In May, the U.S. Department of Labor changed its rules for white-collar employees who are exempt from overtime pay requirements, which may change the way businesses need to compensate their employees. Under the Fair Labor Standards Act, all employees who work more than 40 hours per week must be paid one and one-half times their normal salary unless they qualify for exemption. It is estimated that this change will affect more than four million additional American employees who will now become eligible for overtime pay. The new rules will go into effect on December 1, 2016. The focus of the rule updates the salary and the compensation exemption levels for Executive, Administrative, Professional, Outside Sales, and Computer employees.
In light of the new rule, all employers should familiarize themselves with the new rules and analyze their current workforces and salaries. Employers will need to begin tracking the number of hours their salaried employees work if they do not meet the revised exemption requirements. Here are some of the most important provisions of the Final Rule:
- The minimum salary level to meet the white collar exemptions was increased to $913 per week, or approximately $47,476 annually. This is more than double the previous threshold amount of $455 per week, or approximately $23,660 annually.
- An employee who earns less than the threshold amount will no longer be exempt as of December 1, 2016, and must be paid at one and one-half times their regular rate for working over 40 hours per week.
- The total annual compensation requirement for highly compensated employees to $134,004. This was previously $100,000.
- Only a minimal showing is needed to establish that the highly compensated employee is exempt. Generally, the employer need only show that the highly compensated employee’s primary duties are office or non-manual work and that he or she performs at least one of the exempt duties of an exempt executive, administrative or professional employee.
- The Final Rule establishes an automatic update procedure, which will update the salary thresholds every three years, beginning January 1, 2020.
- This is designed to ensure that the salary thresholds do not become outdated.
- The Final Rule amends the salary basis test to allow employers to use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10% of the new standard salary level.
- It does not make any changes to the duties test, which are the duties an employee must perform in order to be exempt from overtime as a white collar employee.
Employers have until December 1, 2016 to finalize any adjustments they may wish to make in reaction to the new rule. Options include:
- Converting positions to non-exempt by increasing the salary to more than $47,476 so that employees qualify for the exemption.
- Restructuring an organization to accommodate the new regulations.
- Converting salaried employees to hourly and/or tracking the number of hours worked to 40 hours or less.
Employers will also need to work with their payroll vendor or accounting department to address the new requirements.
If you have any questions regarding the Department of Labor’s overtime exemption requirements, please do not hesitate to contact your attorney at Berluti McLaughlin & Kutchin.
BMK Attorney, Matthew J. Dunn said a second review of Ryder’s application to subdivide the five parcels should have been reviewed by the BZA beforehand.
Protecting Your Home – the New Massachusetts Homestead Law
On March 16, 2011, the newly-enacted Massachusetts Homestead Act took effect, expanding coverage for homeowners and eliminating confusion caused by what many considered a deficient law ripe with ambiguities. The precursor to the modern law was the Homestead Act of 1862, passed by the U.S. Congress to encourage settlement and cultivation of unappropriated public land in the West, providing up to 160 acres of unoccupied public land to each homesteader on payment of a staggering $1.25 per acre after five years of residence.
Today, the homestead law is intended to protect a portion of a homeowner’s equity from seizure by unsecured creditors. In other words, if you are sued, lose and the winning plaintiff attempts to force the sale of your home or attach its equity to satisfy the claim, the law sets aside a portion of the equity in your home so that you are not left homeless. This supports a public policy against displacing individuals from their homes, the economic cost of which would in part fall upon the shoulders of the community. Unfortunately, the benefits of this law accrued only to those who filed a written Declaration of Homestead at the local Registry of Deeds, after which point up to $500,000 was protected against the claims of unsecured creditors. Note that, under the new and old laws, this does not include secured creditors such as a mortgage company, MassHealth, agencies enforcing tax obligations, child or spousal support. Under the new law, all Massachusetts homeowners receive an automatic exemption of $125,000 on their principal residence without having to file. However, G.L. c. 188 provides the same increased amount, $500,000, for those who file a written declaration.
Of particular interest is that homes held in revocable trusts – but not necessarily nominee trusts – are now eligible for protection, along with 2-4 family homes and mobile homes where the home is an individual’s primary residence. Individuals wishing to convey property to a revocable trust to avoid probate costs – which in Massachusetts can add up to 1-3% of probated property – should reexamine the relevancy of this in their estate plans. Also noteworthy is the enhanced protection for elders: where a home is owned by two elderly or disabled persons, the total exemption is $1,000,000. To underscore an exception, if an elderly parent enters a nursing home and MassHealth pays for his or her care, the homestead law does not preclude MassHealth from placing a lien on the property. Grown children come to our office concerned because an ailing parent drives when he should have given up his license long ago. As that parent could strike a pedestrian, the parent, spouse or his children on his behalf should seek to maximize economic protections available to that parent by filing the elder homestead.
In keeping with Massachusetts’ recognition of same-sex marriage resulting from a 2003 case, Goodridge v. Dep’t of Pub. Health, the law affords the same protections to spouses and children of same-sex marriages as a heterosexual marriage. Bankruptcy counsel can rest more easily knowing now that the proceeds from the sale of a home subject to homestead are entitled to protection under the new law until the sooner of the acquisition of another principal residence or one year from the date of sale.
The last notable ambiguity that was resolved, of particular relevance in light of the low interest rate environment, was to provide that a homestead declaration does not need to be re-filed after refinancing as the new law automatically subordinates estates of homestead to mortgages.
For those interested in minutiae, the maximum automatic exemption for homes owned jointly or as tenants-byentirety, a special form of ownership reserved for those who are married, remains whole and unallocated between the owners. Where a trust or tenants in common own a home, the maximum automatic exemption is allocated relative to the individual’s ownership interested. Similarly, as regards to the $500,000 exemption, said exemption is whole and unallocated where a home is held through a joint tenancy or t-by-e; where the home is held in trust or by tenants-in-common, the declared exemption amount for an individual is $500,000 multiplied by her percentage ownership interest.
Does this new law dispense with the need for homeowner’s insurance or umbrella coverage? Absolutely not. Furthermore, you do not need to re-file if you have filed already, as prior declarations remain unaffected. However, the law signifies laudable progress insofar as deficiencies are eliminated and provides yet another reason that clients should contact their advisor to determine if and how to avail themselves of the new law. As always, feel welcome to call our office if you are interested in discussing this or any other asset protection strategy.
David C. Valente, CFP | Trust & Estates Attorney
Berluti McLaughlin & Kutchin, LLP
Have Your Cake and Eat It, Too – Domestic Asset Protection Trusts
“How do I protect my wealth?” While that question means different things to different people, our office is asked that question often, usually by doctors in the context of potential malpractice claims or business owners who want to safeguard their non-business wealth against shareholder litigation. In conjunction with liability insurance, an Scorporation, single-member LLC or other corporate entity is usually adequate to segregate one’snon-business wealth from claims against the business. But what tool is available to protect personal wealth outside the business?
While revocable living trusts provide many benefits – professional money management for children, avoidance of probate costs and time delays, state and federal tax reduction or elimination – creditor protection for the “grantor” or creator of the trust is not one of them. It is well-settled that because said trust is a grantor-trust, wholly revocable as to income and principal, meaning it can be amended at any time, it remains property of the grantor precisely because of that accessibility. Many a client, and counsel on their behalf, have attempted to argue that spendthrift provisions or other carefully-crafted language enables a grantor to have his proverbial cake and eat it too, that is, retain the flexibility to change a trust at any time, and also be afforded protections from creditors, be it a plaintiff in a lawsuit, divorcing spouse or estranged child. So far, all have failed in this respect. Whileproperly-drafted revocable trusts do provide creditor protections for beneficiaries after the grantor dies, the only way to insulate one’s self or his loved ones during his life was to irrevocably transfer wealth to a separate entity, such as a limited liability company or gift away wealth outright to others. If protecting your wealth is a priority, then giving it away would appear to contradict that goal.
Over the past few years, legislators of various states – perhaps to attract new residents, businesses and sources of revenue for depleted state coffers – have adopted new statutes allowing for Domestic Asset Protection Trusts (“DAPTs”). Alaska passed the first domestic asset protection statute; Delaware and Nevada, among others, followed suit shortly thereafter. Massachusetts has yet to enact a similar statute, but a Massachusetts resident may execute an asset protection trust which has a situs, or tax home, in Delaware, invoking Delaware laws and favorable Delaware treatment. Not meant to be exhaustive, benefits include:
- Protection from grantor’s creditors: After to a “tail period”, typically four years, has elapsed, trust wealth becomes unavailable to satisfy a claim1. Each transfer to the trust creates its own tail period.
