CaseLaw Articles and Resources

Incorporate First – Deduct Second

by Garrett Sutton, Esq | Mar 27, 2021 | Case Law, Forming an LLC, Starting a Business

Should you set up a corporation or LLC before you start trying to deduct expenses? A recent case suggests you should.

Many think that they can deduct all of their start up expenses before formally incorporating a business. But in Carrick v. Commissioner of Internal Revenue (T.C. Summ. Op. 2017-56, July 20, 2017) the Tax Court ruled otherwise.

The Facts of Carrick

The taxpayer had a bachelor’s degree in electrical engineering. For approximately 15 years, he was employed in the oceanographic industry. Before the years in issue, and during 2013 and 2014, he was employed by Remote Ocean Systems (ROS), building underwater equipment such as cameras, lights, thrusters, control devices, and integrative sonar.

During the years in issue, ROS was experiencing financial difficulty. The taxpayer was provided some flexibility in his work schedule, and he began exploring business ventures with other individuals, using the name Trifecta United as an umbrella name for the activities, which he named Local Bidz and Stingray Away.

The Local Bidz activity involved creating a website with features similar to those of the websites of Angie’s List, Yelp, and eBay, which would permit people to bid on hiring contractors for products and repairs. The taxpayer first had the idea for Local Bidz in 2012, and he went “full force in the beginning of 2013,” spending time accumulating data and developing software and the website.

At some point in 2013 the web developer moved to Los Angeles and other individuals left the project. For some unspecified period in 2013, the taxpayer traveled weekly from his home in San Diego to Los Angeles to consult with the web developer. The taxpayer abandoned the Local Bidz activity before the end of 2013. Sometime in 2014, the taxpayer began the Stingray Away activity, which involved researching and developing a device to prevent surfers and swimmers from being injured by stingrays.

The taxpayer initially noticed that sonar devices might affect the behavior of sharks and other species, so he conducted research at beaches in La Jolla, where swimmers and surfers often were stung and bitten by stingrays. The taxpayer did not fully develop any devices nor list any devices for sale in 2014. He had had no gross receipts during 2013 or 2014 from either the Local Bidz activity or the Stingray Away activity.

The Decision in Carrick

In Carrick, the taxpayer asserted that his reported expenses were deductible as ordinary and necessary business expenses relating to the activities of Local Bidz and Stingray Away. The Tax Court noted that 26 U.S.C. § 162(a) provides the general rule that a deduction is allowed for “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” The Tax Court stated that it was clear that the taxpayer was not “carrying on” a trade or business in 2013 or 2014 when the expenditures for the Local Bidz and Stingray Away activities were made.

Carrying on a trade or business requires more than preparatory work such as initial research or solicitation of potential customers; a business must have actually commenced. Expenses paid after a decision has been made to start a business, but before the business commences, are generally not deductible as ordinary and necessary business expenses. These preparatory expenses are capital expenditures.

The Tax Court pointed out that, while the taxpayer may have been conducting research in 2013 with respect to Local Bidz, or in 2014 with respect to Stingray Away, neither activity reached the point of actually commencing. There was neither sales activity nor evidence of the offering of products or services to the public. The taxpayer was still in the very early stages of research and development in each of these activities.

The Tax Court observed that there was nothing in the record indicating that the taxpayer had commenced any business activity as a sole proprietor. The taxpayer had not set up a formal business entity. Therefore, the Tax Court concluded that the taxpayer was not “carrying on” a trade or business in 2013 or 2014. See, 26 U.S.C. § 162(a); Frank, supra, 20 T.C. at 513-14 (1953); Shea, supra, T.C. Memo. 2000-179, 2000 WL 688593, at *5n. 10; Christian, supra, T.C. Memo. 1995-12, 1995 WL 9151, at *5.

Brief Discussion

If you’re preparing to open a new business, then you need to make certain that you understand the tax rules. It is crucial that you offer the product or service to the public and that you begin sales activity, because start-up expenditures, i.e., expenditures paid before a business begins, are not deductible in the years they are actually incurred. Instead, they are capital expenditures, which generally must be amortized over a 15-year period, once business begins, meaning gradually write off the cost over 15 years. See, 26 U.S.C. § 195. Thus, in order for an expenditure to be an ordinary and necessary trade or business expense, it must be related to more than a preparatory expenditure.

So, if the taxpayer in Carrick had opened his business first, then he might have been able to deduct his expenditures in the years they were actually incurred, instead of amortizing them over a 15-period.

Conclusion

The moral of the story is: Open your business first, and deduct later.

Courts Limit Pension Payouts

by Garrett Sutton, Esq | Mar 27, 2021 | Asset Protection Resources, Case Law

Is Your Retirement Safe?

Are you certain of your pension? Can you count on Social Security to pay you in the future?

A recent case allowed the State of Rhode Island to unilaterally – and retroactively – reduce public employees’ pension benefits.

The case, Cranston Firefighters vs. Gina Raimondo, governor of Rhode Island, was decided by the U.S. Court of Appeals for the First Circuit on January 22, 2018.

The unions claimed they had a binding contract. They had put in their time. The state claimed they faced ‘fiscal peril’. There was no way to pay. The lower court decided the state was not obligated to pay out as ‘promised.’

The public employees claimed: “But we had a deal!” They appealed to a higher court.

The Appeals Court responded:

“A claim that a state statute creates a contract that binds future legislatures confronts a tropical-force headwind in the form of the ‘unmistakability doctrine’.” Parker, 123 F. 3d at 5. This doctrine precludes finding that a statute creates a binding contract absent a clear and unequivocal expression of intent by the legislature to so bind itself. Nat’l R.R. Passenger Corp. vs. Atchison, Topeka & Santa Fe Ry. Co., 470 U.S. 451, 465-66 (1985). The doctrine recognizes that “the principal function of a legislature is not to make contracts, but to make laws that establish the policy of the state.” Id. At 466. It also serves “the dual purposes of limiting contractual incursions on a State’s sovereign powers and of avoiding difficult constitutional questions about the extent of state authority to limit the subsequent exercise of legislative power.” United States v. Winstar Corp. 518 U.S. 839, 875 (1996) (plurality opinion).

Never once has our court found that state or federal legislation clearly and unequivocally expressed a legislative intent to create private contractual rights enforceable as such against the state.”

In other words, the court ruled that the primary function of those who pass laws is not to create contracts and comply with them, but to legislate.

How does this case affect you?

Are you counting on Social Security?

The Social Security Board of Trustees has stated that their trust funds will “become depleted and unable to pay scheduled benefits in full on a timely basis in 2034.”

In 16 years, Social Security will not be able to pay out all that they’ve promised.

And now we have a federal case saying they won’t have to do so. More such cases will likely follow. The courts can’t print money. But they can limit what is paid out. They can limit previous government promises made to anyone.

The real issue in all of this is: are you prepared for the coming pension crisis?

Mom’s Mistake is No Excuse – You Need a Professional Registered Agent

by Garrett Sutton, Esq | Feb 13, 2021 | Asset Protection Resources, Case Law, Maintaining Your LLCs, Running a Business

Mom’s Mistake Is No Excuse!

Do you have your registered agent service properly in place?

A recent Ohio case illustrated the significant pitfalls of lax procedures.

Your registered agent’s job is to accept service process, meaning notice of a lawsuit. If you don’t receive that notice the persons suing you can get a default judgment – meaning, since you didn’t respond to the charge in time, they win by default. You’ve just lost a case you had no idea was even brought against you!

The new case is John W. Judge Co. v. USA Freight, L.L.C, 2018-Ohio-2658 (Ohio App., July 6, 2018). The facts are that Judge alleged USA Freight owed them $4,405.05. They served their complaint by certified mail upon the registered agent and service was accepted by the mother of USA Freight’s owner. The mother didn’t speak much English, didn’t know the U.S. legal system and didn’t give the lawsuit papers to anyone.

By not responding to the lawsuit USA Freight had a default judgment entered against them. This is when they first learn of Mom’s mistake. They immediately tried to vacate (set aside) the judgment on the basis of “excusable neglect.”

But the Court concluded that when a company is required by law to maintain a statutory agent for service of process, and when certified mail service is successful at the statutory agent’s address that is on record with the Ohio Secretary of State, then the subsequent mishandling of the served documents by the person who signed for and received the documents at the statutory agent’s listed address did not amount to “excusable neglect.”

A full discussion of the case follows. Know that the lesson here is that you want a professional resident agent service to accept important notices for you. Excuses for not responding – even an excuse involving dear ol’ Mom – will not pass muster in the courts.

The Facts of Judge

Judge filed a complaint against USA Freight for money damages arising from alleged unpaid engineering services in the amount of $4,405.05. Judge requested that the complaint and summons be served upon USA Freight via certified mail at the address of USA Freight’s registered statutory agent, Mukhabbat Vasfieva. The trial court received the certified mail receipt, showing that the complaint and summons had been delivered and signed for by “Mukhabbat Koch” on March 24, 2016. USA Freight failed to file a response to Judge’s complaint; accordingly, Judge moved the trial court to enter a default judgment in its favor. The trial court granted Judge’s motion and entered a default judgment against USA Freight for the amount requested plus interest and costs.

After obtaining a certificate of judgment, Judge obtained a writ of execution ordering the court bailiff to levy on the goods and chattels owned by USA Freight.

Three weeks after the writ of execution was filed, USA Freight filed a Rule 60(B) motion to vacate the default judgment on grounds that it never received the complaint and summons, and was otherwise unaware of who signed for the certified mail service. USA Freight attached a supporting affidavit from Baris Koch, who averred that he was the General Manager of USA Freight and that his father was the owner. Koch also averred that he did not receive notice of Judge’s complaint until the court’s bailiff contacted him regarding the writ of execution. Koch further averred that he spoke with the members and employees of USA Freight to ascertain if anyone affiliated with the company had signed for service of the complaint and that he was unaware of anyone who had. Lastly, Koch averred that USA Freight had meritorious defenses to Judge’s lawsuit, which included a claim that USA Freight had paid Judge in full for its services and that any unpaid amounts were owed by Garrett Day, LLC, and/or Mike Heitz. In addition to the affidavit, USA Freight attached several invoices from Judge and copies of checks that USA Freight made payable to Judge. USA Freight also attached a written description and map of the property on which Judge provided its engineering services, indication that Garrett Day, LLC owned part of the property on which Judge’s services were rendered.

