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Tax Planning for Nonresident Aliens Who Own US Property

Individuals who are not citizens or residents of the United States, known as nonresident aliens (NRA), need to be aware of the U.S. estate and gift taxes that will be applicable to their U.S. fixed assets, for example, U.S. real estate. If an NRA owns fixed assets located in the U.S., either directly or in a revocable trust, the liability for estate and gift taxes can be surprising. NRAs do not have the protection of the estate/gift tax exclusion of $11.4 million per individual in 2019; instead the exclusion is $60,000. If a married couple owns property and one spouse dies, the full value of the marital property located in the U.S. is immediately subject to an estate tax of approximately 40 percent. There is no unlimited marital exclusion for NRAs.

Similarly, if one spouse is a U.S. citizen and the other spouse is not, the unlimited marital deduction only applies if the surviving spouse is the U.S. citizen. If the surviving spouse is a non-citizen, even if a U.S. resident, the unlimited marital exclusion does not apply.[1]

If there has been no tax planning, 100 percent of the jointly owned property or property passing to the surviving spouse located in the U.S. must be included in the recently deceased spouse’s estate, with estate taxes due on the amount in excess of $60,000. If faced with this unwelcome news, the property can be placed in a Qualified Domestic Trust (QDOT), which provides for a marital deduction so that the estate tax will not be due until the surviving spouse’s death. The QDOT must be finalized prior to the date the estate tax return is filed, including extensions. If the funds (corpus) are then taken out of the trust, other than limited exceptions explained below, the amounts will be subject to tax and a Form 706-QDT is required to be filed with tax owed unless covered by a treaty.

Due to the onerous nature of these tax provisions, eighteen countries have estate/gift tax treaties with the United States, including Australia, Canada, Germany, Japan, and South Africa. Also, due to the onerous nature of the estate tax and the lack of an unlimited marital exclusion, the annual gift tax exclusion between spouses is $155,000 for 2019 for gifts of property to an NRA spouse. The spouse making the gift must make it intentionally, and so the gift tax exclusion is unavailable upon the date of death.

One caveat is that income from the U.S. assets is not subject to estate/gift tax, although could be subject to income tax. The Internal Revenue Code specifies: “No [estate] tax shall be imposed on any distribution of income to the surviving spouse.” The Treasury Regulations set forth the requirements and definitions to determine the payments that satisfy the definition of “income” for these purposes.

The Internal Revenue Code and accompanying Treasury Regulations set forth different requirements for a QDOT that holds assets that are worth $2 million or less, and a QDOT holding assets worth greater than $2 million. Essentially, there must be a U.S. trustee with the authority and ability to pay any estate taxes that are due upon the death of the surviving spouse. Those principles are accomplished differently depending upon the value of the assets. The effect of the QDOT is to provide an unlimited marital deduction and to defer the estate taxes until the death of the surviving spouse. The property in the QDOT may be reduced in value through distributions to the surviving spouse on account of hardship due to health, maintenance, education, or support. Said qualifying distributions do not subject the QDOT to estate/gift tax. Amounts paid for expenses of the trust are also not taxable distributions. Another option is for the surviving spouse to become a U.S. citizen and resident, and thus become eligible for the $11.4 million exclusion from estate taxes. Another important factor is whether there is an estate/gift tax treaty with the country of citizenship of either spouse since that may also provide tax relief.

The unwelcome news that a U.S. estate tax may be due, not to mention a state inheritance or estate tax, on the value of U.S. real estate upon the death of a nonresident alien should be dealt with as part of intentional U.S. gift and estate tax planning. A little bit of planning can avoid surprises and save money in the long run.

[1]  Internal Revenue Code §2040, §2056(d), and Treasury Regulation §20.2056A-8 provide special rules for joint property where the surviving spouse is an NRA. Either a Form 706 (if decedent is a U.S. citizen) or a Form 706-NA (if the decedent is an NRA) must be filed. The Form 706/706-NA, or a request for an automatic six month extension, is due to be filed within nine months of the date of death.

| Roy L. Kaufmann

TOPA Update – Single-Family Homes, DC Legislation Passed

This is an update from the articles posted March 9, April 4, April 6, and April 10, 2018 relating to Single-Family Homes – DC Legislation Proposed to Exclude from TOPA.

The District of Columbia Council passed legislation today, April 10, 2018, that excludes single-family homes from TOPA. Bill 22-315, was first introduced last year and focused on excluding accessory units (like basement apartments). After a lengthy hearing on that iteration, the proposal was expanded to exclude single-family homes, including those with accessory units.

The name of the Bill was changed to the TOPA Single-Family Home Exemption Amendment Act of 2018 from its earlier name of TOPA Accessory Dwelling Unit Amendment Act of 2017.

The Committee Report from the Housing and Neighborhood Revitalization, chaired by Councilmember Anita Bonds, goes into detail about the circumstances that give rise to the need for the legislation and the positions of the various stakeholders.

The then-current version under consideration, Bill 22-315, was passed at first reading on March 6, 2018.  Voting against the Bill were Councilmembers Nadeau and Silverman.  There was an amendment introduced and passed the same day by Councilmember Cheh which added an additional notice to tenants, to be sent within several days of listing a property, that simply notified the tenant that the property was being offered for sale.

The Bill excludes single family accommodations from TOPA. There are certain protected classes: elderly and disabled. The Bill sunsets those protections if a written lease were not in place on March 31, 2018 or if the property was not occupied by April 15, 2018.

The definition of accessory units is fairly expansive, meaning that a single-family accommodation with a basement apartment or a carriage house would be exempt from TOPA, subject to the carve-out of the protected classes.

The Bill, as voted upon, incorporated almost all of the technical changes requested by the  DC Land Title Association (for which the author serves as lobbyist) designed to 1) ensure clarity so that title insurance underwriting can be achieved without many of the current obstacles, 2) clearing up the concept of “delivery” so that it can  be ascertained with certainty, and 3) to be able to identify if a person is either elderly or with a disability.

Key elements of the Bill:

Notice of Listing or Receipt of Written Offer

This notice, included in an amendment by Councilmember Cheh, will need to be delivered to the tenants within 3 days of entering into a listing agreement, receipt of an offer to purchase, or issuance of an offer to sell.  This “heads-up” notice would need to include the price, and the tenant “may submit an offer to purchase the single-family accommodation in response to the notice”.  This notice needs to be sent not more often than once a year (as long as each tenant receives it once a year), does not trigger any rights and is mainly to allow tenants to plan.

A failure to deliver this fairly non-substantive notice would not give rise to any in rem jurisdiction over the property. No lis pendens could be filed.  The damages, if any, could only be assessed against the owner.

The realtors might incorporate this Notice into their listing package to ensure that it is sent.

notice of intent to sell, demolish, or discontinue the housing use of the single-family accommodation

This notice is optional. But, if utilized, it is a powerful tool for both the owners and the tenants. In effect, this is a “ping” letter to let the tenants know that the owner has an interest in selling the accommodation (or demolish, discontinue, etc.) and asks whether the tenant is elderly or with a disability. If the tenant is in a protected class, the tenant would be covered by TOPA. If, however, the tenant is not in a protected class, TOPA would no longer apply.

What this Notice of Intent would contain.

The form itself is likely to be issued by the DHCD, but would contain a description of the rights and obligations of elderly or disabled tenants as well as a list of organizations that can provide assistance.

How is this Notice delivered (and are delivery methods the same for all required documents)?

The new Bill cleans up a recurring problem which was how to prove that someone actually received a piece of paper.  For example, if a document is delivered to a front desk or concierge, how would anyone be able to prove the date that the document was placed in the tenant’s hands?  Certified mail, the method in the current statute, has proved to be disappointing.  Green cards get lost, and the USPS sometimes disavows that it received a piece of mail, even when the owner has a stamped USPS receipt showing mailing.

Under the new bill, the concept is changed from “receipt” to delivery (as opposed to “mailing” which was a concept in earlier versions of TOPA).  There are now 4 different methods that are offered as to ALL documents required to be delivered:

  • First-Class Mail (since the sender will have to prove delivery, it is unlikely that anyone will choose this method);
  • A delivery service providing delivery tracking confirmation.  Services such as FedEx will likely be the method of choice.  The legislative history of the Bill will likely underscore that, once FedEx has issued a confirmation that the document was delivered, that will be dispositive;
  • Certified Mail is still a permitted method, although perhaps unlikely to be used by owners;
  • Hand delivery is now expressly permitted.  A certificate or affidavit of hand delivery will establish the date and time of delivery.

Copies of Delivered Documents need to be sent.

Except as to the first Notice of Listing, copies of all other notices must be delivered to “the Mayor” (i.e. DHCD) within 10 days along with written evidence of the date of delivery of the original document.

Tracking of Documents

DHCD will be date stamping receipt of documents and upon request of an owner, tenant, title company, or listing brokerage shall provide written confirmation of receipt or non‑receipt of any document (except for the Notice of Listing).

Tenant Deadline?