- Avoid trust fund babies: Many wealth parents are concerned their children’s knowledge of a significant inheritance will erode the child’s work ethic, morphing him into a “trust fund baby.” Though a trustee has a common law duty to disclose a beneficiary’s interest, statute can and does override this law, permitting grantor to direct trustee not to disclose the existence of the trust “for a period of time”, such as child’s age 30.
- Trust may “live” forever, amassing considerable wealth: Delaware has repealed the Rule Against Perpetuities. Unlike Massachusetts, wealth inside a Delaware-based Dynasty asset protection trust may accumulate indefinitely, free from the imposition of transfer taxes at each successive generation. $1,000,000 would grow to over $32,000,000 in 75 years in a DAPT, compared with $6,000,000 were the strategy not employed.2
- Flexibility: Though the DAPT is irrevocable, a “limited power of appointment” allows Grantor to change the ultimate beneficiaries of the trust. Pursuant to trustee’s discretion, Grantor may receive up to 5% of trust’s principal annually. Grantor may remove and replace a trustee and pay the trust’s income taxes.
- Substitute for Prenuptial Agreements: While transfers to a DAPT after marriage are not protected, transfers to a DAPT that predate the marriage are not considered marital property or property of the grantor.
- State Income Tax Savings: Massachusetts imposes income taxes of 5.3% on capital gains and accumulated income in addition to federal taxes. Delaware does not impose state income tax on federally taxable income of irrevocable trusts accumulated in future years to non-resident beneficiaries.
For those unfortunate enough to be treading presently in the deep waters of litigation or threatened with litigation, know that you may not transfer wealth to DAPT to defraud an existing creditor(s). A creditor may establish a “fraudulent transfer”, but only if it can be show that the grantor made the transfer with the actual intend to defraud that particular creditor, arguably a high burden of proof to overcome. The touchstone of “actual fraud” is whether the grantor could have reasonably anticipated the particular future creditor’s claim when the transfer to trust was made.
When faced with the prospect of a Delaware trust, a client might logically ask, “Can I retain my existing advisors?” The answer is “yes”. You may bifurcate responsibilities, dividing duties between your existing financial advisor, attorney and CPA. You would then choose an adjunct administrative trustee, be it a Delaware individual or corporation with whom our office works regularly.
While the DAPT presents significant opportunities, establishing a DAPT comes with numerous implications, including additional costs. The simple addition of a new clause is insufficient to invoke the benefits discussed. What’s more, it is usually advisable to deposit only some, not all, of your wealth into a DAPT, as your family’s wellbeing demands sufficient liquidity outside of the trust. Please contact us if you would like us to help determine if and to what extent a Domestic Asset Protection Trust fits into your family’s personal and corporate estate plan.
David C. Valente, CFP | Trust & Estates Attorney
Berluti McLaughlin & Kutchin, LLP
Get Out Your Shovel – Liability for Snow Accumulation
Many would argue there is nothing more serene and calming than the first snowfall. But anxiety may replace serenity and introspection now that the Massachusetts Supreme Judicial Court decided in Papadopoulos v. Target Corp. to expand the duty and liability of property owners. We have all seen hard working small business owners shoveling – or sometimes sweeping if a shovel is unavailable – the snow from the sidewalk in front of his business.
However, for more than a century, the rule had been that property owners could not be held liability for injuries due to the natural accumulation of snow and ice. From this was borne the legal fiction of “unnatural accumulation.” If property owner did not clear the snow from the sidewalk, he could defend himself by asserting the injury was the result of an “unnatural accumulation”, including but not limited to footprints in the snow and ice melting from gutters. An easier way to understand the law is that if the injury arose from untouched snow or ice, property owner could no be held liable. This is no longer a valid defense, as the property is owner is under a duty to clear both natural and unnatural accumulations.
Insofar as the decision affects virtually all Massachusetts landowners, family and corporate clients should heed their newfound responsibility (and liability). In the words of the SJC, “We now will apply to hazards arising from snow and ice the same obligation that a property owner owes to lawful visitors as to all other hazards: a duty to ‘act as a reasonable person under all of the circumstances including the likelihood of injury to others, the probable seriousness of such injuries, and the burden of reducing or avoiding the risk.”
David C. Valente, CFP | Trust & Estates Attorney
Berluti McLaughlin & Kutchin, LLP
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1 Two classes of creditors are exempt: a spouse or child with a claim for unpaid alimony, child support or share of marital property; a person with a claim for death, personal injury or property damage that predates the transfer to the DAPT [and] if claim arose out of grantor’s act or omission or act or omission of someone for whom grantor is vicariously liable.
2 Assumes 45% federal estate tax rate, no state income taxes, new generation every 25 years and 5% annual investment rate of return
The recent passage of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“the Act”) permeates virtually all socioeconomic classes of the American population. Given the Act creates an opportunity for the next two years, clients and their advisors should discuss how the legislation impacts them and what, if any planning they should implement as a result. A prudent strategy should address income tax planning and incorporate wealth transfer opportunities in coordination with clients’ estate plans. While the Act is far-reaching, we have sought to summarize the key provisions relevant to our clients.
GIFT AND ESTATE TAX PLANNING
In addition to the $13,000 per donee exclusion – the size of gifts a taxpayer may make to as many individuals as he or she wishes each year – a client may use his lifetime gift exemption to make up to an additional $5,000,000 in tax-free gifts, an increase of $4,000,000 from the prior $1,000,000 lifetime exemption.
Planning Idea (lifetime gift): For a client who has already utilized his $1,000,000 lifetime exemption, he should consider using a portion of the remaining $4,000,000 to make a gift outright or in trust. If Bill, a 55 year old, makes an additional $1,000,000 tax-free gift to a trust for his children which grows at 7% annually, Bill will have shifted over $6,000,000 in future appreciation out of his estate by Bill’s age 85, creating an estate tax savings of approximately $2.3MM for his children. Moreover, if Bill makes that $1,000,000 gift to an irrevocable life insurance trust, the Trustee could purchase a single premium life insurance policy with a permanent death benefit of $7,199,6821, which would pass to Bill’s children or grandchildren completely free of income taxes, estate taxes or GST taxes.
Planning Idea (asset protection): As an asset protection strategy, clients could use a portion of the increased lifetime exemption to gift a residence or other property in trust. After five years have elapsed, then the home of a Massachusetts resident would be insulated from the costs of long-term care and/or creditors.
Planning Idea (loan forgiveness or new intra-family loans): Applicable Federal Rates – the minimum interest rate blesses by the IRS that individuals may charge one another without the loan being considered a gift – are historically low as of January, 2011: 0.43% for short-term, 1.95% for mid term and 3.88% for long-term loans. This presents two opportunities. The first is for a wealthy client to provide an intra-family loan to a child, for a mortgage or otherwise, so the child can borrow at 3.88% rather than institutional lending rates. Second, if a client has already loaned money to a family member, or implemented an Installment Sale to a Grantor Trust, the client might consider forgiving the loan, which would constitute a gift; because of the increased lifetime exemption, the forgiveness of the loan could be gift-tax free.
The estate tax now applies retroactively to the estate of individuals dying in 2010, with an exemption of $5.0MM and a 35% rate on amounts that exceed this, but [the personal representative of] wealthy clients may wish to elect the alternative option: to have modified basis rules apply such that capital gains taxes, but not federal estate taxes, apply to the estate.
For individuals dying in 2011-12, the amount that can be passed free of federal estate taxes to beneficiaries is $5.0MM, a marked increase from $3.5MM available in 2009. While some clients may perceive this as a reason not to worry about estate taxes, beware: Massachusetts and most other states impose a separate estate tax, and the increase is only scheduled to last through the end of 2012, reason enough to continue planning.
Generation-Skipping Transfer (“GST”) Tax
Transfers subject to GST tax, for example a transfer to a grandchild, are subject to a flat 35% rate.
Planning Idea: Given the mounting deficit, strain on the Social Security and Medicare programs, and the pattern of the government spending that which it cannot afford based on current revenues, this attorney’s opinion is that the income and/or estate taxes will rise in 2012+. The economy, locally and nationally, cannot support the municipal infrastructure, social programs and defense budget without increased revenue, be it through income taxes, estate taxes, GST taxes or other means. If history is any guide, our government will turn tohigh-income taxpayers to shoulder a disproportionate share of the economic burden (“responsibility”). Thus it is highly likely that Generation-Skipping Transfers, an oft-employed strategy of the wealthy, will not continue to receive the luxury of favorably low, 35% tax treatment. Clients should consider transfers now at a 35% rate rather than subject that wealth – and its future appreciation – to potentially higher rates in years to come.
The executor of a decedent dying after December 31, 2010 can elect to provide his surviving spouse with the unused portion of his “exclusion amount”. To do so, the deceased spouse’s executor must file a timely estate tax return indicating the unused amount and elect to make it available to the surviving spouse. Portability between spouses does not apply to the GST tax exemption.
