eReport 2024 Spring - ABA Section of Real Property, Trust and Estate Law

ASSESSING RISK:

The Importance of Discussing LongTerm Care Insurance with Clients

Don Levin

By Lisa S. Presser and Brian M. Balduzzi

Stephen J. Dunn

Assessing Risk: The Importance of Discussing LongTerm Care Insurance with Clients

By Don Levin1

Don Levin summarizes the benefits of long-term care insurance and its alternatives and emphasizes the need for attorneys to discuss these options with their clients, especially before it is too late due to their age or health.

Most people are particularly bad at assessing risk. For instance, although there is great concern about getting attacked by a shark at the beach, the probability of being attacked and killed by a shark is just one in 3.75 million.2 Meanwhile, over 50% of individuals turning age 65 are expected to require long-term care at some point.3 Why is it that some pay far more attention to the risk of a shark attack than that of requiring long-term care?

When long-term care is mentioned, many people immediately think of a nursing home. In reality, most requisite care takes place in the home. That’s why it’s crucial for clients to consider long-term care as an event to plan for, rather than a place. Not to mention, planning ahead for long-term care gives clients more options for their future care and helps them avoid exhausting their life savings paying the high monthly bill.

Paying for Long-Term Care

Traditional long-term care insurance became available in 1974. Additional amendments to the Social Security Act enforced compliance with certain standards for facilities to participate in Medicare and Medicaid, including staffing levels, staff qualifications, fire safety, and delivery of services. With these changes, several insurance companies launched private long-term care insurance (LTCI), which gave individuals the opportunity to purchase an insurance to mitigate the risk of either paying for these services themselves or becoming reliant upon the public welfare system.

Plus, in order to qualify for long-term care assistance via Medicaid, an individual must spend down their assets to a state-specific limitation (typically $2,000). (For applicants who are married, the healthy spouse can retain a separate amount that varies by state but is no more than $148,620.) To prevent applicants from giving away assets to meet these resource allowances, Medicaid enforces a lookback period of 60 months. If an applicant or their spouse has disposed of assets by gift or by sale for less than fair market value during the lookback period, they can and will be penalized and determined ineligible for benefits.

In addition to the difficulty of meeting Medicaid’s strict qualifications, the ever-aging population in the U.S. and resulting long-term care services required threatens to run our public welfare systems dry.

Despite nearly 50 years of long-term care insurance sales and the high risk of requiring care, only 10% of the general population has LTCI.4 As a result, Medicaid remains the number one payer of long-term care in the U.S.—currently sitting at 42.1%.5 While Medicaid is both federally and state funded, the program is regulated on the state level, meaning rules and requirements vary by state. What remains a constant is that Medicaid continues to be the largest line item in every state’s budget and is the primary reason that more and more states are on the brink of insolvency. As more Americans turn 65 and require financial assistance for long-term care, relying fully on Medicaid to cover these costs threatens the overall collapse of the Medicaid system.

Qualifying for Long-Term Care Insurance

With the advent of the Health Insurance Portability and Accountability Act of 1996 (HIPAA), the federal government standardized private insurance company offerings by mandating certain features and benefits for traditional long-term care insurance plans. Features include tax-qualification, allowing policyholders to deduct the cost of the premium based on annual attained age ranges, and benefit qualification factors based on basic triggers, such as requiring assistance with at least two activities of daily living (ADLs) or evidence of cognitive impairment. ADLs consist of transferring, bathing, dressing, toileting, eating. Organic cognitive impairment includes chronic conditions such as Alzheimer’s disease, dementia, Lewy Body De -

mentia (LBD), and Parkinson’s disease. Non-organic cognitive impairment may be caused by a traumatic brain injury (TBI) incurred during an accident or injury but may also include cases of depression and other behavior-related conditions that impair a person’s ability to safely care for themselves. Like other forms of insurance, long-term care insurance is designed to mitigate the risk of loss to the individual and their family. However, unlike other forms of insurance, LTCI is stringently underwritten based on an applicant’s current health and health history and is priced based on attained age. In other words, the older the applicant, the more premium they will pay. Additionally, the less healthy the client, the more likely they are to be declined LTCI coverage. For many years, insurance carriers collected family health history for anecdotal purposes only, but now most utilize it when considering the insurability of an applicant. To this end, applicants aged 40 to 45 have about a 12.4% chance of being declined coverage, and that risk jumps to 47.2% for those aged 70 to 74.6 This is further evidence that LTCI is paid for with money as well as requisite health. Since long-term care insurance must be purchased when an individual is healthy, it can be challenging for some to determine whether they are a good candidate. In general, individuals who meet the following criteria have a higher likelihood of qualifying for LTCI: have never been prescribed a handicap sticker; do not require help with any activities of daily living; have never been diagnosed with AIDS, HIV, or ARC disorders; have never been diagnosed with or presented symptoms of Alzheimer’s disease, dementia, memory loss, multiple sclerosis, muscular dystrophy, ALS, or Parkinson’s disease; and are capable of walking for blocks or climbing two flights of stairs.

The process of applying for LTCI coverage begins with an interview conducted by an LTCI professional, who will ask the applicant questions regarding their personal health, finances, family health history, and what they want the policy to cover. The LTCI professional will then tailor a plan to fit the applicant’s specific situation. In some cases, the insurance carrier may request the applicant’s medical records, typically based on age or health concerns. With the submission of a completed application, the entire underwriting process usually lasts four to eight weeks, usually depending on the promptness with which doctors respond to requests for their patient’s medical records.

LTCI funds are typically available either on a reimbursement or indemnity basis after an individual qualifies for benefits. Again, basic triggers include a doctor’s diagnosis of cognitive impairment or certification that assistance is required with at least two activities of daily living for a period of at least ninety days.

Discussing LTCI with Clients

The most common reasons individuals purchase long-term care insurance include a desire to avoid being a burden on their family and loved ones, the preservation of assets, access to quality medical care, the maintenance of independence and

Published in eReport, Spring 2024 © 2024 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.

decision-making, avoiding welfare services, and, finally, peace of mind.

Some clients may push back against paying for something they may not utilize or evade purchasing LTCI coverage simply due to the sheer expense of a policy. As a result, carriers developed an alternative to traditional long-term care insurance. These products, often labeled as hybrid, combination, asset based, or linked benefit policies, are largely built on a life insurance policy or an annuity contract. Unlike a traditional long-term care policy, an asset-based policy offers more than just long-term care benefits. It also provides a death benefit typically equal to or more than the premiums paid. Therefore, the benefit is paid whether or not the policyholder needs long-term care. Any amount of the death benefit not used for long-term care while the policyholder is living is subsequently paid tax-free to beneficiaries. Adding even more flexibility, asset-based policies also offer liquidity, which allows the policyholder to redeem their cash value at will. For all the above reasons, these plans present the policyholder ultimate flexibility when it comes to LTCI.

Despite a growing need for long-term care, the decades of policy data from both government and insurance carrier sources, as well as personal experience with family members requiring care, there is still a level of resistance, akin to denial, to purchasing LTCI. In most cases, a primer on LTCI will impart the requisite knowledge necessary for the client to make an informed decision that will lead them to purchase LTCI protection. Whether it is to mitigate risk, institute a stop-loss if they elect some level of co-insurance, or protect their portfolio and financial legacy, the wide range of coverage that is available today allows each individual client to obtain a policy that is tailored to their specific needs, desires, and financial circumstances.

Estate planning and elder law attorneys are in a unique position to have this crucial conversation with their clients. A failure to do so may expose practitioners to a degree of liability if the client, or a loved one, can establish that they were reliant on them for advice regarding the preservation of their estate.

Conclusion

With the advent of new medical procedures and advancements in the pharmaceutical industry, the population continues to live longer, prompting an ever-increasing need for expensive longterm care services. Unless more of the general population elects to privately insure this risk, the Medicaid system will be under an unrelenting burden to cover these services. Fortunately, with the availability of both traditional and asset-based long-term care insurance policies, individuals can tailor their LTCI plan to suit their specific situation.

Since many people fail to properly assess their risk of requiring long-term care, it is imperative that attorneys discuss this risk with clients and guide them to fund a long-term care insurance policy before it’s too late.

Endnotes

1. Don Levin, J.D., MPA, CLF, CSA, LTCP, CLTC, is the Strategic Relations Director for Krause Financial following their acquisition of USA-LTC. Krause Financial is an attorney-led firm that provides asset preservation solutions for estate planning and elder law attorneys and their clients planning for long-term care.

2. The International Shark Attack File 2022 Shark Attack Report, Florida Museum of Natural History.

3. Projections of Risk of Needing Long-Term Care Services and Supports at Ages 65 and Older, U.S. Department of Health and Human Services, January 2021.

4. Long-Term Care Perceptions & Preparation: A Middle-Income Market Study, Arctos Foundation and HCG Secure, January 2022.

5. Who Pays for Long-Term Services and Supports?, CRS analysis of National Health Expenditure Account data obtained from the Centers for Medicare and Medicaid Services, Office of the Actuary, December 2021.

6. American Association for Long-Term Care Insurance, LTC Insurance Applicant Denials, 2021.

Published in eReport, Spring 2024 © 2024 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.

Keystone State Strengthens Its Irrevocable Trusts With Grantor Trust Rules

By Lisa S. Presser, Esq. and Brian M. Balduzzi, Esq., LL.M. (Tax), MBA, CFP®, CEPA®1

Lisa S. Presser and Brian M. Balduzzi provide a synopsis of Pennsylvania’s new grantor trust and income tax rules. The authors also provide practical guidance for estate planners and advisors in light of the new law.

Grantors of Pennsylvania irrevocable trusts may now elect to pay the income taxes on the trusts’ income under the recently-signed Act 64 of 2023, provided that such trusts qualify as “grantor trusts” under federal tax law. For decades, Pennsylvania has deviated from federal income tax laws by specifically

prohibiting grantor trust tax status for irrevocable trusts. This new Act simplifies the rules for irrevocable trusts to mirror those in other jurisdictions, and it provides an opportunity for grantors to plan for new irrevocable trusts, and for grantors, trustees, and beneficiaries to review certain existing irrevocable trusts.

Historical and New Treatment for State Income Taxation of PA Irrevocable Trusts

Since 1971, Pennsylvania and federal laws have differed in their tax treatment for irrevocable trusts, even when the grantor retained certain powers under the trust instrument. Under federal law, a grantor of an irrevocable trust (or another person) can be taxed on the trust income to the extent that the grantor (or such other person) is deemed the “owner” of such trust under the Internal Revenue Code (the “Code”) sections 671 through 679 (the “grantor trust powers”), regardless of whether such income is distributed to the beneficiaries or accumulated. Under prior Pennsylvania law, however, a Pennsylvania Resident Trust (or Non-Resident Trust, to the extent of its sources within the Commonwealth) was subject to tax on its income received during the trust’s taxable year at a rate of 3.07%, regardless of whether the grantor (or another person) held such grantor trust powers.

This difference between Pennsylvania and federal law applied to a trust unless the grantor trust was a wholly revocable trust.

An irrevocable trust is a trust for which the grantor has not retained the power to amend or revoke such trust. This incongruent tax treatment encouraged some grantors to consider moving their irrevocable trusts outside of the Commonwealth in order to benefit from grantor trust treatment under the state tax laws of another jurisdiction. The prior Pennsylvania law also meant that the trust beneficiaries were taxed on income required to be distributed or credited to them and the trust taxed on the remaining income, requiring the trustee to determine when, and how much, to distribute to which beneficiaries, for state income tax planning, even when, for federal income tax purposes, the grantor was treated as the owner of the trust income.

Under Act 64 of 2023, as signed by Governor Joshua Shapiro on December 14, 2023 and as sponsored by Senator Lisa Baker, a Pennsylvania Resident Trust (or a Nonresident Trust with source income from the Commonwealth) shall now be taxable to the grantor (or another person) to the extent that such grantor (or another person) is deemed to be the owner of the trust under sections 671 through 679 of the Code. This new Act aligns the state income tax treatment of a Pennsylvania irrevocable grantor trust with the federal income tax treatment of such trust, and it conforms such laws with those of other jurisdictions in the United States. This change simplifies some matters for grantors, trustees, and beneficiaries, but also requires a careful review of prior and future planning with respect to such trusts.

Planning for Future PA Irrevocable Trusts

Grantors of future Pennsylvania irrevocable trusts have an opportunity to review income tax planning for such trusts. Act 64 of 2023 is effective as of February 12, 2024, sixty days from the date it was enacted. This effective date, however, affects the reporting and filing requirements for Pennsylvania trusts in tax years beginning on or after January 1, 2025. Therefore, any irrevocable Pennsylvania resident grantor trusts established after such date may qualify as grantor trusts for both federal and Pennsylvania income tax purposes. The state income tax treatment for revocable trusts remains unchanged, and the grantor continues to be treated as the owner of such trust assets with the income from such assets includible in the grantor’s income taxes. For irrevocable trusts, however, a Pennsylvania resident trust is any trust created by a grantor who was a Pennsylvania resident at the time the trust was created, or a trust that consisted in whole or in part for any of the taxable year of real or personal property transferred to it by a person who was a Pennsylvania resident at the time of such transfer. Therefore, an irrevocable trust may be deemed to be a resident trust regardless of whether the grantor has since moved and changed his domicile if he or she created such trust while a resident of the Commonwealth.

Grantors of Pennsylvania irrevocable trusts must now consider whether their income tax reporting requirements may change for tax years starting on or after January 1, 2025. For example, these irrevocable trusts may have grantor trust provisions that were included for federal income tax purposes but were not ex-

pected to apply for state income tax purposes because of the prior Pennsylvania rules. These grantors should discuss the implications of the potential additional income from these types of trusts on their own individual income tax returns, or the effects of releasing any grantor trust powers over such trusts. These new tax rules may also affect a trustee’s state quarterly estimated tax payments for these trusts, or the trustee paying tax on the income received by the trust. These changes should relieve some of the administrative burdens for the trustees and the trust beneficiaries, especially given the prior disconnect between Pennsylvania and federal tax laws.

In addition, some Pennsylvania irrevocable grantor trusts may have intentionally qualified under the Commonwealth’s safe harbors as Nonresident Trusts after the grantor is no longer a resident of Pennsylvania, such as by appointing only the non-resident trustees and changing trust situs to another state. This planning was sometimes previously recommended when Pennsylvania did not recognize grantor trusts. These trusts may be reviewed with trust income tax planning in mind, especially if the costs for trust administration outweigh any prior income tax savings, or when the grantor’s domicile or trust assets have changed.

Next Steps

While the new Act 64 of 2023 does not affect the trust tax planning until tax years starting on or after January 1, 2025, grantors, trustees, and beneficiaries should begin reviewing existing irrevocable trusts regarding how Pennsylvania will then treat such trusts for grantor trust purposes. Grantors, whether they live in Pennsylvania or in another state, may also consider creating new grantor trusts as Pennsylvania Resident Trusts, given the relatively low trust income tax rates compared with other neighboring states like New York and New Jersey. Finally, grantors, trustees, and beneficiaries should discuss these trusts, and their individual income tax planning, with their advisors for trust income tax planning in 2025 and beyond.

Endnotes

1. Reprinted with permission from the January 8, 2024, edition of The Legal Intelligencer © 2023 ALM Global Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-256-2472 or asset-and-logo-licensing@alm.com

Published in eReport, Spring 2024 © 2024 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.

Section 6751(b)(1) and Written, Supervisory Approval of Penalties

By Stephen J. Dunn1

Stephen Dunn analyzes the IRS’s procedures for obtaining written, supervisory approval of penalties. Supervisor approval is required for a determination of penalties involving judgment, such as penalties for negligence or fraud, and to reject taxpayers’ reasonable cause arguments raised against other penalties, such as penalties for failure to timely file a tax return or pay tax.

Section 6751(b)(1) provides important due process of law in the assessment of Federal tax penalties. Ambiguity in the language of the Section 6751(b)(1) has sparked much litigation. A split has opened in the U.S. Courts of Appeal on the interpretation of Section 6751(b)(1). This article examines Section 6751(b)(1), its legislative history, cases applying it, and Internal Revenue Service pronouncements on it, and draws conclusions on the interpretation and reach of Section 6751(b)(1).

