Tag: business

Grantor Trusts Rules – Will the Loopholes be Closed in 2025?

While some may see the discovery and use of tax loopholes as a triumph of human ingenuity, others see their exploitation as an abuse of the tax code. The concepts developed here are complex but worth understanding if you want to use them for your clients or participate in the public discourse about related tax law reforms.

When anticipating significant appreciation of an asset, affluent taxpayers typically have two options: 1.  transfer the property now (as a gift) to avoid estate taxes on future appreciation, or 2. transfer the property upon death to avoid income taxes on the appreciation. For each of these options, there is good news and bad news:

If the taxpayer gifts the property today, its value is fixed for transfer tax purposes as of the gift date per IRC Sec. 2512. This avoids transfer taxes on any future appreciation. However, the donee inherits the donor’s basis, often low, under IRC Sec. 1015 and will pay income tax on the appreciation when selling the property.

If the property is transferred at death, its value is determined at the date of death under Sec. 2031, capturing all appreciation for transfer tax purposes. The donee receives a stepped-up basis under IRC Sec. 1014, eliminating income tax on the appreciation that occurred before the donor’s death. However, the property is subject to the estate tax at its current fair market value.

In addition to the above, we need to mention an intermediate situation, the incomplete gift. An incomplete gift occurs when the donor retains certain powers or interests over the transferred property, which prevents the gift from being considered complete for tax purposes. This can have various implications, including the deferral of gift tax liability and the potential inclusion of the property in the donor’s estate.

Tax Planning Conundrum: Wouldn’t it be nice if a taxpayer who has an estate large enough to be subject to estate taxes could do both: avoid capital gains taxes and avoid additions to the taxable estate due to appreciation? In other words, could one obtain a stepped-up basis for income tax purposes while also “freezing” the value of the wealth for transfer tax purposes?

Let’s hold that thought and review the Grantor Trust Rules. They determine when a trust is a grantor trust and when it is not, which in turn determines who pays income taxes. This will be important to solving the tax planning conundrum posed above.

Grantor Trust Rules

The distinction between a grantor trust and a non-grantor trust depends on whether the settlor (grantor) retains any incidents of ownership over the trust. If they do, it is a grantor trust; if they don’t, it’s a non-grantor trust. Incidents of ownership can be any number of things by which control over the trust is exerted, for example, the right to change beneficiaries (Table 1).

As stated, in a grantor trust, the grantor maintains a certain degree of control over the trust’s assets or income. In contrast, non-grantor trusts include irrevocable trusts in which the grantor has relinquished control over the trust assets and does not retain any powers that would cause the trust to be treated as a grantor trust.

Provision Description
Power to Revoke (§ 676) If the grantor has the power to revoke the trust and reclaim the trust assets, the trust is considered a grantor trust.
Power to Control Beneficial Enjoyment (§ 674) If the grantor retains certain powers to control the beneficial enjoyment of the trust’s income or principal, the trust may be treated as a grantor trust.
Administrative Powers (§ 675) If the grantor retains administrative powers that can affect the beneficial enjoyment of the trust, the trust may be considered a grantor trust.
Reversionary Interests (§ 673) If the grantor retains a reversionary interest in the trust that exceeds 5% of the trust’s value, the trust is considered a grantor trust.
Income for the Benefit of the Grantor (§ 677) If the trust income is or may be used to pay premiums on insurance policies on the life of the grantor or the grantor’s spouse, the trust is treated as a grantor trust.

If the trust income can be distributed to the grantor or the grantor’s spouse or held for future distribution to them, the trust is considered a grantor trust.

Table 1: The most important grantor trust rules

The distinction between grantor and non-grantor trusts was made to determine who has to pay income taxes on the trust’s income. In a grantor trust, it’s the grantor; in a non-grantor trust, it’s the trust.

The transfer tax and income tax regimes are closely aligned. When a grantor retains control over transferred property in a trust, they have a grantor trust.  This property is generally considered owned by the grantor at death for estate tax purposes. For instance, if a grantor has the power to revoke a trust, Section 676 treats the grantor as owning the property for income tax purposes, and Section 2038 treats it as owned by the grantor at death for estate tax purposes. However, there is a loophole.

The Loophole – The Intentionally Defective Grantor Trust

An Intentionally Defective Grantor Trust (IDGT) is a type of trust designed to be treated as owned by the grantor for income tax purposes but not for estate tax purposes. This means that the income generated by the trust is taxable to the grantor, but the trust’s assets are not included in the grantor’s estate for estate tax purposes. To draft an IDGT, certain provisions must be included to ensure that the trust is considered defective for income tax purposes. These provisions typically involve intentionally violating one of the above grantor rules so that the trust is taxed on the trust’s income.

A more descriptive name for an Intentionally Defective Grantor Trust (IDGT) could be “Swap Power Grantor Trust”. The swap power is a common feature in the drafting of an Intentionally Defective Grantor Trust (IDGT). It allows the grantor to reacquire trust property by substituting other property of equivalent value. This power is crucial because it helps ensure that the trust is considered a grantor trust for income tax purposes while not causing the trust property to be included in the grantor’s estate for estate tax purposes.

The “Swap Power” in Action:

  • Income Tax Implications:
    • Section 675: The swap power causes the grantor to be treated as owning the property for income tax purposes.
    • No Corresponding Estate Tax Rule: There is no rule that includes this property in the grantor’s estate for transfer tax purposes. Thus, the value of the property for transfer tax purposes is fixed at the time of the gift (Section 2512).

Transferring Property to the Trust:

  • Initial Transfer:
    • When the grantor transfers property to a trust with a swap power, the property is valued for gift and estate tax purposes as of the date of the gift, which freezes its value.
  • Appreciation:
    • Inside the trust, after the transfer, the property may enjoy unlimited appreciation; however, its value for estate tax purposes remains “frozen” at the time of the gift.

