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Supreme Court ruling in Department of Revenue of North Carolina c. Kimberley Rice Kaestner 1992 Family Trust, 588 EE. UU (TBD) and its relevance to the income tax accrued in the California trusts

The Supreme Court ruled unanimously, on June 21, 2019, that the residence of a beneficiary of a trust in a State, by itself, is not sufficient for that State to impose the income tax of that trust. While this case is important for residents of North Carolina and for a small number of other states that depend on the state residence of beneficiaries regardless of whether the beneficiary is certain to receive tax assets, it is likely that have an immediate impact on California trust tax because California currently imposes its tax only if the beneficiary of the relevant trust is "non-contingent".

Facts and celebration

The relevant trust was created by a New York settler and had a trustee resident of New York. The trustee had "absolute discretion" to distribute the assets of the trust to the beneficiaries "in the amounts and proportions" that the trustee could decide "from time to time". The trust was distributed directly to the children of the settler when they turned 40 years old. The trust was subject to New York law and its assets were in custody in Massachusetts. He had no real estate in North Carolina and there were no direct investments in it. One of the beneficiaries (a daughter of Settlor) and her children moved to North Carolina in 1997. The issue in question was the right of North Carolina to tax the proceeds of the undistributed trust from 2005 to 2008.

North Carolina collects taxes on any trust income that "is for the benefit of" a resident of the state. But to comply with the Due Process Clause of the Constitution of the United States, there must be "minimum contacts" between the State and the person, property or transaction that it seeks to tax. In determining that the beneficiary's residence did not establish "minimum contacts," the Court "focused on the scope of the beneficiary's right within the state to control, possess, enjoy or receive trust property." The only connection that this trust had with North Carolina was the residence of a beneficiary. The Court held: "… the mere presence of the beneficiaries within the state does not grant power to a State to tax the income of the trust that has not been distributed to the beneficiaries where the beneficiaries have no right to demand that income and are not sure to receive it. " Because the Court determined that: (a) the beneficiaries did not receive any income from the trust in the years in question; (b) the beneficiaries did not have the right to demand income from the trust or otherwise control, own or enjoy the assets of the trust in the years in question; (c) the trustees, not the beneficiaries, had the right to make fiduciary investments; and (d) the beneficiaries were prohibited from assigning to another person any right they might have over the trust property, there were not enough minimum contacts to satisfy the requirements of the Due Process Clause.

Relevance for California

California law establishes taxes on trust income if (a) there is a California trustee, or (b) the trust has non-contingent beneficiaries resident in California. The Court specifically stated that its decision "does not address state laws that consider residency in a beneficiary's status as one of a combination of factors, that ignite the residence of the settler or that are based on the residence of the non-contingent beneficiaries. "

The key points to follow are: First, this case is only relevant for non-granting trusts. If a trust is a grantor trust, the trust income flows through the grantor's tax return and is taxed in the state of its residence. Second, it only applies to undistributed trust income. Distributed income is generally taxed by the recipient's State of residence. Third, California can always tax income from the California source (as well as income distributed to a resident beneficiary). Fourth, if a trustee is a resident of the state that qualifies as sufficient minimum contacts to allow taxation. Fifth, we now know that if the only nexus with taxes is the residence of a contingent beneficiary in the State, it is not enough. Sixth, California does not impose state income taxes on the accumulated income of the trust if the rights of California beneficiaries are only "contingent" (the North Carolina statute is much broader than California's and sought to tax the trusts that had only contingent beneficiaries). Therefore, it is likely that this decision will not have an immediate impact on the taxation of California trusts.

Future questions

In a concurring opinion, three judges who joined the majority indicated that the beneficiary's residence should never be a determining factor as to whether a state can tax undistributed income from the trust. In his view, even if the beneficiaries are not contingent, a State would still not be able to tax the undistributed income until it was actually distributed. It remains to be seen if there are future challenges for similar state laws. If the views of the concurrent trio are adopted by a future majority, California would not be able to tax the proceeds of the trust not distributed on a base basis even to the residence of the non-contingent beneficiary.

Interest rates of July 2019 for GRAT, sales to trusts of defective grantors, intra-family loans and charitable trusts of divided interest

Important federal interest rates continue to decline by July 2019. The applicable federal rate of July ("AFR") for use with a sale to a defective grantor's trust, an automatic cancellation note ("SCIN") or an intra-family loan. with a note lasting 3-9 years (the medium-term rate, compounded annually) is 2.08%, down from 2.38% in June.

The rate of Section 7520 of July for use with estate planning techniques, such as CRT, CLT, QPRT and GRAT, is 2.6%, compared to 2.8% in June.

