Current Developments in Estate Planning and Business Law: December 2021

Dec 17, 2021 10:00:00 AM


monthly-recap (1)

From the announcement of the increased annual exclusion and gift and estate tax exemption for 2022 to the release of proposed regulations implementing the Corporate Transparency Act, 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.

IRS Releases 2022 Annual Exclusion and Estate, Gift, and Generation-Skipping Transfer Tax Exemption Amounts

Rev. Proc. 2021-45, 2021-48 I.R.B. 764 (Nov. 10, 2021)

On November 10, 2021, the Internal Revenue Service (IRS) issued Rev. Proc. 2021-45, which provides inflation adjustments for sixty-two sections of the Internal Revenue Code (I.R.C.). Most notably, the basic exclusion amount for decedents who die in 2022 was increased to $12.06 million, and the annual exclusion for gifts was increased to $16,000 (last increased in 2018). The “super” annual exclusion for gifts to noncitizen spouses is ​​$164,000 for 2022.

Takeaways: The inflation adjusted amounts above may not apply if the estate and gift tax laws are significantly altered by legislation. A vote on the Build Back Better Act is still pending in the Senate, so practitioners should consult additional guidance if amendments to the IRC are passed.

Transfer of LLC Membership Interests an Indirect Gift

Smaldino v. Comm’r, T.C.M. (RIA) 2021-127 (Nov. 10, 2021)

Louis Smaldino placed numerous rental properties in Smaldino Investments, LLC (LLC), which he owned through a revocable trust. In 2013, he transferred 8 percent of the LLC class B member shares to the Smaldino Dynasty Trust (Dynasty Trust), which he had created in 2012 for the benefit of his children and grandchildren. His wife, Agustina, was not a beneficiary of the Dynasty Trust. At the same time as the transfer to the Dynasty Trust, Louis attempted to transfer approximately 41 percent of the LLC class B member interests to Agustina. However, the transfer did not comply with the terms of the operating agreement, and the operating agreement was never amended to reflect her supposed membership interest. One day after Louis’s purported transfer to Agustina, she took steps to transfer the LLC member interests to the Dynasty Trust.

On his 2013 gift tax return, Louis reported only the 8 percent of the LLC membership interests he had transferred to the Dynasty Trust. The IRS determined that the 41 percent interest purportedly transferred to the Dynasty Trust by Agustina was merely an indirect gift from Louis to the Dynasty Trust. Consequently, the IRS determined that Louis had in fact made a taxable gift to the Dynasty Trust of 49 percent of the class B LLC membership interests and that Louis had a gift tax deficiency of $1,154,000.

Louis did not dispute that the transactions were designed to use Agustina’s estate and gift tax exemption in the transfer of ownership of 49 percent of the LLC class B membership interests to the Dynasty Trust. Agustina acknowledged that she had promised Louis that she would transfer the LLC membership interests to the Dynasty Trust.

To support its position that the attempted transfers of the LLC membership interests from Louis to Agustina and then from Agustina to the Dynasty Trust were simply an indirect gift from Louis to the Dynasty Trust, the IRS cited well established precedent that the substance rather than the form of a transaction determines its tax consequences. Louis sought to distinguish the cases cited by the IRS on the basis that they did not involve an interspousal transfer. He argued that the IRS should respect his transfer of the LLC membership interests to Agustina because I.R.C. section 2523 exempts interspousal transfers from gift tax and that its legislative history showed that Congress intended for spouses to be treated as “one economic unit.” 

The Tax Court disagreed, finding that because the transfer of the LLC membership interests did not comply with the operating agreement, it was not effective to transfer any membership interest in the LLC to Agustina, making I.R.C. section 2523 inapplicable. Rather, the tax court held that the Dynasty Trust received the entire 49 percent of the class B membership interests as a gift from Louis. 