Judge filed a response opposing the motion to vacate on grounds that USA Freight failed to establish the necessary elements for such relief under Rule 60(B). The trial court then held an evidentiary hearing on the motion to vacate. At the hearing, the parties submitted no additional evidence, but simply gave oral arguments.

During that time, USA Freight explained that the certified mail receipt was signed by the mother of USA Freight’s owner. USA Freight explained that the owner’s mother was not part of the company or involved in its day-to-day operations, but that she happened to be present when the complaint was served and did not provide it to any of the members of the family who were involved in the business. USA Freight further explained that the owner’s mother understood and spoke very little English, and had very little knowledge of the legal system. USA Freight therefore claimed it was entitled to relief under Rule 60 (B)(1) for excusable neglect.

At the close of the hearing, the trial court invited the parties to submit post-hearing memoranda in support of their position. After receiving the parties’ memoranda, the trial court issued a decision and entry granting USA Freight’s motion to vacate. In granting the motion, the trial court found “excusable neglect,” noting that USA Freight’s conduct was not willful and that it did not exhibit a disregard for the judicial system. The trial court further found that USA Freight had demonstrated that it had a meritorious defense to Judge’s claim for money damages. Judge appealed from the trial court’s decision granting USA Freight’s motion to vacate.

The Decision in Judge

On appeal, Judge argues that the trial court erred in granting USA Freight’s motion to vacate the default judgment under Rule 60(B), because USA Freight failed to establish that it was entitled to relief under Rule 60(B). More specifically, Judge claimed that USA Freight failed to establish that it did not respond to Judge’s complaint due to excusable neglect.

After reviewing the necessary requirements for USA Freight to obtain relief from a final judgment under Rule 60(B), the Ohio Court of Appeals noted that, because Judge did not dispute the existence of a meritorious defense or that USA Freight filed its motion to vacate within a reasonable time, the only issue before the Court was whether it was an abuse of discretion for the trial court to conclude that USA Freight was entitled to relief under Rule 60(B)(1) on grounds of “excusable neglect.” The Court noted that, in considering whether neglect is excusable under Rule 60(B)(1), a court must consider all the surrounding facts and circumstances. The Court pointed out that the phrase, “excusable neglect” in Rule 60(B)(1) is an elusive concept which has been difficult to define and to apply.

The Court observed that the Ohio Supreme Court had determined that neglect is inexcusable when the movant’s inaction revealed a complete disregard for the judicial system and the right of the appellee. The Court also observed that the Ohio Supreme Court had held that “excusable neglect” in the context of a Rule 60(B)(1) motion generally means the failure to take the proper steps at the proper time, not in consequence of the part’s own carelessness, inattention, or willful disregard of the processes of the court, but in consequence of some unavoidable or unexpected hindrance or accident, or reliance on the care and vigilance of his counsel or no promises made by the adverse party. The Court explained that courts generally find “excusable neglect” in those instances where there are unusual or special circumstances that justify the neglect of a party or the party’s attorney. That said, the Court cautioned that the concept of “excusable neglect” must be construed in keeping with the proposition that Rule 60(B)(1) is a remedial rule to be liberally construed, while bearing in mind that Rule 60(B) constitutes an attempt to strike a proper balance between the conflicting principles that litigation must be brought to an end and justice should be done.

After discussing the conflicting principles that must be borne in mind in ruling upon a Rule 60(B) motion, the Court pointed out that the supporting affidavit signed by USA Freight’s General Manager, Baris Koch, averred that he first learned of Judge’s lawsuit against USA Freight when he trial court’s bailiff notified him that a writ of execution had been filed against the company. The Court noted that the record indicated that the bailiff was ordered to levy execution against USA Freight, and that USA Freight filed its motion to vacate approximately three weeks later. The Court further noted that Koch has averred in his affidavit that he was unaware of any member or employee of USA Freight who had signed for or received service of the complaint; and that, as of the date he signed the affidavit, Koch claimed he did not know who signed for the complaint; and that it was not until the hearing on the motion to vacate that USA Freight explained, through counsel, that service of the complaint and summons was signed for by the mother of the owner of USA Freight. USA Freight explained that the owner’s mother had no role within the company and that she happened to be present when the complaint was delivered by certified mail. USA Freight further explained that the owner’s mother understood and spoke very little English, and that she did not provide the complaint to any of the family member who were involved in USA Freight’s business operations. Although no testimony or affidavits were submitted to verify this information, the trial court found USA Freight’s explanation credible and that it constituted “excusable neglect” under Rule 60(B)(1).

Judge argued that the trial court’s decision was an abuse of discretion because USA Freight failed to provide any evidence establishing that the person who received and signed for the complaint was the non-English speaking mother of USA Freight’s owner. The Court noted that the owner’s mother did not appear at the hearing; that her name was never disclosed on the record; and that USA Freight also never disclosed what the owner’s mother did with the complaint after she received it. In an effort to establish that the person who signed for the complaint was not the owner’s mother, Judge provided the trial court with two prior certified mail receipts with signatures that matched the signature on the receipt at issue. Judge pointed out that one of the prior receipts indicated that the signatory was an “Agent” of USA Freight.

Judge further argued that it was USA Freight’s responsibility to maintain a valid statutory agent who is designated to receive service of process at the agent’s listed address; that it was indeed neglectful for USA Freight to use an address where certified mail could be received and mishandled by a non-English-speaking individual who was not affiliated with USA Freight’s business; and that such conduct did not constitute “excusable neglect.” In support of this claim, Judge cited the following three unpublished decision, providing that insufficient or negligent internal procedures in an organization may not comprise “excusable neglect” and that, therefore, may not support vacation of a default judgment: (1) Middleton v. Luna’s Resturant & Deli, L.L.C., 201-Ohio-4388, 2011 WL 3847184 (Ohio App., Aug. 29, 2011) (unpublished decision); (2) LaKing Trucking, Inc. v. Coastal Tank Lines, Inc., 1984 WL 6241 (Ohio App., Feb. 9, 1984) (unpublished decision) (summons received in a corporate mail room but lost before being brought to the attention of the proper office does not rise to excusable neglect); and (3) Miller v. Sybert, 1975 WL 7351 (July 25. 1985) (unpublished decision)(ordinary mail delivered to defendant when mail is accessible to other persons and where it was never picked up by defendant’s friends while he was out of the state does not constitute “excusable neglect”). The Ohio Court of Appeals noted that the above-cited three unpublished decisions were in accord with the following two decisions: (1) Andrew Bihl Sons, Inc. v. Trembly, 67 Ohio App.3d 664, 667, 588 N.E2d 172 (Ohio App. 1990) (ignoring mail for more than three months due to illness and failing to delegate a competent agent to handle business affairs does not constitute “excusable neglect”); and (2) Meyer v. GMAC mtge., 2007-Ohio-5009, 2007 WL 2773653 (Ohio App., Sept. 25, 2007) (unpublished decision) (employee’s failure to forward the complaint to the appropriate corporate department does not constitute “excusable neglect”).

Finally, Judge argued that the mother’s ignorance of the legal process did not amount to “excusable neglect.”

The Rationale of Judge

Having reviewed the record, the Ohio Court of Appeals found that Judge had presented strong arguments in support of its position that the trial court had abused its discretion in finding “excusable neglect,” especially with regard to USA Freight’s responsibility to maintain a valid statutory agent. The Court cited the Ohio Revised Code for the proposition that “[e]ach limited liability company [such as USA Freight] shall maintain continuously in this state an agent for service of process on the company.” See, R.C. 1705.06(A). The Court pointed out that a limited liability company is required to provide the Ohio Secretary of State with a written appointment of its statutory agent that sets forth the name of the agent and the agent’s address in this state. See, R.C. 1705.06(B)(1)(a), (C); and that the Ohio Secretary of State then kept a record of the statutory agent’s name and address. See, R.C. 1705.06(C). The Court noted that Rule 4.2(g) of the Ohio Rules of Civil Procedure provided that, to serve a limited liability company, a plaintiff may direct service of process to “ the agent authorized by appointment or by law to receive service of process”’ that [c]ertified mail service upon such an agent is effective upon delivery, if evidenced by a signed return receipt”; and that Rule 4.1 (A)(1)(a) provided that “[s]ervice is valid if ‘any person’ at the address signs for the certified mail, whether or not the recipient is the defendant’s agent.”

Applying these principles to the facts and circumstances of Judge, the Ohio Court of Appeals noted that Judge had served its complaint on USA Freight’s statutory agent via certified mail at the address on record with the Ohio Secretary of State and that the certified mail was received at the address of USA Freight’s statutory agent and signed for by the mother of the owner of USA Freight. Under these circumstances, the Court concluded that service of the complaint, because the mother of USA Freight’s owner mishandled the complaint, this type of scenario had not been found to constitute “excusable neglect.”

In support of its conclusion, the Court cited the following decision of the United States District Court for the Northern District of Ohio: Chicago Sweetners, Inc. v. Kantner Group, Inc., 2009 WL 1707927 (N.D. Ohio, June 17, 2009) (unpublished decision) (finding no “excusable neglect” where a defendant company was properly served with a complaint via certified mail to its statutory agent’s address, the certified mail was received and signed for by an administrative assistant of the defendant company, who was also the mother of the defendant company’s president, and the mother thereafter mishandled the complaint so that the defendant company never received the notice of it).

In reaching its decision, the Ohio Court of Appeals agree with Judge, that insufficient or negligent internal procedures in an organization may not compromise excusable neglect and that, therefore, they may not support the vacation of a default judgment,” citing, Middleton, supra, and Denittis v. Aaron Costr., Inc., 2012-Ohio-6213, 2012 WL 6738472 (Ohio App., Dec. 31, 2012) (unpublished decision). In so agreeing, the Court stressed that USA Freight was, by law, responsible for maintaining a valid statutory agent that was calculated to receive service of process at the agent’s listed address; that USA Freight has chosen a statutory agent address where it was possible for a non-English-speaking person who was unaffiliated with the company to receive important documentation that was served at the address; and that, due to USA Freight’s negligence in choosing its statutory agent and/or failure to implement internal procedures to ensure that documentation served at the statutory agent’s address was directed to the appropriate person, the complaint at issue was mishandled by the owner’s mother.

