Private Wealth Developments and Observations

SEC “Common Trust Fund” Exception Narrowly Construed for Private Trust Companies

Posted in Estate Planning, Trust Administration

Recent years have seen a dramatic increase in the number of Private Trust Companies (“PTCs”) established by wealthy families.  PTCs are used to consolidate the trustee function of multiple trusts within a family, and because these trusts are often invested in family-controlled investment vehicles they implicate various federal securities laws.  For instance, the Investment Company Act of 1940, which regulates mutual funds and other pooled investment vehicles (the “1940 Act”) may require significant review and planning for large families considering considering use of a PTC.  Compliance with 1940 Act registration and ongoing regulatory requirements can be extremely burdensome, and therefore we, as advisers, are often faced with the challenge of navigating the maze of exceptions available under the 1940 Act.

As a general rule, there is an exception to the registration and other requirements of the 1940 Act for investment vehicles (such as partnerships or limited liability companies) which have fewer than 100 investors, or whose owners are all “qualified purchasers” (generally a person with over $5 million of investments).  While the 100 investor limit would seem generous in a family context, it is not out of the question that a multi-generational family could have in excess of 100 investment accounts after counting all trusts and individual family members having separate accounts, and therefore fail to qualify for this exception.  Likewise, it is not often the case that all investors are qualified purchasers.  In these situations, a family must seek another exception from the 1940 Act.

For a family that has established a PTC to manage its pooled investments, it is possible that the so-called “Common Trust Fund Exception” could be available, but only in limited circumstances.  There are three primary requirements to qualify for the Common Trust Fund Exception.  First, the exception is available only to a banking institution or trust company supervised by a state or federal regulatory body.  Many PTCs are formed as regulated entities subject to state supervision and therefore do meet this criteria (although certainty on this point in the form of a SEC no-action letter is not available).  Second, the Common Trust Fund must be “maintained by” the PTC.  The SEC has interpreted this to mean the PTC must exercise substantial investment responsibility over the Fund.  The PTC may hire investment professionals to assist with investment management, but the PTC must make all final investment decisions.  This requirement may prove to be difficult to meet for a PTC that intends to delegate investment responsibility.  Third, the PTC must use the Common Trust Fund for a “bona-fide fiduciary purpose”.  Based upon available SEC guidance, this means, essentially, that the Fund is to be used exclusively for the collective investment of moneys contributed by the PTC to the Fund while acting in a fiduciary capacity as trustee of one or more trusts, and therefore, the Fund would not be open to contributions by individual family members for collective investment.  This restriction has been interpreted by the SEC to also exclude revocable trust accounts because the grantor of the trust typically would have the right to direct the investments of his/her own revocable trust—thus defeating the “bona fide fiduciary purpose“ requirement.

In sum, the Common Trust Fund exception may provide needed relief for certain family collective investments maintained by a PTC, but because of the several limitations it is not likely that the exception will find wide application.

IRS Issues Warnings about Email and Telephone Tax Scams

Posted in Income Tax, Tax

As the 2014 tax filing season progresses the Internal Revenue Service has issued warnings to taxpayers about convincing fraudulent email messages and telephone calls seeking payments or personal information that will enable the scammer to directly or indirectly steal from the victim.  All taxpayers should keep in mind that the Internal Revenue Service never initiates contact with taxpayers by email, text or social media, and never asks for credit card, debit card or prepaid card information over the telephone.  A taxpayer who is contacted by telephone by a person claiming to be an IRS representative should not divulge any personal information, should request a written follow-up communication and should confirm the validity of any such communication by contacting the IRS directly at 1-800-829-1040.  The links above provide instructions for reporting suspected fraudulent activity.

The Waiting Game: What to Do (and Not Do) While an Exemption Application is Pending

Posted in Estate Planning, Tax, Uncategorized

So, you have thoughtfully and thoroughly prepared the Form 1023 Application for Recognition of Exemption Under Section 501(c)(3) (“Form 1023” or “application”) on behalf of a charity, and filed it with the IRS along with a completed checklist and the correct user fee.  The charity is now anxious to fundraise and accept donations, commence its charitable programs, or start making grants. Now what?

