Current Developments in Estate Planning and Business Law: April 2023

Apr 14, 2023 10:00:00 AM


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From the clarification of basis rules for assets held by irrevocable grantor trusts to the issuance of guidance by the U.S. Copyright Office for content generated by artificial intelligence, 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.

Grantor Trust Status Does Not Guarantee Basis Adjustment

Rev. Rul. 2023-2, 2023-16 I.R.B. 658

On March 29, 2023, the Internal Revenue Service (IRS) released Revenue Ruling 2023-2, which clarified that no basis adjustment is available at a  grantor’s death under Internal Revenue Code (I.R.C.) § 1014(a) for assets transferred to a trust of which the decedent is treated as the owner for income tax purposes under I.R.C. §§ 671–679 (generally, irrevocable grantor trusts) if the assets are not included in the grantor’s gross estate under I.R.C. §§ 2031–2046. Under the facts considered, the assets did not fall within any of the seven types of property listed in I.R.C. § 1014(b) deemed to have been “acquired or passed from a decedent” for purposes of I.R.C. § 1014(a), so they did not get a basis adjustment. Therefore, “the basis of [the assets] immediately after [the grantor’s] death is the same as the basis of [the assets] immediately prior to [the grantor’s] death.” Rev. Rul. 2023-2, at 9.

Takeaways: It is important to remember that grantor trust status is an income tax concept, not an estate tax concept. Had the assets been included in the grantor’s gross estate, a basis adjustment would have been allowed under I.R.C. § 1014(b)(9). Revenue Ruling 2023-2 merely confirms the position long taken by many estate planners—namely, that grantor trust status alone is not enough to cause estate inclusion or a basis adjustment. Even though grantor trusts are generally disregarded as a separate tax entity by the IRS—and treated as indistinguishable from the grantor for income tax purposes—this concept only applies to the grantor. By contrast, basis adjustment under I.R.C. § 1014 does not apply to the grantor; it applies to “a person acquiring the property from” the now-deceased grantor. See I.R.C. § 1014(a). 

Biden Administration Releases 2024 Greenbook

On March 9, 2023, the Biden Administration released its General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals (informally called the 2024 Greenbook), which explains several proposed changes to the tax code in the administration’s proposed budget, many of which were included in previous Greenbooks released during the Obama and Biden Administrations and in the 2021 Build Back Better Act. 

One new proposal would reduce the wealth transfer benefits of charitable lead annuity trusts (CLATs). CLATs are trusts that pay an annuity to a charity for a term of years or the life of the donor with the remaining assets passing to one or more noncharitable beneficiaries at the end of the term. The Biden Administration proposal includes the following two changes for CLATs:

  1. At present, transfer tax benefits can be achieved by starting with a smaller annuity in the first year that increases by a specified percentage each year, allowing assets to remain in the CLAT for a longer time period and providing a higher distribution to the remainder beneficiaries without gift tax consequences. The Biden proposal would eliminate this strategy by requiring a level, fixed annuity for the term of the CLAT.
  2. Currently, a CLAT can be designed to leave a remainder interest with a present value at or near zero, enabling appreciation to pass gift-tax-free and allowing a 100 percent charitable deduction. The Biden proposal would require the present value of the remainder interest of the CLAT at its creation to be at least ten percent of the value of the assets funding it, ensuring a taxable gift upon its creation. 

Takeaways: Commentators have opined that the proposals have little chance of becoming law in a divided Congress, as many of them have been proposed and rejected in previous years. However, if the proposals are enacted, they will create a significantly greater tax burden for wealthy estate planning clients. 

Holographic Will Executed in Louisiana Not Valid in Florida

Caveglia v. Caveglia, No. 4D21-3624, 2023 WL 2395314 (Fla. Dist. Ct. App. Mar. 8, 2023)

In 2014, Rory MacDowell executed a will while residing in Louisiana. In 2015, while still residing in Louisiana, Rory handwrote a will stating that he was revoking his prior wills, but the handwritten will was not witnessed. In 2018, he moved to Florida, where he resided until his death in 2019. Unaware that Rory had executed a will, his daughter, Margot Caveglia, and her husband, Christopher Caveglia, filed a petition for administration of Rory’s estate and were appointed as personal representatives and issued letters of administration. 