A. Internal Revenue Restructuring and Reform Act of 1998

In 1997, popular cries of excesses in Internal Revenue Service collection action led to introduction of a bill which would become the Internal Revenue Restructuring and Reform Act of 1998 (the “Act”).2 The Act altered Federal tax practice and procedure concerning penalties by the addition of two provisions to the Internal Revenue Code, Sections 6751 and 7491(c).

1. Section 6751

Section 6751 provides: § 6751. Procedural requirements.

(a) Computation of penalty included in notice. The Secretary shall include with each notice of penalty under this title information with respect to the name of the penalty, the section of this title under which the penalty is imposed, and a computation of the penalty.

(b) Approval of assessment.

(1) In general. No penalty under

this title shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate.

(2) Exceptions. Paragraph (1) shall not apply to—

(A) any addition to tax under section 6651, 6654, 6655, or 6662 (but only with respect to an addition to tax by reason of paragraph (9) or (10) of subsection (b) thereof); or

(B) any other penalty automatically calculated through electronic means.

(c) Penalties.--For purposes of this section, the term “penalty” includes any addition to tax or any additional amount.

It is clear from the face of Section 6751(b)(1) that Congress did not want low-level IRS employees unilaterally making judgments to assess penalties.

The Senate Finance Committee had this to say concerning Section 6751:

Present Law

Present law does not require the IRS to show how penalties are computed on the notice of penalty. In some cases, penalties may be imposed without supervisory approval.

Reasons for Change

The Committee believes that taxpayers are entitled to an explanation of the penalties imposed upon them. The Committee believes that penalties should only be imposed where appropriate and not as a bargaining chip.

Explanation of Provision

Each notice imposing a penalty is

required to include the name of the penalty, the code section imposing the penalty, and a computation of the penalty.

The provision also requires the specific approval of IRS management to assess all non-computer generated penalties unless excepted. This provision does not apply to failure to file penalties, failure to pay penalties, or to penalties for failure to pay estimated tax.3

The Senate Finance Committee thus advocated the written, supervisory approval requirement of Section 6751(b)(1) to prevent rogue revenue agents from using the threat of penalties to exact better settlements from taxpayers.

To ascertain whether the IRS has secured required written, supervisory approval of penalties, a taxpayer can make a Freedom of Information Act request for the IRS’ administrative file concerning the penalties, and review the copies of documents produced in response.

2. Section 7491(c)

Section 7491(c) provides:

Notwithstanding any other provision of this title, the Secretary shall have the burden of production in any court proceeding with respect to the liability of any individual for any penalty, addition to tax, or additional amount imposed by this title.

The Conference Committee Report on the Act says the following regarding Section 7491(c):

[I]n any court proceeding, the Secretary must initially come forward with evidence that it is appropriate to apply a particular penalty to the taxpayer before the court can impose the penalty. This provision is not intended to require the Secretary to introduce evidence of elements such as reasonable cause or substantial authority. Rather, the Secretary must come forward initially with evidence regarding the appropriateness of applying a particular penalty to the taxpayer; if the taxpayer believes that,

because of reasonable cause, substantial authority, or a similar provision, it is inappropriate to impose the penalty, it is the taxpayer’s responsibility (and not the Secretary’s obligation) to raise those issues.4

Thus, the burden of production to determine the appropriateness of any penalty is upon the IRS. Once the IRS meets that burden, the burden shifts to the taxpayer to raise reasonable cause, substantial authority, or other defenses to the penalty.

B. The Case Law

In Chai v. Commissioner,5 the IRS timely issued a Notice of Deficiency asserting self-employment tax on a $2 million payment, and a Section 6662(a) 20 percent accuracy-related penalty. The taxpayer petitioned the Tax Court for review. The Tax Court sustained the IRS’ determination of tax on the $2 million payment. In a post-trial brief, the taxpayer attempted to argue that the initial determination of the penalty had not been approved (in writing) by the immediate supervisor of the individual making the determination, in violation of Section 6751(b). The Tax Court found the taxpayer’s Section 6751(b) argument untimely, and declined to consider it.

On appeal, the U.S. Court of Appeals for the Second Circuit sustained the IRS’ assessment of tax on the $2 million payment, but reversed as to the penalty. The IRS sought to bring the penalty within the “automatically calculated through electronic means” exclusion of Section 6751(b)(2)(B). Citing Internal Revenue Manual 4.19.3, the Second Circuit said that it was aware of no record evidence that the IRS’ penalty determination was, or could have been, made through the IRS’ IMF Automated Underreporter Program. Further, the Court of Appeals noted that the Notice of Deficiency indicated that the determinations had been made by a named Technical Services Territory Manager, or a Revenue Agent under her authority. The Form 886-A, Explanation of Items, included with the Notice of Deficiency detailed why the IRS determined to assess the penalty, including that the IRS employee determined that the taxpayer lacked reasonable cause for the underpayment. The Court of Appeals concluded:

Because Chai’s penalty was not imposed “free of any independent determination by a Service employee as to whether the penalty should be imposed,” see I.R.S. Gen. Couns. Mem. 200211040, at 3 (Jan. 30, 2002) (emphasis added), it was not “calculated automatically through electronic means.” I.R.S. Gen. Couns. Mem. 2014004, at 2 (May 20, 2014). The IRS was therefore required to ob -

tain written approval of the penalty pre-assessment.6 [Emphasis in original.]

Turning to the language of Section 6751(b)(1), the Second Circuit found ambiguity in the phrase, “initial determination of such assessment.” The Court of Appeals noted that “[a]ssessment under Section 6203 “is the formal recording of a taxpayer’s tax liability on the tax rolls.”7 The Court of Appeals added:

If “assessment” is the formal recording of a taxpayer’s tax liability, then § 6751(b) is unworkable: one can determine a deficiency, see I.R.C. §§ 6212(a), 6213(a), and whether to make an assessment, “but one cannot ‘determine’ an ‘assessment.’”8

The Court of Appeals noted that Section 6751(b)(1) does not define when the IRS “initial[ly] determine[es]” a penalty. The Court of Appeals divined Congress’ intent in approving Section 6751(b)(1): “The Committee believes that penalties should only be imposed where appropriate and not as a bargaining chip.”9 This suggests that “initial determination” of a penalty occurs when the IRS formally communicates the penalty to the taxpayer. The Court of Appeals held that issuance of a notice of deficiency asserting a penalty is an “initial determination” of the penalty, requiring written, supervisory approval under Section 6751(b)(1).

The Court of Appeals held that compliance with Section 6751(b)(1) was part of the IRS’ initial burden of production under Section 7491(c). The Court of Appeals found that there was no evidence that the IRS had complied with Section 6751. “In fact, the Commissioner has never said there was.”10 The Second Circuit reversed the Tax Court’s order upholding the penalty assessment.

In Clay v. Commissioner,11 a revenue agent issued a Revenue Agent’s Report (“RAR”) to the taxpayers on September 13, 2010 proposing assessment of proposing Section 6662 substantial understatement and other accuracy-related penalties against the taxpayers. The revenue agent’s supervisor initialed a Civil Penalty Approval Form approving the penalties on October 18, 2010. The IRS included the penalties in a notice of deficiency issued to the taxpayers on March 14, 2011. The Tax Court noted the Senate Committee’s concern with revenue agents using the threat of penalties “as a bargaining chip” to exact better settlements from taxpayers. The Tax Court concluded that the “initial determination” of a penalty assessment for purposes of Section 6751(b)(1) occurs at the earlier of issuance of an RAR or a Notice of Deficiency asserting the penalties. As initial determination of the penalty assessment in Clay occurred on September 13, 2010, before written, supervisory approval of the assessment on October 18, 2010, the Tax Court disallowed the penalties.

The Tax Court’s Section 6751(b)(1) jurisprudence continued to develop in Belair Woods, LLC v. Commissioner 12 On October 22, 2012, the IRS sent Belair Woods LLC a Letter 1787 informing the taxpayer that “we’re beginning our audit of your partnership’s federal tax return.” The letter was signed by Ellie Pennington, the revenue agent assigned to conduct the examination.

The examination proceeded on a fast track as less than a year remained on the assessment statute of limitations. On December 18, 2012, Pennington sent to Belair Woods a Letter 1807 inviting the tax management partner (TMP) and other partners to a closing conference to discuss the IRS’ proposed adjustments. The enclosed summary report proposed to deny a $4,778,000 charitable contribution deduction in its entirety. The summary report also proposed a gross overvaluation penalty under Section 6662(h), or, in the alternative, a Section 6662(c) negligence penalty and a 6662(d) substantial understatement penalty. The summary report also explained in detail defenses that might be available against the proposed penalties, including “reasonable cause and good faith,” reliance on appraisals, and reliance on professional tax advice.

The IRS exam team attended an initial conference with Belair Woods’ representatives in February, 2013. At that conference, those representatives agreed that Belair Woods would execute Form 872-P, Consent to Extend the Time to Assess Tax Attributable to Partnership Items.

Pennington prepared a Civil Penalty Approval Form for the penalty proposed under Section 6662(h) or, in the alternative, the penalties proposed under Sections 6662(c) and (d). In the box captioned “Reason(s) for Assertion of Penalty(s)” she wrote:

The contribution deduction flowing through to the individuals is overvalued by over 8,000%. No reasonable cause was established. Discussed the assertion of penalties with the group manager. He concurred that penalties are applicable prior to issuance of the summary report.13

In a section of the Civil Penalty Approval Form captioned “Penalties Requiring Group Manager Approval,” Pennington checked the “Yes” box for a Section 6662(h) penalty as the primary position, and the “Yes” box for Section 6662(b) and (c) penalties as an alternative.14

On August 27, 2014, Pennington forwarded the case file, including the Civil Penalty Approval Form, to Cheryl Mixon, her then-supervisor. On September 2, 2014, Mixon, in her capacity as Group Manager, signed the Civil Penalty Approval Form, approving assertion of the three penalties indicated on the form.

On March 9, 2015, the IRS issued a “TMP 60-Day Letter” to Belair Woods. The 60-Day Letter offered Belair Woods the options of accepting the adjustments or appealing them to the IRS Appeals Office. Belair Woods sought review in the Appeals Office, but the appeal was unsuccessful. On June 19, 2017, the Appeals Office issued to Belair Woods a final partnership administrative adjustment (FPAA) disallowing the charitable contribution deduction in its entirety and determining a gross valuation misstatement penalty. In the alternative, the FPAA determined penalties for negligence, substantial understatement of tax, and Section 6662(e) substantial valuation misstatement. This was the first time the IRS had communicated its intention to assert a Section 6662(e) penalty to Belair Woods. The IRS admitted that it could not show timely supervisory approval of a Section 6662(e) penalty, and conceded it.15

In the Tax Court, Belair Woods contended that Section 6751(b) (1) required written, supervisory approval of the penalties to occur by the time the IRS issued the Letter 1807 to Belair Woods mentioning the penalties in December, 2012. The Tax Court said:

The Letter 1807 launched a lengthy communication and fact-gathering process during which [petitioner] had the opportunity to present its side of the story. Only after that process concluded did the Examination Division finalize its penalty determination by issuing the 60-day letter.16

The Tax Court said that “[t]he statute requires approval for the initial determination of a penalty assessment, not for a tentative proposal or hypothesis” [Emphasis in original].17 The Tax Court (somewhat arbitrarily) found that the Letter 1807 failed to rise to the level of an “initial determination” under Section 6751(b) (1). It held that issuance of the 60-day letter on March 9, 2015, “formally communicated” the IRS’ penalty determination to Belair Woods, and constituted the IRS’ “initial determination” to assert the penalties.18 Because Pennington’s Group Manager signed the Civil Penalty Approval Form on August 27, 2014, the Tax Court concluded that the written, supervisory approval of the penalties was timely under Section 6751(b)(1).

In Beland v. Commissioner,19 the IRS commenced an examination of Brian and Denae Beland’s 2011 Form 1040, U.S. Individual Income Tax Return, on October 30, 2014. Revenue Agent Ivana Raymond met with the Belands’ CPA in December, 2014, and with the Belands and their CPA in January, 2015. Following the December meeting, Raymond and her immediate supervisor, IRS Group Manager Gabriel Pardo, referred the Belands’ case to an IRS fraud technical advisor (FTA). Upon the request of the IRS Criminal Investigation Division and the FTA, on June 5, 2015 Pardo and Raymond issued an administrative summons

to the Belands to appear before Raymond again on June 30, 2015. The Belands sent a letter to Raymond dated June 23, 2015 requesting postponement of the summons interview because Ms. Beland had just given birth to the Belands’ second child. In response, IRS counsel sent a letter to the Belands dated July 27, 2015 to compel their appearance before Raymond on August 19, 2015. The letter stated that “[l]egal proceedings may be brought against you in the United States District Court for not complying with [the] summons.” The Belands acquiesced and appeared with their CPA before Raymond, Pardo, and IRS Group Manager John Yu at the August 19, 2015 meeting.

The August 19, 2015 meeting was the Belands’ closing conference. During the conference, Raymond presented to the Belands a Form 4549, Income Tax Examination Changes, commonly referred to as a revenue agent’s report. The RAR included a fraud penalty of specified amount, and contained Raymond’s electronic signature. The Belands declined to sign the RAR during the meeting, because they did not agree with the fraud penalty. The Belands also declined to sign Form 872, Consent to Extend the Time to Assess Tax. With less than 240 days remaining on the assessment statute of limitations, Raymond informed the Belands that they would forgo their appeal rights, their 2011 examination case would be closed, and respondent would issue a notice of deficiency.

On August 21, 2015, Raymond sent the 2011 examination case file to Pardo. The file included a Civil Penalty Approval Form for the fraud penalty, as well as an alternative assertion of an accuracy-related penalty under Section 6662(a), which Pardo signed that day. On September 1, 2015, the IRS issued a notice of deficiency to the Belands for tax year 2011 asserting the civil fraud or, in the alternative, the accuracy-related penalty.

The Tax Court concluded that the completed RAR given to the Belands at the August 19. 2015 closing conference, coupled with the context surrounding its presentation, represented a “consequential moment” in which Raymond formally communicated to the Belands her initial determination to assess the fraud penalty. As Pardo did not approve the fraud penalty in writing until August 21, 2015, the Tax Court held that the IRS failed to meet its Section 7491(c) burden of production as to the penalty, and disallowed the penalty.

Section 6751(b)(1) jurisprudence took a different turn in Laidlaw’s Harley Davidson Sales Inc. v. Commissioner.20 Section 6011(a) and Treasury Regulation Section 1.6011-4(a), (b)(2), (e) require taxpayers to disclose on a statement filed with their tax return their participation in transactions designated by the IRS as “listed transactions.” In 1999, the taxpayer became a participating employer in a purported welfare benefit plan called the Sterling Benefit Plan (“Plan”). The IRS later determined that the Plan was the same as, or substantially similar to, the tax avoidance transactions designated as “listed transactions” in the IRS’s Notice 2007-83, and that a taxpayer participating the Plan

would be subject to a penalty under Section 6707A if it did not disclose its participation on its tax return.

The IRS issued Notice 2007-83 on November 5, 2007. The taxpayer filed its 2008 income tax return on February 16, 2009, without disclosing its participation in the Plan. In December 2010, the taxpayer filed amended income tax returns for 1999 and 2005 through 2008. The amended tax returns included IRS Forms 8886, Reportable Transaction Disclosure Statement, disclosing the taxpayer’s participation in the Plan.

Revenue Agent Sandra Czora examined taxpayer’s 2007-2008 income tax returns with a view to assessing penalties under Section 6707A for failure to timely report taxpayer’s participation in the Plan. Section 6707A penalties are assessable, i.e., are not subject to deficiency procedure. On May 26, 2011, Czora sent the taxpayer a “30-day letter” proposing to assess a Section 6707A penalty in the amount of $96,900 against the taxpayer. The 30-day letter explained the taxpayer’s rights to contest the proposed penalty. The taxpayer could sign consenting to assessment of the penalty. If the taxpayer did not consent to the penalty, the taxpayer could file a written protest for IRS Appeals Office review. Alternatively, the taxpayer could pay the penalty and sue for a refund in U.S. District Court or the Court of Federal Claims. The letter said that if the taxpayer took no action by the 30-day response date (June 27, 2011), “we will assess the penalty and begin collection procedures.”

Czora enclosed with the 30-day letter a Form 4549-A, Income Tax Discrepancy Adjustments, showing her computation of the proposed penalty, and a Form 886-A, Explanation of Items, explaining the basis for the proposed penalty.

