Posts Categorized: Tax Update

Upcoming Trusts & Estates Events at the BBA – June 2021

By: Jennifer D. Taddeo, Conn Kavanaugh and Rebecca Tunney, Goulston & Storrs, Communications Committee, Trusts and Estates Section

Upcoming Trusts & Estates Section Programs at the BBA this month: 

Trusts & Estates End of Year Review 2021    Monday, June 21, 2021, 2:00 pm – 3:00 pm  An annual event not to be missed, the Trusts & Estates End of Year Review covers recent federal and state case law, legislation and tax law matters, with updates presented by the New Developments Committee, Public Policy Committee and Tax Law Updates Committee.

McGregor v. McGregor, 308 Neb. 405 (2021)

By: Craig Cataldo, Nutter

The Nebraska Supreme Court recently declined to approve a Non-Judicial Settlement Agreement (NJSA) because it violated a material purpose of the relevant trust.  While the ruling relies on a statutory presumption specific to the Nebraska Uniform Trust Code, it serves as an important reminder to practitioners that NJSAs are only valid to the extent they do not violate a material purpose of the underlying trust.  

Facts:

The trust at issue in McGregor provides for a “family trust” benefiting the decedent’s surviving spouse.  Upon her death, two “carve-out” trusts will be created for the benefit of the decedent’s children and their respective issue.  These carve-out trusts are to be funded with specific tracts of real estate and are to be equalized, to the extent possible, with liquid assets in the trust.  The trust specifically states the assets in the carve-out trusts “shall remain in trust” and that the trusts “shall be irrevocable and shall not be revoked or amended in whole or in part by the trustee, beneficiary, or any other person.”  Furthermore, the trust provides that the donor intended that each carve-out trust be a “non-support discretionary spendthrift trust that may not be reached by the beneficiaries[’] creditors for any reason.”  The decedent’s children have limited testamentary powers of appointment under the carve-out trusts and, in default of exercise, the trusts will be held for their issue.

Following the decedent’s death, the surviving spouse and the decedent’s two children executed a settlement agreement which provided for an equal, outright distribution to the decedent’s children upon the death of the surviving spouse.  Six years after the agreement was signed, the surviving spouse attempted to revoke it via email and one of the decedent’s children sought to have the agreement approved by the court.  

The trial court issued an order finding the agreement was nonbinding.  First, the court stated that the undetermined beneficiaries of the carve-out trusts—the decedent’s grandchildren—were “interested persons” and, therefore, needed to consent to the agreement for it to be binding.  Second, the court found that even if all interested parties consented, the agreement violated a material purpose of the trust, which was to leave the property in trust for the decedent’s children during their lives and then to their issue when they die.  The ruling was appealed. 

Analysis:

Under Neb. Rev. Stat. § 30-3801, “[a] nonjudicial settlement agreement is valid only to the extent it does not violate a material purpose of the trust” and spendthrift provisions are presumed to be a material purpose of the trust.  The court looked at the language in the trust evidencing that a material purpose was to keep the property in trust; specifically, the instrument provides that the carve-out trusts “shall remain in trust”, that the trusts shall be irrevocable, and that the donor intended the carve-out trusts to be spendthrift trusts that cannot be reached by the beneficiaries’ creditors.  Therefore, the court concluded the trusts were designed to “hold the beneficiaries’ interests in trust and restrain the transfer of such interests”.  The court explained that an outright distribution would allow the beneficiaries’ creditors to reach the property and allow the decedent’s children to transfer the property during their lives and not at death, which also conflicts with the limited power of appointment in the carve-out trusts. 

Result:

The Nebraska Supreme Court concluded the spendthrift provision was a material purpose of the trust which the settlement agreement violated by distributing the assets outright rather than in trust.  Accordingly, the Court held the settlement agreement was invalid.

Relevance to Massachusetts:

Unlike the Massachusetts Uniform Trust Code (MUTC), the Nebraska statute explicitly states that “[a] spendthrift provision in the terms of the trust is presumed to constitute a material purpose of the trust.”  This provision clearly guided the Nebraska Supreme Court in reaching its decision as the trust at issue specifically provided that the carve-out trusts were intended to be spendthrift trusts. 