Subsequently, both the 2014 and 2015 wills were discovered. In 2021, Diana Heinen, Rory’s longtime partner, filed a petition to admit a later-discovered will to probate and an amended petition seeking probate of the 2014 will. In their answer, Margot and Christopher asserted that the 2015 holographic will revoked the 2014 will. Diana contended that the 2015 will was invalid under Florida law, which did not recognize holographic or unwitnessed wills. Diana, Margot, and Christopher stipulated that the 2014 will was valid under both Florida and Louisiana laws. The trial court ruled that the 2015 holographic will was invalid under Florida law and could not validly revoke the 2014 will. It entered a judgment revoking Margot and Christopher’s letters of administration and appointing Edward Downey as personal representative pursuant to the terms of the 2014 will.

On appeal, the Florida District Court of Appeals affirmed the lower court’s ruling. The court noted that under Florida law, “strict compliance with the statutory requirements is a prerequisite for the valid creation or revocation of a will.” Caveglia v. Caveglia, No. 4D21-3624, 2023 WL 2395314, at *2 (Fla. Dist. Ct. App. March 8, 2023). The validity of the revocation is determined at the death of the decedent and is governed by the “law that would be applied by the courts of the state where the testator was domiciled at the time of his death.” Id. (quoting Restatement (Second) of Conflict of Laws § 263 (Am. L. Inst. 1971)). In contrast to Louisiana, which allows holographic wills, Fla. Stat. § 732.502(2) expressly provides that only wills “other than a holographic or nuncupative will” are valid in Florida if they are valid in the state where executed. As a result, because the 2015 holographic will was not executed with the formalities required under Florida law, it could not be probated in Florida or revoke the 2014 will.

Takeaways: Although the general rule is that a will that is validly executed in one state is recognized as valid in another state, that is not always the case. Considering the massive geographic shifts in the US population over the past few years, the Caveglia case reminds estate planners to advise clients who have moved from another state to update their estate planning documents to ensure their validity under the laws of their new state of residence. 

Recent Cases Emphasize Need for Biological Parent with No Parental Rights to Name Child They Wish to Inherit in Their Will

Estate of Franco, 87 Cal. App. 5th 1270 (Cal. Ct. App. Jan. 30, 2023)

Marilyn and Frank Bertuccio Sr. were married and then divorced in 1967. During the marriage, Frank Jr. was born, and Frank Sr. was identified as his father on his birth certificate. In addition, the couple’s divorce decree identified Frank Jr. as their minor child and directed Frank Sr. to pay child support. 

After Frank Jr. reached adulthood, he asked his mother about his parentage. According to Frank Jr., Marilyn told him that another man, Roy Raul Hector Franco, whom she had dated during a separation from Frank Sr., was his biological father, but that she had subsequently reunited with Frank Sr. during the pregnancy. Frank Sr., Marilyn, and Roy allegedly agreed that Frank Sr. and Marilyn would raise Frank Jr. Once Frank Jr. learned that Roy was his biological father, they became involved in each other’s lives, and Roy acknowledged to others that Frank Jr. was his son.

Marilyn and Frank Sr. died prior to Roy, who died intestate in 2017. Frank Jr. filed a petition to administer Roy’s estate, and letters of administration were issued to him in early 2018. Roy’s sister and niece (the Morenos) both filed petitions to remove Frank Jr. as administrator of Roy’s estate. However, this already complicated situation became even more fraught when Frank Jr. died in 2020, and his half-sister, Tamara, was granted letters of special administration to represent Frank Jr.’s estate in the probate proceeding for Roy’s estate. The probate court granted summary judgment in favor of the Morenos on the basis that Frank Jr. was a child of the marriage of Marilyn and Frank Sr. based on California’s statutory marital presumption (that children born into a marriage are children of the spouses, further discussion below) and that consequently, Frank Jr. was barred under California law from proving Roy was his natural parent from whom he could inherit under the applicable intestacy statute.

