Current Developments in Estate Planning and Business Law: June 2023

Jun 16, 2023 11:51:31 AM


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From the Ninth Circuit Court of Appeals’ ruling holding trustees and beneficiaries liable for unpaid estate taxes to the invalidation on constitutional grounds of a California statute requiring diversity in corporate board membership, 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.

Trustees and Beneficiaries of Living Trust Held Liable for Unpaid Estate Taxes

United States v. Paulson, 68 F.4th 528 (9th Cir. May 17, 2023)

Allen Paulson died in 2000, with most of his estate, which was valued at nearly $200 million, held in a living trust (the trust). Upon his death, his son, John Michael Paulsen, became a co-trustee of the trust and was appointed co-executor by the probate court. John was appointed the sole executor in October 2001 and had a different co-trustee at that time. He filed a Form 706 with the Internal Revenue Service (IRS) in October 2001, which reported a total gross estate of $187,729,626, a net taxable estate of $9,234,172, and an estate tax liability of $4,459,051; he paid $706,296 with the return. The estate elected under 26 U.S.C. § 6166 to defer the remaining balance of $3,752,755 to be paid in installments over fifteen years. The IRS assessed the reported estate tax liability of $4,459,051 in November 2001. After auditing the estate tax return, the IRS asserted a deficiency in estate tax, which was challenged by the estate. In 2005, the Tax Court entered a stipulated decision determining that the estate owed an additional $6,669,477 in estate taxes. The estate elected to pay the additional estate tax liability in the remaining Section 6166 installments. John made payments or requested extensions until 2009.

To settle disputes between Allen’s surviving wife, Madeleine Pickens, and his other heirs, John and his co-trustee transferred assets that the IRS asserted were worth $19 million from Allen’s trust to Madeleine, as trustee of her living trust. Allen’s granddaughter Crystal and his son Richard Paulson’s widow, Vikki, asserted that the transfers to Madeleine included assets worth more than $42 million. John also distributed more than $7 million to other beneficiaries, including Crystal. 

John was removed as trustee in 2009 for misconduct, and over the following two years, several Allen’s heirs, including Allen’s other son James, were appointed as co-trustees. James was removed as co-trustee in 2010 after the IRS terminated the Section 6166 election. Vikki and Crystal were co-trustees in 2011 when the IRS recorded notices of tax liens against the estate. In 2013, to settle a dispute between James and Allen’s other beneficiaries, James received the trust’s interest in several assets in exchange for his resignation as executor. Vikki and Crystal asserted that by 2009, the trust was insolvent, with liabilities far exceeding its assets and that at the time of the settlement with James, the trust was completely depleted.

In 2015, the United States filed an action against John, Madeleine, James, Vikki, and Crystal in their individual and representative capacities seeking to recover the outstanding estate taxes—which exceeded $10 million—under several statutes, including Internal Revenue Code (I.R.C.) § 6324(a)(2). James, Vikki, Crystal, and Madeleine filed motions to dismiss claiming in part that they were not personally liable as trustees, beneficiaries, or transferees for the unpaid estate taxes under I.R.C. § 6324(a)(2). The district court granted their motions to dismiss in part based on its reading of I.R.C. § 6324(a)(2), and the United States appealed.

The Ninth Circuit Court of Appeals, which considered questions of statutory interpretation in a de novo review, disagreed with the district court’s ruling. The statute at issue, I.R.C. § 6324(a)(2), provides:

If the estate tax imposed by chapter 11 is not paid when due, then the spouse, transferee, trustee (except the trustee of an employees' trust which meets the requirements of section 401(a)), surviving tenant, person in possession of the property by reason of the exercise, nonexercise, or release of a power of appointment, or beneficiary, who receives, or has on the date of the decedent’s death, property included in the gross estate under sections 2034 to 2042, inclusive, to the extent of the value, at the time of decedent's death, of such property, shall be personally liable for such tax.