On July 21, 2011, the taxpayer filed a timely protest of the proposed penalty with the IRS Appeals Office. On August 23, 2011, Czora’s immediate supervisor, Group Manager Virginia Korzec, signed a Form 300, Civil Penalty Approval Form, approving the proposed penalty. The next day Korzec transferred the case to the Appeals Office. The taxpayer’s administrative appeal was unsuccessful, and the Appeals Office recommended assessment of the § 6707A penalty. The IRS assessed the penalty, in the amount of $96,900, on September 16, 2013.

The taxpayer did not pay the penalty after notice and demand, and the IRS issued a notice of intent to levy informing the taxpayer of its right to a Collection Due Process (“CDP”) hearing before the IRS Appeals Office. The taxpayer timely requested a CDP hearing, which was held on May 9, 2014. On May 21, 2014, the Appeals Office sustained the proposed levy, stating that the Appeals Office had “obtained verification from the IRS office collecting the tax that the requirements of any applicable law, regulation or administrative procedure with respect to the proposed levy . . . have been met,” in accordance with Section 6330(c)(1).21

In June, 2014, the taxpayer timely petitioned the Tax Court for review of the penalty assessment, as provided by Section

6330(d)(1). The Tax Court held that Section 6751(b)(1) required written, supervisory approval of the penalty to occur by the time of initial determination of the penalty, and that initial determination occurred on May 26, 2011, when the IRS first formally communicated the penalty to the taxpayer. As written, supervisory approval of the penalty occurred on August 23, 2011, after the May 26, 2011 initial determination of the penalty, the Tax Court disallowed the penalty, and granted summary judgment to Taxpayer.

On appeal, the Ninth Circuit noted that the term “assessed” in Section 6751(b)(1) “refers to a ministerial function: ‘the formal recording of a taxpayer’s tax liability on the tax rolls,’ which is ‘the last of a number of steps required before the IRS can collect’ a tax or penalty from a taxpayer.’”22 The Court of Appeals said that an IRS supervisor could “approve” a penalty only so long as the supervisor has discretion to approve the penalty. In a deficiency procedure case, a supervisor could lose discretion to approve a penalty before assessment of the penalty, i.e., upon issuance of a notice of deficiency asserting the penalty. The Court of Appeals held that Supervisor Korzec retained discretion to approve the Section 6707A penalty in Laidlaw’s, which was not subject to deficiency procedure, up to the time of assessment of the penalty on September 16, 2013, and that written, supervisory approval of the penalty on May 26, 2011 satisfied Section 6751(b)(1). As a result, the Ninth Circuit, in a 2-1 decision, reversed the Tax Court.

In Kroner v. Commissioner, the Eleventh Circuit extended the Ninth Circuit’s Section 6751(b)(1) jurisprudence to a deficiency procedure case. 23 On August 6, 2012, Revenue Agent John Cox met with the taxpayer’s representatives, and delivered to them a Letter 915 and a Form 4549, Income Tax Examination Changes. The Letter 915 and its attachments proposed accuracy-related penalties under Section 6662, and granted the taxpayer the opportunity to protest the proposed changes to the IRS Appeals Office. On October 31, 2012, Cox’ supervisor, Supervisory Revenue Agent Diane Acosta, signed Workpaper #300-1.1, Civil Penalty Approval Form. On the same day, Cox mailed to the taxpayer a Letter 950, enclosing Form 4549-A, Income Tax Discrepancy Adjustments.

The IRS issued a notice of deficiency dated July 10, 2014 to the taxpayer. It proposed assessment of substantial amounts of additional income tax, and just under $2 million in Section 6662 penalties.

The taxpayer timely requested a conference before the IRS Appeals Office, and continued negotiating with the IRS. These efforts proved unavailing, and IRS finally issued a statutory notice of deficiency to the taxpayer. The taxpayer petitioned the U.S. Tax Court for review.

After trial, the Tax Court sustained the additional tax asserted by the IRS against the taxpayer, but not the penalties. The Tax Court found that the IRS’ August 6, 2012 letter and examination

report was the “initial determination” of the penalty assessment against the taxpayer for purposes of Section 6751(b). As Acosta did not sign the Civil Penalty Approval Form until October 31, 2012, the Tax Court held that the IRS had failed to obtain written, supervisory approval of the penalty within the time required by Section 6751(b)(1), and disallowed the penalty.

On appeal, the Eleventh Circuit found that Section 6751(b)(1) “regulates assessments[, not] communications to the taxpayer.”24 The Eleventh Circuit further observed, “We likewise see nothing in the text that requires a supervisor to approve penalties at any particular time before assessment.”25 The Court of Appeals reduced its interpretation of Section 6751(b)(1) to the following:

Stripped to bare bones, the statute directs that the IRS shall not take action X “unless” condition Y is met. X is the assessment of a covered penalty, and Y is the act of obtaining supervisory approval of the initial determination of assessment.26

Citing the Ninth Circuit’s opinion in Laidlaw’s Harley Davidson Sales, Inc., the Eleventh Circuit concluded “that the IRS satisfies Section 6751(b) so long as a supervisor approves an initial determination of a penalty assessment before it assesses those penalties.”27 The penalties had not yet been assessed, as a final judgment sustaining the penalties had not yet been entered when the Eleventh Circuit issued its opinion. Therefore, the Court of Appeals held Acosta’s October 31, 2012 written approval of the penalties timely under Section 6751(b)(1), and reversed the Tax Court.

The position of the Ninth Circuit in Laidlaw’s Harley Davidson Sales, Inc., and of the Eleventh Circuit in Kroner and its progeny, is problematic, for at least two reasons. First, by rendering the term “initial determination” in Section 6751(b)(1) superfluous, the position of the Ninth and Eleventh Circuits violates the Supreme Court’s “canon of superfluity.” This provides that where competing interpretations of a stature are urged, and one of them gives effect to every word and clause of the statute and one does not, the interpretation that gives effect to every word and clause of the statute should be adopted.28

Second, the position of the Ninth and Eleventh Circuits that written, supervisory approval of a penalty satisfies Section 6751(b)(1) if it occurs anytime before assessment of the penalty lacks fidelity to Congress’ intention that the spectre of penalties not be used as a “bargaining chip” in exacting concessions from taxpayers. If revenue agents need not obtain written, supervisory approval of a penalty until it is assessed, they are free to use the threat of a penalty as a bargaining chip in seeking a favorable settlement from the taxpayer throughout the long pendency of the case up to assessment.

The Supreme Court likely will need to step in and resolve the split in the Circuits. The Second Circuit’s position in Chai, embraced in Tax Court decisions, seems to be the betterreasoned position, and faithful to Congress’ intent in enacting Section 6751(b)(1).

C. Penalties Subject to Section 6751(b)

Cases have applied the Section 6751(b)(1) written, supervisory approval requirement to Section 6662 accuracy-related penalties,29 to Section 6662 substantial understatement penalties,30 and to Section 6663(a) civil fraud penalties.31 Section 6662 accuracy-related penalties and Section 6663 civil fraud penalties involve a judgment, Section 6662 accuracy-related penalties about whether the taxpayer was negligent, and Section 6663 penalties about whether the taxpayer was fraudulent. A reasonable cause argument, under Section 6664, also is available against all Section 6662 or Section 6663 penalties.

Section 6651 penalizes failure to timely report or pay tax, or failure to timely file a tax return.32 International information return penalties, too, penalize the failure to file an international information return.33 It may seem that assessment of Section 6651 penalties or international information return penalties international penalties does not involve a judgment. But each of these penalties has a reasonable cause exception: the penalty is not to be assessed if the noncompliance for which the penalty would be assessed is due to reasonable cause.34

Section 7491(c) allocates to the taxpayer the burden to raise reasonable cause, as noted above. But once the taxpayer raises reasonable cause against a penalty assertion, it is up to the IRS to decide it. And whether the taxpayer’s noncompliance is due to reasonable cause surely does involve a judgment.

The IRS does not want low-level employees unilaterally making judgments about reasonable cause, just as it does not want them making judgments about negligence or fraud. Internal Revenue Manual 20.1.5.2.3, Supervisory Approval of Penalties – IRC 6751 Procedural Requirements, provides in part:

(6) Any penalties automatically calculated through electronic means are excluded from IRC 6751(b)(1) requirement.

a. AUR (Automated Underreporter) and CEAS (Correspondence Examination Automation Support) cases in which the Substantial Understatement Penalty is systemically asserted, will fall within the exception for penalties automatically calculated through electronic means if the taxpayer does not submit any response to the 30-day letter that proposes the penalty.

b. However, if a taxpayer submits a response, written or otherwise, that challenges the penalty or the liability to which the penalty relates, written supervisory approval under IRC 6751(b)(l), is required before any written communication of penalties that offers the taxpayer an opportunity to sign an agreement, or consent to assessment or proposal of the penalty. See IRM 20.1.1.2.3.1, Timing of Supervisory Approval. The exception for penalties automatically calculated through electronic means no longer applies once a Service employee makes an independent determination to pursue a penalty or to pursue adjustments to tax for which a penalty is attributable. Similarly, Proposed Regulation § 301.6751(b)-1(a)(3)(iv) provides:

(vi) Automatically calculated through electronic means. A penalty, as defined in paragraph (a)(3)(i) of this section, is automatically calculated through electronic means if an IRS computer program automatically generates a notice to the taxpayer that proposes the penalty. If a taxpayer responds in writing or otherwise to the automaticallygenerated notice and challenges the proposed penalty, or the amount of tax to which the proposed penalty is attributable, and an IRS employee considers the response prior to assessment (or the issuance of a notice of deficiency that includes the penalty), then the penalty is no longer considered “automatically calculated through electronic means.”

Thus, by raising a good faith reasonable cause argument against a proposed Section 6651 penalty or a proposed international information return penalty, the taxpayer removes the penalty from the vague wasteland of Section 6751(b)(2) and places it within the ambit of Section 6751(b) (1). Once this happens, the IRS must secure written, supervisory approval of the penalty before sending the taxpayer a written communication asking the taxpayer to sign consenting to assessment of the penalty.35 If the IRS fails in this, by virtue of IRM 20.1.5.2.3 and Proposed Regulation § 301.6751(b)-1(a)(3)(iv) the penalty must not be sustained.

What about a Section 6651 penalty or a penalty for failure to timely file an international information return that is assessed without written supervisory approval when (1) the taxpayer was not afforded due process of law, or (2) the taxpayer failed to raise reasonable cause or other available defenses? This will have to await examination in a later article.

D. Summary

Section 6751(b)(1) requires the IRS to secure written, supervisory approval of an initial determination to assert a Section 6662 negligence penalty or a Section 6663 civil fraud penalty. Section 6662 negligence penalties and Section 6663 civil fraud penalties, as well as Section 6651 penalties and international information return penalties, are subject to a reasonable cause defense. Rejection of an asserted reasonable cause defense also requires written, supervisory approval by the IRS. Whenever written, supervisory approval is at issue, taxpayer’s counsel should make a Freedom of Information Act request for the IRS’ administrative file concerning the penalties, and obtain the file and review it for proof of required written, supervisory approval. Absence of required written, supervisory approval is a good defense to an assessed penalty.

Endnotes

1 Stephen J. Dunn is the founder and member of Dunn Counsel PLC, Troy, Michigan. He thanks Ryan Peruski for his assistance in reviewing this article. A version of this article first appeared in Tax Notes Federal and Tax Notes International. Copyright 2024 Stephen J. Dunn. All rights reserved.

2. PL 105-206 (Jul. 22, 1998), 112 Stat. 685.

3. S. Rep. 105-174, at 65, 105th Cong., 2nd Sess. 1998, 1998 WL 197371. [Emphasis added].

4. H.R. Conf. Rep. 105-599, at 241, 105th Cong., 2nd Sess. 1998, 1998 U.S.C.C.A.N. 288, 1998 WL 915495.

5. 851 F.3d 190 (2d Cir. 2017).

6. Id. at 217.

7. Id. at 218. “[A]n assessment is ‘made by recording the liability of the taxpayer in the office of the Secretary in accordance with rules or regulations prescribed by the Secretary.’” Id., quoting Section 6203.

8. 851 F.3d 218-219 (quoting dissenting opinion of Gustafson, J., in Graev v. Commissioner, 147 T.C. 16, No. 30638-08, 2016 WL 6996650 at *31).

9. 851 F.3d at 219, quoting S. Rep. No. 105-174, supra, at 65.

10. 851 F.3d at 223.

11. 152 T.C. 223 (2019).

12. 154 T.C. 1 (2020).

13. 154 T.C. at 5.

14. Id.

15. In an examination of a partnership income tax return, unless the partnership has 100 or fewer partners and elects out of Subtitle F, Chapter 63, subchapter C of the Code, a FPAA functions like a notice of deficiency in other examinations. The FPAA becomes final upon the partnership and the partners 90 days after issuance of the FPAA unless, within said 90 days, the partnership petitions for review of the FPAA in the U.S. Tax Court, the U.S. District Court for the district of the partnership’s principal place of business, or the U.S. Court of Federal Claims. If the partnership petitions for such judicial review, the FPAA becomes final upon issuance of a final judgment sustaining the FPAA. See Section 6234.

16. Id. at 9.

17. Id.

18. The Tax Court wrote:

In the instant case the 60-day letter determining penalties under section 6662(b), (c), and (h) was issued on March 9, 2015. That letter, like the 30-day letter in Clay, formally communicated to Belair the Examination Division’s definite decision to assert those penalties, thus concluding the Examination Division’s consideration of the case. See Internal Revenue Manual (IRM) pt. 8.19.1.6.8.4(3) (Oct. 1, 2013) (“The 60-day letter is the equivalent of a 30-day letter in deficiency proceedings. It gives the partners the opportunity to appeal the findings of the examiner.”).

154 T.C. at 8-9.

19. 156 T.C. 80 (2021).

20. 29 F.4th 1066 (9th Cir. 2022).

21. Id. at 1069.

22. Id. at 1071, quoting Chai v. Commissioner, 851 F.3d 190, 218 (2d Cir. 2017), and citing Roth v. Commissioner, 922 F.3d 1126, 1131 (10th Cir. 2019).

23. 48 F.4th 1272 (11th Cir. 2022).

24. 48 F.4th at 1275.

25. 48 F.4th at 1278.

26. Id.

27. 48 F.4th at 1276.

28. See Microsoft Corp. v. i4i Limited Partnership, et al., 564 U.S. 91, 106-107 (2011), citing Duncan v. Walker, 533 U.S. 167, 174, 121 S.Ct. 2120, 150 L.Ed.2d 251 (2001) and United States v. Menasche, 348 U.S. 528, 538–539, 75 S.Ct. 513, 99 L.Ed. 615 (1955) (“It is our duty ‘to give effect, if possible, to every clause and word of a statute”).

29. See, e.g., Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017); Carter v. Commissioner, T.C. Memo 2020-21, aff’d, 2022 WL 4232170 (11th Cir. 2022); Castro v. Commissioner, T.C. Memo 2022-120; Kroner v. Commissioner, T.C. Memo 2020-73, rev’d, 48 F.4th 1272 (11th Cir. 2022); Simpson v. Commissioner, T.C. Memo 2023-4.

30. See, e.g., Clay v. Commissioner, 152 T.C. 233 (2019), aff’d, 990 F.3d 1296 (11th Cir.), cert. denied, 142 S.Ct. 342 (2021).

31. See, e.g., Minemyer v. Commissioner, 2023 WL 314832 (10th Cir. 2023); Belanger v. Commissioner, T.C. Memo 2020-130; Benavides & Co., P.C. v. Commissioner, T.C. Memo 2019-115; Beland v. Commissioner, 156 T.C. 80 (2021); Estate of Clemons v. Commissioner, T.C. Memo 2022-95; Degourville v. Commissioner, T.C. Memo 2022-93; Dorval v. Commissioner, T.C. Memo 2018-167; Purvis v. Commissioner, T.C. Memo 2020-13.

32. Section 6651(a)(1) imposes a penalty for failure to file a tax return when due (determined with regard to any extension of time for filing), unless it is shown that such failure is due to reasonable cause and not willful neglect. Section 6651(a)(2) imposes a penalty for failure to pay tax reported on any return by the date prescribed therefor (determined with regard to any extension of time for payment), unless it is shown that such failure is due to reasonable cause and not willful neglect. Section 6651(a)(3) imposes a penalty for failure to pay tax reportable on a return, which is not so reported, within 21 days after notice and demand therefor, unless it is shown that such failure is due to reasonable cause and not willful neglect.