This case may be of interest to practitioners in Massachusetts, however, because many standard trusts include spendthrift provisions.  Although § 111 of the MUTC does not explicitly state that a spendthrift provision is a presumed material purpose, a spendthrift clause is a common example of a material purpose and would likely be treated as such under the MUTC.  See 21 Mass. Prac., Probate Law and Practice § 3:2 (3d ed.); cmt. to § 411 of MUTC Ad Hoc Committee Report.  Moreover, it was not only the spendthrift language that factored into the Nebraska Supreme Court’s reasoning.  The Court also highlighted that the carve-out trusts were structured to restrain the beneficiaries from transferring the assets during life, evidenced by the limited power of appointment at death.  Given that this is a common structure for many trusts benefiting a decedent’s children, practitioners preparing NJSAs involving distributions may need to consider whether a material purpose of the trust would be violated by distributing trust assets outright.

Another interesting element of the McGregor case is that just because the surviving spouse previously consented to the agreement, does not mean it is valid.  This serves as a reminder to practitioners that NJSAs are only valid to the extent they comply with the MUTC.  Accordingly, if a party who signs an NJSA decides to back out of it, the agreement’s enforceability on all parties involved may hinge on whether it violates a material purpose of the trust. 

Upcoming Trusts & Estates Events at the BBA – May 2021

By: Jennifer D. Taddeo, Conn Kavanaugh and Rebecca Tunney, Goulston & Storrs, Communications Committee, Trusts and Estates Section

Upcoming Trusts & Estates Section Programs at the BBA this month: 

Trust Administration and Recent Developments in Massachusetts Divorce Law    Thursday, May 20, 2021  Our panelists will discuss recent developments in divorce law relating to trusts and how these developments can impact the drafting and administration of trusts to protect assets in the event of a beneficiary divorce.

Wealth and Estate Planning in the Digital Age: A Guided Tour of Cryptocurrencies, Non-Fungible Tokens, and Other (Stunningly Valuable) Digital Assets  Monday, May 24, 2021   Our distinguished panel will explore the rapidly evolving world of digital property, to look at how old ideas (like burying gold in the backyard) are being translated into new and exotic technologies.  The panel will then examine the extraordinary impact that these new technologies are having on what used to be prosaic estate planning strategies. For example, Bitcoin, with its staggering volatility, is an asset well-suited for funding a Grantor Retained Annuity Trust – or GRAT.  Meanwhile, the secrecy – and value – of passwords and passkeys in the digital era is the equivalent of holding the treasure map to Blackbeard’s buried treasure; if it is not preserved carefully and passed on at death, the treasure can be lost forever.  And that could lead to a personal representative’s nightmare: the IRS recently held that the estate of an individual who died owning millions of dollars’ worth of cryptocurrency owed tax of the known value of those assets at death, even though the passkey was lost with the death of the decedent and the assets are now unreachable by the estate!  Come join us for a fascinating journey to the intersection of technology, huge wealth, and estate planning, where tax analysis and science fiction often complete – and sometimes collide.  

Charitable Estate Tax Deduction for LLC Membership Interests Reduced by Discounts for Lack of Marketability and Control

By: Keirsa Johnson, Hemenway & Barnes LLP

Warne v. Commissioner, T.C. Memo 2021-17, United States Tax Court

Background

Miriam Warne owned ground leases on several properties in California, which she and her late husband held through five separate LLCs.  Prior to her death, Miriam transferred fractional interests in four of the five LLCs to her children and grandchildren but retained 100% ownership over Royal Gardens LLC (“Royal Gardens”) through her revocable trust.  Upon her death, Miriam left 75% of her interest in Royal Gardens to the Warne Family Charitable Foundation (“Foundation”), and the remaining 25% to St. John’s Lutheran Church (“Church”).

On the timely filed Form 706, the estate reported the date of death value for Warne Family Trust’s 100% ownership interest in Royal Gardens as $25,600,000.  It also reported a corresponding charitable deduction of $19,200,000 for the gift of its 75% interest in Royal Gardens to the Foundation, and a deduction of $6,400,000 for the gift of its 25% interest to the Church. The Commissioner issued a notice of deficiency determining, among other things, a decrease in the estate’s charitable contribution deduction to $21,405,796. [1]

Analysis

The Commissioner argued that, because both the Foundation and the Church received only a partial interest in Royal Gardens, lack of control and lack of marketability discounts should apply to those gifts.  The value of the deduction, the Commissioner argued, should reflect the value received by the charity.

