wealthcounsel quarterly - january 2016

VOLUME 10 / NUMBER 1JANUARY 2016

WEALTHCOUNSEL

Q UA RT E R LY

QUARTERLY

Contents

From the Editor... ...............................................................................................3

Making Drafting Excellence Even Better: The Latest Highlights from WealthDocx ............................................................................................. 4

Uber: Playing Fair in the Sharing Economy? ......................................8

Finally Clarity with Portability ................................................................. 12

The Estate Planning Lawyers Ethical Considerations ...................... 16

Charitable Gifts with Strings Attached ................................................ 22

Thinking More Deeply on Trust Advisors and Protectors ............... 24

Uniform Protected Series Act: Coming Soon?....................................30

Income Taxation of Estates and Trusts ..................................................36

Member Spotlight ..........................................................................................42

Hindsight is 20/20: .......................................................................................48

A Review of Selected 2015 LLC Cases ...................................................48

Education Calendar ....................................................................................... 55

WC QuarterlyMEMBER MAGAZINE

Volume 9, Number 2 Q2 2015

STAFF

SENIOR EDITOR

Matthew T. McClintock, JD

EDITORS

Jennifer Villier, JD

Jeremiah Barlow, JD

PRODUCTION EDITOR

Caryl Ann Zimmerman

ART DIRECTOR

Ellen Bryant

CONTRIBUTING WRITERS

Lew Dymond, JD

Jackie Wertheimer, JD

Jeramie Fortenberry, JD

Gregory Herman-Giddens, JD

Samantha Reichle, JD

Katie H. Muhlenkamp, JD

WealthCounsel Quarterly is published four times annually by WealthCounsel,

LLC, P.O. Box 44403, Madison, WI 53744-4403. Comments and questions

about WealthCounsel Quarterly may be addressed to the editor at

[email protected].

VOLUME 10 NUMBER 1

PAGE 3

From the Editor...MATTHEW T. MCCLINTOCK, JD, VICE PRESIDENT OF EDUCATION, WEALTHCOUNSEL

INNOVATION.

It really isnt the word most people associate with the practice of law especially a boring kind of law like trusts & estates. The major-ity of attorneys who claim to practice T&E law are using the same forms and sam-

ple clauses theyve used for decades or that theyve borrowed, plundered, or pillaged from others. Many of them seldom think creatively about distribution guidelines, marital deduction options, trustee succes-sion issues, inheritance protection, basis adjustment opportunities, or the ability to change the way a trust gets administered after it becomes irrevocable.

We believe that estate planning and business law neednt be boring at all. But to advance the industry we must be creative, and part of a community with a shared commitment to innovation.

In this issue well explore together some of the ways we believe the industry is innovating, and other ways where we think it should be. We will examine the use of trust advisors and trust protectors, uncover some of the sloppiness and confusion in practice today, and start working toward a different way to think about these power holders to try and shape the practice go-ing forward.

Greg Herman-Giddens will examine one of the emerg-ing frontiers of tax-driven planning with a careful look at key issues in fiduciary taxation. With innumerable multi-generational trusts in existence today many of which are under active administration much of the tax game of estate planning gets played on the field of fiduciary income tax. Even for attorneys who do not want to actively practice fiduciary taxation, a solid understanding of key issues is essential to com-petent practice.

As ATRA came into bloom in early 2013 one of its most prominent features was permanent exemp-tion portability for spouses. The Treasury issued final Regulations this year and Jeremiah Barlow discusses

key elements we must consider in order to provide modern planning and estate administration for mar-ried couples.

Business law must also evolve. One of the more in-novative strategies in LLC design in the past decade is the use of series LLCs to establish intra-series asset protection for LLCs with diverse assets and members. Many attorneys have been slow to use series LLCs, es-pecially for actively operating businesses, due in part to the lack of uniformity among series LLC statutes and lack of clarity concerning their actual effective-ness. Jenny Villier discusses the possibility of a Uni-form Protected Series Act for LLCs, which may begin to pave the way for more acceptance of series LLC strategies.

Jenny will also take a look at the Uber case mak-ing its way through the California court system. This multimillion-dollar case may have far-reaching impli-cations for employers who hire employees and inde-pendent contractors, so its worthwhile to become fa-miliar with the key issues while we await resolution of the class action litigation.

One longtime WealthCounsel member has built a practice on the bedrock of innovation, and you will meet her in this issues member spotlight. Eden Rose Brown has been with WealthCounsel from the begin-ning. Her creative and curious mind coupled with patience and a desire to connect deeply with clients allows her to develop new approaches to some of the stickiest client problems.

Whether we challenge some of your existing assump-tions or make you think about something youve nev-er considered before, we hope that this issue encour-ages you to add some creativity to your practice.

QUARTERLY

It takes a village to update and enhance WealthCoun-sels premier drafting product, and that village in-cludes all our members. One of the most important aspects of our work is getting to know our members so that we can deliver a product that best suits their needs. Many of you have been extremely generous with your time and insights, and we are working hard to make the enhancements that you value most.

Our goal is to continuously improve our product and your experience using it. While we reaffirm our com-mitment to paying close attention to requests for new content and options, we are expanding our ef-forts to deliver the most benefit to the greatest num-

ber of Wealth Docx subscribers. To that end, weve instituted several new member research initiatives in the last year, including focus groups, surveys, and ad-visory committees. We continue to solicit and receive your feedback in informal ways and through content support requests, but we are doing more to validate individual suggestions with the greater membership. Some of these approaches leverage technology while others depend on personal interactions.

There is a team of people working on this initiative, and we have recently expanded that team so that we can gather more feedback and implement the results quickly. In addition to reviewing and implementing in-cremental improvements to strategies in Wealth Docx, our editorial team spends time providing content sup-port. This allows our editors to hear from members

Making Drafting Excellence Even Better

The Latest Highlights from WealthDocxLEW DYMOND, JD, WEALTHCOUNSEL PRINCIPAL AND FACULTY

JACKIE WERTHEIMER, JD, VICE PRESIDENT OF CONTENT

VOLUME 10 NUMBER 1

PAGE 5

directly. We are also increasing our focus on providing state specificity within the documents.

During the 2015 Symposium in San Diego we conduct-ed several focus groups to help us determine what members look for concerning state specificity. In the past we have relied almost exclusively on input from state forum document committees, but based on the information gathered from the focus groups as well as submissions to content support, we are becoming more proactive when it comes to these matters.

As we sharpen our focus on state specificity, we will be addressing four types of state specific issues: no-tary blocks and will attestations, statutory references, state statutory documents, and necessary modifica-tion to existing Wealth Docx content. Please note that many of the screenshots shown below are currently in Beta and wont appear in an update until they are fully tested. In addition to our own initiative, we will continue to rely on input from our state forum draft-ing committees as well as individual members.

NOTARY BLOCKS AND WILL ATTESTATIONS

Wealth Docx has always inserted state specific notary blocks and will attestations into the merged docu-ments based on the notary state selected in the Inter-view. All notary block and will attestation templates are being reviewed to make sure they are current. If you believe any of the notary block or will attestation clauses are not up to date for a particular state please let us know by submitting a Content Support Request. There is an option to contact support from within the desktop and online versions of Wealth Docx, or you can send an email to [email protected].

STATUTORY REFERENCES IN WEALTH DOCX

Wealth Docx has also addressed state specificity by allowing users to enter state statutory references, such as the name or statutory reference of the state principal and income act or fiduciary powers act. As part of our state specific initiative we will be including a recommended reference based on the state select-ed in the document assembly. You will then have the

opportunity to set the answer to the recommended reference and, if desired, set that reference as the de-fault for future documents.

STATE STATUTORY DOCUMENTS

For states that have recommended or approved stat-utory documents such as Statutory Short Form Du-rable Power of Attorney, we will be formatting, pro-gramming and then adding those to state folders under the State Statutory & Forum Templates Folder.

Because the statutory forms vary widely from state to state and frequently are not restricted to use with a specific document, these will be standalone tem-plates and not part of another Wealth Docx Interview. As we work through this initiative we will attempt to group the ancillary documents for each state togeth-er in a single interview for the state.

QUARTERLY

In most cases the state statutory documents will fol-low the language, structure and options as they are set forth in the state statute. The exception will be in cases where a State Forum has reviewed the state statute, made a determination that other options or provisions are permitted and submitted the requested options or additional provisions to the WealthCounsel Content Committee. An example of that is in the soon-to-be-released California Advanced Healthcare Direc-tive set forth in the California Probate Code 4701. When assembling the California Advanced Healthcare Directive you will have the option of assembling the document exactly as set forth in the statute or with selected optional provisions and format.