The AFRs (based on the annual composition) used in relation to intra-family loans are 2.13% for loans with a term of 3 years or less, 2.08% for loans with a term of 3 to 9 years, and 2.50% for loans with a term of more than 9 years. With the medium-term rate now less than the short-term rate, customers will probably prefer the medium-term rate in their estate planning transactions.

Thus, for example, if a 9-year loan is granted to a child, and the child can invest the funds and obtain a return in excess of 2.08%, the child will be able to maintain any performance higher than 2.08%. These same rates are used in connection with sales to trusts of defective grantors.

The AFRs for July 2018 were 2.38%, 2.87% and 3.06%, respectively. Therefore, rates have not increased as was rumored at the end of 2018.

Blau et al. v. Internal Revenue Commissioner, No. 17-1266 (May 24, 2019)

The United States Circuit Court of Appeals for the Circuit of the District of Columbia has ruled that the fact that a taxpayer does not report his base on donated assets means that he does not "substantially" comply with the charitable reporting requirements. For the taxpayer in question, this meant the total rejection of his claim for a charitable deduction and the evaluation of severe fines.

On February 7, 2002, RS Hawthorne, LLC ("Hawthorne") purchased a web hosting facility in Hawthorne, California (the "Property") for $ 42,350,000. Hawthorne was owned by RS Hawthorne Holdings, LLC ("Holdings"), which, in turn, was owned by Red Sea Tech I, Inc. ("Red Sea"). The property was leased to AT & T for 15.5 years, ending May 2016. AT & T also had options to renew the lease up to three times, for five years at a time. Hawthorne financed the purchase with a loan. In connection with the loan, the bank had the property appraised. The value was $ 47,000,000 as of August 16, 2001.

Also on February 7, 2002, Red Sea divided its participation of the members into Units in (a) a period of interest for years that extends until December 31, 2020 and (b) a remaining interest. Red Sea then sold the remaining interest to RJS Realty Corporation ("RJS") for $ 1,610,000.

In March 2002, RERI Holdings I, LLC ("RERI") purchased the remaining RJS interest for $ 2,950,000.

In August 2003, a donor and RERI member promised a $ 4,000,000 grant to the University of Michigan (the "University"), and then increased it to $ 5,000,000. Then, RERI assigned the remaining interest to the University in accordance with an agreement stipulating that the University "will maintain the remaining State for a minimum of two years, after which the University will sell the remaining State one way and the buyer of its election. "

In December 2005, the University sold the remaining interest to HRK Real Estate Holdings, LLC for $ 1,940,000, although it had assessed the property at $ 6,500,000 in early 2005. Earnings from the sale were credited to Ross's promise.

RERI claimed a charitable contribution deduction on its 2003 federal income tax return in the amount of $ 32,935,000 for the remainder of the interest grant. This assessment came from an evaluation conducted in September 2003 by Greenwich Realty Advisors. RERI attached the evaluation to its declaration and completed Form 8283 for non-monetary charitable contributions; however, RERI left blank for "Donor Cost or Adjusted Basis". RERI also did not provide an explanation for the omission.

In March 2008, the IRS audited the return of RERI in 2003 and issued a Notice of final administrative adjustment of the association to RERI. He dismissed $ 29,000,000 from the charitable deduction, based on his conclusion that the remaining interest was worth only $ 3,900,000. The IRS also imposed a 20% fine for a material misstatement.

In April 2008, RERI filed a petition in the Tax Court to challenge the FPAA. In its response, the IRS reviewed its determinations, stating that RERI was not entitled to any deduction for a charitable contribution because the transaction giving rise to the deduction was "a farce for tax purposes or lacks economic substance." He argued in the alternative that the deduction should be limited to $ 1,940,000, the amount the University had obtained from the sale of SMI. Finally, the IRS claimed that the erroneous valuation statement was "gross" rather than simply "substantial," resulting in a fine equivalent to 40% of the underpayment of taxes.

After a four-day trial, the Tax Court ruled in favor of the IRS, holding that (a) RERI was not entitled to any charitable contribution because it did not justify the value of the property donated, (b) the fine of error 40 % was appropriate, and (c) RERI did not qualify for an exception of reasonable cause to penalties related to accuracy.

On appeal, the United States Court of Appeals for the Circuit of the District of Columbia upheld the decision of the Tax Court. The Circuit of D.C. He argued that "RERI did not substantially comply (with the requirements of Treas. Reg. § 1.170A-13) because it did not disclose its basis in the property donated."

RERI argued that its base on the remaining interest was not necessary to evaluate its charitable contribution because the deductible amount was the fair market value of the property donated. The Circuit D.C. stated, on the contrary, that:

RERI does not recognize that the purpose of the justification requirements is not simply to gather the information necessary to calculate the value of the donated property. The requirements have the broadest purpose of helping the IRS detect and deter inflated valuations. Because the cost or other basis in the property generally corresponds to your FMV at the time the taxpayer acquired it, an unusually large difference between the claimed deduction and the base alerts the IRS of a possible overvaluation, particularly if the date of acquisition, which must also be reported, is not long before the date of donation.