Takeaways: Although the Tax Court held that the attempted transfer of the LLC interests to Agustina was ineffective in form, it is not clear that an effective transfer would have changed the court’s decision. Arguably, the court could still have collapsed the transaction under the substance-over-form doctrine: the undisputed facts of the case demonstrated that the couple’s intention was to transfer the LLC interests to the Dynasty Trust and that Agustina never intended to hold the LLC interests. As noted by the court, the tax consequences of a transaction involving a straw party must be determined with regard to the true beneficial interests involved. Transactions that “do not vary, control or change the flow of economic benefits” must be “dismissed from consideration.” To reduce the risks of Smaldino-like outcomes, taxpayers should respect the form and substance of their transactions, for example, by following governing documents, allowing transferees to experience the economic and legal realities of ownership (such as distributions and voting), making their income tax reporting consistent with their characterizations for wealth transfer tax purposes, avoiding prearranged plans, and allowing time between transactions that could be perceived as having been prearranged.  

Massachusetts Court Holds Agent under Power of Attorney Failed to Prove She Had Not Unduly Influenced Principal

Coscia v. Sweezey, 175 N.E.3d 1243 (Mass. App. Ct. 2021) (unpublished table decision)

Prior to suffering a stroke in 2013, Russell Sweezey stated that he wanted to leave the family home to all five of his adult children. After his stroke, his daughter Laura moved to Massachusetts to care for her parents, who suffered from dementia, cancer, and diabetes. She described them as “mentally incapacitated” and needing “24/7 care.” Laura moved into the family home in April 2014, and in September 2014, she suggested to Russell that he should execute a durable power of attorney appointing her as his attorney-in-fact. Russell executed the power of attorney, and Laura took complete control of her parents’ finances. After Russell was diagnosed with Alzheimer’s disease, Laura took him to his medical appointments. 

Shortly after her mother died in 2015, Laura scheduled a meeting with an estate planning attorney, which she attended with Russell. Laura provided the attorney with information about the family and a letter from Russell’s doctor opining that Russell was competent. She later sent a message to the attorney stating: “For passing on the house, I’m thinking a trust may be better than a will, to avoid probate court, expenses and delays.” The attorney met with Russell alone for ten to fifteen minutes at a meeting two months later to execute the trust documents. The attorney believed that Russell understood the terms of the trust, which named Russell as the settlor and Laura as the sole trustee and beneficiary. Russell executed documents creating the trust and transferring the family home to Laura as trustee. Laura changed the beneficiary designation on Russell’s retirement account, naming each of her siblings as a beneficiary. Upon Russell’s death in 2017, Laura, who was the administrator of the estate, distributed $5,000 from the retirement account to each of her siblings and transferred the family home from the trust to herself.

Laura’s siblings contested the distribution, asserting that Russell had been subject to undue influence by Laura. The Massachusetts Appeals Court noted in an unpublished decision that although those contesting the distribution normally bear the burden of proving undue influence, the burden shifts when someone who is a fiduciary under a power of attorney “was fully involved in all the undertakings relative to the revisions of the testator’s will and estate plan, yielding the beneficial inheritance; and exercised expansive power over the testator’s finances.” As a result, the lower court’s inference that Laura had “played an instrumental role in arranging for the trust and the deed to be drafted and executed” was reasonable. The court found no clear error in the lower court’s findings that (1) Russell was susceptible to Laura’s influence; (2) Laura had provided no credible evidence of a close relationship with Russell that would explain the transfer of the family home to her alone, particularly considering her sibling’s testimony that Russell had stated he wanted the home to go to all the children; and (3) Russell had not received truly independent legal advice.

Takeaways: In some jurisdictions, cases setting aside estate plans created by and executed in the presence of attorneys are rare. But Coscia is such a case. In light of Coscia, even if an estate planning attorney is convinced that a client has the mental capacity to execute estate planning documents, additional caution and thorough recordkeeping are prudent if a person who is favored in the client’s estate plan was also involved in its creation, because that person may have the burden of proof in an undue influence case. Independent attorney advice and explanations of favoritism may also help reduce the likelihood of a successful undue influence claim. 

