Current Developments in Estate Planning and Business Law: August 2021

Aug 13, 2021 10:00:00 AM


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From penalties for the nonwillful failure to file reports of foreign financial accounts to new consumer privacy legislation, 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.

Penalties for Nonwillful Failure to Timely File IRS Report of Foreign Bank and Financial Accounts Survive Taxpayer’s Death

United States v. Gill, No. H-18-4020, 2021 WL 2682533 (S.D. Tex. June 30, 2021)

The Bank Secrecy Act requires “United States persons,” including citizens, residents, corporations, partnerships, limited liability companies, trusts, and estates, to report certain foreign financial accounts (bank accounts, brokerage accounts, and mutual funds) to the US Treasury and maintain records for those accounts. Failure to comply with these Report of Foreign Bank and Financial Accounts (FBAR) reporting and recordkeeping requirements may result in civil monetary or criminal penalties. 

In United States v. Gill, the United States District Court for the Southern District of Texas addressed the issue of whether the civil penalties imposed for a nonwillful failure to file an FBAR survive a taxpayer’s death. The United States filed a complaint against Jagmail Gill (Gill) on October 14, 2018, asserting that he failed to report foreign income on his income tax returns for 2005 through 2010 and failed to disclose that he had an interest in or had signature authority, control, or authority over foreign bank accounts with a total balance of more than $10,000. The United States asserted that Gill’s failure to file was nonwillful. The Internal Revenue Service (IRS) assessed FBAR penalties of $748,848, and the United States filed a lawsuit in December 2019 after Gill did not pay the penalties. 

Gill passed away on April 2, 2020, in the United Kingdom, and the United States filed a motion to appoint and substitute a personal representative for Gill’s estate. Gill’s counsel filed an opposition on the basis that the United States’s claims did not survive his death. On March 15, 2021, counsel for Gill’s wife notified the court that Mrs. Gill had been appointed as the representative of his estate, and Gill’s estate (Estate) filed a motion to dismiss. The Estate asserted that the question of whether claims under a federal statute survive death turns on whether the primary purpose of the statute is remedial or penal, and that a claim against the Estate survives only if the statute’s primary purpose is remedial. According to the Estate, the primary purpose of the FBAR penalties is penal, providing a recovery for the general public, not individual restitution, and the penalties are disproportionate to any harm suffered by the United States. The United States argued that the FBAR penalties automatically survive pursuant to 28 U.S.C. § 2404 (“civil action for damages commenced on behalf of the United States or in which it is interested shall not abate on the death of a defendant but shall survive and be enforceable against his estate as well as against surviving defendants”), and alternatively, that the FBAR penalties are remedial, compensating the United States for harm.

In determining whether the primary purpose of the FBAR penalties is penal or remedial, the court noted that neither the Estate nor the United States had cited a case considering whether FBAR penalties for nonwillful conduct are primarily remedial or penal. Nevertheless, the court was more persuaded by the case law finding FBAR penalties to be primarily remedial. Noting that the amount of the penalty increases with the number of unreported accounts, the court found that they are not wholly disproportionate to the harm to the United States. In addition, although the Senate committee report explaining the inclusion of penalties for nonwillful FBAR violations and the IRS Manual’s discussion of FBAR penalties suggested a deterrent purpose, this was not enough for the court to find that the primary purpose was penal rather than remedial in light of the number of cases involving willful violations that had been decided otherwise. Because the question was a “close call” and ambiguities in the law must be resolved at the motion to dismiss stage in favor of the plaintiff—here, the United States, —the court denied the Estate’s motion to dismiss.

Takeaways: At the time of writing, no appeal had been filed in the Gill case. In light of the court’s decision that penalties assessed for nonwillful FBAR violations survive death, it is crucial for taxpayers who have foreign accounts to ensure that they have met the FBAR reporting and recordkeeping requirements. Because FBAR penalty claims, even for nonwillful violations, survive the death of the taxpayer, the risk of substantial penalties impacts not just taxpayers but also their heirs after their death.