The Court emphasized that “excusable neglect” does not result from the party’s own carelessness, inattention, or willful disregard of the processes of the court, but in consequence of some unavoidable or unexpected hindrance or accident; and that, had USA Freight chosen a better statutory agent, or had better procedures in place for receiving service of process at the statutory agent’s address, then the mishandling of the complaint would likely have been avoided.

Accordingly, the Ohio Court of Appeals concluded that the circumstances in Judge did not constitute an unavoidable or unexpected hindrance or accident. In addition, the Court pointed out that, while abuse of discretion was an extremely high standard of review that required the Court to find the trial court’s “excusable neglect” decision unreasonable, the Court, nevertheless, had reached that conclusion. The Court reiterated that the trial court’s decision was unreasonable, because the mishandling of the complaint was the result of USA Freight’s own negligence, and stated that, a company should be adequately prepared to receive service of process at the statutory agent’s address.

Although the Court recognized that Rule 60(B) motions are to be liberally construed in favor of the movant, the Court, nevertheless, found that USA Freight’s negligence in choosing its statutory agent and its procedures for receiving service of process was in willful disregard of the processes of the Court. Therefore, the Court narrowly held that, when a company is required by law to maintain a statutory agent to receive service of process, and when there is successful service of process via certified mail at the statutory agent’s address that is on record with the Ohio Secretary of State, the subsequent mishandling of served documents by the person who signed for and received the documents at the statutory agent’s listed address does not amount to “excusable neglect.”

Conclusion

The Ohio Court of Appeals decision in Judge should serve as a warning to companies and LLCs to check their statutory agent procedures in order to ensure that documents served at their statutory agent’s address are directed to the appropriate person(s); otherwise, they may by subject to enforceable default judgments against them in lawsuits of which they were entirely unaware.

Don’t let this happen to you!

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Six Ways Joint Ownership Could Cost You

by Garrett Sutton, Esq | Jan 6, 2020 | Real Estate, Real Estate Information

Many people use joint ownership (the holding of title by two or more people), without really thinking about it. It is often used as a substitute for estate planning because it is cheaper, which is why some call it the “poor man’s will”. It may seem like a simple and inexpensive way to avoid probate (the costly court review of your transfers at death), but it is not a good idea in most cases, and can be fraught with unexpected peril. Joint property ownership disputes can really cost you.

What Is Joint Ownership?

Joint ownership occurs when the names of two or more people are placed on bank accounts, stocks, bonds, or deeds to real property. Then, when one of the joint tenants die, the surviving joint tenants own the entire property automatically by operation of law, meaning it happens without going to court or requesting any change. When the first joint owner passes, the survivors own it all regardless of the will of the deceased joint tenant.

The Disadvantages of Joint Ownership

Vulnerable to Creditors
Joint ownership property is subject to the claims of a joint owner’s creditors. If one joint owner experiences financial difficulties, then his creditors may be able to reach into his interest in the joint ownership property, creating an unexpected co-owner. This new co-owner could, if they wished, file a partition action to force a sale of the property.
Unexpected Use of Joint Ownership Property
There is nothing to prevent one joint owner from unexpectedly using the joint ownership property for his or her own benefit, thereby eliminating or reducing the value of the joint ownership property to the other owner. For example, you may show up to your vacation home one day and find some unsuspecting B&B guests had it rented to them by the other owner.
Unequal Distributions Among Children
If the parent of three children adds the name of one of her children to a joint ownership property before passing away, the entire property will pass solely to that one child. What starts out as a matter of convenience (i.e. being able to sign on a bank account), could lead to a family battle royale.
Reconveying Joint Ownership Property is Difficult
In order to convey joint ownership property back to the original owner, both joint owners must agree, and must be willing to sign the deed and all of the paperwork. If one owner refuses to do so, then reconveying the property to one owner may require a court order.
The Incapacitation of a Joint Owner Could be Devastating
If one joint owner becomes sick or mentally incapacitated, then it may not be possible to sell the property without the appointment of a guardian and the approval of a probate court. If the sale is approved, the probate court could order that the incapacitated joint owner’s share of the sale be placed in a separate guardianship account to pay for their care, effectively leaving the seller with only one half of the sale proceeds.
Divorce Divisions
If a joint owner is married, then it is possible that a divorce court might regard the joint ownership property as marital property and award all, or a portion of it, to a joint owner’s soon-to-be ex-spouse.

Examples of Joint Ownership Gone Awry

Case No. 1

John and Martha had been married for many years, but John was in the early stages of dementia. He and Martha began drifting apart. They both agreed that John would live in their marital home for the rest of his days and that Martha would live in another state until John died. Then, after John died, Martha would come back to live in their home. This might well have worked out all right for John and Martha, except that, after Martha was gone, John’s neighbor, Willie, saw a way to make some easy money.

Willie befriended John, and eventually talked John into divorcing Martha. Willie kindly helped John fill out all of his divorce paperwork, and convinced John to swear (falsely) in his affidavit that Martha had deserted him and that he did not even know where she was. The divorce court accepted John’s (Willie’s) lies and granted John a divorce from Martha. John was awarded all of the parties’ martial property, including John and Martha’s marital home.

John’s health steadily deteriorated, and a few weeks before John’s death, Willie convinced John to make him a joint owner of his home, so that he could better help John take care of it.

When John died, Willie became the sole owner of the home automatically, and, being the weasel that he was, Willie immediately borrowed $100,000 from a local bank by mortgaging John and Martha’s home, which was now his.

You can imagine Martha’s surprise when she returned to her marital home and discovered that not only was Willie it’s sole owner, but he was now living in it.

Case No. 2 — The Bad Actions of One Joint Owner Costs Both

After Joyce’s husband passed away, her son Dan offered to help her take care of her home. She made him joint owner of the property so that he could do things like pay utilities. Well, Dan was an idealistic man and held many strong beliefs, including that federal income tax was unconstitutional. True to his convictions, and unbeknownst to Joyce, Dan had not paid any federal income tax for the last ten years. Unfortunately for Joyce, the Internal Revenue Service (IRS) got around to investigating Dan’s finances and discovered his joint property interest in Joyce’s home. The IRS asserted a tax lien against Dan’s interest in the jointly owned property and Joyce was forced to pay back all of Dan’s back taxes to the IRS, together with interest and penalties, in order to continue living undisturbed in her own home.

Case No. 3 — The Need for Guardianship Costs Both

Bill and Mary had been married happily for 58 years. They had always owned their home jointly with the understanding that when one of them passed away, the other would receive the home. Unfortunately, a little after her 87th birthday, Mary was diagnosed with Alzheimer’s disease. Bill wanted to do what was best for his wife, so he decided to sell their home so he could provide care for Mary. It would not be that simple. Because Mary was considered mentally incapacitated, Bill had to hire a probate attorney to set up guardianship for Mary and her estate, and appoint himself as the guardian. He then had to hire the attorney again so he could sell the house. When the house was sold, the probate court ordered Bill to set up a separate account for Mary’s half of proceeds, and every time he wanted to use that money for something, he had to hire his expensive probate attorney and petition the court for approval. This was certainly not what Bill and Mary had in mind for their last few years of life.

CONCLUSION

Although joint ownership seems like a simple and inexpensive way to avoid probate, it is littered with traps. Luckily, there are other options such as using a living trust or an LLC for asset protection. Call 800-600-1760 to learn more about protecting your property the right way.

IRS Liens Don’t Die

by Garrett Sutton, Esq | Jan 1, 2020 | Real Estate, Real Estate Information

Beware of Purchasing Real Estate with Unpaid Liens on It

Can the Internal Revenue Service (“IRS”) collect a prior owner’s delinquent federal income taxes from the subsequent purchaser of real property?

Yes.

In Shirehampton Drive Trust v. JP Morgan Chase Bank, N.A., 2019 WL 4773799 (D.Nev., Sept. 29, 2019) (unpublished decision) (Case No. 2:16-cv-02276-RFB-EJY), the United States District Court for the District of Nevada concluded that the IRS was entitled to enforce its federal income tax liens against the new owner of real property.

The Course of Proceedings in Shirehampton

Plaintiff Shirehampton Drive Trust (“Shirehampton”) sued Defendant, United States of America Treasury Department, Internal Revenue Service (“IRS”), and Defendant, JP Morgan Chase Bank, N.A. (“Chase”), seeking a declaration that from the Court that a Las Vegas property that it had obtained at a foreclosure sale in 2013 was not encumbered by Chase’s deed of trust. To that end, Shirehampton asserted claims for injunctive relief, quiet title, and declaratory relief. The IRS removed the case to federal court, and answered and counterclaimed against Shirehampton, and crossclaimed against Chase and other Defendants, to enforce federal tax liens pursuant to 26 U.S.C. §§ 6321, 6322 and 7401. Chase answered the complaint and asserted counterclaims for quiet title under NRS 40.010, declaratory relief under NRS 30.010 and 28 U.S.C. § 2201, and unjust enrichment. Shirehampton answered the counterclaims, and the Court dismissed the other Defendants without prejudice. All three remaining parties then moved for summary judgment. The Court administratively stayed the case pending the Nevada Supreme Court’s decision in SFR Investments Pool 1, LLC v. Bank of New York Mellon, 134 Nev. 438, 422 P.3d 1248 (2018), but then lifted the stay.

The Facts in Shirehampton

This matter concerned a nonjudicial foreclosure on a property located at 705 Shirehampton Drive, Las Vegas, Nevada 89178 (the “property”). The property was located in a community governed by a homeowners’ association (“HOA”) that required its community members to pay dues.

Louisa Oakenell (“Oakenell”) borrowed funds from MetLife Home Loans, a Division of MetLife Bank, N.A. (“MetLife”) to purchase the property in 2008. To obtain the loan, Oakenell executed a promissory note and a corresponding deed of trust to secure repayment of the note. The deed of trust listed Oakenell as the borrower, MetLife as the lender, and Mortgage Electronic Registration Systems, Inc. (“MERS”), as the beneficiary. In May, 2013, MERS assigned the deed of trust to Chase.

Oakenell fell behind on her HOA payments. The HOA, through its agent Red Rock Financial Services, LLC (“Red Rock”), sent Oakenell a demand letter by certified mail for the collection of unpaid assessments on June 26, 2009. On July 21, 2009, the HOA, through its agent, recorded a notice of delinquent assessment lien. The HOA sent Oakenell a copy of the notice of delinquent assessment lien on July 24, 2009. The HOA subsequently recorded a notice of default and election to sell on October 21, 2009, and then a notice of foreclosure sale on September 18, 2012. Red Rock mailed copies of the notice of default and election to sell to Oakenell, the HOA, the IRS, and Metlife Home Loans. Red Rock did not mail a copy of the notice of default and election to sell to MERS. On January 28, 2013, the HOA held a foreclosure sale on the property under NRS Chapter 116. Shirehampton purchased the property at the foreclosure sale, and a foreclosure deed in favor of Shirehampton was recorded.