The tenant has 20 days from the date of delivery to deliver a written response to the owner that states that the tenant claims status as elderly or a tenant with a disability. If a tenant fails to deliver that response is deemed a waiver of TOPA rights.  Apart from informing the owner of a claim of protected status, the tenant also needs to supply documentation to DHCD (discussed below).

Limitations on when this Notice of Intent can be sent?

The current version of the Bill under consideration says “An owner may not serve a tenant with notice of intent to sell … more than 60 days before issuing the offer of sale.” That might happen more than 60 days after an owner elected to send a Notice of Intent. If resending a Notice of Intent every 60 days is curative under this statute, it might be more work and notices than advisable. The committee that advanced this Bill considered changes to this language, but opted to leave the language as is.

Offer of Sale

The version of the Offer of Sale depends upon are in the building.  Now, the Offer of Sale for a single-family accommodation, even with an accessory unit, will be a single-unit offer. Delivery, tracking, and confirmation by DHCD are the same as set forth above.

As to single-family accommodations, the Offer of sale:

  • include a description of tenant’s rights and obligations
  • include a list of organizations that might be able to assist the tenant
  • send a copy of the Offer of Sale to Office of Tenant Advocate on the same day the Offer of Sale is sent (Councilmember Trayon White amendment) (and OTA has 4 business days to try to contact tenant to offer assistance).
  • copies to DHCD

As to single-family accommodations, the tenant must then:

  • deliver to owner a written statement of interest
  • within 20 days after delivery of the Offer of Sale to tenant
  • must be a clear expression of interest by tenant that tenant wants to exercise the right to purchase
  • copy to DHCD
  • “A tenant’s failure to deliver a written statement of interest to the owner in a timely manner shall be deemed a waiver of the tenant’s rights under this section.

Negotiation Period

If the tenant has timely delivered their written statement of interest, there are 25 days to negotiate a contract of sale (not counting the 20 days the tenant must deliver notice of interest). “For every day of delay in providing information by the owner as required by this title, the negotiation period is extended by one day.”

Settlement to be at least 45 days after date of contract; but, if a lender says that it needs up to 75 days after the contract to decide to lend, the owner shall afford an extension to close.

Assignment of TOPA rights.

This has changed radically.  Tenants may no longer receive compensation for assigning their TOPA rights (either to the owner or to anyone else) except for the right to immediately use and occupy the tenant’s unit for up to 12 months following the sale at the same rent as of the date of offer of sale. Reassignments are further limited to corporations or partnerships of which the assignee is a principal and no consideration is allowed in exchange for a secondary assignment.

Nor can a tenant receive consideration to vacate before the end of the 12-months.

It has been suggested that, notwithstanding the foregoing, a tenant could accept consideration for vacating early after receiving a notice to vacate for personal use.

How does a tenant prove disability or age?

 When does a tenant have to submit proof?

A tenant who asserts rights as an elderly tenant or tenant with disability would need to provide documentation to DHCD by the same date the tenant’s written statement of interest is due to the owner.

What proof will DHCD be looking for?

For age, DHCD will be looking for birth certificate, District-issued driver’s license or identification card, or other documentation satisfactory to DHCD.

For disability, DHCD would be looking for:

  • an award letter for disability benefits from the U.S. Social Security Administration,
  • a letter from a physician stating that the tenant is a tenant with a disability, or
  • other such documentation the Rental Conversion and Sale Administrator deems sufficient to establish proof of disability.

 Deadline for DHCD determination of status as elderly or with a disability.

DHCD will, within 30 days after receiving documentation, determine whether a tenant qualifies as an elderly tenant or a tenant with a disability and would provide that determination to an owner, tenant, title company, or listing broker.

What is next? Mayorial and Congressional Review

The legislation will now go to the Mayor for her signature and then to Congress for review.

This article is an update of articles posted on March 9, April 4, April 6, and April 10, 2018. It reflects the passage of the legislation.

Related article: https://jackscamp.com/topa-proposal-eliminate-bankruptcy-court-order-exemptions/

| Roy L. Kaufmann

DC Reduced Rate of Recordation Tax – Applies to Revocable Trust

The District recently passed legislation which reduces the Recordation Tax for most first-time homebuyers.  The Recordation Tax for a “first-time District homebuyer” purchasing “eligible property” is reduced to 0.725% (transfer taxes owed by the seller of 1.1% or 1.45% are unchanged) for houses and, for transfers of economic interests in a housing cooperative unit (co-op unit), the recordation tax rate is reduced from 2.2% to 1.825% for units under $400,000, and from 2.9% to 2.175% for units $400,000 or greater (there is no transfer tax).

A question arose whether a buyer who has established a revocable trust for estate-planning purposes would be precluded from taking the important tax reduction.

A Notice of Proposed Rulemaking was issued on February 16, 2018 to which no comments were received. Accordingly, the District has issued a Notice of Final Rulemaking making it clear that the revocable trust is a viable vehicle and its use will not interfere with the lower tax rate. Specifically,  9 DCMR 528.5 will read as follows:

528.5  For purposes of determining eligibility for the reduced rate of recordation tax
provided under Section 303(e) of the District of Columbia Deed Recordation Tax
Act of 1962, approved March 2, 1962 (76 Stat. 11; D.C. Official Code § 42-
1103(e) (2013 Repl.)), the grantee of a deed conveying real property to a
revocable trust (as defined under this section), or the trustee of such a trust, shall
be deemed to be the individual grantor, settlor, transferor, creator or trustor of
such trust, and the determination of entitlement to the reduced tax rate shall be
made based upon such individual without regard to the existence of such
revocable trust.

A first-time homebuyer would submit their application at the time the deed is to be recorded. The application would likely be prepared by the title company if the buyer requests it. The application cannot be filed after the deed is recorded.

| , David H. Cox, Roy L. Kaufmann

TOPA – Proposal to eliminate Bankruptcy and Court-Order Exemptions

Earlier this month, Bill 22-0739 was introduced to the District of Columbia Council. The Bill is named the TOPA Bankruptcy Tenant Displacement Prevention Amendment Act of 2018. The Bill seeks to amend the Tenant Opportunity to Purchase Act to remove TOPA’s exemption of bankruptcy sales and to require owners of property acquired via court order to submit to TOPA regulations.

Bill 22-0739 removes the bankruptcy sales exemption. Under current TOPA subsection (c)(2)(E), bankruptcy sales do not count as a “sale. ” D.C. Code sec. 42-3404.02(c)(2)(E) (exempting bankruptcy sales from TOPA regulation). With the new Bill, bankruptcy sales would instead fall inside TOPA’s scope and would require the “owner” to file a written Notice of Transfer. The Bill explicitly repeals the aforementioned subsection (c)(2)(E).

The new Bill also includes new requirements for owners of property acquired through the courts, such as through an order or a court-approved settlement. Under current TOPA, these owners are exempted. D.C. Code sec. 42-3404.02(c)(2)(M) (exempting court-ordered sales from TOPA regulation). Bill 22-0739 stops short of expanding the “sale” definition to include such court-approved transfers, but instead adds an entire section that gives tenants under these owners an opportunity–within one year of the owner’s acquisition of title–to purchase the transferred property at 105% of the purchase price, plus reasonable out-of-pocket third-party and capital improvement costs.

The Bill calls this new section “402b” and the section differs from other TOPA provisions in that 402b triggers following the transfer of title rather than prior to the transfer of title. However, this new section does not require owners of court-transferred, single-family accommodations to afford their tenants any reasonable time to secure financing. See D.C. Code sec. 42-3404.09(3) (providing time before settlement for tenants in single-family accommodations to seek financial assistance).

The Bill, as currently written, may pose several legal complications. Bill 22-0739 does not address partial transfers, no-money transfers, partition suits, or how TOPA intersects with federal bankruptcy law. For example, if a party sues for partition of real property, how will the final court order  be subject to the TOPA rights of the property’s tenants?. Despite the new section providing a post-transfer trigger, the Bill also fails to address whether every suit involving interest in real property requires the tenants to be brought on as nominal defendants. Moreover, it is unclear how the Bill would affect the rights of a bankruptcy trustee and what notice needs to be given to the tenants of bankruptcy properties, especially given the Supremacy clause and any conflict between TOPA and federal bankruptcy statutes.

Bill 22-0739 is currently under Council review.

Related article: https://jackscamp.com/single-family-homes-topa-exclusion/

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Court Rejects Fifth Circuit’s “Substantial Need” Test For Funding Under 18 U.S.C. sec. 3599(f)

Under 18 U.S.C. sec. 3599(f), a defendant charged with a crime punishable by death can petition the trial court for funds that would be “reasonably necessary” for investigative, expert, or other services needed for the defense. In Ayestas v. Davis, a man sentenced to death made such a petition to support his federal habeas claim for ineffective assistance of counsel. The trial court denied the application based on a procedural default, and the Fifth Circuit affirmed under its standard that defendants must show a “substantial need” for such services to support “a viable constitutional claim that is not procedurally barred.” The Court, in a unanimous opinion by Justice Alito, reversed, holding that the Fifth Circuit’s “substantial need” test was more stringent than the “reasonably necessary” test set forth in the statute. The Court also determined that it had jurisdiction to hear an appeal of a denial of funding because the ruling was not “administrative” in nature. However, the Court did not consider whether funding could be “reasonably necessary” in pursuit of a procedurally defaulted ineffective assistance of counsel claim, and so left that issue for the Fifth Circuit to consider on remand. Justice Sotomayor, joined by Justice Ginsburg, lodged a concurrence, arguing that the defendant had shown on the record that such funding was “reasonably necessary” under the statute.