Planning Idea: Clients and advisors should review: a) their trusts; and b) how their assets are titled. If portability becomes the “new normal”, clients might consider holding assets in a joint trust, dispensing with the need to “equalize” estate (keeping ½ of the combined estate in each spouse’s name) to maximize wealth transfer.
INCOME TAX PLANNING
The reduced income tax rates under the Economic Growth and Tax Relief Reconciliation Act of 2001, also known as “EGTRRA”, have been extended through 2012. While all taxpayers would have paid an average of 2-3% higher income taxes had the bill not been passed by the Senate and the House, high income earners arguably would have been impacted most significantly, with the top rate rising from 35% to 39.6%.
Social Security Tax Cut
All taxpayers will reap the benefit of a temporarily-reduced social security payroll tax, from 6.2% to 4.2% for individuals, and from 12.4% to 10.4% for self-employed individuals.
Repeal of the personal exemption phase-out and itemized deduction limitation has been extended for an additional two years. The effect on high-income earners is a continued respite from a reduction in allowable deductions.
Capital Gains and Dividend Rates
A favorable capital gains rate – 15% for those in the 25%+ income tax bracket – is extended. Such taxpayers would have faced higher capital gains rates and ordinary income tax rates on dividends had legislation not been passed.
Exemption amounts are increased to $47,450 ($72,450 if married filing jointly) for 2010 and $48,450 ($74,450 if mfj) for 2011.
IRA Charitable Rollover
Individuals who are 70.5 or older may transfer up to $100,000 annually to a qualified public charity without the transfer being treated as a taxable withdrawal. Furthermore, the transfer can be counted towards taxpayer’s Required Minimum Distribution.
As always, it is our job to identify opportunities for your family’s benefit as well as keep you apprised of topical legal, tax, and financial developments. Feel welcome to call if you have questions or would like to schedule a conference call with us and your other investment professionals.
David C. Valente, CFP | Trust & Estates Attorney
Berluti, McLaughlin and Kutchin, LLP
1Assumes preferred plus non-smoker, 44 year old male, Massachusetts resident; quote provided by John Hancock Life Insurance; actual rates may be higher or lower than illustrated and are subject to medical and financial underwriting.
The New Ruling on Post-Nuptial Agreements and its Impact
Post-nuptial agreements are quickly becoming more common, and perhaps more importantly, legally valid. Originally, post-nuptial agreements were widely rejected as valid contracts, due to the idea of marital unity, whereby two people legally become one. Since a person cannot enter into a contract with him or herself, married couples, now considered one person, could likewise not enter into contracts with themselves. Even as courts began to reject marital unity as a legal concept, they were still very cool on the idea ofpost-nuptial agreements, on the grounds that the contracts would encouraged divorce.
However, as divorce became more commonplace and socially acceptable, views towardspost-nuptial agreements have changed accordingly. With its ruling on July 16, 2010 in Ansin v. Craven-Ansin, the Supreme Judicial Court of Massachusetts upheld the validity of post-nuptial agreements in the state. The decision lays much of the groundwork for what is required in valid marital agreements, and marks another milestone in the evolution of marriage laws in Massachusetts.
The court determined that marital agreements must be closely scrutinized in order to determine their validity. In general, the major criteria considered are as follows:
- Each party has an opportunity to obtain separate legal counsel of their own choosing. This ensures that throughout the process, neither side has an unfair legal advantage.
- There can’t be any fraud or coercion in obtaining the agreement. This is perhaps the most murky area legally, because it can be difficult to prove the negative. For example, if one party entered into the contract, and was already planning on ending the marriage at the time, that could be considered fraud. It is the burden of the part accused of fraud to prove their innocence. In Ansin v. Craven-Ansin case, the court found that the couple had worked towards mending their rocky relationship, including buying and renovating a home together, and it was only later that the marriage broke down for good. Thus, at the time of the agreement, the couple did in fact have every intention of staying together.
- There must be accurate disclosure of assets. In Ansin v. Craven-Ansin, not all of the husband’s assets had an exact dollar value, and so he substituted in a rough estimate that was found to be accurate.
- The parties must agree to a meaningful waiver of rights, essentially affirming that the post-nuptial agreement was meaningful and meant to be enforced.
- The agreement must be judged to be fair and reasonable. Although this is somewhat of a judgment call by a judge, various criteria can be used. For example, if both parties were represented by their own competent counsel, or the terms of the agreement are similar to terms of other types of separation agreements, the contract would most likely be judged fair.
Estate Tax Planning Strategies
1. Trust agreements could unintentionally disinherit spouses or children
The revocable trusts of many married couples funds two sub-trusts at death: one for the spouse and another for the children. Language which governs how much wealth goes into each sub-trust may allude to “estate exemption amount” or other tax terminology which does not technically exist in 2010. The result could be 1) all wealth flows into one trust, disinheriting the spouse or the children; or 2) ambiguity which requires court involvement to resolve. Clients should incorporate tax planning objectives and non-tax goals, e.g. “providing enough for my spouse to live comfortably”, into an amendment of existing trusts.
2. Failure to address carryover basis issues could create large capital gains for beneficiaries
Normally, if a person buys an asset for $100,000 then sells it for $1.1MM, he must pay capital gains of 15% or $150,000 on the $1MM of growth. Before 2010, decedent’s heirs receive an unlimited “step up” in cost basis. If their heirs inherit the asset, purchased for $100,000, worth $1.1MM on decedent’s death, the basis is increased or stepped-up from $100,000 to 1.1MM, thus eliminating the $150,000 capital gain tax. Capital assets include, among other things, mutual funds, stocks, your home, but not investments like an annuity, a 401(k) or IRA. In 2010, non-spouse beneficiaries receive only 1.3MM worth of basis adjustment or step-up, not an unlimited amount. Spouses are eligible for an additional $3MM. Without proper planning, clients with significant unrealized gains on legacy positions or a family business could create an enormous capital gains liability which may have been avoided.
3. Reduced gift tax rates appear to create an opportunity – but beware !
Currently, the rate imposed on gifts is 35%, which appears to present an opportunity to pass wealth to loved ones at lower rates than in the past (45% in 2009) or near future (55% in 2011.) However, be aware that Congress could reinstate a higher rate retroactively, eradicating the benefit. Discuss potential gifts with your advisors before taking action.
1. Grantor Retained Annuity Trusts (“GRATs”)
GRATs are a common technique for shifting future appreciation of an asset to beneficiaries with little or no gift tax. It operates by establishing an irrevocable trust to which the grantor transfers an asset with appreciation potential. In exchange, the grantor receives a stream of payments equal to the value of the deposited asset plus interest as prescribed by the IRS Section 7520 rate, approaching a historic low of 3.0% as of January 2010. If the assets in the trust appreciate sufficiently, then the remaining funds, plus all their future appreciation, can pass to the beneficiaries free of any transfer tax. Recently, attorneys have favoredshort-term GRATs to ensure bursts of appreciation are captured. Because of the effectiveness of this technique, current legislation may mandate minimum terms of 10 years. Clients looking to transfer wealth should consider this strategy, given the recent stock market downturn and the uncertain future of wealth transfer techniques.
2. Intra-family Loans , Sales to Defective Grantor Trusts and Private Financing
Clients may lend wealth to family members through an intra-family loan or by transferring an asset to a defective grantor trust, both of which require a prescribed interest rate to avoid the incursion of gift tax. In the context of a trust, a wealth client can loan money or an asset to the trust, which invests the proceeds and generates income, part of which is utilized to pay back the lender. The balance of the income and appreciation accrues to the benefit of the borrower, who pays back the principal at the end of the term. As of September 2010, the Applicable Federal Rate is 0.46% for short term loans (<3 years), 1.94% for mid term loans (3-9 years), and 3.66% for long-term loans (>9 years). Many clients integrate such planning with their irrevocable life insurance trusts wherein the interest paid on the loan funds the life insurance premiums. Such potent strategies are ripe with opportunity to transfer wealth in a low interest-rate environment.
Income Tax Planning Strategies
Given the plethora of upcoming changes in the U.S. tax code, clients should work with their advisors to plan proactively, the effects of which may be felt this year or in subsequent years. While some changes in the Code will not take effect until 2011 or later, most strategies require action in 2010.
Clients and their advisors should develop a strategy to address the following likely income tax changes:
- An increase in the top applicable federal capital gains rate in 2011 from 15% to 20%
- Dividends becoming taxable at ordinary income tax rates (from 15% to as high as 39.6%)
- An average income tax increase of 2-3% for most tax payers with the highest bracket rising from 35% to 39.6%
In formulating a plan, consider the following strategies:
- Accelerating 2011 income to 2010, e.g. executives could exercise nonqualified stock options.
- Accumulating cash to maximize retirement plan contributions in 2011.