In addition to falling behind on her HOA payments, Oakenell also stopped paying federal income taxes. The IRS subsequently filed notices of federal tax liens against Oakenell at the Clark County Recorder’s office on May 1, 2009, and June 24, 2009. As of October 1, 2018, Oakenell had accrued $250,953.37 in income tax liability plus daily compounding interest.

The Decision in Shirehampton

The Court concluded that the IRS was entitled to enforce its federal income tax liens against Shirehampton, the new owner of real property, but that Shirehampton acquired the property free and clear of Chase’s deed of trust.

The Rationale of Shirehampton

Chase Deed of Trust.

The Court first addressed whether Shirehampton purchased the property subject to Chase’s deed of trust, and concluded that it did not.

Chase argued that the foreclosure sale was void because the HOA, through its agent, did not comply with the notice requirements of the version of NRS 107.090 in effect at the time by serving a copy of the notice of default and notice of sale on MERS, its predecessor-in-interest. See, NRS 107.090(3)(b) (requiring that any person recording a notice of default mail a copy of the notice within ten days of recording to “[e]ach other person with an interest whose interest or claimed interest is subordinate to the deed of trust.”). The Court disagreed, and found the facts to be substantially similar to the Nevada Supreme Court’s decision in West Sunset 2050 Trust v. Nationstar Mortgage, LLC, 134 Nev. 352, 354-55, 420 P.3d 1032 (2018) (concluding that “Nationstar’s failure to allege prejudice resulting from defective notice dooms its claim that the defective notice invalidates the HOA sale”).

The Court next considered Chase’s argument that the HOA did not intend to foreclose on the superpriority portion of the lien, because the assessment lien notices did not specify that the sale was a superpriority sale. The Court disagreed, and distinguished the Shirehampton case from the recent decision of the Nevada Supreme Court’s in Cogburn Street Trust v. U.S. Bank, N.A., as Trustee to Wachovia Bank, N.A., 2019 WL 2339538 (decided May 31, 2019) (concluding that HOA properly nonjudicially foreclosed on subpriority portion of lien after bank’s tender satisfied superpriority portion of the lien). The Court concluded that Chase’s evidence was insufficient to find that the HOA intended to foreclose on the subpriority portion of the lien as a matter of law, and did not establish fraud, oppression, or unfairness sufficient to void the sale. In addition, the Court noted that it had previously addressed Chase’s further argument regarding the facial unconstitutionality of NRS Chapter 116, and thus incorporated by reference its reasoning in Carrington Mortgage Services, LLC v. Tapestry at Town Center Homeowners Association, 381 F. Supp. 3d 1289, 1294 (D.Nev. 2019). Thus, the Court finds that Chase’s deed of trust was extinguished by the HOA foreclosure sale.

IRS Tax Lien.

The Court next addressed the priority of the IRS tax lien versus that of the HOA’s lien, and concluded that, because the HOA lien was not perfected at the time that the IRS recorded its notice of tax liens, the IRS tax liens had priority over the HOA lien

The Court initially noted that, when the IRS assesses a person for unpaid federal taxes, a lien is created in favor of the United States as a matter of law, citing, 26 U.S.C. § 6321. While the lien is automatically created when the assessment occurs, the lien is not valid against purchasers, holders of security interests, mechanic’s liens, or judgment lien creditors until notice of it has been filed, citing, 26 U.S.C. § 6323(a). Federal tax liens do not automatically have priority over all other liens. Absent a provision to the contrary, priority for purposes of federal law is governed by the common-law principle that the “the first in time is in the first in right”; and a competing state lien exists for “first in time” purposes when it has been perfected, meaning that the identity of the lienor, the property subject to the lien, and the amount of the lien are established, citing, U.S. v. McDermott, 507 U.S. 447, 449, 113 S.Ct. 1526, 123 L.Ed.2d 128 (1993).

Applying these principles to the Shirehampton case, the Court observed that the IRS first assessed Oakenell for lack of income tax payments on November 7, 2005, and July 3, 2006; and that the IRS then recorded its notice of tax liens with the Clark County recorder on May 1, 2009, and June 24, 2009. The Court further observed that Oakenell first became delinquent on her HOA dues on March 1, 2009; that the HOA recorded its notice of delinquent assessment lien on July 21, 2009; and that the HOA mailed Oakenell a copy of the notice of delinquent assessment lien on July 24, 2009.

Despite these facts, Shirehampton argued that the HOA lien was first in time. Shirehampton claimed that, because the notice of delinquent assessment recorded in July, 2009, incorporated delinquent assessments that had been owed since January, 2009, it was technically first in time. Shirehampton pointed to the language of NRS 116.3116 at the time, which stated that the “association has a lien…from the time the…assessment or fine becomes due.” Oakenell did not become delinquent until March 1, 2009, so Shirehampton argued that the HOA lien was perfected on March 1, 2009. The Court disagreed, and found that the HOA lien was not perfected until the notice of delinquent assessment lien was sent to the unit owner, citing, In re Priest, 712 F.2d 1326, 1329 (9th Cir. 1983) (“[A] lien cannot arise prior to the taking of any administrative steps to establish the lien.”). The Court emphasized that the Nevada Supreme Court has held that the mailing of the notice of delinquent assessment lien to the delinquent homeowner pursuant to NRS 116.31162(1)(a) “institutes proceedings to enforce the lien,” quoting, Saticoy Bay LLC Series 2021 Gray Eagle Way v. JPMorgan Chase Bank, N.A., 388 P.3d 226, 231 (2017) (“A party has instituted ‘proceedings to enforce the lien’ for purposes of NRS 116.3116(6) when it provides the notice of delinquent assessment.”). Thus, the Court stressed that providing notice of delinquent assessment is the first administrative step to perfecting a superpriority lien, because “no action can be taken unless and until the HOA provides a notice of delinquent assessments pursuant to NRS 116.31162(1)(a),” quoting, Saticoy Bay LLC Series 2021, supra, 388 P.3d at 231. The Court pointed out that the notice of delinquent assessment also establishes, pursuant to NRS 116.31162(1)(a), the amount of the lien as is required under federal law before a lien can be perfected, citing, Loanstar Mortgagee Services, LLC v. Barker, 282 Fed.Appx. 572, 573 (9th Cir. 2008). While assessments and related fees may be delinquent prior to this mailing, they are not set until the mailing, citing, NRS 116.31162(1)(a) (explaining that notice must contain a set “amount” for the delinquency). The Court reasoned that the mailing of the notice of delinquent assessment was the first administrative step to establish a superpriority lien, and was the first time that the amount of this lien was fixed and set. Thus, the Court found that an HOA lien cannot be perfected under federal law until at least the notice of delinquent assessment lien has been provided to the unit owner. The Court stated that, it is only with this notice that the identity of the lienor, property subject to the lien, and, most significantly, the amount of the lien are sufficiently established.

Applying these principles to the Shirehampton case, the Court observed that Red Rock sent the notice of delinquent assessment lien pursuant to NRS 116.31162(1)(a) to Oakenell on July 24, 2009, which was after the IRS recorded its notice of tax liens. As such, the Court concluded that, because the HOA lien was not perfected at the time that the IRS recorded its notice of tax liens, the IRS tax liens had priority over the HOA lien, citing, LN Management LLC Series 31 Rue Mediterra v. United States Internal Revenue Service, 729 Fed.Appx. 588 (9th Cir. 2018) (finding no record evidence that identity of HOA lienors, property subject to lien, and amount of lien were established before notice of federal tax lien was recorded). The Court concluded that was IRS was entitled to enforce its tax liens against the new owner of the property, citing, U.S .v. Bess, 357 U.S. 51, 57, 78 S.Ct. 105, 42 L.Ed.2d 1135 (1958) (noting that “[t]he transfer of property subsequent to the attachment of [a federal tax lien] does not affect the lien”).

Thus, the Court held that the IRS could enforce its tax liens against Shirehampton, but that Shirehampton acquired the property free and clear of Chase’s deed of trust.

BRIEF DISCUSSION

This case is fairly straightforward; however, it does illustrate the potential difficulties that may ensue from purchasing real property at a foreclosure sale. Obviously, a purchaser of real property at a foreclosure sale must be careful in doing so, because the IRS potentially can collect the prior owner’s federal income taxes from the subsequent purchaser of the real property.

It should be noted that Shirehampton filed a Notice of Appeal to the Ninth Circuit on November 5, 2019.

CONCLUSION

Under some circumstances, the IRS can collect a prior owner’s delinquent federal income taxes from the subsequent purchaser of real property.

U.S. Supreme Court Unanimously Rules: States Can’t Tax Out-of-State Trusts

by Garrett Sutton, Esq | Aug 1, 2019 | Asset Protection Resources, Case Law

Do you live in a high-tax state? Would you be better off having assets in a trust in a state with no taxes? The U.S. Supreme Court just answered the second question with a resounding “Yes” in the Kaestner case. States cannot tax out-of-state trusts. A case summary of this important decision follows:

ISSUE

Can a State lawfully tax the income of a trust merely because a beneficiary of the trust lives in the State?

APPLICABLE LAW

In North Carolina Department of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust, 588 U. S. _ (2019) WL 2552488 (decided June 21, 2019), the United States Supreme Court unanimously conclude that the North Carolina state residence of a trust beneficiary did not supply the minimum connection with North Carolina to support the State’s imposition of tax on trust income, and thus the State’s tax as applied to the trust violated the Due Process Clause of the United States Constitution.

The Decision in Kaestner

Justice Sotomayor delivered the opinion for a unanimous Court, and Justice Alito filed a concurring opinion, in which Justices Roberts and Gorsuch joined.

The court stated that this case was about the limits of a State’s power to tax a trust, and observed that North Carolina imposes a tax on any trust income that “is for the benefit of” a North Carolina resident. The court noted that the North Carolina courts interpret this law to mean that a trust owes income tax to North Carolina whenever the trust’s beneficiaries live in the State, even if—as was the case here—those beneficiaries received no income from the trust in the relevant tax year, had no right to demand income from the trust that year, and could not count on ever receiving income from the trust.

