Tag: Tax

Renewable Energy Tax Credit Transfer Guidance Provides Both Clarity And Pitfalls

Highlights

The renewable tax credit transfer market will accelerate with new government guidance; public hearing and comments deadlines are scheduled for August

Risk allocation puts the usual premium on sponsors with a balance sheet and/or recapture insurance coverage

While the guidelines provide clear rules and examples, many foot faults are present

On June 14, 2023, the Treasury Department and Internal Revenue Service issued long-awaited guidance on the transferability of certain renewable energy-related federal tax credits. The guidance takes the form of a notice of proposed rulemaking, proposed regulations, and an online Q&A, with a public hearing to follow in August.

Under new Code Section 6418, eligible taxpayers can elect to transfer all or any specified portion of eligible tax credits to one or more unrelated buyers for cash consideration. While the tax credits can be sold to more than one buyer, subsequent transfers by the buyer are prohibited.

This alert highlights several practical issues raised by the guidance, which should allow participants waiting for more clarity to proceed.

Individual Buyers Left Out

  • The guidance applies the Code Section 49 at risk rules and Section 50(b) tax-exempt use rules, generally restricting sellers in calculating the amount of tax credits for sale, and Code Section 469 passive activity rules, generally restricting buyer’s use of such tax credits, in various contexts. On the buyer side, these rules appear to be more restrictive than the limitations that would apply to identical tax credits in an allocation, rather than sale, context. Suffice to say, this will prohibit individuals from taking part in the transfer market for practical purposes outside of fact patterns of very limited application.
  • While this result may not be surprising since such rules currently severely restrict individuals from participating in traditional federal tax credit equity structures, there was some hope for a different outcome due to the stated policy goal of increasing renewable energy investment (not to mention the Inflation Reduction Act’s general departure from decades of case law precedent and IRS enforcement action prohibiting sales of federal tax credits with the enactment of Section 6418).

Lessees Cannot Sell the Tax Credits

  • A lessee cannot transfer the credit. With the prevalence of the master lease (inverted lease) structure in tax equity transactions, this prohibition created an unexpected roadblock for deal participants who have been structuring tax equity transactions with backstop type sale provisions for almost a year now. This presents developers, at least in the inverted lease context, with a choice of utilizing a traditional tax equity structure for the purpose of obtaining a tax-free step up in basis to fair market value, or forgoing the step up for less financing but also less structure complexity. The standard partnership flip project sale into a tax equity type of holding company structure could still remain a viable alternative.
  • As the transfer is generally made on a property-by-property basis by election, creative structuring, in theory, could allow for a lessor to retain certain property and sell the related tax credits (e.g., on portfolios with more than one solar installation/project, or even with large projects that go online on a block-by-block basis assuming the “energy project” election is not made – a term that future guidance will need to provide more clarity on).
  • However, this seems to be an ivory tower conclusion currently, and the practical reality is that too many unknown issues could be raised by such out of the box structuring, including the fact that conservative institutional investors may refuse to participate in such a structure until clear objective guidance is published addressing the same.

Bonus Credits Cannot Be Sold Separately

  • Bonus credits cannot be sold separately from the underlying base credit. This is more problematic for certain adders – for example, the energy community adder rules are now out and amount to simply checking a location on a website. Others (e.g., the low-income community or domestic content adder) require more extensive and subjective application and qualification procedures which makes when and how such adders can be transferred difficult to ascertain. Projects hoping to transfer such credits may need to be creative in compensating buyers for such uncertainty and qualification risk. Tax equity transactions that closed prior to the guidance’s issuance may also need to be revisited, as provisions in such transaction documents commonly attempted to bifurcate the bonus credit away from the base credit in order to allow the sponsor to separately sell such adders.

Buyers Bear Recapture Risk and Due Diligence Emphasis

  • While the Joint Committee on Taxation Bluebook indicated the buyer is responsible for recapture, industry participants were still hoping such risk would remain with the seller. Outside of the limited situation of indirect partnership dispositions (which still results in a recapture event to the transferring partner if triggered), the recapture risk is borne by the buyer, using the rationale that the buyer is the “taxpayer” for purposes of the transferred tax credits. While this is familiar territory for tax equity investors, whose allocated tax credits would be reduced in a recapture scenario, tax credit purchase transactions are now burdened with what amounts to the standard tax equity type of due diligence, including negotiation of transaction documents outside of a basic purchase agreement.
  • The guidance provides that indemnity protections between the seller and buyer are permitted. Tax equity transactions historically have had robust indemnification provisions, which should remain the case even more so in purchase/sale transactions. Tax equity investors traditionally bear “structure risk” dealing with whether the investor is a partner for tax purposes – such risk is eliminated in the purchase scenario as the purchasing investor no longer needs to be a partner (subject to the caveat of a buyer partnership discussed below).
  • If the buyer claims a larger credit amount than the seller could have, such “excessive credit transfer” will subject the buyer to a 20 percent penalty on the excess amount (in addition to the regular tax owed). All buyers are aggregated and treated as one for this purpose – if the seller retains any tax credits, the disallowance is first applied to the seller’s retained tax credits. A facts and circumstances reasonable cause exception to avoid this penalty is provided, further emphasizing the need for robust due diligence.
  • Specific non-exclusive examples that may demonstrate reasonable cause include reviewing the seller’s records with respect to determining the tax credit amount, and reasonable reliance on third-party expert reports and representations from the seller. While not unique to this new tax credit transfer regime, the subjective and circular nature of such a standard is complex – for example, when is it not “reasonable” for buyers or other professionals to rely on other board certified and licensed professionals, such as an appraiser or independent engineer with specialized knowledge?
  • Buyers thus need to remain vigilant about potential recapture causing events. For example, tax equity investors will not generally allow project level debt on investment tax credit transactions without some sort of lender forbearance agreement that provides that the lender will not cause a tax credit recapture event (such as foreclosing and taking direct ownership of the project). Buyers remain responsible for such a direct project level recapture event, which again aligns the tax credit transfer regime with tax equity due diligence and third-party negotiation requirements. The guidance is more lenient for the common back-leverage debt scenario.
  • While similar interparty agreements between back leverage lenders and the tax equity investor are required for non-project level debt facilities to address tax credit recapture among other issues, the guidance provides that a partner disposing of its indirect interest in the project (e.g., the lender foreclosing and taking ownership of a partner’s partnership interest) will remain subject to the recapture liability rather than the buyer provided that other tax-exempt use rules are not otherwise implicated. However, the need to negotiate such lender related agreements is still implicated as not all recapture risk in even this scenario was eliminated to the buyer.
  • While the recapture risk could place a premium on production tax credit deals (that are technically not subject to recapture or subjective basis risk), the burdensome process of needing to buy such tax credits on a yearly basis in line with sales of output may make such transactions more tedious.
  • The insurance industry already has products in place to alleviate buyer concerns, but this is just another transaction cost in what may be a tight pricing market. Not unlike tax equity transactions, sponsor sellers with a balance sheet to backstop indemnities may be able to demand a pricing premium; other sponsors may need to compensate buyers with lower credit pricing to reward such risk and or/to allow the purchase of recapture insurance. While this seems logical, the guidance also includes anti-abuse type rules whereby low credit pricing could be questioned in terms of whether some sort of impermissible transfer by way of other than cash occurred (e.g., a barter for some sort of other service). What the IRS subjectively views as “below market” pricing could trigger some sort of audit review based on this factor alone which further stresses the importance of appropriate due diligence.

