From the SECURE 2.0 Act’s changes for special needs trusts to the Federal Trade Commission’s issuance of a proposed rule banning noncompetition clauses, 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.
SECURE 2.0 Act Allows Certain Special Needs Trusts to Name Charity as Beneficiary While Preserving Stretch Distributions for Disabled or Chronically Ill Beneficiary
Consolidated Appropriations Act, 2023, Pub. L. 117-328, 136 Stat. 4459
The 2019 Setting Every Community Up for Retirement Enhancement Act (SECURE) Act replaced the stretch distribution scheme for inherited retirement accounts with a ten-year payout rule for most nonspouse beneficiaries following the death of the plan participant. However, under the SECURE Act, preservation of the stretch distribution is possible for eligible designated beneficiaries, including special needs beneficiaries. An applicable multi-beneficiary trust (AMBT) is an accumulation trust for multiple beneficiaries, one or more of whom is disabled or chronically ill as defined by the SECURE Act; AMBTs may be either type I or type II. Type I AMBTs provide that, immediately upon the death of the plan participant, the trust divides into separate trusts for each beneficiary (and one of the separate trusts can be a type II trust). Type II AMBTs allow for multiple beneficiaries, but all of them must be disabled or chronically ill until after the death of the final disabled or chronically ill beneficiary.
Generally, when naming a trust as the beneficiary of a retirement asset, the ability to stretch distributions relies on having only living persons as countable beneficiaries. If a charity (which is not a living person) is named as one of the countable beneficiaries of the trust, the trust will not qualify for stretch distributions.
The SECURE 2.0 Act, passed as part of the Fiscal Year 2023 Omnibus Spending Bill, changes the AMBT rules to allow a qualified charity to be named as a remainder beneficiary of the AMBT while still allowing stretch payments from the retirement account to the AMBT over the life expectancy of the disabled or chronically ill beneficiary—provided certain other requirements are met. For example, no one other than the disabled or chronically ill beneficiary can benefit during their lifetime; the charitable beneficiary therefore can only be a remainder beneficiary after the death of the last surviving disabled or chronically ill beneficiary. The charity must also be a qualified charity under Internal Revenue Code (I.R.C.) § 408(d)(8), so if a donor-advised fund (which is not a qualified charity under § 408(d)(8)) is named as a remainder beneficiary of the trust, stretch distributions are not allowed.
If the trust is not designed appropriately and stretch distributions are not allowed, distributions must be made to disabled or chronically ill beneficiaries over a much shorter period: depending upon when the retirement account owner died, distributions must be made according to the five-year rule or the remaining life expectancy of the retirement account owner. The SECURE 2.0 Act fix only applies starting in 2023; it is not applicable where the owner of the retirement account died after the SECURE Act’s effective date and before the enactment of the SECURE 2.0 Act.
Takeaways: It is possible to name a charitable remainder beneficiary of an AMBT without jeopardizing the stretch distribution for special needs beneficiaries, provided certain requirements are met. The changes made by the SECURE 2.0 Act will benefit those who are charitably inclined, providing them with additional flexibility while preserving the tax savings for special needs beneficiaries of AMBTs.
Distribution of Assets to a New Trust Did Not Cause Trust to Lose Exempt Status for GST Tax Purposes
I.R.S. Priv. Ltr. Rul. 2023-01-001 (Jan. 6, 2023)
In Private Letter Ruling 202301001, the Internal Revenue Service (IRS) addressed whether the distribution of assets from Trust A to Trust B, which had several different provisions than Trust A, would cause the trusts to lose their exempt status for generation-skipping transfer (GST) tax purposes.
According to the ruling, on Date 1, a date prior to September 25, 1985, a grantor established and funded Trust A, an irrevocable trust for the benefit of his descendants: a son, a daughter, the spouses of the son and daughter, and the issue of the son and daughter. Trust A was to terminate after the deaths of the grantor and the grantor’s spouse, son, and daughter upon the latest to occur of (1) the youngest issue of the grantor living on Date 1 attaining the age of x, or (2) the expiration of a y-year period after the death of the grantor and or grantor’s spouse, son, or daughter. Upon termination, all of the property was to be distributed in equal shares per stirpes to the issue of the grantor. Trust A was not to continue for more than twenty-one years after the death of the survivor of certain named beneficiaries who were alive on Date 1. At the end of this period, the entire trust was to be paid over and distributed as provided in the trust document.