The estate disagreed, arguing that applying valuation discounts to charitable gifts would undermine the public policy encouraging charitable giving.  Furthermore, the estate argued that, because it held 100% of the interest in Royal Gardens and gave that 100% to charitable organizations, it was entitled to deduct 100% of the Royal Gardens value.

The Commissioner and the estate both cited the Ninth Circuit case of Ahmanson Foundation v. United States[2] as support for their positions.  In Ahmanson, the decedent owned 100 shares of a corporation.  Upon his death, he gave 99 nonvoting shares to a charitable foundation and one voting share to his son.  The Ninth Circuit ruled that the 100 shares were fully includable in the decedent’s estate, but the charitable deduction for the gift of 99 nonvoting shares would be discounted.  The Tax Court summarized the Ahmanson ruling by stating that “when valuing charitable contributions, we do not value what an estate contributed; we value what the charitable organizations received.”

The Warne estate argued that, unlike Ahmanson, 100% of the Royal Gardens value was given to charity, and therefore a valuation discount should not apply.  The Tax Court disagreed, ruling that it does not matter who receives the majority interest, “it is the value of the property received by the donee that determines the amount of the deduction available to the donor.”  The Tax Court went on to uphold the charitable valuation discounts stipulated to by the parties.

Takeaway

This case illustrates the fact that, even when 100% of a decedent’s interest in property passes to charitable beneficiaries, valuation discounts may still apply, resulting in the estate paying some estate tax on such property.  Therefore, it is important to think about the structure of the charitable gifts during the planning stage, and to note any split when calculating the actual value of the gift after the decedent’s death.  If the decedent had left the interest in the LLC to only one of the charities, it would have received a full charitable deduction, resulting in no estate tax payable with respect to such property.

[1] The Commissioner disputed the appraised value, the reported valuation discounts, or both, for each of the five LLCs owned by the Warne family.  Where these values were disputed, the Tax Court provided a detailed analysis of both the estate’s and the Commissioner’s expert evaluations, and the ultimate determination as to the value and discount of each property in dispute.  The valuation of the four LLCs for which no charitable deduction was claimed is not part of this discussion.

[2] Ahmanson Found. v. United States, 674 F.2d 761 (9th Cir. 1981).

Interested in writing for the Boston Bar Association’s Trusts & Estates Section Blog?   Please contact the Communications Committee co-chairs, Rebecca Tunney at RTunney@GOULSTONSTORRS.com and Jennifer Taddeo at jtaddeo@connkavanaugh.com.

IRS Issues Final Carried Interest Regulations

By: Justin M. Hannan, Day Pitney LLP

On January 7, 2021, the IRS released final regulations regarding the taxation of carried interests under Section 1061 of the Internal Revenue Code (the Code).  The final regulations retained many of the basic features described in the proposed regulations last summer, but with certain helpful revisions. 

First, some background: Investment partnerships such as hedge funds and private equity funds typically compensate their fund managers by granting a right to future partnership profits. This partnership interest is commonly known as a “carried interest” or a “promote” and is usually not taxable to the fund manager upon receipt. Gain recognized by the fund from its investments and allocated to the fund manager is generally taxed at favorable long‑term capital gain rates.

In 2017, Congress enacted Section 1061 of the Code as part of the Tax Cuts and Jobs Act. Section 1061 generally extends the holding period required to qualify for long-term capital gain treatment from one year to three years with respect to gains related to an “applicable partnership interest” (API). An API is any interest in a partnership which is held by a taxpayer in connection with the performance of services in any applicable trade or business (ATB), defined generally as (A) raising or returning capital, and (B) investing in or developing specified assets. The definition of “specified assets” includes securities, commodities, real estate held for rental or investment, cash or cash equivalents, options or derivative contracts with respect to any of the foregoing, and interests in partnerships to the extent of the partnerships’ proportionate interests in any of the foregoing. Most investment partnerships will fall within this definition, and therefore a fund manager that receives a carried interest from an investment partnership will typically be subject to the rules of Section 1061.