Once upon a time you could reasonably approximate the processing time for a Form 1023, based on various facts and characteristics.  A non-operating private foundation that only makes grants to domestic public charities?  One could anticipate receiving a favorable determination letter in three to six months.  A public charity with highly compensated employees, joint venture activity, affiliated entities, and/or and foreign activities?  One could similarly predict a longer processing time and greater likelihood that the IRS would respond with questions and a request for further information, regardless of how carefully the Form 1023 was prepared. Continue Reading


Posted in Estate Planning, Income Tax, Tax, Trust Administration

Because trusts are subject to the 3.8% Net Investment Income Tax at a very low income level, $12,150 for 2014, trustees of trusts owning interests in operating entities have been considering ways to meet the material participation requirements to avoid this tax.  As discussed in a prior post, differing points of view have arisen regarding determining whether trusts can actively participate in entities in which they own interests.  The conflicting positions of the Internal Revenue Service (Technical Advice Memorandum 201317010) and case law (Mattie K. Carter Trust v. U.S.) have caused uncertainty as to whether active participation can be satisfied by the trustee, the officers, employees, agents or beneficiaries of a trust.  This week’s long awaited United States Tax Court decision in Frank Aragona Trust et al. v. Commissioner; 142 T.C. No. 9 was a big win for many trusts.

In the Frank Aragona Trust case, the Tax Court disagreed with the Service’s arguments that a trust was incapable of providing “personal services” to meet the material participation test under IRC § 469 (c)(7).  The Service argued that “personal services” are defined to mean “any work performed by an individual in connection with a trade or business” and, because the trust was not an individual, it could not perform those personal services.  The Tax Court held that services performed by individual trustees on behalf of the trust may be considered personal services performed by the trust.  The Tax Court then further disagreed with the Service’s attempt to exclude from actions counting toward material participation the actions of the trustees who were also employees.  Noting that the trust had no business activities other than real estate and that a majority of the trustees participated in these activities, the Tax Court concluded that the activities of the employee-trustees should be considered in determining whether the trust materially participated in its real estate operations.

This decision only covers situations in which the trustee is materially participating in the trust activity.  Although the Tax Court did not go as far as the Mattie K. Carter Trust case in which the Texas U.S. District Court solely relied upon participation of trust employees in determining whether the trust materially participated in an activity, it did open the door to participation closed by TAM 201317010.  This decision provides clarity for practitioners and is a big win for many trust clients.

Will Camp Tax Plan Impact Charitable Giving and Tax-exempt Organizations?

Posted in Estate Planning, Income Tax, Tax

Capitol hillIn late February 2014, House Ways and Means Committee Chairman Dave Camp (R-MI) released a nearly 1,000 page discussion draft addressing tax reform.  Chairman Camp’s proposal includes changes to numerous sections of the Internal Revenue Code, including changes with respect to the taxation of individuals, capital gains and businesses.  The discussion draft also includes changes relating to charitable giving and tax-exempt organizations.

The current sense of most political prognosticators is the Camp proposal has little chance of being enacted into law in the near term.  Notwithstanding that the proposal is likely a “dead letter” in its current form, it is significant because it may well provide a framework for future tax legislation, including provisions impacting charitable contributions and tax-exempt organizations.

Charitable Giving.  Chairman Camp’s proposal includes several potential changes to the rules applicable to charitable giving, including:  Continue Reading

BakerHostetler’s 25th Annual Tax, Budget and Health Care Policy Seminar

Posted in Tax
Seminar ImagePlease save the date for BakerHostetler’s 2014 Legislative Seminar. BakerHostetler will be hosting its 25th Annual Tax, Budget and Health Care Policy Seminar on Wednesday, May 7, 2014. This year’s seminar will again be held at the Hyatt Regency Washington on Capitol Hill. Please be on the lookout for more details as we finalize this year’s agenda.

