SCOTUS Decision Affects Diversity Jurisdiction of Business Trusts

Many registered investment companies and real estate investment trusts are organized as business trusts. Certain states, such as Maryland, Delaware, and Massachusetts have been hospitable to such entities, and therefore are home to many of these entities. In some states, such as Massachusetts, the entities are formed as common-law trusts, while in others there is a statutory authorization for the formation of a business trust. However, unlike corporations which exist as “persons” for the purpose of legal actions, there have been questions raised as to whether business trusts have a separate legal existence.

The issue of whether a trust is a separate legal entity can impact how trusts access courts.  In a decision that could significantly impact the way in which business trusts determine the forum in which they sue or are sued, on March 7, 2016 the U.S. Supreme Court decided a case involving Americold Realty Trust. In that decision, the Court held that, unlike a corporation, a trust does not have a separate legal existence for the purpose of determining the citizenship of the entity.

The decision reaffirmed that a corporation is a citizen of the state in which it is organized (and the state in which it maintains its principal office, if different).  However, in an 8-0 decision, the Court held that trusts are not separate legal entities with a defined state of citizenship.  Rather, the citizenship of a business trust will be determined by where the beneficiaries of the trust are located.  For a large, publicly-owned business trust, such as a registered investment company or a REIT which have shareholders scattered in many or all of the states, that may effectively destroy any basis for such a trust to use diversity of citizenship to affect federal court jurisdiction.  If sued, this could force such entities to litigate in jurisdictions where the trust is not organized and does not maintain an office because an isolated shareholder resides in that jurisdiction.

While there may be little that investment companies or REITs can do to alter the impact of this decision, it will be interesting to see if the state laws authorizing such trusts can be revised in a way that may impact the consequences of this decision.

©2016 Greenberg Traurig, LLP. All rights reserved.

The Artist’s Legacy – Business and Legal Planning Issues

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Photographers face unique issues that must be carefully considered to ensure a continued market for the creative output and to preserve the artistic reputation. Prudently managed business affairs will minimize problems commonly encountered when closing down a studio and during the transition of business affairs from the photographer’s life to the photographer’s estate.

First, there is the issue of care for the physical works, the critical planning for the inventory, conservation and storage of the photographer’s works. Second is the issue of advantageously placing the photographer’s works; which works should be preserved, which donated, and when, where, how, including considering a sale or donation to a publicly-accessible archive as a permanent home for papers and other materials. This naturally leads to the third issue, prudent sales; how much and what part of the inventory should be released for sale each year and through what means? Is this the moment to re-examine the extant gallery relationship? These decisions require knowledge of the market, including a sense of timing, market conditions, and museum/collector interest.

Getting the house in order also includes appointing executors, attorneys, and accountants who can be trusted, who know the family or estate, who are familiar with and responsible toward the photographer’s work and the market, and who have both sensitivity and concern for the future of the photographer’s works and artistic reputation. Estate planning considerations for a photographer also include issues relevant for any individual: to provide for the surviving children, spouse and others according to the law and the photographer’s wishes so as to assure orderly transition and minimize the potential for probate litigation. For a photographer, though, preserving and enhancing a legacy also includes efficiently managing the estate to maintain continuity and safeguard the assets.

Photographers must likewise consider their intangible assets, which include copyrights, trademarks, licensing potential, and the like. It is important for photographers to register copyrights and keep track of any copyright renewal or termination rights, to be aware of current assignments and licenses of the intellectual property, and to maintain orderly files of subject releases, photographer agreements and other agreements affecting the works. Photographers should also consider licensing decisions to promote accessibility and generate revenue. It is crucial to weigh each transaction in terms of its potential for affecting the photographer’s stature in the art market. Indeed, one should consider the implications of each decision as it promotes and/or dilutes the overall value of the photographer’s oeuvre.

The photographer must identify and implement a comprehensive business and legal framework that can guide the present and govern the future in order to assure that legacy is preserved in accordance with the photographer’s wishes.

Above is the text of a handout on business and legal planning issues prepared by Christine Steiner. Christine Steiner and Lauren Liebes recently joined Weston Naef, Getty Photography Curator Emeritus, and ASA appraiser Jennifer Stoots for “What Will Become of Your Legacy”, a panel discussion at Los Angeles Center of Photography.  The panel addressed business and estate planning issues for photographers. In our next post, Lauren Liebes will address the myriad estate planning issues to consider.