Income Tax Treatment of Transactions with the Trust:

  • Disregarded Transactions:
    • Under Section 675, transactions between the grantor and the trust (due to the swap power) are disregarded for income tax purposes.
    • Exercise of Swap Power:
      • When the grantor exercises the swap power (exchanging property within the trust), it is seen as moving assets between the grantor’s own “pockets,” so there are no income tax consequences.

Basis and Tax Implications:

  • Carryover Basis Rule (Section 1015):
    • Normally, the basis of the gifted property carries over to the donee, meaning any appreciation is subject to income tax when the property is sold.
  • Stepped-Up Basis (Section 1014):
    • By using the swap power, the grantor can transfer appreciated low-basis property out of the trust and high-basis property of the same value into the trust.
    • The appreciated property is back in the grantor’s hands. When the grantor dies, it gets a stepped-up basis to its fair market value at death.
    • This eliminates the capital gains tax on the appreciation of the property that occurred before the grantor’s death.
    • In addition, estate taxes are at a lower level because the valuation for estate tax purposes was frozen before appreciation in the trust.

This is all very well, but let’s see how this works out in practice.

Simplified Example

  • Grantor: John
  • Trust Beneficiary: Emily
  • Property: Real estate
  • Initial Value: $2 million
  • Appreciated Value: $6 million

Steps:

See Figure 1.

  1. Initial Transfer:
    • John transfers real estate valued at $2 million to a trust with a swap power. This value is fixed for gift and estate tax purposes.
  2. Appreciation:
    • The property appreciates to $6 million over several years, but its value for estate tax purposes remains “frozen” at $2 million.
  3. Using the Swap Power:
    • John uses the swap power to exchange the $6 million property in the trust for $6 million in cash or other assets.
    • This transaction has no income tax consequences because it is disregarded under Section 675.
  4. Basis Adjustment:
    • Normally, the property in the trust would retain John’s original basis, making any appreciation subject to income tax when sold.
    • By swapping the property out of the trust for $6 Million, John reclaims the house. Upon his death and transfer to beneficiaries, the property gets a stepped-up basis to its fair market value of $6 million.
    • This eliminates capital gains tax on the appreciation that occurred before John’s death.

avoid capital gains and estate taxes with a swap power

Figure 1: How to avoid capital gains and estate taxes with a swap power in a grantor trust (Intentionally Defective Grantor Trust)

John effectively avoids income tax on the property’s appreciation during his lifetime and ensures the property gets a stepped-up basis at his death, providing significant tax advantages for Emily. Our tax planning conundrum from above has been solved.

A number of other techniques have a similar effect, but their discussion goes beyond the scope of this article.

Biden’s Reform Plans

Historical Background

Until 1986, taxpayers aimed to avoid having their trusts classified as grantor trusts to escape the burden of personally paying income taxes on trust earnings. This was crucial in an era with a highly progressive income tax system, exemplified by 1954’s 24 tax brackets ranging from 20% to 91%. In 1954 Congress, codifying judicial decisions and wanting to prevent income shifting from higher to lower tax brackets, enacted the grantor trust rules. However, the 1986 Tax Reform Act and subsequent reforms compressed income tax rates, making grantor trusts more favorable. Today, classifying a trust as a grantor trust often results in better tax outcomes. Moreover, as explained above, careful drafting of grantor trusts can limit both estate and income taxes to an extent otherwise not possible (1).

The current situation subverts Congress’s original intent and is also perceived as societally unfair, as it benefits only the already very wealthy. Reforms are periodically suggested, most recently by the Biden administration in the Greenbook, the Tax Proposal for 2025 (2).

Several reform efforts are aimed at Grantor Retained Annuity Trusts, which we will discuss in a follow-up article but list here for context.

1. Grantor Retained Annuity Trusts (GRATs)

  • Minimum Value for Gift Tax: The remainder interest in a GRAT must have a minimum value for gift tax purposes equal to the greater of 25% of the value of the assets transferred or $500,000.
  • Annuity Payments: The annuity payments cannot decrease during the term of the GRAT.
  • Minimum and Maximum Terms: The GRAT must have a minimum term of ten years and a maximum term equal to the annuitant’s life expectancy plus ten years.
  • Prohibition on Tax-Free Exchanges: The grantor cannot exchange assets held in the trust without recognizing gain or loss for income tax purposes.
  • Impact: These changes aim to reduce the use of short-term and “zeroed-out” GRATs, which are often used for tax avoidance purposes.

2. Sales and Transfers Between Grantor Trusts and Deemed Owners

  • Taxable Events: Sales of appreciated assets between a grantor and a grantor trust will be recognized as taxable events, requiring the seller to pay capital gains tax on the appreciation.
  • Basis Adjustment: The buyer’s basis in the transferred asset will be the amount paid to the seller.
  • Purpose: This proposal aims to prevent tax-free transfers of appreciated assets and ensure that such transactions are treated similarly to sales between unrelated parties.

3. Income Tax Payments as Gifts

  • Gift Treatment: The grantor’s payment of income tax on the trust’s income will be treated as a taxable gift to the trust. This gift will occur on December 31 of the year the tax is paid unless the trust reimburses the grantor.
  • Impact: This change ensures that the grantor’s payment of the trust’s income tax liabilities is recognized as a transfer of value subject to gift tax.

4. Realization of Capital Gains

  • Realization Events: Unrealized capital gains on appreciated property will be taxed at the time of transfer by gift or upon death. This includes transfers to or from most types of trusts and distributions from revocable grantor trusts to persons other than the trust’s owner or their spouse.
  • Impact: This would treat transfers of appreciated assets as taxable events, departing from the current practice of realizing such gains only upon sale. It aims to ensure that high-income taxpayers do not benefit from deferred capital gains taxes indefinitely.

5. Intrafamily Asset Transfers

  • Valuation Discounts: Discounts for lack of marketability and control will be reduced or eliminated for intrafamily transfers of partial interests in assets if the family collectively owns at least 25% of the property.
  • Collective Valuation: The transferred interest’s value will be calculated as a pro-rata share of the total fair market value of the property held by the transferor and their family members, as if a single individual owned all interests.
  • Purpose: This proposal aims to curb the use of valuation discounts to reduce the taxable value of intrafamily transfers.