Partnerships and Syndications

  • The guidance provides very clear rules with helpful examples, which should allow partnership sellers and buyers to proceed with very objective parameters. For example, the rules allow a partnership seller to specify which partner’s otherwise allocable share of tax credits is being sold and how to then allocate the tax-exempt income generated. The cash generated from sales can be used or distributed however the partnership chooses.
  • Similar objective rules and examples are provided for a buyer partnership. Subsequent direct and indirect allocations of a purchased tax credit do not violate the one-time transfer prohibition. Purchased tax credits are treated as “extraordinary items” that must be allocated among the partners of the buyer partnership as of the time of the transfer, which is generally deemed to occur on the first date a cash payment is made. Thus, all partners need to be in the partnership on such date to avoid an issue. Purchased tax credits are then allocated to the partners in accordance with their share of the nondeductible expenditures used to fund the purchase price.
  • What level of end-user comfort is needed in such a syndicated buyer partnership is an open question. While the rules provide objective guidelines in terms of when and how such purchased credits are allocated, subjective questions that are present in (and focused on) traditional tax equity partnerships are implicated. For example, could a syndication partnership set up for the business purpose of what amounts to selling the tax credits somehow run afoul of the subjective business purpose and disguised sale rules in tax credit case precedent, such as the Virginia Historic Tax Credit Fund state tax credit line of precedent? Will the market require a robust tax opinion in such scenario, thereby driving up transaction costs?
  • An example in the proposed regulations speaks to this sort of partnership formed for the specific purpose of buying tax credits, but leaves out of the fact pattern a syndicator partner. The example itself should go a long way towards blessing such arrangements, but the IRS taking a contrary position when dealing with such issues would not be a new situation. For example, the IRS challenged allocations of federal historic tax credits as prohibited sales of federal tax credits to the point of freezing the entire tax equity market with its positions in Historic Boardwalk Hall, which was only rectified with the release of a subsequent safe harbor revenue procedure.
  • Moreover, the guidance provides that tax credit brokers are allowed to participate in the market so long as the tax credits are not transferred to such brokers as an initial first step in the transfer process (as the subsequent transfer to an end user would violate the one-time transfer rule). Specifically, at no point can the federal “income tax ownership” be transferred to a broker. It is an open question if further distinction will be made at where this ownership line should be drawn. For example, can a third party enter into a purchase agreement with a seller and then transfer such rights prior to the transfer election being made? Does it matter under such analysis if 1) purchase price installments have been paid (which implicates rules in the buyer partnership context as noted above) and/or 2) the tax credit generating eligible property has been placed in service (which is when the investment tax credit vests for an allocated tax credit analysis; a production tax credit generally arises as electricity or the applicable source is sold)?
  • Indirectly implicated is what effect the new transfer rules will have on established case law precedent and IRS enforcement action in traditional tax equity structures. The Inflation Reduction Act and guidance dances around certain of these issues by creating a fiction where the buyer is treated as the “taxpayer” – this avoids the issue of turning a federal tax credit into “property” that can be sold similar to a certificated state tax credit. This also provides a more logical explanation as to why the buyer of these federal tax credits does not need to report any price discount as income when utilized, unlike the well-established federal tax treatment of certificated state tax credits that provides the exact opposite (e.g., a buyer of a certificated state tax credit at $0.90 has to report $0.10 of income on use of such tax credit).

Other Administrative and Foot-Fault Issues

  • The purchase price can only be paid in cash during the period commencing with the beginning of the seller’s tax year during which the applicable tax credit is generated and ending on the due date for filing the seller’s tax return with extensions. Thus, such period could be as long as 21.5 months or more (e.g., a calendar year partnership seller extending its return to Sept. 15). Tax equity transactions generally have pricing timing adjusters for failure to meet placement in service deadlines. Such mechanism will not work if advanced payments were made and then the project’s projected placement in service year changes. Tax credit purchase agreements executed prior to the June 14 guidance may require amendments or complete unwinds to line up with the rules to avoid foot faults (e.g., purchase agreements executed in 2022 where a portion of the purchase price was paid in 2022 for anticipated 2023 tax credits would not fall within the “paid in cash” safe harbor period). Advanced commitments, so long as cash is not transferred outside of the period outlined above, are permitted.
  • The typical solar equity contribution schedule of 20 percent at a project’s mechanical completion makes purchase price schedules approximating the same a reasonable adjustment for most investment tax credit energy deals in terms of the timing of financing. In addition, the advance commitment blessing of the guidance will give lender parties the comfort necessary similar to having executed tax equity documents in place. Thus, typical project construction financing mechanisms should be similar in the tax equity versus purchase agreement scenario, with projects that allow for a more delayed funding mechanism possibly obtaining a tax credit pricing premium. Production tax credit deals, for which tax credits can only be paid for on a yearly basis within the cash paid safe harbor timing window, may have more significant project financing hurdles without further tax credit transfer rule modifications.
  • Sellers can only make the transfer election on an original return, which includes extensions. Buyers, by contrast, may claim the purchased tax credit on an amended return.
  • Buyers need to be aware that usage of the purchased tax credits is tied to the tax year of the seller. For example, a fiscal year seller could cause the tax credits to be available a year later than an uninformed buyer anticipated, regardless of when the tax credit was generated using a traditional placement in service analysis. For example, a solar project placed in service during November 2023 by an August fiscal year seller would generate credits first able to be used in a calendar year buyer’s 2024, instead of 2023, tax year. A buyer can use the tax credits it intends to purchase against its estimated tax liability.
  • The pre-registration requirements, which are expansive and open-ended, are also tied to the taxable year the tax credits are generated and generally must be made on a property-by-property basis. For example, 50 rooftop installations could require 50 separate registration numbers outside of the “energy project” election. When such registration information needs updated is also not entirely clear – for example, a project is often sold into a tax equity partnership syndication structure on or before mechanical completion. Needing to update registration information could delay transactions and implicates unknown audit risk.

While these rules provide much-needed clarity, failure to adhere may be catastrophic and will require sellers and buyers to put proper administrative procedures in place to avoid foot faults. The new transfer regime will expand the market to new buyers who may have viewed tax equity as either too complex or had other reasons to avoid these transactions, such as the accounting treatment of energy tax credit structures. However, it would be prudent for such buyers to approach such transactions with eyes wide open.

© 2023 BARNES & THORNBURG LLP

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A Summary of Inflation Reduction Act’s Main Energy Tax Proposals

On August 7, the Senate passed the Inflation Reduction Act of 2022 (the “IRA”). The IRA contains a significant number of climate and energy tax proposals, many of which were previously proposed in substantially similar form by the House of Representatives in November 2021 (in the “Build Back Better Act”).

Extension and expansion of production tax credit

Section 45 of the Internal Revenue Code provides a tax credit for renewable electricity production. To be eligible for the credit, a taxpayer must (i) produce electricity from renewable energy resources at certain facilities during a ten-year period beginning on the date the facility was placed in service and (ii) sell that renewable electricity to an unrelated person.[1] Under current law, the credit is not available for renewable electricity produced at facilities whose construction began after December 31, 2021.

The IRA would extend the credit for renewable electricity produced at facilities whose construction begins before January 1, 2025. The credit for electricity produced by solar power –which expired in 2016—would be reinstated, as extended by the IRA.

The IRA would also increase the credit from 1.5 to 3 cents per kilowatt hour of electricity produced.

A taxpayer would be entitled to increase its production tax credit by 500% if (i) its facility’s maximum net output is less than 1 megawatt, (ii) it meets the IRA’s prevailing wage and apprenticeship requirements,[2] and (iii) the construction of its facility begins within fifty-nine days after the Secretary publishes guidance on these requirements.

In addition, the IRA would add a 10% bonus credit for a taxpayer (i) that certifies that any steel, iron, or manufactured product that is a component of its facility was produced in the United States (the “domestic content bonus credit”) or (ii) whose facility is in an energy community (the “energy community bonus credit”).[3]

Extension, expansion, and reduction of investment tax credit

Section 48(a) provides an investment tax credit for the installation of renewable energy property. The amount of the credit is equal to a certain percentage (described below) of the property’s tax basis. Under current law, the credit is limited to property whose construction began before January 1, 2024.

The IRA would extend the credit to property whose construction begins before January 1, 2025. This period would be extended to January 1, 2035 for geothermal property projects. The IRA would also allow the investment tax credit for energy storage technology, qualified biogas property, and microgrid controllers.

The IRA would reduce the base credit from 30% to 6% for qualified fuel cell property; energy property whose construction begins before January 1, 2025; qualified small wind energy property; waste energy recovery property; energy storage technology; qualified biogas property; microgrid controllers; and qualified facilities that a taxpayer elects to treat as energy property. For all other types of energy property, the base credit would be reduced from 10% to 2%.

A taxpayer would be entitled to increase this base credit by 500% (for a total investment tax credit of 30%) if (i) its facility’s maximum net output is less than 1 megawatt of electrical or thermal energy, (ii) it meets the prevailing wage and apprenticeship requirements, and (iii) its facility begins construction within fifty-nine days after the Secretary publishes guidance on these requirements.