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Same Sex Marriage and Tax Law…A Rough Landscape

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Another tax season is upon us, and the hardships of complying with another annual tax return filing requirement affects most of us. However, for same sex couples, the hardships are further exacerbated by the different tax laws at the state level. At the time this post is published, same-sex marriage bans remain in place in Alabama, Arkansas, Georgia, Kentucky, Louisiana, Michigan, Mississippi, Missouri, Nebraska, North Dakota, Ohio, South Dakota, Tennessee and Texas. These bans and various appeals cause uncertainty for some same sex couples with regard to their filing status. Fortunately, though, clarity (we hope) is just around the corner as the U.S. Supreme Court has finally agreed to take up the matter of same-sex marriage in April 2015.

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2014 Year-End Illinois Estate Planning: It’s Time for a Careful Review

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As 2014 comes to a close, now is the perfect time for careful planning to address the income, estate, gift and generation-skipping taxes that can directly affect you.  In addition to making sure your estate plan is up to date, making a few important decisions now can reduce your tax liability later.

Transfer Tax Exemption and GST Exemption

The exemption amount that individuals may transfer by gift and/or at death without being subject to federal transfer taxes increased in 2014 to $5,340,000; it will further increase to $5,430,000 in 2015.  The maximum federal estate tax rate remains 40%.  In contrast, Illinois imposes a state estate tax once a decedent’s estate exceeds $4,000,000 (which is not adjusted for inflation). The rates of Illinois estate tax range from 8% to 16% (with the Illinois estate tax paid allowable as a deduction for federal estate tax purposes). Both the federal and Illinois estate tax laws allow for a marital deduction for assets passing outright to a spouse or to qualifying trusts for the benefit of a surviving spouse.  Illinois allows this deduction to be claimed even if a marital deduction is not elected for federal purposes.

In order to impose a death tax at each successive generational level, a generation-skipping transfer (“GST”) tax – equal to the highest estate tax rate – is assessed on transfers to grandchildren or more remote descendants.  However, every taxpayer is also given a separate federal GST exemption equal to the federal transfer tax exemption (i.e., $5,340,000 in 2014 and $5,430,000 in 2015).

Estate planning documents should be reviewed to make certain that beneficial use of the federal and state transfer tax exemptions, federal and/or state marital deductions and federal GST exemption are being utilized.

Annual Exclusion Gifts

Making use of annual exclusion gifts remains one of the most powerful – and simplest – estate planning techniques. For 2014 (and 2015), individuals can make an unlimited number of gifts of up to $14,000 per recipient, per calendar year.  Over a period of time, these gifts can result in substantial transfer tax savings, by removing both the gift itself and any income and growth from the donor’s estate, without paying any gift tax or using any transfer tax exemption.  An individual cannot carry-over unused annual exclusions from one year to the next.  If such exclusions are not utilized by the end of the year, the balance of any annual exclusion gifts that could have been made for that year are lost.  These transfers may also save overall income taxes for a family, when income-producing property is transferred to family members in lower income tax brackets (who are not subject to the “kiddie tax”.)

Tuition and Medical Gifts

Individuals can make unlimited gifts on behalf of others by paying their tuition costs directly to the school or their medical expenses directly to the health care provider (including the payment of health insurance premiums).

Lifetime Utilization of New Transfer Tax Exemption

The ability to transfer $5,430,000 ($10,860,000 per married couple) – after annual exclusion and medical and tuition gifts, and without having to pay gift taxes – paves the way for many planning opportunities.  When combined with valuation discounts and leveraging strategies (e.g., family partnerships, sales to grantor trusts, grantor retained annuity trusts,  etc.), tremendous amounts of wealth may pass for the benefit of many generations free of federal and Illinois transfer taxes. Lifetime gifts utilizing the exemption amounts will almost always result in overall transfer tax savings (unless the assets which have been transferred decline in value). The main reason is the removal of the income and growth on the gifted assets from the taxable estate.

For individuals who fully used their transfer tax exemptions in prior years, consideration should be given to making gifts of the additional inflation adjusted amount (i.e., the $90,000 increase in the transfer tax exemption from 2013 to 2014, and an additional $90,000 increase in the exemption from 2014 to 2015).

Benefits of Acting Early. The main benefit of making gifts that utilize the transfer tax exemption is to remove from the taxable estate the income and appreciation on those assets from the date of the gift to the date of death. The sooner the gifts are made, the more likely that additional income and growth on such assets will escape taxation.