What if the Republicans Gain Control of Congress?

The Republican proposals regarding grantor trusts largely focus on maintaining the status quo established by the 2017 Tax Cuts and Jobs Act (TCJA). This includes making the increased estate, gift, and generation-skipping transfer (GST) tax exemptions permanent, thus avoiding the reduction scheduled for 2026. Additionally, Republicans are likely to oppose the Biden administration’s suggested reforms, such as treating sales between a grantor and a grantor trust as taxable events and recognizing the payment of income tax on trust income as a taxable gift.

Conclusion

As we anticipate potential changes to the grantor trust rules in 2025, it’s clear that the landscape of estate planning may undergo significant transformations. The Biden administration’s proposals, likely to be adopted in a similar form by Vice President Harris, aim to close loopholes that currently allow for substantial tax advantages through mechanisms like the swap power and GRATs. These reforms would impose stricter requirements and tax consequences, curbing the ability to avoid capital gains and transfer taxes. Conversely, Republican proposals focus on maintaining the current tax benefits established by the 2017 Tax Cuts and Jobs Act. Understanding these proposals and their potential impacts is crucial for tax professionals and affluent taxpayers. Staying informed and proactive will ensure the optimal structuring of trusts and asset transfers, aligning with the evolving tax regulations and maximizing the benefits within the legal framework.

 References:

1  Jesse Huber. The grantor trust rules: An exploited mismatch. The Tax Adviser. November 1, 2021

2  Department of the Treasury March 11, 2024. General Explanations of the Administration’s Fiscal Year 2025 Revenue Proposals. Green Book p.127

© 2024 wealthcarelawyer.com. All rights reserved.

PTAB MTA Pilot Program to the Rescue

On review of a final written decision from the Patent Trial & Appeal Board in an inter partes review (IPR), the US Court of Appeals for the Federal Circuit found that all challenged claims were obvious but left open the possibility of the patent owner amending the claims under the Motion to Amend (MTA) Pilot Program. ZyXEL Communications Corp. v. UNM Rainforest Innovations, Case Nos. 22-2220; -2250 (Fed. Cir. July 22, 2024) (Dyk, Prost, Stark, JJ.)

ZyXEL Communications petitioned for IPR challenging claims 1 – 4, 6, 7 and 8 of a patent owned by UNM Rainforest Innovation (UNMRI). The patent relates to methods for constructing frame structures in communication systems using orthogonal frequency-division multiple access (OFDMA) technologies. The patent describes a method for constructing a frame structure with two sections, each of which is configured for a different communication system, where the second communication system is used to support high mobility users (i.e., faster moving users).

Before the Board, ZyXEL argued that claims 1 – 4, 6 and 7 were unpatentable in light of two prior art references (Talukdar and Li), and that claim 8 was unpatentable in light of Talukdar and another prior art reference (Nystrom). During the Board proceedings, UNMRI filed a contingent motion to amend if any of the challenged claims were found to be unpatentable. As part of its motion, UNMRI requested preliminary guidance from the Board pursuant to the Board’s MTA Pilot Program. In its opposition to UNMRI’s motion to amend, ZyXEL argued that UNMRI’s amended claims lacked written description support, and in its preliminary guidance, the Board agreed. UNMRI attempted to file a revised motion to amend, but the Board rejected the revised motion and instead permitted UNMRI to file a reply in support of its original motion. It also allowed ZyXEL to file a sur-reply. The Board determined that claims 1 – 4, 6 and 7 were unpatentable, but that claim 8 was not. The Board also granted UNMRI’s motion to amend and determined that the new claims were nonobvious over the prior art of record. Both sides appealed.

With respect to the Board’s decision on the obviousness of claims 1 – 4, 6 and 7, the Federal Circuit found that substantial evidence supported the ruling. UNMRI’s primary argument was that a person of skill in the art (POSA) would not have been motivated to combine Talukdar and Li, but the Court credited the Board’s reliance on ZyXEL’s expert, who demonstrated sufficient motivation to combine the two references.

The Federal Circuit reversed the Board’s finding that claim 8 had not been shown to be obvious, however. The Court noted that while the Nystrom reference may not explicitly state the benefit of the missing limitations, “a prior art reference does not need to explicitly articulate or express why its teachings are beneficial so long as its teachings are beneficial and a POSA would recognize that their application was beneficial.”

Regarding UNMRI’s motion to amend, ZyXEL argued that the Board erred in granting the motion because UNMRI did not satisfy the requirement that the motion itself contain written description support for all of the claim limitations of the substitute claims. The parties agreed that UNMRI’s reply contained the missing written description, but ZyXEL argued that this could not cure the procedural defect. The Federal Circuit acknowledged the procedural error but determined that “the core purpose of the MTA Pilot Program is to allow for the correction of errors in the original motion [and is thus] designed to allow reply briefs to address and correct errors.” The Court noted that ZyXEL had opportunity to respond in its sur-reply brief. The Court upheld the Board’s decision to grant UNMRI’s motion to amend and remanded the IPR back to the Board to determine, in light of the Court’s rulings on claim 8 and the fair teachings of Nystrom, whether the substitute claims were nonetheless obvious.

The Federal Circuit also reminded the Board that it may sua sponte identify a patentability issue for the proposed substitute claims based on any prior art of record in the proceedings.

© 2024 McDermott Will & Emery
For more news on PTAB’s Motion-to-Amend Pilot Program, visit the NLR  Intellectual Property section.

The New Paradigm in Mexico for Damage Claims in Industrial Property.

The Federal Law for the Protection of Industrial Property, in force since the 5th of November of 2020, is distinguished from its predecessor, among other things, by the particularities in the claims of a compensation for damages caused by the infringement of industrial property rights.

