From new anti-clawback proposed regulations to pay transparency statutes, 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 New Proposed Anti-Clawback Regulations

Estate and Gift Taxes; Limitation on the Special Rule Regarding a Difference in the Basic Exclusion Amount, 26 C.F.R. 20, 87 Fed. Reg. 24918 (April 27, 2022) 

On April 27, 2022, the Internal Revenue Service (IRS) issued new proposed regulations applicable to estates of decedents who die after a reduction in the basic exclusion amount (BEA) who made certain types of gifts after 2017 and before a reduction in the basic exclusion amount, which supplement the final regulations that took effect November 26, 2019. 

The 2019 final regulations addressed concerns that the benefit to taxpayers of gifts made between January 1, 2018, and December 31, 2025—the period during which the gift and estate tax BEA is double the $5 million (adjusted for inflation) exclusion amount in place before the 2017 Tax Cuts and Jobs Act—could be “clawed back” in the calculation of taxpayers’ estate taxes if they die after the reversion of the BEA to the pre-reform level. Under the final regulations, a special rule was adopted allowing an estate to compute its estate tax credit using the greater of the BEA applicable during a taxpayer’s lifetime or the BEA applicable on the taxpayer’s date of death, ensuring that taxpayers will not be adversely impacted if they take advantage of the increased BEA by making lifetime gifts and then die in a year with a reduced BEA. The final regulations also clarified that the increased BEA is a “use or lose” benefit, that is, it is available only to the extent that a taxpayer actually uses it by making gifts during the period in which the increased BEA amount is available.

The 2019 final regulations did not distinguish between (1) completed gifts treated as adjusted taxable gifts for estate tax purposes and not included in the donor’s gross estate and (2) completed gifts that are treated as testamentary transfers for estate tax purposes and are included in the donor’s gross estate (includible gifts). 

Learn more about this topic by attending the webinar, New Proposed Regulations: Anti-Clawback Rule Exception with Robert Keebler on June 3, 2022. 

The new proposed regulations deny the benefit of the special anti-clawback rule to includible gifts: 

Given the plain language of the Code describing the computation of the estate tax and directing that certain transfers, including transfers made within three years of death that otherwise would have been includible in the gross estate, are treated as testamentary transfers and not as adjusted taxable gifts, it would be inappropriate to apply the special rule to includible gifts. This is particularly true where the inter vivos transfers are not true bona fide transfers in which the decedent “absolutely, unequivocally, irrevocably, and without possible reservations, parts with all of his title and all of his possession and all of his enjoyment of the transferred property.” Comm’r v. Church’s Estate, 335 U.S. 632, 645 (1949).

In addition, under the new proposed regulations, the special rule would not apply to certain transfers, eliminations, or relinquishments by the donor or a third party. 

The following transfers would fall within the exception to the special anti-clawback rule:

• Gifts subject to a retained life estate or subject to other powers or interests as described in Internal Revenue Code sections 2035 to 2038 and section 2042
• Gifts made by enforceable promise, to the extent they remain unsatisfied as of the date of the donor’s death
• Transfers of certain applicable retained interests in corporations, partnerships, or trusts
• Transfers that would have been included in the foregoing except for the transfer, relinquishment, or elimination of an interest, power, or property effectuated within eighteen months of the date of the donor’s death by the donor, by the donor in conjunction with another person, or by another person

The anti-clawback rule would continue to apply to transfers includible in the donor’s gross estate where the taxable amount is 5 percent or less of the total amount of the transfer valued on the date of the transfer. In addition, it would also apply to the aforementioned transfers, relinquishments, or eliminations effectuated by the termination of a period described in the original instrument of transfer by either the passage of time or the death of any person.

The explanation of the proposed rule includes the following example:

Assume that when the BEA was $11.4 million, a donor gratuitously transferred the donor’s enforceable $9 million promissory note to the donor’s child. The transfer constituted a completed gift of $9 million. On the donor’s death, the assets that are to be used to satisfy the note are part of the donor’s gross estate, with the result that the note is treated as includible in the gross estate for purposes of section 2001(b). Thus, the $9 million gift is excluded from adjusted taxable gifts in computing the tentative estate tax under section 2001(b)(1). Nonetheless, if the donor dies after a statutory reduction in the BEA to $6.8 million, the credit to be applied in computing the estate tax is the credit based upon the $6.8 million of the BEA allowable as of the date of death.