NECESSARY MODIFICATIONS TO EXISTING DOCUMENTS

Finally, through a joint effort on the part of the Wealth-Counsel Content Team, State Forums and direct in-put from members, we will address any modifications that need to be made to Wealth Docx to comply with state law. An example of this would be Florida Stat-ute 737.115 Notice of Trustee duties which states that a trust must contain a notice that the trustee may have duties and responsibilities in addition to those described in the trust document and goes on to give a sample of a provision that will comply with that requirement. When requesting a modification of this type, we will need the statutory or case authority along with the requested modified language or ad-

ditional provision.

FOCUS ON INDIVIDUAL MEMBER REQUESTS

Every Wealth Docx release has always contained many changes inspired by members. This year, we made those changes the focus of our efforts in the fourth quarter of 2015. These enhancements run the gamut from the addition of options in our interviews and new language in the assembled documents to expanded help text and improvements in formatting. Here are some examples of what will be available ear-ly in 2016:

NEW OPTION

We added a new option to the Revocable Living Trust (RLT) to allow for easier and less costly administration (compared to getting a probate court order).

VOLUME 10 NUMBER 1

PAGE 7

NEW DIGITAL ASSETS SECTION

Similar to the language included in many trust mod-ules, we included a Digital Assets Section in the Fi-duciary Powers Article of the Will as well as digital assets language to the Pour-Over Will.

Section 1.08 Digital Assets

My Fiduciary has the authority to access, modify, control, archive, trans-fer, and delete my digital assets.

Digital assets include my sent and received emails, email accounts, digital music, digital photographs, digital videos, gaming accounts, software li-censes, social-network accounts, file-sharing accounts, financial accounts, domain registrations, Domain Name System (DNS) service accounts, blogs, listservs, web-hosting accounts, tax-preparation service accounts, online stores and auction sites, online accounts, and any similar original asset that currently exists or may be developed as technology advances.

My digital assets may be stored in the cloud or on my own digital devices. My Fiduciary may access, use and control my digital devices in order to access, modify, control, archive, transfer, and delete my digital assets - this power is essential for access to my digital assets that are only accessi-ble through my digital devices. Digital devices include desktops, laptops, tablets, peripherals, storage devices, mobile telephones, smartphones, and any similar hardware that acurrently exists or may be developed as tech-nology advances.

NEW INTERVIEW QUESTION

A new question was inserted in the Pour-Over Will interview to identify an alternate disposition of the es-tate if the pour over fails.

NEW FEATURE

You will be able to add the names of Disability Panel members to the Confirmation of Names and Fiducia-ries ancillary in the Revocable Living Trust (RLT) and the Will.

NEW COMPARISON CHART

To assist members with choosing the appropriate Will format, a comparison of the simplified and full ver-sions will be included in contextual help within Wealth Docx and as resource on the Member Website.

Watch for more updates as we continue to improve your drafting with Wealth Docx.

QUARTERLY

Uber: Playing

Fair in the Sharing

Economy?JENNIFER L. VILLIER, JD

Anyone unfamiliar with the Uber con-cept at the start of 2015 likely recog-nized it by year-end. Uber, meaning an outstanding or extreme example of something, is, according to the com-panys website, evolving the way the world moves.

Is the Uber business model outstand-ing or extreme? If imitation really is the sincerest form of flattery, then it would seem that Uber certainly is both out-standing and extreme, as many other industries have attempted to copy the on-demand, app-driven, cashless busi-ness model that has brought Uber so much success.

Ubers success, however, lies in the shadow of conflict and legal uncertain-ties. From issues related to liability and insurance, to lawsuits from taxi compa-nies and unions, the company has faced unprecedented challenges as it contin-ues to navigate the sharing economy. Most recently, Uber has made headlines with continued labor disputes with its drivers. For instance, in cities across the U.S., UberBLACK drivers are striking over the companys mandate that they must serve lower-paying UberX pas-sengers. The drivers contend that they

VOLUME 10 NUMBER 1

PAGE 9

are being forced to incur higher overhead expenses (more expensive vehicles, increased maintenance and gasoline costs) and receive less pay.1 However, the biggest issue currently confronting Uber and the one most instructive to industries and em-ployers nationwide is whether Ubers drivers are employees or independent contractors. This article (i) summarizes the pending class action lawsuit against Uber by its drivers, (ii) considers the likely outcome given recent U.S. Department of Labor advice and other recent case law, and (iii) ultimately concludes that the independent contractor vs. employee distinc-tion is one likely to continue to make headlines in 2016 and beyond as the sharing economy is fueled by the growth of companies like Uber. The lessons and lin-gering questions surrounding Ubers business model are instructive to business planning attorneys repre-senting clients on matters pertaining to the structur-ing of work arrangements with employees and inde-pendent contractors.

OCONNOR V. UBER2On September 1, 2015, Judge Chen of the U.S. Dis-trict Court for the Northern District of California cer-tified a class action lawsuit against Uber by drivers alleging they were misclassified as independent con-tractors rather than employees. The case, which be-gan as a 2013 lawsuit by four Uber drivers seeking reimbursement for certain expenses such as gas and vehicle maintenance, now involves 160,000 current and former California-based Uber drivers. A decision in favor of the plaintiffs in this case would certainly have widespread implications, including a significant devaluation of Uber3 and a closer look at the practices of other businesses with similar business models.

COMPLAINT

The issue at the heart of the Uber class action is the plaintiffs contention that Uber has violated California labor laws4 by failing to (i) reimburse its drivers for expenses directly incurred as a consequence of the drivers employment duties and (ii) pass on tips left for the employees by patrons. Thus, the class action turns on whether the drivers are in fact employees of Uber.5

ALLEGED MISCLASSIFICATION AS INDEPENDENT CONTRACTORS

Under California law, the determination of whether a worker is an employee or an independent contractor involves a two-part analysis. First, a plaintiff presents evidence that he provided services for an employer. This establishes a prima facie case that the relation-ship was that of an employer and employee.6 The burden then shifts to the employer to prove that the presumed employee was an independent contractor.7 In its 1989 Borello8 opinion, the Supreme Court of California enumerated a number of factors indicating an employment relationship exists. A court will ana-lyze the Borello factors in determining whether the employer has satisfactorily rebutted the presumption of an employment relationship. The most significant factor is the putative employers right to control work details (i.e., the extent to which the employer retains all necessary control over the workers per-formance).9 Additional factors constituting second-ary indicia of an employment relationship must also be considered.10 These include: whether the service provider is engaged in a dis-

tinct occupation or business;

the kind of occupation, and whether it is work typ-ically done with or without supervision;

the skill required in the particular occupation;

whether the service provider supplies the instru-mentalities, tools and place of work for himself;

the length of time the services are to be per-formed;

the method of payment (e.g., by time or per job);

whether the work is part of the regular business of the principal; and

whether the parties believe they are creating an employer-employee relationship.11

Despite the plain language of the control test, which seemingly indicates that the principals right to con-trol is a crucial factor, Judge Chen makes clear that no one Borello factor is dispositive when analyzing employee/independent contractor status.12 In citing case law that reached conflicting outcomes despite similar facts, Judge Chen highlighted the flexibility and variability of the Borello test.13 That flexibility

QUARTERLY

and variability is precisely what makes the analysis unpredictable and the outcome seemingly arbitrary. Thus, despite facts that seem to point in favor of the Uber drivers, it is difficult to predict how a jury would weigh the factors, particularly in light of contradictory legal precedent.

Nonetheless, Judge Chen seemed to find credence in many of the plaintiffs arguments. Judge Chen rec-ognized that a number of secondary factors (such as plaintiffs using their own vehicles, plaintiffs ability to hire subcontractors or agents to drive on their behalf, and the parties agreement that no employment re-lationship exists) support an independent contractor classification. Yet, Judge Chen indicates that even as to these factors, their significance is ambiguous.14 Seemingly more persuasive to Judge Chen is the fact that Uber drivers are required to follow numer-ous detailed requirements imposed on them by Uber. Furthermore, Uber drivers are monitored and graded using a star system of feedback provided directly by customers to Uber. Drivers are subject to termination based on their willingness to abide by Ubers man-dates and the grades received from customers. Addi-tionally, Ubers argument that it is a technology (and not a transportation) company seemed diluted by the fact that the companys motto is we are everyones on-demand private driver. As such, its business could not exist without its drivers.

Notably, Uber is not paid unless its drivers drive. Cer-tain taxi companies charge drivers a flat daily fee but no per trip stipend, permitting their independent contractor drivers to retain all proceeds from custom-ers. Uber, by contrast, unilaterally sets the price of a given ride, collects the fares directly from customers, retains a percentage from each trip, and remits the remainder to the driver. The more drivers drive, the more money Uber makes (without incurring the over-head expenses associated with driving, such as gas and vehicle maintenance). Finally, Uber exercises sub-stantial control over the qualification and selection of its drivers, by performing background checks, city knowledge exams, vehicle inspections, and personal interviews.15 The facts seem to stack in plaintiffs favor, and a re-cent California Labor Commissioner decision16 finding an Uber driver was indeed an employee, has bolstered commentators views that the Uber class action is not

likely to go well for Uber. To be clear, the Labor Com-missioners ruling has no precedential value in the present case, and applies only to the driver at issue in that decision.