FinCEN Issues Proposed Rule for Implementation of Beneficial Ownership Reporting under the Corporate Transparency Act

Beneficial Ownership Information Reporting Requirements, 31 C.F.R. §1010 (2021)

The Corporate Transparency Act of 2020 (CTA), found in §§ 6401–6403 of the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021, Pub. L. No. 116-283, 134 Stat. 338, requires that beneficial ownership and applicant information for businesses that meet the definition of a reporting company be reported to the Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN). The CTA defines a reporting company as any corporation, limited liability company (LLC), or other similar entity created by filing a document with the secretary of state or a similar office under the laws of a state or Indian tribe or formed under the laws of a foreign country and registered to do business in the United States. There are a significant number of exemptions from the definition, including the following:

  • Entities subject to substantial federal regulation or supervision, including, for example, banks, credit unions, and insurance companies
  • Publicly traded companies
  • Companies with more than twenty employees that have filed tax returns reporting gross receipts exceeding $5 million that have a physical office in the United States
  • Companies owned or controlled by exempt companies
  • Certain dormant companies

On December 8, 2021, FinCEN issued its proposed regulation for the CTA’s implementation. Limited liability partnerships, limited liability limited partnerships, business trusts, and most limited partnerships are identified in the proposed regulation as within the definition of a reporting company. Subsidiaries wholly owned by a reporting company are excluded from the definition of a reporting company.

Business entities that meet the definition of a reporting company must provide information such as the full legal name, date of birth, current address, and a unique identifying number such as a driver’s license or passport number for all beneficial owners (i.e., individuals who own or control 25 percent or more of the ownership interests of the company or who exercise “substantial control” over the company) and company applicants (i.e., the individual who files the document that forms the entity, including anyone who directs or controls the filing of the document by another). The applicant could include, for example, both an attorney who files the document and the paralegal who assists with filing. 

To minimize burdens for long-standing reporting companies formed or registered before the effective date of the regulation and whose company applicant died before the obligation to obtain identifying information arose, the proposed regulation allows the reporting company to report that fact, along with any identifying information the reporting company has about the company applicant.

Pursuant to the proposed regulation, the reporting company must provide a residential address for beneficial owners. However, reporting companies would need to provide the business address for company applicants that provide a business service as a corporate or formation agent. Also, the reporting company must provide its own name, any alternative names such as d/b/a names, its jurisdiction of formation or registration, business address, and a unique identification number. 

The proposed regulation requires that reporting companies file their initial report with FinCEN within fourteen calendar days of the date on which they are created or registered, respectively. At present, FinCEN has not yet established a system for the filings, which must be developed before those filings can be made. Reporting companies will have thirty calendar days to file an updated report if there is a change in the information previously reported.

The regulation also provides guidance about what is considered “substantial control” of a reporting company: (1) service as a senior officer; (2) authority over the appointment or removal of any senior officer or dominant majority of the board of directors or similar body; and (3) direction, determination, or decision of, or substantial influence over its important matters.

The proposed regulation provides that an individual may directly or indirectly control an ownership interest in a reporting company through a trust by way of the individual’s position as (1) a grantor that has retained the right to revoke the trust or otherwise withdraw the assets of the trust, (2) a beneficiary who is the sole permissible recipient of both income and principal from the trust, or has the right to demand a distribution or withdraw substantially all assets from the trust, or (3) a trustee or other individual with the authority to dispose of trust assets.

The reporting company is not required to file an updated report with FinCEN upon the death of a beneficial owner, but an updated report removing the deceased beneficial owner and identifying any new ones is required when the beneficial owner’s estate is settled.

The penalties for noncompliance with the CTA are steep. Businesses that fail to report the required information or provide false or fraudulent information will be subject to a civil penalty of $500 per day during the period of noncompliance. In addition, there are criminal fines of up to $10,000 and the possibility of imprisonment for up to two years. There is no corresponding obligation for the beneficial owners to provide the reporting company with the required information, which could pose a problem if they fail to cooperate.

