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From a US Supreme Court decision that proceeds of life insurance purchased by a closely-held corporation to redeem a deceased owner’s shares must be reflected in the fair market value of the corporation for estate tax purposes, to the Texas Supreme Court’s decision requiring prior occupancy for a home to be excluded from countable resources for Medicaid eligibility and a US Supreme Court case ruling that the Federal Arbitration Act requires a stay, not dismissal, of suits pending arbitration, we have recently seen significant legal developments.
To ensure that you stay abreast of these changes, we have highlighted some noteworthy developments and analyzed how they may impact your estate planning, elder and special needs law, and business law practices.
Estate Planning
Proceeds of Life Insurance Purchased by Closely-Held Corporation and Used to Redeem Deceased Owner’s Shares Included in Value of Corporation for Estate Tax Purposes
Connelly v. United States, No. 23-146, 2024 WL 2853105 (June 6, 2024)
Michael Connelly, President and CEO of Crown C, a closely-held family business, owned 77.18 percent of its shares. His brother, Thomas Connelly, owned the remaining 22.82 percent of Crown C’s shares. The brothers entered into a stock purchase agreement providing that at the death of one of the brothers, the other had the right to buy his shares. If the surviving brother chose not to purchase the shares, Crown C was required to purchase the deceased brother’s shares. Crown C purchased $3.5 million in life insurance policies for Michael and Thomas to fund its redemption obligation.
Michael died October 1, 2013. Thomas chose not to purchase his brother’s shares, and Crown C used part of the $3.5 million it had received in insurance proceeds to purchase Michael’s shares. Thomas and Michael’s son agreed that the value of Michael’s shares was $3 million, and Crown C paid that amount to the estate.
Thomas, as executor, filed an estate tax return that valued Michael’s shares at $3 million as of the date of his death. The Internal Revenue Service (IRS) issued a notice of deficiency for $889,914 in additional estate taxes based on its assertion that the fair market value of Crown C should have included the $3 million in life insurance proceeds used to redeem Michael’s shares. Thomas paid the additional taxes but sought a refund. The federal district court for the Eastern District of Missouri found in favor of the government. The Eighth Circuit Court of Appeals affirmed its ruling, and the United States Supreme Court granted certiorari.
On appeal, the US Supreme Court noted that the parties did not dispute that the value of a decedent’s shares in a closely held corporation must reflect that corporation’s fair market value to calculate the federal estate tax. In addition, there was no dispute that insurance proceeds payable to a corporation were an asset that increases its fair market value. The only issue was whether Crown C’s obligation to redeem Michael’s shares at fair market value offset the value of life insurance proceeds used to fund the redemption. The court determined that it did not because a share redemption at fair market value does not affect any shareholder’s economic interest.
Further, the court rejected Thomas’s argument that Crown C’s redemption would make it impossible for a hypothetical buyer seeking to purchase Michael’s shares to capture the full value of the insurance proceeds because those proceeds would leave the company as soon as they arrived to complete the redemption. Thomas viewed the relevant inquiry as what a buyer would pay for the same percentages of shares after the redemption. The court concluded that, in calculating the estate tax, the fair market value of Crown C must be determined as of the date of Michael’s death, not the later date when his shares were redeemed. At that point, the hypothetical buyer would treat the life insurance proceeds used to redeem Michael’s shares as a net asset. Therefore, the life insurance proceeds must be included in the valuation of Michael’s shares for estate tax purposes.
Takeaways: Estate and business planning attorneys should review clients’ buy-sell or stock redemption agreements with Connelly in mind to ensure they are structured to achieve their goals while minimizing estate tax. The US Supreme Court suggests that Michael and Thomas could have avoided the additional estate tax liability by using another type of agreement:
For example, the brothers could have used a cross-purchase agreement—an arrangement in which shareholders agree to purchase each other’s shares at death and purchase life-insurance policies on each other to fund the agreement. A cross-purchase agreement would have allowed Thomas to purchase Michael's shares and keep Crown in the family, while avoiding the risk that the insurance proceeds would increase the value of Michael's shares.
Id. at *5. Nevertheless, the court acknowledges that each strategy has drawbacks, for example, the risk created by a cross-purchase agreement that one of the brothers would have been unable to pay the premiums for an insurance policy on the other brother. Michael and Thomas avoided this risk by having Crown C purchase the insurance policies and pay the premiums. In addition, the court acknowledged that such a cross-purchase arrangement would have its own tax consequences.