At the time of the request for the Private Letter Ruling, the grantor and the grantor’s spouse were both deceased. The court accepted jurisdiction over the administration of Trust A and issued an order changing the administration of Trust A to another state and changing the trustee of Trust A to a trust company. The trust company appointed all of the principal and accumulated income of Trust A to a new trust, Trust B. Trust B differed in some respects from Trust A: instead of providing an outright distribution of assets to the beneficiaries, Trust B provided that, after the termination of Trust B, the balance of the trust estate would be allocated and distributed to separate trusts to the living descendants of the grantor, per stirpes, as described in Article 4 of Trust B. Under Article 4 of Trust B, the beneficiary of each Article 4 trust would be the sole lifetime beneficiary of their trust and would be granted a testamentary general power of appointment over the principal of the trust. Trust B also modified provisions relating to the administration of trust, allowing the future appointment of (1) a distribution committee with the authority to make discretionary distribution decisions, (2) an investment committee with authority limited to investment and administrative decisions, and (3) a trust protector.
The court authorized the appointment of principal and income from Trust A to Trust B, contingent upon the receipt of a favorable Private Letter Ruling on the following issues:
- The proposed transfer of Trust A assets to a successor trust, Trust B, and the modifications caused by the distribution to Trust B, would not cause the loss of the exempt status from the GST tax under I.R.C. § 2601.
- As a result of a beneficiary’s testamentary power to appoint in Article 4.2 of Trust B with respect to the property of that beneficiary’s Article 4 trust, the property subject to the power would be includible in that beneficiary’s gross estate under I.R.C. § 2041.
I.R.C. § 2601 imposes a tax on every GST, which is defined in I.R.C. § 2611 as a taxable distribution, a taxable termination, and a direct skip. Treas. Reg. § 26.2601-1(b)(1)(i) addresses when a modification of a trust that is exempt from the GST tax will not cause the trust to lose its exempt status. It provides that the distribution of trust principal from an exempt trust to a new trust will not lead to a loss of exempt status if it does not shift a beneficial interest in the trust to a beneficiary who occupies a lower generation or extend the time for vesting of any beneficial interest beyond the period provided for in the original trust. To determine if there has been a shift of a beneficial interest to a lower generation, the IRS must measure the effect of the instrument on the date of the modification against the effect of the instrument in existence immediately before the modification. A modification that indirectly increases the amount transferred by lowering administrative costs or income taxes will not constitute a shift in the beneficial interest in the trust.
The IRS noted that Trust A and Trust B had identical income and principal distribution terms, the same time of termination, and the same class of remainder beneficiaries. Trust A and Trust B differed in that Article 4 of Trust B provided for the trust estate to be allocated and distributed in separate trusts to the living descendants of the grantor per stirpes after the termination of Trust B, and that the beneficiary of each separate trust would be the sole lifetime beneficiary of the separate trust and granted a testamentary general power of appointment over the principal of the trust.
The IRS stated that the grant of a testamentary general power of appointment to a sole lifetime beneficiary of a trust is deemed to be functionally equivalent to a grant of outright ownership. Therefore, the grant of the power of appointment would cause each separate trust to be includible in the gross estate of the beneficiary at their death under I.R.C. § 2041(a)(2). In addition, the grant of the power would cause each beneficiary to be treated as the transferor of their separate Article 4 trust for GST tax purposes under I.R.C. § 2652(a)(1).
Treas. Reg. § 26.2601-1(b)(4)(i)(D)(2) provides that modifications that are administrative in nature that only indirectly increase the amount transferred are not considered to shift a beneficial interest in the trust. The IRS determined that Trust B’s administrative provisions would not cause the distribution of principal from Trust A to Trust B to amount to a shift of a beneficial interest to a lower generation beneficiary or extend the time for vesting of any beneficial interest beyond the period provided for in the original trust. Therefore, the distribution of assets from Trust A to Trust B would not cause either trust to lose its exempt status for GST tax purposes.