Section 1061 addresses a wide variety of fact patterns, and the final regulations contain 166 pages of additional guidance. From a trust and estates perspective, the focus has historically been on Section 1061(d), which recharacterizes certain long-term capital gain as short-term capital gain when a taxpayer transfers an API to a related person. Notably, Section 1061(d) does not define “transfer” or otherwise limit its application to income-taxable transfers. Thus, the statute suggests that tax-free transfers of an API (e.g., a gift, bequest or a transfer to a grantor trust) are also subject to Section 1061(d), and the proposed regulations furthered this view by stating that a transfer does inclu de gifts and at least certain other transfers that are otherwise tax-free. This created a substantial amount of uncertainty, as it became unclear whether making a tax-free transfer of an API could somehow trigger unrealized built-in gain that is recharacterized as short-term gain. The final regulations resolved this issue favorably by stating that Section 1061(d) does not apply to nontaxable transfers. Treas. Reg. § 1.1061-5(b). Thus, transfers of carried interests via death or gift do not trigger Section 1061(d).

The final regulations generally apply to taxable years beginning on or after January 19, 2021. It remains unclear how President Biden plans to address carried interest taxation, but note that the tax plan that President Biden released prior to the election did propose to increase the maximum tax rate applicable to long-term capital gains and qualified dividends from 20% to 39.6%. Any change to the long-term capital gain rate would have a substantial impact on Section 1061 and carried interest planning in general. For starters, taxpayers might decide to dispose of capital assets before rates increase without realizing that some are actually subject to a three-year holding period.  It is also important to note that one of the key benefits of carried interest is the fact that it is currently eligible for a maximum 20% long-term capital gains rate instead of today’s maximum 37% ordinary income rate. Should both of those rates increase to 39.6%, the benefit of carried interest would be substantially diminished. On one hand, this would lessen the sting of triggering Section 1061 in the first place. However, this might also push investment funds to devise new ways to compensate and incentivize their fund managers, which in turn would lead to new tax planning opportunities.

Upcoming Trusts & Estates Events at the BBA – April 2021

By: Jennifer D. Taddeo, Conn Kavanaugh and Rebecca Tunney, Goulston & Storrs, Communications Committee, Trusts and Estates Section

Upcoming Trusts & Estates Section Programs at the BBA this month: 

Nonprobate Transfers: Joint, Property, Retirement Planning, Life Insurance Beneficiary Designations Wednesday, April 7, 2021 This program will provide an overview of nonprobate transfers, which involve the transfer of a decedent’s property by methods other than via probate of the decedent’s will.  The presentation will specifically highlight the treatment of joint property, retirement assets, life insurance and the use of beneficiary designations.

Proving Testamentary Capacity At Trial  Wednesday, April 14, 2021 This program will review the standard for testamentary capacity and will explore the role of fact and expert witnesses and how to and select and prepare those witnesses.

Special Needs Planning Tools: Trusts, ABLE accounts, and other planning considerations  Wednesday, April 21, 2021 Our expert panelists will compare and contrast the various tools available to estate planners with respect to special needs planning. Discussion will include a comparison of individual and pooled trusts, first party and third party trusts, and newer tools such as ABLE accounts. Attendees will be provided a summary chart handout at the end of the presentation. 

Last Month at the BBA – Trusts & Estates Section Events in March 2021

By: Jennifer D. Taddeo, Conn Kavanaugh and Rebecca Tunney, Goulston & Storrs, Communications Committee, Trusts and Estates Section

Trusts & Estates Section Programs at the BBA this month: 

A Practical Guide to Estate Administration Wednesday, March 3, 2021 This program will provide an overview of the basic steps to administer the estate of a deceased person, including probate, paying debts, satisfying creditor claims, preparing income and estate tax returns, accountings and distribution of the decedent’s assets.

Estate Planning for Private Equity Professionals and Firm Principals Monday, March 15, 2021  This program will cover tax and estate planning issues that commonly arise when representing private equity professionals and firm principals.  The presentation will include an overview of the unique nature of private equity fund interests, including carried interest, as well as the particular challenges and tax-planning opportunities they present for estate planners at different stages of the fund life cycle.