Takeaways: The exception to the special rule, which requires the estate tax credit to be calculated using the BEA applicable on the taxpayer’s date of death (and thus a lower exemption amount post-2025), is likely to apply to grantor retained annuity trusts, qualified personal residence trusts, promissory note transactions, and possibly preferred partnership techniques. Thus, proper planning is necessary to avoid inclusion in the gross estate and take advantage of the benefit of the increased exemption amount. Once published as final regulations, the proposed regulations will be applicable to the estates of decedents dying on or after April 27, 2022. 

US Supreme Court Denies Certiorari for Challenge to Constitutionality of SALT Deduction Cap

New York v. Yellen, 2022 WL 1131382 (April 18, 2022)

On April 18, 2022, the US Supreme Court denied the plaintiffs’ petition for writ of certiorari in a case challenging the constitutionality of the Internal Revenue Code’s cap on the state and local tax (SALT) deduction. In New York v. Yellen, 15 F.4th 569 (2nd Cir. 2021), four states—New York, Connecticut, New Jersey, and Maryland—sued the federal government to enjoin it from enforcing the state and local deduction cap of $10,000 established by the 2017 Tax Cuts and Jobs Act. They argued that the SALT cap violated the Sixteenth Amendment, which they claimed required any federal income tax to permit “a deduction for all or a significant portion of state and local taxes.” In addition, they asserted that the SALT cap violated Article I, Section 8 of the Constitution and the Tenth Amendment because it forces them to lower taxes or cut spending. They argued that because many of their taxpayers’ state and local taxes exceeded the $10,000 maximum, the cap increases the effective cost of those taxes, makes home ownership more expensive, and depresses taxpayers’ equity in their homes as well as the real estate market. As a result, the plaintiffs will collect less revenue, creating shortfalls that will force them to change their fiscal and tax policies. The federal district court had dismissed their complaint on the basis that the Constitution does not require a SALT deduction and that the plaintiffs’ complaint failed to assert a plausible claim of coercion. The plaintiffs appealed and the Second Circuit Court of Appeals reviewed the district court’s decision de novo.

The Second Circuit Court of Appeals agreed with the district court’s conclusion that the plaintiffs had standing to proceed with their constitutional claims and that it was not barred by the Anti-Injunction Act. However, the court also agreed with the district court’s conclusion that Congress is not constitutionally foreclosed from eliminating or curtailing the SALT deduction. Rather, the court held that nothing in the US Constitution “compels the federal Government to protect taxpayers from the true costs of paying their state and local taxes” or mandates the SALT deduction, which is not the only means of reserving taxable resources for the states and had previously been limited by Congress several times. 

In addition, the court found that the plaintiffs had failed to state a Tenth Amendment claim by asserting an infringement of their state sovereignty. Rather, the court concluded that the plaintiffs had failed to plausibly allege that their injuries were significant enough to be coercive and that Congress was permitted to use its taxing and spending authority to encourage them to change their preferred fiscal policies in favor of lowering taxes and spending.

The SALT deduction did not violate the constitutional principle of equal sovereignty among the states by causing the plaintiffs an injury that is unevenly distributed. Rather, the increased impact of the SALT deduction cap on the plaintiffs arose only because they previously benefited the most from the SALT deduction, not because the cap applied only to them and not to other states.

Takeaways: Although the Supreme Court’s denial of the plaintiffs’ petition for a writ of certiorari represents the end of the road for the plaintiffs’ action against the federal government, a growing number of states (twenty-two at present) have developed workarounds for the SALT deduction cap for pass-through business owners. States adversely impacted by the SALT cap have adopted elective pass-through entity tax (PTET) laws allowing a pass-through entity such as a limited liability company or S corporation to elect to pay state taxes on business income at the entity level and claim a federal deduction instead of passing the full tax liability through to the individual business owners. The IRS released Notice 2020-75 in November 2020 indicating its intention to propose regulations authorizing these types of workarounds. The SALT cap will expire at the end of 2025 unless Congress extends it. 