However, the Court pointed out that, even the North Carolina courts held the tax to be unconstitutional when assessed in such a case, because the State lacked the minimum connection with the object of its tax that the Constitution requires. The Court agreed, and affirmed the decision of the North Carolina courts, because, as applied in these circumstances, the Court concluded that the State’s tax violated the Due Process Clause of the Fourteenth Amendment.

The Facts in Kaestner

Originally, the precursor of the trust in question was formed nearly 30 years ago when New Yorker Joseph Lee Rice III formed a trust for the benefit of his children. Rice decided that the trust would be governed by the law of his home State, New York, and he appointed a fellow New York resident as the trustee, who was later succeeded by a Connecticut resident as trustee.

The trust agreement provided that the trustee would have “absolute discretion” to distribute the trust’s assets to the beneficiaries in such amounts and proportions as the trustee might from time to time decide. When Rice created the trust, no trust beneficiary lived in North Carolina. That changed in 1997, when Rice’s daughter, Kimberley Rice Kaestner, moved to the State. She and her minor children were residents of North Carolina from 2005 through 2008, the time period relevant for this case.

A few years after Kaestner moved to North Carolina, the trustee divided Rice’s initial trust into three subtrusts. One of these subtrusts—the Kimberley Rice Kaestner 1992 Family Trust (the “Kaestner Trust”)—was formed for the benefit of Kaestner and her three children. The same agreement that controlled the original trust also governed the Kaestner Trust. Critically, this meant that the trustee had exclusive control over the allocation and timing of trust distributions.

North Carolina admitted in the state-court proceedings that the State’s only connection to the Trust in the relevant tax years was the in-state residence of the Trust’s beneficiaries. From 2005 through 2008, the trustee chose not to distribute any of the income that the Trust accumulated to Kaestner or her children, and the trustee’s contacts with Kaestner were “infrequent”; there were only two meetings between Kaestner and the trustee I those years, both of which took place in New York.

The trustee also gave Kaestner accounts of trust assests and legal advice concerning the Trust. The Trust was subject to New York law; the grantor was a New York resident; and no trustee lived in North Carolina. The trustee kept the Trust documents and records in New York, and the Trust asset custodians were located in Massachusetts.

The Trust also maintained no physical presence in North Carolina, made no direct investments in the State, and held no real property there. The Trust agreement provided that the Kaestner Trust would terminate when Kaestner turned 40, after the time period relevant here. After consulting with Kaestner and in accordance with her wishes, however, the trustee rolled over the assets into a new trust instead of distributing them to her. This transfer tool place after the relevant tax years.

Between 2005 and 2008, North Carolina required the Connecticut trustee to pay more than $1.3 million in taxes on income earned by the assets in the Kaestner Trust. North Carolina levied this tax solely because of Kaestner’s residence within the State.

Course of Proceedings in Kaestner

The Court noted that North Carolina taxes any trust income that “is for the benefit of” a North Carolina resident, and that the North Carolina Supreme Court interprets the statute to authorize North Carolina to tax a trust on the sole basis that the trust beneficiaries reside in the State. Applying this statute, the North Carolina Department of Revenue assessed a tax on the full proceeds that the Kaestner Trust accumulated for tax years 2005 through 2008 and required the trustee to pay it. The resulting tax bill amounted to more than $1.3 million.

The trustee paid the tax under protest and then sued in state court, arguing that the tax as applied to the Kaestner Trust violated the Due Process Clause of the Fourteenth Amendment. The trial court decided that the Kaestner’s residence in North Carolina was too tenuous a link between the State and the Trust to support the tax and held that the State’s taxation of the Trust violated the Due Process Clause.

The North Carolina Court of Appeals affirmed, as did the North Carolina Supreme Court. A majority of the State Supreme Court reasoned that the Kaestner Trust and its beneficiaries “have legally separate, taxable existences” and thus that the contacts between the Kaestner family and their home State cannot establish a connection between the Trust “itself” and the State. The Court granted certiorari to decide whether the Due Process Clause prohibits States from taxing trusts based only on the in-state residency of trust beneficiaries.

The Rationale in Kaestner

Initially, the Court noted that, in its simplest form, a trust is created when one person (a “settlor” or “grantor”) transfers property to a third party (a “trustee”) to administer for the benefit of another (a “beneficiary”). As traditionally understood, the arrangement that results is not a distinct legal entity, but a fiduciary relationship between multiple people.

The trust comprises the separate interests of the beneficiary, who has an equitable interest in the trust property, and the trustee, who had a legal interest in that property. In some contexts, however, trusts can be treated as if the trust itself has a separate existence from its constituent parts, and that trusts are treated as distinct entities for federal taxation purposes.

The court noted that the Due Process Clause provides that “[n]o State shall…deprive any person of life, liberty, or property, without due process of law.” The Court pointed out that the Clause centrally concerns the fundamental fairness of governmental activity; and that in the context of state taxation, the Due Process Clause limits States to imposing only taxes that bear fiscal relation to protection, opportunities, and benefits given by the state. The Court observed that the power to tax is essential to the very existence of government, but cautioned that the legitimacy of that power requires drawing a line between taxation and mere unjustified confiscation.

The Court concluded that the boundary turns on the simple but controlling question whether the state has given anything for which it can ask return. In this regard, the Court applied a two-step analysis to decide if a state tax abides by the Due Process Clause. First, there must be some definite link, some minimum connection, between a state and the person, property, or transaction it seeks to tax. Second, the income attributed to the State for tax purposes must be rationally related to values connected with the taxing State.

To determine whether a State has the requisite “minimum connection” with the object of its tax, the Court borrowed from the familiar test of International Shoe Co. v. Washington, 326 U.S. 310, 66 S.Ct. 154, 90 L.ED. 95 (1945). Thus, a State has the power to impose a tax only when the taxed entity has certain “minimum contacts” with the State such that the tax does not offend “traditional notions of fair play and substantial justice.” The Court stated that the “minimum contacts” inquiry is flexible and focuses upon the reasonableness of the government’s action. Ultimately, only those who derive benefits and protection from associating with a State should have obligations to the State in question.

The Court noted it had already held that a tax on trust income distributed to an in-state resident passes muster under the Due Process Clause, as does a tax based on a trustee’s in-state residence (this is a planning opportunity for creating Nevada based trusts, where there are no state taxes). The Court also suggested that a tax based on the site of trust administration was constitutional. However, the Court carefully distinguished the Kaestner Trust upon the following grounds: (1) the Kaestner Trust made no distributions to any North Carolina resident in the years in question; (2) the trustee resided out of State; (3) the Trust administration was spilt between New York (where the Trust’s records were kept) and Massachusetts (where the custodians of its assets were located); (4) the trustee made no direct investments in North Carolina in the relevant tax years; and (5) the settlor did not reside in North Carolina. The Court emphasized that of all the potential kinds of connections between a trust and a State, North Carolina sought to rest its tax on just one—the in-state residence of the beneficiaries.

For these reasons, the Court held that the presence of in-state beneficiaries alone did not empower a State to tax trust income that had not been distributed to the beneficiaries where the beneficiaries had no right to demand that income and were uncertain ever to receive it. In limiting its holding to the specific facts presented, the Court did not imply approval or disapproval of trust taxes that were premised on the residence of beneficiaries whose relationship to trust assets differed from that of the beneficiaries here.

In discussing its holding, the Court noted that, in the past, it had analyzed state trust taxes for consistency with the Due Process Clause by looking to the relationship between the relevant trust constituent (settlor, trustee, or beneficiary) and the trust assets that the State sough to tax. In the context of beneficiary contacts specifically, the Court noted that it had focused upon the extent of the in-state beneficiary’s right to control, possess, enjoy or receive trust assets. The Count pointed out that its emphasis on these factors emerged in the following two early cases: (1) Safe Deposit & Trust Co. of Baltimore v. Virginia, 280 U.S. 83, 50, S.Ct. 59, 74 L.Ed. 180 (1929) (rejecting Virginia’s attempt to tax a trustee on the whole corpus of the trust estate, and explaining that nobody within Virginia had the present right to the trust property’s control or possession, or to receive income therefrom); and (2) Brooke v. Norfolk, 277 U.S. 27, 48 S.Ct. 422, 72 L.Ed. 767 (1928) (rejecting a tax on the entirety of a trust fund assessed against a resident beneficiary because the trust property was no within the State, did not belong to the beneficiary, and was not within her possession or control).

Both of these cases invalidated state taxes premised on the in-state residency of beneficiaries, and in each of these cases, the challenged tax fell on the entirety of a trust’s property, rather than on only the share of trust assets to which the beneficiaries were entitled. On the other hand, the Court noted that the same elements of possession, control, and enjoyment of trust property had let it to uphold state taxes based upon the in-state residency of beneficiaries who did have close ties to the taxed trust assets, and where the trust income actually was distributed to an in-state beneficiary. The Court states that, in those circumstances, the beneficiary owned and enjoyed an interest in the trust property, and the State could exact a tax in exchange for offering the beneficiary protection.

The Court observed that its past cases reflected a common governing principle, i.e., when a State seeks to base its tax on the in-state residence of a trust beneficiary, the Due Process Clause demands a pragmatic inquiry into what exactly the beneficiary controls or possesses and how that interest relates to the object of the State’s tax. Although the Court stated that its resident-beneficiary cases were most relevant here, similar analysis also appeared in the context of taxed premised on the in-state residency of settlors and trustees; and that a focus on ownership and rights to trust assets also featured in the Courts; ruing that a trustee’s in-state residency can provide the basis for a state to tax trust assets.

In summary, the Court concluded that, when assessing a state tax premised on the in-state residency of a constituent of a trust—whether beneficiary, settlor, or trustee—the Due Process Clause demands attention to the particular relationship between the resident and the trust assets that the State seeks to tax. Because each individual fulfills different functions in the creation and continuation of the trust, the specific features of that relationship sufficient to sustain a tax may vary depending on whether the resident is a settlor, beneficiary, or trustee. However, when a tax is premised on the in-state residence of a beneficiary, the Constitution requires that the resident have some degree of possession, control, or enjoyment of the trust property, or a right to receive that property, before the State can tax the asset; otherwise, the State’s relationship to the object of its tax is too attenuated to create the “minimum connection” that the constitution requires.