Tax Court: Termination of Marital Trusts, Distribution of QTIP Assets to Surviving Spouse, and Later Sale of QTIP Assets in Exchange for Promissory Notes Not Taxable Gifts
In re Estate of Anenberg v. Comm’r, No. 856-21, 162 T. C. No. 9 (May 20, 2024)
Sally and Alvin Anenberg created a revocable living trust (the RLT) that held certain property, including 100 percent of the shares in their company, the Al-Sal Oil Company (Al-Sal). When Alvin died in 2008, under the terms of the RLT, some of the property it held was passed to several subtrusts, including two marital trusts. Under the marital trusts, Sally held an income interest for life and Alvin’s children held contingent remainder interests. The RLT provided that the trustee could elect to treat certain property in the marital trusts as a qualified terminable interest property (QTIP). Pursuant to Internal Revenue Code (I.R.C.) § 2056(b)(7), QTIP election was made on the estate tax return for the property passed to the marital trusts, and Alvin’s estate claimed a marital deduction.
Pursuant to Cal. Prob. Code § 15403, the marital trusts were terminated in 2012 with the consent of Sally and Alvin’s children, and the trust’s assets were distributed to Sally. Later in 2012, Sally made gifts of part of Al-Sal’s shares to Alvin’s children, with each gift having a fair market value of $1,632,622. Also in 2012, she sold the rest of Al-Sal’s shares to Alvin’s children and grandchildren and received interest-bearing promissory notes from them for the purchase price. On her gift tax return, Sally reported only the gifted shares. Sally then passed away.
The IRS issued a notice of gift tax deficiency to Sally’s estate for more than $9 million and an accuracy-related penalty of $1.8 million. The IRS asserted that the termination of the marital trust and the sale of the Al-Sal shares in exchange for the promissory notes were dispositions of Sally’s qualifying income interest for life in QTIP and that the estate was liable for gift tax on the value of the QTIP, minus the value of Sally’s qualifying income interest for life. Sally’s estate filed a petition for redetermination of the deficiency and penalty and a motion for summary judgment on the basis that neither of the transactions resulted in a taxable gift.
The Tax Court rejected the IRS’s argument that gift tax liability was triggered by Sally’s disposition of her qualifying income interest in the QTIP within the meaning of I.R.C. § 2519 either (1) upon the termination of the marital trust and distribution to her of its assets or (2) at the sale of the Al-Sal shares. The court noted that a transfer alone will not create a gift tax liability under I.R.C. § 2501, which states that gift tax applies “on the transfer of property by gift during [the] calendar year.” In re Estate of Anenberg v. Comm’r of Internal Revenue, 162 T. C. No. 9, at *8 (May 20, 2024) (emphasis added).
In determining whether Sally made a gift when the marital trust was terminated and its assets were distributed to her, the court compared what she had before and after the transaction: Under I.R.C. § 2519, for gift and estate tax purposes, any disposition of the surviving spouse’s qualifying income interest in QTIP is treated as if the surviving spouse transferred 100 percent of her interest in QTIP other than her qualifying income interest. Before the transaction, Sally was deemed under I.R.C. § 2056(b)(7) (“no part of such property shall be treated as passing to any person other than the surviving spouse”) to have received all of the QTIP passing from Alvin—a legal fiction, as she only acquired a lifetime income interest in the property. After the transaction—which, under I.R.C. § 2519, was a deemed transfer of the remainder interests in the Al-Sal shares held in trust minus her qualifying income interest—Sally had full ownership of the Al-Sal shares. Accordingly, the court held that Sally “gave away nothing of value as a result of the deemed transfer” to anyone else. In re Estate of Anenberg v. Comm’r of Internal Revenue, 162 T. C. No. 9, at *8. Rather, the result of the transaction was that Sally received all the property that the marital trust had held. Because the termination of the marital trusts did not result in a gratuitous transfer, Sally had made no taxable gift. In addition, the court determined that a conclusion that Sally had made a taxable gift would be difficult to reconcile with Treas. Reg. § 25.2511-2(b), which provides that a gift is complete when the donor “has so parted with dominion and control as to leave in [her] no power to change its disposition, whether for [her] own benefit or for the benefit of another.” Her decision to consent to the termination of the marital trusts was conditioned on her receipt of the property they held: rather than parting with dominion and control over the property, “she had full control over the disposition of the assets previously held in trust” after it was distributed to her. Id. at *9.
In addition, I.R.C. § 2512(b), which addresses how gifts should be valued in calculating gift tax, states that if property is transferred for less than full and adequate consideration, the amount by which the value of the property exceeds the value of the consideration is a gift. If the value of the transferred property is the same as that of the consideration received, there is no taxable gift. In the present case, although she held an income interest, Sally was deemed to hold the entirety of the marital trust property, valued at $25.5 million. After the termination of the marital trust, Sally held property valued at $25.5 million. Therefore, she had been fully compensated for the interest she was deemed to transfer and had not made a gift.