33. Section 6677 imposes a penalty for failure to timely file Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, reporting information required in Parts I-III thereof. Section 6677 also imposes a penalty or for failure to timely file Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner. Section 6039F(c) imposes a penalty for failure to timely report on Form 3520, Part IV, the receipt of large gifts or bequests from foreign sources. 6679(a) imposes a penalty for failure to timely file Form 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations, or Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. Section 6038B(c) imposes a penalty for failure to timely file Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation. 34. Sections 6651(a)(1), (2), and (3) each contain a reasonable cause exception. The Section 6677 penalty “shall [not] be imposed . . . on any failure which is shown to be due to reasonable cause and not willful neglect.” Section 6677(d). The Section 6039F penalty “shall not apply to any failure to report a foreign gift if the United States person shows that the failure is due to reasonable cause and not due to willful neglect.” Section 6039F(c)(2). The Section 6038D penalty “shall [not] be imposed . . . on any failure which is shown to be due to reasonable cause and not due to willful neglect.” Section 6038D(g). The 6679(a) penalty does not apply if “it is shown that [the] failure [to timely file Form 5471 or Form 8865] is due to reasonable cause.” Section 6679(a)(1).

The Section 6038B(c) penalty “shall not apply to any failure [to file Form 926] if the United States person shows that such failure is due to reasonable cause and not to willful neglect.” Section 6038B(c)(2). 35. The taxpayer should, of course, raise, in addition to reasonable cause and Section 6751(b)(1) written, supervisory approval, whatever other arguments the taxpayer may have against the penalty, such as first time abatement under Internal Revenue Manual 20.1.1.3.3.2.1.

Published in eReport, Spring 2024 © 2024 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.

DEALING WITH STOCK PRICE VOLATILITY IN EQUITY COMPENSATION PLANS

By Steven H. Sholk, Esq.1

Steven H. Sholk identifies and outlines the issue with stock volatility in equity compensation plans and offers various approaches to address such prospect to help ensure the adequacy of a plan’s share reserve and avoid upending established award practices.

Companies that sponsor equity compensation plans often face volatility in the price of the company’s stock. This volatility, especially declines in price, can put unexpected pressure on the adequacy of the plan’s share reserve and upend established award practices. Indeed, this prospect can cause companies to envy the lovelorn man in the song I Can’t Get Started With You

who sold short in 1929.2 But unlike the lovelorn man in that song, companies can get started with approaches to address this prospect. This article discusses those approaches.

The effects of price volatility often turn on how the plan limits awards to participants individually and in the aggregate. Plans may place an annual limit on individual awards, especially on awards to nonemployee directors. The annual limit is often expressed as a dollar amount, and occasionally as a limit on the number of shares. In addition, the plan may place an annual limit on the aggregate amount of all awards, which may be expressed as a dollar amount, a number of shares, or a percentage of common shares outstanding.3 Most importantly, the plan will place a limit on the aggregate number of shares subject to all awards during the term of the plan, otherwise known as the share reserve.

Use of a dollar amount provides consistent grant date value by adjusting the number of shares on the grant date to match the dollar amount, and consistent proxy disclosure regardless of fluctuations in stock price.4 It is often used by established companies with less stock price volatility. However, when a plan limits awards by dollar amount, and the company’s stock price declines, the decline results in a larger number of shares per grant. The increase in the number of shares per grant can put

pressure on the plan’s annual individual and aggregate limits and the share reserve. Furthermore, if the company has experienced reduced cash flow, it may shift from annual or long-term cash bonuses to equity compensation. In these situations, the plan’s share reserve will be depleted more rapidly, and the plan’s burn rate and level of shareholder dilution will increase.

For example, if the company’s stock price declines by 25%, the number of shares needed to deliver the same dollar value as before the decline increases by 33.3%. If the company’s stock price declines by 50%, the number of shares need to deliver the same dollar value as before the decline increases by 100%.5

Companies facing stock price volatility should consider approaches to reduce the rate of depletion of the share reserve, otherwise known as the plan’s burn rate. When a plan limits awards by a dollar amount and the company’s stock price declines so that the number of shares per grant increases, the company may wish to stanch this increase by amending the plan to limit awards by the number of shares. This approach is often used by companies that have recently gone public. It provides a lower burn rate and less dilution of shareholders, and can head off claims by proxy advisors and institutional shareholders of an undeserved economic windfall for directors and executives. When the company wishes to amend the plan to limit awards by the number of shares, under the NYSE and NASDAQ listing rules as long as the amendment does not increase the share reserve, the amendment is not a material revision to the plan that requires shareholder approval.6

Another approach is to set a floor below which the price per share value used to determine the number of shares in an award will not fall. The floor will apply regardless of the share’s market value. A variation on this approach is to use the same price used for a prior grant made in a less volatile market when stock prices were higher. Since these approaches reduce the number of shares available per grant, they have employee retention risk.

When the plan places an annual limit on the aggregate amount of all individual awards expressed as a percentage of common shares outstanding, this approach provides a more predictable burn rate and dilution of shareholders. It is often used by private companies and companies that have recently gone public.

When a plan limits annual awards by dollar amount, the company has to consider how to determine the annual dollar limit. One method is the value under Financial Accounting Standards Board Accounting Standards Codification Topic 718. Another method is the fair market value on the grant date, such as the closing price. However, when shares are subject to substantial volatility, use of a single day spot price can reflect a major price fluctuation. One way to avoid this result is for the plan to use a thirty to sixty day trailing average of closing prices, which smooths out the effect of volatility. When a plan does not use a trailing average to determine award limits and the company

wishes to amend the plan to provide for its use, under the NYSE and NASDAQ listing rules the amendment is not a material revision to the plan that requires shareholder approval.7

If after taking any of the foregoing approaches the company faces the prospect of depleting the share reserve and being unable to make ordinary course annual awards, the company will need to increase the share reserve. Under the NYSE and NASDAQ listing rules, a material increase in the share reserve is a material revision to the plan that requires shareholder approval.8 In determining the number of additional shares to request approval for, the company should take into account the decline in stock price and any shift from cash compensation to equity compensation. It should also assess the risk that if its stock price recovers as part of a sector or other macroeconomic recovery, proxy advisors and institutional shareholders will view the awards as an undeserved economic windfall for directors and executives, rather than an appropriate reward for company or individual performance.

Pending shareholder approval, to avoid fully depleting the share reserve a company should consider the following five approaches to making annual awards. First, the company can adopt an across-the-board reduction in the number of shares to be used for awards. This approach has employee retention risk.

Second, the company can make larger awards to key executives, and either forego awards to employees below a certain level or limit awards to those employees to a specified percentage of the employee population. This approach has employee retention risk for the adversely affected employee population.

Variations on this approach are the grant of awards only to employees below the executive level; the grant to employees, especially those below the executive level, of the right to select their mix of awards, e.g., 50% options and 50% restricted stock units; and a partial grant of awards before the annual meeting and the remainder after shareholder approval is obtained at the annual meeting.9

With these approaches, the company often uses restricted stock units for a greater portion of annual awards.10 Unlike options, restricted stock units do not require stock price appreciation to provide intrinsic value and therefore provide value in declining markets. Furthermore, restricted stock units require fewer shares than options to deliver the same dollar grant value as options, and therefore are less dilutive of shareholders than options. Finally, when a plan provides for restricted stock, under the NYSE and NASDAQ listing rules amendment of the plan to provide for restricted stock units is not a material revision to the plan that requires shareholder approval.11

Third, a company can make cash-settled awards of phantom stock or stock appreciation rights outside of a shareholder-approved plan. The disadvantage of cash-settled awards is that

they are treated as liability awards subject to variable or markto-market accounting. Under the NYSE and NASDAQ listing rules, shareholder approval for cash-settled awards is not required.12

Fourth, a company can make inducement awards for newly hired employees. Under the NYSE and NASDAQ listing rules, inducement awards do not require shareholder approval or count against share limits on individual awards or the share reserve.13 To make inducement awards, a company can use a separate share pool under an existing equity compensation plan, adopt a separate equity compensation plan limited to inducement awards, or make inducement awards outside of an equity compensation plan. The company should understand that proxy advisors consider inducement awards when assessing plan cost, burn rate, and overhang. Proxy advisors also treat inducement awards as outstanding awards when determining the number of shares available for future equity plan proposals.

Fifth, subject to the NYSE and NASDAQ listing rules, a company can create a legally binding right of a promise to grant awards after the annual meeting contingent on shareholder approval to increase the share reserve.14 With this approach, the company must safely navigate the notoriously complex rules of Section 409A of the Internal Revenue Code for nonqualified plans of deferred compensation, 15 and its regulatory exemptions for options, stock appreciation rights, and restricted stock.16

The exemptions for options and stock appreciation rights allow employees to exercise these stock rights at any time after vesting free from the shackles of the Section 409A limitations on the permissible exercise times and events. To come within these exemptions, the exercise price must be equal to or greater than the fair market value of the stock on the date of grant of the option or stock appreciation right.17 Therefore, correctly determining the date of grant is essential to ensure that the exercise price satisfies this requirement.18

The date of grant is the date when the granting corporation completes the corporate action necessary to create a legally binding right constituting the option or stock appreciation right. The corporate action is not complete until the date on which the maximum number of shares that can be purchased and the minimum exercise price are fixed or determinable, and the class of underlying stock and the identity of the employee are designated.19

Ordinarily, if the corporate action provides for an immediate offer of stock for sale to an employee, or provides for a particular date on which such offer is to be made, the date of grant is the date of such corporate action if the offer is to be made immediately, or the date provided as the date of the offer.20

If the company imposes a condition on the grant of an option or stock appreciation right, such condition generally will be given

effect. However, if the grant of an option or stock appreciation right is subject to shareholder approval, the date of grant is determined as if the option or stock appreciation right had not been subject to shareholder approval.21

When a company promises to grant options or stock appreciation rights after the annual meeting contingent on shareholder approval to increase the share reserve, and the promise does not provide an exercise right or establish a fixed or determinable exercise price, a grant does not occur. The promise is not a legally binding right constituting an option or stock appreciation right. In addition, the shareholder approval is to increase the share reserve for all future grants, and not for the grant of any option or stock appreciation right to any employee. The grant occurs when the company issues the option or stock appreciation right after shareholder approval is obtained. To come within the exemption from Section 409A, the exercise price must be equal to or greater than the fair market value of the stock on that grant date.

For restricted stock, the Section 409A regulations focus on whether there is a legally binding right to receive nonvested or vested property in a future taxable year. There is a two-step analysis. First, whether there is a legally binding right to compensation, which here is the restricted stock. Second, whether the legally binding right to compensation is a deferral of compensation.

A legally binding right to compensation generally means a contractual right, regardless of whether the right is conditional or contingent, that is enforceable under the law governing the contract. It also includes an enforceable right created by governing law, such as a statute. For example, an agreement to pay an employee a bonus equal to a percentage of the amount that the employer receives on sale of a property is a legally binding right to compensation. The requirement that the property be sold is a condition to the right to the payment, but the right to payment is a legally binding right created when the parties enter into the agreement.22

There is a deferral of compensation when an employee has a legally binding right during a taxable year to compensation that is or may be payable to, or on behalf of, the employee in a later taxable year. A legally binding right to an amount that will be excluded from income when and if received is not a deferral of compensation unless the employee has received the right in exchange for, or has the right to exchange for, an amount that will be includible in income.23

The Section 409A regulations provide specific rules for whether a legally binding right to receive property in a future taxable year is a deferral of compensation. A legally binding right to receive property in a future taxable year in which the property will be substantially nonvested under Treasury Regulation Section 1.83-3(b) at the time of transfer will not provide for the

deferral of compensation.24 However, a legally binding right to receive property in a future taxable year in which the property will be substantially vested under Treasury Regulation Section 1.83-3(b) at the time of transfer may provide for the deferral of compensation.25

In the case of an award of nonvested shares, since the creation of the legally binding right to the transfer of the shares is not a deferral of compensation, the legally binding right can provide for the transfer within thirty days of shareholder approval regardless of whether shareholder approval occurs in the same taxable year as the creation of the legally binding right or in the following taxable year.

In the case of an award of vested shares, the creation of the legally binding right to the transfer of the shares is a deferral of compensation. Accordingly, the company should ensure that the legally binding right satisfies the requirements of Section 409A or an exemption thereto. There are three potential scenarios. First, the company creates a legally binding right before the annual meeting to transfer vested shares once shareholder approval is obtained at the meeting, and the annual meeting and transfers must occur in the same taxable year as the creation of the legally binding right. Under this scenario, there is no plan for the deferral of compensation.26

Second, the company creates a legally binding right before the annual meeting to transfer vested shares once shareholder approval is obtained at the meeting, and the annual meeting and transfers must occur no later than the end of the short-term deferral period ending on March 15 of the following taxable year. Under this scenario, the legally binding right is a short-term deferral exempt from Section 409A.27

Third, the company creates a legally binding right before the annual meeting to transfer vested shares once shareholder approval is obtained at the meeting, and the annual meeting and transfers can occur after the end of the short-term deferral period ending on March 15 of the following taxable year. Under this scenario, the arrangement is a plan of deferred compensation subject to Section 409A. As a result, the transfer of the vested shares must satisfy the permissible distribution event of payment at a specified time or fixed schedule.28

Under the rule for payment at a specified time or fixed schedule, in the absence of a vesting event the amount of a payment cannot be based all or in part on the occurrence of an event.29 Since shareholder approval to increase the share reserve may come within this prohibition, the legally binding right should not provide for the transfer of shares at a time determined by reference to the date of shareholder approval. Rather, the legally binding right should provide for the transfer of shares on a specified date without reference to the date of shareholder approval. For example, if the company creates a legally binding right in December, and the annual meeting takes place in April

in the following taxable year, the legally binding right should provide for the transfer of the vested shares in June.

Alternatively, the legally binding right can provide that the employee must be employed on the date of shareholder approval, and the transfer of the vested shares must occur within thirty days thereafter. This arrangement will be a short-term deferral exempt from Section 409A.30

For the creation of a legally binding right to the grant of restricted stock units contingent on shareholder approval to increase the share reserve, the creation of the legally binding right will not be a plan of deferred compensation. Restricted stock units are unfunded promises subject to vesting conditions to make future distributions of shares or cash equal to the value of the shares. The units are most often structured to provide that once they vest, distributions are made within the short-term deferral period so that the units come within the short-term deferral exemption.31 Alternatively, the units are structured to provide that once they vest, distributions are made on one or more Section 409A permissible distribution times and events so that the units comply with Section 409A.32

The grant of an unfunded restricted stock unit is not a taxable event.33 Accordingly, the creation of a legally binding right to the grant of an unfunded and unvested restricted stock unit contingent on shareholder approval to increase the plan reserve is not a deferral of compensation. The company can create a legally binding right before the annual meeting to grant a restricted stock unit once shareholder approval is obtained at the meeting. The legally binding right can provide for the grant within thirty days of shareholder approval regardless of whether the annual meeting occurs in the same taxable year as the creation of the legally binding right or in the following taxable year before or after March 15. Once the company grants the restricted stock unit that entitles the employee to distribution of stock or cash, the grant must satisfy the requirements of Section 409A or an exemption thereto.

Endnotes

1. Steven H. Sholk is Counsel in the Corporate Department in the Newark, N.J. office of Gibbons P.C.

2. I Can’t Get Started With You, Music by Vernon Duke and lyrics by Ira Gershwin (Chappell & Co. 1936) (“You’re so supreme, lyrics I write of you. Scheme just for a sight of you. Dream both day and night of you. And what good does it do? In 1929 I sold short. In England I’m presented at court. But you’ve got me down-hearted ‘cause I can’t get started with you.”); see also Ted Gioia, The Jazz Standards A Guide to the Repertoire, “I Can’t Get Started With You,” at 172 (Oxford University Press 2d ed. 2021) (“The clever premise here is for the singer to enumerate many grand accomplishments ̶ circumnavigating the globe or breaking par on the golf course ̶ in each eight-bar A theme, before concluding ‘but I can’t get started with you.’ The song ranks among the most popular ‘list songs’ of the first half of the twentieth century.”).