Takeaways: A Private Letter Ruling has no precedential value and cannot be relied on by other taxpayers. However, this ruling suggests that, at least in cases involving similar facts, this strategy will not affect the GST tax-exempt nature of two trusts when trust assets are distributed from one trust to another if the two trusts (1) have identical income and principal distribution terms, dates of termination, and classes of remainder beneficiaries, and (2) provide for the creation of separate trusts for each beneficiary that include a power of appointment that would cause each beneficiary to be treated as the transferor of their separate trust for GST tax purposes.
New Florida Statute Exempts Court Cases Involving Privately Owned Family Trust Companies from Inspection by the Public
Fla. Stat. § 662.1462 (2022)
Trillions of dollars in wealth are expected to be transferred in the coming decades.1 As a result, Florida has passed several laws designed to attract ultra high net worth individuals and their trust business to the state. Fla. Stat. § 662.1462, passed in 2022, creates a public records exemption for court cases in which a privately owned family trust company is a party. Written notice that the section applies must be provided to the clerk of the court. Upon a court order, persons the court deem to have a specific interest in the trust, a transaction related to the trust, or an asset currently or previously held by the trust may inspect the court records if the court determines there is a compelling need for the information to be released. In addition, the clerk must make court records available to the trust’s settlor, fiduciaries, beneficiaries, or attorneys for the foregoing.
Takeaways: Section 662.1462 will enable wealthy individuals to maintain confidentiality surrounding their assets and further solidify Florida’s reputation as one of the nation’s most trust-friendly states.
Federal Trade Commission Issues Proposed Regulation That Would Ban Noncompetition Clauses
Non-Compete Clause Rule, 88 Fed. Reg. 3482 (proposed Jan. 5, 2023)
On January 5, 2023, the Federal Trade Commission (FTC) issued a proposed rule providing that it is an unfair method of competition under Section 5 of the FTC Act for an employer to enter into a noncompetition clause with a worker, maintain a worker who is subject to a noncompetition clause, or represent to a worker that the worker is subject to a noncompetition clause. Whether a contractual provision is a noncompetition clause would depend not upon what it is called, but upon how it functions. Although nondisclosure and nonsolicitation provisions would not typically fall within this scope, if the provisions are so broad that they function as a noncompetition clause, they will be prohibited under the proposed rule. Nondisclosure and nonsolicitation agreements would generally not be prohibited under the proposed rule, however, because they do not prohibit a worker from working for another employer or starting their own business after they leave their prior employer.
The proposed rule would not apply to a noncompetition clause entered into by a seller of a business or an ownership interest in the business or most of the business’s assets, if the seller is a substantial owner, member, or partner in the business entity when the seller enters into the noncompetition clause. In addition, the rule would not apply to restrictions on what a worker may do during the worker’s employment, but only to postemployment restraints.
Under the proposed rule, the definition of workers includes employees, independent contractors, and unpaid interns and volunteers, and the ban applies without regard to the worker’s earnings or job function. However, a franchisee in a franchisee-franchisor relationship is not a worker within the scope of the proposed rule.
The employer must rescind any existing noncompetition clauses. One acceptable method of rescinding an existing agreement is to provide notice of the rescission to the affected workers, including former workers who were subject to a noncompetition clause and may believe they are still bound by it. The notice must be provided in an individualized communication such as an email or text message, not by posting a notice at the employer’s place of business or by an oral communication.
Takeaways: As the FTC notes in the proposed rule, one in five American workers—around 30 million—are currently bound by noncompetition clauses. Consequently, the implementation of this rule, which would have a compliance date 180 days after the publication of a final rule in the Federal Register, would have a significant effect. There are likely to be court challenges to the FTC’s proposed rule. Although the FTC advocates a categorical complete ban on noncompetition clauses in the employment context, it acknowledges that other standards, such as a rebuttable presumption of unlawfulness, could be adopted. Comments must be received by March 20, 2023.
Stay on top of the latest business law developments by attending An Overview of the Corporate Transparency Act for Estate and Business Planning Attorneys on February 21, 2023. We will cover steps to ensure compliance, penalties for noncompliance, and provisions that should be included in operating agreements or trust documents.
Protections for Pregnant and Nursing Employees Required Under New Federal Laws
Consolidated Appropriations Act, 2023, Pub. L. 117-328, 136 Stat. 4459
On December 29, 2022, President Biden signed the Fiscal Year 2023 Omnibus Spending Bill into law, which included two laws providing protections for employed pregnant women and nursing mothers.