ALLEGED VIOLATION OF CALIFORNIA TIP LAWS

California Labor Code section 351 governs an em-ployers obligation to remit employee-earned tips and gratuities to employees. Ubers policy, as stated to customers on its website and in its marketing materi-als, is that a gratuity need not be paid to the driver because it is already included in the total cost of the car service. Plaintiffs contend that Uber has not re-mitted the total proceeds of gratuities to the drivers who earned them. In determining whether Uber is li-able under section 351, the jury must first consider whether Uber took or received any gratuity from its riders. If so, then the jury must then consider whether Uber has paid or given the full amount of those tips to its drivers.

It seems plausible based on the facts that the first an-swer is yes, and the second answer is no, as Uber stip-ulated that it kept the entire amount of any tip that might be included in its fares. In other words, despite representing to customers that a tip was included in all of its fares, Uber never calculated, segregated or remitted any tips to its drivers.

The Uber class action will be brought before a Califor-nia jury on June 20, 2016. While the litigation is based upon California law, the implications will undoubtedly be farther reaching than the Golden State. When cou-pled with the U.S. Department of Labors Misclassi-fication Initiative, described below, the employee/in-dependent contractor distinction will likely be among the primary employment issues facing businesses in the coming years.

DOL ADMINISTRATORS INTERPRETATION NO. 2015-1

During the summer of 2015, the U.S. Department of Labor issued Administrators Interpretation No. 2015-1, a document offering business owners additional guidance for properly classifying an employee vs.

VOLUME 10 NUMBER 1

PAGE 11

an independent contractor. The historic economic realities test, widely used by courts when determin-ing a workers classification, consists of a number of factors that have over time been applied inconsistent-ly and with certain factors given substantial weight over the others.17 The Administrators Interpretation does not change or reject the economic realities test, but rather sheds light on proper application of the test based on the circumstances.

In determining whether an individual is classified as an employee or an independent contractor, the DOL instructs that more attention and focus must be placed on the collective factors that make up the working relationship between an employer and its la-borers, with no one factor being determinative. Ad-ditionally, the DOL emphasizes that most workers are employees under the Fair Labor Standards Act (FLSA) due to the statutes broad definition of the term employ. The DOLs Misclassification Initiative is therefore aimed at identifying those employees that are misclassified as independent contractors as a result of the manipulation of one or more factors of the economic realities test.

There are obvious advantages for an employer who classifies a worker as an independent contractor rather than an employee less oversight, lower benefits-relat-ed costs, and reduced taxes, to name a few. Although independent contractor relationships can be advanta-geous for workers and businesses, some employees may be intentionally misclassified as a means to cut costs and avoid compliance with labor laws. In Ubers case, classifying its drivers as independent contractors has enabled the company to avoid the expense and obligations associated with an employer/employee re-lationship, including the need to comply with some-times onerous state employment laws, such as the California Labor Code at issue in the Uber class action.

CONCLUSION

Clearly, the DOL is dialing up their attention and scru-tiny in the classification of employees vs. independent contractors. Administrators Interpretation No. 2015-1 provides guidance in the form of examples and cita-tions to relevant case law to help employers properly determine a workers status. Attorneys representing small businesses or their workers should review the

document and share with clients, while awaiting the highly-anticipated decision in the Uber class action.

ENDNOTES1 Uber operates on a multi-tier pricing model based upon the car. UberBlack drivers, for instance, are able to charge a higher fare in exchange for their investment in a high-end black sedan or other limousine-like vehicle. Sometimes, UberBlack drivers obtain access to the high-end vehicles through arrangements with third-party lim-ousine companies. UberX drivers, by contrast, charge less but oper-ate smaller, more modest sedans. Ubers position is that available UberBlack drivers must help out with the excess demand of UberX users and charge them the lower, UberX rate. Furthermore, the driv-ers are not permitted to accept tips to make up for the reduced fare.

2 Douglas OConnor, et al. v. Uber Technologies, Inc., No. C-13-3826 (N.D. Cal. 2015)

3 Ubers profit margins and success are due in large part to its pricing structure and low overhead costs. Notwithstanding the sub-stantial expenses Uber is facing in litigation, reclassification of its drivers as employees will potentially lead to fines, penalties, back pay liability, and increased overhead costs associated with employ-ees and related benefits.

4 California Unfair Competition Law, Cal. Bus & Prof. Code 17200 et seq., Cal. Lab. Code 2802, 351.

5 The class action was partially certified. Judge Chen approved the class action with respect to the proper classification of the driv-ers as employees versus independent contractors and as to wheth-er Uber improperly withheld tips. Judge Chen denied the plaintiffs request to certify a class action with respect to the expense reim-bursement claims under section 2802 because there may be sub-stantial variance as to what kind of expenses were even incurred by [the putative employees] in the first place. Harris v. Vector Mktg. Corp., 753 F. Supp. 2d 996, 1022 (N.D. Cal. 2010).

6 Narayan v. EGL, Inc., 616 F.3d 895, 900 (9th Cir. 2010).

7 Id.

8 S.G. Borello & Sons, Inc. v. Dept of Indus. Relations (Borello), 48 Cal. 3d 341, 350 (1989).

9 Id. at 357.

10 Id. at 350.

11 See id. at 351.

12 OConnor, et al. v. Uber Technologies, Inc., No. C-13-3826 (N.D. Cal. 2015)

13 Id. (citing Mission Ins. Co. v. Workers Comp. Appeals Bd., 123 Cal. App. 3d 211 (1981) and Alexander v. FedEx Ground Package Sys., Inc., 765 F.3d 981 (9th Cir. 2014)).

14 Id.

15 Id.

16 Barbara Ann Berwick v. Uber Technologies, Inc., No. 11-46739 EK (Cal. Labor Commr, June 3, 2015).

17 The economic realities test generally weighs the following five factors: (1) the degree of control exercised by the alleged employer; (2) the extent of the relative investments of the [alleged] employee and employer; (3) the degree to which the employees opportu-nity for profit and loss is determined by the employer; (4) the skill and initiative required in performing the job; and (5) the perma-nency of the relationship. United States v. Silk, 331 U.S. 704 (1947).

QUARTERLY

PORTABILITY THE BASICS

The Tax Relief, Unemployment Insurance Reauthoriza-tion, and Job Creation Act of 20101 amended section 2010(c) of the Internal Revenue Code to allow the estate of a decedent who is survived by a spouse to make a portability election. A portability election allows the surviving spouse to apply the Deceased Spouses Unused Exclusion (DSUE) amount to the surviving spouses own transfers during life and at death. Portability was set to expire December 31, 2012. However, in January 2013, the American Taxpayer Relief Act of 2012 made the portabil-ity provisions permanent.

In 2012, the IRS issued temporary and proposed regula-tions that clarified the portability election that was put into effect in 2010. On June, 16, 2015, the IRS released final regulations.2 (The temporary regulations continue to apply to estates of decedents who died between January 1, 2011 and June 12, 2015.)

The original portability requirements remain unchanged by the final regulations, which are as follows: 1) the dece-dent must be a U.S. citizen; 2) the DSUE amount portabil-ity election must be made on a timely filed 706 within 9

We all know what portability is, but the IRS has now produced

finalized regulations about how to apply portability. After five

years of ambiguity and temporary regulations, the 2015 final

regulations have ushered in a new season of clarity for portability.

Finally Clarity with Portability

JEREMIAH H. BARLOW, JD

VOLUME 10 NUMBER 1

PAGE 13

months of the decedents date of death, or when al-lowed, within 15 months using an automatic extension; 3) the estate tax return must be complete and prop-erty prepared; and 4) the unused exclusion amount may only be used from the last deceased spouse.

A LOOK AT THE FINAL REGULATIONS:

The final regulations clarified several issues that had lingered with the temporary regs. We will consider each of them in turn.

How will extensions be treated for purposes of sat-isfying the timely filed requirement (especially for estates under the threshold)?

In order to elect portability, an executor must file a timely estate tax return, which is defined as 9 months after the date of decedents death.3 The final regula-tions clarify that if an estate is required to file an es-tate tax return because the estate is over the federal estate tax threshold ($5.45 million in 2016), an exten-sion to elect portability under Regs. Sec. 301.9100-3 may not be granted because the due date for the re-turn is governed by statute. However, if an estate is under the threshold, the IRS may grant an extension of time to elect portability.

Who is responsible for making the decision to file for portability?