Gifts in Trust. Despite the tax savings, many individuals are uneasy about making outright gifts to their descendants. Such concerns are usually addressed by structuring the gifts in trust, which allows the donor to determine how the assets will be used and when the descendants will receive the funds. The use of gift trusts can also provide the beneficiaries with a level of creditor protection (including protection from a divorcing spouse) and additional transfer tax leverage. This is particularly effective when coupled with applying GST exemption to the trust (discussed above) and making the trust a “grantor trust” for income tax purposes (discussed below).

Many individuals may not be comfortable giving away significant amounts of wealth. However, the gift trust technique is not limited to trusts for descendants, but may also include a spouse as a beneficiary (or as the sole primary beneficiary).  Making the spouse a beneficiary of a gift trust (generally referred to as a spousal lifetime access trust, or “SLAT”) provides indirect access to the trust assets, while allowing the income and growth to accumulate in the trust (if not otherwise needed), and pass free of estate and gift taxes.

One of the most powerful estate planning strategies is the utilization of a “grantor trust.”  Significant additional transfer tax benefits can be obtained by structuring a gift trust as a “grantor trust” for income tax purposes. The creator (or “grantor”) of a “grantor trust” is required to report and pay the tax on the income earned by the trust. This allows the grantor to pass additional funds to the trust beneficiaries free of gift and estate taxes and income taxes, as the grantor’s payment of the trust’s income taxes each year would be considered his or her legal obligation and would not be considered additional gifts.

Taxable Gifts

Although individuals generally dislike paying taxes, making taxable gifts and paying a gift tax may prove to be beneficial.  While the federal government imposes a 40% estate tax on taxable estates and a corresponding 40% gift tax on taxable gifts, Illinois does not impose a gift tax. Thus, taxable gifts result in an overall savings of state estate and gift tax.  Moreover, the differing manner in which the gift and estate taxes are computed and paid results in overall transfer tax savings.

The gift and estate tax, although “unified,” work quite differently. The estate tax is “tax inclusive:” the tax is determined based upon the assets owned at death, and paid from those assets (similar to the income tax, which “after tax” dollars must be used to pay the tax). However, the gift tax is “tax exclusive:” the gift tax is determined based on the assets gifted, and paid from other assets owned by the donor. As an example, if you previously used your transfer tax exemption and then make a $1,000,000 gift you would incur a $400,000 gift tax, $1,400,000 will be removed from your estate, and the donees will receive $1,000,000.  However, if you die without making the $1,000,000 gift, you would have the full $1,400,000 included in your estate, resulting in approximately $676,000 of federal and Illinois estate taxes, leaving only $724,000 rather than $1,000,000 for your descendants. In order to leave $1,000,000 for your descendants at death you would need approximately $1,934,000. The estate tax on such amount would be approximately $934,667, leaving $1,000,000 for your descendants. Stated another way, by gifting assets the IRS gets 40¢ for each $1.00 your beneficiaries receive, but by dying with the assets the IRS gets 93¢ for each $1.00 your beneficiaries receive. However, there are also potential downsides: paying a tax earlier than otherwise may be needed, the possibility that the estate tax may be repealed or the rates reduced, the loss of income/growth on assets used to pay the gift tax, the possibility that the transfer tax exemption may be increased which would have allowed the gifts to pass tax free, etc.

Making Use of Historically Low Interest Rates

Interest rates remain very low (with increases likely on the horizon). The current (and historically low) interest rates continue to create an environment ripe for estate planning and transferring wealth to descendants on a tax-advantaged basis.  Techniques such as grantor retained annuity trusts (“GRATs”), charitable lead trusts (“CLTs”), intra-family loans (bearing the minimal interest in order to avoid a gift of 0.39% for loans of 3 years or less, 1.90% for loans of 3 to 9 years, and 2.91% for loans of 9 years or more as of November 2014), and sales to “grantor trusts” are sensitive to interest rate changes – and are very beneficial in a low interest rate environment.

Illinois QTIP

Given the disparity between the $5,340,000 federal estate tax exemption and the $4,000,000 Illinois estate tax exemption, married couples domiciled in Illinois should make certain that their estate plans are structured to take advantage of the Illinois QTIP marital deduction.  Otherwise, an estate plan that is designed to fully utilize the federal $5,340,000 exemption can inadvertently cause a $382,857 Illinois estate tax upon the death of the first spouse.