Applying these principles to the Kaestner Trust, the Court concluded: (1) the residence of the Kaestner Trust beneficiaries in North Carolina alone did not supply the minimum connection necessary to sustain the State’s tax; (2) the beneficiaries did not receive any income from the trust during the years in question (if they had, such income would have been taxable); (3) the beneficiaries had no right to demand trust income or otherwise control, possess, or enjoy the trust assets in the tax years at issue; (4) the decision of when, whether, and to whom the trustee would distribute the trust’s assets was left to the trustee’s “absolute discretion”; (5) the Trust agreement explicitly authorized the trustee to distribute funds to one beneficiary to the exclusion of others, with the effect of cutting one or more beneficiaries out of the Trust; (6) the Trust Agreement authorized the trustee, not the beneficiaries, to make investment decisions regarding Trust property, thus making the beneficiaries’ interest less like a potential source of wealth that was property in their hands; (7) not only were Kaestner and her children unable to demand distributions in the tax years at issue, but they also could not count on necessarily receiving any specific amount of income from the Trust in the future; (8) Kaestner and her children had no right to control or possess the trust assets or to receive income therefrom; and (9) Kaestner and her children received no income from the Trust, had no right to demand income from the Trust, and had no assurance that they would eventually receive a specific share of Trust income. The Court concluded that, given these features of the Kaestner Trust, the beneficiaries’ residence could not, consistent with due process, serve as the sole basis for North Carolina’s tax on trust income. For these reasons, the Court affirmed the judgment of the Supreme Court of North Carolina.

Justice Alito’s Concurring Opinion

Justice Alito noted that he joined the opinion of the Court because he believed that it properly concluded that North Carolina’s tenuous connection to the income earned by the trust was insufficient to permit the State to tax the trust’s income. However, he cautioned that, because this connection was unusually tenuous, the opinion of the Court was circumscribed. He stated that he wrote separately to make clear that the opinion of the Court merely applies its existing precedent and that its decision not to answer questions not presented by the facts of this case did not open for reconsideration any points resolved by its prior decisions.

Justice Alito observed that, although states have broad discretion to structure their tax systems, in a few narrow areas the Federal Constitution imposes limits on that power. The Due Process Clause creates one such limit. It imposes restrictions on the persons and property that a State can subject to its taxation authority. The Due Process Clause requires some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax. North Carolina assesses this tax against the trustee and calculates the tax based on the income earned by the trust. Therefore, it is necessary to look at the connections between the assets held in trust and the State.

Justice Alito pointed out that it is easy to identify a State’s connection with tangible assets. A tangible asset has a connection with the State in which it is located, and generally speaking, only that State has power to tax the asset. However, intangible assets–stocks, bonds, or other securities–present a more difficult question. In the case of intangible assets held in trust, Justice Alito noted that the Court previously had focused upon whether a resident of the State imposing the tax has control, possession, or the enjoyment of the asset. Because a trustee is the legal owner of the trust assets and possesses the powers that accompany that status–power to manage the investments, to make and enforce contracts respecting the assets, and to litigate on behalf of the trust–the trustee’s State of residence can tax the trust’s intangible assets. On the other hand, the Court now was being asked whether the connection between a beneficiary and a trust is sufficient to allow the beneficiary’s State of residence to tax the trust assets and the income they earn while the assets and income remain in the trust in another State.

Justice Alito stated that the following two cases provide a clear answer: (1) Brooke, supra; and (2) Safe Deposit, supra.

In Brooke, supra, Virginia assessed a tax on the assets of a trust whose beneficiary was a resident of Virginia. The trustee was not a resident of Virginia and administered the trust outside the Commonwealth. Under the terms of the trust, the beneficiary was entitled to all the income of the trust and had paid income taxes for the money that had been transferred to her. But the Court held that, despite the beneficiary’s present and ongoing right to receive income from the trust, Virginia could not impose taxes on the undistributed assets that remained within the trust because the property was not within the State, did not belong to the petitioner, and was not within her possession or control. Even though the beneficiary was entitled to and received income from the trust, the Court observed that she was a stranger to the assets within the trust because she lacked control, possession, or enjoyment of them.
In Safe Deposit, supra, Virginia again attempted to assess taxes on the intangible

assets held in a trust whose trustee resided in Maryland. The beneficiaries were children who lived in Virginia. Under the terms of the trust, each child was entitled to one half of the trust’s assets (both the original principal and the income earned over time) when the child reached the age of 25. Despite their entitlement to the entire corpus of the trust, the Court held that the beneficiaries’ residence did not allow Virginia to tax the assets while they remained in trust, and noted that nobody within Virginia had the present right to the assets’ control or possession, or to receive income therefrom, or to cause them to be brought physically within her borders. The Court concluded that the beneficiaries’ equitable ownership of the trust did not sufficiently connect the undistributed assets to Virginia as to allow taxation of the trust, and that the beneficiaries’ equitable ownership yielded to the established fact of legal ownership, actual presence, and control elsewhere.

Justice Alito pointed out that in Kaestner, as in Brooke and Safe Deposit, the resident beneficiary had neither control nor possession of the intangible assets in the trust. She did not enjoy the use of the trust assets. The trustee administered the trust and held the trust assets outside the State of North Carolina. Justice Alito stressed that, under Safe Deposit and Brooke, that was sufficient to establish that North Carolina could not tax the trust or the trustee on the intangible assets held by the Kaestner Trust.

In summary, Justice Alito concluded that the Due Process Clause requires a sufficient connection between an asset and a State before the State can tax the asset. For intangible assets held in trust, the Court’s precedents dictate that a resident beneficiary’s control, possession, and ability to use or enjoy the asset are the core of the inquiry. Justice Alito stated that the opinion of the Court rightly concluded that the assets in the Kaestner Trust and the Trust’s undistributed income could not be taxed by North Carolina because the resident beneficiary lacked control, possession, or enjoyment of the Trust assets. Justice Alito emphasized that the Court’s discussion of the peculiarities of the Kaestner trust did not change the governing standard, nor did it alter the reasoning applied in the Court’s earlier cases. On that basis, he concur with the Court’s opinion.

BRIEF DISCUSSION

The gist of Kaestner was that a State cannot tax trust income merely because a beneficiary of the trust lives in that State; however, the discussion in Kaestner also provides some indication as to when it may be permissible for a state to tax the income of a trust. The following is a list of some of the factors to be considered:

Income Distributed to an In-State Resident. The Court noted that the in-state beneficiaries in Kaestner did not receive any income from the trust during the years in question; and that, if they had, then such income would have been taxable. The Court further noted that it had already held that a tax on trust income distributed to an in-state resident passes muster under the Due Process Clause. The court emphasized that, not only were Kaestner and her children unable to demand distributions in the tax years at issue, but they also could not count on necessarily receiving any specific amount of income from the Trust in the future; they had no right to control or possess the trust assets or to receive income therefrom; they received no income from the Trust; they had no right to demand income from the Trust; and they had no assurance that they would eventually receive a specific share of the Trust income.
Residence of Trustee. The Court noted that a tax based on a trustee’s in-state Residence also passes muster under the Due Process Clause.
Site of Trust Administration. The Court suggested that a tax based on the site of trust administration was constitutional.
Residence of Grantor/Settlor. The Court concluded that, although the residence of the grantor/settlor of a trust is an important factor to be considered, the mere fact that the grantor/settlor of a trust lives in the taxing state may not, in and of itself, be sufficient to support taxation of the trust.
Control, Possession, and Ability to Use or Enjoy Intangible Asset. The Court noted that the beneficiaries had no right to demand trust income or otherwise control, possess, or enjoy the trust assets in the tax years at issue. Justice Alito’s concurring opinion also emphasized that, for intangible assets held in trust, the Court’s precedents dictate that a resident beneficiary’s control, possession, and ability to use or enjoy the asset are the core of the inquiry.
Trustee’s Exclusive Control. The Court noted that the Trust agreement provided that the Trustee would have “absolute discretion” to distribute the trust’s assets to the beneficiaries in such amounts and proportions as the trustee might from time to time decide; that the Trustee’s exclusive control over the allocation and timing of trust distributions was “critical”; that the Trust agreement explicitly authorized the trustee to distribute funds to one beneficiary to the exclusion of others, with the effect of cutting one or more beneficiaries out of the Trust; and that the decision of when, whether, and to whom the Trustee would distribute the Trust’s assets was left to the Trustee’s “absolute discretion.” The Court stressed that the Trust Agreement authorized the Trustee, not the beneficiaries, to make investment decisions regarding Trust property, which made the beneficiaries’ interest less like a potential source of wealth that was property in their hands.
Trust Not Subject to Governing Law. The Court noted that the Trust was formed under New York law, and not under North Carolina law, and that the Trust was subject to New York law.
Physical Location of Trust Records. The Court indicated that the Trustee kept the Trust documents and records in New York, and not in North Carolina.
Physical Location of Asset Custodians. The Court indicated that the Trust asset custodians were located in Massachusetts, and not in North Carolina.
No Direct Investments in Taxing State. The Court noted that the Trust maintained no physical presence in North Carolina, made no direct investments in the State, and held no real property there.
Number of Meetings Between Trustee and Beneficiary. The Court noted that the Trustee’s contacts with Kaestner were “infrequent”; therefore, the number of meetings between the trustee and the beneficiary may be relevant.
Geographic Location of Meetings Between Trustee and Beneficiary. The Court noted that there were only two meetings between Kaestner and the Trustee, both of which took place in New York; therefore, the geographic location of trustee/beneficiary meetings may be important.
Termination of Trust at Specified Age. The Court noted that the Trust agreement provided that the Kaestner Trust would terminate when Kaestner turned 40; but that, after consulting with Kaestner, and in accordance with her wishes, and after the relevant tax years, the Trustee rolled over the assets into a new trust instead of distributing them to her. Thus, it would seem that drafting a trust as long-term trust, or even as perpetual trust, would be a safer option.

CONCLUSION

Although the decision in Kaestner generally was a favorable decision for taxpayers, it was, by its terms, a very narrow holding. The Court concluded that the residence of the Trust beneficiaries in North Carolina alone did not supply the minimum connection necessary to sustain the State’s tax; and could not, consistent with due process, serve as the sole basis for North Carolina’s tax on trust income. For these reasons, the Court affirmed the judgment of the Supreme Court of North Carolina. As noted by the concurring opinion of Justice Alito, for intangible assets held in trust, the Court’s precedents dictate that a resident beneficiary’s control, possession, and ability to use or enjoy the asset are the core of the inquiry.