- Implementing a deferred compensation arrangement for 2011 to supplement other qualified plans.
- Deferring 2010 charitable contributions and other deductions to 2011 to amplify deduction.
- Transitioning dividend paying investments (large value, bonds) to retirement accounts.
- Banking losses in 2010 to offset gains in 2011 (more helpful in 2011 at 20% than in 2010 at 15%).
- Utilizing tax-free municipal bonds.
- Implementing ETFs, reducing portfolio turnover thereby increasing tax efficiency.
- Reviews timing of income tax payments on Roth conversion.
Increased capital gains taxes in 2011
Issue: If Congress does not take preventative action before the end of 2011, the top applicable federal capital gains tax will revert to 20%, an increase from the current level of 15%. While no one can predict whether corrective measures will be taken, most experts agree that reduced revenues from temporary estate tax hiatus, wartime spending and increased dependency on health care subsidies make a return to higher tax brackets likely – capital gains as well as income tax. Moreover, beginning in 2013, an addition 3.8% Medicare tax will be imposed on taxable investment income by families with adjusted gross income above $250,000 ($200,000 for individuals), and a 0.9% tax will be imposed on employment compensation in excess of $250,000 ($200,000 for individuals).
Practical Solutions: Clients should collaborate with their advisors to determine whether they should “bank” capital losses through tax harvesting. Tax harvesting traditionally involves selling securities that have an unrealized loss (worth less than their purchase cost) to ameliorate the tax burden caused by selling securities with capital gains throughout the year. However, clients should consider realizing losses which exceed their current gains, the excess of which may be carried forward into 2011 and beyond, where their tax savings will arguably be worth 25% more than they are now (20% vs 15%.) While an investor might be inclined to delay action until year end – when intentions of Congress are more visible – this might be too late. Investors might also choose to recognize a gain at 2010 rates and immediately repurchase the security. The “wash sale” rule applies only to recognition of losses, not gains.
Increased taxation of qualified dividends in 2011
Issue: Again dependent on the action of Congress, taxes on qualified dividends could return to ordinary income levels – as high as 39.6% – almost a three-fold increase from the current level of 15%.
- Clients and advisors should pay particular importance as to where particular asset classes are invested. A client’s investment objective may warrant a 60% equity allocation. However, a client could own a disparate percentage of equities in each of many accounts as long as the cumulative result is in line with his investment objective. Consider depositing the majority of fixed income and dividend-producing securities into retirement accounts, the withdrawals from which will be taxed as ordinary income anyway. In contrast, securities more likely to receive capital gains treatment such as mutual funds with a capital appreciation objective into non-retirement accounts where their growth will be taxed at a more favorable 20% rate federally.
- As taxes rates rise, municipal bonds become more attractive, as you would need to get a higher tax adjusted yield from a corporate bond to get a better return from it. Be aware that the supply of municipal bonds is decreasing as more states issue Build America Bonds, so do not be late to the game.
Plan for income taxes due on Roth conversion
Issue: As many investors have decided to convert a portion of their qualified monies to Roth IRAs in light of income limits disappearing temporarily in 2010, taxpayers must find a way to finance the resulting tax liability. Be aware that while you may postpone income taxes on a 2010 conversion until 2011-2012, you must then pay income taxes at rates in effect in 2011-12, not 2010.
- Losses from sole proprietor or S-corp income may offset ordinary income tax.
- If it becomes apparent that income tax rates will increase in 2011, it may be beneficial to pay conversion taxes in 2010 at 2010 rates than 2011-12 at rates in effect in those years.
Higher income tax rates for everyone
Issue: Taxpayers will likely face an average increase in their income taxes of 2-3%.
- Where possible, increase your cash reserves now to accommodate lower take-home pay next year.
- For business owners, consider a deferred compensation arrangement to complement your existing retirement plans. This will allow you to defer additional income, reducing your current tax burden.
- If you contribute to charity but have no yet done so for 2010, consider delaying such contribution to 2011. At the top federal rate in 2010, a $100 donation generates a benefit of $35, but in 2011 that benefit could be almost $40.
- As always, clients should consider donating a low-basis, long-term capital asset, receiving a deduction on the fair market value and avoiding capital gains on the asset’s sale.
By: Robert R. Berluti, Partner
In industries where employees must keep pace with rapid changes in technology, companies often value workers with advanced skills over workers who have more years of experience. And when companies attract younger and more recently trained workers who also have lower salary expectations, it often can be tempting to let older, more highly paid workers go.
Thus, a dilemma: How can technology-based companies remain competitive while avoiding age discrimination? While the termination of older workers (at least 40 years old) may be justified at times, the decision to fire someone should not be based on age. If it is, the stakes are very high.
It is against the law to discriminate on the basis of age when firing or hiring. In the wake of recent rulings such as Harnett v. CSA Financial Corp., in which the plaintiff was awarded $1.7 million in damages, aggrieved employees in Massachusetts are now more likely to litigate.
In similar cases of age discrimination, employees can receive major compensation in lost wages and emotional distress. What’s more, the actual damages may be tripled, and the employer may have to pay the employee’s attorney fees.
With this as a backdrop, employers are well advised to exercise due diligence with older workers in their employ they should also think twice before terminating these workers. And they should move swiftly to engage counsel if legal action is imminent.
What follows is a road map to help management avoid liability:
Exercise caution before termination
While older workers are still on staff, management should avoid being shortsighted or hasty. Management’s actions should prevent employees from being able to argue that the reasons they were given for termination are only a pretext for age discrimination, as illustrated in the examples below:
Outdated skills –
A typical rationale for firing is that an employee’s skills are outdated. Too often, however, employers transparently try to fulfill the prophecy by assigning less demanding work to older workers, then claiming that they are less productive. Ironically employers frequently underestimate the skills of these workers, taking the attitude that you “can’t teach an old dog new tricks.”
In many instances, 50-year-olds have, in fact, performed advanced tasks through the years, making them at least as proficient as workers 20 years younger. In this light jurors may well view the outdated skills rationale as shallow.
Another specious justification is the so-called age gap. For example, managers revered for beinghard-driving throughout their careers might be summarily dismissed because they are deemed “too demanding” or not in tune with younger workers.
A corollary of this can occur when the older worker is a commissioned marketing representative. If his or her responsibility is sales rather than management, then termination based on a lack of communication with younger marketing reps may not ring true.
In technology fields, training is often required to keep abreast of industry changes. If the employer doesn’t select older workers for training, this may serve to establish pretext.
In the event of reorganization, older workers must receive a fair chance to compete for new positions. Too frequently, however, employers don’t interview older workers, or claim they were considered but simply lost out.
Another tactic is to describe the reorganized position erroneously. For instance, the employer may say that the position requires a specific skill when that skill actually comprises just a small part of the overall work. Here again, a jury may see this strategy as a thinly veiled pretext.
Changing corporate culture
The modern organizational paradigm is moving away from a hierarchical structure to that of flat organizations working in teams. Older workers may feel threatened by such changes, but that doesn’t give employers a license to presume that older workers can’t adapt.
Prepare a termination checklist
Even if management passes the “smell tests,” there are further considerations that should precede a decision to fire an older worker. A final checklist includes the following:
- Has management adequately communicated the older worker’s deficiencies?
- Has the older worker received an opportunity to make the necessary adjustments?
- Has management planned to deal with an older worker’s reticence to change?
- Has management adequately documented its efforts to counsel older workers through employment evaluations and other progressive disciplinary or counseling efforts?
- Has management considered the prospects for the older worker’s future employment?
One additional Factor: Is the older worker the only one being terminated, or is he one of many employees of various ages to lose their jobs? In the latter case, the employer will be in a stronger position.
Dealing with a claim
If management learns of an actual or imminent claim, it must be proactive. This involves seeking counsel, trying to settle quickly, or preparing for trial.
It is best to engage competent counsel before terminating an employee. Such counsel can objectively evaluate records that are key to a defense. In the unlikely event of an internal complaint, it is critical to conduct a prompt, comprehensive investigation, report the results, punish the wrongdoer, and otherwise remedy the wrong.
For many of us, our home is our greatest financial asset. To protect the equity in your home, Massachusetts permits an owner to declare a “homestead,” which allows you to protect up to $500,000 of the value of your home from creditors. Unlike other states, there is no automatic homestead in Massachusetts; an owner must file a “Declaration of Homestead” at the registry of deeds in the county where the home is located in order to receive the homestead protection.
The Homestead works by excluding up to $500,000 in the value of your primary residence from creditors. You still may incur debts and, if you have other assets like bank accounts or a vacation home, those assets can be seized to satisfy your debts, but your home would be protected for as long as you or your family continue to live in it.
