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Making Your Employees’ Votes Count: Employer Obligations on Election Day

With just days to go before the 2018 midterm elections, candidates are sending out their final pleas for voters’ endorsements and employers are taking steps to ensure that their employees have the ability to voice their choice.  According to electionday.org, nearly 60% of voting-eligible Americans did not vote in the last midterm elections, with 35% of those nonvoters reporting that “scheduling conflicts with work or school” kept them from getting to the polls.

So, what are employers’ obligations to employees when it comes to getting out to vote?  Federal law does not require employers to provide workers with time off to vote, though it does generally protect an employee’s right to vote by prohibiting interference with the voting process.  The majority of states (nearly 60%), however, have laws on the books that provide some level of protection to employees who need to take time off work in order to cast their vote.  The laws vary state-by-state – some states simply require an employer to allow an employee “sufficient” unpaid leave time to vote, while other states mandate 2-4 consecutive non-working hours of paid leave to vote.  In states with laws requiring employers to allow employees time off to vote, they apply to both public and private employers, and the majority of these state laws require that employees be paid for at least a portion of any such voting leave.

In order to ensure compliance with various state laws, employers should consider the following practices:

  • Maintaining voting leave policies that are compliant with the laws in all states/localities in which the company operates;

  • Training managers on the applicable voting laws and any policies in advance of any major elections – particularly if they manage non-exempt employees;

  • Providing employees anywhere between 2-4 hours of paid or unpaid time off at the beginning or end of a shift for voting leave in certain circumstances (typically where the employees’ daily schedule would not allow them a block of 2-4 consecutive non-working hours between the opening and closing of the polls to vote);

  • Scheduling employees’ work hours on election days so that every employee will have the opportunity to exercise their right to vote;

  • Allowing employees to vote during the first two hours in which polls are open in the state;

  • Posting notices in the workplace reminding employees that they have the right to use time off to vote (note that such posted notices are required by some states, including California and New York); and

  • Requiring employees to provide reasonable notice (anywhere from 1-7 days, depending on the applicable law) of their intention to take time off to vote.

At a minimum, employers should ensure they are in compliance with any state or local voting leave laws applicable to their locations.  Some of those laws are very detailed (time off can vary based on the mileage between a voter’s place of employment and their designated polling location; some laws apply only to employees in certain industries) while others are much more generic in scope (requiring employers to allow “reasonable” or “sufficient” time off, or “encouraging” employers to allow time off, but setting no specific rules).  In order to prevent abuse, some state laws require proof of voting before an employer is obligated to make a payment for voting leave, and many require that employees provide some level of advance notice that they will be taking time off to vote.  In many states, failure to comply with the applicable laws can subject employers to the possibility of criminal or civil penalties.

Even in states where the law does not mandate employee time off to vote, best practice for employers is to provide some base level of paid time off to employees to vote.  For employers operating in multiple states, maintaining one policy that complies with the most favorable of all of the states’ laws where the company is located is advisable.  In addition, employers will be well-served by training managers on any company voting leave policy well in advance of any major election in order to ensure that employees are aware of the policy and that managers know how to apply it.

In preparation for next week, employers should review their existing voting leave policies to ensure compliance with applicable laws.  Employers without voting leave policies should analyze the potential barriers their employees face in getting to the polls, determine the legal requirements of the states in which they operate and implement a policy that is compliant with the applicable laws and meets the company’s operational needs.  Employers should also treat time off for early voting the same way they do Election Day voting, document employees’ requests for time off to vote, direct non-exempt employees to record their time appropriately, and maintain a record of voting leave.  In addition, employers can be proactive by adding Election Day to the work calendar and having managers remind employees that the company encourages employees to use their time to vote.

 

©1994-2018 Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. All Rights Reserved.

ABLE Accounts: What They Are and What They Mean for Your Family

Individuals with disabilities and their families have many options to set aside funds without jeopardizing eligibility for means-tested government benefits. However, until recently most of the available options require the person with a disability to lose control over his or her own money.  With the 2014 enactment of the Stephen J. Beck Achieving a Better Life Experience (ABLE) Act, people with disabilities can once again control some of their own money and retain a sense of autonomy. While ABLE accounts will not replace other forms of planning that are available to and recommended for people with disabilities, there are definite advantages to adding the ABLE account into an overall plan.

The Basics

ABLE accounts are tax-deferred savings accounts that are closely modeled on 529 education savings plans. While ABLE is a federal program, much like 529 education plans, each state is responsible for crafting and administering its own program. Some states only allow residents to enroll, while others welcome out-of-state residents. It’s important to consider not only whether an ABLE account is appropriate, but also which state’s program best suits your situation.

To be eligible for an ABLE account, a person must be diagnosed, before age 26, with a disability that would entitle him or her “to benefits based on blindness or disability under Title II or XVI of the Social Security Act.” Once eligibility is determined, the individual or a third party (e.g., the disabled individual’s parents, siblings, or friends) can establish and fund an ABLE account.

Contributions and Account Limits

In any given year, the aggregate cash contribution from all donors (including the beneficiary him/herself) cannot exceed the annual gift tax exclusion amount ($15,000 for 2018). ABLE accounts accept cash only. Stocks, bonds, investments, and real estate cannot be contributed.

In addition to the annual contribution limits, as of January 1, 2018, the Tax Cuts and Jobs Act of 2017 authorizes an employed ABLE account beneficiary to contribute an amount up to the lesser of (i) his or her compensation or (ii) the poverty line for a one-person household ($12,140 for 2018). In order to be eligible for this additional contribution the individual cannot also contribute to an employer-sponsored defined contribution plan, such as a 401(k). Since the earned income contribution can be made in addition to the aggregate cash contribution, the total possible contribution for 2018 is $27,140.

Starting this year, a new funding option is available that allows individuals to “roll over” assets from a 529 plan into an ABLE account. While this is certainly a boon for families who initially set aside funds in a 529 account for a beneficiary who cannot use it, the funds rolled over cannot exceed the standard annual ABLE account contribution limit, so depending on the value of the 529 account the rollover could take several years to complete.

One of the biggest differences between the various state programs is the maximum amount that may be held in the account. For New York plans, the limit is $100,000. In other states, the limits are significantly higher and are tied to the limits those states have imposed for 529 education plans. For example, Illinois plans have a limit of $400,000. So for people who plan to accumulate larger sums in an ABLE account, it is wise to shop around to different states.

Although ABLE accounts are generally disregarded as a resource when determining eligibility for means-tested benefits, there is an exception. The first $100,000 of assets held in the ABLE account will not count as a resource when determining Supplemental Security Income (SSI) eligibility. However, once the account balance exceeds $100,000, the individual’s SSI will be suspended until the balance is again below that amount. There is no impact on Medicaid eligibility regardless of how much money is in the account.

Growth and Distributions

Income generated on assets held in an ABLE account are not taxed. Disbursements made for qualified expenses of the disabled individual are also not taxed. If a distribution is made that does not constitute a qualified expense, the beneficiary will be responsible for both ordinary income tax and a 10 percent penalty.