In addition, a taxpayer would be entitled to a 10% domestic content bonus credit and 10% energy community bonus credit (subject to the same requirements as for bonus credits under section 45). The IRA would also add a (i) 10% bonus credit for projects undertaken in a facility with a maximum net output of 5 megawatts and is located in low-income communities or on Indian land, and (ii) 20% bonus credit if the facility is part of a qualified low-income building project or qualified low-income benefit project.

Section 45Q (Carbon Oxide Sequestration Credit)

Section 45Q provides a tax credit for each metric ton of qualified carbon oxide (“QCO”) captured using carbon capture equipment and either disposed of in secure geological storage or used as a tertiary injection in certain oil or natural gas recovery projects.  While eligibility for the section 45Q credit under current law requires that projects begin construction before January 1, 2026, the IRA would extend credit eligibility to those carbon sequestration projects that commence construction before January 1, 2033.

The IRA would increase the amount of tax credits for projects that meet certain wage and apprenticeship requirements. Specifically, the IRA would increase the amount of section 45Q credits for industrial facilities and power plants to $85/metric ton for QCO stored in geologic formations, $60/metric ton for the use of captured carbon emissions, and $60/metric ton for QCO stored in oil and gas fields.  With respect to direct air capture projects, the IRA would increase the credit to $180/metric ton for projects that store captured QCO in secure geologic formations, $130/metric ton for carbon utilization, and $130/metric ton for QCO stored in oil and gas fields.  The proposed changes in the amount of the credit would apply to facilities or equipment placed in service after December 31, 2022.

The IRA also would decrease the minimum annual QCO capture requirements for credit eligibility to 1,000 metric tons (from 100,000 metric tons) for direct air capture facilities, 18,750 metric tons (from 500,000 metric tons) of QCO for an electricity generating facility that has a minimum design capture capacity of 75% of “baseline carbon oxide” and 12,500 metric tons (from 100,000 metric tons) for all other facilities.  These changes to the minimum capture requirements would apply to facilities or equipment that begin construction after the date of enactment.

Introduction of zero-emission nuclear power production credit

The IRA would introduce, as new section 45U, a credit for zero-emission nuclear power production.

The credit for a taxable year would be the amount by which 3 cents multiplied by the kilowatt hours of electricity produced by a taxpayer at a qualified nuclear power facility and sold by the taxpayer to an unrelated person during the taxable year exceeds the “reduction amount” for that taxable year.[4]

In addition, a taxpayer would be entitled to increase this base credit by 500% if it meets the prevailing wage requirements.

New section 45U would not apply to taxable years beginning after December 31, 2032.

Biodiesel, Alternative Fuels, and Aviation Fuel Credit

The IRA would extend the existing tax credit for biodiesel and renewable diesel at $1.00/gallon and the existing tax credit for alternative fuels at $.50/gallon through the end of 2024.  Additionally, the IRA would create a new tax credit for sustainable aviation fuel of between $1.25/gallon and $1.75/gallon.  Eligibility for the aviation fuel credit would depend on whether the aviation fuel reduces lifecycle greenhouse gas emissions by at least 50%, which corresponds to a $1.25/gallon credit (with an additional $0.01/gallon for each percentage point above the 50% reduction, resulting in a maximum possible credit of $1.75/gallon). This credit would apply to sales or uses of qualified aviation fuel before the end of 2024.

Introduction of clean hydrogen credit

The IRA would introduce, as new section 45V, a clean hydrogen production tax credit. To be eligible, a taxpayer must produce the clean hydrogen after December 31, 2022 in facilities whose construction begins before January 1, 2033.

The credit for the taxable year would be equal to the kilograms of qualified clean hydrogen produced by the taxpayer during the taxable year at a qualified clean hydrogen production facility during the ten-year period beginning on the date the facility was originally placed in service, multiplied by the “applicable amount” with respect to such hydrogen.[5]

The “applicable amount” is equal to the “applicable percentage” of $0.60. The “applicable percentage” is equal to:

  • 20% for qualified clean hydrogen produced through a process that results in a lifecycle greenhouse gas emissions rate between 2.5 and 4 kilograms of CO₂e per kilogram of hydrogen;

  • 25% for qualified clean hydrogen produced through a process that results in a lifecycle greenhouse gas emissions rate between 1.5 and 2.5 kilograms of CO₂e per kilogram of hydrogen;

  • 4% for qualified clean hydrogen produced through a process that results in a lifecycle greenhouse gas emissions rate between 0.45 and 1.5 kilograms of CO₂e per kilogram of hydrogen; and

  • 100% for qualified clean hydrogen produced through a process that results in a lifecycle greenhouse gas emissions rate of less than 0.45 kilograms of CO₂e per kilogram of hydrogen.

A taxpayer would be entitled to increase this base credit by 500% if (i) it meets the prevailing wage and apprenticeship requirements or (ii) it meets the prevailing wage requirements, and its facility begins construction within fifty-nine days after the Secretary publishes guidance on the prevailing wage and apprenticeship requirements.

FOOTNOTES

[1] All references to section are to the Internal Revenue Code.

[2] The IRA would require new prevailing wage and apprenticeship requirements to be satisfied in order for a taxpayer to be eligible for increased credits. To satisfy the prevailing wage requirements, a taxpayer would be required to ensure that any laborers and mechanics employed by contractors or subcontractors to construct, alter or repair the taxpayer’s facility are paid at least prevailing local wages with respect to those activities. To satisfy the apprenticeship requirements, “qualified apprentices” would be required to construct a certain percentage of the taxpayer’s facilities (10% for facilities whose construction begins before January 1, 2023 and 15% for facilities whose construction begins on January 1, 2024 or after). A “qualified apprentice” is a person employed by a contractor or subcontractor to work on a taxpayer’s facilities and is participating in a registered apprenticeship program.

[3] An “energy community” is a brownfield site; an area which has (or had at any time after December 31, 1999) significant employment related to the extraction, processing, transport, or storage of coal, oil, or natural gas; and a census tract in which a coal mine closed or was retired after December 31, 1999 (or an adjoining census tract).

[4] A “qualified nuclear power facility” is any nuclear facility that is owned by the taxpayer, that uses nuclear energy to produce electricity, that is not an “advanced nuclear power facility” as described in section 45J(d)(1),  and is placed in service before the date that new section 45U is enacted.

“Reduction amount” is, for any taxable year, the amount equal to (x) the lesser of (i) the product of 3 cents multiplied by the kilowatt hours of electricity produced by a taxpayer at a qualified nuclear power facility and sold by the taxpayer to an unrelated person during the taxable year and (ii) the amount equal to 80% of the excess of the gross receipts from any electricity produced by the facility (excluding an advanced nuclear power facility) and sold to an unrelated person during the taxable year; (y) over the amount equal to the product of 2.5 cents multiplied by the kilowatt hours of electricity produced by the taxpayer at a qualified nuclear power facility and sold by the taxpayer to an unrelated person during the taxable year.

[5] “Qualified clean hydrogen” is hydrogen that is produced (i) through a process that results in a lifecycle greenhouse gas emissions rate of no more than 4 kilograms of CO₂e per kilogram of hydrogen, (ii) in the United States, (iii) in the ordinary course of the taxpayer’s trade or business, (iv) for sale or use, and (v) whose production and sale or use is verified by an unrelated party. The IRA does not explain what “verified by an unrelated party” means.

Article By David S Miller, Amanda H Nussbaum, Martin T Hamilton, J. Tyler Moser, and Rita N. Halabi of Proskauer Rose LLP

For more tax law legal news, click here to visit the National Law Review.

© 2022 Proskauer Rose LLP.

Joint Trusts: A Useful Tool for Some Married Couples

Though not a silver bullet for every situation, in appropriate circumstances, a Joint Revocable Living Trust (“Joint Trust”) can provide a married couple with significant benefits and simplify the administration of assets upon death or incapacity.

The Probate and Estate Administration Process

In order to illustrate the benefits that can be achieved with a Joint Trust, it’s helpful to first understand the typical probate and estate administration process that occurs when a person dies.

When a person dies with a Will, the designated Executor in the Will typically submits the original Will for probate in the Estates Division of the Clerk of Superior Court in the county where the decedent resided at the time of death.  “Probate” is the legal process by which the court validates the submitted document as the legal Will of the decedent.  When offering the Will for probate, the designated Executor typically also files an application with the court to be appointed as Executor of the estate and granted Letters Testamentary, which is the legal document confirming the Executor’s authority to act for the decedent’s estate.