Expressions of a Future Intention to Convert Separate Property to Community Property Not Sufficient to Effectuate Conversion Under Texas Law

LaPree v. LaPree, No. 03-20-00465-CV, 2022 WL 548285 (Tex. Ct. App. Feb. 24, 2022)

When Kelly LaPree was a minor, her grandparents named her as the sole beneficiary of three trusts and provided the trustee with the discretion to distribute the balance of the trust’s assets to her upon her thirty-second birthday. In 2017, Kelly turned thirty-two while she was married to Justin LaPree; at that time, the trustee terminated the trusts and distributed the assets, then worth approximately $2.3 million, to Kelly. A few months later, Kelly and Justin hired an attorney to assist them with estate planning. The engagement letter sent by their attorney stated: “We discussed the characterization of property as separate or community, and you told me that you consider your current assets (including the funds that Kelly has inherited thus far) to be community property.” Further, the revocable living trust (RLT) the attorney drafted for them included the following provision: “At the time this Agreement is signed, TRUSTORS contemplate that all of their assets that will be transferred to the Trust will be community property.” Another provision of the trust (paragraph 18.2) stated: “[A]n individual TRUSTOR, without joinder of the other TRUSTOR, can modify or revoke this Agreement in writing during the TRUSTORS’ joint lifetimes while that individual TRUSTOR is not disabled with respect to any separate property of that individual TRUSTOR held as an asset of the Trust and such individual TRUSTOR may terminate this Agreement in whole or in part with respect to such separate property by written notice delivered to the TRUSTEE.” Kelly and Justin were both trustees of the trust. Between December 2017 and March 2018, Kelly transferred the funds from the prior three trusts into a joint Charles Schwab trust account and funded the new RLT with $10.

In August 2018, Kelly filed for divorce and Justin asserted claims of breach of contract and fraud against her, alleging that she had promised or agreed that the trusts were community property. Kelly moved for summary judgment on the basis that the assets held in the joint Schwab account were her separate property. The trial court ruled in favor of Kelly, determining that the trust agreement did not constitute an agreement to convert separate property to community property because it did not meet the requirements of Texas Family Code section 4.203, and that the creation of the RLT did not amount to a gift from Kelly to Justin.

On appeal, Justin asserted that the trial court had erred in determining that the trust agreement was not an enforceable agreement converting the assets in the prior trusts from separate to community property. However, the Texas Court of Appeals determined that Texas Family Code section 4.203 provides the exclusive method for converting separate property to community property: there must be an agreement that (1) is in writing, (2) is signed by both parties, (3) identifies the property being converted, and (4) specifies that the property is being converted to the spouses’ community property. The trust agreement forming the RLT stated that the parties contemplated that all of their assets that “will be transferred to the trust” will be community property: it did not meet the requirement that the assets were being converted contemporaneously with the execution of the trust document. Rather, “[a]t best, the statement signifies an aspiration about future unspecified property—that unspecified property transferred into the Revocable Trust will be community property.” Further, paragraph 18.2 of the trust agreement expressly recognized that some of the trust’s assets may be separate property.

In addition, the court of appeals rejected Justin’s assertion that Kelly had given him a one-half interest in the assets she was receiving from the prior trusts by transferring the trust assets to the joint Schwab trust account and forming the RLT. The court found that there was no genuine issue of material fact as to Kelly’s donative intent, one of the elements that must be established to show the existence of a gift, because there was no contemporaneous transfer of property when she allegedly told Justin she was going to give him half of the assets. Kelly’s deposits of the trust assets in the joint account also do not establish donative intent under Texas law. In addition, the RLT provided Kelly the power to revoke the trust as to her separate property: the court found that her retention of control “conclusively negates any donative intent on her part evidencing that she ‘absolutely and irrevocably’ intended to divest herself of the ‘title, dominion, and control’ of the Norris Trust assets and could exercise ‘no further act of dominion or control over’ the property.” Further, there was no evidence to show that the contract alleged by Justin was supported by consideration, nor was there evidence in support of his fraud claim that Kelly had made a misrepresentation of fact or that he had been injured by relying on any representation.