The Homestead, however, only protects you from debts incurred after the Homestead has been recorded; you cannot shield your home from debts incurred before a homestead election was made. If you have not already declared a “Homestead” for your primary residence you should consider doing this immediately to protect your family and your home from creditors.
Please call us if you would like to learn more or would like us to prepare a Declaration of
Homestead for your primary residence.
The Massachusetts Senate has passed an amendment to the homestead law, which is now pending (Bill S. 2653) in the House Ways and Means Committee. If passed, all homeowners would have an automatic homestead of up to $125,000 of home equity and homeowners who record a homestead election would still be able to protect up to $500,000. The proposed legislation would also definitively allow a homestead election to be filed on a home owned by a trust.
The Massachusetts Appeals Court recently concluded that a real estate broker’s failure to verify a property’s zoning status before putting it on the market did not constitute an unfair or deceptive business practice in violation of the state’s consumer protection law. Buyers should, therefore, always be prepared to conduct their own due diligence regarding a property’s zoning status and should not rely on their brokers’ representations about zoning when purchasing real estate.
Quinlan v. Clasby, 71 Mass. App. Ct. 97 (2008), involved the sale of a house in South Boston that contained three separate apartment units. Although it was zoned as a three-family home, the variance permitting this use allowed for no more than one unit to be above the first floor. At the time of its sale, the house had twosecond-floor apartments.
The seller informed the broker that the house was a “three-family” and the broker inspected the property and determined that it was being used as a three-family residence. The broker also obtained copies of the tax records that showed that the property had been taxed as a four-family home for the previous eight years. Without checking the applicable records on file, the broker advertised and sold the house as athree-family dwelling.
Several years later, the buyers attempted to resell the property, and received an original offer to purchase of $390,000. Once the new buyer determined that the property was not a lawful three-family house, however, she opted out of the deal. The buyers eventually sold the property for $320,000, $70,000 less than the original offer.
The buyers filed suit against the broker seeking to recoup their lost profits. They argued that the broker could have reasonably ascertained the unlawful zoning status of the property by checking the public records and that her failure to do so was both unfair and deceptive. They also argued that the fact that the property had previously been taxed as a four-family residence should have put her on notice that there was a problem with the property’s zoning status.
At trial, the broker testified that when listing a property she typically obtains information from the owner, inspects the property, and checks the deed and tax information. She does not check the zoning status because she lacks the experience necessary to determine what the legal zoning status of a property is. The Massachusetts Association of Realtors also submitted an amicus brief in support of the broker establishing that brokers do not generally perform title searches and that they lack the training necessary to give advice regarding compliance with legal zoning laws. The buyers offered no contrary evidence.
The Appeals Court ruled in the broker’s favor, finding that the consumer protection statute does not impose liability for failing to disclose what one does not know. The Court further held that given that brokers, industry-wide, typically do not review zoning records or provide advice regarding zoning matters, brokers are under no duty to determine whether a property is in compliance with applicable zoning laws before putting it on the market. By inspecting the property and confirming that it was a three-family unit and by obtaining relevant tax documents, the broker “did all that was legally required of a real estate broker in the sale” of a property.
In light of the Appeals Court’s ruling in Quinlan, buyers should not rely on a broker’s representations regarding the zoning status of a property. To ensure that the property is as advertised, buyers should perform their own due diligence through a qualified professional, such as an attorney, to verify that the property is in compliance with all applicable zoning laws.
Buyers can further protect their interests by ensuring that any representations or warranties made about the property, including its legal status and uses, are included in the purchase and sale agreement.
In the Greater Boston Real Estate Board’s Standard Purchase & Sale Agreement (available at www.gbreb.com), buyers and sellers can include any additional warranties and representations made between the parties in Section 25 of the contract. Although it is common practice for parties to write in “none, property sold as is,” buyers must include any warranties and representations they wish to enforce against the seller in the agreement. In the case of zoning, any and all representations made by the seller regarding the legal uses and status of the property should be written into the contract.
During the past few years, preservation of electronic information has become a hot-button topic in litigation. Effective December 1, 2006, the Federal Rules of Civil Procedure were amended to ensure proper discovery of electronically stored information. While the Massachusetts Rules of Civil Procedure have not yet been modified, proper preservation and production of electronically stored information is an important first step whenever the possibility of a lawsuit requires.
Upon awareness of the possibility of a lawsuit or actual notification of a lawsuit, a company and/or individual is required to take steps to preserve any and all information and documents, including electronically stored information that may be relevant or related to the lawsuit. The first question in preserving electronically stored information is what must be kept? Initially, it is important to always remember that files that are stored in electronic format must remain in electronic format, i.e. printing a hardcopy does not satisfy a requirement to preserve electronically stored information.
Examples of electronically stored information that needs to be preserved in its native (electronic) form include, but are not limited to: letters, memos, notes, outlines, spreadsheets, e-mails, and other documents or information evidencing communications, financial information, word processing documents and spreadsheets, and databases, calendars, telephone logs (for and including cell phones), contact information, Internet history (or usage files) and plan and network access information.
In addition, the following must also be preserved:
- Software: databases and networks computer systems, including obsolete systems enterprise servers and archives for backup or disaster recovery systems types and disks drives cartridges and other storage media; and
- Hardware: laptops, business and personal computers (even home computers if used for business purposes), Internet data, personal digital assistants (PDA’s), handheld wireless devices, extra hard drives, zip or thumb drives, mobile telephones, pagers and audio systems (living voicemail).
Any and all routine data destruction and backup tape recycling policies which can relate to the potential or pending litigation must be discontinued. Computer hardware storing any information cannot be disposed of unless an exact replica (or mirror image) is made by appropriate experts. In addition, all manuals with written instructions, network access codes, and like information, especially those concerning obsolete systems, must be preserved.
These requirements will apply to any contractors working for an individual or company, as well as any employees. Furthermore, these requirements should be taken into consideration during the drafting or editing process on the retention or destruction of documents and other information so as to ensure compliance even where litigation is not anticipated.
Atticus Finch would recognize that technology and lawsuits are established facts of business life. It is hardly revolutionary to note that increasing amounts of information is stored and transmitted using computers and other electronic gadgets and tools. This reality has, as of December 1, 2006, formally made its way into the Federal Rules of Civil Procedure and less formally into the State Courts. In civil (i.e., noncriminal) lawsuits, the rules of procedure allow for a broad exchange of information between the parties to the lawsuit. An increasingly vast majority of the valuable information resides in electronic format on computers and other devices. Managing the request and production of this electronically stored data, so called E-Discovery, is a reality we must all embrace.
Each party to a lawsuit will have among its first tasks the consideration of what types of information to request from the other side. For example, in employment cases, the parties will always want all e-mails for both home and work computers. In contract cases, the parties will seek the various drafts of the written contract, any subsequent amendments, and perhaps PowerPoint presentations or similar materials prepared pursuant to the contract. Generally, internal and external communications will play a critical role in proving and defending a dispute. An informational technology specialist must guide the process to ensure the responsive information is found and copied for transmission to the requesting party in an appropriate format. The time period for which information will be sought will likely require review, analysis and copying of backup tapes or other archiving systems.
Some information may be corrupted or not retrievable. Explaining when and how the information was corrupted will become important. Once a lawsuit or serious dispute arises, parties must take reasonable steps to preserve all relevant data. Morgan Stanley & Co., Inc. learned the hard way when the mismanagement of its electronically stored data resulted in a series of unfavorable court rulings culminating in $1.45 billion dollar jury verdict against it.
Individuals and businesses alike must be aware of the court’s expectations and their obligations regarding electronically stored data. Businesses should have a “go to” computer expert either employed or regularly consulted so that someone knows what systems exist and how they are configured. This information, moreover, should be reduced to writing. The new rules make the development of a records retention policy imperative. If a dispute arises and information is lost because backed up information is destroyed, dire consequences could result. Similarly, information that no longer exists because it was written over pursuant to a reasonable, written policy will protect a party from sanctions.
Whether a business employs good organization and sound policies, and its level of adherence to those policies, will be the lens through which the courts will evaluate a party’s conduct. The more resources available to the company, the greater the burden the company has to manage and retrieve its electronically stored data. Attorneys must be fully educated about their client’s hardware and software. Judges in early pre-trial and discovery conferences will expect disclosures of what information exists and where it resides. Often, courts will enter orders based upon the party’s representations regarding this information. If the production is inconsistent with the court’s expectations or the party’s representations, then the cost to retrieve and reconstruct information will be borne by the unprepared and noncompliant party.
Individuals as well as businesses will bear the brunt of this new era of technology. Employees who bring actions against employers can expect to have their home or laptop computers imaged and reviewed. Complaining employees will likely know before their employers that an objectionable workplace circumstance exists.
