Current Developments in Estate Planning and Business Law: December 2022

Dec 16, 2022 10:00:00 AM


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From the US Tax Court setting aside Internal Revenue Service (IRS) Notice 2017-10 to clarification of an employer's obligation under the Fair Labor Standards Act to compensate employees for certain preshift duties, 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.

Tax Court Sets Aside Notice 2017-10 Due to IRS’s Failure to Adhere to Notice-and-Comment Requirements

Green Valley Invs., LLC v. Comm’r, 159 T.C. No. 5 (Nov. 9, 2022)

On December 31, 2014, Green Valley Investors and several other limited liability companies (LLCs) granted a conservation easement to Triangle Land Conservancy (Triangle). Another LLC, Vista Hill, also granted a conservation easement to Triangle on December 3, 2015. Green Valley, Vista Hills, and the other entities timely filed Forms 1065, U.S. Return of Partnership Income, on which they deducted substantial sums for their charitable contributions of these conservation easements.

On December 23, 2016, the Internal Revenue Service (IRS) issued Notice 2017-10, which identified all syndicated conservation easement transactions (and substantially similar transactions) that occurred on or after January 1, 2010, as “listed transactions” under Treas. Reg. § 1.6011-4(b)(2). That regulation defines a listed transaction as a transaction that the IRS has determined to be a tax avoidance scheme—or other transactions substantially similar to them—and is identified as a listed transaction by the IRS in a notice, regulation, or other form of published guidance. 

In 2019, the IRS sent the LLCs notices disallowing their claimed deductions for noncash charitable deductions and asserting accuracy-related penalties. The IRS also asserted that the LLCs were subject to reportable transaction penalties under Internal Revenue Code (I.R.C.) § 6662A (imposition of accuracy-related penalty on understatements with respect to reportable transactions), which apply to any item attributable to any listed transaction. In their motion for summary judgment regarding the section 6662A penalties, the LLCs asserted that Notice 2017-10 was procedurally invalid under the Administrative Procedure Act (APA) because the IRS had failed to comply with its notice-and-comment requirements. The IRS also filed a motion for summary judgment, asserting that it did not need to meet the notice-and-comment requirements of the APA because Notice 2017-10 was an interpretive rule and not a legislative rule and Congress had authorized its issuance by procedures other than the APA’s notice-and-comment requirements.

In considering whether Notice 2017-10 was an interpretive or legislative rule, the Tax Court noted that in contrast to interpretive rules, which “merely advise the public of an agency’s construction of the statutes it administers,” legislative rules “impose new rights or duties and change the legal status of regulated parties.” In its opinion, the court examined relevant case law, including the Sixth Circuit Court of Appeals’ decision in Mann Construction, Inc. v. United States, 27 F.4th 1138 (6th Cir. 2022). In Mann Construction, Notice 2007-83, which identified certain trust arrangements as a listed transaction, was invalidated because it was determined to be a legislative rule and the IRS had failed to comply with the APA’s notice-and-comment requirements. 

The Tax Court determined that under I.R.C. § 6707A (penalty for failure to include reportable transaction information with return), Congress had delegated the authority to the IRS to determine which transactions are reportable transactions with a potential for tax avoidance or are similar to those transactions. Notice 2017-10 identifies certain transactions (syndicated conservation easement and similar transactions) as listed transactions for purposes of Treas. Reg. § 1.6011-4(b)(2) and I.R.C. §§ 6111 (general requirement of return, statement, or list) and 6112 (material advisors of reportable transactions must keep lists of advisees, etc.). The court held that “[t]he act of identifying a transaction as a listed transaction by the IRS, by its very nature, is the creation of a substantive (i.e., legislative) rule and not merely an interpretive rule.” This is because the IRS’s identification in Notice 2017-10 of the transaction as a listed transaction imposes new duties on taxpayers and their advisors such as reporting and recordkeeping requirements—and penalties for noncompliance—that would not exist but for the notice. 

The court noted that Notice 2017-10 imposes a significant reporting obligation on taxpayers for listed transactions, which must be reported on Form 8886, Reportable Transaction Disclosure Statement. Form 8886 requires substantial narrative information and information about all individuals and entities involved in the transaction rather than information solely related to the computation of tax. Further, Form 8886 must not only be included with their tax returns, but also must be attached to each amended return and sent to the Office of Tax Shelter Analysis. 