Protecting Private Wealth: Recent Bankruptcy Cases Involving Tuition Payments and Profit Sharing Plans

Posted in Estate Planning

The BakerHostetler Bankruptcy, Restructuring, and Creditor’s Rights team has issued an Executive Alert highlighting two recent decisions involving debtors in bankruptcy.  The first case holds that tuition payments for the debtor’s minor children’s parochial school tuition are not fraudulent transfers.  The second case holds that profit sharing plan assets used to fund the debtor’s IRA are not exempt from the claims of the debtor’s creditors because the debtor failed to maintain the profit sharing plan in substantial compliance with the tax laws.

See “Protecting Private Wealth: Recent Bankruptcy Cases Involving Tuition Payments and Profit Sharing Plans” for more details.

Transfers to Non-Citizen Spouses: Planning Considerations

Posted in Estate Planning, Estate Tax, Tax, Trust Administration

Estate planning professionals commonly encounter married couples with mixed nationalities.  That is, one spouse is an American citizen and the other is not.  The U.S. estate and gift tax rules are generally the same for U.S. citizens and resident aliens.  However, the estate tax marital deduction differs significantly as applied to non-U.S.-citizen surviving spouses.

The unlimited gift and estate tax marital deduction generally allows U.S. citizens and U.S. resident non-citizens to make unlimited transfers of property to their U.S. citizen spouses, whether during lifetime or at death, without gift or estate tax consequences.  The marital deduction defers estate tax on assets passing to a surviving spouse until his or her death.  However, the unlimited estate tax marital deduction does not apply to gifts to a surviving spouse who is not a U.S. citizen. Therefore, the resulting amount of estate tax liability can be significantly increased for those with non-U.S. citizen surviving spouses.

Given this background, estate planners should be aware of several planning methods to help mixed-nationality couples minimize their tax liability. Continue Reading

International Grant-Making: Best Practices for U.S. Public Charities

Posted in Tax

U.S. public charities are blessed, but also challenged, by a relative lack of regulation governing their grants to foreign persons and foreign entities.

U.S. public charities are blessed by this lack of regulation because the rules applicable to them when making grants are fairly simple, flexible and easy to understand, particularly when compared to the rules applicable to foreign grants made by private foundations.  When a public charity makes a grant to an individual or organization, foreign or domestic, the funds must be used to further the public charity’s exempt purpose.  If the public charity makes a grant to another Section 501(c)(3) organization, this requirement is presumed to be met.[1]  If a grant is made to a party other than another Section 501(c)(3) organization, the public charity has added burdens. The charity must establish that the grant was made consistent with its exempt activity by retaining control and discretion over the use of the funds and by maintaining records that memorialize that the funds were, in fact, used only for such exempt purposes.[2]  This burden can be greater and more difficult to meet when a grantee is located in a foreign country. Continue Reading

A Disconcerting Proposal from the Senate: Proposed Repeal of Section 1031

Posted in Income Tax, Tax

PolicyLast November, Senate Finance Committee Chairman, Max Baucus, released the third package in a series of “Staff Discussion Drafts” proposing various changes to reform the Internal Revenue Code.  Of course, it is likely that any major changes to the Code will be shelved until the inevitable discussion begins regarding the difficult process to address federal tax revenues, the costs of federal programs, the U.S. budget deficit and the burgeoning national debt.

Whether Congress delays action until after the midterm elections in 2014 or (worse) until after the next Presidential election in 2016, the current set of tax rules and federal spending are not in harmony.  In this author’s opinion, with apologies to those economists who believe otherwise, a healthy U.S. economy cannot be maintained over the long term if the United States government continues to operate at a fiscal deficit, carrying over $17 trillion of national debt (and growing).

When the day of reckoning arrives, and Congress finally takes on the unenviable task of balancing the federal budget (much less, making any inroads on the national debt), there will be a mad scramble for “revenue raisers”.   No doubt there will be a plethora of untested ideas, some of which will be enacted.

Last November’s Staff Discussion Drafts included a proposal to repeal Section 1031, which for many years has permitted tax-free, like-kind exchanges of real estate and certain other types of property held for productive use in a trade or business or for investment.  Also included were proposals to lengthen the “cost recovery periods” for depreciable real property and improvements, and to provide for full recapture (at ordinary income tax rates) of depreciation deductions upon sale or exchange of any real property. Continue Reading