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Government Must Prove Specific Interference With Targeted Tax-Related Proceedings For Tax Obstruction Charge

IRS code makes it a crime under 26 U.S.C. sec. 7212(a) to “obstruct or impede, or endeavor to obstruct or impede, the due administration of” the Internal Revenue Code, either “corruptly or by force or threats of force.” The IRS investigated Carlo Marinello, and ultimately charged him with several violations of the tax code, including for tax obstruction under Section 7212(a). At trial, the trial court did not instruct the jury that it had to find that Marinello knew he was being investigated, and intended corruptly to interfere with that investigation. Marinello was convicted, and he appealed, arguing that the Government had to prove he interfered with a “pending IRS proceeding” to be guilty of tax obstruction. The Second Circuit disagreed. Resolving a split among the circuits, the Supreme Court, in a 7-2 opinion by Justice Breyer, reversed. Comparing the language of Section 7212(a) to the statute the Court examined in United States v. Aguilar, 515 U.S. 593 (1993), which prohibited obstruction of “the due administration of justice,” the majority held that the language in both cases required the Government to prove specific interference with targeted tax-related proceedings, or at least a nexus with the same, observing that to hold otherwise would convert almost any lesser tax-related offense into a felony tax obstruction charge. Justice Thomas, joined by Justice Alito, dissented, arguing that the statute as written permitted the Government to convict a person for tax obstruction of any kind, whether connected to a particular proceeding or otherwise. See the opinion in Marinello v. United States.

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Court Permits State Court Jurisdiction Over Securities Class Actions

In Cyan, Inc. v. Beaver County Employees Retirement Fund, the Fund purchased shares in Cyan which then declined in value, prompting the Fund and others to file a class action suit against Cyan in state court under the Securities Act of 1933. Cyan argued that the Securities Litigation Uniform Standards Act of 1998, as it amended the 1933 Act, removed state court jurisdiction over the Fund’s claims. The state court declined to dismiss the case, California’s appellate court affirmed. The Court, resolving a split among state and federal courts in a unanimous opinion by Justice Kagan, affirmed. First, the Court held that the 1998 Act’s language did not preclude state court jurisdiction over securities class actions by its express terms—the Act only barred certain securities class actions based on state law. The Court also rejected Cyan’s arguments as to the legislative history and purpose of the 1998 Act. The Court further held, upon prompting by the Government, that the 1998 Act did not permit defendants to remove securities class actions to federal court, concluding that the plain language of the 1998 Act did not indicate any intent by Congress that actions brought under the Securities Act of 1933 be litigated solely in federal court.

| , David H. Cox

DC Super-Priority Lien on a Condo Cannot Foreclose Subject to First Priority Mortgage

Following from its decision in Chase Plaza Condominium Assoc. v. JPMorgan Chase Bank, 98 A.3d 166 (DC 2014), in which the DC Court of Appeals held that a DC condominium foreclosing on its statutory six-month super-priority lien could by law extinguish an otherwise first-priority mortgage when the proceeds of the sale were insufficient to satisfy that mortgage, the Court was asked to determine whether a condo association could choose to sell a condo unit “subject to the first mortgage” on the property while still enforcing its super-priority lien. The Superior Court held that it could, but in Liu v. U.S. Bank N.A., Chief Judge Blackburne-Rigsby, joined by Judges Glickman and Thompson, held that it could not without contravening the Chase Plaza decision. The appellate court agreed that the anti-waiver provision of DC Code sec. 42-1901.07 prevented such a variance and protected associations from pressure by lenders. The Court rejected the equitable arguments by the lender. The result proved costly to U.S. Bank, which lost its nearly $800,000 lien on the unit. Worse, U.S. Bank tried to pay off the roughly $5,200 super-priority lien to stop the foreclosure sale, but did not get the payment to the association until the day after the sale was completed. Lenders clearly must act quickly to protect their interests upon receiving notice of a foreclosure under a super-priority condo lien. As a result of U.S. Bank’s delay, the foreclosure sale buyer paid $17,000 for the unit, which was assessed at over $700,000, and received it free and clear of U.S. Bank’s lien. Importantly, this case only addressed a condo lien for fees not paid prior to April 7, 2017, when DC Code sec. 42-1903.13(c)(4)(B) was changed to permit a condo association to foreclose either on the six-month super-priority lien not subject to a first deed of trust, or for more than the six-month lien but subject to the first deed of trust.

| Arthur D. Burger

Art Burger to Participate on Panel, Ethics in a Changing World

On April 24 at 6:00 p.m. Arthur D. Burger, Chair of Jackson & Campbell’s Professional Responsibility Practice Group, will participate on a panel before the Federal Communications Bar Association for a CLE course entitled:  Ethics in a Changing World. Mr. Burger and the other panelists will discuss ethical issues attorneys should consider when changing firms, or when hiring lateral attorneys, how to safeguard the firm’s client base and client confidentiality when a colleague leaves, and the rules governing notification to clients when leaving a firm.

For more information about the CLE Seminar is available through the FCBA Foundation.

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Collective Bargaining Agreements Must Be Interpreted Under Ordinary Principles of Contract Law

In a per curiam opinion in CNH Industrial N.V. v. Reese, the Court reversed the Sixth Circuit’s decision to apply its precedent to render a collective bargaining agreement ambiguous as a matter of law. In a previous case, M&G Polymers USA, LLC v. Tackett, 574 U.S. ___ (2015), the Court required the Sixth Circuit to interpret such agreements using ordinary principles of contract law, rejecting the Sixth Circuit’s practice of using a series of inferences stemming from its decision in International Union, United Auto, Aerospace, & Agricultural Implement Workers of Am. v. Yard-Man, Inc., 716 F.2d 1476 (1983). In this case, the Sixth Circuit used the “Yard-Man inferences” to find CNH’s group benefit plan to be ambiguous as to whether it created a vested right to lifetime health care benefits, using extrinsic evidence to hold that it did. The Court noted that “no other Court of Appeals would find ambiguity in these circumstances,” and remanded the case for proper application of Tackett.

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Prisoner’s Attorneys’ Fee Award Must First Come From The Judgment

Murphy v. Smith

Under 42 U.S.C. sec. 1997e(d)(2), a prisoner who prevails in a civil rights suit, and receives an attorneys’ fee award, has a portion of his judgment, not to exceed 25 percent, applied to that award. When Charles Murphy won his suit against two prison guards, the district court ordered that Murphy pay ten percent of his attorney’s fee from his judgment, and the guards the remainder. The Seventh Circuit reversed, holding that the statute required that fully 25 percent of the judgment be used toward the fee before the defendants could be responsible for anything further. The Court, in a 5-4 opinion by Justice Gorsuch resolving another circuit split, affirmed, holding that the plain language of the statute required the district court to apply the judgment with the purpose of fully discharging the fee award, up to 25 percent of the judgment amount, and rejecting the argument that district courts had any discretion in the matter. Justice Sotomayor, joined by Justices Ginsburg, Breyer, and Kagan, dissented, arguing that the statute’s language did allow a district court discretion in applying less than 25 percent of a judgment toward a fee award.

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Court Restricts Collections Efforts Under Foreign Sovereign Immunities Act

In Rubin v. Islamic Republic of Iran, certain parties obtained a judgment against Iran under the state sponsors of terrorism exception to the Foreign Sovereign Immunities Act. They then sought to enforce that judgment against Iranian historical artifacts housed at the University of Chicago. The district court declined to permit the attachment, and the Seventh Circuit affirmed. The Court, resolving a circuit split in a unanimous opinion by Justice Sotomayor (with Justice Kagan recused), affirmed as well, holding that while Iran’s sovereign status was abrogated for the purposes of a judgment under the Act, Iran’s property had to be separately addressed within the exceptions of the Act contained in 28 U.S.C. sec. 1610 before any could be seized to satisfy a judgment. The Court rejected the creditors’ argument that the Act provided a freestanding basis to enforce as being contrary to the plain language of the Act.

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Guilty Plea Does Not Bar A Constitutional Challenge To Conviction

Class v. United States

When Rodney Class was indicted for possessing firearms in his locked vehicle parked at the U.S. Capitol, he moved to dismiss on the basis that the law violated his Second Amendment and Due Process rights under the Constitution. The district court declined Class’ motion, and he entered into a written plea agreement, which did not expressly waive his right to challenge the constitutionality of the statute he was pleading guilty to violating. When he later sought to raise his constitutional argument on direct appeal, the D.C. Circuit held he had waived that argument. The Court, in a 6-3 opinion by Justice Breyer, reversed, holding that a guilty plea does not, by itself, constitute a waiver of constitutional arguments. Relying on cases up to 150 years old, the majority held that a guilty plea admits to the actions taken in violation of the law, but does not admit to the court’s authority to convict under that law. Justice Alito, joined by Justices Kennedy and Thomas, dissented, arguing that the majority’s opinion leaves a “muddle” that threatens to undermine the finality of a guilty plea.