On appeal, the California Court of Appeal agreed with the probate court’s conclusion that the marital presumption established by Cal. Fam. Code § 7540 (“the child of spouses who cohabited at the time of conception and birth is conclusively presumed to be a child of the marriage”) barred Frank Jr. from proving there was a parent-child relationship between himself and Roy for purposes of inheritance under California’s statutory scheme for intestate succession. The court relied upon the California Supreme Court’s decision in Estate of Cornelious, 35 Cal. 3d 461, 674 P.2d 245 (Cal. 1984). 

In Cornelious, the California Supreme Court held that the presumption of legitimacy codified in Cal. Fam. Code § 7540 is based on the principle that when husband and wife are cohabitating, “the integrity of the family should not be impugned.” 87 Cal. App. 5th 1270, 1278. The interests of the adult child in establishing another man as their father for financial considerations were not as weighty as those of ‘putative fathers . . . who [seek] to care for and nurture their own children,’ particularly when the familial relationship with the putative father who raised and supported the child is ‘far more palpable’ than the biological relationship with the man from whom the adult child seeks to inherit under the intestacy statute.” Id. at 1279 (quoting Cornelious, 35 Cal. 3d at 467).    

However, the court held that the probate court had failed to make any finding on the issue of whether Marilyn and Frank Sr. were cohabiting as husband and wife at the time when Frank Jr. was conceived and born, and as a result, the Morenos’ motion for summary judgment was improperly granted. The court reversed the order granting summary judgment and remanded the matter to the probate court for further proceedings consistent with its ruling, and for the probate court, in its discretion, to allow the Morenos to renew their motion for summary judgment and to make the requisite finding regarding cohabitation. 

Taulbee v. Kozel, 354 So. 3d 618 (Fla. Ct. App. Jan. 18, 2023)

David and Lyobov Taulbee had a biological son (Child). In 2014, David executed a will naming Lyobov as the principal beneficiary of his estate, with Child as the contingent beneficiary if she predeceased him. In a codicil executed in 2016, he named his cousins, John and Anne, to serve as personal representatives if Lyobov predeceased him. Lyobov died, and David was Child’s primary caregiver until 2018, when he was diagnosed with severe dementia and declared incapable of parenting. The guardian appointed to represent David was unable to find a relative to care for Child, and David’s parental rights were terminated. Child was placed in the custody of the Department of Children and Families, and in 2019, was adopted by Amy Kozel and given a new middle and last name. After the termination of parental rights and subsequent adoption, David died in 2020 and his cousins, John and Anne, filed a petition for administration. Child sought a determination that he was a beneficiary under the will, which was opposed by John and Anne on the basis that although David wanted Child to inherit under the will, Child was no longer David’s son at the time of David’s death. The trial court ruled that Child could inherit from David under his will. John and Anne filed an appeal.

The District Court of Appeals of Florida affirmed the trial court’s ruling. Although Fla. Stat. § 63.172 generally provides that a judgment of adoption terminates the legal relationship between the adopted person and their relatives, there is an exception regarding “rights of inheritance,” which are governed by the Florida Probate Code. In situations in which there is a will, “[t]he intention of the testator as expressed in the will controls the legal effect of the testator's dispositions.” Fla. Stat. § 732.6005(1). In determining the testator’s intentions, the court must read the entire instrument, rather than relying on “isolated words, phrases, and . . . paragraphs.” Taulbee v. Kozel, 354 So. 3d at 620. Once the testator’s intent is determined, “the entire will should be considered and construed liberally to effectuate the testator’s intent.” Id. (quoting McKean v. Warburton, 919 So. 2d 341, 344 (Fla. 2005)).

John and Anne’s primary argument was that because Child’s name was changed at his adoption, the child named in David’s will no longer existed. However, the court noted that “courts have universally given effect to the intent of the testator even when a beneficiary is identified by a name different than his or her legal name in a testamentary document.” Id. at 620. Accordingly, the adoption, name change, and termination of David’s parental rights did not change his intention as expressed in his will to devise his assets to Child. Because the will unambiguously expressed that intention, the trial court’s ruling that Child was David’s beneficiary was correct.