The decedents executor is responsible for decid-ing whether to make the portability election or not. If there is no appointed executor, any person in ac-tual or constructive possession of any the decedents property may file the estate tax return. If the elector chooses not to make an election, he or she can do so by either making an affirmative statement on the estate tax return or by not filing a timely estate tax return.

How do you make an election with assets qualifying for marital or charitable deduction?

A valid portability election is made on a complete and properly prepared estate tax return. For those want-ing to take advantage of portability, but do not need to file an estate tax, a special rule applies for valuing assets that qualify for the marital or charitable deduc-tion.4 If this rule is used, the executor is only required to report the description, ownership, and/or benefi-ciary of the property, along with information neces-

sary to establish the right of the estate to the marital or charitable deduction of the property. By electing this option, the executor is responsible for estimat-ing the total value of the gross estate based on the executors good faith and due diligence in valuing the assets.

Importantly, this rule is not available if the value of the property is needed to determine the estates eligibil-ity for another estate or GST tax provision where the value of the property must be known.

How do we determine the DSUE Amount?

The value of the DSUE amount is critical for porta-bility, as it determines what amount can be claimed by a surviving spouse. Calculating the DSUE amount starts by using the basic exemption in the year of the decedents death. Next, if the decedent paid gift tax on taxable gifts because the taxable gifts exceeded the applicable exemption amount at the time of the gift, then these gifts are exempted from adjusted tax-able gifts for the purposes of computing the dece-dents DSUE amount. This adjustment is necessary so that the decedents exemption amount is not used for amounts on which gift tax was paid.

The final regulations state that the eligibility for the estate tax credit does not factor into the calcula-tion of the DSUE amount. Rather, estate tax liability is calculated by first subtracting the applicable credit amount and then applying the credits under Secs. 2012 through 2015. Any unused credit is lost, so there is no need to adjust the computation of the DSUE amount to account for any unused credits.

The impact of the last deceased spouse provision

The surviving spouse can claim any unused exclusion amount that is left over from the death of the first spouse to die, but the decedent must still be the sur-vivors last predeceased spouse when use is made of transferred amount. The last predeceased spouse is the most recent deceased individual who was mar-ried to the surviving spouse at the individuals death.5

The final regulations state that, if the surviving spouse has more than one deceased spouse, an ordering rule is applied. First, count any gifts made by a surviving spouse using the DSUEA of the last deceased spouse, is determined by the date of each gift, before using up the surviving spouses exemption amount. Next, the surviving spouses DSUE amount becomes the

QUARTERLY

DSUE of the last deceased spouse, plus any DSUE ac-tually applied to the surviving spouses taxable gifts to the extent the gift was from a decedent who is no longer the deceased spouse.6

Importantly, the final regulations indicate that the IRS may scrutinize returns of every deceased spouse of the surviving spouse in order to adjust, or even eliminate, the DSUE amount, irrespective of any statute of limita-tions. Importantly, this expanded scrutiny only applies to adjusting the DSUE amount, and does not toll the limitation period for any prior estate tax returns.

How does portability work with noncitizen spouses and Qualified Domestic Trusts?

Qualified Domestic Trust (QDOTs) are particularly interesting when it comes to portability. Specifically, where a non-citizen spousal beneficiary of a QDOT later becomes a United States citizen. Prior to the final regulations, a U.S. citizen decedent could pass his or her DSUE amount to a non-U.S. citizen surviv-ing spouse, as long as it is in left in a QDOT. However, there would be no portability of the DSUE amount to the surviving spouse until the assets of the QDOT are fully subject to estate tax (e.g. when the surviv-ing spouse dies). At the surviving spouses death, the predeceased spouses DSUE amount would then be reported on the surviving spouses estate tax return.

The final regulations allow a surviving spouse who becomes a U.S. citizen after the decedent spouse passes away to use the DSUE amount of the de-ceased spouse.7 The surviving spouse can use the DSUE amount as of the date he or she becomes a U.S. citizen as long as the estate of the deceased spouse elected portability. This is helpful as no additional steps are necessary other than the proper and timely filing of an estate tax return.

Is there a short form return if were just filing for por-tability?

No. The IRS rejected the idea of a short form estate tax return to be used only to elect portability when an estate tax return is not otherwise required. The rea-soning given by the IRS for this decision was that use of short and abbreviated forms creates accuracy and administrative problems.

IN SUMMARY

With clarity on these issues the IRS has created a clearer map for practitioners to navigate what has felt like a portability minefield. We now have direction on the timeline for filing for portability, who is respon-sible, how to determine the DSUE amount, and how remarriage may affect portability. All vital pieces of information when planning with clients to use porta-bility.

There are still some unknowns that went unaddressed in these regulations. For example, the IRS provided no guidance on whether a QTIP election8 is valid when electing portability, particularly when an estate does not exceed the estate tax exemption. Some say that there is no need for clarification on this point because with portability, an executor may choose to make a QTIP election solely to preserve a decedents exclu-sion amount to use it in the future. But absent clarity from the Service, the question may remain.

ENDNOTES

1 Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, P.L 111-312

2 See, T.D. 9725

3 See, Sec. 2010

4 Special rule is codified under Regs. Sec. 20.2010-2(a)(7)(ii)(A)

5 Appling only to deaths after December 31, 2010

6 See example illustrations provided with the final regulations

7 See Treas. Reg. 20.2010-3(c)(2) and Treas. Reg. 25.2505-2(d)(3)(ii).

8 Made under Sec. 2056(7)

REFERENCES:

Journal of Accountancy, found at http://www.journalofaccountancy.com/news/2015/jun/irs-portability-rules-for-estate-tax-201512499.html

U.S. Government Publishing Office, found at http://www.gpo.gov/fdsys/pkg/FR-2015-06-16/pdf/2015-14663.pdf

http://www.currentfederaltaxdevelopments.com/blog/2015/6/20/final-portability-regulations-issued-by-irs

http://www.kpmg.com/us/en/issuesandinsights/articlespublica-tions/taxnewsflash/pages/2015-1/final-regulations-portability-of-deceased-spousal-unused-exclusion-amount.aspx

VOLUME 10 NUMBER 1

PAGE 15

Cool headline would go here.

Uptasincta culparum nis voluptatur sam

ut providem et asped qui tem volectas et

quist, vendit am, coreniet pratus et estrum

et ilit harcimo l debis eatur, que sundus,

imi, nem que estios simin rem que nobit.

I heard about WealthCounselfrom a trusted collea e.

I joined, because he was right.

Darrin K. JohnsMember since 2015

Deacon HaymondMember since 2012

When you invite a fellow

attorney to WealthCounsel,

youre introducing a world of

opportunity to them. Our legal

drafting solutions will bring

effi ciency and professionalism

to their practice, while our

educational programs are

proven to grow and lengthen

careers. And we dont have

to tell you how personally

and professionally rewarding

our member network can be.

This is where connections are

made, relationships are built,

and confi dence is found.

Why not invite someone new

to WealthCounsel today?

Youll help a colleague and

enrich your own network

along the way.

NOW GET 1 MONTH FREE MEMBERSHIP for you and for your referral when they join.

wealthcounsel.com/sharethewealth

QUARTERLY

The Estate Planning Lawyers Ethical Considerations

KRISTIN YOKOMOTO, JD - WEALTHCOUNSEL MEMBER SINCE 2014

All lawyers practicing in every area of the law owe ethical and performance duties to their clients, the breaches of which can result in severe consequences. However, due to the unique nature of estate planning which may involve, among other types of planning: (a) planning for joint clients; (b) planning for a death which will occur at a future date; (c) planning for the purpose of benefiting third parties; or (d) planning for benefits which revolves around potentially changing tax and related laws, this area of law is specifically plagued with ethical issues and malpractice pitfalls. A novice, and even an experienced estate planner, can too easily become named as a defendant in an ac-tion alleging ethical violations or negligence, both of which could lead to disbarment and legal malpractice liability.

Interesting, is the intertwined relationship between ethics and legal malpractice. In some states, the ap-plicable rules provide that the ethical rules are not in-tended to create civil causes of action; yet, despite such disclaimer, it is clearly established that breaches of ethical duties can give rise to causes of action for legal malpractice and breach of fiduciary duty. For ex-ample, a breach of the duty of confidentiality owed to a client or an unaddressed conflict of interest could both result in a negligence claim. Similarly, there are many unrelated, yet potentially related, additional considerations for estate planning lawyers such as fee agreements, trust accounting, capacity determi-

nation, potential duties to beneficiaries and property transmutations, all of which could lead to allegations of ethical violations, negligence or other disputes.