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Court Reads Dodd-Frank Whistleblower Law Narrowly, Excludes Internal Whistleblower

Digital Realty Trust, Inc. v. Somers

In 2014, Paul Somers, a vice president for a real estate investment trust, reported to senior management several suspected securities-law violations by the trust. He was subsequently terminated. He brought suit claiming protection as a whistleblower as defined under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which defines whistleblowers as “any individual who provides . . . information relating to a violation of securities laws to the [Securities and Exchange] Commission”—he did not seek protection under the Sarbanes-Oxley Act of 2002 which first required whistleblowers to exhaust their administrative remedies before filing suit. The trust moved to dismiss the complaint, arguing that Somers did not qualify as a whistleblower under Dodd-Frank because he had not reported anything to the SEC. The district court denied the motion, and the Ninth Circuit affirmed, in part because it believed the statutory definition as written would narrow protections “to the point of absurdity.” Resolving a circuit split on the issue, the Court reversed in an opinion by Justice Ginsburg, holding that the Dodd-Frank definition must be read as written, requiring that whistleblowers report matters to the SEC to receive protection, and holding that the statutory language was sufficiently clear to preclude any deference to the SEC’s alternative definition that would have included Somers. Justice Sotomayor, joined by Justice Breyer, filed a concurrence to note her support of using legislative history to resolve the case. Justice Thomas, joined by Justices Alito and Gorsuch, also filed a concurrence objecting to the use of legislative history in this case, given the clarity of the statute.

 

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United States Permitted To Intervene In Water Dispute Between States

In an original action concerning water rights agreed to between several states under the Rio Grande Compact, Texas argued that New Mexico was permitting its users to siphon off more water than the Compact permitted. The United States sought to intervene, making the same claims as Texas, in part because New Mexico’s actions depleted a reservoir through which the Government had agreed to provide water to Mexico under a 1906 treaty. The special master recommended that the Government’s claims be dismissed, but the Court, in a unanimous opinion by Justice Gorsuch, sustained the United States’ request to intervene. Describing the peculiar nature of original actions, the Court held that while the United States could not intervene in every such action, it was proper to do so here because its interests were “inextricably intertwined” with the Compact, and threatened the Government’s ability to comply with its own treaty with Mexico. The Court also noted the Government’s integral role in the Compact. The Court noted that it was not deciding whether the United States could initiate litigation to force a State to perform its obligations under the Compact, or expand the scope of litigation concerning the Compact. See opinion in Texas v. New Mexico.

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Insider Status In Bankruptcy Reviewed For Clear Error, Not De Novo

In U.S. Bank, N.A. v. Village at Lakeridge, LLC, the Village petitioned for Chapter 11 bankruptcy with two primary creditors, U.S. Bank and an insider owner. It needed consent to enter into a “cramdown” reorganization plan, but U.S. Bank refused to consent, and the insider was statutorily unable to provide consent. To fix the problem, the insider owner transferred its $2.76 million claim to a non-insider for $5,000, who then consented to the cramdown. U.S. Bank objected, and the bankruptcy court held that the purchaser was indeed a non-insider, although he dated the insider seller, because the transaction was at arm’s length. A divided Ninth Circuit affirmed, holding that it could only review the bankruptcy court’s determination for “clear error,” and the evidence was insufficient to overcome that standard, although one judge dissented, arguing that de novo review should have applied. The Court, in a unanimous decision by Justice Kagan, affirmed on the sole issue of the standard of review, holding that the determination of insider status was a mixed question of law and fact that weighed in favor of clear error review rather than de novo. Specifically, the Court held that the determination of whether the transaction to the non-insider was at “arm’s length” was central to the inquiry, thus making the inquiry more of a fact question suitable for trial court determination, and less a legal determination suitable for appellate review. Justice Sotomayor, joined by Justices Kennedy, Thomas, and Gorsuch, filed a concurrence, agreeing with the Court’s result on the question at issue, but noting her concerns with whether the Ninth Circuit’s underlying test for determining insider status was correct, since the nature of that test would heavily affect the standard of review. Justice Kennedy filed a separate concurrence noting that lower courts may still fine-tune their tests for insider status, noting that, in this case, the insider seller’s failure to make the same offer to third parties might weigh against an “arm’s length” determination.

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Immigrants Detained By The Government Not Entitled To Bond Hearings

Under immigration law, applicants for admission to the United States may be detained by the Government until certain proceedings have concluded. Nothing in the applicable statutes limit the duration of detention, nor mention bond hearings. In Jennings v. Rodriguez, an immigrant filed a habeas corpus suit arguing that he should be entitled to a bond hearing once his detention reached six months in duration. After certifying all similarly-situated immigrants in the Central District of California as a class, the district court entered a permanent injunction in favor of the immigrants. The Ninth Circuit affirmed, relying on the doctrine of constitutional avoidance to hold that the statutes imposed an implicit six-month time limit on detentions, and requiring that bond hearings be given every six months, with further detention allowed only if the Government provided clear and convincing evidence to justify it. The Court, in an opinion by Justice Alito, reversed, explaining that constitutional avoidance did not allow courts to “rewrite a statute,” but only to “choose between competing plausible interpretations of a statutory text.” The statutes in this case made no mention of bond hearings or of any limit in duration, and so such limitations could not be added by a court. The Court further ordered on remand that the Ninth Circuit review the immigrants’ constitutional claims, and whether the immigrants can proceed in litigation as a class. Justice Thomas, joined by Justice Gorsuch except as to a footnote, filed a concurrence to argue that, in his view, no court has jurisdiction over the case under 8 U.S.C. sec. 1252(b)(9), which limits judicial review to final removal orders or other inapplicable circumstances. Justice Breyer, in a length dissent joined by Justices Ginsburg and Sotomayor (although Sotomayor agreed with the majority’s view that the Ninth Circuit could not add procedures not set forth in the statutory text), argued that the majority’s view, precluding any bond hearing or limitation on detention, was likely unconstitutional, and so he would have upheld the Ninth Circuit’s ruling.

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Fractured Court Acknowledges Congress’ Power To Abridge Court Jurisdiction Mid-Case

While a case was pending in federal district court regarding a taking of land into trust on behalf of an Indian Tribe, Congress passed the Gun Lake Trust Land Reaffirmation Act, which provided that suits relating to the land “shall not be filed or maintained in a Federal court and shall be promptly dismissed.” The plaintiff argued that the law infringed the court’s authority under Article III of the Constitution. The D.C. Circuit dismissed plaintiff’s case. While a majority of the Court could not agree on the rationale, it ultimately affirmed the D.C. Circuit’s ruling. Justice Thomas, joined by Justices Breyer, Alito, and Kagan, held that Congress acted well within its authority to change the jurisdiction of the federal courts, even while a case was pending. Justice Ginsburg, joined by Justice Sotomayor, held that the Act merely reaffirmed Congress’ authority to affirm sovereign immunity from suit, which it can do at any time. Justice Sotomayor, in a separate concurrence, noted her agreement with the dissent’s view that Congress cannot dictate an outcome in a particular case, but that her agreement with Justice Ginsburg overrode that concern. Justice Breyer, in a concurrence, set forth his argument why the Act did not qualify as a dictate from Congress solely as to the case at issue. Chief Justice Roberts, joined by Justices Kennedy and Gorsuch, dissented, arguing that the Act was, in fact, a mandate from Congress as to the outcome of a single case, and thus impermissibly infringed upon the authority granted to the judiciary under Article III. See opinion in Patchak v. Zinke.

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Court Narrows Bankruptcy Safe Harbor Provision

In Merit Management Group, LP v. FTI Consulting, Inc., the Court addressed 11 U.S.C. sec. 548(e), which allows bankruptcy trustees to set aside and recover certain transfers for the benefit of the bankruptcy estate, but not a “settlement payment . . . made by or to (or for the benefit of) a . . . financial institution . . . or that is a transfer made by or to (of for the benefit of) a . . . financial institution . . . in connection with a securities contract.” Often, such transfers involve several steps, and the Court was asked whether 548(e) should consider the overall transfer (A to D) or the component parts (A to B to C to D) in determining whether the safe harbor provision applied. In this case, two companies jockeying for a horse racing license decided that one would buy out the other’s stock if it got the license. When the license was obtained, the stock purchase was executed, with the funds going through the parties’ respective banks. But the buyer couldn’t use the license in the end, because it couldn’t secure a different license from the state, and it declared bankruptcy. The trustee sought to claw back the money from the stock purchase under the claim that it was constructively fraudulent. The seller argued that the transfer met the definition of 548(e), which put it out of the trustee’s reach, because the transfer of money went through two financial institutions before the seller received anything. The Seventh Circuit disagreed, creating a circuit split. The Court, in a unanimous decision by Justice Sotomayor, affirmed, holding that the “overarching transfer” between the buyer and seller (i.e. A to D) is what courts must consider when applying the safe harbor provision, and not whether an intermediate step in that process involved a financial institution. Since the buyer and seller were not financial institutions, the safe harbor provision of 548(e) did not apply.