In addition to taxpayers, their material advisors—“anyone who advises with respect to a reportable transaction and receives fees in excess of a threshold amount”—must file Form 8919, Material Advisor Disclosure Statement, which requires specific and narrative information responses, “essentially obligat[ing] the taxpayer’s advisor to become an unwilling advisor to the IRS.” Material advisors are also required to maintain lists identifying parties they have advised regarding listed transactions and information describing the transactions. 

In addition, failure to report a listed transaction may result in a myriad of substantial penalties, not only for taxpayers but also for their material advisors. Taxpayers involved in listed transactions are also subject to enhanced accuracy-related penalties if a taxpayer’s treatment of them is not upheld by a court, even if there is no tax deficiency. Accordingly, the court held: “We cannot see how Notice 2017-10 could be considered an interpretive rule; consequently, we find it to be a legislative rule.”

The court also rejected the IRS’s argument that by enacting I.R.C. § 6707A, Congress had exempted it from following the APA’s normal procedures, allowing it to properly issue Notice 2017-10 without notice-and-comment rulemaking. Although the APA permits an agency to depart from notice-and-comment procedures for good cause, the IRS did not invoke good cause when it issued Notice 2017-10 and, thus, the court declined to consider whether the exception was applicable. In addition, the APA permits its procedures to be modified or superseded by a subsequent statute only to the extent that it does so expressly; it cannot be done by implication. I.R.C. § 6707A and I.R.C. § 6011, which I.R.C. § 6707A references, do not expressly exempt the IRS from the APA’s notice-and-comment requirements. Rather, as noted by the Sixth Circuit in Mann Construction, “[t]he statutes do not say anything, expressly or otherwise, that modifies the baseline procedure for rulemaking established by the APA.” After a thorough analysis, the court held that it was “unconvinced that Congress expressly authorized the IRS to identify a syndicated conservation easement transaction as a listed transaction without the APA’s notice-and-comment procedures, as it did in Notice 2017-10.” As a result, it granted the LLCs’ motion for summary judgment prohibiting the imposition of I.R.C. § 6662A penalties with respect to reportable transactions and set aside Notice 2017-10. 

Takeaways: Although the decision and subsequent order in Green Valley Investors is only applicable to the petitioner, in a footnote, the Tax Court explicitly indicated its intention to set aside Notice 2017-10 for any similarly situated petitioners. This Tax Court decision is one of a growing number of cases that have invalidated IRS notices that were issued without complying with the notice-and-comment requirements of the APA. In addition to the Sixth Circuit’s ruling in Mann Construction, some lower courts have recently come to similar conclusions: CIC Services, LLC v. IRS, 592 F. Supp. 3d 677 (E.D. Tenn. 2022) (IRS Notice 2016-66, classifying microcaptive transactions as “transactions of interest,” was vacated for IRS’s noncompliance with APA); GBX Associates, LLC v. United States, 2022 WL 16923886 (N.D. Ohio Nov. 14, 2022) (Notice 2017-10 set aside in reliance upon Mann Construction for material advisor only; universal vacatur not appropriate or necessary). Taxpayers who have been penalized based on IRS notices issued without complying with the APA’s notice-and-comments requirements now have a stronger negotiating position in tax disputes and should consider challenging the notices rather than settling their disputes. In addition, taxpayers who have paid penalties in prior years arising from transactions identified in such IRS notices should consider filing amended returns.

Watch this space! On December 6, 2022, in response to Green Valley and Mann Construction, the IRS issued proposed regulations that would identify certain syndicated easement transactions as listed transactions. The comment period will remain open until February 6, 2023.