Executor May Be Personally Liable for Unpaid Estate Tax When Distributions Are Made after Receiving Notice of Deficiency

Estate of Lee v. Comm’r of Internal Revenue, T.C.M. (RIA) 2021-092 (July 20, 2021)

Kwang Lee died on September 30, 2021. Anthony Frese (Frese), a licensed attorney and municipal court judge, was named executor of Lee’s estate (Estate). In May 2003, Frese filed a Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. After examining the Estate’s tax return in 2006, the IRS determined that there was a $1,020,129 estate tax deficiency, and that the Estate owed a $255,032 penalty for untimely filing and a $204,026 accuracy-related penalty. The IRS mailed a notice of deficiency to Frese in April 2006. In July 2006, Frese filed a petition for redetermination of the deficiency in the tax court, which entered a decision in 2010 reducing the amount of the deficiency to $536,151 with no penalties. The Estate submitted a request for a hearing with the IRS Office of Appeals after the Commissioner of Internal Revenue sent a Notice of Federal Tax Lien Filing in 2013. The case was suspended until 2016, when the Estate submitted forms showing that its only asset was a checking account with a balance of $182,941 and an Offer in Compromise (OIC) for that amount.

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Frese had made distributions totaling $1,045,000 from July 2003 to February 2007, including $640,000 distributed in February 2007. In considering the Estate’s OIC, the Commissioner’s settlement officer determined that the IRS could potentially collect the distributed amounts from Frese under a fiduciary liability theory (31 U.S.C. § 3713). The settlement officer rejected the Estate’s OIC and sustained the filing of the notice of federal tax lien because the amount of the distributions exceeded the outstanding estate tax liability. The Estate challenged the settlement officer’s determination in the tax court, in part on the basis that the distributed amounts were improperly included in the calculation. The Commissioner filed a motion for summary judgment, asserting that there were no disputed issues of material fact and that the settlement officer’s determination was proper as a matter of law.

The tax court granted the Commissioner’s motion for summary judgment on the basis that the executor of an estate is personally liable for unpaid claims of the United States if the executor, with knowledge or notice of the government’s claim, distributes assets from the estate that render the estate unable to satisfy the Commissioner’s deficiency claim. The Commissioner’s notice of deficiency, which the court held was sufficient to provide notice of the government’s claim, was issued to Frese before he made the February 2007 distribution. In addition, the facts in the record showed that Frese had actual knowledge of the claim at the time of the February 2007 distribution, as he was a named party in the July 2006 petition filed with the court disputing the claim. There was no evidence to show that Frese, an attorney and judge, relied upon the advice of the Estate’s tax advisor in making the February 2007 distribution. Thus, “Mr. Frese made the February 2007 distribution at his own peril, and any advice he may have received in this regard cannot absolve him from liability.” The court determined that the settlement officer’s decision to reject the Estate’s OIC and sustain the Commissioner’s lien act was not arbitrary or capricious.

Takeaways: Personal representatives who receive notices of deficiency should consider themselves on notice of the government’s claim, even if they dispute the amount of the liability and despite what their counsel indicates the outcome of the case will be. 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. Personal representatives should request (nine months after filing the estate tax return to allow time for processing) and wait to receive an estate tax closing letter before distributing the assets of the estate. If state-level tax returns were also filed, estate tax closing letters should also be requested from each state’s taxing authority. Because of restrictions due to COVID-19, the IRS will currently only accept a request for an estate tax closing letter by facsimile to (855) 386-5127 or (855) 386-5128. Alternatively, an acceptable substitute for a closing letter may be an account transcript available online to authorized tax professionals reflecting the acceptance of Form 706 and the completion of an examination. However, an account transcript may not be sufficient in states with probate laws that require filing estate tax closing letters with the probate court. If beneficiaries are demanding distributions before the personal representatives have received estate tax closing letters, the personal representatives should look to their states’ laws for limitations on beneficiaries’ powers to compel distributions before the estate tax is paid or security provided. To the extent those protections are unavailable, personal representatives should consider utilizing a receipt, release, refunding, and indemnification agreement in which the beneficiaries agree to refund and indemnify the personal representatives for any overpayments or erroneous distributions in return for an early partial distribution of the beneficiaries’ shares. The amount of the partial distribution is ultimately the decision of the personal representatives and depends on how much personal risk they are willing to assume.