Qualified expenses of the disabled individual that can be paid for from the ABLE account without incurring taxes or penalties include, but are not limited to, education, legal fees, financial management and administrative services, health and wellness, housing, transportation, personal support services, and funeral and burial expenses.

As of January 1, 2018, the designated beneficiary is permitted to claim the saver’s credit for contributions made to his or her ABLE account. The saver’s credit is a nonrefundable tax credit for eligible tax payers who make contributions to retirement savings accounts.  The maximum annual contribution eligible for credit is $2,000 per individual, and the amount of the credit depends on the taxpayer’s adjusted annual income.

Benefits Eligibility Tip: An important benefit of the ABLE account is that, unlike when payments are made from a Special Needs Trust, payments for the beneficiary’s housing and food are not viewed as in-kind maintenance support for the purposes of SSI, and the beneficiary will not suffer the usual reduction for payments made by someone other than the SSI recipient for those purposes.

Words of Caution

Although ABLE accounts can be a valuable tool, there are several pitfalls to consider before opening an ABLE account. As with any decision that may affect government benefits, it is always best practice to discuss the situation and your options with your attorney, as there are many issues to consider before adding an ABLE account to a beneficiary’s plan.

For example, an important thing to consider is whether the beneficiary is capable of managing the ABLE account. Since the beneficiary is allowed to manage the funds in the account, families should carefully consider the risks (e.g., making non-qualified distributions or risking abuse and undue influence by an outside person) of the funds being immediately available. While this risk can be mitigated in several different ways beyond the scope of this article, it is certainly a point worthy of consideration.

Additionally, ABLE accounts are similar to first party Special Needs Trusts in that, to the extent the beneficiary receives medical assistance funded by Medicaid after the account is established, any funds remaining in the ABLE account at his or her death will be used to pay back the state for benefits that are paid for the beneficiary. This is the case regardless of whether the funds originally come from the beneficiary or a third party.

Notwithstanding the limitations, ABLE accounts can still be a valuable addition to a carefully crafted special needs plan.

 

© 2018 Schiff Hardin LLP

Army Corps Issues Guidance for Dam and Culvert Removal Credits

The Army Corps of Engineers recently issued a Regulatory Guidance Letter (RGL) that sets out factors that should be considered by district engineers when determining the amount of mitigation credits that may be allowed for removal of dams or other structures in rivers and streams. These mitigation credits may be used or sold as compensatory mitigation required by Army Corps permits issued for projects that result in impacts to waters of the United States.

There are approximately 14,000 dams in New England, many of which were built in the 19th century, and thousands of undersized or poorly designed culverts. These dams and culverts impair river and stream values. The Corps’ mitigation credit RGL is significant because, in the past, when a dam was removed or culvert replaced the positive environmental effects were not easily quantified. Further complicating the mitigation credit analysis is the fact that dam removal or culvert replacement sometimes results in short-term wetland loss.

The new RGL describes specific considerations for making credit determinations. Further, the RGL makes it clear that wetland loss resulting from dam removal will not require compensatory mitigation. Perhaps most importantly, the RGL gives district engineers latitude to determine the number of mitigation credits produced and to consider local conditions in their determinations, although they will still prefer on-site and in-kind mitigation (meaning, to mitigate impacts that occur nearby and are of the same type as the mitigation project, e.g., fish passage credits could be used for fish passage impacts).

For owners that have been considering removing dams or other in-water structures, this guidance may offer opportunities, but we should caution that those opportunities are constrained by limited availability of mitigation banks and the effort needed to create one, by the need for close coordination and agreement with any available in lieu fee programs, and by limited availability of in-kind permittee-responsible mitigation needs. If those constraints can be overcome, the RGL will allow the long-term value of the removal to be considered and more consistently credited and monetized through mitigation banks or in-lieu fee programs or, if such programs are not available, for the dam owner’s own mitigation responsibilities.

 

©2018 Pierce Atwood LLP. All rights reserved.

Five Things You Should Know About Employment Practices Liability Insurance

If you listen closely on a quiet weekday afternoon, you can hear the steady thumping of stamps on inkpads at the Equal Employment Opportunity Commission’s (EEOC) offices on West Madison Street in Chicago. And it’s no different throughout the country — employee claims of discrimination, harassment, and retaliation are high paced and showing no signs of slowing down.

This high rate of claims means your company needs to be savvy about a number of key strategies that can help you minimize risk. One of these strategies may include purchasing employment practices liability insurance (EPLI). Here, we answer some core questions about EPLI:

1. What is EPLI, and how does it differ from related insurance policies?

EPLI policies allow employers to protect themselves against the exposure and costs associated with claims and litigation arising out of the employment relationship. These policies generally cover claims made by current and former employees, applicants who were never hired, or third-parties claiming the employer has engaged in wrongful conduct.

Discrimination, harassment, retaliation, wrongful discharge, and invasion of privacy are the typical claims covered by EPLI. On the other hand, claims that an employer violated the Fair Labor Standards Act (e.g., failure to pay overtime, misclassification as an independent contractor) are typically not covered by EPLI policies, nor are claims under ERISA, COBRA, or the National Labor Relations Act, although it may be possible to purchase limited coverage for defense costs.

Not surprisingly, EPLI is but one item on a buffet of insurance offerings to employers; alongside it are directors and officers (D&O), commercial general liability (CGL), and errors and omissions (E&O) policies, each serving a distinct purpose. D&O insurance covers acts committed by a company’s directors and officers only; it is of no help when an employee’s supervisor is accused of sexually harassing an employee. Likewise, E&O policies are concerned with true errors and omissions allegedly committed in the course of doing what your company does for a living, and are not implicated by allegations of discriminatory discharge, which is seldom an accident. CGL policies often expressly exclude wrongful employment practices. In other words, EPLI may overlap with other types of coverage, but it largely exerts its own force in confronting an array of everyday claims.

2. Should my company purchase EPLI?

Maybe — it’s a business decision that requires you to take into account several factors, such as the cost of the EPLI premiums and the extent of the deductible (or self-insured retention, to be explained below), your company’s location and number of employees (and how these correlate with the likelihood of a claim being filed against your business), history of claims and losses, and whether you have written, preventative employment policies in place.

According to the 2017 Hiscox Guide to Employee Lawsuits, U.S. companies have a 10.5% chance of being on the receiving end of an employment-related charge, and the chances for Illinois companies are 35% higher than the national average. On average, small-to-medium size companies facing such claims battle for 318 days before resolution and leave the arena with a $160,000 bruise.

As with every type of insurance, the perceived value of the coverage depends upon the company’s level of comfort with the self-insured retention (SIR) or deductible. The SIR is the amount the company must pay out of pocket at the beginning stages of a claim; the insurer is not required to pay a penny until after the SIR has been met by actual payment of defense costs and/or losses by the insured. A deductible, on the other hand, is subtracted by the insurer from its total policy payment, which then must be paid by the company.

As expected, the policy premium will seesaw with SIR levels. Policies with a high SIR amount (or deductible) typically will have lower premiums than the same policy with a low SIR or deductible. These policies are better suited for companies that view EPLI as a type of catastrophic coverage. On the flip side, if your cash flow would make it difficult to absorb a high SIR, then a higher premium with a lower SIR amount may make economic sense.