If a person dies without a Will, the decedent’s spouse or nearest relative typically files an application with the court in the county where the decedent resided at the time of death seeking to be appointed as Administrator of the estate and granted Letters of Administration which is the legal document confirming the Administrator’s authority to act for the decedent’s estate.

Once the court appoints an Executor or Administrator of the estate, as the case may be, that person is referred to as the “Personal Representative” of the estate and is charged with several duties and obligations.  Actions required of the Personal Representative include:

  • Taking control of the decedent’s assets;
  • Filing an inventory with the court identifying the value of all of the decedent’s assets to the penny;
  • Publishing a notice to creditors giving them three months to file claims with the estate;
  • Satisfying any creditors’ claims;
  • Distributing all remaining assets to the decedent’s beneficiaries; and,
  • Filing an accounting with the court to report to the penny what occurred with all of the assets.

The court supervises the process at every step along the way and must ultimately approve all actions taken in the course of the estate administration before the Personal Representative will be relieved of their appointment.

Movement Away from Probate

Over the last few decades, a trend has developed in the estate planning community to attempt to structure a person’s affairs so that no assets will pass through a probate estate supervised by the court.  That trend has developed in response to a public perception that the court supervised process is not only unnecessary but also yields additional costs.  For instance, additional fees must be paid to attorneys and other advisors to prepare the inventory, accountings, and other documentation necessary to satisfy a court that the estate was properly administered.  Also, in North Carolina, the court charges a fee of $4 per $1,000 of value that passes through the estate, excluding the value of any real estate.  Currently, there is a cap on this fee in the amount of $6,000, which is reached when the value of the estate assets equals $1,500,000.

Additionally, all reporting made to the court about the administration of an estate is public record, meaning that anyone can access the information.  The public nature of the process is why news organizations often are able to publish articles soon after a celebrity’s death detailing what assets the celebrity-owned and who received them.  Such publicity causes concern for many people because they fear that their heirs will become targets for gold-diggers.  This has further strengthened the trend away from court supervised estate administration.

Several techniques are available to avoid the court supervised estate administration process.  These include:

  • Registering financial accounts as joint with rights of survivorship;
  • Adding beneficiary designations to life insurance or retirement accounts; and,
  • Adding pay-on-death or transfer-on-death designations on financial accounts.

However, because it is rarely possible to utilize those techniques to fully exempt a person’s assets from the court supervised estate administration process, the most commonly used avoidance device is the Revocable Living Trust.

The Revocable Living Trust

A Revocable Living Trust is essentially a substitute for a Will.  To create a Revocable Living Trust, a person typically transfers the person’s assets to himself or herself as trustee and signs a written trust document that contains instructions as to what the trustee is to do with those assets while the person is alive as well as upon death.  The trust document also identifies who should take over as successor trustee when the person is no longer able to serve due to death or incapacity.

During life, the person’s assets in the trust may be used in any way the person, as trustee, directs, and the person may change the instructions in the trust document in a similar manner as one can change a Will.  If the person becomes incapacitated, the successor trustee is instructed to use the trust assets for the person’s care.

At death, the successor trustee wraps up the person’s affairs by utilizing the trust assets to satisfy all of the person’s liabilities and distributes the remaining assets to the beneficiaries identified in the trust document.  No court supervises the process, so no court fees are incurred.  Moreover, advisors’ fees related to preparing court filings are avoided.  Also, the administration of the trust is a private matter with nothing becoming public record.  This process often results in a much better outcome for the person’s beneficiaries as compared to having the assets pass through the court supervised estate administration process.

The Joint Trust

Typically, when a married couple utilizes a Revocable Living Trust-based estate plan, each spouse creates and funds his or her own separate Revocable Living Trust.  This results in two trusts.  However, in the right circumstances, a married couple may be better served by creating a single Joint Trust.

A Joint Trust tends to work best when a couple has the following characteristics:

  • The couple has a long, stable relationship;
  • Divorce is not a concern for either spouse;
  • The couple is willing to identify all assets as being owned one-half by each of them;
  • No creditors’ claims exist, whether current or contingent, for which the creditor could seek to collect from only one spouse and not the other;
  • Neither spouse has children from a prior relationship;
  • Each spouse is comfortable with the surviving spouse having full control over all of the assets after the death of one of the spouses; and,
  • The value of the couple’s assets is less than the federal estate tax exemption amount.  For deaths occurring in 2022, this amount is $12.06 million (or $24.12 million per couple) reduced by any taxable gifts made during life.

A couple who meets these criteria could establish a Joint Trust by transferring their assets to themselves as co-trustees and signing a trust document to provide instructions as to what the co-trustees are to do with the assets.  Typically, while both spouses are alive and competent, they retain full control over the trust assets and can change the trust document at any time.  If one of the spouses becomes incapacitated, the other spouse continues to control the trust and can use the trust assets for the couple’s care.

After the death of one of the spouses, the Joint Trust will continue.  The surviving spouse would continue serving as trustee and have full control over the trust assets.  No transfers of assets are required at the first death because all assets are already in the Joint Trust.

Upon the death of the surviving spouse, the designated successor trustee wraps up the surviving spouse’s affairs by utilizing the Joint Trust assets to satisfy any liabilities and distributes the remaining assets as directed in the trust document.

The following are some of the benefits afforded by a Joint Trust:

  • Throughout this entire process, there is no court involvement.  This minimizes costs and promotes privacy.
  • The couple no longer has to worry about whether a particular asset is owned by one of the spouses or by one of the spouses’ separate Revocable Living Trusts.  All assets are simply owned by the Joint Trust.
  • Since only one trust is ever created, no transfers need to be made after the death of the first spouse to die.  This simplification in the administration process minimizes advisors’ fees and other costs and is a key advantage of using a Joint Trust.

A Joint Trust can possibly yield even more benefits in certain situations.  For instance, it may be possible to characterize some or all of the assets in a Joint Trust as community property.  The benefit of having assets characterized as community property is that such property will receive a full basis adjustment for income tax purposes (commonly referred to as a “step-up” in basis) at the death of the first spouse to die as opposed to only one-half of the property receiving such a basis step-up.

Additionally, it may be possible to include asset protection features in the Joint Trust so that any real property owned by the trust would be afforded the same protection as real property owned by a married couple as tenants by the entireties.  Such protection prevents a creditor of just one spouse from enforcing the liability against the real property owned by the couple.  Though the details of these benefits are beyond the scope of this article, they demonstrate that a Joint Trust potentially can provide additional advantages beyond those listed above.

Conclusion

In the right circumstances, utilizing an estate plan that involves a Joint Trust can simplify a married couple’s affairs and, as a result, make the administration process easier after death and ultimately lower costs.  Any couple interested in a Joint Trust should contact competent counsel to assist them in evaluating whether the technique is appropriate for them.

Article By Zachary F. Lamb of Ward and Smith, P.A.

For more family, estates and trusts legal news, click here to visit the National Law Review.

© 2022 Ward and Smith, P.A.. All Rights Reserved.

Suing Attorneys In Texas For Participating in Fiduciary Breaches

It is not uncommon for an attorney to execute all or part of his or her client’s wishes, which may be in breach of a fiduciary duty owed by the client to a third party. The third party can certainly sue the client for breaching fiduciary duties. But can the third party also sue the attorney for participating in the client’s actions?

An officer or director of a company may set up a competing business and direct company business to the new competing business. If the officer or director uses an attorney to set up this business and the attorney knows that new business will be used to usurp opportunities, can the company sue the attorney for facilitating the creation of the new business? What if the attorney is an owner of the new company or works for the new company in a nonlegal position?