This article highlights some non-state-specific ethi-cal considerations applicable to estate planning law-yers with reference to some of the commentary from the American College of Trusts and Estate Counsel (ACTEC)1 2. The purpose of this article is to bring at-tention to some of the gray or conflicted ethical areas to help ensure that adequate policies and procedures are employed to identify and handle such issues. While hindsight is 20/20, there is no reason to have to learn from mistakes when awareness and proper handling may prevent them from occurring.

The below hypotheticals with facts common to real situations will highlight some of the ethical consid-erations to be identified and addressed by an estate planner. Upon review of the facts, note the ethical is-sues and questions which arise, consider the informa-tion that would be needed in order to give sound ad-vice and weigh the impact of different options.

HYPOTHETICAL #1:

An advisor tells you that he has referred a married couple to you for estate planning. The husband calls you the next day to schedule an appointment for him to discuss estate planning for him and his wife who is unable to attend. You schedule a time and

VOLUME 10 NUMBER 1

PAGE 17

send him a worksheet. Upon review of the work-sheet, you discover that husband was previously divorced, has one child with his ex-wife, a vacation home which he purchased before his current mar-riage with an outstanding mortgage and a home in his name only which he purchased during his current marriage. Wife is the co-owner of an S corporation and is expecting an inheritance from her parents. Together they own one residential home, stocks and cash and have one child. The total estate is valued at approximately five million dollars with husbands estate valued at three million and wifes estate at two million. They have asked you to serve as their successor trustee.

Who Is the Client? It is essential to determine who the lawyers client is in order to define the duties owed to such client. A husband and wife seeking joint es-tate planning is a very common situation. The lawyer should meet and talk with both potential clients, not just the husband, and the client worksheet should be approved by both. In some states, it is common for the husband and wife to become joint clients for es-tate planning services; while, in other states, lawyers regularly represent the spouses as separate clients. If the choice is joint representation, then all information parted by one client to the lawyer will be assessable to the other client and thus, the attorney-client privi-lege will not apply between the clients. Accordingly, if future litigation arises, there is no protection from disclosure of evidence. In contrast, if the choice is separate representation, then there is no duty to dis-close client confidences from one spouse to the other spouse.

What is the Scope of Representation? While nar-rowly defining the scope of representation in the engagement letter is essential, it is often mistakenly overlooked or addressed by a form engagement let-ter without specific review. A carefully prepared pro-vision in the engagement letter could turn helpful in defending a legal malpractice claim for failure to ad-equately provide certain services. Equally important is the disclosure by the lawyer to the client of the omitted services that the lawyer will not be perform-ing, such as the funding of certain assets or providing updates on future changes to the tax and related laws which could impact their estate planning.

Conflicts of Interest - Potential conflicts of interest exist in every joint representation matter. Joint rep-

resentation can also make certain ethical duties that a lawyer has to his or her clients challenging to ful-fill, such as the duty of loyalty and duty to maintain confidences. As with conflicts with former clients, if the conflict between the joint clients is only potential, most ethical rules allow the lawyer to represent both parties if he or she obtains informed written consent and waivers. In obtaining the waivers, the lawyer must discuss examples of actual conflicts that could arise and ensure that the clients understand the effect that joint representation has on the practical ability of the lawyer to keep client confidences. The lawyer also needs to explain that, upon the happening of an ac-tual conflict, he or she may be required to withdrawal from representing either of them. For example, if one spouse undertakes to conceal assets from the other spouse, it would be inappropriate under the rules to continue joint representation. As an aside, conflict checks should also be run against husbands former spouse and the wifes business and co-owner.

Competency - The Model Rules require that lawyers act competently, which essentially means that the lawyer shall not intentionally, recklessly or repeatedly fail to perform legal services with competence. The rules require that the lawyer must be able to apply the diligence, learning and skill, and mental, emotion-al and physical ability reasonably necessary to per-form the requested services. If the lawyer does not have sufficient learning and skill, then the lawyer may nonetheless perform such services competently by associating or consulting with another lawyer reason-ably believed to be competent or by acquiring suf-ficient learning and skill before performing the ser-vices. If the lawyer co-counsels with another lawyer, depending on the applicable state laws, disclosure must be made to the client in writing.3 Note that mis-taken judgment does not necessarily reflect a lack of competence.4 Further, while the lawyer has a duty to engage in thorough research sufficient to enable the lawyer to make an informed and intelligent judgment on a clients behalf, the lawyer generally does not have a duty to advise a client on remote or tenuous positions and outcomes.

Duty of Diligence The ethical rules provide that a lawyer shall act with reasonable diligence and prompt-ness in representing a client. This means that the law-yer must move forward with the estate planning en-gagement on a timely basis.5 It is important that any

QUARTERLY

lawyer who takes on an estate planning engagement is ready, willing and able to produce documentation that reflects the clients intent within a reasonable pe-riod of time.

Engagement Letters - Some states require that the engagement for legal services be provided to the client in writing.6 7 Among other things, conflicts of interest and the related written waivers, payment of referral fees, co-counsel arrangements, payment of fees on anothers behalf or the lack of malpractice coverage should be disclosed in the engagement let-ter or other written documentation. In fee disputes, the arbitrators or judges will scrutinize, among other things, the scope of services provision and calculation of fees, whether fixed, hourly or a combination. The engagement letter can also be very helpful in stating the time frame for the completion of particular ser-vices which can appropriately set client expectations.

Referral Fees - The referring advisor is an insurance agent and lawyer. In most or all states, lawyers are prohibited from sharing fees unless it is with another lawyer. Whether the lawyer can pay a referral fee in this instance may depend on whether the agent pro-vided the clients with insurance products or legal ser-vices. If a referral fee is to be paid, such would need to be disclosed in writing to the clients.8

Separate Property Transmutation - If the lawyer practices in a community property state, represent-ing a husband and wife with separate property can be tricky. The relevant trust provisions, schedules and any property agreements need to be carefully com-pleted and acknowledged, especially if there is any quasi-community property. In this instance, a portion of husbands vacation real property may be trans-muted if the outstanding mortgage is being paid with community property funds. Similarly, the other prop-erty which he purchased during marriage may consti-tute quasi-community property. The lawyer has obli-gations to discuss these issues with the couple and may have an obligation to properly address the prop-erty ownerships in the trust schedules or property agreements. Upon a divorce filing, family law lawyers will often call the estate planning lawyer as a witness if one spouse is claiming separate property, while the other spouse claims that such has been transmuted to community property through their estate planning.

Lawyer as Trustee - Husband and wife have requested

that the lawyer serve as successor trustee. Lawyers should check their states laws on any prohibitions on the drafting lawyers ability to serve as trustee. Note that the drafting lawyers inclusion of an exculpatory clause in the trust may create a conflict of interest if the attorney is also named as trustee.9 10 Also, the law-yer may have limitations on compensation for serving as trustee. Even if there are not any problems raised by the lawyer serving as trustee, most commentators take the position that the lawyer should avoid agree-ing to serve as trustee.

HYPOTHETICAL #2

What if the assets of the husband and wife exceed the current gift and estate tax exemption amounts?

Advanced Planning If husband and wifes assets ex-ceed the current gift and estate tax exclusion amounts, the lawyer may be ethically obligated to advise them on the potential benefits of additional planning. If the clients desire to implement advanced planning, the lawyer would need to be competent to provide such services or co-counsel or acquire the required skills in a diligent manner. If the decision is not to help them with advanced planning, such should be clearly stated as a specifically omitted service in the scope of repre-sentation provision in the engagement letter.

HYPOTHETICAL #3

Wife has asked you to prepare a buy-sell agreement for her business with her co-owner and recommend an insurance agent who can issue an entity-pur-chase policy.

Who is the Client? Again, the first task is to deter-mine who the lawyers client is for the requested legal services. Generally, it would be the business. In such case, the co-owners would need to understand that the lawyer is not representing either of them as indi-viduals.

What is the Scope of Representation? - The engage-ment letter with the business should carefully define that the scope of representation of the business is solely for the purpose of drafting the buy-sell agree-ment between the business and its owners and ex-cludes providing any advice to the owners or their spouses.

VOLUME 10 NUMBER 1

PAGE 19

Conflicts of Interest - The potential conflicts of interest which could arise need to be discussed thoroughly with wife, co-owner and husband. The lawyer should disclose to the co-owner that the lawyer has separately prepared wife and husbands estate planning. Equally important is for husband to understand that by signing a spousal consent to the terms of any buy-sell agreement he may be giving up some rights, such as the right to become a shareholder upon his wifes death. Each party in this instance should be advised, and given the opportunity, to seek independent counsel and written informed consent and conflict waiv-ers would be necessary.