Currently, individuals may claim a compensation for damages through the administrative venue, before the Mexican Institute of Industrial Property (IMPI), or through the civil venue before the corresponding Courts in the matter. This implies that the holder of infringed exclusive rights may opt for two procedures and authorities of different nature, which has its benefits and disadvantages.

Before the IMPI, the compensation action is exercised in an ancillary proceeding, provided that such authority has previously issued a declaration of administrative infringement that is enforceable. Alternatively, it is still possible for the action to be brought directly before the Civil Courts, once the resolution from IMPI is final.

Although the exercise of the action for compensation before the administrative authority implies that a specialized authority in the matter is to hear the case, it has the disadvantages that its ancillary proceeding requires the prior prosecution of an administrative infringement claim before the same administrative authority (IMPI) and the lack of experience to quantify damages and losses. Additionally, the time required for the enforcement of the resolution issued by the IMPI before the Federal Courts in Civil Matters must be added to the time required for the substantiation of the action.

Thanks to the entry into force of the new Law, individuals may also resort directly to the civil Courts to claim infringement of their industrial property rights and compensation for damages, without the need for a prior declaration of infringement by the IMPI. This implies that a Judge, an expert in civil law, will have to delve into complex, specialized and technical issues, specific to industrial property.

Additionally, it is provided that the proceeding of the civil action will be suspended if an invalidity claim is filed before the IMPI against the right basis the civil claim, as long as the administrative authority does not issue a final resolution to such nullity action. This counteracts the advantage of a civil proceeding whose resolution may be quicker than before IMPI.

The new landscape for the claim for damages requires a careful study of the particularities of each specific case to determine the suitability of each route, since this is influenced, among other factors, by the complexity, the sophistication of the counterparty, the causes and technical considerations of the violation caused, among others.

© 2005-2024 OLIVARES Y COMPAÑIA S.C.
For more news on Damage Claims in Industrial Property in Mexico, visit the NLR Real Estate section.

Biden Administration Changes Green Card Process for Mixed-Status Families

To improve immigration processes and provide additional support to immigrants, the Biden administration has announced several policy changes.

Starting Aug. 19, 2024, unauthorized spouses and children of U.S. citizens who have been in the United States for at least 10 years can apply for parole in place, allowing these individuals to obtain green cards without having to leave the country. If approved, eligible family members will have three years to apply for permanent residency while being granted work authorization. By enabling family members to adjust their immigration status from within the United States, rather than traveling abroad and potentially facing a 10-year reentry ban, this change may significantly simplify the permanent residency process for eligible individuals.

The U.S. Department of State has also revised its guidance to favor immigrants with U.S. college degrees and job offers. The updated guidelines clarify that it is in the public interest for these individuals, including those with work authorization from the Deferred Action for Childhood Arrivals (DACA) program, to utilize their degrees in the United States. Consular officers will now have the discretion to weigh an applicant’s college degree and job offer favorably when deciding whether to grant a waiver to a visa applicant who would otherwise be ineligible. These adjustments aim to expedite the work visa process for college graduates.

Additionally, the Biden administration announced plans to double the locations for the Executive Office Immigration Review (EOIR), a program that provides volunteer attorneys in immigration courts for those without legal representation. Currently operating in San Francisco, Chicago, and New Orleans, the EOIR will expand to Maryland, New York City, and Atlanta by the end of the fiscal year. This expansion seeks to ensure fair representation for immigrants during legal proceedings. The EOIR has issued a call for attorneys to provide pro bono support to the program.

To expand opportunities for Latino communities, the Biden administration also announced that the U.S. Department of Education will propose to expand federal outreach programs targeting beneficiaries of the DACA program. Known as the Trio Program, this initiative aims to assist individuals from disadvantaged backgrounds as they transition from high school to college. The Department of Education’s proposal would extend the Trio Program to reach an additional 50,000 individuals.

©2024 Greenberg Traurig, LLP. All rights reserved.
For more news on Biden Administration Green Card Processes, visit the NLR Immigration section.

15% Discount on Chinese Patent Annuities for Open Licensing

Per a slightly ambiguous notice from the Ministry of Finance and the National Development and Reform Commission released July 24, 2024 (财政部 国家发展改革委关于调整优化专利收费政策的通知), annuity fees will be reduced by 15% for Chinese patents for participating in China’s open licensing system. As of the time of writing, there were over 2,000 open licenses published on China’s Intellectual Property Administration’s (CNIPA) online publication system.

15% Discount on Chinese Patent

Specifically, section 2 reads:

A 15% reduction in annual patent fees during the implementation period of patent open licensing. If other patent fee reduction policies are also applicable, the most favorable policy can be selected, but it cannot be enjoyed repeatedly.

However, it is unclear if this requires an actual license or simply having an offer to license published on CNIPA’s open license system.

In addition, there appears to be an additional annuity fee due for patents that receive patent term compensation (presumably for both patent term extensions for pharmaceutical patents and patent term adjustment for CNIPA delay in patent examination). It is unclear if this additional annuity is due for the entire patent term or just for the added patent term.

Specifically, section 1 reads, in part:

A patent owner who files a request for patent term compensation shall pay a patent term compensation request fee.

If a request for patent term compensation is found to meet the conditions for term compensation upon review, an annual patent compensation fee shall be paid…

CNIPA earlier this month also released additional information about open licensing system including royalty rates.

The full text of the Notice if available here (Chinese only).

© 2024 Schwegman, Lundberg & Woessner, P.A. All Rights Reserved.
For more news on Chinese Patent Licensing, visit the NLR Intellectual Property section.

Triggers That Require Reporting Companies to File Updated Beneficial Ownership Interest Reports

On January 1, 2024, Congress enacted the Corporate Transparency Act (the “CTA”) as part of the Anti-Money Laundering Act of 2020 and its annual National Defense Authorization Act. Every entity that meets the definition of a “reporting company” under the CTA and does not qualify for an exemption must file a beneficial ownership information report (a “BOI Report”) with the US Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”). Reporting companies include any entity that is created by the filing of a document with a secretary of state or any similar office under the law of a state or Indian tribe (this includes corporations, LLCs, and limited partnerships).

