From the announcement of the projected 2023 estate and gift tax exclusion amounts to newly issued final regulations implementing the Corporate Transparency Act, we have recently seen significant developments in estate planning and business law. To ensure that you stay abreast of these legal changes, we have highlighted some noteworthy developments and analyzed how they may impact your estate planning and business law practices.

Projected 2023 Estate and Gift Tax Exclusion Amounts Are Announced

Bloomberg Tax projects that the basic exclusion amount for decedents dying in 2023 and the generation skipping transfer tax exemption amount for 2023 will be $12,920,000 (up from $12,060,000 in 2022). The annual exclusion amount for gifts made in 2023 is projected to be $17,000 (up from $16,000 in 2022). The amount of gifts to noncitizen spouses not included in the total amount of taxable gifts made during 2023 is estimated to be $175,000 (up from $164,000 in 2022).

Takeaways: These projections reflect the high rate of inflation. The projected increase in basic exclusion amount means that an individual will be able to transfer an additional $860,000 ($1,720,000 for married couples) free of transfer tax liability in 2023. The $17,000 annual exclusion  amount for gifts represents the second increase in two years: the exclusion amount for gifts was increased to $16,000 in 2022 after remaining at $15,000 from 2018 through 2021. Estate planning attorneys should work with clients to determine if they should take advantage of the planning opportunities provided by these increases, especially in light of the sunset of the doubled exemption amount at the end of 2025.

IRS Releases Notice Clarifying Proposed Regulations Related to Required Minimum Distributions

I.R.S. Notice 2022-53, 2022-44 IRB 1 (Oct. 7, 2022)

The IRS recently issued Notice 2022-53, which clarifies that proposed regulations related to required minimum distributions (RMDs) under IRC §401(a)(9) will apply no earlier than the 2023 distribution calendar year, and provides guidance and clarification regarding RMDs for 2021 and 2022. 

In 2020, the SECURE Act created a 10-year payout rule for most inherited retirement assets, such that the account must be fully withdrawn within 10 years after the death of the plan participant. Whether withdrawal of RMDs would be required during that 10-year period was unclear, with many believing that no RMDs were required in years one through nine following the death of the plan participant. In February 2022, the IRS issued proposed regulations clarifying that RMDs are, in fact, required during the 10-year period under most circumstances. This caught many beneficiaries, especially those who had opted not to take distributions, by surprise—and left them looking for guidance. Notice 2022-53 provides such guidance. 

Takeaways: As mentioned, some beneficiaries, acting in good faith based upon the information they had, did not take RMDs in 2021 or 2022. The notice clarifies that the IRS will not penalize beneficiaries for not taking those RMDs. However, they will have to ask for a refund of any excise tax already paid; the IRS will not automatically reimburse it.

Offer in Compromise Was Properly Rejected Where IRS Could Collect from Executor Who Distributed Assets After Receiving Notice of Deficiency 

Estate of Lee v. Comm’r, 2022 WL 3594523 (3rd Cir. Aug. 23, 2022)

Anthony Frese was the executor of the Estate of Kwang Lee (Estate), who died in 2001. Frese miscalculated the estate tax owed, and although the Estate received a notice of deficiency in 2006, followed by a formal assessment in 2010, the Estate distributed more than $1 million to the beneficiaries of the Estate between 2004 and 2010, including distributions of $640,000 shortly after receiving the notice of deficiency. In 2013, the Commissioner of Internal Revenue filed a tax lien. The Estate made an offer in compromise (OIC) (“an agreement between a taxpayer and the Internal Revenue Service that settles a taxpayer's tax liabilities for less than the full amount owed”) of its remaining assets. The OIC was rejected by the Internal Revenue Service (IRS), which may reject an OIC if it is less than the reasonable collection potential (RCP), i.e., the amount the Commissioner determines can likely be collected from available sources. One of the sources to which the IRS can look is the executor, who may be personally liable for amounts transferred out of the estate before satisfying the estate tax that is due. 

After the Estate exhausted its administrative remedies, it petitioned for relief in the tax court. The tax court granted summary judgment in favor of the Commissioner, holding that the Commissioner did not abuse his discretion by rejecting the OIC, and the Estate appealed to the Third Circuit Court of Appeals.