3. See Olivia Wakefield, James Dickinson, David Fitt & Joey Franks, Pay Governance, Biotech Equity Is Largely Underwater: Now What? Alternatives to Option Exchanges or Repricing, at 4 (March 14, 2023) (available at www.paygovernance.com/viewpoint/biotech-equity-is-largely-underwater-now-what).

4. See David A. Katz & Laura A. McIntosh, “Dealing With Director Compensation,” New York Law Journal, May 21, 2015, at 5; Alec Lentz & Ken Sparling, “Scrutiny And Standardization Of Director Pay,” The Corporate Board, at 8-9 (May/June 2016) (available at www.fwcookcom/ alert...05-16_Scrutiny_And_Standardization_of_Director_Pay.pdf).

5. Louis C. Taormina & Rachel Chiu, FW Cook, Equity Grants in Volatile Times, at 2 (Jan. 29, 2023) (available at https://www.fwcook.com/Publications-Events/Articles/Equity-Grants-in-Volatile-Times/).

6. NYSE Listed Company Manual §303A.08 and Frequently Asked Questions on Equity Compensation Plans §B-6 (if a plan with a fixed maximum number of shares out of which certain grants are made pursuant to a formula is amended to change the formula, the amendment is not a material revision as long as the shares granted pursuant to the formula continue to count against the maximum number and the maximum number remains unchanged); cf. NYSE Listed Company Manual, Frequently Asked Questions on Equity Compensation Plans §B-4 (an existing plan provides for the grant of options and restricted stock subject to an overall limit of 10 million shares that may be delivered pursuant to options and restricted stock grants together, and a further limit of 1 million shares available for restricted stock; an amendment to materially increase the restricted stock limit but not the aggregate 10 million share limit is a material revision; it is similar to the material revisions of the expansion of the types of awards available under the plan and a material increase in the number of shares available under the plan).

NASDAQ Listing Center, Rule 5635(c) and Frequently Asked Questions, Identification No. 227 (July 31, 2012) (if a plan provides for periodic automatic awards of a specific number of options, for example, annual awards of 10,000 options, it is not a material amendment to increase the awards to 15,000; generally, increasing the size of awards is not a material amendment provided that the maximum number of shares available under the plan is not increased); cf. NASDAQ Listing Center, Frequently Asked Questions, Identification No. 1673 (Jan. 11, 2019) (a plan must provide for an overall limit on the number of shares that may be issued under the plan; a plan may also have a further sublimit on the number of shares available for a particular type of award, such as restricted stock or options; a revision to increase the number of shares available under the sublimit would generally be a material amendment to the plan because this change would be an expansion of the types of awards available under the plan).

7. NYSE Listed Company Manual §303A.08; NASDAQ Listing Center,

Rule 5635(c).

8. NYSE Listed Company Manual §303A.08 and Frequently Asked Questions on Equity Compensation Plans §B-1; NASDAQ Listing Center, Rule 5635(c), IM-5635-1 (March 12, 2009), and Frequently Asked Questions, Identification Nos. 219 and 226 (July 31, 2012).

9. See Olivia Wakefield, James Dickinson, David Fitt & Joey Franks, Pay Governance, Biotech Equity Is Largely Underwater: Now What? Alternatives to Option Exchanges or Repricing, at 5-7 (March 14, 2023) (available at www.paygovernance.com/viewpoint/biotech-equity-is-largely-underwater-now-what).

10. See Michael Keebaugh, Brian Lane & Ryan Peterson, Pay Governance, Biotech Industry Trends in Equity Compensation: Influence of Market Volatility on Equity Program Strategy, at 8 (Oct. 10, 2023) (“The recent increase in the use of RSUs was in reaction to several factors, starting with the market downturn (e.g., the need to retain talent in a competitive market, desire to conserve cash, and declining perceived value of options), and we anticipate that they will remain a popular vehicle among biotech companies. Nevertheless, we expect that stock options will continue to be the primary equity vehicle of choice.”) (available at https://www.paygovernance.com/viewpoints/biotech-industry-trends-in-equity-compemnsation-influence-of-market-volatility-on-equity-program-strategy).

11. NYSE Listed Company Manual, Frequently Asked Questions on Equity Compensation Plans §B-3 (if a plan provides for restricted stock, an amendment to permit the award of restricted stock units is not a material revision that requires shareholder approval; options, stock-settled stock appreciation rights, and similar awards based on the appreciation in value of stock over an exercise or base price are one type of award; restricted stock, restricted stock units, and similar wards without any exercise or base price are a second type; since restricted stock units and restricted sock are the same type of award, this revision is not material).

NASDAQ Listing Center, Frequently Asked Questions, Identification No. 233 (July 31, 2012) (shareholder approval is not required to add restricted stock units to a plan that allows for restricted stock; an award of restricted stock units typically results in the issuance of restricted stock on a deferred basis after vesting requirements are met; as such, this type of award is substantially equivalent to the award of restricted stock, and if the plan allows for the award of restricted stock, the addition of restrict4ed stock units is not a material modification that requires shareholder approval; shareholder approval would be required to add restricted stock units to a plan that does not provide for restricted stock awards because the addition would expand the types of awards available).

12. NYSE Listed Company Manual §303A.08; NASDAQ Listing Center, Rule 5635(c) and Frequently Asked Questions, Identification No. 232 (July 31, 2012).

13. NYSE Listed Company Manual §303A.08; NASDAQ Listing Center, Rule 5635(c)(4), IM-5635-1 (March 12, 2009), and Frequently Asked Questions, Identification Nos. 247, 251, 253, 258, and 259 (July 31, 2012 and Nov. 26, 2019).

14. See NYSE Listed Company Manual, Frequently Asked Questions on Equity Compensation Plans §E-2 (if shareholder approval of a new equity compensation plan is required, grants may not be made before the approval is obtained regardless of whether the grants are forfeited if the shareholder approval is not obtained, and no shares may be issued until the approval is obtained; grants may be made before shareholder approval provided that no shares can actually be issued pursuant to the grants until shareholder approval is obtained; for example, a company could grant stock options that would not become exercisable until after shareholder approval is obtained; restricted stock could not be issued before shareholder approval because

Published in eReport, Spring 2024 © 2024 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.

restricted stock is issued upon grant; however, the company could promise to issue restricted stock at a future date after shareholder approval is obtained).

NASDAQ Listing Center, Frequently Asked Questions, Identification No. 212 (July 31, 2012) (a company may adopt an equity plan and grant options prior to obtaining shareholder approval provided that: (i) no options can be exercised prior to obtaining shareholder approval; and (ii) the plan can be unwound and the outstanding options cancelled if shareholder approval is not obtained ); NASDAQ Listing Center, Frequently Asked Questions, Identification No. 213 (July 31, 2012) (unlike the situation in which the exercise of stock options is contingent on shareholder approval, a company may not grant shares of stock prior to obtaining shareholder approval).

15. Section 409A was added to the Internal Revenue Code by the American Jobs Creation Act of 2004, Pub. L. No. 108-375, §885, 118 Stat. 1418, 1634-41. The formidable final Section 409A regulations were issued at the Department of the Treasury, Internal Revenue Service, “Application of Section 409A to Nonqualified Deferred Compensation Plans, Final Regulations,” 72 F.R. 19,234 (April 17, 2007), and Department of the Treasury, Internal Revenue Service, “Application of Section 409A to Nonqualified Deferred Compensation Plans, Correction,” 72 F.R. 41,620 (July 31, 2007).

Cf. The Temptations, Ball of Confusion (That’s What the World is Today), Music and lyrics by Barrett Strong & Norman Whitfield, on Greatest Hits II (Gordy 1970) (“Evolution, revolution, gun control, sound of soul. Shooting rockets to the moon, kids growing up too soon. Politicians say more taxes will solve everything. And the band played on.”).

16. I.R.C. §409A(e) (the Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of Section 409A) (introductory text); Treas. Reg. §1.409A-1(b)(5)(i)(A)-(B) (exemptions for options and stock appreciation rights); Treas. Reg. §1.409A-1(b)(6) (exemption for restricted stock).

17. Treas. Reg. §1.409A-1(b)(5)(i)(A)-(B). The rules for determining the fair market value of stock readily tradable on an established securities market and stock not so readily tradable are set forth in Treas. Reg. §1.409A-1(b)(5)(iv).

See generally Gregg D. Polsky, “Fixing Section 409A: Legislative and Administrative Options,” 57 Villanova Law Review 635, 645 (2012); David I. Walker, “The Non-Option: Understanding the Dearth of Discounted Employee Stock Options,” 89 Boston University Law Review 1505 (2009).

18. Treas. Reg. §1.409A-1(b)(5)(vi)(B) and (H).

19. Treas. Reg. §1.409A-1(b)(5)(vi)(B)(1).

20. Id.

21. Treas. Reg. §1.409A-1(b)(5)(vi)(B)(2).

22. Department of the Treasury, Internal Revenue Service, “Application of Section 409A to Nonqualified Deferred Compensation Plans, Explanation of Provisions and Summary of Comments,” §III.B (first and second paragraphs), 72 F.R. 19,234, 19,236 (April 17, 2007).

See also Sutardja v. United States, 109 Fed. Cl. 358 (2013) (in determining whether a legally binding right is created, courts look initially to state law to determine the rights and interests of the taxpayer in property that the government seeks to reach; once this determination is made, federal tax law determines which rights and interests are subject to tax; under California law vested options give the optionee the legally binding right to purchase shares at a designated price; grant of a discounted option for stock traded on NASDAQ was a deferral of compensation in violation of Section 409A and the exercise of a vested option in 2006 was subject to tax under Section 409A; Section 409A treatment of option exercised in 2006 was governed by law in effect prior to the issuance of the final Section 409A regulations).

23. Treas. Reg. §1.409A-1(b)(1).

24. Treas. Reg. §1.409A-1(b)(6)(ii).

25. Id.

26. Treas. Reg. §1.409A-1(b)(1).

27. Treas. Reg. §1.409A-1(b)(4) and (d).

28. I.R.C. §409A(a)(2)(A)(iv); Treas. Reg. §§1.409A-1(b)(4) and (d) and 1.409A-3(a)(4) and (i)(1).

29. Treas. Reg. §1.409A-3(i)(1).

30. Treas. Reg. §1.409A-1(b)(4) and (d); Erica F. Schohn, “Equity Arrangements,” in Section 409A Handbook 14-1, 25 ex. 3 and 4 (Regina Olshan & Erica F. Schohn eds., Bloomberg Law 2023) (in hiring an employee, the employer awards the employee a legally binding right to receive fully vested common stock on the third anniversary of his date of hire so long as he remains employed through the grant date. The arrangement to transfer vested common stock in the future is a deferral of compensation that is not exempt from Section 409A by reason of being a transfer of property that is not vested under Section 83, but the arrangement is likely exempt from Section 409A as a short-term deferral).

See also Securities & Exchange Commission Form 8-K, Cedar Fair, L.P., Item 5.02 (Dec. 4, 2023) (Cedar Fair granted unit-based awards to certain named executive officers in recognition of their efforts in connection with Cedar Fair’s entry into the merger agreement dated Nov. 2, 2023 with Six Flags Entertainment Corporation, and to facilitate the successful completion and closing of the merger; units will only be earned under the awards if the closing occurs and upon closing the awards will be converted into awards relating to shares of common stock; 50% of the equity would be payable twelve months after Dec. 4, 2023, and the other 50% of the equity would be payable eighteen months after Dec. 4, 2023; the recipient officers must remain in continuous employment with Cedar Fair through the closing and with the combined entity from the closing through both payment dates).

31. Treas. Reg. §1.409A-1(b)(4) and (d).

32. I.R.C. §409A(a)(2)(A); Treas. Reg. §1.409A-3(a); see also Regina Olshan, Daniel Hogans & Russell E. Hall, Equity Pitfalls Under Section 409A Checklist, Practical Law Checklist 3-502-9252, at 1-6 (Thomson Reuters 2023).

33. I.R.C. §83(a); Treas. Reg. §1.83-1(a).

CLICK HERE TO REGISTER TODAY!

Expert Webinars: Master the Corporate Transparency Act

FOR ATTORNEYS, BY ATTORNEYS!

Take your CTA knowledge to the next level with our expert-led webinar series.

From foundational insights to advanced strategies, gain a comprehensive understanding of CTA compliance. Each session features a live Q&A segment, allowing your questions to get answered in real-time.

Join Our Expert: Jonathan B. Wilson

Jonathan B. Wilson, co-founder of FinCEN REPORT, is an attorney and author of “The Corporate Transparency Act Compliance Guide.” He has been recognized by The Best Lawyers in America® and Georgia Super Lawyers. Jonathan is a leading authority on CTA compliance.

“Supercharging” Office to Housing Conversions: New Federal Resources Available to Speed Conversion of Downtown Buildings

By Kristin Niver, Katriina McGuire and Talar Berberian1

This article will discuss the federal government’s recent efforts to “supercharge” office to housing conversions across the country, examining what role government at all levels and policymakers should play in encouraging such conversions given the myriad of challenges.

The future of office space and office to housing conversions have been hot topics for some time now, as municipal governments are embracing the idea of office to housing conversions by offering tax incentives to developers to help subsidize the often-prohibitive costs and expanding by-right zoning policies to ease the burden of entitlement processes.

In October 2023, the federal government also entered the game in a big way. The Biden administration launched a multi-agency effort to encourage states and cities to convert more empty office buildings into housing units, with billions of dollars now available to help spur such transitions. They even released a White House guidebook on commercial to residential federal resources, with over 20 federal programs across six federal agencies that can be used to support conversions, including low-interest loans, loan guarantees, grants and tax incentives for developers.

This new federal initiative involves the Department of Housing and Urban Development, the Department of Transportation, the Department of Energy, the Department of Treasury, the General Services Administration and the Office of Management and Budget in a multi-pronged effort to address the national shortage of affordable housing and the post-pandemic surplus of vacant office buildings. The $35 billion in lending capacity from federal agencies is intended to provide below-market rate

loans to finance new housing construction and office conversions near transportation hubs. This year the Department of Transportation in particular will issue new guidance to states and municipalities on how to access funding through a pair of new federal programs – the Transportation Infrastructure Finance and Innovation Act (TIFIA) and the Railroad Rehabilitation & Improvement Financing (RRIF) programs. The GSA will also work with the Office of Management and Budget to identify surplus federal properties that could similarly be transferred for development into affordable housing units.

In summary, the federal government’s new package of initiatives includes:

Department of Housing and Urban Development (HUD) – Community Development Block Grants (CDBG)

HUD has made conversions eligible for direct funding under the Community Development Block Grants program. To show how significant this is, this HUD guidance represents the first update to the CDBG program in 15 years, and HUD has also increased outreach efforts to support municipalities and developers seeking to use HUD tools to finance conversions. States and localities can access up to five times their annual CDBG allocation in low-cost loan guarantees to fund conversion projects. HUD is also accepting applications for the $85 million Pathways to Removing Obstacles to Housing Program, which includes the development of adaptive reuse strategies and the financing of eligible conversions. In addition to directly offering lower than market rate interest loans, CDBG funds may also be used as loan guarantees to encourage lending institutions to offer more favorable rates and boost markets facing disinvestment.

Department of Transportation (DOT) – TIFIA and RRIF Loan Programs

As noted above, the Department of Transportation has two new federal programs, the Transportation Infrastructure and Finance Innovation Act (TIFIA) and Railroad Rehabilitation & Improvement Financing (RRIF) programs, which combined have over $35 billion in lending capacity for transit-oriented development projects at below market interest rates that can be used to finance housing development near transportation, including conversion projects. This year, the DOT is expected to release guidance making it easier for transit agencies to repurpose properties for transit-oriented development and affordable housing projects, including conversions near transit. Under the new guidance, transit agencies may transfer properties to local governments, non-profit and for-profit developers of affordable housing at no cost. The new policy has the potential to turn property no longer needed for transit into affordable housing development, particularly when combined with loans from TIFIA or RRIF programs. The DOT will also launch technical assistance to support municipalities and developers seeking to use DOT tools to finance conversions.

The push to place housing near transit aims to, among other

things, 1) decrease single-occupancy vehicle travel, 2) increase affordability, 3) limit construction of wasteful parking infrastructure, etc. and 4) to align the goals of affordability and sustainability that urban municipalities have been avidly pursuing in recent years. The financial support of the federal government in achieving these aims is a heartening step toward true transit-oriented development and redevelopment.