In most circumstances, a reporting company only has to file an initial BOI Report to comply with the CTA’s reporting requirements. However, when the required information reported by an individual or reporting company changes after a BOI Report has been filed or when either discovers that the reported information is inaccurate, the individual or reporting company must update or correct the reporting information.

Deadline: If an updated BOI Report is required, the reporting company has 30 calendar days after the change to file an updated report.

What triggers an updated BOI Report? There is no materiality threshold as to what warrants an updated report. According to FinCEN, any change to the required information about the reporting company or its beneficial owners in its BOI Report triggers a responsibility to file an updated BOI Report.

Some examples that trigger an updated BOI Report:

  • Any change to the information reported for the reporting company, such as registering a new DBA, new principal place of business, or change in legal name.
  • A change in the beneficial owners exercising substantial control over the reporting company, such as a new CEO, a sale (whether as a result of a new equity issuance or transfer of equity) that changes who meets the ownership interest threshold of 25%, or the death of a beneficial owner listed in the BOI Report.
  • Any change to any listed beneficial owner’s name, address, or unique identifying number provided in a BOI report.
  • Any other change to existing ownership information that was previously listed in the BOI Report.

Below is a reminder of the information report on the BOI report:

  • (1) For a reporting company, any change to the following information triggers an updated report:
    • Full legal name;
    • Any trade or “doing business as” name;
    • A complete current address (cannot be a post office box);
    • The state, territory, possession, tribal or foreign jurisdiction of formation; and
      TIN.
  • (2) For the beneficial owners and company applicants, any change to the following information triggers an updated report:
    • Full legal name of the individual;
    • Date of the birth of the individual;
    • A complete current address;
    • A unique identifying number and the issuing jurisdiction from one of the following non-expired documents; and
    • An image of the document.

It is important to note that if a beneficial owner or company applicant has a FinCEN ID and any change is made to the required information for either individual, then such individuals are responsible for updating their information with FinCEN directly. This is not the responsibility of the reporting company

© 2024 Winstead PC.

The Gig Continues: California Supreme Court Upholds Proposition 22

On July 25, 2024, the California Supreme Court issued its long-awaited ruling in Castellanos et al., v. State of California and Protect App-Based Drivers and Services, et al., upholding the 2020 voter initiative known as Proposition 22 the allows certain gig economy companies to classify drivers as independent contractors.

In 2019, California Assembly Bill 5, also known as AB5, expanded the landmark California Supreme Court decision in Dynamex Operations West, Inc. v. Superior Court, and made the “ABC” test law.

Pursuant to the ABC test, in order to maintain independent contractor status, the hiring entity must establish each of the following three factors:

  1. that the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact; and
  2. that the worker performs work that is outside the usual course of the hiring entity’s business; and
  3. that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

As a result, AB5 is widely perceived as the most draconian independent contractor test in the country.

The impact of AB5 has been pronounced and widespread, perhaps most noticeably for California’s gig economy.

In November 2020, following significant investment by affected companies such as Uber and Lyft, Proposition 22 hit the ballot. It asked voters whether “App-Based Transportation and Delivery Companies” should be exempted from providing employee rights and benefits to their drivers. In other words, whether gig drivers could be classified independent contractors. The initiative passed by 59% of the vote, and was codified as Business and Professions Code section 7451.

Shortly thereafter, drivers’ groups and unions challenged Proposition 22, arguing that section 7451 was unconstitutional because it infringed upon the power granted to the legislature to regulate workers’ compensation. After winning that argument in the Superior Court, the Court of Appeal reversed, and the Supreme Court agreed to hear the dispute.

The state’s highest court rejected the challenge in a unanimous decision, holding that the state constitution does not preclude the “electorate from exercising its initiative power to legislate on matters affecting workers’ compensation.” The decision was careful to examine only the question presented, i.e., whether section 7451 was unconstitutional. The Court specifically declined further exploration of the underlying workers’ compensation issue, stating: “We reserve these issues until we are presented with an actual challenge to an act of the Legislature providing workers’ compensation to app-based drivers.”

As a result of this decision, covered gig workers may maintain independent contractor status, with additional rights such as guaranteed earnings above minimum wage, health care stipends, and insurance — but without the protections of California’s employment laws — while maintaining the flexibility often attractive to those who choose this work.

In addition to drivers for app-based companies covered by Proposition 22, there are other limited exceptions to AB5, such as businesses that work through referral agencies, real estate professionals, and workers providing professional services. Each of the applicable tests is involved and often complicated.

At this stage, before classifying anyone as an independent contractor in California, companies would be wise to review the issues closely with their counsel.

©2024 Epstein Becker & Green, P.C. All rights reserved.
For more news on California Proposition 22, visit the NLR Labor Employment section.

DOE Ramping Up General Service Lamp Enforcement

Largely out of public view, the U.S. Department of Energy (DOE) has been ramping up enforcement of its “backstop” efficiency standard and sales prohibition regarding general service lamps, including incandescent bulbs. After a period of enforcement discretion (previewed in published guidance) that has now passed, we expect at least some of DOE’s efforts to become public in the coming months as the Department begins to settle enforcement actions and assess civil penalties against non-compliant lamp manufacturers, importers, distributors, and retailers.

The Final Rule

Following a rulemaking process that took many twists and turns over the past decade (as summarized in a prior alert), as of July 25, 2022, the sale of any general service lamp that does not meet a minimum efficacy standard of 45 lumens per watt hour (lm/W) is prohibited. 10 C.F.R. § 430.32(dd).