Beneficiaries’ Claim Time Barred: Trustee’s Report Adequately Disclosed Existence of Potential Claim for Breach of Trust

Kilian v. TCF Nat’l Bank, 2022 WL 12073427 (Mich. Ct. App. Oct. 20, 2022)

David, John, and Janice Kilian were beneficiaries of a trust, called the Beryl Kilian Trust (the Trust), which was established by their mother. Seventy percent of the Trust assets were set aside in a separate trust for David, who dealt with mental health struggles, and the remainder was split between John and Janice. The Trust provided for installments of income and property to David, and he was permitted to withdraw the greater of $5,000 or five percent of the value of the trust annually. The Trust owned a majority share of a resort property, Three Pines Resort, and John and Janice owned minority shares.

David served as a co-trustee along with Empire National Bank after his mother’s death in 1996. He removed Empire as co-trustee in 2000 and appointed Northwestern Bank, which was the predecessor to the defendant, TCF National Bank (the Bank). From 2001 to 2014, Northwestern provided statements showing details of the trust accounts, including the beginning and ending market values, receipts, disbursements, and gains and losses. In addition, details about the Trust’s miscellaneous assets were provided for each parcel of property, including their market values, broken down into tax cost basis and unrealized gain and loss. Starting in November 2013, the statements included a notice citing the Michigan Compiled Laws (MCL), stating that “under MCL 700.7905(1) (a), a trust beneficiary has one (1) year from the date this report is sent to commence a proceeding claiming breach of trust.”

Between September 2002 and October 2016, David exercised his right to withdraw five percent of the value of the Trust, but, starting in 2011, the amounts withdrawn were not always properly calculated and documented. However, the actual amounts of the withdrawals were reflected on the account statements. Between 2013 and 2017, various notes by the bank’s agent reflected concerns related to a cottage that was among the Trust’s assets that David had allowed someone to use without a lease and needed repairs, as well as David’s mental health, overspending, and overdrafts. The notes also mentioned meetings in which he was informed that there were insufficient funds to cover expenses for the Three Pines Resort. In October 2017, the Bank resigned as co-trustee, and $488,110 was distributed from the Trust’s account in November 2017.

In 2019, David and his siblings filed a lawsuit against the Bank for breach of trust, waste, breach of fiduciary duty, and fraudulent misrepresentation. They claimed that the Bank had failed to keep adequate records for the Trust, had not kept them informed about relevant facts necessary to protect their interests, and had mismanaged the Three Pines Resort. Among their allegations, they asserted that despite customary practices of certifying appraisals on a regular basis, the appraised value of the Trust’s real estate assets remained unchanged for years at a time. 

The probate court granted the Bank’s motion for summary judgment on the basis that the plaintiffs’ pre-April 1, 2010 claims were time-barred based a provision in the trust document requiring beneficiaries to object within ninety days of receiving an accounting, and the post-April 1, 2010 claims were barred by the one-year limitation in Mich. Comp. Laws § 700.7905, which became effective on that date.

David and his siblings appealed the trial court’s ruling regarding application of the statute of limitations in Mich. Comp. Laws § 700.7905, arguing that because the account statements sent before November 2013 did not include the notice stating that the beneficiaries had a year to file a claim for breach of trust, they should be permitted to pursue claims for five years after the Bank’s resignation as trustee in 2017. 

Mich. Comp. Laws § 700.7905(1)(a) provides that a trust beneficiary is barred from commencing a proceeding more than one year after being sent “a report that adequately disclosed the existence of a potential claim for breach of trust and informed the trust beneficiary of the time allowed for commencing a proceeding.” However, Mich. Comp. Laws § 700.7905(3) states: “If subsection (1) does not apply, a judicial proceeding by a trust beneficiary against a trustee for breach of trust shall be commenced within 5 years after the first of the following to occur: (a) The removal, resignation, or death of the trustee.” David and his siblings asserted that before November 2013, the date on which they began receiving statements with the notice of the statutory limitations period, they did not receive a report disclosing the existence of a claim for breach of trust and informing them of the time during which they could commence a lawsuit as required by Mich. Comp. Laws § 700.7905(1)(a). 

The Michigan Court of Appeals disagreed, holding that, in light of the language and intent of the statute, David and his siblings did not have five years after the resignation of the Bank to file suit for breach of trust. Their interpretation of the statute would not result in “simplicity or clarity” because it would mean that “different limitations periods would apply depending upon whether a trustee included a notice in one report but not another, even if potential claims had been adequately disclosed in previous reports.” Rather, the court held that if at the time of the November 2013 statement, the statements the Bank sent to David and his siblings adequately disclosed any potential claims for breach of trust that had arisen prior to that date, then they had received a report that would satisfy the requirement of Mich. Comp. Laws § 700.7905(1)(a) and the one-year limitation period would apply. 