Department of Energy (DOE)

The Department of Energy’s Better Buildings Initiative includes a toolkit with technical and financial guidance on how to achieve zero emissions on commercial to residential conversions. The DOE’s loan and guarantee programs and tax incentives through the Inflation Reduction Act, such as the new energy efficient home tax credit (45L), the energy efficient commercial buildings tax deduction(179D), and the clean energy investment tax credit (48), will help to pay for more sustainable (and often more costly) “green” building system upgrades in aging office buildings in office to residential conversion.

General Services Administration and Office of Management and Budget

The General Services Administration (GSA) is expanding on its Good Neighbor Program to promote the sale of surplus federal properties that buyers can potentially redevelop for residential use. The GSA will work with the Office of Management and Budget (OMB) to identify current and upcoming sale opportunities and will maintain a list of current opportunities. Such programs may have additional positive externalities like relieving the pressure caused by land shortages (particularly in urban centers) and lowering government costs of maintaining surplus or unused property.

Department of Treasury

In October 2023, the Treasury launched a blog that describes tax incentives available through the Inflation Reduction Act that can be used for conversions.

PROS AND CONS

Should the federal government be encouraging conversions despite often-prohibitive costs and the proven design and underwriting challenges?

PRO #1: Converting Underused Commercial Buildings to Residential Can Reduce Carbon Emissions

Nearly 30 percent of carbon emissions come from the building sector. According to an Arup report released in early December, as an example, if New York City expanded zoning eligibility for office to housing conversions, this could result in up to a 54 percent reduction in whole life carbon emissions by 2050. The Arup study concluded that the significant carbon savings attainable from office to residential conversions should urge policymakers to expand eligibility for conversions. Office to housing conversions could contribute to decarbonization goals and to greener, more inclusive cities for everyone.

PRO #2: Conversions Could Help Solve the Affordable Housing Crisis

While office vacancies have reached a 30-year high, housing supply is constrained and rents in most major cities are at a record high. Conversions could create more housing affordability by increasing supply.

CON #1: Conversions Are as Expensive as Ground-Up Construction

Even with the new federal programs outlined above, many critics say office to residential conversions are not practical or economically feasible even with subsidies. Discussions about the desirability of office to residential conversions are therefore ongoing. The Brookings Institution has even created a calculator to estimate the feasibility of a conversion in selected major metro areas. The interactive calculator was launched in November 2023 and can help determine which conversions are viable without a subsidy, and, if not viable without a subsidy, how big the subsidy needs to be to make a conversion viable. The calculator also helps policymakers assess the financial cost to investors of requiring a greater share of affordable housing in the conversion.

CON #2: Design Challenges

Many office buildings are not physically suited for conversion. Since most office buildings are laid out differently from residential spaces, some developers estimate that only about one in 20 office buildings is actually a good candidate for conversion to housing. Because of this, a common criticism of office to residential conversion is that while they seem promising theoretically, they are difficult to execute and unlikely to turn a profit. Underwriting generally takes twice as long. One of the biggest costs in such conversions is the conversion of the façade. Many conversions attempt to minimize the façade work to make it more economically feasible, but this is problematic due to the minimum window requirements for natural light in the converted units. Allowing for smaller windows would make conversions easier and more attractive. Elevators and related infrastructure are another issue. Conversions typically require elevator shafts to be upsized, necessitating structural modifications with significant costs making conversions infeasible. Requirements for additional staircases are yet another design issue with conversions.

Furthermore, often, local zoning regulations pose challenges to office to residential conversion. Density restrictions in “as of right” zoning can limit the number of units in a given building, resulting in unused or underutilized space. Parking requirements and restrictions on ground floor uses are also barriers to redevelopment. However, amending such regulations requires engaging in lengthy entitlement processes, which can impose costly affordability, sustainability and wage-related requirements to already expensive conversions.

As municipalities adjust their policies in these areas, there is hope that local and federal requirements could align so that developers can avail themselves of multiple tiers of incentives and credits simultaneously to help projects make financial sense.

Conclusion

This new year, it remains to be seen how much federal subsidy and the technical assistance and outreach provided by federal agencies, coupled with new tools like the Brookings Institution’s new interactive calculator, will help developers determine what an office-to-apartment conversion will actually cost, and if including affordable units is feasible. The new federal subsidies available are a step in the right direction in getting conversions to “pencil out,” and more outreach and technical assistance could accelerate conversions, which would contribute to the creation of greener and more affordable housing. Fostering adaptive reuse across the country will require concentrated efforts and collaboration at all levels of the private sector and government.

Endnotes

1. Kristin Niver is counsel in Thompson Coburn’s Real Estate group, concentrating her practice in all aspects of commercial real estate finance and development. Kristin has experience representing banks, insurance companies and debt funds in construction and permanent loans, debt restructurings and secondary market transactions, as well as working with market-rate and affordable housing developers and owners on financings, acquisitions and sales, joint venture arrangements, condominium regimes, and leases.

Katriina McGuire is a partner in Thompson Coburn’s Real Estate group and Managing Partner of the firm’s Chicago office. Katriina helps clients navigate challenging land use and zoning issues, paving the way for successful developments. She combines a deep understanding of highly technical and constantly evolving regulations with the strong relationships she’s built with zoning and economic development departments.

Talar Berberian is a partner in Thompson Coburn’s Real Estate group. She advocates for clients in land use, zoning and licensing matters and represents them in commercial real estate sales and acquisitions, financing and development matters. She helps property owners, developers, and real estate purchasers secure timely zoning approvals for residential and commercial developments.

Understanding Swap Transactions

By Susan Zuhowski1 and Nicole Monsees2

This article provides a primer to the basic structure and logistics of swap transactions, and the title insurance coverage available for these transactions via the ALTA 29 series of endorsements.

An interest rate swap agreement is a method for hedging interest rate risk. A swap agreement is essentially a derivative contract, which is an agreement that derives its value based upon a formula which is applied to an underlying asset, rate, or index. Usually, it will be derived from its application to a notional amount, the nominal or face amount that is used to calculate payments made on swaps and other risk management instruments. This amount generally does not change hands, it is simply a representative value utilized in the formula, and is thus referred to as notional.

The agreements are executory in nature, and generally involve, two counterparties, one the ultimate user, the mortgagor, who wishes to hedge or reallocate some asset, liability, or risk, and the other party, a dealer, most commonly a commercial or in-

vestment bank. Because the contract is an executory contract, both parties owe duties to one another, as well as future performance obligations at various points in time. Because derivative contracts are based upon changes in the value of an underlying asset, rate, or index, the value changes continuously during the term of the contract. Thus, either party may be “in” or “out” of money, pursuant to the terms of the contract, as to the other counterparty, at any particular moment in time.

A borrower, with a floating rate of interest, may hedge against rate fluctuations, by entering a fixed rate swap agreement with a lender/swap dealer. The difference between the floating and fixed rate, when they are applied to the notional amount, during the interval, results in the borrower being in or out of the money for the period; the net difference, in the amount between the two rates, would constitute a payment liability, either owed to the borrower, or owed to the lender. Where the variable rate exceeds the fixed rate, in the swap, the borrower would be in the money and where it falls below the fixed rate, the borrower would be out of money for the period – here the borrower would be liable for a net payment in accordance with the terms of the swap agreement.

This creates a credit risk; the derivative contract may either constitute a liability or an asset on the balance sheet of the respective counterparties at any point in time. It is this credit risk, the risk

to the institutional swap dealer, when the mortgagor is “out” of money on the swap (the swap derivative is now a liability on the mortgagors’ balance sheet) that the swap dealer wishes to secure by a mortgage on the mortgagor’s real property. Essentially, the credit risk, inherent in the possibility of a default by the mortgagor on its obligation to pay, has been collateralized by the mortgage.

The credit risk in a swap transaction is referred to as “breakage.” The “breakage” constitutes damages that the swap dealer/counter party would suffer in the event of a default by the mortgagor in its obligations, or an early termination of the swap, under the swap agreement. The breakage is intended to make the non-defaulting counterparty whole from the loss of its bargain and to cover the costs of entering into a substitute swap. Breakage is not intended to constitute a penalty provision, which courts have shown a proclivity to void, or modify; rather, it is designed to constitute liquidated damages. The breakage fees, in swap contracts, can be very high due to the contingent and variable valuations countenanced in swap instruments; often ranging from about 10 to 20 percent of the principal amount of the loan.

Absent a default, or early termination, resulting in breakage fees, the contract usually provides for net payments (e.g. the difference between the sums derived from the application of a fixed interest rate and a floating rate applied to the notional amount for the respective swap interval), which are paid, periodically, to the “in” the money counter party by the “out” of money counter party. They can also result from close out netting, under a master agreement, as to multiple transactions. The provisions, providing for these net payments of “swap interest,” are set forth in the swap agreement. The swap payments, and swap interest, are thus an independent obligation from the terms of the mortgage note, and are created by the terms of a separate swap agreement, which is also secured by the terms of the mortgage or deed of trust.

Most swap transactions are created by the use of standardized forms of agreement, an example of which, and probably the largest purveyor of which, is the International Swap & Derivatives Association (ISDA). The ISDA forms, which are copyrighted, are usually comprised of a Master Agreement, an agreement containing the standard terms, conditions, and definitions covering all swap transactions between two counterparties; a Schedule, an agreement designed to modify terms in the Master Agreement; and a Confirmation, which comprises the actual terms and conditions of the particular swap transaction itself. Keep in mind that a master agreement may have multiple swap transactions, evidenced by multiple confirmations, associated with it. A swap contract is comprised of the master agreement, the schedule (if needed), and the respective confirmation- these agreements together constitute the swap agreement. The master agreement standing alone, without the schedule (if needed), and the executed confirmation is not a swap agreement.

Swap transactions generally fall into three categories: direct contingent obligations of the mortgagor to the mortgagee, obligatory

advances by the mortgagee to the swap provider (here the swap dealer is not the mortgagee, but purely a third party provider, with no direct interest in the mortgage or deed of trust), and finally, as additional interest.

The swap lender is seeking to have the swap breakage insured as secured by the insured mortgage. The breakage, as we have discussed, constitutes liquidated damages owed to the swap provider, incurred as a result of a default by the mortgagor of its obligations under the swap agreement, or an early termination of the swap agreement. The local law of the jurisdiction determines the ability to insure against loss or damage, occasioned by reason of a final decree of a court of competent jurisdiction finding that the lien of the insured mortgage, as it secures the breakage, is invalid or unenforceable, or does not, share the same priority, in relation to other claims, or liens, as is afforded the principal of the loan secured by the insured mortgage. The transaction must always be structured so that it comports with the local law. In some jurisdictions title insurance over the interest rate swap will be unavailable; in others, it will be less expansive and subject to more exceptions. The direct contingent obligation is the riskiest structure, and is only employable where the mortgagee is the swap provider. The swap provider must have an interest in the mortgage or deed of trust to afford this coverage. Here the swap obligation is an obligation owed directly to the mortgagee, who has an interest in the mortgage or deed of trust, and not an obligation owed to a third party, be that a related third party, or otherwise. In some jurisdictions, mortgages or deeds of trust may only secure determinate non-contingent obligations.

The doctrine of obligatory advance is recognized in most jurisdictions, and is a familiar feature in many commercial mortgage loans. The issue of what is or what is not deemed obligatory is a question for local law- in many jurisdictions, obligatory means obligatory- the advance obligation is absolute. The swap provider should be an unrelated party; this is to preserve the three party structure found in an obligatory advance scenario- lender, borrower, beneficiary. The concern with a related party arises due to a concern of whether the advance between related parties is obligatory (can the relationship between lender and beneficiary affect the obligatory nature of the advance needed to preserve priority). Again, a related party’s affect on the obligatory nature of the advance will be a matter of local law. It should be noted that an obligatory advance structure, in jurisdictions where mortgage or intangible taxes on mortgages have application, may result in additional mortgage taxes; since, the maximum amount of the advance for the breakage may have to be stated, in both the swap agreement and the mortgage securing it, which will result in a higher mortgage tax. The mortgage or intangible tax likely will need to be paid on the maximum amount stated for the advance.

In jurisdictions where mortgage taxes or intangible taxes on mortgages, or deeds of trust are in effect, the breakage under a swap agreement is secured as additional interest. The breakage is characterized in the mortgage or deed of trust as additional interest, payable pursuant to the terms of the rate swap agreement,

which is one of the referenced loan documents. The mortgage or deed of trust provides that it secures the additional interest, as provided for in the loan documents. Usually the additional interest is defined as a defined term in the mortgage or deed of trust and its method and manner of calculation are set forth as well. The swap provider must have an interest in the mortgage, i.e., it must be the mortgagee, to derive interest on the swap obligation.

Any payments under the swap agreement are characterized as additional interest under the loan documents, usually as a defined term, and the additional interest is secured by the terms of the mortgage, as provided for in the loan documents. In some jurisdictions, particularly New York, it may be necessary to add a clause indicating the maximum principal sum that is secured by the mortgage – a capping clause. This clause is necessary to preserve the mortgage tax benefit- no mortgage tax on the additional interest and to make it clear that the mortgage does not secure an indefinite amount; the mortgage tax is owed only on the maximum amount of principal indebtedness secured by the mortgage, which is clearly stated. The maximum amount of principal indebtedness would not include interest, additional or otherwise. It is the principal sum due under the mortgage. Interest is not subject to the mortgage tax.

Title insurance over interest rate swaps contained in secured mortgages and deeds of trust is provided by use of one of four ALTA 29 series endorsements. The ALTA 29-06 is used when there is a direct obligation swap agreement, and the maximum amount of the swap is undefined. The ALTA 29.1-06 is used when the maximum amount of the swap obligation is undefined and the swap obligation is characterized as additional interest. When there is a direct obligation swap with a defined amount, the ALTA 29.2-06 is the endorsement that most often used. The ALTA 29.3-06 is used when the maximum amount of the swap obligation is defined and is treated as additional interest.

Practice Tips: which title insurance endorsement is right for your transaction?

ALTA 29 and 29.1

• Available for Loan Policies only.

• Verify the mortgage secures a Swap Obligation and complies with any applicable state requirements.

• Verify the Swap Obligation is evidenced by an existing master swap agreement or interest rate exchange agreement and confirmation.

• Verify the mortgage secures a maximum amount of the Swap Obligation.

• If the endorsement is issued subsequent to the Date of Policy, add applicable date down exceptions in section 3.e. of the endorsement.

ALTA 29.2 and ALTA 29.3

• Available for Loan Policies only.

• Verify the mortgage expressly secures a Swap Obligation and complies with any applicable state requirements.

• Verify the Swap Obligation is evidenced by an existing master swap agreement or interest exchange agreement and confirmation.

• Verify the Insured Mortgage states the additional amount to be secured under the Swap Agreement or Interest Exchange Agreement, in addition to the loan amount. Insert this value in the Additional Amount of Insurance in Section 1.c. of the endorsement. Collect the appropriate title insurance premium and any applicable mortgage tax on this additional amount.

• If the endorsement is issued subsequent to the Date of Policy, add applicable date down exceptions in section 3.e. of the endorsement.

Endnotes

1. Susan Zuhowski is an Assistant Vice President of Old Republic National Title Insurance Company, and serves as Underwriting Counsel in Maryland and the District of Columbia.

2. Nicole Monsees serves as Commercial Underwriting Counsel for Old Republic National Title Insurance Company in Maryland and the District of Columbia.

Granting a Profits Interest in a Tax-Free Manner*

By Brooke Benjamin1

This article discusses certain benefits associated with granting a profits interest to a key employee or service provider, specifically with regard to real estate profits, and the Internal Revenue Code conditions to be met to grant interests in a taxfree manner under Rev. Proc. 2001-43 and Rev. Proc. 93-27.

It is well-known that limited liability companies (“LLCs”) and partnerships are the vehicles of choice in acquiring real property. Generally, many owners select the LLC or partnership structure to provide asset protection.2 Furthermore, many owners form partnerships to take on joint investments with other real estate investment partners and reap the benefit of i) flexibility in distributing profits and losses, ii) combined portfolios for perspective lenders, iii) shared ownership and responsibilities, iv) valuable insight, and v) extensive networks and resources. As the partnership begins to develop and becomes profitable, owners seek out the best strategies to implement tax-savings and to provide added compensation to key members. The LLC and

partnership structure provides flexibility that is incomparable to C-corporations and S-corporations. One key component in the partnership structure is in its ability to grant equity to key employees in the form of “profits interest.”