Certainly, Texas has legal theories that can hold a party liable for participating with a fiduciary in breaching duties owed by the fiduciary. There is a claim for knowing participation in a breach of fiduciary duty. See Kinzbach Tool Co. v. Corbett-Wallace Corp., 138 Tex. 565, 160 S.W.2d 509, 514 (1942); Paschal v. Great W. Drilling, Ltd., 215 S.W.3d 437, 450 (Tex. App.—Eastland 2006, pet. denied) (holding wife liable for knowing participation in employee’s embezzlement where funds were placed in joint account and wife benefitted from stolen funds). See also Westech Capital Corp. v. Salamone, 2019 U.S. Dist. LEXIS 143577, 2019 WL 4003093, at *1 (W.D. Tex. Aug. 23, 2019) (collecting cases that explain that “Texas appellate courts have routinely recognized the existence of a cause of action for knowing participation in the breach of fiduciary duty.”). The general elements for a knowing-participation claim are: 1) the existence of a fiduciary relationship; 2) the third party knew of the fiduciary relationship; and 3) the third party was aware it was participating in the breach of that fiduciary relationship. D’Onofrio v. Vacation Publ’ns, Inc., 888 F.3d 197, 216 (5th Cir. 2018); Meadows v. Harford Life Ins. Co., 492 F.3d 634, 639 (5th Cir. 2007). There is also a recognized civil conspiracy claim in Texas. The essential elements of a civil conspiracy are (1) two or more persons; (2) an object to be accomplished; (3) a meeting of the minds on the object or course of action; (4) one or more unlawful, overt acts; and (5) damages as the proximate result. Juhl v. Airington, 936 S.W.2d 640, 644 (Tex. 1996). Finally, there may be an aiding-and-abetting breach-of-fiduciary-duty claim. The Texas Supreme Court has stated that it has not expressly adopted a claim for aiding and abetting outside the context of a fraud claim. See First United Pentecostal Church of Beaumont v. Parker, 514 S.W.3d 214, 224 (Tex. 2017); Ernst & Young v. Pacific Mut. Life Ins. Co., 51 S.W.3d 573, 583 n. 7 (Tex. 2001); West Fork Advisors v. Sungard Consulting, 437 S.W.3d 917 (Tex. App.—Dallas 2014, no pet.). Notwithstanding, some Texas courts have found such an action to exist. See Hendricks v. Thornton, 973 S.W.2d 348 (Tex. App.—Beaumont 1998, pet. denied); Floyd v. Hefner, 556 F.Supp.2d 617 (S.D. Tex. 2008). One court identified the elements for aiding and abetting as the defendant must act with unlawful intent and give substantial assistance and encouragement to a wrongdoer in a tortious act. West Fork Advisors, 437 S.W.3d at 921. Some courts have held that here is no aiding and abetting breach of fiduciary duty claim. Hampton v. Equity Trust Co., No. 03-19-00401-CV, 2020 Tex. App. LEXIS 5674 (Tex. App.—Austin July 23, 2020, no pet.). See also Midwestern Cattle Mktg., L.L.C. v. Legend Bank, N.A., 2019 U.S. App. LEXIS 36966, 2019 WL 6834031, at *7 (5th Cir. Dec. 13, 2019); In re DePuy Orthopaedics, Inc., Pinnacle Hip Implant Prod. Liab. Litig., 888 F.3d 753, 782, 781 (5th Cir. 2018)  For a discussion of these forms of joint liability for breach of fiduciary duty, please see E. Link Beck, Joint and Several Liability, STATE BAR OF TEXAS, 10TH ANNUAL FIDUCIARY LITIGATION COURSE (2015).

It is clear that at least under some theories, that third parties can be held liable for participating in fiduciary breaches with the party owing fiduciary duties. Can the third party be an attorney? Prior to Cantey Hanger, LLP v. Byrd, 467 S.W.3d 477 (Tex. 2015), it was unclear in Texas whether a party could assert a claim against an attorney not representing the party, such as for negligent misrepresentation or aiding and abetting fraud or breaches of fiduciary duty. Some courts allowed the claim if the attorney was committing or participating in fraud. Others did not.

The plaintiff in Cantey Hanger alleged that the attorneys who represented her husband in a divorce proceeding had committed fraud by falsifying a bill of sale to shift tax liabilities from the sale of an airplane from her husband to her. Id. at 479-80. The Texas Supreme Court held that attorney immunity barred the claim because “[e]ven conduct that is ‘wrongful in the context of the underlying suit’ is not actionable if it is ‘part of the discharge of the lawyer’s duties in representing his or her client.’” Id. at 481. The following are key excerpts from the opinion:

Texas common law is well settled that an attorney does not owe a professional duty of care to third parties who are damaged by the attorney’s negligent representation of a client. Barcelo v. Elliott, 923 S.W.2d 575, 577 (Tex. 1996); see also McCamish, Martin, Brown & Loeffler v. F.E. Appling Interests, 991 S.W.2d 787, 792 (Tex. 1999) (explaining that a lack of privity precludes attorneys’ liability to non-clients for legal malpractice). However, Texas courts have developed a more comprehensive affirmative defense protecting attorneys from liability to non-clients, stemming from the broad declaration over a century ago that “attorneys are authorized to practice their profession, to advise their clients and interpose any defense or supposed defense, without making themselves liable for damages.” Kruegel v. Murphy, 126 S.W. 343, 345 (Tex. Civ. App. 1910, writ ref’d). This attorney-immunity defense is intended to ensure “loyal, faithful, and aggressive representation by attorneys employed as advocates.” Mitchell v. Chapman, 10 S.W.3d 810, 812 (Tex. App.—Dallas 2000, pet. denied).

….

In accordance with this purpose, there is consensus among the courts of appeals that, as a general rule, attorneys are immune from civil liability to non-clients “for actions taken in connection with representing a client in litigation.” Alpert v. Crain, Caton & James, P.C., 178 S.W.3d 398, 405 (Tex. App.—Houston [1st Dist.] 2005, pet. denied); see also Toles v. Toles, 113 S.W.3d 899, 910 (Tex. App.—Dallas 2003, no pet.); Renfroe v. Jones & Assocs., 947 S.W.2d 285, 287-88 (Tex. App.—Fort Worth 1997, pet. denied). Even conduct that is “wrongful in the context of the underlying suit” is not actionable if it is “part of the discharge of the lawyer’s duties in representing his or her client.” Toles, 113 S.W.3d at 910-11;

….

Conversely, attorneys are not protected from liability to non-clients for their actions when they do not qualify as “the kind of conduct in which an attorney engages when discharging his duties to his client.” Dixon Fin. Servs., 2008 Tex. App. LEXIS 2064, 2008 WL 746548, at *9; see also Chapman Children’s Trust v. Porter & Hedges, L.L.P., 32 S.W.3d 429, 442 (Tex. App.—Houston [14th Dist.] 2000, pet. denied) (noting that “it is the kind of conduct that is controlling, and not whether that conduct is meritorious or sanctionable”).

Because the focus in evaluating attorney liability to a non-client is “on the kind—not the nature—of the attorney’s conduct,” a general fraud exception would significantly undercut the defense. Dixon Fin. Servs., 2008 Tex. App. LEXIS 2064, 2008 WL 746548, at *8. Merely labeling an attorney’s conduct “fraudulent” does not and should not remove it from the scope of client representation or render it “foreign to the duties of an attorney.” Alpert, 178 S.W.3d at 406 (citing Poole, 58 Tex. at 137); see also Dixon Fin. Servs., 2008 Tex. App. LEXIS 2064, 2008 WL 746548, at *9 (“Characterizing an attorney’s action in advancing his client’s rights as fraudulent does not change the rule that an attorney cannot be held liable for discharging his duties to his client.”).

….

Fraud is not an exception to attorney immunity; rather, the defense does not extend to fraudulent conduct that is outside the scope of an attorney’s legal representation of his client, just as it does not extend to other wrongful conduct outside the scope of representation. An attorney who pleads the affirmative defense of attorney immunity has the burden to prove that his alleged wrongful conduct, regardless of whether it is labeled fraudulent, is part of the discharge of his duties to his client.

Id. at 481-484.

Based on the holding in Cantey Hanger, if an attorney is performing duties that a lawyer would typically perform, the attorney immunity defense would apply. This defense would likewise apply to aiding and abetting fraud and breaches of fiduciary duty. See Kastner v. Jenkens & Gilchrist, P.C., 231 S.W.3d 571, 577-78 (Tex. App.—Dallas 2007); Span Enters. v. Wood, 274 S.W.3d 854, 859 (Tex. App.—Houston [1st Dist.] 2008).