The court determined that Sally’s sale of the Al-Sal shares to Alvin’s children in exchange for promissory notes also did not trigger gift tax. Because the termination of the marital trusts and the distribution of their assets to Sally would have triggered I.R.C. § 2519, it was no longer applicable when Sally later sold the shares; rather, the ordinary estate and gift tax rules applied because Sally had already satisfied the requirements of the QTIP regime. Further, even if the termination of the marital trusts and distribution of the property they held to Sally was not a disposition under I.R.C. § 2519, the QTIP no longer existed at that point because Sally held outright ownership of the property—not merely a qualifying income interest. Because the QTIP no longer existed, I.R.C. § 2519 could not be triggered by any future transaction. As a result, Sally’s sale of the Al-Sal shares in exchange for promissory notes could not trigger I.R.C. § 2519.
The court further reasoned that this conclusion was consistent with the purpose of the marital deduction, which does not eliminate or reduce tax on the transfer of marital assets out of the marital unit but rather defers it until the death of or gift by the surviving spouse:
Where, as here, a surviving spouse receives the QTIP with respect to which she is deemed to transfer remainder interests, the value of the marital assets is preserved in her estate and will be taxed upon her death, assuming she does not consume the property or transfer it by gift at a later date. This is the same result that obtains when the marital deduction applies without regard to the QTIP regime.
Id. at* 12. As a result, the Tax Court granted Sally’s estate’s motion for partial summary judgment and denied the IRS’s motion for summary judgment.
Takeaways: QTIP elections are often made on estate tax returns for property passed to a marital trust when the grantor wishes to provide income for the surviving spouse for life while preserving an inheritance for other beneficiaries, often children from a previous marriage. The marital deduction is available for QTIPs, allowing the surviving spouse to receive income without paying estate tax, which is deferred until after the surviving spouse dies. Wealthy clients can use this strategy to reduce their estate tax liability and will be relevant for more taxpayers if the current high exemption amount ($13.61 for a married couple) expires as expected at the end of 2025. The In re Estate of Anenberg court expressly declined to address whether the nonspouse beneficiaries of the marital trusts, in consenting to their termination, “could be treated as making a gift to the surviving spouse for gift tax purposes.” Id. at *17, n. 18. This is interesting in light of the position recently taken by the IRS in I.R.S. Chief Counsel Adv. 2023-52-018 that beneficiaries who consented to modifying an irrevocable grantor trust to include a tax reimbursement clause were subject to gift tax.
New York Adopts New Law Authorizing Transfer-on-Death Deeds
N.Y. Real. Prop. § 424 (2024)
On April 20, 2024, the New York legislature enacted legislation as part of its fiscal year 2025 budget authorizing transfer-on-death (TOD) deeds to transfer property to one or more beneficiaries at the transferor’s death. Under the new law, a TOD deed must
- contain the essential elements and formalities of a properly recordable inter vivos deed,
- state that the transfer to the designated beneficiary is to occur at the transferor’s death,
- be signed by two witnesses present at the same time and who witnessed the signing of the TOD deed,
- be acknowledged by a notary public, and
- be recorded before the transferor’s death in the public records of the county clerk’s office in the county where the property is located.
Where the transferor is a joint owner and other joint owners survive them, the property passes to the surviving joint owners. The TOD deed is effective upon the transferor’s death if the transferor is the last surviving joint owner. TOD deeds are nontestamentary and revocable by an instrument, not an act, even if the deed or other instrument contains a contrary provision. However, the TOD deed does not affect the transferor’s right to transfer the property during their lifetime, and the interest of a designated beneficiary who does not survive the transferor lapses. The statute specifies that, to execute a TOD deed, the transferor must have the same capacity to execute a will. The statute contains a form that may be used to create a TOD deed.
Takeaways: The new law takes effect July 19, 2024. New York joins more than half of the US states that currently allow TOD deeds, which permit real property to pass to named beneficiaries at the transferor’s death without going through the probate process. The new law authorizes TOD deeds for property in New York; however, the transferor is not required to be located in New York.