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Key Provisions of the Tax Cuts and Jobs Acts

By:  Nancy Ortmeyer Kuhn, Esq.

The “Tax Cuts and Jobs Act” or “TCJA” is the new tax law effective for tax years beginning January 1, 2018 or later.  TCJA has many interconnected parts and it is not yet completely clear how some of these parts will co-exist to impact certain taxpayers.  Already, many questions have arisen regarding interpretation of terms and competing provisions. There are many areas which could be aided by technical corrections or Treasury Regulations to clarify what even government officials concede is murky or inconsistent language.  However, highlights of the TCJA are as follows.

EXEMPT ORGANIZATIONS

Nonprofit Executive Compensation

Internal Revenue Code §4960 was added by the TCJA, and imposes a 21% excise tax on any executive compensation for an employee of the tax-exempt organization that is in excess of $1 million.  The excise tax is to be paid by the employer and is tied to the corporate rate.  It is unknown if the tax will be paid as part of the Form 990-T or if the excise taxes will be added to the Form 990, Form 990-PF, or a separate form to be attached to the exempt organization’s filing. The excise tax applies only to the top five executives paid over $1 million, plus certain former executives, and includes all remuneration and benefits other than amounts that are excludable from the executive’s gross income such as donations to a qualified retirement plan.  The covered organizations include all nonprofit organizations described under §501(a), along with §527 political organizations, §115 state and local governmental entities, and farmers’ cooperatives. Amounts paid by the employer to a Roth IRA are not included within the definition of “remuneration”, nor are amounts that are subject to a substantial risk of forfeiture. There is some debate as to whether public colleges and universities are covered by this provision.  Public educational institutions are not necessarily exempt under §115(1) and most have not sought exempt status under §501(c)(3).

In addition, employers of licensed medical personnel receiving remuneration for the provision of medical services, including veterinarians providing vet services, are exempt from this excise tax.  The definition of “medical services” is not included in the statutory language, and so until further guidance is provided through Treasury Regulations or judicial decisions, it could be broadly interpreted to include licensed hospital administrators performing some medical services, even if they do not provide direct patient services.  It may be that the wisest course of action is to bifurcate the income, and to the extent remuneration for services that are not clearly medical services exceeds $1 million, the excise tax would be applicable.

Under a separate provision, “excess parachute payments” are subject to the 21% excise tax as well  Generally the excise tax will apply if the amount of the parachute payment (generally paid upon separation from employment) is more than three times the employee’s five year average annual compensation, even if the amount is under $1 million. The excise tax applies to the entire amount that is more than the employee’s average annual compensation.

An employee’s compensation subject to the excise tax includes not only remuneration from the primary employer, but also remuneration from related organizations which are defined through the application of a control test.  This also includes IRC §509(a)(3) supporting and supported organizations and IRC § 501(c)(9) voluntary employees’ beneficiary associations (VEBA). In a situation of more than one employer, the excise tax is paid proportionally by each employer. IRC §4960(d) directs the Secretary to prescribe regulations to prevent avoidance of the excise tax through use of a pass-through or other entity established specifically to avoid the excise tax.  However, until guidance is issued the new provisions may be interpreted favorably toward taxpayers, including any work-around structures, within reason. However, legal guidance should be requested before structuring a work-around for the excise taxes.

New Taxes on Colleges and Universities

New § 4968 imposes a 1.4% excise tax on the net investment income of private colleges and universities with 500 or more students, and with assets of at least $500,000 per student (valued at fair market value) excluding assets used directly in carrying out the educational activities.  Also, more than 50% of the institution’s students must be located in the United States.  There is currently no guidance regarding the definition of the assets that are used directly in carrying out educational activities. Although some educational institutions have expressed concern with their ability to fund scholarships due to this excise tax, there are planning opportunities regarding classification of assets to measure the $500,000 per student figure.  To the extent assets are dedicated for scholarships there is an argument that those accounts are “used directly in carrying out educational activities” and should not be included as part of the assets making up the per student number.  It is probable that there will eventually be guidance on this issue, but it is not clear that the guidance will be forthcoming for purposes of the 2018 tax year.

Unrelated Business Taxable Income

Section 512(a) was amended by the TCJA by adding paragraph (6):   An organization’s unrelated business income tax is to be computed separately for each unrelated business. An organization will not be able to offset income from one unrelated business with the losses from another unrelated business.  Any prior year net operating loss carryforward will still be allowed to offset that unrelated business’ income.  However, §512(a)(6) does not allow net losses to carry forward except to offset the gains for that particular business. The net business taxable income from each business will “not be less than zero”.   Of concern to many nonprofits is the subjective nature of determining each unrelated business.  It is likely that guidance will be forthcoming on this issue, but currently an organization’s interrelated businesses are in uncertain territory and the level of risk the organization wishes to assume will presumably dictate how each organization interprets the provision.

Stadium Seating Not Deductible

Section §170(l) was amended by the TCJA and repeals a donor’s charitable contribution deduction for contributions to colleges and universities that provide the donor with the right to purchase tickets and/or receive preferential seating at athletic events.

CORPORATIONS

As has been widely publicized, the primary benefit to corporations from TCJA is the lower corporate tax rate of 21%.  Some other highlights include that the corporate alternative minimum tax (“AMT”) was repealed with provisions allowing AMT credit carryovers to offset regular tax liability for the next three years with 50% refundable.  Also, § 168(k) allows 100% expensing through 2022 for qualified depreciable property to corporate taxpayers. Newly amended § 1031 allows like-kind exchanges only for real estate transactions. Finally, the net operating loss (“NOL”) deduction under §172 is limited to 80% of taxable income, with a repeal of the option to carryback the NOL in exchange for an indefinite period of time for the carryforward of any NOLs.

Some of the more interesting and widely applicable provisions that have been amended for purposes of corporate tax accounting include the elimination of many of the tax deductions previously enjoyed by corporate employers.  The deductions for expenses incurred for client entertainment have been repealed, for the most part.  Business lunches with clients are still deductible (50%) and food and entertainment expenses for employees remain deductible by the corporate employer.  Also, expenses for employees to attend conferences are generally deductible, although there are detailed substantiation requirements for cruise ship and international conventions.

Also, there is no longer a deduction for any transportation expenses paid by the employer for employees—including parking and public transit other than the minimal bicycle expense benefit.  One option is to include the benefit in an employee’s wages so that it is subject to withholding and within the taxable income of the employee.  It would then be deductible by the employer as wage income.  Additionally “expenses for recreational, social, or similar activities ..primarily for the benefit of employees (other than employees who are highly compensated employees within 414(q))” are deductible.  Thus, as long as the entertainment is for mid-level and entry-level employees, the expenses are deductible by the corporate employer.   For example, the expense for season tickets for sporting events is still deductible if the corporate employer provides them primarily to employees rather than clients.

INTERNATIONAL TAX PROVISIONS

The tax system for international entities changed substantially, with an attempt to more closely replicate a territorial tax system rather than a worldwide tax system. Previously a U.S. taxpayer was taxed on worldwide income with a system of treaties with favored nations lowering the rates of withholding and taxes, along with foreign tax credits allowed for taxes paid to foreign taxing jurisdictions.

An immediate key portion of the new international tax regime is for the deferred income of U.S. corporations, held offshore, to be subject to tax in 2018.  This is portrayed as an incentive for these corporations to bring those funds back to the United States.  These Deferred Foreign Income Corporations (“DFIC”) are now subject to tax to the extent of a complex set of formulae with regard to income that has been deferred since the 1986 tax act went into effect.  IRC §965 now treats the deferred foreign income as subpart F income, with various modifications, including that deficit Earnings & Profits are taken into account.  Without getting into the weeds, the resulting deferred income is subject to tax at either 8% or 15.5%.  These percentages are defined terms called “equivalent percentages”, and the deferred income is subject to a separate set of conditions determining which percentage is applicable.  The IRS Office of Chief Counsel has already issued two IRS Notices to deal with confusion on §965 and the Deferred Foreign Income Corporations.  See IRS Notice 2018-07 and IRS Notice 2018-13.