(emphasis added). The court addressed whether the phrase “on the date of the decedent’s death” modified only the preceding verb “has” as the United States contended, or if it also modified the verb “receives” as the defendants contended. The United States argued that § 6324(a)(2) imposes personal liability for estate taxes on those listed in the statute who (1) receive estate property at any time on or after the date of the decedent's death, or (2) have estate property on the date of the decedent's death. Under the defendants’ interpretation, § 6324(a)(2) imposes personal liability only on those who receive or have property included in the gross estate on the date of the decedent's death and not on those who receive property from the estate after the date of the decedent’s death.

In an opinion containing an extensive discussion of grammatical rules, canons of statutory construction, and the context and structure of § 6324(a)(2), the court agreed with the interpretation advocated by the United States, concluding that “§ 6324(a)(2) imposes personal liability for unpaid estate taxes on trustees, transferees, beneficiaries, and others listed in the statute, who receive or have estate property on or after the date of the decedent's death.” United States v. Paulson, 68 F.4th 528, 551 (9th Cir. May 17, 2023). Accordingly, the court ruled that James, Vikki, and Crystal were liable, “as trustees, for the unpaid estate taxes on property from the gross estate, held in the living trust, ‘to the extent of the value, at the time of the decedent's death, of such property,’ . . . [but] each defendants’ liability cannot exceed the value of the property at the time that they received or had it as trustees.” Id. (quoting 26 U.S.C. § 6324(a)(2).) In addition, the court determined that the “ordinary meaning of beneficiary, which includes trust beneficiaries, applies to § 6324(a)(2),” and that Crystal and Madeleine were therefore liable for unpaid estate taxes as beneficiaries. Id. (internal quotations omitted). The court reversed the district court’s ruling and remanded the case to the district court to enter judgment in favor of the United States and to determine the amount of each defendant’s liability.

Takeaways: Paulson provides a reminder for trustees to not distribute assets too early, as it may lead to personal liability for both the trustees and beneficiaries if the trust is left without sufficient funds to pay estate taxes due. Trustees should retain enough cash as a reserve to handle final expenses, including taxes. Particularly for estates that have filed a Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, executors should request an estate tax closing letter for a small fee at before making distributions to beneficiaries. Alternatively, a free account transcript can be requested as a substitute for an estate tax closing letter (Notice 2017-2). 

Spouse of Person Ruled Incapacitated May Not Be Compelled to Transfer Property Owned as Tenants by Entirety to Guardian for Sole Benefit of Incapacitated Spouse

Hudkins v. Hudkins, 2023 WL 3129513 (Fla. Dist. Ct. App. Apr. 28, 2023)

LaDonna and Keith Hudkins were married in 2017. In 2018, Keith executed a durable power of attorney naming LaDonna as his attorney-in-fact. Keith executed a quitclaim deed conveying title of a condominium he owned individually to LaDonna and himself as tenants by the entity in 2018; soon after, they transferred the condominium into their joint trust. In addition, Keith transferred a house he owned individually to LaDonna and himself as tenants by the entirety in 2019.

In July 2020, Keith was injured in an automobile accident and placed in a residential treatment facility. LaDonna obtained legal counsel to assist her in sheltering Keith’s assets to enable him to qualify for Medicaid benefits. To accomplish this goal, LaDonna executed another power of attorney using her authority under the 2018 power of attorney, and using the two powers of attorney, executed quitclaim deeds transferring the house owned as tenants by the entirety into her individual trust and transferring the condominium held by the joint trust into her individual trust. LaDonna then listed the condominium for sale.

Keith’s adult son from a prior relationship, Matthew, filed a petition to determine that Keith was incapacitated due to dementia and for the appointment of a plenary guardian and an emergency temporary guardian on the basis that Keith’s assets were in immediate danger of being wasted, misappropriated, or lost; Matthew further alleged that LaDonna had placed the condominium on the market without Keith’s knowledge. Matthew filed a motion to initiate an independent legal action to invalidate the transfer of the house to LaDonna’s individual trust, but the court did not issue a ruling on this motion. The court did not enjoin the sale of the condominium, but directed that the proceeds from its sale be held in trust. The court then issued an order appointing Matthew as Keith’s emergency temporary guardian, and later entered an order finding that Keith was totally incapacitated. 