The court of appeals affirmed the judgment of the tax court, rejecting the following three arguments asserted by the Estate:

1. The Estate asserted that Internal Revenue Manual 5.8.5.18(2), which states that “[g]enerally, a three year time frame will be used to determine if it is appropriate to include a dissipated asset in RCP.” The court of appeals disagreed on the basis that the Commissioner had not asserted a dissipation, i.e., the transfer of assets to avoid payment of tax liability, and that the three year time frame set forth in the Manual is not mandatory, but instead is merely a guideline.
2. The court of appeals determined that the Estate’s assertion that certain stock options were transferred to the beneficiaries by operation of law rather than by Frese, as executor, was waived because it was not raised before the tax court.
3. The court of appeals found that the Estate’s argument that Frese had relied on professional advice was without merit because Frese consulted counsel only with respect to the preparation of the estate tax returns rather than the distribution of assets. Further, Frese had actual knowledge of the deficiency because he had received the notice of deficiency prior to distributing the assets, so the defense of reliance on professional advice was inapplicable.

Takeaways: Although the court of appeal’s opinion does not constitute binding precedent because it was not issued by the full court, it provides a reminder that attorneys should warn executors or personal representative of estates that under I.R.C. § 3713(b), “[a] representative of a person or an estate … paying any part of a debt of the person or estate before paying a claim of the Government is liable to the extent of the payment for unpaid claims of the Government.”  Some leniency may be shown for executors who rely in good faith on mistaken advice provided by their attorney, but leniency is unlikely where the executor received notice that the estate owed taxes prior to making distributions to beneficiaries.

LLC Operating Agreement That Did Not Specify to Whom Deceased Member’s Interest Should Pass Did Not Trump Specific Devise in Deceased Member’s Will 

Tita v. Tita, 334 So.3d 646 (Fla. Ct. App. March 2, 2022)

John Tita’s last will and testament contained a specific devise of his interest in a Utah limited liability company (LLC) to two of his children, Andre Tita and Sandra Tita, in equal shares. The will named Andre and Sandra as the co-personal representatives of his estate. The will further specified that John’s wife was to receive the residuary estate. In addition, it disinherited another one of John’s children, Michael Tita, providing that he “shall be treated as predeceased for purposes of the will.” When the LLC was created, the membership interests were as follows: John and his wife each owned 39.5 percent, Andre held 11 percent, and Sandra and Michael each held 5 percent.

Section 8.4 of the LLC operating agreement stated: 

On the death … of a Member, unless the Company exercises its rights under Section 8.5, the successor in interest to the Member (whether an estate, bankruptcy trustee, or otherwise) will receive only the economic right to receive distributions whenever made by the Company and the Member's allocable share of taxable income, gain, loss, deduction, and credit (the “Economic Rights”) unless and until a majority of the other Members determined on a per capita basis admit the transferee as a fully substituted Member in accordance with the provisions of Section 8.3.

Section 8.5 of the LLC operating agreement provided: 

Notwithstanding the foregoing provision of Section 8, the Members covenant and agree that on the death of any Member, the Company, at its option, by providing written notice to the estate of the deceased Member within 180 days of the death of the Member, may purchase, acquire and redeem the Interest of the deceased Member in the Company pursuant to the provision of Section 8.5.

After John’s death, his wife and his son Michael obtained an order in Utah declaring that the LLC had exercised its option to purchase and redeem John’s interest in accordance with Section 8.5. In the Florida probate proceedings, the court entered an order in which the parties stipulated that the Utah order was binding on John’s estate, and that the LLC had exercised its option to purchase John’s interest in the LLC. 

John’s wife moved for an order determining the disposition of a failed devise. She argued that the LLC operating agreement contained specific language addressing the disposition of John’s interest in the LLC upon his death, and that the LLC had exercised its option to purchase and redeem his interest pursuant to Section 8.5. She asserted that the proceeds of the buyout were part of the residuary estate because John’s attempted devise of his LLC membership interests to Andre and Sandra failed. The probate court disagreed, holding that John’s devise had not failed and that the proceeds of the LLC’s buyout must be paid to Andre and Sandra pursuant to the terms of the will.

The Florida Court of Appeals, applying Utah law, agreed. The court of appeals found that the LLC operating agreement did not specify to whom John’s membership interest should be transferred and did not provide that the interest would immediately vest in another at his death. Rather, it simply indicated that the LLC had an opportunity to provide notice to the estate within 180 days if it decided to redeem John’s membership interest. In addition, the LLC operating agreement acknowledged in Section 8.4 that the transfer of a member’s interest would not be controlled by the operating agreement because it listed an estate as one of several possible “successors in interest to the Member.” Rather, John’s bequest to Andre and Sandra vested upon his death, and once vested, the LLC operating agreement “controlled the nature of [Andre and Sandra’s] interest and the terms of a buyout.” The LLC operating agreement did not operate to “trump the will and effect a transfer of the membership interest outside of the will.” In addition, the membership interest was a specific legacy in the will to Andre and Sandra. As a result, upon the LLC’s election to redeem the membership interest, Andre and Sandra were entitled to receive the proceeds of the sale. 