Net Investment Income (Medicare) Tax

Higher-income-earners should also plan for the 3.8% surtax on certain unearned income and the additional 0.9% Medicare tax that applies to individuals earning in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately.) While the 0.9% additional tax on wages is only imposed on individuals, the 3.8% tax on net investment income is imposed on individuals, estates and trusts. Individuals are only subject to this new 3.8% Medicare tax if their “modified adjusted gross income” exceeds $250,000 for joint filers ($125,000 for a married individual filing a separate return) and $200,000 for single individuals.  In 2014, trusts and estates are subject to this tax at a $12,150 threshold ($12,300 in 2015). The approach to minimizing or eliminating the 3.8% surtax depends on each taxpayer’s individual situation. Some taxpayers should consider ways to minimize (e.g., through deferral) additional net investment income for the balance of the year, while others should review whether they can reduce modified adjusted gross income other than unearned income. In contrast, others may want to accelerate net investment income and/or modified adjusted gross income that would be received next year so that it is included this year (e.g., to take advantage of deductions this year). Year-end planning (such as timing the receipt of net investment income, the receipt of modified adjusted gross income and the payment of deductible expenses) can save significant taxes.

Retirement Plans and Beneficiary Designations

Contribution limitations for pension plan and other retirement accounts for 2015 were recently released by the IRS.  The following adjustments were triggered by an increase in the cost-of-living index:

  • Elective deferral contribution limits for employees who participate in a 401(k), 403(b) and 457(b) plans increased from $17,500 in 2014 to $18,000 in 2015.
  • The catch-up contribution limit for employees (aged 50 or older) who participate in a 401(k), 403(b) and governmental 457(b) plans increased from $5,500 in 2014 to $6,000 in 2015.

The end of the year is a good time to review the beneficiary designations on your pension plan and other retirement accounts (as well as life insurance policies).  Failing to name beneficiaries or keep designations current to reflect changing circumstances can create substantial difficulties and expense (both emotionally and financially) – and may lead to unintended estate, gift and income tax consequences.  You should make certain to designate beneficiaries when participating in a new retirement plan and update beneficiary designations when circumstances dictate (e.g., death of a spouse).  Finally, it is prudent to maintain a current list of accounts with beneficiary designations – which specifies the type of asset, account numbers, account custodians/administrators and beneficiaries designated for each account (primary and contingent).

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Are iWills The Way of the Future?

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Smartphones sure make lives a lot easier (and, arguably, busier). With a few taps of a screen, individuals can do everything from checking the weather to buying stock to engaging in FaceTime across the world. One individual in Australia recently came up with another innovative use for his smartphone. He used it to prepare his Last Will and Testament shortly before taking his own life.

Karter Yu typed his Will on the Notes application installed on his iPhone, titling the document his “Last Will and Testament.” When challenged, the Supreme Court of Queensland, Australia declared the electronic document to be in fact the Will of Mr. Yu, the decedent. Consequently, the document was admitted to probate. The court specifically noted that the document contained the decedent’s signature and was automatically time and date stamped by the phone.

While the Australian case presents a unique example of how technology is transforming the world of estate planning, it is not recommended that individuals use the same “do-it-yourself” digital approach. First, electronic communications can easily be lost or outdated as technology rapidly advances. Such communications may also fail to meet the traditional requirements of testamentary formalities (which vary from one jurisdiction to another) and may raise red flags about the document’s validity or authenticity. For instance, how can a court be sure that the true author was the decedent and not someone simply using his iPhone? Was the document composed under duress? Was it meant to invalidate a previous Will? Under the current statutes and laws of Kentucky, such “writing” would not qualify as a person’s Living Will and Testament.

However, as we move further into the digital age, courts will likely be required to re-examine what type of instrument may qualify as a Will. For now, though, estate planning is best done on paper with the aid of an estate planning attorney. Instead of trying to use your iPhone to write a Will, use it to call an estate planning attorney who can work with you to ensure your estate planning needs are met in accordance with your wishes and within the applicable law.

© 2014 by McBrayer, McGinnis, Leslie & Kirkland, PLLC. All rights reserved.
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In Estate Planning, Where There's a Will There's a Way

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An August 15, 2014 article, by Robert Wood, in Forbes.com, told how many large companies, such as GM and Merck, pay zero taxes. It told how Apple avoided $9 billion in US taxes in 2012, according to a US Senate Report issued in 2013.