Takeaways: In Estate of Franco, on remand, if the Morenos can establish that Marilyn and Frank Sr. were cohabiting at the time of Frank Jr.’s conception and birth, Frank Jr. may be prevented from inheriting from Roy under California’s intestacy statute even if they had developed a close and loving relationship after Frank Jr. discovered that Roy was his biological father. If Roy intended for Frank Jr. to be his beneficiary, he should have executed a will naming Frank Jr. as a beneficiary of his estate, potentially preventing years of litigation. As demonstrated in Taulbee v. Kozel, courts will honor the clearly expressed intention of testators to benefit their biological children even when they do not have a legal relationship.

US Supreme Court Holds Debt Incurred Due to a Partner’s Fraud Is Not Dischargeable Under Bankruptcy Code

Bartenwerfer v. Buckley, No. 21-908, 143 S. Ct. 665 (Feb. 22, 2023)

In 2005, Kate and David Bartenwerfer purchased a house in San Francisco. As business partners, they decided to remodel the house and sell it with the hope of making a profit. David was actively involved in the project, but Kate was not. David hired the architect, contractor, and other professionals and monitored and paid for their work. They eventually sold the house to Kieran Buckley, attesting that they had disclosed all material facts relating to the property. However, after he purchased the house, Buckley discovered defects that they had not disclosed, including problems with the roof, windows, fire escape, and permits. He sued Kate and David in a California court, alleging that he had paid too much for the house based on their misrepresentations, and received a judgment for more than $200,000 in damages.

The Bartenwerfers were unable to pay the judgment and filed for relief under chapter 7 of the Bankruptcy Code. Buckley filed an adversary complaint asserting that the $200,000 in damages the Bartenwerfers owed him was nondischargeable under U.S.C. § 523(a)(2)(A), which bars the discharge of debts to the extent the money was obtained by “false pretenses, a false representation, or actual fraud.” At trial, the bankruptcy court determined that the evidence showed that David had knowingly concealed the house’s defects from Buckley and that his fraudulent intent should be imputed to Kate because they had formed a legal partnership to “flip” the house. The Bankruptcy Appellate Panel disagreed that David’s fraudulent intent would bar Kate’s debt from being discharged. In a second trial, the court determined that Kate did not have the requisite knowledge of David’s fraud and that her debt to Buckley was dischargeable. The Bankruptcy Appellate Panel affirmed the judgment, but the Ninth Circuit reversed.

The Supreme Court granted certiorari to clarify the meaning of U.S.C. § 523(a)(2)(A), which states in relevant part: 

A discharge under section 727 . . . of this title does not discharge an individual debtor from any debt . . . 

(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by—

(A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor's or an insider's financial condition.

Kate argued that the statute should be read to bar the discharge of debts for money obtained by the debtor’s fraud and should not bar discharge for debtors who did not commit fraud. The court disagreed, however, based on the use of the passive voice in the wording of the statute. The court found that “[p]assive voice pulls the actor off the stage,” and that Congress had framed U.S.C. § 523(a)(2)(A) to “focu[s] on an event that occurs without respect to a specific actor, and therefore without respect to any actor's intent or culpability.” Bartenwerfer v. Buckley, No. 21-908, 143 S. Ct. 665, 671 (Feb. 22, 2023) (quoting Dean v. United States, 556 U.S. 568, 572 (2009)). In the context of common law fraud, liability is not limited to the wrongdoer; rather, principals are liable for the fraud of their agents and one partner may be liable for the fraud of another partner.

Although Kate argued that exceptions to discharge should be “confined to those plainly expressed,” the court ruled that it had never used that principle to “artificially narrow ordinary meaning.” Further, the court rejected Kate’s contention that neighboring statutory provisions required action by the debtor supported her argument that § 523(a)(2)(A) should also be read to require a culpable act by the debtor. Instead, the court held that, where Congress included language in one section of a statute but not in another, “we take the choice to be deliberate.” Id. at 673 (quoting Badgerow v. Walters, 596 U.S. ___, 142 S. Ct. 1310, 1318, 212 L. Ed. 2d 355 (Mar. 31, 2022)).