Takeaways: The court of appeals acknowledged that the LLC operating agreement could have explicitly provided that John’s membership interest would immediately pass to the LLC or another party upon his death, removing it from his estate and nullifying any contrary bequest in his will. However, in this case, the operating agreement did not contain such language; instead, it merely provided the LLC with an option to redeem John’s interest if it chose to do so. Estate planning attorneys with clients who are business owners should review the governing documents of any business (1) to ensure that any disposition of business interests contemplated as part of the estate planning process is permitted thereunder and (2) to confirm that there are not clauses in such governing documents that would create ambiguity regarding the business owners’ intentions regarding the disposition of their ownership interests.

Paycheck Protection Program Loan Forgiveness Amount Must Be Reported as Gross Income Where Taxpayer Was Not Eligible for Qualifying Forgiveness and SBA Could Pursue Reimbursement

I.R.S. Chief Couns. Mem. 2022-37-010 (Aug. 19, 2022)

A recent memorandum issued by the Internal Revenue Service’s Office of Chief Counsel addressed whether a taxpayer whose Paycheck Protection Program loan was forgiven despite not qualifying for forgiveness must report the loan proceeds as gross income. 

The Paycheck Protection Program (PPP) was established by the 2020 CARES Act and extended by the 2020 Economic Aid Act to help small businesses struggling as a result of the shutdowns and restrictions put in place in response to COVID-19 to cover payroll costs and other eligible expenses. The PPP loans were available only to eligible recipients and were required to be used for eligible expenses as set forth by statute and relevant interim final rules. PPP loans that meet certain statutory criteria are eligible for qualifying forgiveness: (1) at least 60 percent of the PPP loan proceeds must be used for payroll costs, and the remaining 40 may be used for other eligible expenses and (2) the forgiveness amount may not exceed the sum of certain specified costs incurred and paid during the covered period. PPP loan recipients must submit applications for forgiveness attesting to their eligibility for forgiveness and verifying that the loan proceeds were expended as required and that the forgiveness amount satisfied all limitations regarding the specified costs. The Small Business Administration (SBA) allowed lenders to rely on the recipients’ certification and documentation in originating and forgiving PPP loans. 

The taxpayer seeking advice had received a PPP loan in 2020 but did not use the loan proceeds for eligible expenses. She applied for forgiveness but failed to include facts indicating that she was not eligible for qualifying forgiveness of the loan. As a result of the inaccurate or incomplete information she supplied, the taxpayer’s lender forgave her PPP loan. 

In general, the receipt of PPP loan proceeds is not an accession to wealth under I.R.C.§  61(a) because the recipient is obligated to repay it. Once the lender forgives the PPP loan, the recipient enjoys an accession to wealth unless a statutory exception under 15 U.S.C. § 636m(i)(1) and § 276(b)(1) of the Covid-Related Tax Relief Act of 2020 is applicable permitting the loan recipient to exclude the forgiven amount from gross income as a qualifying forgiveness. The Office of Chief Counsel quoted the Second Circuit Court of Appeals, which held: 

[F]orgiveness is neither automatic nor guaranteed. A borrower must apply for forgiveness, which will only be granted if specified criteria are met, see 15 U.S.C. § 636m(b)–(d), and the CARES Act places several additional conditions upon obtaining forgiveness [including that the funds are “used for statutorily authorized purposes”].

Springfield Hosp., Inc. v. Guzman, 28 F.4th 403, 424 (2nd Cir. 2022). 

Because the taxpayer’s PPP loan was forgiven based upon “omissions and misrepresentations,” the forgiveness was not a qualifying forgiveness that may be excluded from her gross income. The taxpayer’s loan forgiveness amounted to a payment that was an undeniable accession to wealth, clearly realized, and over which she had complete dominion: thus it was gross income. Despite the ability of the SBA to pursue repayment of the loan proceeds based on misuse, the taxpayer retained the loan proceeds under a claim of right as set forth in North American Oil Consolidated v. Burnet, 286 U.S. 417, 424 (1932) (“[i]f a taxpayer receives earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent.”). Thus, the improperly forgiven loan was gross income despite the SBA’s ability to pursue its repayment.

Takeaways: The memorandum does not have precedential value, but the advice it provided was endorsed by IRS Commissioner Chuck Rettig, who stated: "This action underscores the Internal Revenue Service’s commitment to ensuring that all taxpayers are paying their fair share of taxes. . . . We want to make sure that those who are abusing such programs are held accountable, and we will be considering all available treatment and penalty streams to address the abuses."