Are Individuals Protected Within Their LLC?

by Garrett Sutton, Esq | May 1, 2019 | C Corps / S Corps, Case Law, Maintaining Your LLCs, Running a Business

New Texas Case Sends Shock Waves

LLCs are set up to make personal assets inaccessible for any obligations of the entity. Protection may be lost, however, if you are not aware of your personal conduct when managing business through your LLC. The case below deals with water and environmental issues, an area where governments like to hold individuals liable.

In State v. Morello, the Texas Supreme Court recently found that an agent or a member of an LLC can be found personally liable for any violation of statutes or regulations.

In Morello, the State of Texas brought a civil action under the Texas Water Code against both Bernard Morello and his single member entity, White Lion Holdings, LLC (White Lion).

In 2004, Morello purchased a piece of property that was subject to a hazardous waste permit and compliance plan under the Texas Commission of Environmental Quality (TCEQ). After the purchase, Morello assigned the TCEQ compliance plan and all other property interests from his own name into White Lion.

In hindsight, Morello should have first taken title in the LLC, as he would have removed his individual name from the chain of title. Once your name is associated with the title to environmental problems, you can be held personally responsible for the remediation and cleanup.

Over time, the obligations were not performed, and the state decided to press charges against both White Lion and Morello for violating the TCEQ compliance plan.

The state’s argument for targeting Morello as an individual rested on section 7.102 of the Texas Water Code stating that any “person who codifies, suffers, allows, or permits a violation of a statute…within the [TCEQ’s] jurisdiction…shall be assessed” civil penalties.

Morello’s argument depended on a section of the Texas Business Organizations Code which states that, “a member…is not liable for a debt, obligation, or liability of a limited liability company.”

Morello eventually worked its way up to the Texas Supreme Court. The high court ultimately ruled in favor of the State, writing that “the State’s position is not based on the Business Organizations Code; it is based on the Water Code.” The Texas Supreme Court also found Morello personally liable on three primary arguments.

First, the Court found no reason whatsoever to exclude an individual from the term “person” from section 7.102. Second, the Court found that White Lion being the sole owner and being solely responsible for the compliance plan was immaterial. Third, the Court cited cases stating that a corporate agent may not escape individual liability where that agent “personally participated in the wrongful conduct,” citing that Morello’s actions were in his capacity as an agent and member of White Lion.

The Court’s opinion stated that where a statute applies to any “person,” an “individual cannot use the corporate form as a shield when he or she has personally participated in conduct that violates the statute.”

Haven’t We Seen This Before?

Federal and state courts have consistently rejected the position that where an environmental statute applies to a “person,” corporate officers can avoid individual liability for violating a statute if they personally participated in the wrongful conduct:

Riverside Mkt. Dev. Corp. v. Int’l Bldg. Prods., Inc., 931 F.2d 327, 330 (5th Cor. 1991) (concluding that the federal act “prevents individuals from hiding behind the corporate shield” when they “actually participate in the wrongful conduct”)
U.S. v. Ne. Pharm. & Chem. Co., 810 F.2d 726, 745 (8th Cir. 1986), cert. denied, 484 U.S. 848 (1987) (“[I]mposing liability upon only the corporation, but not those corporate officers and employees who actually make corporate decisions, would be inconsistent with Congress’ intent to impose liability upon the persons who are involved in the handling and disposal of hazardous substances.”)
T.V. Spano Bldg. Corp. v. Dep’t pf Natural Res. & Envtl. Control, 628 A.2d 53,61 (Del. 1993) (concluding that the State could impose personal liability on an officer who “directed, ordered, ratified, approved, or consented to the improper disposal”)
People ex. Rel. Burris v. C.J.R. Processing, Inc., 647 N.E.2d 1035, 1039 (Ill. App. Ct. 1995) (“[C]orporate officers may be held liable for violations of the [state environmental act] when their active participation or personal involvement is shown.”).

While these cases involved different statutes than the one at issue here, it is important to know that under an environmental regulation applicable to a ‘person,’ an individual cannot use the corporate form as a shield when he or she has personally participated in conduct that violates the statute.

And Morello was not held liable for a debt, obligation, or liability of White Lion as he asserts is prohibited by the Business Organizations Code. See Tex. Bus. Orgs. Code § 101.114. Rather, he was held individually liable based on his individual, personal actions.

The Morello case is groundbreaking and could have a ripple effect across Courts in the United States. It is important for people to be aware of their behavior when acting as a member or an agent of an LLC, even before the entity is formed. This recent Texas case demonstrates that in certain specific circumstances individual persons may be found personally liable for any wrongdoing.

Ted Sutton is a graduate of the University of Utah. He will be attending Law School at the University of Wyoming in the Fall of 2019.

Case Study: Florida Single Member LLC’s and Charging Orders

by Garrett Sutton, Esq | Apr 1, 2019 | C Corps / S Corps, Case Law, Charging Order

When it comes to charging orders, the key asset protection feature of LLC’s and LP’s, there are two opposing trends.

First, some states do not provide charging order protection for a single member (one owner) LLC. The rationale is that the charging order exists to protect innocent partners, the people who were not sued by someone trying to reach their partner’s assets.

The second trend is to protect even single owners from an outside attack with a charging order. The states of Wyoming, Nevada and Delaware offer this strong protection in their state statutes. Everyone thought Florida offered strong protection until the Olmstead case was decided. The federal government was going after the single member LLC assets of a scamster named Olmstead.

The Florida Supreme Court, wanting to accommodate their government brethren found a way to declare multi member LLC’s protected by the charging order but not single member LLC’s. And so the feds were able to reach Olmstead’s assets.

But Florida law has been a bit confused ever since.

The Pansky Case

In Pansky v. Barry S. Franklin & Associates, P.A. (Fla. 4th DCA, Feb. 13, 2019), a judgment creditor brought a motion for a charging order and for transfer of the judgment debtor’s interest in an LLC. The trial court authorized both the charging order and transfer of the judgment debtor’s interest. The judgment debtor appealed, and the District Court of Appeal for the Fourth District reversed and remanded, holding that the exclusive statutory remedy available to a judgment creditor as to a judgment debtor’s interest in the LLC was a charging order.

More specifically, the Court of Appeal concluded that the exclusive statutory remedy available to a judgment creditor as to a judgment debtor’s interest in an LLC was a charging order, and that the trial court’s order transferring right, title, and interest in the LLC to the judgment creditor exceeded the allowable scope, at least where there was a factual dispute was whether judgment debtor was the sole member of the LLC.

The Facts of Pansky

The underlying facts in Pansky show that the law firm had previously represented Pansky in a divorce proceeding. The law firm withdrew as counsel, claiming it was owed attorney’s fees that Pansky had not paid. The law firm obtained monetary judgments for the claimed fees and attempted to collect on the judgments by filing a motion for a charging order against Daniel Pansky, LLC, in which Pansky had an ownership interest.

The law firm also sought transfer of Pansky’s ownership interest in the LLC to the law firm. Pansky conceded that the law firm was entitled to entry of a charging order, but objected to any transfer of his ownership interest in the LLC.

The trial court held a hearing on the law firm’s motion and orally ruled that, based on Pansky’s concession, an agreed order granting a charging order would be entered. The court stated that it would reserve ruling on any additional relief beyond a charging order that the law firm requested. The trial court entered a written order granting the charging order; however, the trial court also transferred Pansky’s “right, title, and interest” in the LLC. It is from this latter order that Pansky appealed.

The Rationale in Pansky

The District Court of Appeal for the Fourth District noted that above-quoted Section 605.0503(3), Florida Statutes, provides that a charging order is the sole and exclusive remedy by which a judgment creditor of a member or member’s transferee may satisfy a judgment from the judgment debtor’s interest in a limited liability company or rights to distributions from the limited liability company; and that above-quoted Section 605.0503(1) provides that a charging order constitutes a lien upon a debtor’s transferable interest and requires the LLC to pay over to the judgment creditor a distribution that would otherwise be paid to the judgment debtor.[1]

The Court of Appeal found that a factual dispute existed as to whether Pansky was the sole member of the LLC. Pansky maintained that it was a two-member LLC, such that only a charging order was authorized, and the law firm contended that Pansky was the sole member.

The Court of Appeal observed that, at the hearing on the law firm’s motion, the trial court stated, “I don’t have enough in front of me to show it’s a one-member LLC that I can give you-all [sic] that other relief. But since there’s no opposition to the entry of the charging order, that’s granted.”

As such, the trial court stated it would “reserve jurisdiction on the other prayers for relief, such as [a freeze order] and transferring Mr. Pansky’s ownership interest” until the factual disputes were determined at a later proceeding. The law firm contended that the trial court’s order did not make a transfer of conveyance of property or assets.

The firm asserted that the order merely adjudicated the law firm’s entitlement to a charging order. The Court of Appeal found this argument unconvincing, and stated that the trial court’s order plainly contained language transferring Pansky’s “Right, title and interest” in the LLC to the law firm.

The Court of Appeal disagreed with the trial court, and concluded that the trial court’s order plainly contained language transferring Pansky’s “right, title, and interest” in the LLC to the law firm and went beyond granting a charging order–as was agreed to by the parties and authorized by statute. The Court of Appeal noted that in Abukasis v. MTM Finest, Ltd., 199 So.3d 421, 422 (Fla. 3d DCA 2016), the District Court of Appeal for the Third District reversed a trial court’s order which transferred the appellant’s “membership interest” in an LLC toward the satisfaction of a debt, finding no authority for an order directly transferring an interest in property to a judgment creditor in partial or full satisfaction of a money judgment, and stating that the trial court failed to conform with even the most rudimentary requirements of Section 605.0503.

The Court of Appeal further noted that, in McClandon v. Dakem & Assocs., LLC, 219 So.3d 269, 271 (Fla. 5th DCA 2017), the District Court of Appeal for the Fifth District explained that a charging order should only divest a debtor of his or her economic opportunity to obtain profits and distributions from the LLC, and should charge only the debtor’s membership interest, and not managerial rights. The Court of Appeal further noted that, in Capstone Bank v. Perry-Clifton Enter., LLC, 230 So.3d 970, 971 (Fla. 1st DCA 2017), the District Court of Appeal for the First District explained that a charging order instructs the entity to give the creditor any distributions that would otherwise be paid to the member of the entity.