The number of individuals employed by your company should also factor into your decision-making. Although most federal anti-discrimination statutes apply only to businesses with 15 or more employees, smaller companies are subject to state anti-discrimination laws, which may govern employers with only one employee (depending on the nature of the claim). Nevertheless, it is not unreasonable for a small company in certain industries to forego EPLI, while maintaining strong training and preventative strategies, until it grows closer to 15 employees.

Given the numerous factors that must be taken into account, employers should consult with their attorneys and business advisors to reach a sound decision about whether and what type of EPLI to purchase.

3. What should I do when negotiating the purchase of an EPLI policy?

It is better to negotiate a good EPLI policy up front, than to sign up for standard terms, stuff the policy packet in your desk drawer, and later bemoan its shortcomings when an issue pops up.

A good first step is to talk to your attorney about her previous experiences with various insurance companies; lawyers repeatedly deal with EPLI carriers and it’s best to make decisions based upon known trends than to shop just based on price.

You should determine whether the policy imposes on the insurer a “duty to defend” or a “duty to reimburse.” A duty to defend requires the insurer to defend the claim or lawsuit, cover legal fees and costs, and pay for liability (all up to the policy limits). Insurers with a duty to defend retain high levels of control over the defense of claims, the selection of counsel, and litigation and settlement strategies. The duty to defend extends to all claims, even frivolous ones, or issues reasonably related to the underlying claim.

An insurer subject to a “duty to reimburse,” on the other hand, must reimburse covered costs and losses and is typically not required to defend matters reasonably related to the underlying claim. However, the company retains higher levels of control in selecting counsel and executing its defense strategies.

You may want to consider negotiating a “mutual selection of counsel” endorsement to the policy, which will provide you with greater flexibility in retaining your own counsel, even where the insurer has a duty to defend with the corresponding high levels of control. This will prove helpful when you want your preferred counsel to handle a case, and do not want to relinquish your fate to unknown lawyers selected by the insurance company. Be aware, however, that even if you are able to obtain a selection of counsel provision, you may be required to share in the cost of attorneys’ fees to the extent your preferred counsel charges rates higher than the default panel rates typically paid by insurers. This should be another point of discussion during your negotiations.

4. Even if my company has an EPLI policy, does it always make sense to report a claim?

Unlike auto insurance policies, reporting a claim does not typically impact the cost of maintaining or renewing your EPLI policy. Therefore, it is usually wise to report claims as you become aware of them. However, there may be circumstances where it does not make sense to do so. For example, if your policy comes with an SIR (self-insured retention) of $25,000, and you believe you can settle the matter for $10,000, reporting the claim may achieve nothing but a headache. But even that logic comes with risks; if you are wrong in your estimates and the settlement numbers start to creep up, you risk losing coverage altogether due to untimely notice to the insurer. When in doubt, err on the side of reporting, and consult your attorney to help reach a sound decision.

It is also wise to “park” a potential claim. “Parking” a claim means notifying your carrier that you have been made aware of facts or circumstances that might give rise to a future claim (but for which no current claim exists). If a claim based upon those facts or circumstances later materializes outside of the policy period, because you “parked” your claim, it will be treated as though it arose and was reported during the relevant period.

Staying silent when you know something is brewing may backfire, as insurers are not interested in selling fire insurance to someone who already smells smoke. Providing timely and transparent notice via “parking” also demonstrates to the insurer that your company is prudent, which fosters confidence in the relationship and promotes a sense that you are serious about risk management.

5. What are some common mistakes companies make regarding EPLI policies?

Because most companies prefer to focus on running their business than worrying about the minutiae of an insurance policy, it is easy to overlook potentially critical missteps. Many companies, for example, have never heard of EPLI or don’t even know if they have it. Others automatically renew policies they’ve never read, rather than negotiate more favorable terms. Sometimes, a company is unaware of relevant policy periods, or neglects to promptly ascertain whether an event or awareness of an event constitutes a claim or otherwise triggers reporting requirements. Finally, because there are so many types of insurance policies out there, it is not uncommon for companies to think their existing policies will address employment practices claims, only to later discover that they’re hung out to dry.

© 2018 Much Shelist, P.C.

ARTICLE BY

Laura A. Elkayam
Neil B. Posner
Much Shelist, P.C.

Correcting the Record: Manatt Attorneys & Inner City Law Center Find Legal Remedy to Amend Discharge Record of Navy Veteran

When serving in the military, how you are discharged can have a big impact on how things go for you after you leave the service.  A less than honorable discharge can restrict access to benefits and can force the servicemember to carry a burden that follows him or her through their post-military career.  With “Don’t Ask, Don’t Tell” no longer a part of the military lexicon and sexual orientation no longer a barrier to service, many discharges are ripe for re-examination.  Attorneys with Manatt, Phelps & Phillips; including Craig de Recat, partner, and Cherise Latortue, associate in partnership with the Inner City Law Center worked to correct the discharge record of Rickey Lane, who had been less than honorably discharged from the Navy in the late 70’s, in large part because of assumptions about his sexual orientation. In the process, they have created a path for others looking to do the same thing.

From the Ninth Circuit Back to the Board for the Correction of Naval Records

Because of his discharge status, Mr. Lane had been denied services from the VA, and had felt stigma because of how his discharge from the Navy was labeled.  Latortue says Mr. Lane pursued this process because “he wanted to get the record straight and he wanted the record to reflect the service that he provided his country, that he excelled in bootcamp and that he was happy to be in the Navy.”

Requests to have records amended are handled through the Board for the Correction of Naval Records, or the Board.  Mr. Lane’s case was complicated by the fact that his discharge had been almost thirty years ago, and the standard statute of limitations for corrections is fifteen years.  In seeking a legal remedy for Mr. Lane’s situation, La Tortue and the other attorneys working on the case initiated a lawsuit in the Ninth Circuit Court, in Washington, where Mr. Lane had been when he was discharged.

In order to give Mr. Lane’s application the best chance for success, Latortue says filing in the Ninth Circuit was a strategic decision.   Latortue points out,  “we wanted to be in the Ninth Circuit because they had heard prior cases with similar facts that we thought would help us in our argument. “  After filing a lengthy complaint for summary motion judgment and feeling good about their chances, the government attorney reached out and offered to remand the case back to the Board, to give the board a chance to revisit the case and correct their mistake.

The Board Rules

In looking at Mr. Lane’s case, the biggest challenge was focusing on incidents in Mr. Lane’s record that the Board had initially labeled as aggravating, but upon further reflection and analysis, could not have met that standard.  While serving in the Navy, Mr. Lane had received a NJP–or a non-judicial punishment–for leaving the ship without permission.  Mr. Lane left the ship due to harassment he had received from his shipmates based on their erroneous perception that he was gay.  His punishment in that instance was a fine–which he paid, and he continued to serve.   After the incident, after the harassment, and he even earned positive commendations in his records–again, and importantly, after his NJP.