Special Needs Planning: Guidance and Strategies for Estate Planning, Trust Administration and Beyond Monday, March 22, 2021 There are several unique and complex considerations when planning for beneficiaries with special needs. Those who attend this CLE will receive practical guidance and tips from our expert panelists on several topics, including: when to use a special needs trust (SNT), the types of SNTs and drafting considerations, serving as a special needs trustee, trust distributions and asset management, and other related topics.

 

Biden Campaign’s Proposal to Eliminate the Step-Up in Basis at Death

By: Katie Sapp, Day Pitney

In the wake of the change of administration, many have continued to speculate about what tax reforms we can expect from the Biden administration and Democratic-controlled Congress.  While the likelihood of imminent tax reform is still widely unknown, proposals from President Biden and his campaign during the 2020 presidential race suggest that they have part of their focus on eliminating the step-up in basis for property transferred at death.

Early in Biden’s campaign, he told fundraisers that he would like to “close loopholes like capital gains and stepped-up basis.”  In a more recent proposal, Biden’s Plan for Education Beyond High School explicitly states that it would raise funds to support said plan in part by “eliminating the stepped-up basis loophole.”  More generally, Biden’s campaign highlighted their commitment to capital gains reform with the goal of getting rid of capital gains tax loopholes for the wealthy.  In addition to eliminating the step-up in basis, Biden has proposed increasing the income tax rate on capital gains above $1 million to the same rates as ordinary income.

Biden has not elaborated on what eliminating the stepped-up basis would look like.  With such little information surrounding this proposal, commentators have had to look to other sources for more detail, such as the “Greenbook” revenue proposals of the Obama Administration.  The final 2016 edition of the Greenbook includes a proposal to “Reform the Taxation of Capital Income.”  This plan would treat the transfer of property at death or during life as a realization event, thereby imposing an income tax on the property’s appreciation.

The Greenbook includes the following additional details:

  • The gain would be taxable income to the donor in the year the gift was made, and to the decedent either on the final individual return or on a separate capital gains return. The tax imposed on gains realized at death would be deductible on the decedent’s estate tax return, if any.
  • Gifts or bequests to a spouse or charity would carry the donor’s basis. Capital gain would not be realized until the spouse’s later death or disposal of the asset.  Any property donated to charity would be exempt from capital gains tax.
  • No gain would be realized on tangible personal property, specifically excluding collectibles.
  • The current $250,000 in the case of single taxpayers (and presumably the $500,000 in the case of married taxpayers filing jointly) exclusion of capital gain on a principal residence would be extended to apply to all residences. Every taxpayer would also be allowed an additional exclusion of capital gains up to $100,000 (indexed for inflation).  Both exclusion amounts would be portable to a surviving spouse.
  • To facilitate and implement the proposal, the Greenbook outlined additional legislative changes that would take effect, including: the allowance of a deduction for the full cost of appraisals of appreciated assets, the imposition of liens, the waiver of penalty for underpayment of estimated tax if the underpayment is attributable to unrealized gains at death, and broad authority granted to the Secretary to issue regulations as necessary, among other changes.

Noting that the Biden administration has not formally submitted its own proposal with respect to reforming taxation on capital income, the Greenbook proposal might accurately reflect the current administration’s vision.  That said, assuming the Greenbook proposal were adopted in full, we could see a dramatic decrease in inheritances.  For example, assume a taxpayer with more than $1 million in annual income bought $10,000 worth of X shares 20 years ago.  Assume further that, today, those shares are worth $500,000 and that she leaves these shares to her only child.  As of today, that child would receive the full $500,000 worth of shares (subject to estate tax) and the new basis for those shares would also be $500,000.  The child could then sell those shares with an effective appreciation of $0 and have no capital gains tax liability. 

Assuming the facts above and that Biden’s plan also includes the taxation of capital gains at the same rates as ordinary income, the new capital gain tax liability would be $194,040 at the top proposed rate of 39.6%.  The child would now only receive $305,960 worth of shares (subject to estate taxes).

Eliminating the step-up in basis at death would have serious implications for wealthy individuals looking to pass significantly appreciated assets to their heirs.  That said, it’s not entirely clear whether or not the step-up in basis will actually be eliminated.  For one, the Biden administration has not provided any detail as to their own plans for implementing this proposal.  In addition, this is not the first time an elimination of the stepped-up basis has been proposed.  Even with a Democratic-controlled Congress, interest in this issue may wane in favor of other issues as it makes its way through the deal-making process.  Still, this is a potential change in law estate planners should keep an eye on, particularly if and when the Biden administration begins to provide more details on this proposal.