The new territorial tax system is a hybrid, rather than a pure territorial system. There are various provisions that were implemented to attempt to discourage evasionary tactics.  For example, the following acronyms are now part of the tax discussions engaged in by tax professionals trying to make sense of this very lengthy and complex tax legislation.  These acronyms provide some of the anti-abuse provisions:

  1. BEAT: Base Erosion and Anti-Abuse Tax (think Alternative Minimum Tax for international transactions; corporate AMT repealed)
  2. GILTI: Global Intangible Low-Taxed Income. And yes, it is pronounced “guilty”.
    1. QBAI: Qualified Business Asset Investment
  3. FDII: Foreign Derived Intangible Income. Applies to income that is not GILTI.
  4. DRD: Dividends Received Deduction (§245A). This provides a  100% deduction for foreign source dividends received by US shareholder (10% by vote or value) in certain situations.
  5. Subpart F: Subpart F remains, although Subpart F income attributable to controlled foreign corporations is now taxed at the new corporate rate of 21%.  (§951 through §964)

 

  1. BEAT: The Base Erosion and Anti-Abuse Tax (§59A) applies to large corporations with $500 million or more annual gross receipts (3 year average). It is a limited alternative minimum tax primarily on related-party payments.  The BEAT liability is equal to the excess of 10% (5% as a phase-in for 2018) of the modified taxable income over the taxpayer’s regular tax liability reduced by certain credits.  It applies to corporations, other than a RIC, REIT or S Corporation.  A base erosion payment is the amount paid or accrued to a foreign related person, where that payment is deductible, or the acquisition of depreciable property, reinsurance payments, or certain amounts paid or accrued to surrogate foreign corporations which result in a reduction of gross receipts of the taxpayer.  Certain services are excepted from the BEAT tax, when those services are eligible for the cost method under §482 for purposes of transfer pricing.  Other limited exceptions also are available.
  1. GILTI taxes most foreign earnings, other than Subpart F, but is taxed at one-half the U.S. corporate tax rate or 10.5% and applies only to CFCs. In addition, GILTI excludes a 10% annual return of the adjusted tax basis of tangible assets.  GILTI is calculated separately for each U.S. shareholder. GILTI is “tested income” which is the gross income of a CFC, subtracting out effectively connected income; Subpart F income; §954(b)(4) high tax exception income; dividends from a related person; and foreign oil and gas extraction income. Also, §954(b)(5) deductions allocable to the gross income are allowed. This tested income amount is then offset by the net deemed tangible income return, which equals GILTI which is taxed at 10.5%.  The net deemed tangible income return is the QBAI multiplied by 10% less any interest expense.
  1. FDII, or Foreign Derived Intangible Income, taxes a U.S. resident on deemed intangible income. Deemed intangible income is any return over and above 10% of the tangible assets.  Above 10% is assumed to be attributable to intangible assets. Certain deductions are allowed and to avoid double taxation, the GILTI income is excluded from FDII.  Combining GILTI and FDII, there is less incentive for offshore holding of intellectual property.  However, moving intellectual property back to the U.S. is not generally advised, since the worst case scenario is a parity whether held in the U.S. or foreign low-tax country.

This is a very high level summary of some of the new international tax provisions.  There are many exceptions, exclusions, caveats and other factors which could impact tax liability.  Thus, this is intended to provide a “big picture” view which is likely to be refined and clarified as technical corrections are issued, along with the promised Treasury Regulations.  However, it is not expected that additional legislation or formal guidance such as Treasury Regulations will be forthcoming in 2018 regarding these international tax provisions.

PARTNERSHIPS AND OTHER PASS-THROUGHS

Section 199A was added by the TCJA and provides a new 20% deduction for combined qualified business income (“CQBI”) and qualified cooperative dividends for pass-through entities.  The deduction is taken at the partner level.  However, these provisions only apply for certain types of businesses.  For example, businesses which provide professional services, such as law firms and accounting firms, are not eligible for the deduction.  Architectural and engineering firms, on the other hand, are specifically included as service organizations that are eligible for the deduction. §199A(d).  To calculate CQBI, the taxpayer must include only U.S. effectively connected income and no investment income.  The limitation is equal to the greater of 50% of W-2 wages or 25% of W-2 wages plus 2.5% of unadjusted basis in qualified property to determine Qualified Business Income (“QBI”).  The QBI is separately added for each trade or business, including REIT dividends and certain Publicly Traded Partnership (“PTP”) income. The deduction is taken at the partner level.

Other provisions applicable to partnerships include §163(j) and the limitation on interest deductions to 30% of adjusted taxable income and §168(k) regarding 100% expensing for depreciable tangible property for property placed in service after 9/27/17 and before 1/1/23.

IRS Notice 2018-08 was recently issued stating that Treasury and the IRS would not enforce the new §1446(f) withholding requirements on the disposition of publicly traded partnership interests until Treasury regulations or other guidance is issued.  The Notice states that stakeholders reported “significant practical problems” in complying with this new statutory requirement, and so Treasury and the IRS “determined that withholding under new §1446(f) should not be required with respect to any disposition of an interest in a publicly traded partnership until regulations or other guidance have been issued under new §1446(f).”  Note that the suspension only applies to dispositions of partnership interests that are publicly traded.  It does not apply to non-publicly traded interests.

INCREASED ESTATE, GIFT AND GENERATION SKIPPING TAX EXEMPTIONS

While the estate and gift tax regime survived, the lifetime exemption doubled, and so each taxpayer has an $11.2 million exemption from federal estate and gift taxes, and a separate $11.2 million exemption from the GST tax.  This increased exemption sunsets on December 31, 2025, absent future Congressional action. Thus, a taxpayer could transfer up to $11.2 million to recipients who were two or more generations below the taxpayer without generating a GST tax liability.  If there are no legislative changes, taxpayers with large estates would be well advised to make generous gifts prior to 2026 to take advantage of the increased exemption amounts.  §§2001(g); 2010(c)(3)(C); 2631(c).

Caveat and Conclusion

This Client Alert is intended only as a high level summary of some of the provisions of the TCJA.  The complexities and intricacies of each provision are beyond the scope of this Alert.  Each tax situation is dependent upon its own unique facts and circumstances, and therefore taxpayers are encouraged to seek professional advice when determining whether these and other provisions of the TCJA are applicable.  The tax community is awaiting promised guidance from the IRS and Department of Treasury on the provisions discussed above, among others.  In addition, there are provisions of unnecessary complexity and subjectivity that would benefit from corrective legislation by Congress.  Therefore, before relying upon any of the new tax provisions, it is best to ensure that the interpretation is based upon the most recent legislation and the most recent Treasury guidance.

 

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DC Circuit Reverses Attempt At Currency Conversion Through Rule 59(e)

The case of Leidos, Inc. v. Hellenic Republic is a study in “be careful what you wish for.” After requesting an arbitration award in euros, and obtaining a judgment from the federal district court confirming that award in euros, Leidos, Inc. moved under Fed. R. Civ. P. 59(e) to convert that award to U.S. dollars, nunc pro tunc to the date of the arbitration award. Leidos’ reason for the request was simple: the value of the euro declined greatly (by almost 20%) after the arbitration award was entered. The post-judgment currency conversion would increase the value of the award by approximately $11.9 million. The district court granted Leidos’ motion, but the D.C. Circuit, in a unanimous opinion by Circuit Judge Henderson, reversed, holding that the district court committed “two errors”: (1) not applying Rule 59(e) precedent to Leidos’ request, and (2) concluding it was “manifestly unjust” to award Leidos judgment in euros even though it expressly requested relief in euros “at least three times, and had not asked for dollars until its post-judgment motion.” The Court held that Rule 59(e) precluded arguments that could have been raised before the judgment was entered, including those by a prevailing party like Leidos. The Court stressed that Leidos was not prejudiced because it “could have asked for dollars instead of euros at any time before judgment; it chose not to.”

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Southern District Heightens Lawyers’ Duties in Preventing Spoliation of Evidence by Clients

In Industrial Quick Search, Inc. et al. v. Miller, Rosado & Algois, LLP et al., January 2, 2018, the Southern District of New York issued a decision underscoring the importance of lawyers paying early attention to the need for imposing “litigation holds,” being proactive in ensuring compliance with such holds, and making a clear record of steps taken with the client to preserve discoverable records.  After a client had its defenses stricken under Rule 37 when the court found it had “intentionally destroyed the documents at issue” that were sought by the opposing party in discovery, the client sued its law firm for malpractice, claiming that the firm failed to adequately put the client on notice that the documents needed to be preserved. Citing Zubulake v. UBS Warburg LLC, 229 F.R.D. 76 (S.D.N.Y. 2004), the court denied cross motions for summary judgment and held that a lawyer’s failure to meet her ethical obligations to preserve evidence can constitute a violation of the lawyer’s duty of care and potentially serve as grounds for a legal malpractice suit.  The court stated:  “This is not to say that counsel is always responsible for their client’s destruction of documents, but that counsel has an obligation to take reasonable steps to ensure the preservation of relevant information.”  The lesson here is that a lawyer may be held to a standard in discovery to take and document affirmative steps to ensure that a client takes adequate measures to comply with a litigation hold and preserves potentially relevant documents.

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Challenges to EPA “Waters of the United States” Rule Must Be Filed In Federal District Court

The Clean Water Act limits the discharge of pollutants into “navigable waters,” which is defined by Congress as “the waters of the United States.” The EPA issued a Rule to define that term. While most agency rules are properly challenged in the federal district courts, the Act required challenges to rules issuing “any effluent limitation” or “issuing or denying any permit” to be filed in the federal courts of appeal. The Court, in a unanimous opinion by Justice Sotomayor, held that the definitional rule did not implicate the Act’s stated exceptions, and therefore the challenges must be made in the federal district courts. First, the Court reasoned that the Rule by its terms did not restrict the discharge of pollutants since it only defined a statutory term, and thus was not an “effluent limitation”. Second, the Court held that the same Rule by its terms did not approve or deny any permits. In both cases, the Court adopted a straightforward textual reading of the Rule, and rejected the Government’s argument that the potential implications of the Rule should control. A link to the opinion in Nat. Assoc. of Manufacturers v. Dept. of Defense is here.