Initially, the Board had focused on this incident as an aggravating factor for his discharge, however, by providing a closer look at the record and the series of events, Latortue and other attorneys involved were able to demonstrate to the board how the initial explanation simply did not make sense.   While Mr. Lane was outside the 15-year statute of limitations, Latortue says, “the board has the authority to waive the statute of limitations in the interest of justice.“  And in this case, that’s what the board elected to do.  The Board amended the discharge, providing Mr. Lane with peace of mind and providing him with access to the VA’s services.

A Larger Context

This case will have a big impact on Mr. Lane’s life–as with his change in status, he will be eligible for benefits provided by the VA.  In fact, Latortue says, “the board will advise that there be no further litigation, or back and forth with the VA at this point as to whether he’s eligible for benefits.”  So Mr. Lane will have access to the services at the VA, and this decision clears the path for him to get the treatment and services he needs.

Further, Latortue says, this case has provided a sort of roadmap for other veterans in a similar situation.  With the repeal of “Don’t Ask, Don’t Tell” many veterans have an interest in challenging their discharge status.  Through what the Inner City Law Center, Latortue, and other attorneys have learned about how these cases work, Latortue says, “we can explain to our clients that this is the relief we think you’re entitled to, and we know how to get it.”

Copyright ©2018 National Law Forum, LLC

ARTICLE BY: Eilene Spear
The National Law Review / The National Law Forum LLC

How to Avoid Halloween Horror Stories in the Workplace

This is the season of pumpkin spice, crisp air, falling leaves, and costume parties. But as much as we love autumn, it brings its own set of workplace complexities—especially when celebrating Halloween. Below are a few tips for keeping Halloween festive and nonlitigious:

Optional Participation

Employers may want to ensure that employees are not forced to wear costumes, pass out candy, or attend a Halloween party. Today, Halloween is largely secular, but some believe it has its roots in the religious holiday of All Hallows’ Eve, the night before All Saints’ Day. All Hallows’ Eve celebrations were influenced by ancient Celtic harvest festivals, such as Samhain. Several religions choose not to celebrate Halloween because of these roots in other traditions.

To avoid religious discrimination claims and prevent overall morale concerns for those who may not want to participate, an employer can convey that participation in office Halloween events is optional, not mandatory, and that retaliation against and harassment of people who opt out is not acceptable. Calling someone a “party pooper” or “poor team player” because he or she doesn’t feel comfortable participating in Halloween festivities—either because he or she does not want to be “spooked” or because Halloween traditions conflict with his or her religious or cultural beliefs—could expose an employer to liability.

Appropriate Costumes

If an employer allows employees to wear costumes to work, it can provide clear guidelines of what’s acceptable and specific examples of what’s not. For example, an employer can discourage employees from making racially and culturally insensitive costume choices as well as sexually suggestive outfits. Employers can keep in mind that employees dressed in the traditional attire of any ethnicity, as undocumented immigrants, or as Middle Eastern terrorists may face national origin discrimination accusations. In addition, some costumes could be considered racially insensitive and lead to race discrimination claims, such as wearing blackface or carrying nooses.

In addition, the office isn’t the place for provocative outfits, such as scantily clad nurse uniforms. Employees or third parties may make offensive comments or jokes to an employee in a revealing costume, and the costumes themselves may make other employees uncomfortable. Keeping the office PG should keep those concerns to a minimum.

Job-Specific Costume Concerns

Employers can encourage employees to think about context when deciding on a costume to wear to work. A waiter serving food while fake brains ooze out of his head is not appetizing. A hospital chaplain breaking bad news while she’s dressed as a unicorn is not very comforting. A schoolteacher diagramming a sentence while he’s decked out as a pack of cigarettes doesn’t send a great message to students. A bank teller counting change with a mask on could make customers uneasy. Even on Halloween, these combinations don’t work well.

Key Takeaways

Employers can make sure everyone understands that normal workplace rules about harassment and professionalism apply, even on Halloween. If complaints of harassment surface, employers can investigate them promptly and thoroughly.

Most importantly, Halloween is an opportunity to have fun, boost employee morale, and foster a sense of community in the workplace.

 

© 2018, Ogletree, Deakins, Nash, Smoak & Stewart, P.C., All Rights Reserved.

Estate Planning for Founders

Founders and entrepreneurs face many pressure points while building their company into their vision. Important decisions must be made relating to the choice of a business entity, how to fund the business, what sort of regulations impact the business, how to protect intellectual property, how to manage employees, and what to do if sued. Most of these points focus on the business.

As Founders are busy building their business and working towards success, they often overlook their personal estate planning. Founders are not alone in avoiding this topic – as few people enjoy considering what happens to their assets upon incapacity or death. Founders have unique needs that necessitate proactive estate planning as early in a company’s existence as possible in order to minimize tax consequences and maximize liquidity options. In order to simplify estate planning and encourage Founders to focus, estate planning for Founders should be broken down into the following segments:

  • Segment I: Core Planning.
  • Segment II: Business Continuity and Liquidity.
  • Segment III: Advanced Wealth and Transfer Strategies.

This article will detail each of the segments that all Founders should consider. Although presented in numerical order, we find that Founders are often driven into a particular segment that meets their personal situation. We note that once a Founder starts a segment, it almost always makes sense to consider the other segments as well.

Segment I: Core Planning

Core estate planning answers the question of what happens to the business and your other assets at death – including who controls those assets (the fiduciaries), who receives the assets (the beneficiaries), and how much tax is paid. Core estate planning involves putting together a well-constructed set of wills and revocable trust agreements that capture the available exemptions from state and federal estate taxes, protect your children’s inheritances from “creditors and predators” and name appropriate individuals or institutions to manage your estate after your death. This phase also includes setting up simple documents that appoint individuals to manage your financial and personal affairs in the event of your incapacity, including a living will and power of attorney.

Under current law, everything you own is subject to federal estate tax, and potentially state estate tax as well. Every person is entitled to an exemption from federal estate tax – that exemption is currently $11,180,000 (note that the exemption increases every year). The federal estate tax rate is currently 40 percent on the assets in excess of the federal exemption (reduced by any taxable gifts made during your life).

Even though the tax exemptions seem large, it is important for Founders to engage in estate planning that minimizes the taxes’ impact, especially since a startup’s value can grow rapidly over a short period of time. A married Founder’s estate plan can be carefully crafted to delay tax until the death of the survivor of the Founder and the Founder’s spouse.

Segment I planning also includes incapacity planning. If you become incapacitated and no planning has been done, your family may be forced to go to court to obtain the appointment of a guardian or conservator to manage your financial and personal affairs. This result can be avoided in almost all cases through power of attorney and health care proxy naming your spouse or other individual to make financial and health care decisions in the event of your incapacity.

Upon completion of Core Planning, a Founder will have created tax efficient wills and revocable trusts, considered asset protection planning for a spouse and children, and appointed fiduciaries to administer your estate and continuing trusts.

To us, Core Planning is the minimum amount of estate planning a Founder should complete. The Core Plan helps educate Founders on the planning, taxes and asset protection. The Core Plan ensures that the Founder is able to select the correct fiduciaries to manage his/her estate upon death and that the intended beneficiaries benefit from the Founder’s success. The Core Plan can, and should, change with time.