A “general service lamp” (GSL) is a lamp that:

  1. Has an ANSI base;
  2. For an integrated lamp, is able to operate at a voltage or in a voltage range of 12 or 24 volts, 100–130 volts, 220–240 volts, or 277 volts;
  3. For a non-integrated lamp, is able to operate at any voltage;
  4. Has an initial lumen output of greater than or equal to 310 lumens (or 232 lumens for modified spectrum general service incandescent lamps) and less than or equal to 3,300 lumens;
  5. Is not a light fixture;
  6. Is not an LED downlight retrofit kit; and
  7. Is used in general lighting applications.

10 C.F.R. § 430.2. GSLs include, but are not limited to, general service incandescent lamps, compact fluorescent lamps, general service light-emitting diode lamps, and general service organic light-emitting diode lamps. GSLs consist of pear-shaped A-type bulbs, but also five categories of specialty incandescent lamps (rough service lamps, shatter-resistant lamps, 3-way incandescent lamps, high lumen incandescent lamps, and vibration service lamps), incandescent reflector lamps, and a variety of decorative lamps (T-Shape, B, BA, CA, F, G16-1/2, G25, G30, S, M-14 of 40W or less, and candelabra base lamps). DOE maintains exclusions for twenty-six categories of lamps, including appliance lamps and colored lamps, among others. Id.

Approximately 30 percent of light bulbs sold across the United States in 2020 were incandescent or halogen incandescent lamps. Almost all such lamps would fail to meet the statutory 45 lm/W backstop standard. Because many LED lamps, in contrast, can meet the 45 lm/W standard, DOE’s actions are accelerating a transition to LEDs.

Federal and State Enforcement

During this transition, DOE enforcement is likely to most aggressively target manufacturers and importers continuing to distribute non-compliant lamps, and will include the assessment of civil penalties. DOE is authorized to assess penalties of as much as $560 for each non-compliant lamp sold. While enforcement actions typically settle for tens or hundreds of thousands of dollars, DOE has obtained seven-figure settlements for more significant violations or where a business has repeatedly failed to comply.

Specifically with respect to general service lamps (but not for other covered products), the Department is also authorized to enforce against distributors and retailers who sell non-compliant lamps, and early indications are that DOE is beginning to act on that authority. Because the federal backstop standard is enforced at the time of sale, lamps imported into the United States before July 25, 2022, are not exempt from enforcement if sold after the deadline.

Separately, some states—including California—also enforce their own efficiency standards for products not subject to federal standards. The California Energy Commission recently settled an enforcement action for over $120,000 against a company that was selling state-regulated LEDs that were not certified in California’s compliance database prior to sale, and which did not meet state standards.

Next Steps

Businesses operating at any stage in the lamp supply chain should, therefore, take immediate steps to ensure they are not making, importing, distributing, or selling to consumers any lamps that do not meet applicable federal or state requirements. To determine whether a particular general service lamp meets the backstop standard, one can take the total lumens produced by the lamp and divide it by its wattage. If the calculated number is below 45, and the product does not qualify for any of the listed exclusions, then it is non-compliant, and its continued sale could prompt federal enforcement.

© 2024 Beveridge & Diamond PC
For more news on DOE Lighting Enforcement, visit the NLR Environmental Energy Resources section.

Environmental Compliance in 2024: What Does it Take to Avoid Triggering EPA Scrutiny?

As environmental concerns continue to take center stage, more and more companies are finding themselves facing scrutiny from the U.S. Environmental Protection Agency (EPA). As a result, from a risk management perspective, environmental compliance is more important than ever in 2024—and this is likely to remain the case for the foreseeable future.

What does this mean for companies whose operations have (or have the potential to have) environmental impacts? The short answer is that they need to make EPA compliance a priority. They must proactively address all areas of concern, and they must be prepared to demonstrate their proactive efforts to the EPA if necessary.

The EPA’s enforcement arm is extremely active, and several offices within the agency are tasked with uncovering and addressing environmental regulations violations. As discussed below, many federal environmental laws include criminal enforcement provisions as well, and the EPA regularly works with the U.S. Department of Justice (DOJ) to pursue criminal charges when warranted.

7 Keys to Avoiding EPA Scrutiny in 2024 (and Beyond)

With all of this in mind, what do company owners and executives need to know in order to avoid triggering EPA scrutiny in 2024 (and beyond)? Here are seven tips for effectively manage environmental compliance in today’s world:

1. Thoroughly Assess the Company’s Environmental Compliance Obligations

The EPA enforces numerous federal environmental statutes, and it has promulgated an extraordinarily long, dense, and complicated set of regulations under these statutes. The EPA enforces a number of environmentally focused Executive Orders (EOs) as well. As a result, for all companies, the first step toward implementing an effective EPA compliance program is determining which laws, regulations, and EOs apply. Here are just some of the most common examples:

  • Clean Air Act (CAA) compliance
  • Clean Water Act (CWA) compliance
  • Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) compliance
  • Endangered Species Act (ESA) compliance
  • Energy Independence and Security Act (EISA) compliance
  • Federal Insecticide, Fungicide, and Rodenticide Act (FIFRA) compliance
  • Food Quality Protection Act (FQPA) compliance
  • Marine Protection, Research, and Sanctuaries Act (MPRSA) compliance
  • Resource Conservation Recovery Act (RCRA) compliance
  • Safe Drinking Water Act (SDWA) compliance
  • Toxic Substances Control Act (TSCA) compliance
  • Environmental Executive Order (EO) compliance

Determining applicability requires an in-depth understanding of each source of authority’s focus and scope. As a result, assessing a company’s environmental compliance obligations generally involves engaging experienced outside EPA counsel.

2. Develop Custom-Tailored Environmental Compliance Policies, Procedures, and Protocols

Of course, simply understanding a company’s compliance obligations is not enough. To effectively manage environmental compliance, companies must develop environmental compliance policies, procedures, and protocols that are custom-tailored to their operations and facilities. These should be sustainable practices that will increase operational efficiency and reduce costs and waste.