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Court Holds That Tolling Statute “Stopped The Clock” On State Law Claims, Instead Of Providing A “Grace Period”

In Artis v. District of Columbia, Artis filed a suit against D.C. in federal court with a federal discrimination claim and some state claims. Two and a half years later, the district court dismissed the federal claim, and with it dismissed the state claims for lack of jurisdiction. Under 28 USC sec. 1367(d), the “period of limitations” for re-filing the state claims in state court “shall be tolled while the claim is pending [in federal court] and for a period of 30 days after it is dismissed unless State law provides for a longer tolling period.” Artis filed his state claims 59 days after the dismissal, and the D.C. Court of Appeals held that his claims were now untimely under the statute. This created a split among the state supreme courts as to how to interpret Section 1367(d). The court, in a 5-4 opinion by Justice Sotomayor, reversed, holding that the word “tolled” here meant that the statute “stopped the clock” on the limitations period, and that clock picked up where it left off once the dismissal order was entered. Therefore, the entire time the claims spent before the district court did not count for the limitations period, and Artis’ re-filed claims were timely. Justice Gorsuch, joined by Justices Thomas, Kennedy, and Alito, dissented, arguing that Section 1367(d) was properly interpreted as providing a “grace period” instead, and that the majority’s decision “represents no small intrusion on traditional state functions and no small departure from our foundational principles of federalism.” A link to the opinion is here.

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Court Finds Probable Cause To Arrest Partygoers For Unlawful Entry

When police officers busted a raucous party being held in a vacant house, some of the partygoers said that “Peaches” owned the house and allowed the party. On the phone, though, Peaches admitted she had no such authority, and the true owner told police he had never given anyone permission to be there. The officers arrested the partygoers for violating the D.C. law against unlawful entry, which makes it illegal to remain on a property after being told by the rightful owner to leave. The partygoers sued under the Fourth Amendment claiming false arrest. A divided D.C. Circuit Court held that the officers lacked probable cause to arrest and lacked qualified immunity for their actions, but the Supreme Court, in an opinion by Justice Thomas, reversed. While the lower courts focused on Peaches’ alleged invitation to the party as destroying probable cause, the Court held that the officers could, from the totality of the circumstances, make the “entirely reasonable inference” that the partygoers knew they were “taking advantage of a vacant house” for their party. The house was vacant, in poor condition, and being made worse by the conduct of the partygoers. “Most homeowners do not live in near-barren houses,” the Court reasoned, and do not authorize invitees to further harm the premises. The fact that the partygoers fled when the officers arrived was another tip that they knew they did not belong. The Court also “readily concluded” that the officers were entitled to qualified immunity since the circumstances were unique, and there were ample reasons to doubt Peaches’ authority. Justice Sotomayor filed a concurrence, agreeing as to qualified immunity, but disagreeing with the Court’s decision to analyze the probable cause issue. Justice Ginsburg also filed a concurrence, worrying that the majority decision was weighted too heavily in favor of finding probable cause. A link to the decision in District of Columbia v. Wesby is here.

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Exempt Organizations: Tax Reform Provisions to Watch

Part II:  Senate and House proposals

By Nancy Ortmeyer Kuhn, Chair of Jackson & Campbell’s Tax Group

The Joint Committee on Taxation released the Senate’s “Description of the Chairman’s Mark of the ‘Tax Cuts and Jobs Act’” on November 9, 2017.  The Ways and Means Committee of the U.S. House of Representatives previously released its long-awaited tax bill on November 2, 2017.  The House bill is also entitled Tax Cuts and Jobs Act, H.R. 1 (“TCJA”) Of interest to nonprofit organizations are the following provisions of both proposals:

  • House Proposal: A tax exempt organization will pay a 20% excise tax on any executive compensation in excess of $1 million.  The excise tax applies only to the top five executives, and includes all remuneration and benefits, other than amounts that are excludable from the executive’s gross income such as donations to a qualified retirement plan.  (TCJA §3803)   This 20% excise tax applies to all organizations described under §501(a), along with political organizations exempt under §527, §115 state and local governmental entities, and farmers’ cooperatives.
    • Senate Proposal: Similar 20% excise tax, although this excise tax applies to any part of an excess parachute payment even if the payment is not over $1 million.
  • House Proposal, as updated: The Johnson Amendment would be partially repealed, and all  section 501(c)(3) religious organizations and public charities would be free to express partisan political statements during the ordinary course of the religious organization’s activities, assuming its expenses in making those statements are de minimis.  (TCJA §5201)  Originally this provision only applied to religious organizations. The proposal has now been updated to include all section 501(c)(3) organizations.
    • Senate Proposal: No provision.  The Johnson Amendment would remain and religious organizations and other section 501(c)(3) charities would still be prohibited from engaging in any political activity.
  • House Proposal: Private foundations would be subject to a 1.4% tax on net investment income, rather than the 1% or 2% investment tax under §4940. This is one of a very few provisions that would simplify current law. (TCJA §5101)  The 1.4% tax would also be collected from certain private colleges and universities on their net investment income.  (TCJA §5103)
    • Senate Proposal: Similar provision.
  • House Proposal: Private foundations would be exempt from the excess business holding excise tax for any of its 100% subsidiaries (by voting stock) that annually distribute all net operating income to the private foundation. The foundations that are eligible for this exemption are limited to those that have independent executives and boards of directors.  Thus, the exemption would not apply to foundations where the majority of the members of the board of directors are substantial contributors or executives of the foundation.  (TCJA §5104)
    • Senate: No proposal
  • House Proposal: Donor advised funds would be subject to additional reporting requirements regarding their policies on inactive donor advised funds as well as a requirement to report the average amount of grants made from their donor advised funds. (TCJA §5202)
    • Senate: No proposal
  • House Proposal: The bill clarifies that the unrelated business income tax applies to all tax-exempt organizations recognized under §501(a), along with §115 state and local entities such as public pension plans. (TCJA §5001)
    • Senate: No proposal
  • House Proposal: Any net income that a tax-exempt organization realizes from research would now be subject to the unrelated business income tax, unless the research is publicly available. (TCJA §5002) Previously, net income from research performed by colleges, universities, hospitals or performed for government entities was also generally exempt from UBIT regardless of whether the research was publicly available.
    • Senate: No proposal
  • Senate Proposal: Sections 512 and 513 of the Internal Revenue Code would be amended to delete the exclusion from unrelated business income tax for royalties from the sale or license of a nonprofit’s name and/or logo.  This includes income from any trademark or copyright related to the name or logo. The net revenue from the royalty stream or sales income would be treated as an unrelated trade or business and subject to tax.
    • House: No proposal.
  • Senate Proposal: An organization’s unrelated business income tax would be computed separately for each unrelated business. An organization would not be able to offset income from one unrelated business with the losses from another unrelated business.
    • House: No proposal.
  • Senate Proposal: Section 501(c)(6) would be amended to exclude professional sports leagues as eligible for tax-exempt status. Thus, the Senate bill would repeal tax exempt status for professional sports leagues.
    • House: No proposal.
  • Senate Proposal: The so-called “intermediate sanctions” excise tax provisions under section 4958 of the Internal Revenue Code would be substantially changed.  This excise tax is imposed on excess benefits received by “responsible persons” of certain tax-exempt organizations.  Also, the “rebuttable presumption of reasonableness” set forth in the Treasury Regulations would be eliminated and replaced with a due diligence standard.  The Senate is proposing a 10% excise tax on the organization if the initial section 4958 excise tax is imposed on a disqualified person.  The organization would have a “reasonable cause” defense to the imposition of the 10% tax.  The Senate’s proposal also eliminates certain protections for organization managers, making it more likely that an organization manager would also be personally liable for the excise tax.  The proposal adds investment advisors (in particular those advising donor advised funds) and athletic coaches of colleges and universities within the definition of “disqualified persons” subject to the intermediate sanctions excise taxes.
    • House: No proposal
  • Senate Proposal: Section 170 of the Internal Revenue Code would be amended to disallow any charitable contribution deduction to the donor for contributions to colleges and universities that provide the donor with the right to purchase tickets and/or receive preferential seating at athletic events.
    • House: No proposal

Whether any of these provisions will be passed by Congress and signed into law as currently stated is unknown. The most controversial is the House’s proposal to partially repeal the Johnson Amendment. The House provision would allow a section 170 charitable deduction for contributions to religious and charitable organizations in exchange for political endorsements or other activities promoting the candidacy of an individual running for political office.  Donations to religious entities and charities are not only tax deductible to the donor, they are not disclosed to the public, and so this provision would expand the Supreme Court’s decision in Citizens United, allowing anonymous tax-deductible political donations. Thousands of charities and churches have expressed their opposition to this provision, fearing that their religious and charitable work would become susceptible to the political factions currently dividing the country, rather than be a respite from divisiveness.  The outcome is far from certain, and so stay tuned for additional updates.