The court further held that the information that David and his siblings had at the time of each statement was sufficient to inform them that they had potential causes of action: the market values that were listed in the statements—which remained unchanged for years at a time—were sufficient to inform David and his siblings that the Bank was not frequently updating those values. In addition, the court rejected the beneficiaries’ claim that the Bank had failed to inform that David was taking improperly calculated distributions because the statements included both the value of the trust, which remained the same for several years at a time, and the amounts of the distributions to David. Because the statements included a detailed list of income and expenditures, the court also determined that David and his siblings had sufficient knowledge to inquire if the Bank was mismanaging the Three Pines Resort. Mich. Comp. Laws § 700.7905 did not require the Bank to ensure that the Trust’s beneficiaries “clearly understood” the information that was provided to them. As a result, the court affirmed the probate court’s ruling that David and his siblings were barred by the one-year limitations period from bringing an action for breach of trust in November 2019 for the Bank’s actions between April 2010 and November 2013.

Takeaways: Trustees should provide detailed, accurate, complete, and reasonably understandable accountings to beneficiaries who are entitled to them in accordance with applicable state law. In Kilian, the court found that the Bank was required by statute to provide a report that adequately disclosed the existence of a potential claim for breach of trust, and that it had done so, triggering the one-year limitations period. However, the Bank, as trustee, was not responsible for ensuring that the beneficiaries examined the report or understood the information contained in it. 

IRS Cracking Down on Cryptocurrency Tax Crimes

A 2022 NBC News poll indicated that one out of five American adults have traded or used cryptocurrency. However, according to an analysis from Barclays Bank, there may be as much as $50 billion a year in unpaid taxes on cryptocurrency transactions. 

The IRS has begun to provide guidance on virtual currency transactions over the past several years to bring clarity to taxpayers regarding their tax obligations related to virtual currency transactions. In Notice 2014-21, the IRS clarified that virtual currency was to be treated as property rather than currency for federal income tax purposes. Therefore, those who purchase goods or services with cryptocurrency or exchange it are required to report capital gains or losses resulting from those transactions on their tax returns. If someone receives virtual currency as a payment for goods or services, they must report it as gross income using the fair market value of the virtual currency as of the date that they received it. Revenue Ruling 2019-24 provides additional guidance about the tax effects of “hard forks” and “airdrops” of cryptocurrency.

In addition, Form 1040 and its accompanying instructions have been updated to require taxpayers to indicate whether they have engaged in transactions involving virtual currency. Beginning in 2019, Form 1040 included the following question for taxpayers: “Did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” For 2022, the language in Form 1040 has been changed in an effort to provide additional clarity to taxpayers: “At any time during 2022 did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?” 

Bloomberg Tax reports that the IRS intends to prosecute hundreds of cases involving cryptocurrency. Many of the IRS’s cases target money laundering, but about half of them involve tax crimes. Several federal courts have authorized the IRS to use John Doe summonses (which require court approval) on third parties to obtain information regarding entire classes of cryptocurrency users that it would otherwise be unable to identify. Because of the IRS’s efforts to educate the public about their tax-related obligations, the IRS may now be able to prove criminal tax evasion, which requires a showing that the taxpayer voluntarily and intentionally misreported or failed to report virtual currency transactions. 

Takeaways: Taxpayers should keep complete records of their transactions involving digital assets and strive to accurately report gains, losses, and income arising from those transactions. In addition to more IRS prosecution of tax crimes, regulation of cryptocurrency will almost certainly continue to increase. The Infrastructure Investment and Jobs Act, signed into law in November 2021, (1) expands reporting requirements to include digital assets such that brokers or others responsible for providing services effectuating transfers of digital assets must report those transfers on Form 1099-B, and (2) adds digital assets to existing rules requiring that trades or businesses that receive payments of more than $10,000 in cash or digital assets must file Form 8300. These new reporting requirements will enable the IRS to better track virtual currency transactions and will apply to transactions occurring for digital assets acquired on or after January 1, 2023.