Takeaways: Although Kelly may have intended for the trust assets to be converted to community property, she did not take the steps necessary under Texas law to effectuate that intent. In this case, that failure worked in her favor. However, estate planners in community property states should be mindful of the specific requirements of their state’s law to effectuate a conversion from separate to community property, particularly in the not uncommon situation in which one spouse receives an inheritance during a marriage that later ends in divorce.

Bad Behavior and Inadequate Trust Document Results in Frustration of Settlor’s Intentions

Galavich v. Hale, No. 21 BE 0033, 2022 WL 985850 (Ohio Ct. App. Mar. 31, 2022)

Carol Galavich owned a 172-acre farm that had been passed down through her family for 150 years. In March 2011, she was diagnosed with cancer and contacted an attorney to plan for her estate. They discussed creating a trust with Bonnie Stetson named as the trustee. Carol wanted Bonnie to hold the property for her son, Dennis, who was experiencing financial problems and considering filing for bankruptcy. Bonnie was to transfer the farm to Dennis after his financial problems had been resolved. However, Carol did not want to execute a “complicated 10–15 page trust document.”

The attorney wrote the following letter to Bonnie:

As you know, Carol Galavich is in the hospital and remains concerned about her son Dennis and his finances. Because of this, I believe she has talked with you about signing an Affidavit which would transfer certain property to you upon her death. This transfer would be to you as Trustee with the understanding that should Carol die you would ultimately transfer this property to Dennis once his financial problems were taken care of.

This is an unusual situation, but Carol trusts you and tells me that you understand and are agreeable to this. If that is the case, I would ask that you sign the original of this letter at the space below and return the same to me in the enclosed self-addressed envelope.

This letter was signed by Bonnie and kept in the attorney’s file. Carol also executed and signed a transfer on death designation affidavit naming Bonnie Stetson, Trustee as the beneficiary.

In July 2011, Carol died. Dennis filed for bankruptcy less than one week prior to her death. He never disclosed to the bankruptcy court that he was a beneficiary of a trust or that property was being held for his benefit. Instead, he represented that he had been disinherited by his mother. The bankruptcy proceedings concluded at the end of 2012. In 2013, Dennis requested that Bonnie transfer the family home to him. She conveyed the home to him along with one acre of land that was part of the farm. Over the years, she signed other documents and entered into contracts as trustee. However, she also signed some in her individual capacity. 

In 2019, Bonnie, as trustee, executed a transfer-on-death designation affidavit naming her caregiver, Carol Hales, as the beneficiary of the farm. After Bonnie died in April 2020, an affidavit of confirmation of transfer was filed. Dennis became aware of the transfer to Ms. Hales after Bonnie’s death and filed suit against Bonnie’s estate and Ms. Hales, alleging breach of trust, breach of fiduciary relationship, trespass, and conversion, and sought to quiet title. Ms. Hales and Bonnie’s estate asserted defenses of laches, estoppel, unclean hands, and waiver. Ms. Hales and Bonnie’s estate filed a motion for summary judgment asserting that no trust had been created, or if it was, it was ineffective on several bases, including judicial estoppel.

The trial court granted summary judgment in favor of Ms. Hales and Bonnie’s estate. On appeal, the Court of Appeals of Ohio found that (1) the letter Carol’s attorney sent to Bonnie, which she signed; the affidavit in confirmation of transfer; and Carol’s statements to her attorney showed an intention to create a trust, and (2) the various other documents and contracts signed by Bonnie in her capacity as trustee were the actions of a trustee. Further, the letter from Carol’s attorney to Bonnie indicated that Dennis was the intended beneficiary. Lastly, the testimony of Carol’s attorney clearly indicated that Carol’s farm was the trust res. Based on the foregoing, the court concluded that an express trust was created.

