereafter be submitted to binding arbitration as provided by the Federal Arbitration Act . . . and not by or in a court of law or equity.
The deed contained covenants, conditions, and restrictions that bound the original and all subsequent purchasers and required arbitration for disputes concerning the home. It also stated that accepting the deed binds successors and assigns to its terms.
In 2010, the home’s first owners sold it to the Hayslips. Their deed provided that the property was subject to “easements, restrictions, reservations, and limitations, if any.” In 2017, the Hayslips filed a lawsuit against U.S. Home, alleging improper installation of the home’s stucco system in violation of Florida’s building codes. A general magistrate granted U.S. Home’s request to stay the action and compel arbitration. The circuit court adopted the magistrate’s recommendation. The Hayslips appealed, and the Second District Court of Appeals held that a valid arbitration agreement existed and that it was a covenant running with the land. It certified a question to the Florida Supreme Court, which was rephrased by that court as
Does a deed covenant requiring the arbitration of any dispute arising from a construction defect run with the land, such that it is binding upon a subsequent purchaser of the real estate who was not a party to the deed?
The Hayslips argued that the arbitration provision was not a covenant running with the land that was binding on them. The court noted that covenants are divisible into two major classes: real covenants that run with the land and typically bind the heirs and assigns of the covenanting parties and personal covenants that personally bind only the covenanting parties. To have a valid and enforceable covenant running with the land, the following three conditions must be met: (1) a covenant must exist that touches and involves the land, (2) there must be an intention that the covenant run with the land; and (3) there must be notice of the restriction on the part of the party against whom enforcement is sought. The court concluded that all three elements were present with respect to the arbitration provision and that it was a covenant running with the land.
- The arbitration provision touched and concerned the enjoyment of the land because it dictated how the Hayslips could pursue a remedy for the building defects affecting the home, and the outcome of the arbitration would impact the home because the Hayslips would benefit from a repair to the defective stucco.
- The original deed expressly provided that the original parties intended for the arbitration provision to run with the land, stating “[a]ll covenants, conditions and restrictions contained in this Deed are equitable servitudes, perpetual and run with the land including, without limitation,” several sections, including the arbitration provision.
- The Hayslips had constructive notice of the arbitration provision because it was properly recorded in Lee County.
The Florida Supreme Court ruled that the Hayslips were bound by the arbitration provision.
Takeaways: Estate planning attorneys frequently prepare deeds for clients who are gifting real property to others or transferring title to real property to their trust. Attorneys should review the original deed, in addition to any governing covenants for planned communities, to determine if there are any covenants running with the land that may affect their clients or the transferees.
New Reporting Requirements for Entities in Critical Infrastructure Sectors
Consolidated Appropriations Act, H.R. 2471, 117th Cong. (2022)
On March 15, 2022, President Biden signed an omnibus appropriations bill, including the Cyber Incident Reporting for Critical Infrastructure Act of 2022 (Act). The new law imposes new reporting requirements for businesses in a large number of sectors defined in the 2013 Presidential Policy Directive 21 as “critical infrastructure sectors”: chemical; commercial facilities; communications; critical manufacturing; dams; defense industrial base; emergency services; energy; financial services; food and agriculture; government facilities; healthcare and public health; information technology; nuclear reactors, materials, and waste; transportation systems; and water and wastewater systems. The new reporting obligations will not become effective until the director of the Cybersecurity and Infrastructure Security Agency (CISA) promulgates implementing regulations that provide, among other things, a clear description of the “types of entities that constitute covered entities” and the “types of substantial cyber incidents that constitute covered cyber incidents.” In addition, the regulations will provide additional details about the information that should be included in the report.
The Act requires covered entities to provide a report to the CISA within seventy-two hours for covered incidents and within twenty-four hours after making any ransomware payment, including for ransomware attacks that are not covered cyber incidents. However, there is an exception for covered entities that are already required to report substantially similar information to another federal agency having an information-sharing arrangement with the CISA. Covered entities must also provide supplemental disclosures following covered cyber incidents as necessary and retain certain records.