Because the Court of Appeal found that the trial court’s order went beyond granting a charging order, as was agreed to by the parties and authorized by statute, the Court of Appeal reversed and remanded the case to the trial court.

Discussion

It would appear that the opinion of the District Court of Appeal for the Fourth District did not go far enough. Section 605.0503(4), Florida Statutes, provides:

“(4) In the case of a limited liability company that has only one member, if a judgment creditor of a member or member’s transferee establishes to the satisfaction of a court of competent jurisdiction that distributions under a charging order will not satisfy the judgment within a reasonable time, a charging order is not the sole and exclusive remedy by which the judgment creditor may satisfy the judgment against a judgment debtor who is the sole member of a limited liability company or the transferee of the sole member, and upon such showing, the court may order the sale of that interest in the limited liability company pursuant to a foreclosure sale. A judgment creditor may make a showing to the court that distributions under a charging order will not satisfy the judgment within a reasonable time at any time after the entry of the judgment and may do so at the same time that the judgment creditor applies for the entry of a charging order.”

If the trial court truly believed that the LLC had only one member, rather than two members, and relied upon the provisions of Section 605.0503(4), then the trial court perforce should have adduced evidence that distributions under the charging order would not satisfy the judgment within a reasonable time. The trial court did not do so.

Although the Court of Appeal tacitly concurred with the District Court of Appeal for the Third District in Abukasis, supra, 199 So.3d at 422, that the trial court failed to conform with even the most rudimentary requirements of Section 605.0503, the Court of Appeal failed specifically to note the trial court’s failure to comply with the explicit provisions of Section 605.0503(4).

Conclusion

Thus, in Florida, it is safe to say that charging order protection is the exclusive remedy available to a judgment creditor of an LLC, at least where there is a factual dispute as to whether the judgment debtor is the sole member of the LLC.

[1]The Court of Appeal carefully distinguished single-member LLCs, and pointed out that above-quoted Section 605.0503(4) provides that, for single-member LLCs, a charging order is “not the sole and exclusive remedy by which the judgment creditor may satisfy the judgment”; rather, in the case of a single-member LLC, “if a judgment creditor of a member or member’s transferee establishes to the satisfaction of a court of competent jurisdiction that distributions under a charging order will not satisfy the judgment within a reasonable time … upon such showing, the court may order the sale of that interest in the limited liability company pursuant to a foreclosure sale.”

Sales Taxes are a Big Issue in 2019

by Garrett Sutton, Esq | Jan 1, 2019 | C Corps / S Corps, Running a Business

Businesses With E-Commerce, We’re Talking To You

What You Should Know About Internet Sales and the South Dakota v. Wayfair, Inc. Case

Sales tax policy has changed dramatically within the past year, thanks to the Supreme Court ruling of South Dakota v. Wayfair, Inc. The Court overruled a ‘physical presence’ rule that prevented states from taxing remote sales, such as internet purchases. The standard now is ‘economic nexus’, or how much is sold into a state whether there is a physical presence (i.e. stores or employees) or not. Given the rapid increase of e-commerce within the past decade, this ruling will have a monumental impact on state sales tax revenue in the near future. It will also require all online sellers to collect and remit sales taxes to states across the country.

In December of 2017, the U.S. Government Accountability Office (GAO) released a report which estimated that only 14%-33% of online marketplace transactions are subject to sales tax. Under the Wayfair ruling, states should see a large increase in their sales tax revenue once states start taxing online purchases.

The Wayfair ruling has resulted in a snowball effect, where state legislatures have acted quickly to implement remote sales taxation. In 2017, only nine states had remote taxation laws. By the end of 2019, that number will swell to 31 states. By 2020, there is a possibility that all 50 states will have remote taxation laws.

If you sell anything over the internet this new standard affects you and your business. It is important to note that each state will allow exemptions to smaller out-of-state sellers, with most states exempting remote sellers with fewer than $100,000 in sales or fewer than 200 transactions in the previous calendar year. But some states hold that once you cross their threshold you must start collecting their sales tax the very next day.

Given how technology has grown rapidly and sales tax collection has not, the Wayfair case will be a benchmark as it will inevitably bridge the gap between the two.

In other related developments, Ohio now allows taxpayers to pay any taxes with bitcoin, with other states considering cryptocurrency payment options. Chicago now taxes streaming services such as Netflix and Hulu. Iowa is beginning to tax digital products, such as digital audio, digital books, and pay television. Iowa also taxes personal transportation services such as Lyft and Uber.

As tax policy is ever changing, we will keep you updated on future developments.

Do Land Trusts Provide Asset Protection?

by Garrett Sutton, Esq | Sep 1, 2018 | Asset Protection Resources, Real Estate

Have you heard that land trusts provide asset protection? Do you believe it?

Applicable Law

Two cases from Illinois concluded that, in a land trust, although the legal and equitable title lies with the trustee, most of the usual attributes of real property ownership are retained by the beneficiary under the trust agreement: (1) Just Pants v. Bank of Ravenswood, 136 Ill.App.3d 543, 483 N.E.2d 331, 335-36 (Ill.App. 1985); and (2) People v. Chicago Title and Trust Co., 75 Ill. 479, 389 N.E.2d 540 (Ill. 1979).

Just Pants v. Bank of Ravenswood

In Just Pants v. Bank of Ravenswood, 136 Ill.App.3d 543, 483 N.E.2d 331, 335-36 (Ill.App 1985), the lessee of property which was subsequently sold under a land trust sued the trustee of the land trust for conversion and breach of contract. Following judgment in favor of the trust, the trial court granted the lessee’s motion to amend the complaint and judgment to include the beneficiaries, and entered judgment against only the beneficiaries. The beneficiaries appealed, and the Illinois Court of Appeals held that reversal was required where the reviewing court had no way of knowing the respective responsibilities of the trustee and the beneficiaries. 483 N.E.2d at 333-34. The Court noted that, in an action involving a land trust, the question of whether the beneficiary or the trustee is the proper party depended upon the nature of the action in light of the rights and duties established by the trust agreement. The Court pointed out that the beneficiary in a land trust is the proper party to litigation involving his rights and liabilities of management, control, use and possession of the property; and, moreover, that beneficiaries in land trusts oftentimes retain managerial rights in the property, and in exercising these rights, enter into a variety of contractual arrangements resulting in the accrual of causes of action against then that do not involve the trustee. The Court observed that actions sounding in tort involving land trust property usually arise from the operation and maintenance of the property; that such causes are based on negligence, and accrue against only the beneficiary, and not the trustee; and that the trustee is insulated from these responsibilities if he has no rights of possession, operation, control, or maintenance. Thus, the Court concluded that trustees who hold legal title to realty through a trust agreement are not liable for damages resulting from defects in the trust premises when the agreement gives the beneficiaries, and not the trustees, the power to make the needed repairs; and furthermore, that beneficiaries can also be held responsible for the torts or frauds of the trustee where they participate in or authorize the commission of the wrongs. 483 N.E.2d at 335. The Court remanded the case to the trial court to determine the respective responsibilities of the trustee and the beneficiary under the trust agreement. 483 N.E.2d at 336.

People v. Chicago Title and Trust Co.

In People v. Chicago Title and Trust Co., 75 Ill. 479, 389 N.E.2d 540, 542-43, 546 (Ill. 1979), a consolidation of six separate actions brought in the name of the People of the State of Illinois to recover unpaid real estate taxes on land held in land trusts, the State sought to impose personal liability for the real estate taxes on the following three entities: (1) the banks or trust companies in their individual corporate capacities; (2) the banks or trust companies in their capacities as land trustees of land trust property; and (3) the beneficiaries of the land trust, all as “owners” of the tracts of land trust property. The trial court found the trustees in their individual corporate capacities liable, and dismissed the cases as to the banks and trust companies as trustees, and as to the beneficiaries. 389 N.E.2d at 542. The Illinois Supreme Court granted motions for direct appeal, and held that, since the beneficiaries of a land trust controlled the purchase, sale, rental, management, and all other aspects of land ownership and title; and since the trustees could act only upon the beneficiaries’ written direction, the beneficiaries were “owners,” within the meaning and intendment of the statute providing that “owners” of realty shall be liable for taxes. As such, the beneficiaries were personally liable for the unpaid real estate taxes. The Court stated that the realities of land ownership clearly indicated that land trust beneficiaries were “owners”; and that, as “owners,” they were personally liable for the unpaid real estate taxes. 389 N.E.2d at 546.

In so concluding, the Court reviewed the history of the Illinois land trust. The Court noted that the Illinois land trust was a unique creation of the Illinois bar, although its acceptance elsewhere had received a great deal of attention. The Court pointed out that its origin was rooted in case law rather than in statute; and that, over the years, the land trust had served as a useful vehicle in real estate transactions for maintaining the secrecy of ownership and allowing for the ease of transfer. The Court noted that, despite recent disclosure statutes, the Illinois land trust remained a widely utilized and useful device. 389 N.E.2d at 543. The Court emphasized that, in land trusts, the legal and equitable title lies with the trustee, and the beneficiary retains what is referred to as a personal property interest; however, most of the usual attributes of real property ownership are retained by the beneficiary under the trust agreement. In fact, the Court observed that the only attribute of ownership ascribed to the trustee is that relating to title, upon which third parties may rely in in transactions where title to the real estate is of primary importance. 389 N.E.2d at 543.

Conclusion

The prevailing belief, that land trusts protect property owners from all liability, is not even true in Illinois, which originated land trusts.

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CaseLaw Articles and Resources

The Facts of Carrick

The Decision in Carrick

Brief Discussion

Conclusion

Is Your Retirement Safe?

Mom’s Mistake Is No Excuse!

The Facts of Judge

The Decision in Judge

The Rationale of Judge

Conclusion

The Disadvantages of Joint Ownership

Examples of Joint Ownership Gone Awry

Beware of Purchasing Real Estate with Unpaid Liens on It

The Course of Proceedings in Shirehampton

The Facts in Shirehampton

The Decision in Shirehampton

The Rationale of Shirehampton

Chase Deed of Trust.

IRS Tax Lien.

BRIEF DISCUSSION

CONCLUSION

The Pansky Case

The Facts of Pansky

The Rationale in Pansky

Discussion

Conclusion

Applicable Law

Just Pants v. Bank of Ravenswood

People v. Chicago Title and Trust Co.

Conclusion

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