This, too, involves working with experienced EPA counsel. To establish and maintain EPA compliance, companies may need to take a variety of different steps. Depending on the specific environmental risks a company’s operations present (or may present), these steps may include:

  • Applying for a license, permit, or registration with the EPA
  • Passing EPA inspections
  • Restricting or preventing the discharge of contaminants or pollutants
  • Issuing notifications to consumers and/or the EPA
  • Promptly remediating spills and other exposure events

These are just a handful of numerous possibilities. While managing EPA compliance will be relatively straightforward for some companies, for others it can be a substantial undertaking. In both cases, developing custom-tailored policies, procedures, and protocols is a critical step toward effective regulatory compliance management.

3. Prioritize Environmental Compliance as an Element of Corporate Culture and Responsibility

Managing EPA compliance is not a one-time event. In other words, while developing custom-tailored policies, procedures, and protocols is a critical step toward effective compliance management, it is ultimately just one step in an ongoing process.

To effectively manage EPA compliance, companies need to take a top-down approach. They need to prioritize environmental compliance as an element of corporate culture and responsibility, and they need to make clear that personnel at all levels of the organization play an important role in protecting both the environment and the company. Lack of understanding and commitment at the executive level is a red flag for the EPA, and ineffective implementation of a company’s EPA compliance program can significantly increase its risk of both committing violations and facing enforcement.

4. Monitor and Audit Environmental Compliance

Another critical aspect of effectively managing a company’s environmental compliance-related risk is internally assessing compliance on an ongoing basis. Once a company has implemented its custom-tailored policies, procedures, and protocols, it must determine whether these are functioning as intended. While they should be, companies cannot afford to assume that this is the case. Ineffective training, oversights during implementation, changes in a company’s operational procedures, and various other issues can lead to compliance failures despite the implementation of an otherwise well-suited EPA compliance program.

Internally assessing compliance has two main components: (i) continuous monitoring, and (ii) periodic auditing. Companies should have safeguards in place that are designed to detect material violations when they occur. Companies must also conduct compliance audits at least annually to perform a deep-dive analysis of the efficacy of their compliance efforts. Crucially, if a company’s monitoring or auditing efforts uncover a violation of environmental rules, the company must then respond appropriately—and it must do so as efficiently as possible.

5. Generate and Store Environmental Compliance Documentation as a Matter of Course

When facing scrutiny from the EPA, being prepared to affirmatively demonstrate a company’s good-faith environmental compliance efforts is essential. In almost all cases, this is both the most effective and the most efficient way to resolve an EPA inquiry. Doing so requires clear and comprehensive documentation of the company’s ongoing compliance efforts, including its efforts to monitor, audit, and enforce compliance.

This means that companies need to generate and store environmental compliance documentation as a matter of course. By building documentation into their procedures and protocols, companies can do this efficiently and in a manner that facilitates demonstrating compliance to the EPA when necessary.

6. Respond Promptly (and Appropriately) to Information Requests and Other Inquiries

Companies can hear from the EPA under a variety of different circumstances. While different types of inquiries call for different types of responses, in all cases, a prompt and informed response is critical.

Once the EPA initiates an inquiry, it isn’t simply going to go away. Delay tactics will raise red flags; and, in the meantime, the EPA will be continuing its investigative and enforcement efforts. As part of their EPA compliance policies and procedures, companies should establish a step-by-step process for responding to the EPA in various scenarios. In most scenarios, the first step in this process will be engaging the company’s outside EPA counsel to provide guidance.

7. Update the Company’s Environmental Compliance Program as Necessary

Just as companies need to monitor their EPA compliance efforts on an ongoing basis, they must also monitor for any changes that necessitate updates to their environmental compliance programs. These changes could involve either: (i) changes in the environmental legislation; or, (ii) changes in the company’s operations that present new environmental compliance risks. In both cases, prompt action is key, as the EPA expects companies to consistently maintain comprehensive compliance.

Failing to Effectively Address Environmental Compliance: What Are the Risks?

Ideally, companies will maintain effective EPA compliance programs, and this means that they won’t have to worry about the risks of noncompliance. But, let’s say a company doesn’t do everything that is required. If the EPA has grounds to pursue enforcement, what are the risks involved?

Depending on the circumstances, the risks of environmental noncompliance can include:

  • Loss of License, Permit, or Registration – Companies may need to obtain a license, permit, or registration from the EPA in various scenarios. Failure to comply with the terms of licensure, permitting, or registration can lead to temporary suspension or permanent revocation.
  • “No Sale” Orders, Injunctions, and Other Administrative Remedies – The EPA also has the authority to impose “no sale” orders, injunctions, and other administrative remedies as necessary. If a company’s products or operations pose immediate environmental risks, the EPA can—and will—step in to intervene.
  • Civil Monetary Penalties – Environmental noncompliance can also trigger civil monetary penalties in many cases. Under several statutes, these penalties accrue on a daily or per-violation basis, which can lead to substantial financial liability for companies of all sizes.
  • Criminal Fines – As noted above, many of the statutes within the EPA’s enforcement jurisdiction include provisions for criminal enforcement. In criminal enforcement cases, companies can face substantial fines—and, in the aggregate, these fines can easily total millions, if not tens or hundreds of millions, of dollars.
  • Federal Imprisonment for Owners, Executives, and Others – Criminal enforcement cases can also expose companies’ owners, executives, and others to the risk of federal imprisonment. While relatively rare, the EPA and DOJ do not hesitate to pursue incarceration of implicated individuals when warranted.
Oberheiden P.C. © 2024
For more news on Environmental Compliance in 2024, visit the NLR Environmental Energy Resources section.

PFAS CERCLA Expansion Now On Hold

We have regularly reported on the EPA‘s long-anticipated  rule to designate PFOA and PFOS as “hazardous substances” under CERCLA. In April 2024, the EPA also issued an Advanced Notice of Proposed Rulemaking (ANPRM), which aimed to have seven additional PFAS added to the CERCLA list of “hazardous substances.” EPA originally set a deadline of April 2025 to finalize the rule to add seven additional PFAS to CERCLA; however, EPA’s July 2024 Unified Agenda now indicates that the deadline to finalize the rule for the additional seven PFAS is “to be determined.”