Segment II: Business Continuity and Liquidity

While Segment I planning is essential for everyone, Segment II planning addresses the unique needs that Founders have regarding business continuity and liquidity. With regard to continuity, it is often appropriate for Founders to consider a buy-sell agreement, which is a contractual arrangement providing for the mandatory purchase (or right of first refusal) of a shareholder’s interest upon the occurrence of certain events described in the agreement (the so-called “triggering events”). The buy-sell agreement’s primary objective is to provide for the stability and continuity of the startup in a time of transition through the use of ownership transfer restrictions. Typically, such agreements prohibit the transfer of ownership to unwanted third parties by setting forth how, and to whom, shares may be transferred. The agreements also usually provide a mechanism for determining the sale price for the shares and how the purchase will be funded.

Because a startup is built from nothing, it is often important to a Founder to maintain control while providing for a smooth transition to his chosen successors upon his death or disability. Structuring a buy-sell agreement provides a nonthreatening forum for the Founder to begin thinking about who should manage the startup in the future. By specifically carrying out the Founder’s intent, a properly structured buy-sell agreement avoids the inevitable disputes between people with competing interests. If the Founder becomes disabled or retires, a buy-sell can provide him with the security that his case flow won’t disappear, as the agreement can provide for the corporation and/or the other shareholders to purchase the shares, at a predetermined price, either in a lump sum or installments, typically at preferable capital gains rates.

Funding a buy-sell agreement is essential to its success, but that requires liquidity. Life insurance is an extremely common and effective funding choice. Whether owned by the business in a redemption agreement or by the other shareholders in a cross-purchase agreement, it provides the purchasers with the ability to guarantee a certain amount of money will be there when the Founder dies—as long as premiums are paid. The type of life insurance typically purchased in the startup context is some form of permanent insurance (such as whole life, universal life, or variable life) rather than term insurance, which gets more expensive as the insured ages and may not be able to be renewed beyond a certain age (usually between 60 and 70 years of age).

There are downsides in certain circumstances to using life insurance in this manner. As mentioned, if a cross-purchase agreement is chosen and there are more than two shareholders, each shareholder will need to purchase a life insurance policy on every other shareholder (unless a partnership is established to own the insurance). Additionally, life insurance doesn’t solve the funding problem for transfers while the Founder is still alive.

In addition to providing liquidity to the business, liquidity may also be important for the Founder’s beneficiaries. If significant wealth is tied to the business, the Founder’s beneficiaries may have little to no access to liquid funds upon the death of a Founder. The most common strategy to deal with this lack of liquidity is to purchase life insurance. As noted above, there are several types of life insurance available. In addition to the type of insurance, a Founder should consider whether it is recommend to own the life insurance policy inside an irrevocable life insurance trust in order to remove the proceeds of such policy from the Founder’s estate for tax purposes.

Aspects of Business Continuity and Liquidity are often addressed in the business’ governing documents. However, as the business grows, partners enter the business and investors come and go – these documents should be reviewed on a regular basis. The liquidity concerns of the Founder should also be regularly reviewed.

Segment III: Advanced Wealth and Transfer Strategies

Generally, Segment III planning involves the transfer of assets out of your estate to shelter them from estate tax. Although we often encourage clients to at least consider Segment I planning first, often a business is about to “pop” in value – this “pop” offers a great opportunity for tax planning. In those circumstances, Advanced Wealth and Transfer Strategies is often the initial introduction to estate planning.

If an individual attempts to transfer assets during life in order to avoid an estate tax, the transfer will generally instead be subject to a federal gift tax. Since the gift tax and the estate tax apply at the same rates and generally have the same exemptions, there should be no incentive for an individual to transfer wealth during life as opposed to waiting to transfer it at death. In effect, by enacting the gift tax as companion to the estate tax, Congress created an “airtight” transfer tax system. There are, however, leaks in that system. The three primary examples of the leaks in the system are: removing value from the system; freezing value within the system; and discounting values within the system.

Removing value from the transfer tax system is hard to do and takes time. In most cases, if an individual makes a gift during lifetime, that gift is brought back into the taxable estate at death. However, there are two exceptions to this general rule, which are the annual gift tax exclusion and the “med/ed” exclusion. If an individual makes a gift using his or her $15,000 annual gift tax exclusion, the gifted property is entirely removed from the taxable estate. Individuals are also permitted to make gifts of unlimited amounts for tuition and certain medical expenses, as long as the payment is made directly to the provider of services. Such med/ed gifts are entirely excluded from the taxable estate.

Removing value is done over-time and is a consistent theme for Founders in their estate planning. However, the real benefit of a business “popping” in value is in the freeze and
discount strategies. Freezing value within the system usually connotes the individual making a gift using some or all of his or her lifetime exemption from federal gift tax. For example, you might make a gift of $5 million worth of stock to a child. Upon your death, the $5 million gift is actually brought back into your estate for purposes of calculating your estate tax. However, it is only brought back into the estate at its value at the time the gift was made and is sheltered from tax at that time via the use of your $5 million estate tax exemption. Accordingly, if the value of the gifted property increases between the date of the gift and the date of your death, the appreciation avoids transfer tax. In other words, you succeed in “freezing” the value of the gifted property at its date-of-gift value.

A holy grail of estate planners has been to find a way of freezing the value of an asset at some number lower than what it is actually “worth” to the gift-giver’s family, also known as “discounting” values. Suppose an individual owns all of the stock in a business with a total value of $10 million. If the individual gives all of the stock to her child, she will have made a taxable gift of $10 million. On the other hand, suppose that the individual gives 10% of the business to five people. An appraiser is likely to opine that the interests received by the individuals are subject to lack of control and lack of marketability discounts, since none of the recipients can easily control or transfer the entity. If the appraiser applies, say, a 30 percent discount for the lack of marketability and control, the value of the gift would be reduced to $3,500,000.

Accordingly, the Founder succeeds in freezing values at something less than the entity value of the business in the eyes of the family as a whole.

Founders generally use one of two strategies when planning for a “pop” in value – both strategies utilize both the freeze and discounting tactics discussed above – Grantor Retained Annuity Trusts (GRATs) and Sales to Intentionally Defective Grantor Trusts (IDIT Sale).

Grantor Retained Annuity Trust

A GRAT allows an individual to give assets to a trust and retain a set annual payment (an “annuity”) from that property for a set period of years. At the end of that period of years,
ownership of the property passes to the individual’s children or trusts for their benefit. The value of the individual’s taxable gift is the value of the property contributed to the trust minus the value of his right to receive the annuity for the set period of years, which is valued using interest rate assumptions provided by the IRS each month. If the GRAT is structured properly, the value of the individual’s retained annuity interest will be equal or nearly equal to the value of the property contributed to the trust, with the result that his taxable gift to the trust is zero or near zero.