Michigan Court of Appeals Finds Ex-Spouse Waived Claim to Stock Distributed by Decedent’s Trust 

In re Gerald F. Johnson Revocable Trust, No. 351134, 2021 WL 2493533 (Mich. Ct. App. June 17, 2021) 

Barbara Johnson and the decedent, Gerald Johnson, divorced in 2008. As part of the divorce, Barbara and Gerald entered into a settlement agreement distributing the marital assets and setting Barbara’s spousal support at $10,000 a month. Paragraph 4.D of the settlement agreement stated as follows:

[Gerald] shall have as his sole and separate property, free of any claim thereto by [Barbara], except as hereinafter stated to the contrary, the following assets, . . . 

  1. All of his right, title and/or interest in a business known as Novi Spring, Inc. located in Brighton, Michigan, including but not by way of limitation, all stock therein, contents, licenses and real estate where it is located.

An additional provision in paragraph 4.J stated “[Gerald] shall retain as his sole and separate property and be free of any claim from [Barbara] (except which is hereinafter stated to the contrary), all of the other assets of the parties, including but not by way of limitation, all the business interests . . . not herein otherwise awarded and divided between the parties.” A further catch-all provision in paragraph 4.L stated that property retained by Gerald and Barbara would be held by them “with full power to him or her to dispose of same as fully and effectively, in all respects and for all purposes as though he or she were unmarried.”

Gerald held the Novi Spring stock in a revocable trust until his death in 2017. The trustee then transferred the stock to three Novi Spring employees pursuant to the terms of the trust agreement. Barbara filed a petition in the probate court asserting that she should be allowed to reach the stock for continued spousal support and that the stock should be returned to the trust pending litigation in the circuit court related to the modification of spousal support. The probate court dismissed Barbara’s petition on the basis that she had failed to state a claim upon which relief could be granted because the plain terms of the settlement agreement established that Gerald had received the stock as his separate property and Barbara had waived any claim she may have had against it.

Barbara appealed the probate court’s ruling based upon paragraph 11 of the settlement agreement, which stated that except as otherwise expressly stated, the parties agreed to release each other from claims “up to the date of the execution of this Agreement.” She asserted that because the clauses in paragraphs 4.D, 4.J, and 4.L did not expressly state that they applied to all claims after the date of the execution of the settlement agreement, she waived only claims to the stock up to that date. 

The court of appeals affirmed the probate court’s ruling, however, stating that there was no indication that paragraph 11, which addressed claims leading up to the time of the settlement agreement, modified paragraphs 4.D, 4.J, and 4.L, which addressed property division and individually held assets. Further, the paragraph 4 provisions were more specific than paragraph 11, and therefore, controlled.

The court also rejected Barbara’s assertion that any waiver she made in the settlement agreement would be invalid and against public policy, relying on prior case law, including its decision in Staple v. Staple, 616 N.W.2d 219 (Mich. App. 2000). In Staple, the court held that parties to a divorce settlement agreement could waive their statutory rights to spousal support. Thus, Barbara could “certainly contract away claims to a particular asset, i.e., stock.” 

Takeaways: The court relied upon contractual principles to determine that one spouse’s contractual waiver of rights to the other spouse’s asset bars the waiving spouse from reaching that asset to satisfy their other potential claims or rights. Some commentators have pointed out that the court disregarded (and Barbara apparently did not raise the issue of) Michigan’s probate statute and trust code, under which she arguably could have stated a claim. It remains to be seen whether an appeal will be filed. Although In re Gerald F. Johnson Revocable Trust is unpublished and therefore not binding, careful drafters of property settlement agreements should think twice before including language awarding property to one spouse free and clear of any right or claim of the other spouse. 