Illinois Law Firm Subject to Personal Jurisdiction in Florida Stemming from Involvement in Florida Probate Action
Neal, Gerber, & Eisenberg LLP v. Lamb-Ferrara, No. 3D23-0155, 2024 WL 2742043 (Fla. 3rd Dist. Ct. App. May 29, 2024)
Neal, Gerber, & Eisenberg LLP (Neal Gerber) was a law firm organized under the Illinois Uniform Partnership Act. It had a single office in Chicago, Illinois, its principal place of business and headquarters. Wealthy artist Matthew Lamb and his wife retained Neal Gerber to update their estate plans in 2008. Matthew designated Florida as his domicile in his will and other estate planning documents. After Matthew passed away in 2012, his widow, who was executor of his will, retained Neal Gerber in connection with Matthew’s estate. Neal Gerber advised Matthew’s widow, as executor, to retain Florida counsel to commence probate proceedings there. She retained Florida counsel, and probate proceedings were initiated later in 2012. Several months later, Matthew’s widow resigned as executor and was replaced by their daughter, Sheila Lamb-Gabler. Neal Gerber continued the engagement until its formal termination in 2019.
Sheila filed suit in Florida against Neal Gerber in 2021, alleging breach of fiduciary duty and malpractice. Neal Gerber filed a motion to dismiss for lack of personal jurisdiction. In support of the motion, it submitted affidavits attesting that all the services it performed during the engagement were performed in its Chicago office and that none of its lawyers were ever physically present in Florida. Neal Gerber also denied that it was ever counsel of record and asserted that it did not file or serve any pleadings or papers in the probate action. The law firm admitted that it attended hearings by telephone on some occasions.
Sheila submitted an affidavit of the Florida attorney retained by Matthew’s estate in opposition to the motion to dismiss. The affidavit attested that Neal Gerber was the lead counsel for the executor and that the Florida attorney took instructions and directions from that firm. In addition, the Florida attorney attested that all pleadings and activities were undertaken at the direction and control of Neal Gerber, there were no communications with the executor without Neal Gerber’s direction and participation, and no instructions were taken from the executor. Further, the affidavit attested that Neal Gerber prepared most of the pleadings and approved the pleadings prepared and filed by the Florida attorney in the probate action. Further, during the Florida attorney’s representation of the executor, the attorney had hundreds of communications of various types with Neal Gerber. Further evidence was submitted demonstrating that a Neal Gerber attorney remotely attended hearings on behalf of the executor and that the estate paid attorneys’ fees and costs to Neal Gerber.
The trial court denied Neal Gerber’s motion after determining that it had performed most of the legal work for an estate being probated in Florida; therefore, Neal Gerber had sufficient minimum contacts with the state of Florida and could reasonably anticipate being haled into a Florida court.
On appeal, the District Court of Appeal of Florida performed a de novo review in which it conducted a two-part inquiry to determine whether a court has jurisdiction over a nonresident defendant. First, it examined whether the complaint alleged jurisdictional facts sufficient to bring the action within Florida’s long-arm statute. The court relied on prior Florida cases in which the courts found that the long-arm statute may extend to nonresident defendants who perform estate services outside the state of Florida where the estate is probated in Florida in finding that Sheila’s complaint sufficiently alleged facts establishing jurisdiction that had not been rebutted by Neal Gerber.
Second, the court examined whether Neal Gerber had sufficient minimum contacts to satisfy constitutional due process under the test set forth in World-Wide Volkswagen Corp. v. Woodson, 444 U.S. 286 (1980), i.e., whether “the defendant’s conduct and connection with the forum are such that [it] should reasonably anticipate being haled into court there.” Id. at 287. The court found that Neal Gerber had provided estate planning services to Matthew knowing that he was domiciled in Florida and had worked closely with the Florida attorney who the estate had retained. Further, it noted that Neal Gerber had not denied the assertions in the affidavit that Neal Gerber was lead counsel; had directed the actions of the Florida lawyer; and had prepared, reviewed, and approved all filings prepared by the Florida attorney. Consequently, the court ruled that Neal Gerber had sufficient minimum contacts and should have reasonably foreseen being haled into a Florida court.
Takeaways: The Neal, Gerber, & Eisenberg LLP case provides a reminder that it is not a best practice for attorneys to attempt to represent clients who have moved to a different state, even if local counsel is retained. Not only is it unlawful for a lawyer to practice law or give legal advice in a state in which they are not licensed, but out-of-state attorneys are likely to be subject to personal jurisdiction in that state if any lawsuits arise from the representation.