Upcoming Trusts & Estates Events at the BBA – March 2021

By: Jennifer D. Taddeo, Conn Kavanaugh and Rebecca Tunney, Goulston & Storrs, Communications Committee, Trusts and Estates Section

Upcoming Trusts & Estates Section Programs at the BBA this month: 

A Practical Guide to Estate Administration Wednesday, March 3, 2021 This program will provide an overview of the basic steps to administer the estate of a deceased person, including probate, paying debts, satisfying creditor claims, preparing income and estate tax returns, accountings and distribution of the decedent’s assets.

Special Needs Planning: Guidance and Strategies for Estate Planning, Trust Administration and Beyond Monday, March 22, 2021 There are several unique and complex considerations when planning for beneficiaries with special needs. Those who attend this CLE will receive practical guidance and tips from our expert panelists on several topics, including: when to use a special needs trust (SNT), the types of SNTs and drafting considerations, serving as a special needs trustee, trust distributions and asset management, and other related topics.

 

Last Month at the BBA – Trust & Estate Section events in January and February 2021

By: Jennifer D. Taddeo, Conn Kavanaugh and Rebecca Tunney, Goulston & Storrs, Communications Committee, Trusts and Estates Section

Missed it?   You can still benefit from prior Trust & Estates Section programming at the BBA: 

Modifying Irrevocable Trusts: Decanting, Non-Judicial Settlement Agreements and other Trust Amendment Alternatives   Wednesday, January 6, 2021  This program will provide an introduction to various methods for modifying an irrevocable trust, including how and when to consider: (1) Modifications under the Massachusetts Uniform Trust Code, (2) reformations, (3) non-judicial settlement agreements, and (4) decanting.

Breach of Fiduciary Duty Litigation: Superior Court versus Probate & Family Court   Wednesday, January 13, 2021  A panel of probate litigators will share insights for bringing fiduciary duty claims and defending those claims, whether brought in Superior Court or the Probate & Family Court. The panelists will also explore litigation tactics applicable to each court as well as alternate dispute resolution and settlement opportunities.

Ethical Dilemmas and Considerations in Representing Impaired Clients   Wednesday, January 13, 2021   According to a leading mental health organization, 1 in 5 adults in the United States suffers from some form of mental health condition or disorder. It is likely that at some point in your legal career, you will represent an individual client, or a representative of a corporate client, who suffers from some degree of mental incapacity. Knowing how to assess capacity and deciding how to proceed if you have doubts about your client’s mental health is easier said than done. This first part in a 3-part series of programs will focus on an attorney’s legal and ethical duties when facing the prospect of representing a mentally impaired client.

Trusts & Estates Mid-Year Review    Tuesday, January 19, 2021   An annual event not to be missed, the Trusts & Estates Mid-Year Review covers recent federal and state case law, legislation and tax law matters. This year’s program will touch on:

  • New Developments Committee:  The committee will review recent estate planning and administration cases.
  • Public Policy Committee:  The presentation will include an overview of recent and pending legislation.
  • Tax Law Updates Committee:  The committee will report on important updates regarding the Internal Revenue Code, federal tax law, recent cases, private letter rulings, charitable planning updates, retirement cases and other interesting developments.

Charitable Giving Basics for Estate Planners Wednesday, February 3, 2021  This program will provide an introduction to charitable planning. We will discuss the reasons for charitable giving, the types of property that can be used to make a charitable gift, and the techniques that can be used to achieve clients’ charitable goals.

Special Drafting Considerations for Elderly Clients Thursday, February 11, 2021  Attorneys Patricia Keane Martin and Kristin Dzialo will discuss special drafting considerations for practitioners to be mindful of when advising elderly clients.  Specifically, they will discuss language concerning end of life decision-making and care, and the importance of counseling clients on the implications of including or excluding certain powers from their documents with an eye towards protecting the client and achieving his or her planning goals. The discussion will be beneficial both for practitioners new to estate planning and for seasoned estate planners.