Newly Passed California Law Prohibits Employment Discrimination Based on Marijuana Use Away from the Workplace

A.B. 2188 (Sept. 18, 2022)

On September 18, 2022, Governor Gavin Newsom signed California Assembly Bill No. 2188, which amended the California Fair Employment and Housing Act to prohibit employment discrimination based on a person’s “use of cannabis off the job and away from the workplace.”  The law further states that employers are prohibited from discriminating based on “an employer-required drug screening test that has found the person to have nonpsychoactive cannabis metabolites in their hair, blood, urine, or other  bodily fluids” because the results of those tests “have no correlation to impairment on the job” and only demonstrate that the person has “consumed cannabis in the last few weeks.” Although the law recognizes that employees should not work while they are impaired, it directs employers to use other types of tests to detect impairment. Certain employees are not protected by the law, including those in the building and construction trades, employees whose positions require a federal background check, and employees who must be tested for controlled substances under state or federal law as a condition of employment, to receive federal funds or licensing, or to enter a federal contract. The law is effective January 1, 2024.

Takeaways: Several other states—Connecticut, Montana, New Jersey, New York, Nevada, and Rhode Island— have enacted statutes similar to California’s new law, and it is likely that similar statutes will be enacted in additional states. On September 9, 2022, the New Jersey Cannabis Regulatory Commission issued guidance addressing requirements employers must follow under its 2021 statute to take adverse employment actions due to marijuana-related impairment. Employers in these states must ensure that their efforts to maintain a drug-free workplace comply with the law and are not reliant on drug tests that screen for nonpsychoactive cannabis metabolites. 

Final Regulations Issued for the Implementation of the Corporate Transparency Act

Beneficial Ownership Information Reporting Requirements, 31 CFR 1010 (2022)

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

On September 29, 2022, FinCEN issued final regulations for the CTA’s implementation, which will become effective January 1, 2024. The final rule did not further define “other similar entity” in its discussion of the companies that will be considered reporting companies. However, in a recently issued fact sheet, FinCEN indicated that it “expects that these definitions mean that reporting companies will include (subject to the applicability of specific exemptions) limited liability partnerships, limited liability limited partnerships, business trusts, and most limited partnerships, in addition to corporations and LLCs, because such entities are generally created by a filing with a secretary of state or similar office.”  In addition, FinCEN recognized that the creation of most sole proprietorships, trusts, and general partnerships do not require the filing of a formation document with the secretary of state or similar office and thus are excluded from the definition of a reporting company.

Business entities that meet the definition of a reporting company must provide the required information for all beneficial owners (i.e., individuals who own or control 25 percent or more of the ownership interests of the company or who exercise “substantial control” over the company) and company applicants. A company applicant is defined as either (1) the individual who files the document that creates the entity or registers the entity to do business in the United States in the case of a foreign reporting company or (2) the individual who is primarily responsible for directing or controlling another’s filing of the document. The final rule does not require reporting companies that are already in existence or registered before January 1, 2024 to identify or provide information about company applicants. In addition, reporting companies created or registered after January 1, 2024 are not required to update information they provide about company applicants.  

Pursuant to the final rule, the reporting company must provide a Beneficial Ownership Information (BOI) Report identifying itself and, for each of its beneficial owners, their name, birthdate, address, and a unique identifying number and issuing jurisdiction from an acceptable identification document and the image of that document. Reporting companies created after January 1, 2024 (but not those that were created before that date) must also provide the same information and the document image for company applicants. A FinCEN identifier is available for individuals who provide the foregoing information directly to FinCEN.

The final rule requires that reporting companies created or registered after January 1, 2024 file their initial report with FinCEN within thirty calendar days of the date on which the reporting company receives actual notice that its creation or registration has become effective or the secretary of state first provides public notice that a domestic reporting company has been created or a foreign reporting company has been registered. Reporting companies created or registered before January 1, 2024 must submit an initial report within one year of the effective date. If there is a change in the information previously reported, reporting companies will have thirty calendar days to file an updated report

The final rule provides guidance about what is considered “substantial control” of a reporting company, listing activities that could amount to substantial control and including individuals who are empowered to make important decisions on behalf of the company. The rule clarifies that “a trustee of a trust can, in fact, exercise substantial control over a reporting company through the exercise of his or her powers as a trustee over the corpus of the trust, for example, by exercising control rights associated with shares held in trust.”

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

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

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

Takeaways: Attorneys who assist clients with the formation of business entities after the January 1, 2024 effective date should consider urging clients to identify company applicant information in their organizational documents to potentially avoid being considered an applicant themselves. FinCEN will engage in further rulemaking to clarify who may have access to a reporting company’s BOI, the permissible purposes for access, and safeguards to ensure the information is secure. Also, FinCEN will develop compliance and guidance documents, including a Small Entity Compliance Guide, to assist reporting companies to comply with the final rule.