Elder Law and Special Needs Law
Texas Supreme Court Requires Prior Occupancy for Home to be Excluded as Countable Resource
Texas Health & Human Ser. Comm. v. In re Estate of Burt, No. 22-0437, 2024 WL 1945484 (Tex. May 3, 2024)
Clyde and Dorothy Burt lived in their family home in Cleburne, Texas, for many years. They sold the family home to their daughter Linda and son-in-law Robby in 2010 and moved to a rental property. In August 2017, Clyde and Dorothy moved into a skilled nursing facility. Clyde and Dorothy had cash assets and cash value in a life insurance policy that typically would be counted as available resources in determining their eligibility for Medicaid. After moving into the nursing facility, they implemented a spend-down plan to ensure Medicaid eligibility. As part of the strategy, Clyde and Dorothy used cash assets and the cash value of the life insurance policy to buy an undivided one-half interest in the family home from Linda and Robby. After purchasing the one-half interest in the home, Clyde and Dorothy were left with $2016.10, which is below the $3,000 maximum resource threshold for couples to be eligible for Medicaid assistance.
Clyde and Dorothy then executed a Lady Bird deed granting their newly purchased interest to Linda and Robby, reserving an enhanced life estate for themselves that would revert to Linda and Robby at their deaths. On the day of their purchase, Clyde executed Form H1245, notifying the Texas Health and Human Services Commission (the Commission) that he considered the house his home and principal place of residence and that he intended to return to it. Shortly thereafter, he submitted Form H1245 with a joint application for Medicaid nursing facility assistance for himself and Dorothy. Both Clyde and Dorothy died while their application was pending.
The Commission denied the estate’s claim for Medicaid assistance. The Commission determined that Clyde and Dorothy’s property interest in the home was not excludable because they had not lived there for several years before entering the nursing facility. Linda, as executor, petitioned the district court for review. The district court reversed the Commission’s decision, determining that the interest in the home should have been excluded from their available resources. The court of appeals affirmed, holding that the purposes of Medicaid are better served by allowing Medicaid applicants to claim the exemption for a home purchased while in a nursing home because they will need a home to return to after being discharged.
The Texas Supreme Court disagreed. In its de novo review, the court examined the Commission’s construction of home under federal and state law. It noted that the method used by Texas in determining income and resource eligibility must not be more restrictive than the method used by the federal Supplemental Security Income program. Because home is not defined by 42 U.S.C. § 1382b(a) (“In determining the resources of an individual (and his eligible spouse, if any) there shall be excluded . . . the home (including the land that appertains thereto)”), the court first turned to the plain and ordinary meaning of the term, interpreted in the context of the statute. Noting dictionaries define home as one’s principal place of business or domicile, the court determined the following:
a home is the principal place in which one lives and resides, not merely a structure in which one possesses a partial ownership stake. At the time the Burts applied for Medicaid, they did not reside in the Cleburne house. Nor was the Cleburne house their principal residence or domicile during the preceding seven years. Under the plain language of the statute, the Cleburne house was not their “home.”
Texas Health & Human Ser. Comm. v. In re Estate of Burt, No. 22-0437, 2024 WL 1945484, at *3 (Tex. May 3, 2024). The court determined that Medicaid’s purpose of promoting a return to independence meant that applicants would return to the type of residence they occupied before the claim for assistance arose. The court further held that the resources statute should calculate available resources based on the applicant’s living situation before the claim for assistance arose. Permitting the applicant to change the nature of their residence from renting to owning by converting assets that would have been available to pay for the applicant’s care would be an “improper asset transfer” and would prevent the recoverability of Medicaid funds. Id.
In addition, the court determined that federal and state regulations and the Social Security Program Operations Manual System (POMS) supported the definition of home as being the applicant’s residence before the claim for assistance arises: for the home to be excluded, the applicant must move out with the intent to return. Because Clyde and Dorothy’s intent to return to the home arose only after their Medicaid application was submitted, it was not excludable. Therefore, the court reversed the judgment of the court of appeals and rendered judgment in favor of the Commission.
Takeaways: The Texas Health & Human Services Commission case establishes that a property interest purchased after the Medicaid claim arises and where the residence is not occupied prior to the application will not be excluded from the calculation of available resources. Elder law practitioners who wish to counter this position can refer to the dissenting opinion. In the dissent, three justices noted that Texas law specifies that the Commission must follow C.F.R. § 416.1212 regarding the treatment of the home. It defines home as “any property in which an individual (and spouse, if any) has an ownership interest and which serves as the individual's principal place of residence.” The dissent looked to C.F.R. § 416.1212(c), which states that “[i]f an individual (and spouse, if any) moves out of his or her home without the intent to return, the home becomes a countable resource because it is no longer the individual's principal place of residence.” (emphasis added). The dissent argued that, based on the foregoing statement, the reasonable implication is that if an individual moves out with the intent to return, the home remains the principal residence. The dissent asserted that Clyde and Dorothy’s statement of their intent to return to their long-time home was clear and unambiguous, and thus, according to POMS SI 01130.100.E.1., this statement should be dispositive. The dissent noted that others could avoid the “injustice” suffered by Clyde and Dorothy due to the majority’s “judicially created prior-occupancy requirement” by living in the home they purchased for just one day before moving into the nursing facility. Texas Health & Human Ser. Comm. v. In re Estate of Burt, No. 22-0437, 2024 WL 1945484, at *11.