If a covered entity does not submit a report as required, the CISA may contact the entity to gather information needed to determine whether a covered incident or ransomware payment has occurred. Failure to provide the requested information within seventy-two hours may result in the CISA issuing a subpoena. If the entity does not comply with the subpoena, the CISA may make a referral to the Department of Justice for enforcement.
Takeaways: Businesses that may fall within the critical infrastructure sectors should monitor the CISA’s rulemaking process and, if they so desire, comment on any proposed rules after they have been issued. In addition, the businesses should ensure that they have an adequate response plan in place for cybersecurity incidents and evaluate whether their plan needs any modifications to meet the upcoming tight reporting deadlines.
Trump Administration Independent Contractor Rule Reinstated
Coalition for Workforce Innovation et al. v. Walsh, No. 1:21-CV-130 (E.D. Tex. Mar. 14, 2022)
On March 14, 2022, the U.S. District Court for the Eastern District of Texas reinstated a Trump Administration final rule under the Fair Labor Standards Act aimed at clarifying when workers should be classified as employees instead of independent contractors. The court found that the Biden Administration’s Department of Labor had failed to comply with the Administrative Procedure Act by providing only nineteen days for the public to provide comments prior to its proposed withdrawal of the rule. In addition, the court found that withdrawing the rule was arbitrary and capricious because the Department of Labor had not considered alternatives to rescinding the final rule.
Takeaways: The Trump-era final rule became effective March 8, 2021, and currently remains in effect. Stay tuned, as the Biden Administration is likely to take further action to again attempt to withdraw the rule or propose a new rule that it views as more favorable to workers.
Utah Adopts New Comprehensive Privacy Law
S.B. 227, 2022 Gen. Sess. (Utah 2022)
On March 24, 2022, Utah Governor Spencer Cox signed the Utah Consumer Privacy Act (UCPA), joining California, Colorado, and Virginia, which previously adopted comprehensive privacy legislation.
The UCPA, which will take effect on December 31, 2023, has substantive requirements similar to the Virginia Consumer Data Protection Act and the Colorado Privacy Act. The UCPA applies to for-profit controllers and processors that
- conduct business in Utah or produce a product or service targeted to consumers who are Utah residents;
- have annual revenue of $25 million or more; and
- meet one of the following thresholds: (i) during a calendar year, control or process personal data of 100,000 or more consumers or (ii) derive over 50 percent of their gross revenue from the sale of personal data and control or process personal data of 25,000 or more consumers (a consumer is an individual who is a resident of the state acting in an individual or household context).
Under the UCPA, consumers will have the right to
- confirm whether a controller is processing the consumer’s personal data and access the data;
- delete the consumer’s personal data that the consumer provided to the controller;
- obtain a copy of the consumer’s personal data that the consumer previously provided to the controller in a format that (a) to the extent technically feasible, is portable; (b) to the extent practicable, is readily usable; and (c) allows the consumer to transmit the data to another controller without impediment, where the processing is carried out by automated means; and
- opt out of the processing of the consumer’s personal data for purposes of (a) targeted advertising or (b) the sale of personal data.
The UCPA provides broad exemptions for entities and data subject to certain federal privacy laws, e.g., the Health Insurance Portability and Accountability Act and the Gramm-Leach-Bliley Act. There is no private right of action; all enforcement will be carried out by the Utah attorney general. The law provides the attorney general with authority to enforce its provisions by notifying the violating business and allowing thirty days from receipt of the notice to cure the violation. If a violation is not cured within thirty days, the attorney general can seek recovery for the actual damages to the consumer as well as up to $7,500 per violation.
Takeaways: Businesses should evaluate whether they will fall within the scope of the UCPA and, if necessary, adjust their privacy policies and processes to facilitate compliance before the 2023 effective date.