United States Supreme Court Strikes Down California Donor Disclosure Regulation

Americans for Prosperity Foundation v. Bonta, 141 S. Ct. 2373 (July 1, 2021)

Two tax-exempt charities filed suit, asserting that a regulation that requires charitable organizations soliciting funds in California to file with the state attorney general’s office copies of their IRS Form 990, including the Schedule B to Form 990 with the names and addresses of their major donors, was unconstitutional. Although the charities had declined to file unredacted Form 990s for years without incurring any consequences, the attorney general’s office increased its enforcement efforts in 2010, ultimately threatening to suspend the charities’ registrations and impose fines for noncompliance. After years of proceedings, the Ninth Circuit Court of Appeals rejected the charities’ argument and denied a rehearing en banc. The United States Supreme Court granted certiorari.

The Supreme Court reversed and remanded, ruling that California’s disclosure requirement burdened donors’ First Amendment right to freedom of association and was not narrowly tailored to an important government interest. Compelled disclosure is subject to an “exacting scrutiny” standard, whereby there must be a “substantial relation between the disclosure requirement and a sufficiently important government interest.” That is, the disclosure required by the government must be narrowly tailored to the interest asserted by the government. The Court held that the Ninth Circuit’s failure to impose a narrow tailoring requirement was in error, as it was contrary to Supreme Court precedent. Moreover, the Court found that “a dramatic mismatch exists between the interest the Attorney General seeks to promote and the disclosure regime that he has implemented.”

Although the Court acknowledged that California’s asserted interest in preventing charitable fraud and self-dealing was important, the information on the Schedule B was not an integral part of California’s fraud detection efforts and was sought merely for ease of administration. In addition, alternative means, such as subpoenas and audit letters, were available to obtain the names and addresses of donors. The Court held that “[m]ere administrative convenience does not remotely ‘reflect the seriousness of the actual burden’ that the demand for Schedule Bs imposes on donors’ association rights.” In reversing the Ninth Circuit, the Court held that the attorney general’s disclosure requirement was unconstitutionally overbroad, lacking “any tailoring to the State’s investigative goals.” 

Takeaways: The Supreme Court’s ruling has implications for three other states—New York, New Jersey, and Hawaii—which also require charities to provide a copy of their Schedule B. Lawyers handling charitable disclosures in those states should keep an eye out for possible changes in the laws. The ruling has been supported across the ideological spectrum by groups concerned that such disclosure requirements could result in harassment by political opponents.

Colorado Privacy Act Signed into Law

Colo. Rev. Stat. §§ 6-1-1301 to 6-1-1313 (July 7, 2021)

On July 7, 2021, Colorado became the third state to enact a comprehensive consumer privacy protection law. California and Virginia previously passed similar statutes. Although there are certain exclusions, the Colorado Consumer Privacy Act (Act) applies generally to companies that conduct business in Colorado or deliver commercial products or services intentionally targeted to Colorado residents and that either (1) control or process the personal data of 100,000 or more consumers during a calendar year, or (2) derive revenue or receive a discount on the price of goods or services from the sale of personal data and process or control the personal data of 25,000 or more consumers.

The Act will allow residents of Colorado to access, correct, and delete personal data and opt out of the sale, collection, and use of personal data. It does not create a private right of action, but is enforceable only by the Colorado attorney general or district attorneys.

Takeaways: The effective date of the Act is July 1, 2023, but businesses within its scope should begin to make any adjustments necessary to ensure they comply with the new law. Violations will be considered deceptive trade practices under the Colorado Consumer Protection Act and will be subject to fines of up to $20,000 per violation and up to $50,000 if the violation is against an elderly person.

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