Some commentators have argued that Clyde and Dorothy are not the first and will not be the last Medicaid applicants to be disadvantaged because of a decision by a court that seems to be hostile to the concept of Medicaid planning. Many believe that the dissenting justices in Texas Health & Human Services Commission correctly reasoned the existing law regarding the uncountability of a home of a Medicaid applicant being based on the subjective finding of the applicants and not an objective finding by the Medicaid office or other entity. The takeaway for practitioners in Texas is to ensure prior occupancy as part of a spend-down strategy, even for one day. Non-Texans should remember that even the most germane, run-of-the-mill Medicaid rule can be dramatically changed by a court majority with disdain for means-tested benefits planning.
Minnesota Court Rules Assets Held in Irrevocable Trust that Were Not Countable Resources for Initial Medicaid Eligibility Were Countable Under Expanded Estate Recovery Statute
Hammerberg v. Minn. Dept. of Human Serv., A23-0901, 2024 WL 1712748 (Minn. Ct. App. Apr. 22, 2024)
Leonard and Margaret Schubert owned real property valued at $490,228, which they conveyed to an irrevocable trust in 2005. The trust instrument provided that “[t]he settlors or the survivor of them shall be entitled to the use and possession of any real estate held in the trust.” The trustee was required to pay all trust income to Leonard and Margaret and had the authority to distribute some or all of the principal of the trust to their living children during their lifetime. Leonard and Margaret had a right to remove and replace the trustee. In addition, the trust instrument provided that when the survivor died, the trustee shall distribute the income and principal of the trust to their descendants per stirpes subject to Leonard and Margaret’s ability via a power of appointment to modify the distribution in a will specifically referring to the relevant article of the trust.
Although Leonard died without receiving medical assistance, Margeret was determined to be eligible for medical assistance in 2016 and received $210,396.93 prior to her death in 2019. The Minnesota Department of Human Services (DHS) filed notices of potential claims against the real property held in the trust to recover medical assistance paid on behalf of Margaret. The DHS commissioner adopted the recommendation that the property be subject to the liens and to medical assistance recovery. Brad Hammerberg, trustee of the irrevocable trust, appealed the decision to the district court. The district court reversed the commissioner’s decision, and the commissioner appealed.
The Minnesota Court of Appeals noted that under 42 U.S.C. § 1396p(b)(4)(A), an estate subject to Medicaid recovery “include[s] all real and personal property and other assets included within the individual’s estate, as defined for purposes of State probate law.” Further, for Medicaid recovery purposes, 42 U.S.C. § 1396p(b)(4)(B) permits states to expand the definition of estate to include certain assets that would not be part of a decedent’s estate under ordinary probate law as follows:
any other real and personal property and other assets in which the individual had any legal title or interest at the time of death (to the extent of such interest), including such assets conveyed to a survivor, heir, or assign of the deceased individual through joint tenancy, tenancy in common, survivorship, life estate, living trust, or other arrangement.
(emphasis added). Minnesota did expand the definition for Medicaid recovery purposes, passing Minn. Stat. § 256B.15, subdiv. 1a(b)5, which states that, for Medicaid recovery purposes, a decedent’s estate includes “assets conveyed to a survivor, heir, or assign of the person through survivorship, living trust, transfer-on-death of title or deed, or other arrangements.” (emphasis added).
Neither of the parties disputed that the irrevocable trust was a living trust. Further, they agreed that pursuant to the terms of the trust, the trustee must distribute all property to the settlor’s descendants. The court determined that the conveyance fell within the plain language of Minn. Stat. § 256B.15, subdiv. 1a(b)5 because the real property would be conveyed to Margaret’s heirs through a living trust.