In the estate world, billionaires such as George Steinbrenner, the Yankees owner who died in 2010, avoided an estimated $500 million in US estate tax. But that was because he died in 2010, the one year when there was no estate tax. In 2014, US citizens can protect $5 million from estate tax, and that amount is indexed for inflation, so the current figure is $5,340,000. Thus, $10,680,000 protects most American married couples from paying federal estate tax upon the second of their deaths. Married couples fortunate enough to have more than $10,680,000, will pay federal tax at 40%.

Even wealthy families with assets exceeding $10,680,000 (or a single person exceeding $5,340,000) can take advantage of gifting strategies and charitable planning to avoid or reduce estate tax. These strategies include techniques known as “GRATS,” “IDGT’s,” “CRT’s” and “CLT’s,” which mean nothing except to the tax professionals who implement them, and the wealthy who benefit from them. Although Congress has threatened to curtail or eliminate many of these strategies, they currently remain legal options for US citizens upon their deaths to leave more to their families and less to the IRS.

Whether it is multi-national public companies with billions of income, or wealthy US families with millions of assets, when it comes to avoiding taxes, be it income or estate, where there’s a will there’s a way.

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Tax Court Holds that a Trust can Qualify for the "Real Estate Professional Exception" of Section 469(c)(7)

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The Tax Court recently handed down its decision in Frank Aragona Trust v. Commissioner, ruling that a trust can qualify for the real estate professional exception of Section 469(c)(7). By taking into account the actions of the trustees, a trust can be considered to be materially participating in real estate activities. This means that losses from real estate activities can be treated as nonpassive and therefore deductible in determining the trust’s taxable income. This decision is especially relevant to trusts that own business as it affects the application of the passive activity loss rules in Section 469 and whether income from those activities is subject to the new 3.8% net investment income Medicare surtax under Section 1411.

The Frank Aragona Trust (the “Trust”) was a Michigan trust that owned several pieces of real property and was also involved in the business aspects of developing and maintaining the property. The Trust had six trustees, three of whom were also employees of Holiday Enterprises, LLC (the “LLC”). The LLC was owned 100% by the Trust. The LLC also employed other professionals.

The Trust had losses in 2005 and 2006 from its real estate activities and deducted those losses(on the basis that they resulted from nonpassive activities) on its income tax returns. In issuing a notice of deficiency for those tax years, the Service determined that the real estate activities were passive under Section 469 and therefore any related losses were not deductible.

In general, real estate rental activity is considered passive regardless of whether the taxpayer materially participates in the real estate business. However, there is an exception for “real estate professionals” under Section 469(c)(7). Before the Tax Court, the Trustees argued that the Trust was a “real estate professional” as defined in Section 469(c)(7) so that the losses were considered to be from nonpassive activities and therefore deductible. To qualify for the real estate professional exception, a taxpayer must pass two tests. First, more than one-half of the personal services performed in a taxable year must be performed in real property trades or businesses in which the taxpayer materially participates. Second, the taxpayer must perform more than 750 hours or services during the taxable year in real property trades or businesses in which the taxpayer materially participates. The Service argued that the regulations to Section 469(c)(7) define “personal services” as “work performed by an individual in connection with a trade or business [emphasis added].” Because the trust was not an individual, it could not perform personal services and therefore did not fall under the Section 469(c)(7) exception.

The Tax Court rejected the Service’s argument that the trust could not be considered an individual under Section 469(c)(7) and the associated regulations. Further, the Court found that the Trustees’ participation in the real estate activities met the material participation requirements of Section 469(c)(7) because they were regular, continuous and substantial. The Court determined that the participation of the Trustees should be considered in determining whether the taxpayer (the Trust) materially participated in the real estate activities. The Service argued that the activities of the Trustee should only apply if they are performed in their capacity as Trustees (as opposed to employees of the LLC). Here, the Court looked to Michigan law, under which trustees are required to administer trusts solely for the benefit of the trust beneficiaries. The Court explained that the Trustees could not simply stop acting as Trustees because they were also employees of the LLC, so that their activities in other capacities could be considered in whether the Trust was a material participant in the real estate activities.

In summary, a trust may be able to qualify for the real estate professional exception of Section 469(c)(7). If the trust qualifies for the exception, losses from the associated real estate activities may be deductible on the trust’s income tax return. This distinction has increased importance with the application of the new 3.8% net investment income Medicare surtax under Section 1411.

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