The failure to preserve, or worse, to destroy e-mails and the like, may carry adverse and costly consequences including at best an inference that the destroyed emails were harmful to your case, or at worst the sanction of judgment against you. The importance of formulating and adhering to a reasonable policy for the retention of information, electronic or otherwise, therefore, cannot be overstated.
Intertwined with the concept of E-Discovery is the reality of personal use of business computers. Employers sued for sexual discrimination are always surprised to see “jokes” circulated amongst groups of employers clearly communicate in employees, many times including supervisors for whose conduct companies face strict liability.
Policies for computer use must be developed, written, communicated and enforced. Best practices dictate that writing that employees should have no expectation of privacy on their business computers and that periodic inspection may or will occur.
The well known benefits of ease and efficiency of technology has led to the inevitable migration of data to electronic medium. A good New Year’s resolution is to speak to counsel to understand the expectation of retrieving electronically stored data and to establish policies and procedures to manage the information. It will take time, so start now.
ELECTRONICALLY STORED INFORMATION CHECKLIST
o Who is the person most knowledgeable about the hardware and software we use, including the versions of software?
o Do we have a document retention policy for when documents such as emails may be written over?
o If sued, who do we want to testify about our systems capabilities and limitations?
o If information is copied to our hard drives, CD’s, DVDs, flash drives, etc., is it more accessible than information on back-up tapes that may not be immediately accessible? Similarly, how is this media stored?
o If we receive a letter identifying a dispute or potential disputes that demands the preservation of electronically stored data, how will we handle the letter and our so-called preservation obligations?
o Do we communicate and educate our employees about these policies?
o Do we monitor and enforce these policies?
In 2004, Massachusetts enacted General Laws Chapter 149, § 148B, the Independent Contractor Statute, in an attempt to prevent the misclassification of employees as independent contractors and deprive such workers of benefits entitled to them as employees. The Independent Contractor Statute provides that, for certain purposes, an individual performing a service shall be considered an employee unless:
(1) “the individual is free from control and direction in connection with the performance of the service, both under his contract for the performance of service and in fact; and
(2) the service is performed outside the usual course of the business of the employer; and
(3) the individual is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed.”
An employer is in violation of the Independent Contractor Statute if it misclassifies a worker as an independent contractor rather than employee and fails to comply with certain wage and hour provisions. G.L. c. 149, § 148B(d). Liability under this Statute opens an employer up to treble damages and attorney’s fees, and suits may be brought both by the Commonwealth and by the misclassified workers themselves.
An example of an independent contractor under the Independent Contractor Statute would be a worker hired as a caterer with total control over hours of operation and menus for a manufacturing plant producing radios. The worker is performing a service outside that of the ordinary scope of the manufacturing plant and free from all control. An accountant for an accounting firm who is not able to provide services for others and must comply with all dictates of the accounting firm is an employee.
A 2008 advisory from the Attorney General reiterates that the inability to prove a single prong of the
Independent Contractor Statute in its current form makes a worker an employee. Attorney General Advisory 2008/2 on c. 149, § 148B. The Advisory also provides the following interpretations of the three prongs:
- Free from control and direction – A contract or job description alone is insufficient as proof of worker status. To be an independent contractor, a worker’s duties must be carried out with minimal supervision, i.e. the worker completes the job using his own approach with little direction and can dictate his own work hours. However, “[t]he test is not so narrow as to require that the worker be entirely free from direction and control from outside sources.” Div. of Unemployment Assist. V. Town Taxi of Cape Cod., 68 Mass. App. Ct. 426, 434 (2007).
- Outside usual course of business – A worker is an employee if his services “form a regular and continuing part of the employer’s business” and “whose method of operation is not such an independent business” through which workers compensation costs can be channeled. Am. Zurich v. DIA, 2006 WL 2205085, *4 (Mass. Super. 2006). But, if the worker “is performing services that are part of an independent, separate and distinct business from that of the employer,” the worker is an independent contractor.
- Customarily engaged in independent trade of same nature – If the service provided by the worker can be viewed as an independent trade or business because the worker can provide it to anyone wishing to avail themselves of the service, or the nature of the service is such that the worker is not compelled to depend on a single employer for continuation of services, the worker is an independent contractor. See Coverall v. DUA, 447 Mass. 852, 857-58 (2006).
As discussed, to be liable for a violation of the Independent Contractor Statute, an employer must both misclassify a worker and violate a secondary law in so doing. One such secondary law is the
Wage Act, requiring, among other things, that employees be paid on either a weekly or bi-weekly basis within six calendar days of the termination of a particular pay period. G.L. c. 149, §148. It also prevents employers from penalizing an employee for attempting to seek his rights under its provisions.
Another section of the Wage Act leading to liability under the Independent Contractor Statute is the provision setting forth the fair minimum wage rate, currently set at eight dollars per hour, and the requirement to compensate employees at a rate of time and one-half hours for any hours worked over forty in a single work week and for work conducted on a holiday. G.L. c. 151, §§ 1, 1A, 1B, 19.
Liability is also imputed when an employer fails to keep true and accurate payroll records as required under G.L. c. 151, § 15. or violates the tax withholding provisions of G.L. c. 62B. It is important to note that, as to Chapter 62B, the tax laws utilize section 3401 of the Internal Revenue Code to define an independent contractor more liberally than does the Wage Act. A violation of the workman’s compensation requirements, codified in G.L. c. 152, also causes a violation of the Independent Contractor Statute, but again, independent contractors are defined differently.
Brodie compels shareholders to seek advice at the beginning of a business venture and write down agreements to avoid being stuck in a “shotgun business marriage” with no way out!
Massachusetts law is generally very protective of shareholders in corporations with few shareholders, known as closely held corporations. However, a recent decision by the Commonwealth’s highest court, the Supreme Judicial Court (SJC), has conclusively established that without proper planning a shareholder in a close corporation in Massachusetts is not entitled to the remedy of having his or her shares purchased either by the corporation or the other shareholders, even when they have been frozen out and not enjoyed the benefits of stock ownership.
In Brodie v. Jordan, 447 Mass. 866 (2006), a frozen-out minority (one-third) shareholder who was the surviving wife of a deceased shareholder was not entitled to a forced buyout of her shares by the majority, despite being awarded this remedy by the trial court.
The landscape of legal obligations to and from shareholders in close corporations is well established in Massachusetts. Unlike many jurisdictions, including Delaware,
shareholders (both minority and majority) owe each other the highest duty recognized by law, a fiduciary duty. It is the same duty partners in a Massachusetts partnership owe each other. The trial courts have broad discretion to fashion remedies when violations of the fiduciary duty occurs.
The trial court in Brodie found that the majority shareholders had “frozen [Mrs. Brodie] out” from participation in the company, a machine shop, by refusing her access to company information and denying her any economic benefit from her shares. The trial court concluded that the majority shareholders breached their fiduciary duty to Mrs. Brodie. As remedy for this breach, the trial judge ordered the majority shareholders to purchase Mrs. Brodie’s shares in the corporation at a price equal to her share of the corporation’s net assets, as determined by a court appointed expert, plus prejudgment interest.
The Appeals Court agreed with the trial court. The majority shareholders, however, sought a further appeal to the SJC, who ultimately disagreed with the remedy of a forced buyout because there was no provision in the Incorporation Documents (the Articles of Organization), the By-Laws, or a shareholder agreement for such drastic action.
The SJC reasoned that despite the attractiveness of a “clean break” between the fiduciary parties, it could place the frozen-out party in a better position than if there had been no wrongdoing. Fundamentally, the remedy must be proportionate to the harm. Many close corporations have no market to sell their shares, and a forced buyout creates a market where none otherwise exists. The SJC remanded the case to the trial court for an evidentiary hearing to determine Mrs. Brodie’s reasonable expectations of ownership; whether these expectations were frustrated; and, if so, by what means her interests may be vindicated.
CALL TO ACTION
Brodie makes painfully clear the need for shareholders (as well as partners and LLC members) to consider and reduce to writing what should happen in the event of:
- Termination of employment
The shareholders should fully consider what their expectations are both for the business and themselves individually. They need to reach a consensus as to what should happen when a triggering event occurs. The consensus agreement must then be memorialized in writing either in the Articles of Organization, the By-Laws, or a shareholders agreement.
If a buyout is to occur (and probably should be mandatory in many circumstances such as death, retirement, or divorce) then funding or financing the buyout must be considered. Life insurance can be helpful as a funding mechanism in the event of death of a shareholder. Business owners often work with insurance professionals as well as legal counsel when exploring funding options for different scenarios.
If insurance is not available for any reason, the agreement should contemplate financing the purchase over time with a payment schedule spelled out (generally not more than five (5) years) as well as collateral in the form of a stock pledge and perhaps a mortgage or other lien on assets.