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Supreme Court Clarifies Which Deadlines Are Jurisdictional

In Hamer v. Neighborhood Housing Services of Chicago, the Court, in a unanimous opinion by Justice Ginsburg, set forth a clear and easy way to tell whether a deadline is jurisdictional, and cannot be waived or extended, or is merely a “claim-processing rule” that can be extended: deadlines provided by statute are jurisdictional, while deadlines provided by court rules are not. Since Congress determines the jurisdiction of the courts, an appeal filed beyond the statutory deadline necessarily deprives the court of jurisdiction to hear the appeal, while court-created rules do not. In this case, after losing on summary judgment, Hamer sought a two-month extension of the notice of appeal filing date, which was granted by the district court. Hamer filed her notice of appeal a few days before the additional two months expired. On appeal, the Seventh Circuit dismissed the appeal because it was filed beyond the 30-day limit on extensions provided by Fed. R. App. P. 4(a)(5)(C). The Court reversed, holding that the court Rule’s 30-day limitation was not jurisdictional in nature, and thus the district court’s extension was permissible. A link to the opinion is here.

| Crystal S. Deese

The National Practitioner Data Bank: Six Need-to-Knows

The National Practitioner Data Bank (NPDB) was established through Title IV of Public Law 99-660, the Health Care Quality Improvement Act of 1986. Codified at 45 CFR Part 60, the NPDB is an online repository for reports on negative events involving physicians, dentists, and other licensed health care professionals. The statute requires certain health care entities to report the following information about practitioners:

  • Medical malpractice payments made on a practitioner’s behalf (including out-of-court settlement payments);
  • Any adverse licensure actions or loss of license;
  • Any negative action or finding by a State licensing or certification authority;
  • Adverse clinical privileging actions or adverse professional society membership actions;
  • Private accreditation organization negative actions or findings against a health care practitioner or entity;
  • Any negative action or finding by a federal or state licensing and certification agency that is publicly available information;
  • Civil judgments or criminal convictions that are health care-related;
  • Exclusion from federal or state health care programs; and
  • Other adjudicated actions or decisions.

NPDB reports can have a very serious impact on a practitioner’s career. The reports are available to state licensing boards, hospitals, health plans, and other health care entities looking to enter into employment or affiliation relationships with a practitioner. Not only are the reports available to these organizations, but also in some instances entities are required to query this information before hiring and/or engaging a practitioner. Once a report is entered into the database it stays forever. A negative report can lead to a credentialing denial, loss or limitation of licensure or privileges, increases in insurance premiums, and exclusion from health plans. This is often the final piece of a nightmare scenario for any physician facing a medical malpractice claim and/or adverse action licensure or privileges. Despite this reality, many physicians are unaware of several key facets of the statute that could help them avoid the reporting altogether, or at the very least, lessen the damage caused by a report. Below are six key things that every physician should know about all stages of the NPDB reporting process.

  1. The 30-Day Rule

As evidenced by the extensive list above, there is little maneuverability in what must be reported to the NPDB.  When that reporting must occur, however, is a different story. For practitioners facing possible action against their licenses or privileges, the first thing to be aware of is that an adverse action only becomes reportable once it has been in effect for more than 30 days. At that point it becomes reportable regardless of the outcome of any investigation or adjudicative process. While a physician’s natural instinct may be to seek a thorough (slow) investigation of allegations of misconduct, in light of this provision a practitioner may be best served by seeking an expedited investigation and adjudication.  If the issue is resolved in less than 30 days, it will not have to be reported.

  1. Early Resolution

In situations that involve a malpractice suit in addition to/instead of potential adverse action, the 30-day rule does not provide an opportunity to avoid reporting. However, practitioners facing such a situation may still be able to avoid being reported with strategic early action. A medical malpractice payment must be reported to the NPDB only if it is the result of a written complaint or claim demanding monetary payment for damages. In many states, the written complaint clause of this provision has been construed liberally to include even a Notice of Intent To Sue. The rule as currently constructed, however, does not require the reporting of a payment made in the absence of a written claim or demand. This leaves room for a particularly proactive practitioner and/or hospital, in the face of a certain malpractice claim, to avoid reporting by initiating contact with an aggrieved patient and facilitating a payment before pen meets paper in the form of a claim or demand.  It should also be noted that early contact with a patient after a bad outcome, particularly by hospital administration instead of attorneys, could engender positive feelings and eliminate the involvement of plaintiff attorneys, thus making a cost-effective resolution more easily achievable.

 

  1. The Corporate Shield Loophole

As currently constructed, the medical malpractice reporting statute only requires reporting to the NPDB if a provider is a defendant to the action at the time of the payment. This allows medical providers originally named in a lawsuit to avoid the reporting of a malpractice settlement to the NPDB if he or she is dismissed without promise of payment before settlement is finalized. Traditionally this occurs when a practitioner is named alongside his or her hospital or medical group, with whom some type of malpractice coverage is shared. The individual practitioner defendant will obtain dismissal from the case prior to settlement, leaving only a hospital or group medical practice in the case to settle the plaintiff’s claims. This has become known as the corporate shield loophole. Practitioners named as defendants in a lawsuit alongside their hospital or another corporate entity should work with the other parties involved in the suit to negotiate a dismissal before payment as any part of settlement. And the resulting settlement agreement should make no mention of the individual practitioner or that any money is being paid on his or her behalf, thus not creating any reporting obligations.

  1. Using Personal Funds

In instances where a physician is named individually in a lawsuit and the relationship between the defendants prevents the use of the corporate shield loophole, using personal funds is another option to avoid reporting. As noted above payment, on behalf of a physician by another party is a reportable action. Payment made by an individual physician on his or her own behalf, however, is not reportable. Practitioners should consider settling claims, particularly low dollar amount claims, with their own money to avoid reporting. In some instances, taking out a personal loan and using the money to settle a claim may be a better alternative than having one’s name reported to the data bank where it will reside forever, potentially effecting future employment, compensation, and/or insurance premiums.

  1. The Dispute Process

Even after being reported to the NPDB, a practitioner’s efforts should not stop there. Once a report is filed to the NPDB, a copy is sent to the practitioner. The practitioner may notify the NPDB that he or she wishes to place the report into dispute status under the belief that the action was reported incorrectly or not reportable at all. The practitioner must contact the reporting entity and notify it of the dispute. The practitioner and the reporting entity have 60 days to resolve the dispute. If an agreement is reached, the reporting entity can submit a corrected report. If there is no agreement, the practitioner can elevate the issue to the NPDB’s Dispute Resolution team. A Dispute Resolution Manager will review the case and make a determination as to whether the event was reported correctly. The Dispute Resolution Manager will make a final determination as to the contents of the report and issue a decision to allow the report to remain as submitted, require a correction, or even void the report completely from the NPDB. The NPDB reports a shockingly low number of reports submitted each year are challenged.  This suggests that many practitioners are unaware of their right to challenge these reports. Any practitioner who is the subject of a report to the NPDB can benefit from placing it into dispute status. At the very least, initiating a dispute will create an opportunity to negotiate the wording of the report with the reporting entity and possibly shape the way that the event is reported.

It is also important to appreciate that while the dispute process is available, it is very difficult to have a report altered or retracted. When faced with a situation in which reporting is required, practitioners are best served by working with the reporting entity from the outset to make sure it is aware of all aspects of the incident and any mitigating circumstances. Furthermore, a practitioner should also look to negotiate the wording of the report prior to its submission. Front end cooperation with a reporting entity is a very effective way to mitigate the damage that a NPDB report could have. Given the importance of this type of pre-report negotiation, a practitioner should consider engaging legal counsel to assist in the discussion with the reporting entity and in the wording of the subsequent report.

  1. Subject Statements

If the dispute process is unsuccessful and the report submitted is maintained as originally submitted by the reporting entity, there is yet another way that a practitioner can effect what is reported to future recipients of the report. The NPDB allows any practitioner who is the subject of a report in its repository to submit a 4,000-word or less written statement that will be added to the report as a supplement. The supplemental statement will accompany the report any time it is distributed and will be retroactively sent to any entity that received the report in the preceding three years. This provides a practitioner a chance to explain the circumstances of the event, his or her involvement in the event, and the reason for the outcome. This is particularly useful in instances where a practitioner is named in a lawsuit simply because of involvement on a health care team, but was not intimately involved in the alleged malpractice. A supplemental statement allows that practitioner to all but explain away the report that is attached to his or her name. Subject statements are also a woefully underutilized aspect of the reporting system of which many physicians are not aware. Any practitioner who is reported to the NPDB has no reason to forego this step in the process. It is a good idea to consult with counsel with legal counsel in this stage of the process as well about the content of his/her statement before it is submitted to explore all corollary legal issues relating to the statement.  If there is ongoing litigation and/or any other investigation, the importance of consulting counsel pre-submission is even greater.