The term “profits interest” refers to an equity right, essentially a share of the profits and the appreciation of the assets of the partnership, based on the future value of a partnership awarded to an individual for their service to the partnership.3 In addition, the equity right awarded through a profits interest allows the recipient to receive a percentage of the profits from a partnership without having to contribute capital. A profits interest, as opposed to a “capital interest,” is an interest where the holder would receive his or her proportionate share of the partnership’s assets upon liquidation, and does not entitle the holder of the profits interest to any current rights to partnership property. Simply put, a profits interest holds no liquidation value upon date of grant.

A similar example to granting a partner a profits interest is granting stock options to a key employee. Stock-based compensation, where a corporation grants stock to its employees, is typically taxed as compensation upon grant (or vesting) and is almost analogous to profits interest, however, the major difference of course lies within the overall structural differences between the two entities. In addition, a profits interest may be structured in the same way as a stock option, however, it has a tendency to be more appealing to the recipient because, un -

like a stock option, generally, a profits interest grant can provide that all appreciation in value be taxed as long-term capital gains rather than ordinary income. Furthermore, unlike an option, a profits interest holder does not have to pay an exercise price to obtain the equity interest in its share of the profits interest as the recipient is already viewed as a partner under the law. Granting a profits interest to a key employee can be a valuable compensation tool especially since it can be done in a tax-free manner if IRS conditions are met.

On its face, profit interests appear to be solely derived from the day-to-day business profits, however, it is worth noting that these profits can also be the result of the appreciation of any assets owned by the partnership, such as real estate.

Application of Revenue Procedure 2001-43 and 93-27 to Grants of Partnership Interests and Potential Tax Consequences

The IRS’s position on profits interest, in accordance with Revenue Procedure 93-27, states that a person may receive a profits interest without current tax where the profits interest is received in exchange for the provision of services to or for the benefit of a partnership in a partner capacity (or in anticipation of being a partner). Under Revenue Procedure 93-27, the receipt of a profits interest is not treated as income upon its acquisition if a person receives it “for the provision of services to or for the benefit of a partnership in a partner capacity or in anticipation of being a partner.” To achieve that end and carry out its intent, the IRS provided safe harbors to respect purported profits interest if certain conditions are met. Under current IRS guidelines, the purported profits interest must satisfy the following requirements:

1. Receiving the profits interest in exchange for services to or for the benefit of a partnership in a partner capacity or in anticipation of being a partner (meaning that the service partner cannot be given a share of current capital in exchange for the contribution of services);

2. Having the profits interest not relate to a substantially certain and predictable stream of income from partnership assets;

3. Holding the partnership profits interest for 2 years; and

4. The partnership must not be a publicly traded partnership.

Once granted, the partnership entity should treat the recipient as a partner from the date of grant (even if the interest is not fully vested). Under the safe harbor rules, an election under Internal Revenue Code Section 83(b) is not required, although, as a precautionary measure, a recipient may still file the election as a protective measure in case one of the safe harbor requirements is not met (such as a sale or exchange of the interest during the 2-year holding period).

A partnership is a “pass-through” entity for federal income tax purposes. Therefore, any gain or loss recognized at the partnership level will retain that character when allocated to its partners. As a result, if a partnership’s income is generated by the sale or exchange of capital assets such as real estate, the gain recognized by the partnership generally will be treated as capital gain and will retain that character as it passes through to the partnership’s partners. Partners who received their partnership interest (either profits or capital interests) in exchange for services will also treat the gain as a capital gain that retains its character and passes through to the partner.

What are some of the Potential Benefits?

One of the added benefits for a partnership to grant profits interest to partners is to reward and further incentivize its partners to become proactive in pursuing the partnership’s growth. This is similarly the thought process behind offering company stock options to key employees and executives. For example, a partner in a partnership, who provides services to the partnership could receive cash compensation. Alternatively, he or she could receive a partnership profits interest. The latter incentivizes the partner to be proactive and offers significant tax benefits. Some of the dual tax benefits on the partner’s profits interest are as follows:

1. Income is deferred until gain is recognized by the partnership; and

2. Potentially converting compensation income, taxed at ordinary income rates (currently taxed at a maximum rate of 37%) into preferentially-taxed, long-term capital gain (currently taxed at a maximum rate of 20%).

Profits interest offers an added tax benefit to its recipients. From this example, it is clear that the tax rate on partner’s compensation would be significantly lower if the partnership granted a profits interest versus paying the partner for his or her services outright through cash compensation. Further, all appreciation in value would be taxed as long-term capital gains rather than as ordinary income.

What are the Downsides?

Due to the benefits and the ability to convert compensation into capital gains, profits interests have recently faced legislative scrutiny. In addition, there are many hurdles to consider in granting profits interests to ensure certain requirements are being met to reap its benefits. One factor to consider is the “hurdle” amount. To be considered a profits interest, a partnership must be structured so that the recipient essentially starts at a $0 liquidation value and only shares in the growth from there. This is known as a “hurdle” amount, and it must be the fair market value of the company if it were to be liquidated. Essentially, the hurdle rate requires that all value that have accumulated prior to when the profits interests were granted be allocated to

non-profits interest owners before the owner of the profits interest receives any compensation.

In addition, if an employee receives a profits interest, under current IRS guidance, the employee of a partnership interest can no longer be an “employee” of the partnership for tax purposes. The IRS’s position is that a taxpayer cannot be both a partner and an employee of the same partnership. This is due to the self-employment tax. If a profits interest is granted to an existing employee, that employee then becomes self-employed for tax purposes. As a result, the new “self-employed” label may have some unintended consequences to the partnership such as rendering the new partner ineligible for certain benefit plans.

Ultimately, profits interests remain a strong tool to reward key employees. The added flexibility that comes with designing a partnership (or LLC) agreement and the favorable tax treatment upon granting profits interest, are strong factors in its favor. However, the hurdle amount and nature of the partnership structure require additional hoops that a taxpayer has to jump through. These risks, and others, should be considered in a partnerships evaluation before granting profits interest.

* This article is informational and does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this article are for general informational purposes only. Information in this article may not constitute the most up-to-date legal or other information.

Endnotes

1. Brooke Benjamin is an attorney at K&L Gates LLP in their Washington, D.C. office. She is a member of the Tennessee and Washington, D.C. bars. She is also a member of the ABA and a current fellow in the Real Estate Property, Trust and Estate Law (RPTE) section.

2. The structure of the partnership, although not discussed herein, will determine its liability and certain favorable benefits obtained through the limited liability structure. This is generally done through favorable structures such as an LLC, LLP, or S-Corporation.

3. The term “partnership” is used throughout this article, to refer to an entity that is taxed as a partnership for federal income tax purposes, such as an LLC in some instances; in addition, the term “partnership interests”, as used throughout this article, may also include membership interests in a LLC taxed as a partnership.

Federal Push Brings More Incentives for Housing Development Near Public Transportation

By Jeff Merar1 and Andrew White2

This article spotlights how two federal incentive programs related to transportation and transportation infrastructure –the Railroad Rehabilitation & Improvement Financing (RRIF) program and the Transportation Infrastructure Finance and Innovation Act (TIFIA) – may be available to facilitate housing developments.

Amid continued uncertainty surrounding interest rates, property taxes and increased regulatory burdens, many in the real estate industry are looking for advantageous financing opportunities. Notably, developers have been considering government incentives to help offset some of these costs while continuing to build and improve America’s cities. As a follow-up to an earlier overview of new federal resources for supercharging office to residential conversion, this article discusses how these

incentives could have practical benefits. We will summarize the eligibility requirements and benefits of two federal incentive programs related to transportation and transportation infrastructure – the Railroad Rehabilitation & Improvement Financing (RRIF) program and the Transportation Infrastructure Finance and Innovation Act (TIFIA).

With over $35 billion in lending capacity at below-market interest rates, the TIFIA and RRIF programs facilitate housing development near public transportation, including conversion projects. As part of a large-scale White House effort to spur office to residential conversion, the Department of Transportation (DOT) is taking steps to promote transit-oriented development and affordable housing through new guidance on these programs released in October 2023.

The DOT’s policy statement outlines principles for pursuing transportation projects with the dual objectives of increasing affordable housing supply and reducing emissions. By offering low-cost financing for conversions and housing projects near public transportation, this guidance aims to boost housing supply and incentivize state and local governments to enhance zoning, land use, and transit-oriented development policies. Additionally, the DOT’s streamlined approach enables transit agencies to repurpose properties for affordable housing projects, potentially transforming surplus transit properties into valuable assets for housing options at below market prices. Transit-oriented development (TOD) projects are eligible under the RRIF and TIFIA credit programs.

RRIF TOD

Per DOT’s guidance, an eligible purpose for RRIF loans is to “finance economic development, including commercial and residential development, and related infrastructure and activities.” To qualify, the TOD projects must satisfy four criteria. First, total financing must incorporate private investment in excess of 20 percent of the total project costs. Second, geographically, the projects should be physically connected to or situated within half a mile of designated transportation hubs like fixed guideway transit, intercity bus, passenger rail, or multimodal stations with railroad service. Third, applicants must exhibit the capability to initiate construction contracting within 90 days of the loan obligation. Finally, TOD projects must demonstrate their potential to generate new revenue for relevant passenger rail stations or services, surpassing associated costs. RRIF TOD projects must be economic development and meet all four statutory requirements to be eligible.

Eligible projects extend beyond commercial and residential developments, encompassing various land uses permitted under local law, including, among others, office, institutional (e.g. civic, academic, health, etc.), industrial, entertainment, and recreational uses. DOT’s guidance encourages applicants to propose projects that drive transformative improvements, such as increasing housing options, prioritizing safety for pedestrians and non-motorized mobility, enhancing access to essential services, and improving environmental quality. The DOT’s examples include partnerships between private developers and local rail agencies to create economic development projects, constructing new buildings, or improving existing rail stations. This flexible definition encompasses a diverse range of projects. For example, The Port of Everett in Everett, Washington, used RRIF financing in a two-phase project. The project involved upgrades to terminal rail facilities and the relocation of a warehouse. The RRIF direct loan supported the construction of approximately 3,300 feet of on-terminal working track, involving demolition, excavation, utility realignment, track construction, and the relocation of a 39,000-square-foot warehouse to serve as a rail cargo cover within the port’s facilities.

TIFIA TOD

Projects eligible for TIFIA loans encompass two distinct categories. First, eligible projects involve the improvement or construction of public infrastructure within walking distance of fixed guideway transit facilities, passenger rail stations, intercity bus stations, or intermodal facilities, including various transportation, public utility, or capital projects. The second category pertains to projects focused on economic development, covering commercial and residential development and related infrastructure and activities. For this category to qualify, the project must incorporate private investment, be physically or functionally linked to a passenger rail or multimodal station with rail service, exhibit a high probability of commencing construction within 90 days of TIFIA credit assistance, and have a high likelihood of reducing the need for financial assistance

from other federal programs related to the relevant passenger rail station or service by generating revenue exceeding costs.

In essence, TIFIA TOD projects must align with public infrastructure improvement or economic development objectives and meet specified statutory eligibility criteria to qualify for TIFIA loans. In Denver, Colorado, the Denver Union Station project used over $145 million in TIFIA loans. The project was a public-private development spanning around 50 acres in downtown Denver. It involved the redevelopment of the site into an intermodal transit district with a mix of residential, retail, and office spaces, connected to regional multimodal transportation services, including commuter rail, light rail, bus rapid transit, and regular bus services.

The flexible and inclusive criteria for TIFIA and RRIF TOD projects allow the DOT to harness the creativity of the private sector while directly improving public infrastructure and connectivity. The programs empower transit agencies and private real estate developers to repurpose surplus properties for affordable housing, promoting community-centric development and integrating transportation and housing for a sustainable future. However, accessing these funds requires more than just deciphering the word salad of acronyms put forth by the DOT and those interested are urged to obtain professional guidance.

Endnotes

1. Jeffrey A. Merar (About Jeffrey Merar) is a Partner in the Real Estate Group of Thompson Coburn LLP.

2. Andrew White (About Andrew White) is an Associate in the Real Estate Group of Thompson Coburn LLP.

Fourth Circuit Court of Appeals Decides Commercial Lease Dispute Over Renewal Rent

By Ryan Ellard1

This summary of a dispute regarding establishing rent during a lease renewal term reminds us that sophisticated commercial parties will be bound by the plain wording of their agreements. Draft accordingly!

Zayo Group, LLC, an internet provider (“Lessee”), and Norfolk Southern Railway (“Lessor”) entered into an agreement where Lessee would lease a utility duct from Lessor. The lease provided Lessee with two ten-year renewal options, with rent for the renewals terms to be adjusted to reflect fair market value. When the time came to renew the lease, the parties were unable

to agree on the renewal rent, so they secured three appraisers to determine the fair market value rate. The appraisers arrived at a new annual rate of $2,340,000 by a vote of two-to-one. Lessor issued two invoices reflecting the new rate; however, Lessee refused to pay the full amount, arguing that the appraisers’ nonunanimous decision was not binding. Lessor filed suit and was granted judgment on the pleadings by the United States District Court of the Eastern District of Virginia. Norfolk S. Ry. Co. v. Zayo Grp. LLC, No. 1:21-CV-1299, 2022 WL 1185884, at *2 (E.D. Va. Apr. 21, 2022). Lessee appealed to the Fourth Circuit. Norfolk S. Ry. Co. v. Zayo Grp., LLC, 87 F.4th 585, 587 (4th Cir. 2023).

In considering the parties’ arguments, the Fourth Circuit reverted to the lease, which read as follows:

Lessor Initially shall propose the Adjusted Rental and shall notify Lessee thereof during the last six (6) months of the Initial Term or preceding Renewal Term. If Lessee objects to Lessor’s proposed Adjusted Rental, Lessee at its sole cost will obtain and submit to Lessor an appraisal by an MAI member with In sixty (60) days of Lessor’s notice. If Lessor disagrees with Lessee’s appraisal, Lessor at its sole cost will obtain a second appraisal by an MAI member. If Lessee’s and Lessor’s appraisers cannot reach agreement they will select,

and Lessor and Lessee will jointly compensate. a third appraiser similarly qualified, and the three shell determine the Adjusted Rental within sixty (60) days of the third appraiser’s selection, which determination shall be final and binding.

Id. at 587.

Lessee argued that the language meant the parties could only be bound by a unanimous decision of the appraisers and since the appraiser it appointed dissented, the majority’s decision was unenforceable. Lessor countered that the lease included no such unanimity requirement. The Fourth Circuit agreed with Lessor, holding that,

Logically read, the lease introduced a third appraiser to break ties. Ordinarily, “determining” an issue means definitively resolving it, no matter the mechanism. The contract also demonstrates the parties’ desire not to drag out the rent determination. Section 4(b) of the lease provided a timeline for each step of the process. . . The logic of the appraisal sequence, considered as a whole, suggests that the third appraiser’s role was to break a tie. The third appraiser is appointed only if the other two have deadlocked. If unanimity were re -

quired, an appraiser appointed by a single party could indefinitely hold up the process, regardless of whether the lease contemplated a third appraiser. Such a result would render the third appraiser redundant and defy the parties’ express purpose of “determining” the rent. Thus, a unanimity requirement does not follow from a reasonable reading of the lease.

Id. at 591 (4th Cir. 2023) (cleaned up).

The first sentence of the Court’s opinion – effectively dispelling any suspense that might follow – reads, “When two companies agree to a method for resolving their disputes, they are bound by their contract.” The Court’s concise decision serves as a reminder to practitioners that where the plain language of an agreement will resolve the parties’ contentions, the court will look no further. If parties to a lease would like a unanimity requirement, it should be clearly articulated in the contract.

Endnotes

1. Mr. Ellard is an attorney in Womble Bond Dickinson (US) LLP’s Charleston, South Carolina office. His practice includes handling a variety of real property matters. Mr. Ellard graduated from the University of Connecticut School of Law and is a Fellow in the American Bar Association’s Real Property, Trusts and Estates section.

INCOME TAXATION OF PROPERTY ACQUIRED FROM A DECEDENT

This brand-new, comprehensive practice guide provides a resource for tax practitioners and others who advise on estate and income tax matters, offering planning opportunities and considering traps to steer clear of before and after death. With proper planning, discrepancies under the Code are cured, traps are avoided, and traditional estate planning techniques combined with additional income tax planning lead to favorable estate and income tax results.