How does this benefit the children? If the assets contributed to the GRAT appreciate and/or produce income at exactly the same rate as that assumed by the IRS in valuing the individual’s retained annuity payment, the children do not benefit, because the property contributed to the trust will be just sufficient to pay the individual his annuity for the set period of years. However, if the assets contributed to the trust appreciate and/or produce income at a rate greater than that assumed by the IRS, there will be property “left over” in the trust at the end of the set period of years, and the children will receive that property–yet the creator of the trust would have paid no gift tax on it. The GRAT is particularly popular for gifts of hard to value assets such as business interests, private equity and hedge fund interests because the risk of an additional taxable gift upon an audit of the gift can be minimized. If the value of the transferred assets is increased on audit, the GRAT can be drafted to provide that the size of the individual’s retained annuity payment is correspondingly increased, with the result that the taxable gift always stays near zero IDIT Sale

A GRAT is often compared with a somewhat similar technique, known as the IDIT Sale. The general IDIT Sale concept is best understood by means of a simple example. An individual makes a gift to an irrevocable trust of, say, $100,000. Sometime later, the individual sells assets to the trust in return for the trust’s promissory note. The note provides for interest only to be paid for a period of, say, 9 years. At the end of the 9th year a balloon payment of principal is due. There is no gift because the transaction is a sale of assets. The interest rate on the note is set at the lowest rate permitted by IRS regulations.

How does this benefit the individual’s children? If the property sold to the trust appreciates and/or produces income at exactly the same rate as the interest rate on the note, the children do not benefit, because the property contributed to the trust will be just sufficient to service the interest and principal payments on the note. However, if the property contributed to the trust appreciates and/or produces income at a rate greater than the interest rate on the note, there will be property left over in the trust at the end of the note, and the children will receive that property, gift tax free.

Economically, the GRAT and IDIT Sale are very similar techniques. In both instances, an individual transfers assets to a trust in return for a stream of payments, hoping that the  income and/or appreciation on the transferred property will outpace the rate of return needed to service the payments returned to the individual. Why, then, do some clients choose GRATs and others choose IDIT Sales?

The GRAT is generally regarded as a more conservative technique than the IDIT Sale. It does not present a risk of a taxable gift in the event the property is revalued on audit. In addition, it is a technique that is specifically sanctioned by the Internal Revenue Code. The IDIT Sale, on the other hand, has no specific statute warranting the safety of the technique. Unlike the GRAT, the IDIT Sale presents a risk of a taxable gift if the property is revalued on audit and there is even a small chance the IRS could successfully assert that the taxable gift is the entire value of the property sold rather than merely the difference between the reported value and the audited value of the transferred property. Moreover, if the trust to which assets are sold in the IDIT Sale does not have sufficient assets of its own, the IRS could argue that all of the trust assets should be brought back into the grantor’s estate at death.

Although the IDIT Sale is generally regarded as posing more valuation and tax risk than the GRAT, the GRAT presents more risk in at least one area in that the grantor must survive the term of the GRAT in order for the GRAT to be successful; this is not true of the IDIT Sale. In addition, the IDIT Sale is a far better technique for clients interested in generation skipping planning. The IDIT trust can be established as a Dynasty Trust that escapes estate and gift tax forever. Although somewhat of an oversimplification, the GRAT generally is not a good vehicle through which to do generation skipping planning.

Spousal Lifetime Access Trust

When using either a GRAT or an IDIT Sale, we encourage our clients to also consider a Spousal Lifetime Access Trust (SLAT). In addition, the SLAT is often the remainder beneficiary of the GRAT or IDIT transaction. A SLAT can remove, freeze, and discount values all in one fell swoop. In a typical SLAT, an individual creates an irrevocable trust, naming her spouse or some other trusted individual or institution as trustee. During the life of the individual and her spouse, the trustee is authorized to sprinkle income and principal among a class consisting of her spouse and descendants. Upon the death of the survivor of the individual and her spouse, the remaining trust assets are divided into shares for descendants and held in further trust. The SLAT provides several benefits. The individual’s gifts can qualify for the gift tax annual exclusion if the trust is designed properly. This removes value from the owner’s estate. If desired, the owner could use the trust as a repository for a larger gift utilizing her lifetime gift tax exemption, thereby freezing values for transfer tax purposes. Moreover, depending on the type of asset gifted to the trust, it may be possible to apply valuation discounts as well.

Beyond being a good vehicle through which to remove, freeze, and/or discount values for tax purposes, the SLAT provides a number of other benefits. The trust includes the grantor’s spouse as a beneficiary. Although the grantor can never have any legal right to the assets held in the SLAT, and neither can there be any prearrangement or understanding between the grantor and her spouse that the grantor can use assets in the trust, if the grantor is in a happy marriage, it nonetheless can be comforting to know that her spouse will have access to the property in the trust even after the gift. As an additional benefit, the SLAT would be established as a “grantor trust” for income tax purposes. This means that the creator of the trust would pay income tax on the income and gains earned by the trust. This depletes the creator’s estate, and enhances the value of the trust, but is not treated as a taxable gift, in effect providing a very powerful additional means of removing value from the transfer tax system. Finally, the SLAT can be structured as a “generation skipping transfer tax exempt trust” (also known as a “Dynasty Trust”), thereby removing the gifted assets from the transfer tax system for multiple generations.

Conclusion.

Although a Founders’ personal and business life can be complicated and stressful, we find that breaking a Founders’ personal estate planning into three key segments allows the Founder to focus on what is important to them and take strong steps towards successful estate planning.

 

© 1998-2018 Wiggin and Dana LLP
This post was written by Erin Nicholls and Michael T. Clear of Wiggin and Dana LLP.

Congress Enacts Legislation to Promote New Hydropower Development

On October 23, 2018, President Trump signed into law the America’s Water Infrastructure Act of 2018 (AWIA), S. 3021, a comprehensive water resources bill that includes provisions specifically targeted to promote new hydropower development.  The AWIA includes a package of hydropower bills that were previously approved by the U.S. House or Senate.  These include bills to promote new hydropower development at non-powered dams, new closed-loop pumped storage hydropower, new hydropower at qualifying conduit facilities, as well as longer preliminary permit terms and start of construction deadlines for new projects.  The legislation also provides incentives for redevelopment and modernization at existing projects during the license term.

BACKGROUND

Each individual bill that comprises the AWIA has been pending before Congress in one form or another for several years.  Certain of these provisions were included in the comprehensive energy bill that failed to pass at the end of 2016.  Since then, the bills have each been individually reintroduced before Congress and followed individual tracks.  They were only recently combined into the AWIA bill.  The bill passed the Senate by unanimous consent on September 4, 2018.  It passed the House by a vote of 99-1 on October 10, 2018, with Congressman Mike Lee of Utah as the sole dissenting vote.

THE AWIA

The AWIA is composed of five major categories of hydropower reform: (1) extending preliminary permit terms and start of construction deadlines for new construction projects; (2) promoting new, small conduit hydropower facilities; (3) promoting hydropower development at existing nonpowered dams; (4) promoting development of closed-loop pumped storage projects; and (5) incentivizing investments and modernization projects at existing hydropower facilities.