In Bethel v. Quilling, Selander, Lownds, Winslett & Moser, P.C., the Court extended the Cantey Hanger holding to allegations of criminal conduct. 595 S.W.3d 651, 657-58 (Tex. 2020). There, the plaintiff had urged the Court “to recognize an exception” to attorney immunity “whe[n] a third party alleges that an attorney engaged in criminal conduct during the course of litigation.” Id. The Court rejected the invitation to adopt an exception or state a categorical rule because doing so would allow plaintiffs to avoid the attorney-immunity defense through artful pleading—”by merely alleging that an attorney’s conduct was ‘criminal.’” Id. The Court eschewed a categorical exception for criminal conduct because such an exception would defeat the purposes of the attorney-immunity defense. Instead, the Court held that conduct alleged to be criminal in nature “is not categorically excepted from the protections of attorney civil immunity when the conduct alleged is connected with representing a client in litigation.” Id. As we explained there, a lawyer who is doing his or her job is not more susceptible to civil liability just because a nonclient asserts that the lawyer’s actions are fraudulent, wrongful, or even criminal. Id.

In 2021, the Texas Supreme Court further clarified the holding in Cantey Hanger to state that “When an attorney personally participates ‘in a fraudulent business scheme with his client,’ as opposed to on his client’s behalf, the attorney ‘will not be heard to deny his liability’ because ‘such acts are entirely foreign to the duties of an attorney.’” Haynes & Boone, LLP v. NFTD, LLC, 631 S.W.3d 65, 77 (Tex. 2021) (quoting Poole v. Hous. & T.C. Ry. Co., 58 Tex. 134, 137 (1882)). The Court in Haynes & Boone, LLP, also expanded the Cantey Hanger holding to extend to transactional work that the attorney performs, in addition to litigation work covered in the Cantey Hanger opinion:

Today we confirm that attorney immunity applies to claims based on conduct outside the litigation context, so long as the conduct is the “kind” of conduct we have described above. We reach this conclusion because we see no meaningful distinction between the litigation context and the non-litigation context when it comes to the reasons we have recognized attorney immunity in the first place. We have recognized attorney immunity because attorneys are duty-bound to competently, diligently, and zealously represent their clients’ interests while avoiding any conflicting obligations or duties to themselves or others.

Id. at 79.

Most recently, in Taylor v. Tolbert, the Court reviewed whether there was an exception to immunity for private-party civil suits asserting that a lawyer has engaged in conduct criminalized by statute. No. 20-0727, 2022 Tex. LEXIS 385 (Tex. May 6, 2022). The court discussed the immunity defense as follows:

The common-law attorney-immunity defense applies to lawyerly work in “all adversarial contexts in which an attorney has a duty to zealously and loyally represent a client” but only when the claim against the attorney is based on “the kind of conduct” attorneys undertake while discharging their professional duties to a client. Stated inversely, if an attorney engages in conduct that is not “lawyerly work” or is “entirely foreign to the duties of a lawyer” or falls outside the scope of client representation, the attorney-immunity defense is inapplicable.

In determining whether conduct is “the kind” immunity protects, the inquiry focuses on the type of conduct at issue rather than the alleged wrongfulness of that conduct. But when the defense applies, counsel is shielded only from liability in a civil suit, not from “other mechanisms” that exist “to discourage and remedy” bad-faith or wrongful conduct, including sanctions, professional discipline, or criminal penalties, as appropriate.

Conduct is not the kind of conduct attorney immunity protects “simply because attorneys often engage in that activity” or because an attorney performed the activity on a client’s behalf. Rather, the conduct must involve “the uniquely lawyerly capacity” and the attorney’s skills as an attorney. For example, a lawyer who makes publicity statements to the press and on social media on a client’s behalf does “not partake of ‘the office, professional training, skill, and authority of an attorney’” because “[a]nyone—including press agents, spokespersons, or someone with no particular training or authority at all—can publicize a client’s allegations to the media.” Immunity attaches only if the attorney is discharging “lawyerly” duties to his or her client.

A corollary to this principle is that attorneys will not be entitled to civil immunity for conduct that is “entirely foreign to the duties of an attorney.” “Foreign to the duties” does not mean something a good attorney should not do; it means that the attorney is acting outside his or her capacity and function as an attorney. For that reason, whether counsel may claim the privilege turns on the task that was being performed, not whether the challenged conduct was meritorious.

This is so because the interests of clients demand that lawyers “competently, diligently, and zealously represent their clients’ interests while avoiding any conflicting obligations or duties to themselves or others.” To prevent chilling an attorney’s faithful discharge of this duty, lawyers must be able to pursue legal rights they deem necessary and proper for their clients without the menace of civil liability looming over them and influencing their actions. Attorney immunity furthers “loyal, faithful, and aggressive representation” by “essentially . . . removing the fear of personal liability,” thus “alleviating in the mind of [an] attorney any fear that he or she may be sued by or held liable to a non-client for providing . . . zealous representation.” In this way, the defense protects not only attorneys but also their clients, who can be assured that counsel is representing the client’s best interests, not the lawyer’s.

Id. The Court acknowledged that “there is a wide range of criminal conduct that is not within the ‘scope of client representation’ and [is] therefore ‘foreign to the duties of an attorney,’” and that “when that is the case, the circumstances do not give rise to an ‘exception’ to the immunity defense; rather, such conduct simply fails to satisfy the requirements for invoking the defense in the first instance.” Id. “[O]ur approach to applying the attorney-immunity defense remains functional, not qualitative, and leaves an attorney’s improper conduct addressable by public remedies.” Id.

The Court then held that the common-law defense of attorney immunity would still apply to state statutes (unless the statute specifically abrogated that defense). Id. The Court stated:

That does not mean that all conduct criminalized by the wiretap statute is immunized from civil liability or free of consequences. As we explained in Bethel, while criminal conduct is not categorically excepted from the attorney-immunity defense, neither is it categorically immunized by that defense. Criminal conduct may fall outside the scope of attorney immunity, and even when it does not, “nothing in our attorney-immunity jurisprudence affects an attorney’s potential criminal liability if the conduct constitutes a criminal offense.”

Id. However, regarding federal statutes, the Court concluded “that attorney immunity, as recognized and defined under Texas law, is not a defense under the federal wiretap statute because, quite simply, a state’s common-law defense does not apply to federal statutes.” Id.

In light of the foregoing authorities, it appears claims against attorneys merely doing work for a client (whether fraudulent, tortious, or even criminal) would be covered by attorney immunity and bar any participation in breach of fiduciary duty claim. However, if the misconduct relates to the attorney personally benefitting from the transaction, or having been a party to the transaction (as opposed to merely the attorney for a party), such an immunity would not apply. See, e.g., Olmos v. Giles, No. 3:22-CV-0077-D, 2022 U.S. Dist. LEXIS 77134 (N.D. Tex. April 28, 2022) (refused to dismiss breach of fiduciary duty claim and misrepresentation claim against attorneys where it was unclear whether the defendant attorneys were a part of the transaction).

Another issue that should be discussed is the impact on the attorney client privilege when an attorney participates in fraud or criminal activities. The attorney-client privilege cannot be enforced when “the services of the lawyer were sought or obtained to enable or aid anyone to commit what the client knew or reasonably should have known to be a crime or fraud.” Tex. R. Evid. 503 (d)(1). As one court describes:

The exception applies only when (1) a prima facie case is made of contemplated fraud, and (2) there is a relationship between the document at issue and the prima facie proof offered. A prima facie showing is sufficient if it sets forth evidence that, if believed by a trier of fact, would establish the elements of a fraud or crime that “was ongoing or about to be committed when the document was prepared.” A court may look to the document itself to determine whether a prima facie case has been established.…

We begin our analysis by examining the scope of the fraud portion of the crime/fraud exception. The Texas Rules of Evidence do not define what is intended in Rule 503(d)(1) by the phrase “to commit . . . [a] fraud.” Black’s Law Dictionary defines fraud as: “A knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his or her detriment.” The Texas common law tort of fraud also requires proof of misrepresentation, concealment, or non-disclosure. The legal concept of fraud therefore has at its core a misrepresentation or concealment. This definition also dovetails with the apparent reasoning behind inclusion of fraud in the exception: by keeping client communications confidential–pursuant to the attorney-client privilege –the attorney whose client intends to make a misrepresentation or concealment helps prevent the injured party from learning the truth about the misrepresentation or concealment. Thus, in that situation, the attorney’s silence affirmatively aids the client in committing the tort. This is not generally true of other torts (not based on misrepresentation or concealment) and explains why the exception is not the crime/tort exception.