IRS Releases Final Regulations on Exception of Special Enforcement Matters from the Centralized Partnership Audit Regime

Treatment of Special Enf’t Matters, 26 C.F.R. § 301 (2022)

The Bipartisan Budget Act of 2015 (BBA) created the centralized partnership audit regime that generally provides for examination and collection of underpayments at the partnership level. The BBA audit rules became effective for taxable years beginning on or after January 1, 2018, and apply to any entity that elects to be treated as a partnership for tax purposes, including most LLCs. Partnerships to which the audit regime applies choose a representative to act on their behalf during the audit process. On January 2, 2018, the IRS released final regulations on electing out of the centralized partnership audit regime.

On December 9, 2022, the IRS issued final regulations specifying certain “special enforcement matters” (termination and jeopardy assessments, criminal investigations, indirect methods of proof of income, bankruptcy and receivership, and prompt assessment) to which the centralized audit process does not apply. In addition, the final regulations update the existing regulations to reflect changes in the tax code.

Takeaways: These regulations took effect December 9, 2022. According to IRS Notice 2019-06, the regulations are intended to enable the IRS to “effectively and efficiently” focus on a single partner or a small group of partners regarding special enforcement matters without causing an undue burden on the partnership or creating procedural concerns.

Supplier Obligated to Provide Reasonable Notice of Termination under Michigan’s Uniform Commercial Code

Stackpole Int’l Engineered Prods., Ltd. v. Angstrom Auto. Grp., 52 F.4th 274 (6th Cir. Oct. 24, 2022)

In 2014, Stackpole International, a manufacturer of car parts such as transmissions and engine oil pumps, issued a Letter of Intent to Angstrom Automotive, a management company overseeing Precision Metals, a manufacturer of automotive subcomponents, specifying that Stackpole would purchase a large quantity of pump shafts from Precision Metals and would issue purchase orders for each part. The Letter of Intent was signed by the vice president of business development for Angstrom. In early 2015, Stackpole sent the purchase orders, which contained six pages of supplemental terms, including a provision allowing Stackpole to terminate the contract at any time and for any reason by providing written notice of termination. Although the purchase orders stated that they would not become binding until they were signed and returned, neither party signed them. Nevertheless, Precision Metals quickly began shipping parts to Stackpole.

In 2017, Precision Metals determined that it was not able to continue to produce the pump shafts for the contract price. It informed Stackpole that the price would need to increase or it would halt production of the pump shafts. Stackpole agreed to the price increase under protest, but later filed suit against Angstrom and Precision Metals for breach of contract. Precision Metals and Angstrom filed a counterclaim asserting that Stackpole had unreasonably refused to approve a more efficient production process.

The district court found that Stackpole, Angstrom, and Precision Metals had formed a contract for successive performances that was of an indefinite duration and thus was presumptively terminable upon reasonable notification under Michigan’s version of the Uniform Commercial Code (UCC). At trial, the jury considered whether Angstrom had given Stackpole reasonable notice of termination when it threatened to terminate its shipments. The jury found that it had not and awarded Stackpole approximately $1 million in damages.

On appeal, the Sixth Circuit Court of Appeals agreed, holding that the Letter of Intent was a binding contract to which both Angstrom and Precision Metals were parties. Further, Angstrom and Precision metals had an obligation to supply the pump shafts until they offered reasonable notice of termination. The Letter of Intent provided for successive performances and was indefinite in duration, but it did not address termination rights. The initial quotes provided by Angstrom also did not address termination rights. The purchase orders were never signed by Angstrom or Precision Metals, and in any case, the fact that they authorized Stackpole to terminate at any time did not provide a parallel right to Angstrom and Precision Metals. Accordingly, the court affirmed the district court’s judgment that Angstrom and Precision Metals had an obligation to provide reasonable notice prior to terminating the contract.

Takeaways: In contracts for sale of goods, the UCC imposes certain obligations not addressed in the parties’ contract. As discussed in Stackpole, unless an agreement for the sale of goods dispenses with notification of termination (assuming doing so would not be unconscionable), reasonable notice must be provided by the party seeking to terminate the agreement; failure to do so will result in liability for resulting damages.