The Pregnant Workers Fairness Act (PWFA), effective June 27, 2023, will require all employers with fifteen or more employees for twenty weeks or more during a calendar year to make reasonable accommodations for limitations related to pregnancy, childbirth, or pregnancy-related medical conditions of a pregnant worker unless doing so would impose an undue hardship on the business’s operations. In addition, the PWFA prohibits adverse action against a pregnant employee due to a request for those reasonable accommodations.
The Providing Urgent Maternal Protections for Nursing Mothers (PUMP) Act amends the Fair Labor Standards Act to require many employers to provide a reasonable break time for employees to express breast milk for a nursing child when the employee has a need to do so for one year following the child’s birth. The employer is also required to provide a private location at the workplace other than the bathroom for the employee to pump breast milk. The PUMP Act does not apply to employers of less than fifty employees if the requirements would impose an undue hardship on the employer. The PUMP Act became effective on the date of its enactment, but employees can seek legal relief and remedies beginning April 28, 2023.
Takeaways: Employers subject to the PWFA and the PUMP Act should make any modifications needed in their policies and facilities to prepare for accommodation requests and provide training on best practices.
Ohio Supreme Court Holds that Business Property Insurance Policy Did Not Cover Losses Resulting from Ransomware Attack Because Computer Software Cannot Experience Physical Damage
EMOI Servs., LLC v. Owners Ins. Co., 2022 WL 17905839 (Ohio Dec. 27, 2022)
EMOI Services, LLC (EMOI) used software it developed and other software to support medical offices with setting appointments, record keeping, and billing. A hacker gained access to EMOI’s systems and encrypted important files it needed to operate its software and database systems. When EMOI tried to open the files, a ransom note appeared that demanded $35,000 in bitcoins in exchange for an encryption key that would restore the files to normal. When EMOI paid the ransom, however, files needed to operate its automated phone system remained encrypted. No hardware or software was damaged by the ransomware attack.
EMOI filed an insurance claim under its business insurance policy with Owners Insurance Company (Owners) for its losses from paying the ransom, remediating the attack, and upgrading its security systems. Owners denied the claim, asserting that the policy did not cover the type of losses EMOI had experienced. EMOI filed a lawsuit against Owners, asserting that Owners had breached its policy contract by denying coverage. It relied on the following electronic equipment endorsement:
When a limit of insurance is shown in the Declarations under ELECTRONIC EQUIPMENT, MEDIA, we will pay for direct physical loss of or damage to “media” which you own, which is leased or rented to you or which is in your care, custody or control while located at the premises described in the Declarations. We will pay for your costs to research, replace or restore information on “media” which has incurred direct physical loss or damage by a Covered Cause of Loss.
The policy defined media as “materials on which information is recorded such as film, magnetic tape, paper tape, disks, drums, and cards.” In addition, it stated that “media” included “computer software and reproduction of data contained on covered media.”
The trial court granted Owners’ motion for summary judgment on the basis that the ransomware attack had not caused any physical damage to electronic equipment. The appellate court reversed the trial court’s decision, and Owners appealed to the Ohio Supreme Court.
The supreme court reversed the appellate court, finding that the electronic equipment endorsement’s requirement of a “direct physical loss of, or direct physical damage to” electronic equipment or media was clear and unambiguous. Because software is intangible, it could not experience direct physical loss or physical damage. It was not persuaded by EMOI’s contention that the computer software was “media” covered under the policy, holding that all of the covered media defined in the policy were items having a physical nature, and that the software, which is information stored on the media, is intangible and lacked a physical existence that could be damaged. The policy would not cover physical damage to computer software in the absence of physical damage to the hardware on which the software was stored.
Takeaways: Businesses are now subject to risks that did not exist years ago. Similar to cases in which business owners unsuccessfully sought to claim losses they incurred due to government-required shutdowns during the pandemic under business interruption insurance policies, the policy at issue in EMOI Services only covered physical damage to property. Businesses should obtain cyber insurance policies that expressly cover losses due to cyberattacks.
1. Steve Marsh, How The 'Great Wealth Transfer' Is Affecting Financial Advisors, Forbes (Nov. 10, 2022), https://www.forbes.com/sites/forbestechcouncil/2022/11/10/how-the-great-wealth-transfer-is-affecting-financial-advisors/?sh=7752ace33a74.