However, the court found that the doctrine of judicial estoppel, which precludes a party from assuming a position in a legal proceeding inconsistent with a position taken in a prior action, precluded Dennis from collecting under the trust. Although Dennis had no interest in the property when he filed his bankruptcy petition prior to Carol’s death, his failure to update the petition to include the property being held in trust for his benefit after Carol’s death was contrary to his duty to disclose under federal bankruptcy law. Following Carol’s death, Dennis had a contingent or noncontingent interest in the property and was required by 11 U.S.C. § 541(a)(1)(5) (property acquired by bequest, devise, or inheritance within 180 days of the filing of the bankruptcy petition is part of the bankruptcy estate) to inform the court of the trust. There was evidence that Dennis was aware of the property being held for his benefit in the trust and that his failure to disclose it was not due to mistake or inadvertence. Consequently, the court held that judicial estoppel applied as a matter of law and that Dennis was estopped from collecting under the trust. As a result, the court upheld the trial court’s grant of summary judgment in favor of Ms. Hale and Bonnie’s estate.

Takeaways: This case provides a cautionary tale for clients who say they would like to keep things simple and are reluctant to execute complicated estate planning documents. Depending upon the extent and types of assets that clients own, a simple estate plan may be inadequate to achieve their goals and protect the interests of their intended beneficiaries. This case also demonstrates the perils of trying to shield assets from bankruptcy creditors by failing to disclose an inheritance or even a contingent interest in property. However, the most notable aspect of this case is the court’s determination that the estate of Carol’s trustee Bonnie—who appears to have been unworthy of Carol’s trust—and Bonnie’s beneficiary, rather than Carol’s estate, should receive Carol’s family farm. Although this is an unusual and perhaps incorrect result, it most likely could have been avoided if Carol had allowed her attorney to prepare adequate estate planning documents.

Utah Enacts Commercial Financing Registration and Disclosure Act

2022 Utah Laws Ch. 449 (S.B. 183)

On March 24, 2022, Governor Spencer Cox signed Utah’s Commercial Financing and Disclosure Act (the Act), which requires commercial lenders to register as commercial loan providers with the Nationwide Multistate Licensing System and Registry and Utah’s Department of Financial Institutions. The Act applies to commercial-purpose transactions of $1 million or less that qualify as commercial loans, commercial open-end credit plans, or accounts receivable purchase transactions. The Act requires commercial lenders to disclose the following:

• the total amount of funds provided to the business 
• the total amount of funds disbursed to the business 
• the total amount that must be paid to the provider 
• the total dollar cost of the transaction
• the manner, frequency, and amount of each payment
• a statement of the costs or discounts associated with prepayment
• any amount paid to a broker
• the method used to calculate any variable payment amount and the circumstances that would cause a payment amount to vary

The Act does not create a private right of action. Rather, the Department of Financial Institutions may receive and act on complaints, take action to obtain voluntary compliance, or begin administrative or judicial enforcement proceedings on its own initiative. Commercial lenders that violate the Act may be subject to civil penalties ranging from $500 per violation to a maximum of $20,000 for all violations originating from the use of the same transaction documentation or materials.

Several types of transactions are exempt from the Act, including transactions of at least $50,000 where the recipient of funding is a motor vehicle dealer, and transactions involving depository institutions, licensed money transmitters, commercial equipment lessors, and purchase money lenders. Those who violate the Act after receiving written notice of a prior violation are subject to higher penalties.

Takeaways: Utah is the third state to enact a commercial financing disclosure law similar to the federal Truth in Lending Act. California and New York have enacted similar laws, though their statutes include an annual percentage rate disclosure requirement. Utah’s Act will apply to commercial lending transactions consummated on or after January 1, 2023.

Washington State Enacts Pay Transparency Law

2022 Wash. Sess. Laws Ch. 242 (SB 5761)

On March 30, 2022, Washington state Governor Jay Enslee signed a pay transparency law requiring employers to disclose the wage scale or salary range in job postings, whether done directly by the employer or indirectly by a third party. The law, which is effective January 1, 2023, applies to employers with fifteen or more employees.

Takeaways: Washington joins Colorado and New York City, which recently enacted similar pay disclosure laws. Employers that violate the act may be subject to civil penalties imposed by Washington’s Department of Labor and Industry. In addition, an employee may bring a civil action under the law to recover actual or statutory damages as well as interest, costs, and attorney’s fees.