Shareholders in closely held corporations should realize the Probate and Family Court can order that shares be transferred to a divorcing spouse. This happened to one of our clients when a shareholder moved out of state, decided to divorce his spouse, and the Probate and Family Court concluded that since the soon-to-beex-spouse was remaining in Massachusetts and had done some billing work for the company in the past, she should end up with the stock. The remaining shareholder who ended up with the ex-spouse as a new business partner was not happy with the Probate and Family Court’s decision.
Generally speaking, the agreements between the shareholders are memorialized in a shareholders agreement. One of the important decisions is how the business will be valued upon the occurrence of a triggering event. Sometimes the valuation is an agreed-upon amount. More often, a formula is used to determine the value; or an appraisal is done by a business valuation expert. Establishing a valuation formula, moreover, can be very helpful in dealing with the IRS in the event of a death. The corporation’s accountant frequently participates in the valuation process.
Shareholders should also consider other related issues such as whether they should have a right to a job. A time may come when a shareholder’s skills may not be an optimum fit for the needs of the business. Discussing the employment expectations of each shareholder at the outset and memorializing agreements on this issue will minimize future stress.
It is critical to understand that a shareholder who is no longer an employee is still a shareholder unless the founders agree at the outset that if and when the employment of a shareholder terminates, the shares must be sold or redeemed by the company or the other shareholders. The terms of the redemption can be more favorable in some situations such as death or retirement, and less favorable in others such as voluntary termination or where there is wrongdoing. Many entrepreneurs are reluctant to do this necessary planning in the early stages of a new business venture when expectations for the future are bright and everyone seems to be on the same page; but it is naïve not to anticipate that circumstances inevitably will change and problems will arise that can be dealt with more easily and much less expensively if proper planning has been done.
The lesson to be learned from Brodie, therefore, is seek advice at the beginning of a business venture and write down your agreements with your partners to avoid being stuck in a “shotgun marriage” with no way out!
John McLaughlin, Partner
A large percentage of family businesses fail within the second or third generation, but certain actions can be to implemented boost a Family business’s chances for survival.
Q: Why is succession planning important for family businesses?
A: The main reason is to increase the business’s chances for survival. Historically, only 70 percent of family businesses survive to the second generation and 30 percent to the third generation.
Q: Why do family businesses often fail in the second and third generation?
A: Most commonly, family businesses fail due to unresolved family conflicts, lack of leadership and training after the first generation and estate tax burdens.
Q: What are the primary goals of a business succession plan?
A: A well thought out plan preserves and increases the value of the business and the wealth of the owner and the owner’s family Without a succession plan spelling out the owner’s wishes, a family dispute can lead to litigation and financial hardship.
Q: Is there a golden rule regarding succession planning?
A: Both the business and family will survive and do well only if the family serves the business. Neither will do well if the business is run to serve the family. Family members working in the business must be at least as able and hardworking as any non-family employee.
Q: My business doesn’t have a succession plan, so where do I start?
A: The process starts with the owner but should involve the entire family as well as the owner’s attorney, accountant, insurance agent and other relevant consultants. Issues to consider:
- What are the growth plans for the business?
- Who in the family is capable of leading the business?
- What is the owner’s exit strategy?
- How will the owner receive funds during retirement?
- What will the estate tax burden be upon the owners death?
Q: How can advance planning techniques be used to anticipate and avoid family conflict?
A: Techniques such as stock transfer restrictions, buy-sell agreements, multiple classes of stock and shareholder agreements can aid in the resolution of disputes without selling or dissolving the business.
Q: What is a stock transfer restriction?
A: It is a restriction placed upon the transfer of stock to prevent outsiders from acquiring ownership of stock. Stockholders (including heirs) must first offer to sell the stock to the company or to the other stockholder’s).
Q: Why is it a good idea to consider multiple classes of stock ownership?
A: Having two classes of stock, such as voting and non-voting stock, can give owners flexibility in many situations. For example, family members active in the business could have stock with voting rights, while those not active could have non-voting stock. Non-voting stock can also be used to reward or retain keynon-family employees without relinquishing control.
Q: Is it a good idea to have a buy-sell agreement?
A: A closely held family business should almost always have a solid buy-sell agreement reflecting the specific needs and goals of the owner and other family members. It is an important mechanism for maintaining control of the business while allowing for the compensation of another owner or family member upon death, disability, divorce or withdrawal from the business.
Q: What are the primary tax considerations when developing a succession plan?
A: You must know the business’s worth and understand the transfer tax (estate tax). This way, you can coordinate your business and estate plans to provide for your family.
Bernier provides that the earnings of an S corporation should be “tax affected” for purposes of making an equitable distribution between shareholders in a fiduciary relationship.
A recent decision by the Commonwealth’s highest court, the Supreme Judicial Court (SJC), has provided much needed clarification on how to value S corporation earnings in the divorce context. The concept of tax affecting derives from the difference in tax treatment of S and C corporations. C corporations pay tax on earnings at the corporate level, while S corporation earnings pass through to their shareholders on a pro rata basis and are taxed to the shareholders when earned by the corporation, whether or not the corporation pays dividends. When C corporations are valued using the income approach, earnings are reduced by the applicable corporate taxes to determine an accurate value. Valuators also reduce S corporation earnings for taxes. In some instances, valuators base that adjustment on an assumed personal tax rate, but, more commonly, they base the adjustment on corporate tax rates.
In Bernier v. Bernier, 449 Mass. 774 (2007), the SJC was presented with the novel question of whether to discount the value of an S corporation by “tax affecting” income at the rate applicable for C corporations, where one spouse would receive ownership of all shares of the S corporation after the divorce and the other would be required to relinquish all ownership in the business. The SJC concluded that doing so seriously understates the fair market value of the S corporation structure and fails to compensate the seller for the loss of those benefits.
During trial, each party presented the testimony of an expert witness on valuation of the couple’s two S corporations, two supermarkets on Martha’s Vineyard, of which the husband and wife each owned one half. The husband’s expert claimed that application of the C corporation rate was proper because a potential purchaser would factor these tax consequences into the expected rate of return. In contrast, the wife’s expert did not tax affect the S corporations’ income in his valuation because an S corporation does not pay taxes at the entity level and because the husband had no plans to sell the business.
The Probate & Family Court judge adopted the husband’s “tax-affected” value, citing the 6th U.S. Circuit Court of Appeals’ 2001 decision in Gross v. Commissioner of Internal Revenue.
On review, the SJC noted, as a preliminary matter, that in the context of divorce, where one party will retain and the other be entirely divested of ownership of any marital asset, “the judge must take particular care to treat the parties not as arm’s-length hypothetical buyers and sellers in a theoretical open market, but as fiduciaries entitled to equitable distribution of their martial assets.” The SJC observed that while the IRS appeared, in its training materials, to endorse the tax-affecting approach utilized by the husband’s expert, “both case law and professional scholarship have cast serious doubt on the validity of this practice.” Indeed, the Probate & Family Court judge had misapplied Gross, citing it for the proposition that “tax affecting Subchapter S income for valuation purposes should be reflected in determining the ‘cost of capital,’” but ignoring the application of a zero percent corporate tax rate when she adopted the 35% rate proposed by the husband’s expert.
Under these circumstances, the SJC found the Delaware Chancery Court’s 2006 decision in Delaware Open MRI Radiology Assocs. v. Kessler persuasive. Specifically, the SCJ equated the fiduciary considerations that constrain the equitable property division in divorce cases to those that constrained the majority and minority shareholders in Kessler and statutory fair value cases. In Kessler, the Chancery Court held that treating the enterprise as a C corporation failed to account for the comparative tax benefits of S corporation ownership and therefore depressed the estimate of the business’s fair value. However, not tax-affecting it at all would lead to a windfall for the minority shareholders.
The SJC recommended a metric devised by the Kessler court that provided a “fairer mechanism for accounting for the tax consequences of the transfer of ownership” of the S corporations from one spouse to the other. The Court concluded that applying the tax rate applicable to a C corporation to the valuation of the supermarkets understated the value of the supermarkets while failing adequately to account for the loss of S corporation benefits to the wife. This was particularly so in light of the fact that the supermarkets would continue to operate as S corporations after the couple’s divorce; they would continue to be owned by the husband; and the supermarkets were profitable and would continue their historic practice of making cash distributions.
The SJC remanded the case back to the Probate & Family Court on the issue of valuation, as well as on discount and growth rate issues.
By Kim Kramer
Originally Published 2/1/2010 in the Boston Herald
Millions of business owners face the challenge of meeting their retirement needs with illiquid wealth tied up in their privately held business. Many owners believe that selling is the only way to exit their business and realize their personal financial goals.
This is a myth that must be dispelled, and business owners are encouraged to explore all of their options well before their desired exit date.