In re Gen. Agents Ins. Co. of Am., Inc., 224 S.W.3d 806, 819 (Tex. App.—Houston [14th Dist.] 2007, orig. proceeding). Moreover, the Texas Court of Criminal Appeals has held that this exception includes the work-product in the proper circumstances. Woodruff v. State, 330 S.W.3d 709, 2010 Tex. App. LEXIS 9569 (Tex. App. Texarkana Dec. 3, 2010), pet. ref’d No. PD-1807-10, 2011 Tex. Crim. App. LEXIS 749 (Tex. Crim. App. May 25, 2011), pet. ref’d No. PD-1807-10, 2011 Tex. Crim. App. LEXIS 770 (Tex. Crim. App. June 1, 2011), cert. denied, 565 U.S. 977, 132 S. Ct. 502, 181 L. Ed. 2d 347, 2011 U.S. LEXIS 7788 (U.S. 2011).

So, though an attorney may be immune from civil liability, the crime/fraud exception may open up attorney/client communications to the light of day. Regarding crimes involving breaches of fiduciary duty, in addition to theft crimes, the Texas Legislature has created the following crimes: (1) Financial Abuse of Elderly Individual in Texas Penal Code Section 32.55; 2) Financial Exploitation of Vulnerable Individuals in Texas Penal Code Section 32.53; (3) Misapplication of Fiduciary Property in Texas Penal Code Section 32.45; and (4) Failure to Report of the Exploitation of the Elderly or Disabled Individuals in the Texas Human Resources Code Section 48.051.

Article By David Fowler Johnson of Winstead

For more litigation and trial practice news, click here to visit the National Law Review.

© 2022 Winstead PC.

Are You Ready for the UK Plastic Packaging Tax?

The plastic packaging tax (the ‘Tax’) came into force on 1 April 2022, with UK businesses that produce or import plastic packaging components in quantities of 10 or more tonnes per year affected. However, despite already being in force, research conducted by YouGov, on behalf of Veolia, has found that a high proportion of retail and manufacturing businesses (77% of those surveyed) are still not aware of the Tax.

As businesses gain increased awareness, the Tax is likely to receive a mixed reception. Whilst most would support the Government’s aim of increasing the use of recycled content in plastic packaging components, the Tax comes at a time when 92% of manufacturers and 90% of importers are reporting increased costs. With the introduction of the Tax, those businesses that have not already passed these increased costs on to customers will likely do so, meaning that the Tax may unintentionally add to the cost of living in the UK. This is compounded when one considers that the Tax came into force just five days before the controversial increase in national insurance contributions.

To manage increased costs and to ensure compliance with the law, businesses should pay close attention to the rules of the Tax.

© Copyright 2022 Squire Patton Boggs (US) LLP
For more articles on international laws, visit the NLR Global section.

Filing Tax Returns and Making Tax Payments: Best Practices During the Pandemic and Beyond

With staffing shortages and service center closures, it should come as no surprise that the IRS has faced a number of challenges during the pandemic. A couple of the biggest challenges have been in the opening and processing of taxpayer correspondence and in the processing of tax returns. As National Taxpayer Advocate, Erin Collins, stated in her Annual Report to Congress, “Paper is the IRS’s Kryptonite, and the IRS is buried in it.”

Going into 2022, the IRS has a significant backlog of unprocessed taxpayer correspondence and unprocessed returns. The estimates are staggering.

  • Five million pieces of unprocessed taxpayer correspondence
  • Over 11 million unprocessed tax returns, including:
    • Six million individual income tax returns
    • 2.3 million amended individual tax returns
    • 2.8 million business returns (income tax and employment tax returns)

The 2022 tax filing season, which opened on Thursday, January 24 for individual income tax returns, has the potential to create even more challenges for the IRS. Below is a list of best practices taxpayers can follow to ensure timely processing of their payments, tax returns, and claims for refund. These practices apply to individuals and required filing for businesses.

  • File returns and make payments electronically.
  • If you must file a paper return or mail in a payment to the IRS, send the return or payment to the proper address via USPS Certified Mail, Return Receipt Requested. Using this method will assist in resolving timely filing and/or timely payment penalties assessed by the IRS.
  • Properly notate your tax payment and include the form number, tax period and your social security number or employer identification number.
  • Respond to notices from the IRS in a timely manner.

In addition to the above, the IRS has offered a few filing tips for individuals.

  • Fastest refunds by e-filing, avoiding paper returns: Filing electronically with direct deposit and avoiding a paper tax return is more important than ever to avoid refund delays. If you need a tax refund quickly, do not file on paper – use software, a trusted tax professional or IRS Free File.
  • Filing 2021 tax return with 2020 tax return still in process: For those whose tax returns from 2020 have not yet been processed, 2021 tax returns can still be filed. For those in this group filing electronically, here’s a critical point: taxpayers need their Adjusted Gross Income, or AGI, from their most recent tax return at time of filing. For those waiting on their 2020 tax return to be processed, make sure to enter $0 (zero dollars) for last year’s AGI on the 2021 tax return. Visit Validating Your Electronically Filed Tax Return for more details.

More individual filing tips from the IRS can be found here.

If you have unpaid taxes or unfiled returns, you need an experienced tax attorney to represent you in your dealings with the IRS or the Department of Justice. An accountant or enrolled agent is not protected by the attorney-client privilege.

© 2022 Varnum LLP
For more articles about tax returns, visit the NLR Tax type of law section.

Maryland Comptroller Adopts Digital Advertising Gross Revenues Tax Regulations

On December 3, 2021, the Maryland Comptroller published notice of its adoption of the digital advertising gross revenues tax regulations (which was originally proposed on October 8, 2021). Per the Maryland Administrative Procedure Act, the final adopted regulations will go into effect in 10 calendar days, or December 13, 2021. (See Md. Code Ann., State Gov’t § 10-117(a)(1).)

The final regulations were adopted almost entirely as proposed, with just two minor changes that the Attorney General (AG) of Maryland certified as non-substantive. Specifically, the changes to the October 8 proposed regulations concern the information that may be used to determine the location of a device and are described by the AG as follows:

  • Regulation .02(C): The Comptroller is clarifying language regarding the allowable sources of information a taxpayer may use to determine the location of a device. Specifically, this final action amendment changes “both technical information and the terms of the underlying contract” to “both technical information and nontechnical information included in the contract.”
    • Regulation .02(C)(2): The Comptroller is amending the non-exhaustive list of technical information to include “industry standard metrics.”

    Practice Note: While “industry-standard metrics” is a nice addition to the list of sources that may be used to determine the location of devices for sourcing purposes, significant and fundamental questions and concerns submitted as part of the comments were not addressed by the Comptroller in adopting the final digital ad tax regulations. The tax is subject to multiple lawsuits (both state and federal court) and pending a court order to the contrary is scheduled to take effect beginning January 1, 2022, with the first filing obligation for large taxpayers in April 2022. Taxpayers grappling with how to comply with this new tax are encouraged to contact the authors.

    © 2021 McDermott Will & Emery

    Article by Stephen P. Kranz, Eric Carstens, and Jonathan C. Hague with McDermott Will & Emery.

For more updates on tax regulations, visit the NLR Tax section.

Wealth Planning in 2021: Preparing For a Changing Tax Landscape

Since President Biden took office at the beginning of this year, there has been much buzz and conjecture regarding what the tax policy under the Biden-Harris Administration would look like.  In light of the recently released Department of Treasury’s General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals, commonly known as the “Green Book,” we now have a better idea of the proposed tax law changes that the Administration will focus on implementing in the coming year.

While the Green Book contains various tax proposals that could significantly affect estate planning, it interestingly does not include a proposal to decrease the estate and gift tax exemption, which was a major topic of discussion during last year’s election cycle (click here to review our advisory on Estate Planning and the 2020 Election).  However, some Democrats in Congress nonetheless continue to argue for this reduction.  For example, Senator Bernie Sanders’ proposed legislation, For the 99.5% Act, would reduce the gift tax exemption to $1 million per person and the estate tax exemption to $3.5 million per person and would also impose new progressive estate tax rates ranging from 45% to 65%.

In any event, the Green Book contains the proposed tax laws that reflect the Administration’s top priorities and are more likely to be enacted than those proposals not included in the Green Book.  The Green Book proposals seek to reverse many of the tax laws included in the 2017 Tax Cuts and Jobs Act enacted under former President Trump, such as a proposed increase to individual income tax rates and an end to certain capital gains tax preferences, discussed in further detail below.