First, the AWIA amends the Federal Power Act (FPA) to authorize the Federal Energy Regulatory Commission (FERC) to issue preliminary permits for up to four years, instead of the previous three-year limit.  The legislation also authorizes FERC to extend a preliminary permit once for no more than four years, as opposed to the previous two years.  This increases the total possible preliminary permit term from the current limit of five years to a possible eight years.  The AWIA also codifies FERC’s current practice of issuing a new preliminary permit after the expiration of a permit under extraordinary circumstances.  With regard to newly licensed projects, the AWIA authorizes FERC to extend the time a licensee has to commence construction under a license for up to eight years beyond the two years allotted under the license.  Prior to enactment of the AWIA, FERC could extend the license once for no more than two years.  This increases the total possible time to commence construction of a newly licensed project from four years to 10.  These changes should facilitate developers’ ability to take projects from feasibility investigation to project completion without the recurring fear of expiring permits and frequent need for special legislation to extend license construction deadlines.

The AWIA also amends FERC’s current policy on the collection of annual charges for new projects.  Under current regulations, private licensees of unconstructed projects must begin paying annual charges on the date by which they are required to commence construction, or if that deadline is extended, no later than four years after the issuance date of the license (i.e., no later than four years after license issuance).  The legislation changes this policy to provide that annual charges for unconstructed projects commence at the later of (1) the date by which the licensee is required to commence construction, or (2) the date of any extension of the construction commencement deadline.  Because FERC is now authorized under the AWIA to extend the commence construction deadline for up to eight years, this provision of the legislation delays the start of annual charges up to 10 years after license issuance.  These provisions of the AWIA do not distinguish between private licensees and state and municipal licensees, who under current regulations are not required to start paying annual charges until the commencement of project operations.  However, the language appears to permit commencement of annual charges at a later date, allowing FERC to preserve its current regulations on the timing of annual charges paid by state and municipal licensees.

Second, the AWIA directs FERC to issue a rule establishing an expedited process for licensing non-federal hydropower projects at certain existing nonpowered dams.  In establishing this expedited process, the legislation requires FERC to convene an interagency task force with appropriate federal and state agencies and Indian tribes to establish licensing procedures that, to the extent practicable, ensure that such projects will not result in any material change to the storage, release, or flow operations of the nonpowered dam.  This appears aimed at ensuring, if possible, that federal licensing will not result in impairment of dams for their existing nonpower purposes such as irrigation and water supply.  Qualifying projects must not have been previously authorized for hydropower and must use for generation the withdrawals, diversions, releases, or flows from an existing dam, dike, embankment, or other barrier that is or was operated for the control, release, or distribution of water for agricultural, municipal, navigational, industrial, commercial, environmental, recreational, aesthetic, drinking water, or flood control purposes.  Qualifying projects also must not propose to materially change the operations of the nonpowered dam.  The expedited licensing process would result in an order not later than two years after receipt of a completed license application.  The AWIA also directs FERC and the Secretaries of the Army, the Interior, and Agriculture, within 12 months, to develop a list of existing nonpowered federal dams with the greatest potential for non-federal hydropower development.  The Secretary must provide the list to Congress and make it available to the public.

Third, the AWIA directs FERC to issue a rule establishing an expedited process for licensing closed-loop pumped storage projects.  Like the provisions for expedited licensing of projects at existing nonpowered dams, the legislation requires FERC to convene an interagency task force to coordinate the regulatory authorizations required to construct and operate closed-loop pumped storage projects.  Although leaving to FERC to develop a definition for “closed-loop pumped storage,” qualifying pumped storage projects must cause little to no change to existing surface and groundwater flows and uses and be unlikely to adversely affect species listed as threatened or endangered under the Endangered Species Act.  This would appear to narrow the class of qualifying projects considerably.  An expedited licensing process would result in an order not later than two years after receipt of a completed license application.  The AWIA also directs FERC to hold a workshop to explore potential opportunities for development of closed-loop pumped storage projects at abandoned mine sites and provide guidance to assist applicants for such projects.

Fourth, the AWIA amends the FPA with respect to the criteria and process to qualify as a qualifying conduit hydropower facility.  Under the 2013 Hydropower Regulatory Efficiency Act, certain hydropower facilities located on non-federally owned conduits with installed capacity of up to 5 megawatts (MW) are not required to be licensed or exempted by FERC.  The AWIA increases the size limitation to 40 MW for such facilities.  It also reduces the time for FERC to make a qualifying conduit determination decision from 45 to 30 days after an entity files a notice of intent to construct such a facility.

Fifth, the AWIA directs FERC, when determining the term of a new license for an existing project, to give equal weight to project-related investments by the licensee under the existing license, including rehabilitation or replacement of major equipment, and investments proposed under the new license.  This is a modification to FERC’s license term policy issued in 2017, which exempts all “maintenance measures” from consideration toward a new license term.  The AWIA allows a licensee to seek a determination from FERC, within 60 days, on whether any planned, ongoing, or completed investment would be considered by FERC in determining a new license term.

IMPLICATIONS

The hydropower provisions included in the AWIA bill are a meaningful first step in modernizing the hydropower licensing process.  They are intended to generate renewed interest in new hydropower by allowing licensees more time and certainty to secure required approvals and financing for new projects, which was a challenging feat under current deadlines.  While the majority of the provisions in the AWIA are intended to promote new hydropower development, Congress also sought to promote major modernization and rehabilitation projects at existing hydropower projects by ensuring that the investments in such projects are rewarded in the term of a new license.

The AWIA does not include a number of other hydropower relicensing reforms that were included in the bipartisan Senate energy bill in 2016.  These include provisions: (1) designating FERC as lead agency for coordinating federal authorizations from all agencies needed to develop a project; (2) authorizing FERC to refer agency disputes to the Council on Environmental Quality; (3) requiring resource agencies to give equal consideration to developmental and non-developmental values when imposing mandatory conditions or prescriptions; and (4) expanding the definition of renewable energy for federal programs to include all forms of hydropower.  Unless these reforms are passed in the lame duck session, they must be reconsidered in the new 116th Congress beginning in 2019.

 

© 2018 Van Ness Feldman LLP
This post was written by Sharon White and Michael A. Swiger of Van Ness Feldman LLP.

Lawvision’s LPM Training Certification Workshop

Legal Project Management (LPM) is an essential skill for lawyers and other legal professionals. It can help ensure greater client satisfaction, more profitable matters and more satisfying work. This workshop provides a simple, yet powerful framework for applying LPM techniques and approaches to your legal matters immediately. The workshop is highly interactive. You learn from the instructors and the others in the workshop using a case study based on actual legal matters.

Lawyers and other legal professionals are focusing on LPM for the following reasons:

  • An increasing number of clients are pushing for fee estimates, scoping of work and greater efficiencies in the handling of their work;
  • Better use of LPM techniques can help minimize significant write-offs and write-downs;
  • Enhanced LPM can lead to opportunities to win more RFPs;
  • A growing number of clients are asking for trained legal project managers on their matters; and
  • Application of LPM approaches create greater internal teamwork, enhance associate and staff morale / retention and improve client relationships.

WHO SHOULD ATTEND:

  • Practicing lawyers at all levels – partners, associates, counsel and staff / contract lawyers
  • Legal project managers
  • Directors of LPM and / or pricing
  • Finance professionals
  • Practice management professionals – practice group business managers and others helping practice group leaders run their groups
  • Professional development directors interested in expanding their firm’s offerings in project management training

MORE INFORMATION

Please download the LPM Training Certification Workshop brochure.

Learn more and register here.