Takeaways: Attorneys should consider urging clients to identify the beneficial owners and company applicant information in their organizational documents to potentially avoid being considered an applicant themselves. However, it is currently unclear if this will be an effective method for attorneys to avoid having to meet the reporting requirements. There are several other unanswered questions regarding the proposed regulation, including whether a registered series falls within the definition of a reporting company and how reporting companies should handle a situation in which they are unable to obtain the required information from beneficial owners. Public comments must be submitted by February 7, 2022.

Infrastructure Investment and Jobs Act Ends Employee Retention Credit Early; IRS Temporarily Waives Failure to File Penalties for Businesses

Pub. L. 117-58, 135 Stat. 429 (2021); I.R.S. Notice 2021-65 (Dec. 6, 2021)

The employee retention credit was originally provided by the CARES Act as COVID-19 relief for businesses. The credit was extended by the Taxpayer Certainty and Disaster Tax Relief Act and by the American Rescue Plan, which provided the credit for wages paid after June 30, 2021 and before January 1, 2022. However the Infrastructure Investment and Jobs Act, passed November 15, 2021, provides that the employee retention credit shall apply only to wages paid after June 30, 2021 and before October 1, 2021. 

On December 6, 2021, the IRS issued Notice 2021-65 to provide guidance for employers that have already received advance payments of the credit, which is no longer available and must be repaid. The IRS will waive penalties for employers who followed the rules to claim the credit, deposited the amounts initially retained in anticipation of the credit on or before the relevant due date for wages paid on December 31, 2021 (regardless of whether they actually pay them on that date), and reported the tax liability resulting from the termination of the credit on the applicable employment tax return that includes the period from October 1, 2021, through December 31, 2021. The IRS will no longer waive failure-to-deposit penalties for employers that reduce deposits in anticipation of the credit after December 20, 2021.

Takeaways: Given the impending deadline, businesses should quickly take action to comply with the IRS’s guidance to avoid severe penalties for failure to deposit payroll taxes. If an employer does not qualify for relief from penalties, it can appeal to the IRS for “reasonable cause relief.”

Court Must Weigh the Equities to Determine if Outside Reverse Veil Piercing of LLC Is Appropriate

Blizzard Energy v. Schaefers, 2021 WL 5366815 (Cal. Ct. App. Nov. 18, 2021)

A jury in a Kansas court awarded Blizzard Energy a $3.825 million judgment against Bernd Schaefers for fraud. The judgment was later entered in California, and the California trial court added BKS Cambria, LLC (BKS), owned 50 percent by Bernd and 50 by his estranged wife, Karin. BKS and Karin were not defendants in the Kansas case, but the California court determined that BKS was Bernd’s alter ego, justifying outside reverse veil piercing, which arises when the request for piercing is made by a third party outside the targeted business entity—in this case, Blizzard Energy.

Karin moved to intervene in Blizzard’s motion to amend the judgment, claiming that she was an innocent third party who would be inequitably and adversely affected if BKS was added as a judgment debtor. Karin asserted that she lived separate and apart from Bernd pursuant to a separation and property settlement agreement executed in 1996. She further asserted that BKS had been formed in 2001 for real estate management and investment, and that it had purchased an apartment building using proceeds from the sale of her separate property. The apartment building was later sold and the proceeds of that sale were used to pay for the property BKS currently owns. She also asserted that she was retired and not involved with Bernd’s business dealings with Blizzard, and had only recently become aware of the parties involved, the nature of the deal, and the lawsuit. Although the California Court of Appeal agreed that there was sufficient evidence to support the trial court’s finding that BKS was Bernd’s alter ego, it remanded the case to the trial court for further proceedings on the equitable issues consistent with its opinion to determine whether Blizzard’s motion reverse veil piercing should be granted. 

Takeaways: Veil piercing—including outside reverse veil piercing—is an equitable remedy. The California Court of Appeals made clear that even if the trial court determined that Karin was an innocent third party, “whether the motion should be granted or denied is within the trial court’s sound discretion,” and the trial court must weigh the equities to “accomplish ultimate justice.”

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