Agent Referral Referrals are always risky. If a matter ends up in litigation, plaintiffs lawyer will often sue all involved in the chain, including the referral source. Even if the claim against the referral source is unsuccessful, defending any types of claims exhaust time, money and usu-ally result in higher malpractice policy renewal premiums. Clearly, the lawyer cannot accept a referral fee from the agent. But, also, some states disallow lawyers from participating in organizations where the organizations purpose is to increase business through referrals by having paid membership and one individual from each area of ser-vice. 11 If the lawyer is a member of such an organization, he or she may want to refer several options to the clients.

HYPOTHETICAL #4

Wife asks if you can review her parents A-B-C qtip trust prepared prior to the enactment of the 2012 American Tax Payer Relief Plan which permanently set the gift and estate tax exemption to five million dollars per individual, as adjusted for inflation. Their estate consists mainly of commercial buildings valued at approximately nine mil-lion dollars. Her father is healthy, but her mother may have the early onset of mild dementia.

Who is the Client? The same analysis of representing her mother and father, as joint clients, would need to be con-sidered. Note that while the lawyer generally does not rep-resent the beneficiaries, there is a line of legal malpractice cases brought against lawyers by beneficiaries who claimed to be negatively affected by amendments or restatements

QUARTERLY

to trusts. Especially in this instance where the lawyer already represents a beneficiary, the daughter, who is also the one referring them to the lawyer.

What is the Scope of Representation? While estate planning lawyers are often asked to review an exist-ing trust, such can create a complicated situation and the lawyer may be deemed to have assumed respon-sibility for the entire trust. Accordingly, any services to amend or restate the trust should be clearly defined as beneficiaries often mistakenly believe that the law-yer represents the estate or trust and thus, the benefi-ciaries. In this instance, an amendment of the funding clauses of the trust could result in significant income tax savings if the A-B-C qtip trust is amended to an A-C trust or A trust with a disclaimer. The lawyer may have the responsibility to explain this to the clients and suggest the different funding options and conse-quences.

Conflicts of Interest - It is fairly common for an estate planning lawyer to represent multiple family mem-bers, as well as multiple generations of the same family. However, such multiple representation can be complex and risky. It is important to analyze each set of circumstances independently to determine if rep-resentation is proper. The analysis should include, among other things, determining: (1) if any one repre-sentation would be directly adverse to another; (2) if a potential beneficiary, who is also a client, has a legal right to another potential clients bequest or a mere expectancy; or (3) if there is a significant risk that the representation of one client will be materially limited by the lawyers duties to another client, such as the duties of loyalty and confidentiality.

Legal Capacity - Estate planning for the mentally im-paired, sick and aging raises major capacity and un-due duress concerns. As our population lives longer, issues of capacity have become increasingly impor-

VOLUME 10 NUMBER 1

PAGE 21

tant. A complete discussion of capacity is outside of the scope of this article; however, it is critical for law-yers to research their various state rules on capacity12 and the lawyers role in determining legal capacity. The ACTEC Commentaries provide that if testamen-tary capacity is uncertain, the lawyer should exercise particular caution in assisting a client to modify an es-tate plan or seek court assistance.13 Especially in this instance where an amendment to the funding formula could result in significant income tax saving.

IN SUMMARY

Estate planning lawyers duties to clients include, among others:

the duty of loyalty

the duty to maintain confidences

the duty to adequately disclose conflicts and ob-tain informed written consents and waivers

the duty to provide competent representation

the duty to perform services diligently

the duty to ascertain legal capacity

the duty to inform and communicate with clients

the duty to preserve confidences after death of client

These ethical duties are taken seriously by the courts. Having proper policies and procedures in place to identify these ethical considerations with checklists to ensure compliance will help to defend against any state bar investigations or malpractice claims.

ENDNOTES

1 ACTEC recognized that the American Bar Associations Model Rules of Professional Responsibility (MRPR), which have been en-acted with amendments by the majority of the states, Puerto Rico and the Virgin Islands, and comments thereto failed to provide ade-quate guidance on the professional responsibilities of lawyers prac-ticing estate planning, trust and probate law. Thus, in 1994, ACTEC promulgated the Commentaries on the Model Rules of Professional Conduct (ACTEC Commentaries).

2 Check your state bar for ethic guidelines specific to estate plan-ning. In California, the Trusts and Estates section of the California State Bar publishes a Guide to the California Rules of Professional Conduct for Estate Planning, Trust and Probate Counsel.

3 Model Rule 1.5(e) allows attorneys to fee share or fee split if the division is proportionate to the work performed or both attorneys

assume joint responsibility, the client agrees in writing to the share to be received by each attorney and the total fee is reasonable.

4 ACTEC Commentary on MRPC 1.1 provides that: In some in-stances the facts are unclear or disputed, while in others the state of the law is unsettled. In addition, some applications of law and de-terminations of fact made by courts or administrative agencies are not reasonably foreseeable. In other instances, the complexity of a transaction or its unusual nature generate uncertainties regarding the manner in which it will be treated for tax or substantive law pur-poses and may prevent an otherwise thoroughly competent lawyer from accurately assessing how the transaction would be treated for tax or substantive law purposes.

5 The ABA comment to this rule sets a high standard, stating that the lawyer should take whatever lawful and ethical measures are required to vindicate the clients cause or endeavor and a lawyer should carry through to conclusion all matters undertaken for a cli-ent.

6 In California, all services for which the attorneys fees will ex-ceed one thousand dollars are required to be in writing with a fully executed copy delivered to the potential client.

7 See ACTEC sample engagement letters - http://www.actec.org/publications/engagement-letters/

8 Model Rule 5.4 generally prohibits sharing fees with non-lawyers.

9 Model Rule of Professional Conduct 1.8(h) provides that attor-neys shall not make an agreement prospectively limiting the law-yers liability to a client for malpractice unless the client is indepen-dently represented in making the agreement.

10 However, the ACTEC Commentary on Model Rule 1.8 states that, at the clients request and under certain circumstances, a law-yer may properly draft an exculpatory provision in a document that appoints the lawyer as a fiduciary.

11 Some states have issued opinion letters banning lawyers from participating in certain organizations that seek to increase busi-ness through referrals among the members because participation in such could create undisclosed conflicts of interest, compromise a lawyers professional independence, as well as violate solicitation rules.

12 For instance, California has different capacity standards for wills and simple amendments versus complex trusts.

13 ACTEC Commentary on Model Rule 1.14 provides that in cases involving doubtful testamentary capacity, the lawyer should consid-er seeking court supervision of the proposed estate plan, including substituted judgment proceedings.

ABOUT THE AUTHOR

Kristin Yokomoto is the founder of Balanced Legal Planning, APLC which specializes in Estate Planning and Business Planning in Newport Beach, California. Kristin helps her clients by providing plans which balance benefits and risks. She can be reached at (949) 769-3448, kristin@

balancedlegalplanning.com or www.balancedlegalplanning.com.

QUARTERLY

ConditionsCharitable Gifts with Strings Attached

JERAMIE FORTENBERRY, JD, LLM (TAXATION)

For philanthropic clients, year-end tax planning often involves charitable contributions. As youre reading this in January, your clients 2015 planning is, for the most part, behind them. But getting an early start on philanthropic planning for 2016 can mean the differ-ence between success and failure for your clients.

Many donors have specific purposes in mind when they make charitable contributions. They want to en-sure that the contribution achieves their charitable goals. To this end, they may want to restrict the gift or earmark it for a specific purpose. Although these restrictions are usually well-intended, an impermissi-ble restriction could risk the clients charitable deduc-tion. To protect against this, any restrictions should be designed with deductibility requirements in mind.

This article looks at three common pitfalls: use re-strictions, reversionary interests, and deferred gifts. It concludes with drafting suggestions to help attorneys draft gift agreements that ensure the clients wishes will be respected while protecting the clients tax de-duction.

USE RESTRICTIONS

Donors may only deduct contributions made to or for the use of a charity.1 If a donor restricts a con-tribution for a specific use, the restriction must not prevent the charity from freely and effectively em-ploying the transferred assets, or the income derived therefrom, in furtherance of its exempt purposes.2

Any condition that restricts the charitys use of the assets for its exempt purposes will cause the gift to be nondeductible.

Whether a restricted gift will be deductible depends on the nature of the restriction in light of the charitys mission. One example in the Treasury Regulations3 in-volves a gift of land to a city government for use as a public park. The regulations provide that the restrict-ed gift is deductible if two conditions are satisfied. First, the donee must intend to use land as a park on the date of the gift. Second, the possibility that the donee will not use the land for a public park must be so remote as to be negligible.4 If these conditions are satisfied, the donor may deduct the value of the gift notwithstanding the use restriction.