The court rejected Brad’s argument that the language of 42 U.S.C. § 1396p(b)(4)(B) was narrower than the Minnesota statute, allowing the inclusion of certain assets only “to the extent of such interest,” which excluded conveyances via living trusts. The court held that interpreting the parenthetical phrase to exclude conveyances by living trusts would render the language “through [a] living trust” meaningless. In addition, the court held that, contrary to Brad’s contention, DHS was not required to identify the specific interest Margaret held in the real property at the time of her death. The court further disagreed that the commissioner’s decision was inconsistent with the standard set forth in In re Estate of Barg, 752 N.W.2d 52, 63 (Minn. 2008), which provides that, for an interest to be recoverable, the Medicaid recipient must have held the interest at the time of death; under Minnesota case law, for purposes of estate recovery, at the time of death means a point in time immediately before death. The court determined that Margaret had a legally recognized interest in the real property at the time of her death because she was an income beneficiary, had the power to remove and replace the trust, and had a power of appointment. Accordingly, the court reversed the district court’s decision.
Takeaways: The Hammerberg case, although not precedential, is notable for a state advancing novel and aggressive estate recovery arguments. The Hammerberg court upheld the state’s right to recover because, although the trust was irrevocable and its assets were not countable for purposes of initial and continuing eligibility, it was nevertheless recoverable at full value under Minnesota’s expanded estate recovery statute because Margaret had a legally recognized interest in the real property at the time of death under both real property and probate law. Under this reasoning, assets held in a Medicaid Asset Protection Trust, which often include provisions wholly unrelated to Medicaid compliance such as the reservation of a power of appointment to enable a basis adjustment at the grantor’s death, may cause the trust to be recoverable.
The holding is troubling to some commentators because it conflates issues regarding Medicaid eligibility and estate recovery. It also enshrines a legal barrier to protecting assets from estate recovery in Minnesota that the federal statute itself cannot justify. This is not the first time that Minnesota has pursued Medicaid policy in contravention of federal rules and practice. In a notable opinion, In re Geyen v. Commissioner of Minnesota Department of Human Services held that a Minnesota statute prohibiting the use of irrevocable trusts in Medicaid planning was preempted by federal law. The Hammerberg decision flows from the same appellate court and, therefore, is another example that the fight for consistent Medicaid case law may never be won. Practitioners around the country must recognize the unique posture that future estate recovery arguments may present and find strategies to combat them.
Business Law
US Supreme Court: Federal Arbitration Act Requires District Courts to Stay, Not Dismiss, Suits Pending Arbitration
Smith v. Spizzirri, 144 S. Ct. 1173 (2024)
Current and former drivers for a delivery service filed suit alleging violations of federal and state employment laws. The delivery service removed the case from state to federal court and moved to compel arbitration and dismiss the suit. The delivery drivers conceded that their claims were arbitrable under the Federal Arbitration Act FAA), but asserted that under 9 U.S.C. § 3, the district must stay the action pending arbitration rather than dismiss it completely.
The federal district court issued an order compelling arbitration and dismissed the case without prejudice, stating that although the text of 9 U.S.C. § 3 suggests that the action should be stayed, Ninth Circuit precedent indicated that it had the discretion to dismiss the action. The Ninth Circuit Court of Appeals affirmed.
Because courts of appeals were split on the issue of whether a district court must stay an action pending arbitration when a party requests a stay or has the discretion to dismiss the action under the FAA, the United States Supreme Court granted certiorari.
The Court, in interpreting the text, structure, and purpose of the FAA, noted that under 9 U.S.C. § 3, when any issue in a suit is subject to arbitration, the court
shall on application of one of the parties stay the trial of the action until such arbitration has been had in accordance with the terms of the agreement, providing the applicant for the stay is not in default in proceeding with such arbitration.
Smith v. Spizzirri, 144 S. Ct. 1173, 1177 (2024) (emphasis added). The court held that, first, the use in the text of the statute of the word “shall” creates “an obligation impervious to judicial discretion.” Smith v. Spizzirri, 144 S. Ct. 1173, 1177 (2024). Second, the structure of the FAA indicates that a stay is required: under 9 U.S.C. § 16, an immediate interlocutory appeal is authorized when a court denies a request for arbitration, but an order compelling arbitration generally is not immediately appealable. The court noted that requiring a stay is consistent with congressional intent in enacting the FAA to move parties to an arbitrable dispute “out of court and into arbitration as quickly and easily as possible.” Id. Congress’s goal is thwarted if the district court dismisses a suit subject to arbitration even when a party requests a stay because the dismissal triggers the right to an immediate appeal—an outcome Congress sought to forbid. Third, the purposes of the FAA, which envisions that the courts will play an ongoing supervisory role, are achieved by staying the suit and keeping it on the court’s docket rather than dismissing it. Therefore, the court reversed the judgment of the Eleventh Circuit Court of Appeals and remanded the case for further proceedings consistent with its opinion.