Several months later, the court entered an order appointing Matthew as plenary guardian. The order included a finding that LaDonna’s transfers of the house and the condominium were not in Keith’s best interests and required LaDonna to transfer title of the house to Matthew for the benefit of Keith. In addition, the order specified that proceeds of the sale of the condominium were to be transferred to a guardianship account to be used solely for Keith’s benefit despite an earlier agreement between the court and the parties to hold a subsequent hearing regarding the allocation of the proceeds. LaDonna appealed the trial court’s orders determining total incapacity and requiring the transfer of title of the house to Matthew in his capacity as guardian for the benefit of Keith, and of the condominium’s sale proceeds to the guardianship account.

The District Court of Appeal dismissed LaDonna’s appeal of the order determining total incapacity on the grounds that it had not been timely filed. However, it agreed with LaDonna that the trial court had improperly ordered her to transfer title of the house to Matthew. Fla. Stat. § 744.361(12) states “[t]he guardian, if authorized by the court, shall take possession of all of the ward’s property and of the rents, income, issues, and profits from it, whether accruing before or after the guardian’s appointment, and of the proceeds arising from the sale, lease, or mortgage of the property or of any part.” It therefore authorizes a guardian to take possession of preguardianship assets of a ward and to pursue a rescission of a preguardianship transaction. However, despite having the authority to rescind the transfer of the house to LaDonna’s individual trust and to enjoin its sale, the trial court had never ruled on Matthew’s motion to invalidate the transfer.

Further, Fla. Stat. § 744.447 states: “All legal or equitable interests in property owned as an estate by the entirety by an incapacitated person for whom a guardian of the property has been appointed may be sold, transferred, conveyed, or mortgaged in accordance with section 744.447, if the spouse who is not incapacitated joins in the sale, transfer, conveyance, or mortgage of the property.” Therefore, LaDonna’s consent was required before property the couple held as tenants by the entirety could be transferred, and the trial court had erred by ordering LaDonna to transfer the house to Matthew in the absence of that consent.

The court also found that the trial court had erred by ordering the proceeds of the condominium’s sale be placed in the guardianship account solely for Keith’s benefit. Although LaDonna had filed a petition to determine the allocation of the proceeds after they were placed in Matthew’s attorney’s trust account and had requested to be heard on the distribution of the funds at the final hearing, the court issued its final order despite an agreement by the parties that the matter would be addressed at a subsequent hearing. Because the condominium had initially been held in the joint trust and the sale proceeds were joint assets, LaDonna’s procedural due process rights were violated because she was denied the opportunity to be heard regarding their allocation.

Takeaways: Hudkins establishes that the court may not compel a spouse who owns property together with a ward as tenants by the entirety to transfer that property to the guardian without the spouse’s consent. In addition, Florida attorneys should take note that under Fla. Stat. § 744.361(12), in some circumstances, transfers made pursuant to a valid power of attorney granted by a party may be undone by a guardian who is later appointed to act on behalf of that party. Therefore, the authority granted to an agent under power of attorney is not bulletproof because the court may later undo transactions that the agent was empowered to enter into.

Vermont “Right to Die” Law Amended to Eliminate Residency Requirement

Vt. Stat. Ann. tit. 18 § 5283

Vermont Governor Phil Scott signed an amendment to Vermont’s right-to-die statute on May 2, 2023, removing its residency requirement. In March 2023, the state of Vermont reached a settlement with a Connecticut woman who had filed suit against the state in federal court on the grounds that the residency requirement in Vermont’s right-to-die statute was unconstitutional. The settlement agreement allowed her to receive lethal medication provided that she complies with the other requirements of the statute. 