There are seven primary options by which a business owner can transfer the interests of a privately held business:
- Sale/transfer to employees,
- Sale/transfer/gifting to family members,
- Gifting to charity,
- Sale/transfer to co-owner(s),
- Sale to outsider (owner retires),
- Sale to outsider (owner stays) and
- Initial public offering.
Before evaluating each exit option, a business owner should consider her personal goals as they relate to the business exit. When asked for their primary motivator, most business owners cite financial gain.
While money is always a factor, many owners also care about the future of the business and who will be running it in their place.
An owner who has built a foundation of wealth outside the business has more flexibility to consider factors other than price in evaluating her exit options.
An owner who has not built sufficient wealth outside of the business may have more difficultly balancing her financial and personal goals, as the proceeds of the exit are more critical to attainment of her personal goals. All things being equal, it is more work in this case to develop the best strategy.
In addition to the owner’s personal goals, she should recognize that the type of buyer or successor will affect the price of the business, the structure of the transaction and the tax consequences of the sale or transfer.
Transfers to employees, family members or co-owners generally result in fewer dollars up front but allow the owner greater control over the sale-transfer process, potential future cash flow (in the event of a leveraged buyout) and flexible timing and tax characterization of payments.
By contrast, external transfers to industry players, financial groups or by an initial public offering command more money up front but require the owner to largely relinquish control over the timing and tax characterization of payments received.
Finally, the exiting owner should prepare to do a significant amount of business organization and preparation in anticipation of a transfer. A savvy buyer-transferee will require disclosures related to all aspects of the business in evaluating the proposed transaction.
Assembling these records, confessing to any creative accounting or other practices and presenting them to thebuyer-successor is very time consuming, tedious and psychologically difficult. Failure to make these disclosures, however, can be even more painful, particularly if they result in a future lawsuit.
With these preliminary steps completed, the owner should consider each option outlined below with her personal and financial goals in mind.
An owner may wish to engage an exit planning specialist to assist her with this process and formally evaluate her personal financial readiness and other critical factors in selecting an exit option.
Transfer to employee(s) or family members
In the case of a transfer to employees or family members, liquidity is a primary concern. Many family members or proposed employee transferees lack the financial resources and, perhaps, the requisite experience to fund and successfully manage the buy-out of the business.
Strategies for dealing with this hurdle include the following.
- ESOP or Employee Stock Ownership Plan. An owner may transfer shares to employees through an ESOP, without the employees contributing money.
ESOPs are tax favored and give the owner time to advance her business succession planning by permitting her to take cash out of the business today without relinquishing operational control.
- Estate planning, gifting. If an owner has accumulated sufficient assets to meet her financial needs, she may gift shares of stock to family members. The gifting program can coordinate with the owner’s estate plan over time to manage estate taxation.
Larger transfers to family members can occur in a fast-growing business through a Grantor Retained Annuity Trust (GRAT). These estate planning tools can provide significant tax savings to the exiting owner.
- Leveraged buyout option. Employees or family members can use the assets or equity of the company to secure a buyout of the owner’s interest.
In this scenario, the owner finances the buyout and receives a promissory note with payments over time in return as well as a security interest in the equity and/or assets of the business.
The transferees must be comfortable with the payment terms. The exiting owner must be confident that she has received sufficient collateral for the purchase money loan and that the transferees are capable of successfully running the business following the transfer.
If the business is owned by more than one person, the exiting owner may transfer her interest to her partner in the business.
Businesses with more than one owner should have a shareholder agreement in place to govern the ultimate disposition of the owners’ interests and foreseeable events that may cause a premature or unintended exit, such as untimely death, disability, divorce or bankruptcy.
The shareholder agreement sets forth the basic rights of the owners with regard to their ownership interest and dictates what happens on certain events. A well-drafted shareholder agreement answers the following questions:
- Can I transfer my shares to a third party without the consent of the other owner(s)?
- Can the company or the other owner(s) require me to sell my shares or redeem my shares and, if so, under what circumstances – death, disability, termination of employment, divorce, bankruptcy, bona fide offer to purchase accepted by the majority owner(s)?
- Can I require the company or the other owner(s) to buy my shares and, if so, under what circumstances – termination of employment, death, disability?
- What will I be paid for my shares on redemption or repurchase?
- How will I be paid and over what time period?
- How will we resolve any intractable disagreements related to the business?
Planning for these events and answering these questions in advance puts the business on the right path from the start and limits the disruption of a premature or unintended exit.
The sale of the business to an outside buyer is the exit strategy of which most owners are already aware. An outside buyer is likely to pay a higher amount for the business than the owner(s) will achieve using the other options presented.
The price will take into account the synergies of the deal (economies of scale, cross-selling opportunities, etc.) that will be realized by the buyer.
A selling owner should be aware of the tax consequences and transaction fees associated with athird-party sale and evaluate the impact of these costs before moving forward with an offer.
An owner selling to an outsider should also consider whether she is willing to work for the buyer during an interim transitional period or, if the parties agree, in a longer-term capacity.
Many owners desire to continue working with the business, but find that it is extremely difficult to serve as a subordinate to the new owner.
In sum, most owners agree that they built their business because they didn’t want to work for someone else and expect to work for the buyer only during a clearly defined transition period.
Initial public offering
Larger companies, those worth $100 million or more, may offer their shares in an initial public offering.
This type of transaction allows the general public to purchase the company’s shares. In turn, the company accesses public capital and its shares are traded on a public exchange.
An owner considering this option should be aware of the associated costs, including registration requirements and additional shareholder reporting.
Business owners should be aware of their exit options and begin to consider their personal goals well in advance of retirement. This forethought and planning will give them the most flexibility and the best shot at a comfortable retirement and the continued success of their business.
On August 5, 2010, Governor Deval Patrick signed into law Senate Bill No. 2582, An Act Relative to Economic Development Reorganization. With little fanfare, Massachusetts amended G.L. c. 148, § 52C concerning employee personnel records in a way that effects all employers in the Commonwealth with a clause added into the depths of this 134-page bill. Employers are now required to notify an employee within ten (10) days of placing any negative information into the employee’s personnel record. Specifically, the law states:
An employer shall notify an employee within 10 days of the employer placing in the employee’s personnel record any information to the extent that the information is, has been used or may be used, to negatively affect the employee’s qualification for employment, promotion, transfer, additional compensation or the possibility that the employee will be subject to disciplinary action. Senate Bill No. 2582, § 148.
Additionally, while still requiring an employer to provide an employee with his or her personnel record within five (5) days of a written request for review, the new statute limits this compulsory viewing to two times per calendar year. The requirement to allow an employee to view new negative information in his or her personnel file does not count towards the two annual viewings.
A violation of this statute is enforceable by the Attorney General and is subject to a fine of between $500 and $2500.
This statutory amendment will require all employers and human resources departments to adjust and/or amend current policies regarding employee personnel files.
Please contact our offices at (617) 557-3030 or email@example.com if we can be of any service in this matter or answer any questions you may have.
Robert R. Berluti, Esq.
Rebecca L. Sipowicz, Esq.
$2 million arbitration award
By Mass. Lawyers Weekly Staff
Published: August 16, 2010
A large, publicly traded insurance company terminated a long-serving executive without cause. At issue was what amount, if any, the employer was obligated to continue to pay the executive under the contract.
The employment agreement had been amended and extended twice. The language of the second amendment was found to be ambiguous, requiring an evidentiary trial. The executive employment contract provided for salary, bonus, stock awards, stock options and stock grants, among numerous other benefits.
The employer’s position on its obligations under the employment contract evolved continuously to and during the trial, when it raised for the first time that the employee should be barred from receiving any benefits because he had been dishonest in his dealings regarding a prior year’s book of business. The arbitrator rejected that contention.
The core issue for the arbitrator was determining the period of time for which the employer should pay the plaintiff annual compensation in the form of a guaranteed draw and a predetermined bonus, in addition to other compensation. The employer claimed the employee was entitled to nothing, while the employee asked for four years’ salary.
A subsidiary issue was whether the employee should be relieved of fulfilling a condition precedent of a minimum level of a book of business, since the employer terminated his employment without cause.
Significantly, the contract was governed by New York law, wherein the doctrine of “impossibility of performance” was deemed not helpful to the employee. Similarly, the concept of prevention or hindrance under New York law did not vitiate the condition precedent for the final two years of the contract.
The arbitrator awarded the employee two years’ guaranteed draw, two years’ bonus plus other compensation.
Type of action: Employment
Injuries alleged: Breach of contract
Name of case: Withheld
Court/case no.: Withheld
Tried before judge or jury: N/A (arbitrated)
Amount of award: $2 million
Name of arbitrator: Mark L. Irvings
Date: July 23, 2010
Attorney: Robert R. Berluti, Berluti & McLaughlin LLC, Boston (for the plaintiff)
Case Brief: Negligence – Tree Farm – Immunity – Warning Sign
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