REVERSIONARY INTERESTS

What happens if the charity doesnt use the property for the purpose the donor intended? Some donors may want to include reverter clauses that transfer the property back to the donor if the use of the property violates the gift agreement. In this situation, the re-verter clause will cause the gift to be nondeductible unless the possibility of reversion is so remote as to be negligible.5 The phrase so remote as to be neg-ligible has been defined by the Tax Court to mean so highly improbable and remote as to be lacking in reason and substance and a chance which persons generally would disregard as so highly improbable

VOLUME 10 NUMBER 1

PAGE 23

that it might be ignored with reasonable safety in un-dertaking a serious business transaction.6

Rev. Rul. 2003-28, 2003-1 C.B. 594 is also instructive. In that ruling, a donor transferred a patent to a univer-sity on the condition that a faculty member remain on faculty during the patents remaining life of 15 years. The IRS found that this restriction was too onerous. Because the chance that the faculty member might leave the university in a 15-year period was not so remote as to be negligible, the charitable deduction was disallowed.

DEFERRED GIFTS

A deferred gift can occur if the transfer of the contri-bution depends on a future act. Unless the likelihood that the future condition will not occur is so remote as to be negligible, the charitable deduction may be deferred until the condition occurs.

In Rev. Rul. 79-249, 1979-2 C.B. 104, the donor made a gift to a public board of education. The gift includ-ed a reversionary clause that provided that the funds would be returned to donor if there were not suffi-cient funds to complete the building. The IRS ruled that, absent certainty that there were adequate funds to complete the building, the possibility that the do-nation would be returned to the donor was not so remote as to be negligible. As a result, the donors charitable deduction was deferred until there were adequate funds to construct the building.

DRAFTING CONSIDERATIONS

Gift agreements should be drafted with these rules in mind. Both the donor and the charity must have a clear understanding of the terms of the gift agreement before they sign it. Any restrictions or conditions should be clearly described. Any ambiguity is likely to lead to future disputes between the parties. The gift agreement should also clearly specify the consequences of any use of the donated property that vio-lates a use restriction or the failure of any condition to occur.

When possible, gift agreements should include pro-visions that allow for future modification. Future modification could be based on negotiation with

the donor, a condition specified in the agreement, or changes approved by a court that would best enable the charity to fulfill its exempt purpose.

When the gift involves a use restriction, the gift agree-ment should specifically identify the charitys exempt purpose and explain how the restricted gift furthers the charitys exempt purpose. The agreement should also require the charity to monitor the use of the do-nation to ensure that it accords with the donors in-tent.

Because of the ambiguity in the phrase so remote as to be negligible, almost any gift with a reverter clause leaves the door open to a challenge by the IRS. Reverter clauses should be used as a last resort and only in situations where there is a very strong chance that there will be no reversion.

Because reverter clauses should only be used when there is virtually no chance that they will be needed, one might question whether it ever makes sense to include them. A better approach may be to provide an alternative charitable donation of the property in-stead of returning it to the donor. Depending on the circumstances, the gift agreement could provide that, if the condition occurs, the property could be used by the charity for a different use or transferred to an-other exempt organization.

ENDNOTES

1 Internal Revenue Code (Code) 170.

2 Treas. Reg. 1.507-2(a)(8).

3 Treas. Reg. 1.170A-1(e).

4 Id.

5 Treas. Reg. 20.2055-2(b).

6 Briggs v. Commr, 72 T.C. 646, 656-657 (1979).

QUARTERLY

Thinking More Deeply on Trust Advisors and Protectors

MATTHEW T. MCCLINTOCK, JD VICE PRESIDENT, EDUCATION

The use of trust advisors and protectors in the do-mestic trusts & estates context has increased dra-matically over the past couple of decades. Originally found in offshore asset protection trusts, the concept of granting discrete powers to a non-trustee power holder has introduced a great deal of flexibility in trust design and administration.

The popularity of the use of trust advisors and pro-tectors is reflected in the growing body of statutory recognition, now extending to several states with di-rected trust statutes on the books. Statutory recog-nition is sure to grow in the years to come as states consider adopting provisions from the Uniform Trust Code. Section 808(b) of the UTC contemplates the role of the trust protector or trust advisor as autho-rized third parties who may be empowered by a trust settlor to hold and exercise certain powers.

Though statutory law is growing, there is scant case law to guide practitioners through some of the more challenging issues concerning trust advisors and pro-tectors. Moreover, scholars disagree sometimes stringently on the propriety of using trust protectors beyond the offshore asset protection trust context.

Central to the argument is whether a trust protector is a fiduciary: Always? Never? Sometimes? And to what extent does terminology matter? Is a trust protector different than a trust advisor, or are we drawing a distinction without a difference?

These are indeed important issues and we must not wait for legislatures or the courts to color in all the lines for us. Creative and thoughtful trusts & estates attorneys should lead the way in defining and clarify-ing key elements of the use of protectors and advi-sors. Some of the essential questions to be considered as the practice of using trust protectors continues to develop include:

What powers should the protector hold? Protec-tors often hold a series of negative powers, au-thorizing the protector to negate actions taken by another party, and affirmative powers, authoriz-ing the protector to act proactively to either af-firm the actions of another, or make a change to the trust or its administration.

Does the protector owe a duty? If so, to whom is that duty owed? If not, are there any ramifications

VOLUME 10 NUMBER 1

PAGE 25

if the protectors action or failure to act causes harm?

Is the protector a fiduciary? Is the answer to that question fixed, or does it depend on other factors?

How should a trust protectors compensation be computed and paid?

For purposes of this article we will focus only on these few issues, though others merit further examination as well. But chief among the issues is whether the protector is or is not a fiduciary, so we will focus our efforts there. Many of the other important questions concerning advisors and protectors flow from this pivotal issue so resolving it begins to pave the way toward clarity on other issues.

I submit that the nature of the power held should de-termine the capacity with which that power is held, and thus, should define the level of care the protector should be expected to satisfy in holding, exercising, or refusing to exercise a power. And while domestic law provides some guidance, there are many gaps and in-consistencies. We, as learned professionals, must take the lead and guide the law, rather than wait for courts and legislators to fill in blanks based on bad cases and lack of critical thought.

U.S. LAW AND TRUST ADVISORS AND PROTECTORS

At least 22 states statutorily recognize the existence of trust advisors or protectors. Of those, 17 require that the powers the advisor or protector possesses be specifically enumerated within the governing will or trust instrument. Some of the states laws are fairly comprehensive, but many leave wide gaps and little clarification about the scope and limits of the protec-tors role, the nature of permissible powers, and how the protector interacts with other trust parties.

Many states swept in trust protector provisions as they adopted the Uniform Trust Code, as 808 of the UTC contemplates protectors as third parties holding powers over the trust.

Section 808 of the Uniform Trust Code states, in per-tinent part:

SECTION 808. POWERS TO DIRECT.

(b) If the terms of a trust confer upon a person other

than the settlor of a revocable trust power to direct certain actions of the trustee, the trustee shall act in accordance with an exercise of the power unless the attempted exercise is manifestly contrary to the terms of the trust or the trustee knows the attempt-ed exercise would constitute a serious breach of a fiduciary duty that the person holding the power owes to the beneficiaries of the trust.

(c) The terms of a trust may confer upon a trustee or other person a power to direct the modification or termination of the trust.

(d) A person, other than a beneficiary, who holds a power to direct is presumptively a fiduciary who, as such, is required to act in good faith with regard to the purposes of the trust and the interests of the beneficiaries. The holder of a power to direct is li-able for any loss that results from breach of a fidu-ciary duty.

Note that the text of 808 does not contain any spe-cific reference to trust protectors in the substantive provision of the statute. For clarity, we must consider the comments to the draft 808 that provide in per-tinent part:

Subsections (b)-(d) ratify the use of trust pro-tectors and advisers. Subsections (b) and (d) are based in part on Restatement (Second) of Trusts 185 (1959). Subsection (c) is similar to Restatement (Third) of Trusts 64(2) (Tentative Draft No. 3, ap-proved 2001). Advisers have long been used for certain trustee functions, such as the power to di-rect investments or manage a closely-held business. Trust protector, a term largely associated with off-shore trust practice, is more recent and usually con-notes the grant of greater powers, sometimes in-cluding the power to amend or terminate the trust. Subsection (c) ratifies the recent trend to grant third persons such broader powers.

The comments also provide that the provisions set forth under 808 should be alterable by the settlor within the trust agreement. So while the provisions of the model act state that the holder of a power to direct is presumptively a fiduciary and that the trustee shall act in accordance with an exercise of a protectors power, there is nothing in the model act that would prevent a settlor from closely tailoring the roles and powers of those power holders.

QUARTERLY

COMMON POWERS GRANTED TO TRUST PROTECTORS

When it comes to defining trust protector powers, creativity reigns. Surely, the purpose of the trust pro-tector is to provide flexibility for a trust that is likely to last for many years beyond the death of the settlor, accommodating the inevitable changes that will oc-cur to state trust law, state and federal tax laws, and the unique circumstances the beneficiaries will face while the trust is under administration.