The court further relied on its earlier decision in Strang v. Bradner, 114 U.S. 555, 561 (1885), in which it held that, although the statute required the debt to be created by the fraud “of the bankrupt,” “[t]he fraud of one partner . . . is the fraud of all because “[e]ach partner was the agent and representative of the firm with reference to all business within the scope of the partnership.” Id. at 674 (quoting Strang v. Bradner, 114 U.S. at 561). Moreover, in a subsequent overhaul of the Bankruptcy Code, Congress deleted the language “of the bankrupt” from the discharge exception for fraud, implying that Congress embraced Strang’s holding. Although Kate would be held liable for a fraud she did not commit and was barred under the Bankruptcy Code from discharging that debt, Congress “has “evidently concluded that the creditors’ interest in recovering full payment of debts” obtained by fraud “outweigh[s] the debtors’ interest in a complete fresh start,” Grogan v. Garner, 498 U.S. 279, 287 (1991), and it is not our role to second-guess that judgment.” Id. at 676.

Takeaways: The Bartenwerfer court itself mentions one important takeaway: partners can organize as limited liability entities to protect the individual partners or members from exposure to the business’s debts. Although fraud committed by one member of a limited liability company (LLC) may lead a court to pierce the entity veil, allowing the injured party to sue that member personally, the personal assets of other members not involved in or aware of the fraud generally remain protected. Had Kate and David formed an LLC, Kate would likely not have been held liable for David’s fraud, and her debt would have been dischargeable under the Bankruptcy Code.

U.S. Copyright Office Issues Guidance on Works Containing Material Generated by Artificial Intelligence

Copyright Registration Guidance: Works Containing Material Generated by Artificial Intelligence, 88 Fed. Reg. 16190 (Mar. 10, 2023)

In guidance effective March 16, 2023, the U.S. Copyright Office (Office) addressed whether new content produced by artificial intelligence (AI) technology that is trained on preexisting works by human authors is protected by copyright, whether works generated jointly by human authors and AI may be registered, and what information must be provided by applicants seeking to register those works. 

The guidance discusses the well-established requirement that copyright can only protect material that is the creative product of a human author, and that it “will not register works produced by a machine or mere mechanical process that operates randomly or automatically without any creative input or intervention from a human author.” (quoting U.S. Copyright Office, Compendium of U.S. Copyright Office Practices § 313.2 (3d ed. 2021)). 

In determining whether works containing AI-generated content are protected by copyright, the Office stated that it will perform a case-by-case inquiry to consider “whether the AI contributions are the result of ‘mechanical reproduction’ or instead of an author’s ‘own original mental conception, to which [the author] gave visible form.’” (quoting Burrow-Giles Lithographic Co. v. Sarony, 111 U.S. 53, 60 (1884)). When an AI technology produces a work solely in response to a prompt from a human, and the AI technology, not the human, determines the “expressive elements” of its output, the content generated is not the product of human authorship and is not protected by copyright. In cases in which a work contains sufficient human authorship in addition to AI-generated material, for example, because the human has arranged or modified the AI-generated material, the copyright will protect only “the human-authored aspects of the work, which are ‘independent of’ and do ‘not affect’ the copyright status of the AI-generated material itself.” (quoting 17 U.S.C. § 103(b)).

Applicants must disclose the inclusion of AI-generated content in works submitted to the Office for registration and describe the human author’s contributions to it. They must use the Standard Application to claim copyright protection for their contributions to the work and must explicitly exclude AI-generated content that is more than de minimus from the application. To ensure their registration is effective, applicants who previously submitted applications for works containing AI-generated material must correct their information if necessary. Those whose copyrights have already been registered must submit a supplementary registration to disclose any AI-generated material. If the Office determines there is sufficient human authorship, it will issue a new supplementary registration containing a disclaimer regarding the AI-generated content. Failure to update the record may result in loss of the benefits of registration.

Takeaways: Applicants should adhere to the Office’s guidance to ensure content generated by a human receives the benefits of copyright registration. This guidance is part of the Office’s AI initiative to address copyright issues impacted by AI. Later this year, it will seek public input on a variety of issues, including the application of copyright law to the use of copyrighted works in AI training and the treatment of the outputs based on that training. Announcements and upcoming events addressing copyright-related issues raised by AI are available on the Office’s website.

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