Takeaways: The US Supreme Court’s decision in Smith v. Spizzirri resolves a split between the circuits, abrogating Green v. SuperShuttle Int’l, Inc., 653 F. 3d 766 (8th Cir. 2011), Bercovitch v. Baldwin School, Inc., 133 F. 3d 141 (1st Cir. 1997), Alford v. Dean Witter Reynolds, Inc., 975 F. 2d 1161 (5th Cir. 1992), and Sparling v. Hoffman Constr. Co., 864 F. 2d 635 (9th Cir. 1988). The court’s decision is impactful due to the broad scope of the FAA, which applies to any contract “evidencing a transaction involving commerce” that is subject to a written agreement to arbitrate under 9 U.S.C. § 2.
IRS May Not Require Documentation of Ability to Pay Potential Imputed Tax Liability as Part of BBA Election
SN Worthington Holdings LLC v. Comm’r, No. 13248-20, 162 T.C. No. 10 (May 22, 2024)
SN Worthington Holdings LLC (SN Worthington) is a limited liability company classified as a partnership for income tax purposes. In October 2018, the IRS notified SN Worthington by letter that it had selected its 2016 partnership for audit. The IRS’s letter also informed SN Worthington that it could elect into Bipartisan Budget Act (BBA) partnership audit procedures within 30 days of the date of the letter. Within the 30-day window, SN Worthington submitted Form 7036 to elect into the BBA partnership procedures. In completing Form 7036, SN Worthington was required to represent under penalty of perjury that it “[h]as sufficient assets, and reasonably anticipates having sufficient assets, to pay the potential imputed underpayment that may be determined during the partnership examination.”
After receiving Form 7036 from SN Worthington, the IRS sent a letter to it stating the following:
As part of the election, you represented the partnership has sufficient assets, and reasonably anticipates having sufficient assets, to pay the potential imputed underpayment that may be determined during the partnership examination. After reviewing the tax return it appears that you do not meet the requirements.
SN Worthington Holdings LLC v. Comm’r, No. 13248-20, 162 T.C. No. 10, *2 (May 22, 2024). In addition, the IRS’s letter informed SN Worthington that it could submit supporting documentation to the IRS if it disagreed with the IRS’s determination that SN Worthington was unable to pay an imputed underpayment. The IRS sent a subsequent letter to SN Worthington notifying it that its election of BBA partnership procedures was invalid because it had not provided proof of sufficient assets available to pay the potential imputed tax liability. SN Worthington did not respond to either letter. The IRS followed Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)—rather than BBA—procedures, and, in 2020, issued a Notice of Final Partnership Administrative Adjustment (FPAA) determining adjustments to SN Worthington’s 2016 income tax return. SN Worthington filed a timely petition challenging the FPAA and later filed a motion to dismiss, asserting that the court lacked jurisdiction to hear the case because the FPAA was invalid.
The Tax Court noted that Treas. Reg. § 301.9100-22 sets forth the form and manner for an election of BBA procedures and requires the partnership to make a representation that it has sufficient assets to pay a potential imputed underpayment for the tax year at issue. The court held that in determining whether a taxpayer has made a valid election, the IRS may not require the taxpayer to meet requirements that are more stringent than the provision authorizing the election—such as the supporting documentation of SN Worthington’s ability to pay potential imputed tax liability it sought.
The court determined that SN Worthington had made a valid election by complying with “the plain text of the election requirements” by providing a representation that it had and anticipated having sufficient assets to pay a potential imputed underpayment. Therefore, the FPAA issued to it was invalid. In addition, the court rejected the IRS’s argument that SN Worthington should be equitably estopped from asserting that BBA procedures apply. Although the court viewed SN Worthington’s failure to inform the IRS that it had made an incorrect determination until 2020 as misleading silence, equitable estoppel was not available because the IRS had all the relevant and material facts necessary to determine whether a valid election had been made.
The court entered an order of dismissal for lack of jurisdiction because a valid notice is a jurisdictional prerequisite for the proceeding. SN Worthington made a valid election into BBA procedures, and thus the FPAA issued pursuant to TEFRA procedures was invalid. Further, the elements of equitable estoppel were not established.
Takeaways: The TEFRA authorized the IRS to conduct partnership audits and to make adjustments at the partnership level. In 2015, Congress passed the BBA, but the BBA specified that its audit rules would not apply until the 2018 tax year. As a result, the TEFRA rules continued to govern partnership audits until the 2018 tax year. However, the BBA authorized partnerships to elect into the BBA partnership audit rules before 2018 by making a timely and valid election. The court’s decision in SN Worthington Holdings LLC reaffirms that the IRS must adhere to its regulations as written and cannot impose additional requirements on taxpayers.