While it is likely impossible to collect and classify the whole world of powers that may be given to protec-tors, a starting point is to acknowledge that certain powers are affirmative allowing a protector to take some action and other powers are negative em-powering a protector to prohibit or undo actions taken by the trustee or another party to the trust. Unfortunately the states that have enacted protector provisions do not usually provide even this level of clarity concerning protectors powers.

Even more confounding is the disparity with which the states determine whether the protector is or is not a fiduciary. The inconsistencies among the states have fueled much scholarly debate about whether the protector is always a fiduciary, never a fiduciary, or somewhere in between. As we unpack this confusion it is possible to consider a broader framework into which those powers should fall, and within which we can determine whether a power should be held in a fiduciary or nonfiduciary capacity.

INCONSISTENT STATE LAW WEAVES A JOSEPHS CLOAK OF CONFUSION

When we look to the body of state law concerning trust protector powers we find little consensus about whether the protector is or is not a fiduciary, and whether or not the settlor can modify that classifica-tion in the governing instrument. For attorneys prac-ticing in states that have protector statutes on the books, it is imperative that the practitioner be aware of the scope and limits of prevailing protector laws and the degree to which the powers and duties can be shaped by drafting.1

For instance, several states specify that the protector (or in some cases, the trust advisor) is a fiduciary

by default, but that the governing instrument can change that standard. This is also the default provi-sion endorsed in the comments to 808 of the Uni-form Trust Code.

There is, however, a handful of states that have started thinking more deeply on the nature of protector pow-ers and have begun tailoring the protectors fiduciary or nonfiduciary capacity to the nature of the power granted. These states provide that the protector is a fiduciary when he or she holds trustee-like powers. It is here that we begin to find a useful framework within which we can organize protectors powers.

For example:

In Idaho, the trust advisor is a fiduciary when exer-cising investment powers unless the governing in-strument provides otherwise.2

In Wisconsin, the protector is a fiduciary when ex-ercising investment or distribution powers, when construing the trust at the request of the trustee, or when resolving disputes among beneficiaries unless the governing instrument specifies to the contrary. In all other circumstances the protector holds power in a nonfiduciary capacity (unless again, the docu-ment specifies otherwise).3

South Dakota takes a similar approach by stating that the trust advisor is a fiduciary when given au-thority to direct, consent to, or disapprove a fidu-ciarys investment decisions unless the document states otherwise.4 The powers of the trust protec-tor may be exercised or not exercised in the pro-tectors sole and absolute discretion, suggesting that there is no fiduciary duty that attaches to the protector. Presumably the document could specify to the contrary.5

U.S. CASE LAW AND THE ROLE OF THE TRUST ADVISOR & PROTECTOR

While it is true that we generally inherited the use of trust advisors and protectors from the world of off-shore asset protection trust planning, it would be in-accurate to say that domestic case law is silent on the issue. Several cases6 under U.S. law that referenced the use of a non-trustee trust advisor, examined the advisors role and determined the nature with which the advisor held power. All of those early cases found

VOLUME 10 NUMBER 1

PAGE 27

that the trust advisor is a fiduciary, because in each instance the advisor held powers that impacted the manner in which the trustee exercised its fiduciary duty over the trust.

Drawing from the handful of states that have begun to distinguish between types of powers a paradigm first set forth under Crocker7 we can begin to further build a framework within which we can organize pro-tectors powers, and identify the nature with which they hold those powers.

Aside from the categories of affirmative and negative protector powers, trust protector powers can be fur-ther classified as trustee-like or court-like. There is also a group of commonly-granted powers that may not neatly fit into this classification, which likely re-quire additional thought and careful drafting.

TRUSTEE-LIKE POWERS

Some powers just look inherently like the kind of pow-ers that a trustee might hold, which impact the regular operations and management of the trust. In fact, if the trust did not provide for a trust advisor or protector, these are the kinds of powers that might otherwise be held by a trustee. These may include the power to:

Advise or manage the exercise of discretionary distribution authority by a corporate trustee;

Advise the trustee concerning the timing and na-ture of distributions from the trust;

Advise the trustee in making allocations of capital gains to income, or veto those decisions if made by the trustee;

Advise the trustee in selling assets, or vetoing sales if necessary;

Direct or guide the trustee concerning investment decisions;

Supervise other actions of the trustee;

Break a deadlock among trustees;

Manage a trust-owned business; and

Vote stock shares owned by the trust.

Powers like these listed above tend to look and feel like trustee powers. When theyre held by the trustee, obviously theyre exercisable subject to a fiduciarys standard of care. It seems implausible to argue that

these powers should not be subject to that same standard when held and exercisable by another party. Thus, when the trust advisor or protector holds trust-ee-like powers, they should generally be held to a fi-duciary standard.

COURT-LIKE POWERS

Another collection of powers does not look at all like trustee powers, but rather appears to be extrajudi-cial in nature. These powers are often granted for the specific purpose of keeping trust administration out of the court, allowing a knowledgeable and indepen-dent third party to exercise powers that would other-wise be conferred to the court. These may include the power to:

Resolve disputes among the beneficiaries con-cerning the trust;

Modify trust provisions through an amendment power;

Grant, revoke, or modify powers of appointment (as an extension of the amendment power);

Add or delete beneficiaries;

Change the nature of a beneficial interest or change a distribution standard, such as from an ascertainable HEMS standard to a purely discre-tionary distribution power;

Prevent a beneficiary from assigning his or her in-terest in the trust;

Construe trust terms to resolve ambiguity;

Terminate the trust;

Remove or replace the trustee;

Approve the trustees compensation; and

Approve trustee accountings.

These kinds of powers do not directly impact the day-to-day administration of the trust and would gener-ally be exercised only in very limited circumstances. In fact, these are the kinds of issues that historically get referred to the court for resolution. It stands to reason that a third party holding these powers should not be held to a fiduciary standard, but would be treated as an independent arbiter to carry out the probable intent as expressed in the document just as a court might do under the doctrine of equitable deviation.

QUARTERLY

OTHER SPECIAL POWERS

There is a third category of powers that may not neatly fit into the trustee-like or court-like distinction. These are powers that may be held by a trustee (fiduciary) or by a court (nonfiduciary), and so the trust instrument should specify accordingly. These include the power to:

Designate the succession of trustees (for instance, where the trust is silent);

Change the governing law of the trust;

Change the trust situs; and

Provide nonbinding guidance or advice to the trustee.

TRUST ADVISOR OR TRUST PROTECTOR?

As the use of trust protectors and trust advisors has expanded, so has the discussion about whether these terms mean different things, or whether they con-stitute a distinction without a difference. Even some statutes equate the terms, further frustrating our abil-ity to provide some clarity.

As discussed above, early U.S. cases consistently found trust advisors to be fiduciaries because their powers were quasi-trustee in nature. If advisors and protectors are indeed the same thing, then it becomes quite difficult to argue that one should be held to a fi-duciary standard while the other is not.

But the terms trust advisor and trust protector should not be treated synonymously, and it is sloppy and dangerous to do so. If we commit to look closer at the nature of the power granted, perhaps we can begin to draw a true distinction where the law cur-rently does not. And perhaps we should clean up our language a bit to apply a consistent title to a consis-tent set of powers.

Following the logic of those early cases, and track-ing with some of the policies outlined in existing state law, perhaps we could agree on some new definitions:

TRUST ADVISORS

A trust advisor is an appointed individual other than the trustee who holds certain powers or decision-

making authority that impacts the regular administra-tion of a trust. The advisor serves to carry out the set-tlors intent by influencing the exercise of the trustees duties under the trust.

The powers given to a trust advisor are thus among the inherent trustee powers set forth above. These are the kinds of powers that might otherwise be held by a trustee or perhaps by the settlor or a beneficiary without adverse tax consequences, but that are given to a third party as a check-and-balance for the trustee.

Because of the nexus with the trustees role, and be-cause its consistent with early U.S. case law, the trust advisor should be a fiduciary. As far as the trust advi-sors compensation is concerned, because the trust advisors role is ancillary to the role of the trustee, the advisor should perhaps be compensated on a stand-ing retainer or paid in a manner similar to a trustee.

TRUST PROTECTORS

A trust protector should be a nonadverse individual who holds power or decision-making authority over a trust, and who serves to carry out the settlors intent through the interpretation and execution of the trust.

The powers given to a trust protector are quasi-judi-cial in nature. They are powers that would have ad-verse tax or asset protection consequences if held by the settlor or a beneficiary. The protector may step in when matters must otherwise be referred to a court. Because the protectors powers can impact beneficial interests and otherwise cause significant changes to the tax treatment of the trust, the protector must not be related or subordinate to the grantor, a beneficiary, or to the party who may remove and replac

wealthcounsel quarterly - january 2016

Documents