In addition to Vermont, nine other states (Oregon, Washington, Montana, California, Colorado, Hawaii, New Jersey, Maine, and New Mexico) and the District of Columbia have right-to-die statutes allowing medically assisted suicide. Oregon agreed not to enforce its residency requirement in a 2022 settlement that ended a similar federal lawsuit, but has not amended its statute to remove the residency requirement.

Takeaways: Advocates of the right to die have celebrated the amendment, which they say allows people with terminal illnesses to choose to access life-ending medical treatments. Critics have argued that right-to-die laws do not provide sufficient protection against coercion for vulnerable patients.

California Statute Requiring Public Corporations to Have Minimum Number of Directors from Certain Groups Identified as Underrepresented Violates US Constitution’s Equal Protection Clause

Alliance for Fair Bd. Recruitment v. Weber, 2023 WL 3481146 (E.D. Cal. May 15, 2023)

California’s Assembly Bill 979 was enacted in 2020, adding Cal. Corp. Code § 301.4 and § 2115.6 and requiring public corporations headquartered in California to have a minimum number of directors (ranging from one to three depending on the size of the board) that come from groups identified in the bill as underrepresented. The plaintiffs asserted that AB 979 should be invalidated as an impermissible race-based quota. The United States District Court for the Eastern District of California granted the plaintiffs’ motion for summary judgment on the basis that AB 979 imposes a race-based quota and is thus unconstitutional on its face. The court relied on Grutter v. Bollinger, 539 U.S. 306, 335 (2003), which defines a quota as “a program in which a certain fixed number or proportion of opportunities are ‘reserved exclusively for certain minority groups,” and Regents of Univ. of California v. Bakke, 438 U.S. 265, 307 (1978), in which the court held that quotas are “facially invalid” because they violate the Equal Protection Clause of the Fourteenth Amendment to the US Constitution. Further, the court relied on Gratz v. Bollinger, 539 U.S. 244, 276 n.23 (2003), which held that a violation of the Equal Protection Clause also constitutes a violation of 42 U.S.C. § 1981, a federal civil rights statute guaranteeing equal rights under the law.

Takeaways: Cal. Corp. Code § 301.4 was previously found unconstitutional by the Superior Court of California for the County of Los Angeles in Crest v. Padilla, No. 20STCV37513 (Cal. Super. Apr. 1, 2022). Although statutes mandating board diversity may fail to pass constitutional muster, in recent years, there has been increasing pressure from investors, financial institutions, and stockholders to increase diversity on corporate boards.

Texas Legislature Passes Law to Create New Business Courts

H.B. No. 19, 88th Legis., Prior Sess. (2023)

On May 25, 2023, the Texas Senate passed HB 19, which will create specialized business courts. The bill was signed into law by Governor Greg Abbott on June 9, 2023. The law will take effect September 1, 2023, and the changes in the law will apply to civil actions commenced on or after September 1, 2024. The bill specifies that the to-be-created courts will have civil jurisdiction concurrent with the district courts over the following types of disputes:

  1. Disputes exceeding $5 million in controversy (or any amount if one of the parties is a publicly traded company) that involve derivative proceedings, corporate governance, securities or trade regulations, contract and commercial transactions, and claims arising from the Business Organizations Code 
  2. Disputes exceeding $10 million in controversy where the action arises out of a qualified transaction or certain violations of the Texas Finance or Business and Commerce Code, or the parties have agreed to submit to business court jurisdiction

The business courts will also have limited supplemental jurisdiction over related claims. Certain cases involving Texas businesses will not fall within the business court’s jurisdiction, including claims arising out of the estates code.

Takeaways: The to-be-created business courts are intended to relieve the burden on other courts and increase Texas’s stature as a business-friendly state. Such business courts will provide a judiciary system that will exclusively handle business disputes in Texas for large businesses similar to those currently existing in many other states, including the well-established business courts in Delaware and New York, as well as more recently established courts systems in Georgia and Utah.

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