Fair Labor Standards Act Requires Compensation for Preshift Duties That Are Integral and Indispensable to Principal Job Duties

Cadena v. Customer Connexx, LLC, 51 F.4th 831 (9th Cir. Oct. 24, 2022)

Connexx operates a call center providing customer service and scheduling for an appliance recycling service. Its call center employees were nonexempt and paid hourly. The employees were required to record their hours worked each day using a computer-based timekeeping program. However, to use the program, the employees were required to turn on their computers, log in, and open the timekeeping program. The employees indicated that this process could take as little as one minute but as long as twenty minutes depending on the age of the computer and whether it was off or merely in sleep mode. On average, the employees took between six and twelve minutes to boot up their computers. In addition, it took them between four and seven minutes to log off and boot down the computers.

The employees filed suit alleging, among other things, that Connexx had violated the Fair Labor Standards Act (FLSA) by failing to compensate them for the time spent booting up and down their computers at the beginning and end of their work days. The district court granted summary judgment in favor of Connexx on the basis that these activities were not the employees’ principal activities because they were hired to answer calls and provide scheduling for customers. 

On appeal, the Sixth Circuit Court of Appeals considered the Portal-to-Portal Act, which amended the FLSA to provide that “no employer shall be subject to any liability or punishment . . . on account of the failure of such employer to pay an employee minimum wages, or to pay an employee overtime compensation, for or on account of any of the following activities . . . (2) activities which are preliminary to or postliminary to said principal activity or activities.” In Steiner v. Mitchell, 350 U.S. 247, 256 (1956), the United States Supreme Court held that activities performed before or after the regular work shift are compensable if they are an “integral and indispensable” part of the principal activities for which the employees are employed. In a later decision, Integrity Staffing Sols., Inc. v. Busk, 574 U.S. 27, 36 (2014), the Supreme Court ruled that the “integral and indispensable test is tied to the productive work that the employee is employed to perform and does not include all activities an employer requires.” It has further determined that the preparation of equipment necessary to perform principal activities is compensable under the FLSA.

In applying these standards, the Sixth Circuit noted that the parties did not dispute that the employees’ principal duties were answering customer phone calls and performing scheduling tasks. The court held that because the employees could not receive calls or schedule appointments until they turned on and booted up their computers, turning on the computer is integral and indispensable to their duties and is a principal activity under the FLSA. The district court had erred in considering whether engaging with a computer and loading a timekeeping program was integral to the employees’ duties. The Sixth Circuit acknowledged that clocking in may not be integral to the duties for which they were hired, but determined that the correct inquiry is

whether engaging the computer, which contains the phone program, scripts, customer information, and email programs, is integral to the employees' duties. That is, we should evaluate the importance of booting up the computer to the employees' primary duties of answering calls and scheduling rather than to their need to clock in using the electronic timekeeping system.

Because all of the employees’ duties required them to use a functional computer, booting up their computers and logging was integral and indispensable to their principal activities. Clocking into the timekeeping program occurred after booting up their computer—described by the court as “the first principal activity of the day—and thus it was compensable. Although not all required activities are compensable, when the required activity “bears such a close relationship to the employees’ principal duties that employees cannot eliminate the required activity and still perform their principal duties, the activity is compensable.” In a footnote, the court clarified that because shutting down the computers was not integral and indispensable to the employees’ ability to conduct calls, that activity was not compensable under this theory. Nevertheless, it could be compensable “if the task was determined to be a principal activity in and of itself.” As a result, the court reversed and remanded for consideration of whether the time spent shutting the computers down was compensable, as well as several other issues.

Takeaways: The FLSA applies to all nonexempt employees of businesses with an annual gross volume of sales made or business done totaling $500,000 or more, and to employees individually covered because they are engaged in interstate commerce or in the production of goods for commerce. In light of the court’s decision in Cadena, businesses should examine whether booting up or shutting down computers is integral and indispensable for their employees to perform the jobs for which they were hired. In those circumstances, under the FLSA, employees are entitled to be compensated for the time spent on that activity.

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