Green Book Proposals That Would Affect High Net Worth Clients:

Increase Top Marginal Individual Income Tax Rate for High-Income Earners.  The top marginal income tax rate would increase from 37% to 39.6% for taxable income in excess of the top bracket threshold.  For taxable years beginning January 1, 2022, this would apply to income in excess of $509,300 for married individuals filing jointly and $452,700 for single filers, and thereafter be indexed for inflation.

Tax Capital Gains for High-Income Earners at Ordinary Income Tax Rates.  For taxpayers with adjusted gross income of more than $1 million, long-term capital gains and qualified dividends tax rates would increase to match the proposed ordinary income tax rates.  To the extent that a taxpayer’s income exceeds $1 million, rates would go from 20% (or 23.8% including the net investment income tax (“NIIT”)) to 39.6% (or 43.4% including NIIT).  This proposal currently includes a retroactive effective date of April 28, 2021.

Treat Transfers of Appreciated Property by Gift or at Death as Realization Events.  This proposal would eliminate the so called “step up in basis loophole,” which allows for an asset transferred at death to be “stepped up” to fair market value for cost basis purposes resulting in no capital gains tax imposed on the asset’s appreciation through date of death.  Instead, the transfer of an appreciated asset by gift or at death would be treated as sold for fair market value at the time of the transfer, creating a taxable gain realization event for the donor or deceased owner.  There would, however, be a $1 million per person (or $2 million per married couple) exemption from recognition of capital gains on property transferred by gift or at death, indexed for inflation.  In addition, certain exclusions would apply, including:

  • Residence.  $250,000 per person (or $500,000 per married couple) would be excluded from capital gain on the sale or transfer of any residence.
  • Surviving spouse.  Transfers by a decedent to a U.S. citizen spouse would carry over the basis of the decedent and capital gain recognition would be deferred until the surviving spouse dies or otherwise disposes of the asset.
  • Charity.  Appreciated property transferred to charity would not generate a taxable gain; however, the transfer of appreciated assets to a split-interest charitable trust would generate a taxable gain as to the share of the value transferred attributable to any non-charitable beneficiary.
  • Tangible personal property.  No capital gain would be recognized on transfers of tangible personal property (excluding collectibles).

Although the tax imposed on gains deemed realized at death would be deductible on the estate tax return of the decedent’s estate, deductions are not equivalent to tax credits and in high tax states such as New York, the additional tax could be substantial.

Impose Gain Recognition on Property Transferred to or Distributed from an Irrevocable Trust.  Any transfers of property into, and distributions in kind from, an irrevocable trust would be treated as deemed recognition events subject to capital gains tax.  In addition, while the generation-skipping transfer (“GST”) tax exempt status of a trust would not be affected, gain would automatically be recognized on property held in an irrevocable trust which has not otherwise been subject to a taxable recognition event within the prior 90 years.  The first possible recognition event would be December 31, 2030 for any trust in existence on January 1, 1940.  This proposal would also apply to transfers to, and distributions in kind from, partnerships and other non-corporate entities.  Elimination of Valuation Discounts.  The valuation of partial interests in property contributed to a trust would be equal to the proportional share of the fair market value of all of such property.  In other words, no discounts for lack of marketability or minority interests would be allowed in valuing transfers of partial interests in LLCs, corporations, partnerships or real property.

Summary

The legislative text of the Administration’s tax proposals will likely not be available until the fall.  It is important to note that any proposed tax law changes face a split 50-50 Senate, which means that the prospect of passing any tax reform at all is uncertain.  Commentators believe that the Green Book proposals will be the subject of extensive negotiation over the next several months, including significant opposition to large increases in capital gains tax rates.  In the meantime, we at Wiggin and Dana [link to PCS attorneys page] are available to discuss the Green Book proposals in more detail and to make proactive, tailored recommendations in light of the current changing tax law landscape.

© 1998-2021 Wiggin and Dana LLP

Article by Michael T. Clear, Veronica R.S. Bauer, Robert W. Benjamin, Daniel L. Daniels, and Helen C. Heintz with Wiggin and Dana LLP.

For more articles on taxes, visit the NLR Tax section.

Snowy Owls and Constituted Authorities

On January 27, 2021, a snowy owl was seen in New York City’s Central Park for the first time in 130 years.  Nine days later, on February 5, 2021, something almost as rare occurred – the Internal Revenue Service released a private letter ruling dealing with Section 103 of the Internal Revenue Code.[1]  In PLR 202105007, the IRS determined that a nonprofit corporation that amended its articles of incorporation to change its purposes and come under the control of a city became a “constituted authority,” within the meaning of Treas. Reg. 1.103-1(b), of the city that could issue tax-exempt bonds on behalf of the city.

The coincidence of these infrequent events involving ornithology and quasi-governmental entities calls to mind the field guide Johnny Hutchinson prepared on the tax classifications of various species of the latter, which was an homage to Roger Tory Peterson’s Field Guide to Birds, a seminal work in the canon of the former.  February is a good time to brush up on both.      

[1] of 1986, as amended.

© Copyright 2020 Squire Patton Boggs (US) LLP

ARTICLE BY Michael A. Cullers of Squire Patton Boggs (US) LLP
For more, visit the NLR Tax section.

Proposition 13 Overhaul Qualifies for November Ballot

California Secretary of State Alex Padilla announced on Friday, May 29, 2020, that the revised initiative entitled “The California Schools and Local Communities Act of 2020” officially qualified for the November ballot. If passed, the initiative would establish a “split roll” where retail, office, commercial, and industrial real property would be taxed based on their market value, while residential property would continue to be assessed based on its purchase price.

THE CURRENT TAX REGIME: PROPOSITION 13

The current property tax regime under Proposition 13 generally provides that real property is taxed at one percent of its fair market value, which usually is the property’s purchase price. Unless there is a change in ownership of the property such as a sale, this “base value” can only increase by an inflationary rate that cannot exceed two percent per year. When property changes ownership, it is reassessed and the property’s base value is reset to its then current fair market value. Under Proposition 13, a property’s base value can be lower than its current fair market value, which in turn can reduce the amount of property tax that might otherwise be owed.

THE SPLIT ROLL

The ballot initiative creates a “split roll” if voters approve it in November. Under the split roll, commercial and industrial property with a fair market value of more than $3 million would be reassessed at its current fair market value at least every three years. The current tax regime under the Proposition 13 rules described above would continue to apply to all residential property, including both single-family and multi-unit structures and the land on which those structures are constructed or placed. The current rules also would remain in place for real property used for commercial agricultural production.

The process of administering this new tax regime will be determined by the California legislature, which will include, among other things, a process for reassessment appeals. The taxpayer will have the burden of proving that the property was not properly valued. The legislature also will determine a process by which to allocate mixed-use property between its commercial and residential uses for purposes of implementing the split roll.

The new regime will not apply to commercial or industrial property with a fair market value of $3 million or less unless any of the direct or indirect owners of such real property also own interests in other commercial and/or industrial real property. In that case, the new regime will apply if all such real property has an aggregate fair market value in excess of $3 million.

TANGIBLE PERSONAL PROPERTY TAX RELIEF

If passed, the ballot initiative would exempt small businesses from property tax on all of its tangible personal property. A small business is a business that: (1) has fewer than 50 annual full time employees, (2) is independently owned and operated such that the ownership interests, management and operation are not subject to control, restriction, modification, or limitation by an outside source, individual or another business, and (3) owns real property located in California.

For all other taxpayers, an amount up to $500,000 of combined tangible personal property and fixtures (other than aircraft and vessels) will be exempt from taxation.

WHEN WOULD THE SPLIT ROLL TAKE EFFECT?

The split roll would become operative beginning January 1, 2022, and the tangible personal property tax relief would become operative on January 1, 2024.

Despite the split roll becoming operative on January 1, 2022, the reassessment of undervalued commercial and industrial property will be implemented through a phase-in over two or more years. An owner of commercial or industrial property would only be obligated to pay taxes based on the new assessed value beginning with the lien date for the fiscal year when the assessor has completed the reassessment. In addition, if 50% or more of the square footage of a commercial or industrial property is occupied by a small business, such property will not be subject to the new regime at least until the 2025-26 fiscal year.

© 2010-2020 Allen Matkins Leck Gamble Mallory & Natsis LLP

For more on real estate taxation, see the National Law Review Tax law section.