The shift in priorities away from an expanded PFAS CERCLA designation is a significant development that anyone follows PFAS regulatory or litigation news.

CERCLA PFAS Scope Designation To Date

On January 10, 2022, the EPA submitted a plan for a PFAS Superfund designation to the White House Office of Management and Budget (OMB) when it indicated an intent to designate two legacy PFAS – PFOA and PFOS – as “hazardous substances” under the Comprehensive Environmental Response, Compensation & Liability Act (CERCLA, also known as the Superfund law). The EPA previously stated its intent to make the proposed designation by March 2022 when it introduced its PFAS Roadmap in October 2021. Under the Roadmap, the EPA planned to issue its proposed CERCLA designation in the spring of 2022. On August 12, 2022, a CERCLA PFAS designation took a significant step forward when the OMB approved the EPA’s plan for PFOA and PFOS designation. This step opened the door for the EPA to put forth its proposed designation of PFOA and PFOS under CERCLA and engage in the required public comment period.

When OMB initially contemplated approving the EPA’s proposed rule, it designated the rule as “other significant”, which meant that the rule was predicted to have costs or benefits less than $100 million annually. However, the OMB received several pieces of feedback expressing concern that such an estimate fa undervalued the impact that such a designation will have. More specifically, the Chamber of Commerce provided its own estimate that the CERCLA designation would have a cost impact of over $700 million annually. As a result, the OMB changed its designation of the EPA’s propose rule to “economically significant”, which triggered the EPA to have to conduct a RIA prior to proposing the PFAS CERCLA designation. Under the RIA, the EPA will have to provide support for its position that a CERCLA designation is justified to achieve EPA goals and to provide support for the contention that such a designation is the least burdensome and most cost-effective way to achieve the EPA’s goals.

Despite the call for a RIA by the OMB, the EPA nevertheless released its final CERCLA designation in May 2024, the significance of which, if it survives legal challenges, will be felt for some time.

Additional CERCLA Designation

In February 2023, the EPA sent a proposed rule to the OMB that states the following:

“EPA plans to publish in the Federal Register an advance notice of proposed rulemaking requesting public input on whether the agency should consider designating as hazardous substances precursors to PFOA and PFOS, whether the agency should consider designating other PFAS as CERCLA hazardous substances and whether there is information that would allow the agency to designate PFAS as a class or subclass.”

The OMB reviewed the proposal and on March 24, 2023, approved the proposal so as to permit the EPA to proceed with publishing the Advanced Notice of Proposed Rulemaking (ANPRM).

On April 13, 2023, the EPA published in the Federal Register an ANPRM that seeks public comment on a proposal to list as “hazardous substances” the following additional PFAS: PFBS, PFHxS, PFNA, HFPO-DA, PFBA, PFHxA, and PFDA. The EPA indicated that the seven PFAS were chosen based on available toxicity data for the chemicals.

CERCLA PFAS Designation: Impact On Businesses

Once a substance is classified as a “hazardous substance” under CERCLA, the EPA can force parties that it deems to be polluters to either cleanup the polluted site or reimburse the EPA for the full remediation of the contaminated site. Without a PFAS Superfund designation, the EPA can merely attribute blame to parties that it feels contributed to the pollution, but it has no authority to force the parties to remediate or pay costs. The designation also triggers considerable reporting requirements for companies. Currently, those reporting requirements with respect to PFAS do not exist, but they would apply to industries well beyond just PFAS manufacturers. The CERCLA PFAS scope in any final regulation is therefore critical to numerous industries that were or are downstream users of PFAS.

The downstream effects of a PFOA and PFOS designation would be massive, but a designation of the entire class of PFAS or even various subclasses of PFAS would be potentially unquantifiable in financial magnitude. With over 15,000 PFAS in existence according to the EPA and many of them in continued use to this day, the potential environmental pollution ramifications touch on countless industry types. Companies that utilized PFAS in their industrial or manufacturing processes and sent the PFAS waste to landfills or otherwise discharged the chemicals into the environment will be at immediate risk for enforcement action by the EPA given the EPA’s stated intent to hold all PFAS polluters of any kind accountable. Waste management companies should be especially concerned given the large swaths of land that are utilized for landfills and the likely PFAS pollution that can be found in most landfills due to the chemicals’ prevalence in consumer goods. These site owners may be the first targeted when the PFOA/PFOS designation is made, which will lead to lawsuits filed against any company that sent waste to the landfills for contribution to the cost of cleanup that the waste management company or its insured will bear. However, with a broader PFAS designation a possibility now, there should naturally be concern regarding re-openers in the future for these same sites.

Of course, all of the above are subject now to legal challenges of the final CERCLA designation, which will play out over the next several months. In addition, EPA (and the rest of the country) are now living in a post-Chevron world, which is sure to have significant impacts on challenges to EPA’s intentions with respect to PFAS under CERCLA. It is perhaps for these reasons that EPA recently adjusted its deadline to finalize the expended PFAS CERCLA designation to a status of “to be determined.” This is quite significant and shows to me that EPA is adjusting its resources to prepare for the legal challenges to come, as well as focusing more earnestly on initiatives that it can pass prior to a potential shift in party power in the November 2024 elections.

Conclusion

While it is likely fair to say that almost all significant PFAS initiatives that EPA wishes to undertake will not be pushed forward until after the November election cycle, it is nevertheless of great importance for companies, insurers, and financial world specialists to continue to monitor PFAS developments. Even with a party shift in November, PFAS is unlikely to be wiped off of the map, so to speak, in terms of an environmental issue. The awareness of PFAS issues among media, politicians and citizens is simply too great at this point. In addition, developments that will be critical to monitor because of the impact that they may have on PFAS litigation, which will surely subsume PFAS regulatory impacts if November brings a party power shift.

©2024 CMBG3 Law, LLC. All rights reserved.
For more news on PFAS CERCLA Expansion, visit the NLR Environmental Energy Resources section.