Given the disparity between the amount that RERI paid for the remaining interest ($ 3M) and the deduction of the claimed charitable contribution ($ 33M), the basis was particularly important to alert the IRS of an overvaluation. The Circuit D.C., therefore, confirmed the decision of the Tax Court not to allow the deduction of the charitable contribution attributable to the remaining interest.

The Circuit D.C. it also confirmed the assessment of sanctions by the IRS and rejected RERI's claim for the exception of reasonable cause to sanctions related to accuracy.

An update on the Connecticut Uniform Confidence Code

Connecticut is about to enact its version of the Uniform Trust Code. On June 5, 2019, the Connecticut Senate passed HB 7104 (36 to 0), entitled "Adoption of the Connecticut Uniform Trust Code" (the "Act"). The Act was passed in the Connecticut House of Representatives (133 to 0) on May 20, 2019. Governor Ned Lamont signed the Act on June 26, 2019.

The Act is effective generally on January 1, 2020, although it applies to trusts created before, on or after that date. Some notable additions to the Connecticut trust laws would be provisions that would allow the creation of "directed trusts" (Sections 81-98), self-established asset protection trusts (Sections 99-108) and an 800-year waiting and review period. For the Connecticut government against perpetuities. It should be noted that there is a lack of confidence disposition in CTU in Connecticut.

Indiana allows national asset protection trusts

On May 5, 2019, Indiana enacted SB 265, which provides for the creation of "inherited trusts": the Indiana term for national asset protection trusts. In general, SB 265 provides for a two-year term for claims against qualified transfers to inherited trusts.

The states that allow the creation of domestic asset protection trusts now include Alaska, Connecticut (Pending, HB 7104), Delaware, Hawaii, Indiana, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, Dakota of the South, Tennessee, Utah, Virginia, West Virginia and Wyoming.

PLR 201919002 and 201919003 – IRC Section 2042

Settlor created an irrevocable trust (the "Trust") for his son ("Child 1") and the descendants of Child 1. Child 1 was named Trustee of the Trust. El Niño 1, as Trustee, had discretion to distribute the net income and capital to the descendants of El Niño and El Niño under a HEMS standard. El Niño 1 had a limited testamentary power of appointment over the remaining assets of the Trust, which can be exercised in favor of the descendants of El Niño 1.

Section 2042 (2) of the Internal Revenue Code establishes that the gross estate includes the value of all assets "(t) or the extent of the amount receivable by all other beneficiaries (other than the deceased's executor) as insurance under policies on the life of the deceased with respect to which the deceased had at the time of his death any of the incidents of property, exercisable alone or in combination with any other person. "

The Trust agreement stipulated that "Settlor does not intend that the Trustee have any power over fiduciary property that, if the Trustee has in its fiduciary capacity, would result in the inclusion of trust assets in the Trustee's estate. Trust for federal estate tax purposes. "The Trust agreement further stipulated that" a special Co-Trustee will be appointed if a trust governed by this agreement owns or owns any other incident of ownership over any life insurance policy. in the life of the Principal Trustee in the sense of §2042. "

Child 1, as Trustee, proposed to purchase a life insurance policy on the combined lives of Child 1 and the spouse of Child 1. This would have created the risk that the value of the policy would be included in the federal gross estate of the Child 1 , in case no additional measures are taken, since, as Trustee, Child 1 would have all the powers of property in the policy.

El Niño 1 requested a state court to modify the terms of the Trust (1) to eliminate the power of appointment of Child 1 over any life insurance policy on the life of Child 1 or the product of said policy, (2) for add an Insurance Trustee that will only have all the powers of the Trustee with respect to any policy that insures the life of Child 1, and (3) will require that the premium payments of the policies that ensure the life of Child 1 be made with the Director of the Trust. The court approved the modification.

The other Settlor's child ("Child 2") was designated as the initial Insurance Trustee. Child 1 retained the power to appoint, remove and replace the Insurance Trustees, who is not a related or subordinate person within the meaning of Section 672 (c) of the IRC.

El Niño 1, as Trustee, requested a decision that a policy that ensures the life of Child 1 and the property of the Trust, as modified, would not be included in the gross federal estate of Child 1. El Niño 1 stipulated that the Child 1 had not made, and would not make, contributions to the Trust. The IRS ruled that any policy that insures the life of Child 1 that is owned by the Trust would not be included in the gross federal estate of Child 1. The IRS stated that its ruling assumes that "El Niño 1 does not perform as an Insurance Trustee in the moment of the death of Child 1 "and that the Trust is not modified in such a way that" El Niño 1 recovers the fiduciary powers over life insurance in the life of Child 1 ".

(See source.)