IRS Issues Proposed Regulations for Qualified Opportunity Zone Funds

Treasury issued long-awaited Proposed Regulations and a Revenue Ruling today (October 19, 2018) regarding key issues involved with investing in and forming Qualified Opportunity Zone Funds (“OZ Fund”) and the OZ Fund’s investments in Opportunity Zone Businesses (“OZ Business”).  Although the Proposed Regulations do not answer all of our key questions, Treasury did provide generally taxpayer friendly guidance to the issues discussed below.  These Regulations are only proposed, and are therefore subject to further revisions based on comments received by Treasury.  However, Treasury has provided that taxpayers can rely on many of these proposed rules, provided that the taxpayer applies the rule in its entirety and in a consistent manner.

  • Treatment of Land. Land is excluded from the requirement that the original use of opportunity zone property commence with the OZ Fund or that the OZ Fund substantially improve the property, alleviating fears that land could only be a “bad” asset. Very favorably, if the OZ Fund purchases an existing building and the underlying land, the OZ Fund is only required to substantially improve (“double the basis”) the building.  The cost of the land is disregarded for this purpose.
  • Treatment of Capital Gains of Partnerships and other Pass-Thru Entities. Partners have 180 days from the end of the partnership’s taxable year to invest in an OZ Fund. Accordingly, capital gains recognized by a partnership early in 2018 (or even very late 2017) may still be eligible for investment in OZ Funds, even if 180 days have passed. A partnership has the option of either investing capital gains in an OZ Fund itself or allocating the gain to its partners, thereby permitting the partners the opportunity to invest their distribute share of the gain in an OZ Fund. If desired, the partner has the option to select the 180-day period starting from the date of the partnership’s sale of the property.
  • Treatment of Working Capital. The Proposed Regulations provide a working capital safe harbor for investments in OZ businesses that acquire, construct, or rehabilitate tangible business property. An OZ business can hold the working capital for a period of up to 31 months if there is a written plan that identifies the working capital as held for the acquisition, construction, or substantial improvement of tangible property in an opportunity zone and such written plan identifies a schedule of expenditures. This alleviates the concern that cash invested by an OZ Fund in an OZ business would be a “bad asset” for the OZ business.  Working capital can be held in cash, cash equivalents, or debt instruments with a term of 18 months or less.
  • Only 70% of an OZ Business’ Tangible Assets Need to be OZ Property. An OZ Fund that invests directly in assets must have 90 percent of its assets be qualifying OZ Property. Qualifying property includes an investment into an OZ Business. An OZ Business only needs to have “Substantially all” of its tangible assets consist of qualifying OZ Property. The Proposed Regulations define, for this purpose only, “substantially all” as 70 percent of the OZ Business’ tangible assets. This is critical in allowing investors in non-real estate businesses to take advantage of the opportunity zone benefits. The Proposed Regulations provide alternative methods for determining compliance with the “substantially all” test, based either on the values in an applicable financial statement of the OZ business, or, if the business does not have an applicable financial statement, applying the methodology used by its Fund investors (who hold at least 5 percent of the OZ business) for determining their compliance with the 90 percent asset test.
  • The OZ Fund Can Borrow Money. The Proposed Regulations provide that deemed contributions of money derived from a partner’s share of partnership debt do not create a separate, non-qualifying investment in the OZ Fund. There had been concern that the proportion of the investment relating to money borrowed by the Fund would result in a non-qualifying investment. The Proposed Regulations do indicate that Treasury is considering an anti-abuse rule for investments that may be considered abusive. In addition, the Proposed Regulations imply that partners in OZ Funds do get outside basis for amounts borrowed by the OZ Fund, thereby potentially permitting the investors to take advantage of OZ Fund losses.
  • “Gains” are Limited to Gains Treated as Capital Gain. Treasury has specifically limited the OZ Fund benefits to gain that “is treated as a capital gain” for Federal income tax purposes.  Although this provision could have been clarified better, we think that “treated as a capital gain” is intended to include Section 1231 gains (special rules apply gains from hedging/straddles).
  • Special Allocations are Permitted. Investors must receive an equity interest in an OZ Fund.  For OZ Funds organized as partnerships, the Proposed Regulations specifically permit special allocations. Depending on whether additional limits are placed on special allocations, this may permit a certain amount of “carried interest” to be paired with an equity investment for OZ Fund service providers.
  • Early Disposition of OZ Fund interest. If an OZ Fund investor sells all of its interest in an OZ Fund before the end of deferral in 2026, the OZ Fund investor can maintain the original gain deferral by reinvesting the proceeds into a new OZ Fund within 180 days.  This allows an investor to get out of a bad deal without losing the deferral benefits. Note that the Proposed Regulations specifically deferred until future Regulations issues involved when the OZ fund itself sells OZ Fund property. These issues include what a “reasonable period of time” is for the OZ Fund to reinvest in qualifying assets and what the potential income tax consequences to the Fund and its investors of such a sale of OZ Fund property by the OZ Fund.
  • Valuation of Assets for Purposes of the 90% Test. For purposes of determining whether a Fund holds 90 percent of its assets in qualified opportunity zone property, the Proposed Regulations require the Fund to use asset values reported on an applicable financial statement of the Fund. Applicable financial statements are prepared in accordance with U.S. GAAP and either: (1) filed with a federal agency besides the IRS (which includes the SEC); or (2) are audited and used to make decisions by the taxpayer.  If a Fund does not have an applicable financial statement, the Fund must use its cost in acquiring the assets for the calculation. Treasury is seeking comments as to whether adjusted basis or another valuation method is a better measurement than cost.
  • 90% Asset Test Testing Dates. The Proposed Regulations provide for the possibility that an OZ Fund formed late in the taxable year could have to fully comply with the asset tests by the end of that year.  The law requires that an Oz Fund invest 90 percent of its assets in qualified opportunity zone business property, measured as the average of two Testing Dates. The first testing date is the last day of the 6th month following formation, and the second Testing Date is the last day of the taxable year.  For example, if a calendar-year fund selects April as its first month as an OZ Fund, then its first testing dates are the end of September and the end of December.  However, if a Fund is formed in the last half of the taxable year, then it will have only one testing date, which may be soon after formation. This creates the possibility that an OZ Fund formed in December only has until the end of December to fully comply. We are hoping that the final Regulations will provide more time for the OZ Fund to initially comply.
  • Limited Liability Companies (LLCs) Can Be OZ Funds. So long as the LLC is taxed as a partnership or a corporation, an LLC can be an OZ Fund.

The Proposed Regulations are generally favorable to investors, and so we expect that Opportunity Zone investments will really take off. Based on the 70 percent “substantially all” rule for OZ Businesses, we expect that Opportunity Zone investments will not be limited to real estate investors. In addition, we think Opportunity Zone investments are more likely to be structured with OZ Funds owning OZ businesses rather than the OZ Fund owning assets directly, because of the working capital safe harbor, the substantially all test, and the testing dates for OZ Funds.

© Polsinelli PC, Polsinelli LLP in California

This post was written by Korb Maxwell Jeffrey A. Goldman and S. Patrick O’Bryan of Polsinelli PC.