RPTE Standing Committee on Leadership and Mentoring

The RPTE Standing Committee on Leadership and Mentoring has commenced its annual Mentoring Program for the 2023-2024 bar year. This program plays a crucial role in fostering professional development and overall career advancement within the legal field for our RPTE members. Additionally, it pairs experienced and seasoned RPTE Section leaders with newer leaders, or more experienced leaders who wish to advance further in Section leadership, creating a symbiotic relationship that benefits the entire RPTE Section. This year, seven Real Property and seven Trust & Estate mentor-mentee relationships were established. Mentors offer

guidance, share their wealth of experience, and provide insights into the nuances of legal practice. For mentees, this mentorship provides a valuable opportunity to navigate the complexities of the legal profession, gain practical advice, and build a network of contacts. The Leadership and Mentoring Committee’s well-structured mentoring program is instrumental in creating a supportive and collaborative legal community that ultimately enhances the quality of legal services and promotes a culture of continuous leadership development within the RPTE Section.

ABA LEADERSHIP AND MENTORING 2023-2024

MENTOR-MENTEE ASSIGNMENTS

RP DIVISION

Kellye Clarke kclarke@rgstitle.com

Sarah Cline scline@milesstockbridge.com

Alan Di Sciullo adisciu9@comcast.net

Jim Durham jdurham1@udayton.edu

Jennifer Litwak Jennifer.litwak@gmail.com

Cheryl Kelly ckelly@thompsoncoburn.com

Jo-Ann Marzullo jmarzullo@ligris.com

TE DIVISION

Karen Boxx kboxx@wu.edu

Gerard Brew gbrew@mccarter.com

Hugh Drake hdrake@bhslaw.com

Jo Ann Engelhardt Joannengelhardt75@gmail.com

Steve Gorin sgorin@thompsoncoburn.com

Rob Steele rsteele@ssrga.com

David Lieberman david@lsclaw.com

Erin Lapeyrolie elapeyrolerie@goldfarblipman.com

Kristin Niver Kniver@thompsoncoburn.com

D. Brent Wills bwills@gilpingivhan.com

Bomophrega Julius Bomopregha.julius@gmail.com

Aaron Dunlap adunlap@carltonfields.com

Travis Beaton tbeaton@shergarner.com

Andrew Miller drew.miller@kempsmith.com

Abbie Everist Abbie.Everist@rsmus.com

Melissa Dibble mdibble@archerlaw.com

Brian Balduzzi brianbalduzzi@gmail.com

Liz Ochoa lizochoa@gmail.com

Sam Dangremond sdangremond@gmail.com

Jeff Hopkins jeff@basjlaw.com

Preston Demouchet demouchet@clm.com

THANK YOU TO OUR SPONSORS

The Section acknowledges the generous support of the following sponsors for their involvement in this year’s National CLE Conference:

LAW FIRMS

PARTNER

Carlton Fields P.A.

Archer & Greiner, P.C.

Chestnut Cambronne PA

Fredrikson & Byron, P.A.

Dungey Dougherty PLLC

CONFERENCE

Levin Schreder Carey

Saul Ewing LLP

Wittmann LLC SILVER

Prather Ebner & Wilson LLP

Sher Garner Cahill Richter

Klein & Hilbert, L.L.C.

Stone Pigman Walther

FELLOWSHIP OPPORTUNITY

Applications due June 21, 2024.

The ABA Section of Real Property, Trust and Estate Law Fellows Program encourages the active involvement and participation of young lawyers in Section activities. The goal of the program is to give young lawyers an opportunity to become involved in the substantive work of the RPTE Section while developing into future leaders.

Each RPTE Fellow is assigned to work with a substantive committee chair, who serves as a mentor and helps expose the Fellow to all aspects of committee membership. Fellows get involved in substantive projects, which can include writing for an RPTE publication, becoming Section liaisons to the ABA Young Lawyers Division or local bar associations, becoming active members of the Membership Committee, and attending important Section leadership meetings.

www.americanbar.org/groups/real_property_trust_estate/ fellowships-and-awards/fellows/

CALLING ALL LAW STUDENTS!

The Section of Real Property, Trust and Estate Law is now accepting entries for the 2024 Law Student Writing Contest. This contest is open to all J.D. and LL.M students currently attending an ABA-accredited law school. It is designed to encourage and reward law student writing on real property or trust and estate law subjects of general and current interest.

1st Place

$2,500 award

2nd Place

$1,500 award

3rd Place

$1,000 award

n Free round-trip economy-class airfare and accommodations to attend the RPTE National CLE Conference. This is an excellent meeting at which to network with RPTE leadership! (First place only.)

n A full-tuition scholarship to the University of Miami School of Law’s Heckerling Graduate Program in Estate Planning OR Robert Traurig-Greenberg Traurig Graduate Program in Real Property Development for the 2024-2025 or 20252026 academic year.* (First place only.)

n Consideration for publication in The Real Property, Trust and Estate Law Journal, the Section’s law review journal.

n One-year free RPTE membership.

n Name and essay title will be published in the eReport, the Section’s electronic newsletter, and Probate & Property, the Section’s flagship magazine.

Contest deadline: May 31, 2024

Visit the RPTE Law School Writing Competition webpage at ambar.org/rptewriting.

*Students must apply and be admitted to the graduate program of their choice to be considered for the scholarship. Applicants to the Heckerling Graduate Program in Estate Planning must hold a J.D. degree from an ABA-accredited law school and must have completed the equivalent of both a trusts and estates course and a federal income tax course. Applicants to the Robert Traurig-Greenberg Traurig Graduate Program in Real Property Development must hold a degree from an ABA-accredited law school or a foreign equivalent non-US school.

ARIA RESORT & CASINO

CLE Conference Dates: Wednesday, April 30 - Thursday, May 1, 2025

Leadership Meeting Dates: Thursday, May 1 - Friday, May 2, 2025

Commercial Real Estate Transactions Group

The Commercial Real Estate Transactions Group is a very active group that analyzes transactional and ownership issues that confront commercial real estate attorneys when dealing with such things as land transfers, construction, servitudes, title insurance, property and liability insurance, and ownership of commercial real estate. The group is comprised of the following six committees, each of which focuses on one of the foregoing topics: (i) Design and Construction; (ii) Easements, Restrictions and Covenants; (iii) Green and Sustainable Transactions; (iv) Property, Casualty and Other Non-Title Insurance; (v) Purchase and Sale; and (vi) Title Insurance and Surveys.

The Commercial Real Estate Transactions Group has monthly meetings on the first Wednesday of each month at 2:00 (eastern) where we often have a substantive report from one of our 6 committees on a topic or case of interest relevant to that committee. The various committees also provide numerous continuing legal education (CLE) for the Group’s members covering basic concepts in each of the following areas: (a) “purchase and sale agreements,” (b) finance document and due diligence,” (c) “leases and easements” and (d) “construction contracts.” The group regularly provides CLE at the RPTE Section’s National Conference.

We invite you to join the Commercial Real Estate Transactions Group in order to receive calendar invitations about our monthly meetings, upcoming CLE and other events.

https://www.americanbar.org/groups/real_property_trust_estate/about/committees/commercial-real-estate-transactions/

Employee Plans and Executive Compensation Group

Our Group provides value to members by helping them to stay current on the many and changing legal rules that apply to their clients’ plans, especially ones relating to qualified plans, medical and other welfare plans, and nonqualified deferred compensation plans. Our Group also focuses on fiduciary responsibilities related to the operation of plans and the formation and termination of benefit plans, and litigation involving this area of practice.

https://www.americanbar.org/groups/real_property_trust_estate/about/committees/ employee-plans-executive-compensation/

Committee Calls June 2024

Central Time (US and Canada)

COMMERCIAL REAL ESTATE TRANSACTIONS

June 5, 2024 1:00PM CT

Join Zoom Meeting

https://americanbar.zoom.us/j/99891147557?pwd=SitsUVkxQ2FlRVBGKzhRVWF5bkNWUT09

Meeting ID: 998 9114 7557

Passcode: 212639 +13126266799,,99891147557# US (Chicago)

REAL ESTATE FINANCING GROUP

June 6, 2024, 1:00PM CT

Join Zoom Meeting

https://americanbar.zoom.us/j/97748191258?pwd=MmRZVllYbkJiSVlReVFnak92ME82Zz09

Meeting ID: 977 4819 1258

Passcode: 634368

BUSINESS PLANNING GROUP

June 10, 2024, 11:00AM CT

Join Zoom Meeting

https://americanbar.zoom.us/j/99860548109?pwd=Q1NQTVRWeENrZ2owbEpXTkNQY3hKQT09

Meeting ID: 998 6054 8109

Passcode: 059353

LITIGATION, ETHICS AND MALPRACTICE GROUP

June 12, 2024, 12:00PM CT

Join Zoom Meeting

https://americanbar.zoom.us/j/92253353168?pwd=TUlZSmg0Tm9pVmFCZzdLWnJPNVVIQT09

Meeting ID: 922 5335 3168

Passcode: 529377

INCOME AND TRANSFER TAX PLANNING GROUP

June 12, 2024, 1:00PM CT

Join Zoom Meeting

https://americanbar.zoom.us/j/93397675890?pwd=cGpvUXovY3FoREpSRHF4ajAyN01oZz09

Meeting ID: 933 9767 5890

Passcode: 134102

EMPLOYEE PLANS AND EXECUTIVE

COMPENSATION GROUP

June 21, 2024, 11:30AM CT

Join Zoom Meeting

https://americanbar.zoom.us/j/94971185937?pwd=SnRFZTF5bllmNHlGckU3RlBuemdPZz09

Meeting ID: 949 7118 5937

Passcode: 659386

Residential, Multi-Family and Special Use Group

Although a diverse group, this group’s committees share the common thread of dealing with residential properties and issues that pertain to all types of residential properties. The Group is led by Jennifer Litwak, Chair, CEO of PEP Housing, and Sarah Cline, Vice-Chair, Principal at Miles & Stockbridge, P.C..

The Group has four committees:

Single-Family Residential, led by James Marx, Chair, and Arielle Comer and Erin August, Vice-Chairs

This committee deals with all aspects of the development, purchase, financing and ownership of single-family residential property, including regulations affecting residential settlements and best practices for representing consumers in residential transactions.

Affordable Housing Committee, led by Kristin Elizabeth Niver, Chair, and Anna Almon Mahaney and George Weidenfeller, Vice-Chairs

This committee focuses on all aspects of the development, acquisition, financing and ownership of affordable housing, and the governmental programs and policies that support it, including the Community Reinvestment Act. Many of the committee members are involved with HUD programs, and the committee provides a forum to provide commentary for the development and administration of these programs, as well as to simplify the process involving these governmental programs.

Multi-Family Residential, led by Cynthia Langelier Paine, Chair, and Chelsea Patricia Fitzgerald and Ashley Haun, Vice-Chairs

This committee deals with all aspects of the development, sale, financing and ownership of multi-family residential property, including the impact of FHA, the Americans with Disabilities Act, and HUD programs. This committee focuses on the legal issues faced by landlords, property managers and tenants of rental housing and apartments.

Senior Housing and Assisted Living, led by Gregory Limoncelli, Chair, and Colin Gaynor and Jane E. Sternecky, Vice-Chairs

This committee addresses the unique problems of providing housing and related services to seniors. The committee encompasses the continuing care retirement community, congregate care assisted living facilities and residential aspects of nursing care, including subsidies and other government programs. Single Family Residential This committee focuses on all aspects of the development, sale, financing and ownership of single-family residential property, including the impact of FHA, FNMA, FHLMC, VA and HUD programs.

The Group is proud to have sponsored two informative and timely programs this spring, which are now available on demand:

Facilitating Homeownership Through Resource Pooling, presented by Andy Sirkin. This presentation discussed presentation explored various types of shared ownership arrangements that can help buyers of primary and secondary/vacation homes maximize their purchasing power, focusing on four concepts: (1) Subdivision Analogues; (2) Vacation Home Sharing; (3) Equity Sharing; and (4) Co-Living.

Business Email Compromise (“BEC”): Wire Fraud, Seller Impersonation, Cyber Security Issues in Real Estate Transactions, presented by George Piro and Jesus F. Pena.

https://www.americanbar.org/groups/real_property_trust_estate/about/committees/residential-multifamily-special-use/

The Elder Law and Special Needs Planning Group

The Elder Law and Special Needs Planning Group consists of two committees that focus on legal concerns of the elderly and persons with disabilities.

The Elder Law and Long-Term Care Committee focuses on the legal concerns of the elderly and issues related to long-term care; whereas the Special Needs Planning committee focuses on legal and future planning for individuals with disabilities and their families.

The Group holds meetings typically on a bi-monthly basis with various presenters. Previous topics have included:  trends in Elder Law and Special Needs law, defensive estate planning practices, reverse mortgages, ABLE Act, the ABA Commission on Law and Aging, holistic view of special needs planning, transferring guardianships across state lines, estate planning for caregivers, Long Term Care Trust Act of Washington, nursing home patient discharges, the Respecting Choices program, planning for mental health and addiction issues, CDB/DAC benefits, working and governmental benefits, to name a few.

Our Group also has sponsored and presented at CLEs and eCLEs on elder exploitation, VA benefits, Medicaid benefits, undue influence, guardianships, and alternatives to guardianship. At the RPTE National CLE Conference, our group is presenting on “Addressing Financial Abuse of Vulnerable Adults” where we will discuss elder financial exploitation, real estate fraud, representing clients who have been defrauding and ABA  Model Rules of Professional Responsibility Rule 1.14, and fraud in the guardianship setting.

Finally, committee chairs and committee members are frequently asked to advise the Section leadership on policy positions to be adopted by the ABA House of Delegates.

We look forward to new members and attendees at our Group meetings and CLEs.

We encourage your participation in committee activities and hope you will join us.

https://www.americanbar.org/groups/real_property_trust_estate/about/committees/ elder-law-special-needs/

Learn about Section of Real Property, Trust and Estate Law’s eReport

The eReport is the quarterly electronic publication of the American Bar Association Real Property, Trust and Estate Law Section. It includes practical information for lawyers working in the real property and estate planning fields, together with news on Section activities and upcoming events. The eReport also provides resources for seasoned and young lawyers and law students to succeed in the practice of law.

For further information on the eReport or to submit an article for publication, please contact Robert Steele (Editor), Cheryl Kelly (Real Property Editor), Keri Brown (Trust and Estate Editor), or RPTE staff members Bryan Lambert or Monica Larys. Are you interested in reading FAQs on how to get published in the eReport? Download the FAQs here. We welcome your suggestions and submissions!

FREQUENTLY ASKED QUESTIONS BY PROSPECTIVE AUTHORS RTPE eReport

What makes eReport different from the other Section publications? The most important distinction is that eReport is electronic. It is delivered by email only (see below) and consists of links to electronic versions of articles and other items of interest. Since eReport is electronic, it is flexible in many ways.

How is eReport delivered and to whom?

eReport is delivered quarterly via email to all Section members with valid email addresses. At the ABA website, www.americanbar.org, click myABA and then navigate to Email, Lists and Subscriptions. You have the option of receiving eReport. Currently almost 17,000 Section members receive eReport.

What kind of articles are you looking for?

We are looking for timely articles on almost any topic of interest to real estate or trust and estate lawyers. This covers anything from recent case decisions, whether federal or state, if of general interest, administrative rulings, statutory changes, new techniques with practical tips, etc.

How long should my article be?

Since eReport is electronic and therefore very flexible, we can publish a two page case or ruling summary, and we can publish a 150 page article. eReport is able to do this since the main page consists of links to the underlying article, therefore imposing no page restraints. This is a unique feature of eReport.

How do I submit an article for consideration?

Email either a paragraph on a potential topic or a polished draft – the choice is yours – to the Editor, Robert Steele, at rsteele@ssrga.com , and either our Real Estate Editor, Cheryl Kelly, at CKelly@ thompsoncoburn.com , or our Trust and Estate Editor, Keri Brown, at keri.brown@bakerbotts.com

Do I need to have my topic pre-approved before I write my submission?

Not required, but the choice is yours. We welcome topic suggestions and can give guidance at that stage, or you may submit a detailed outline or even a full draft. You may even submit an article previously published (discussed below) for our consideration.

Do citations need to be in formal Bluebook style?

eReport is the most informal publication of the Section. We do not publish with heavy footnotes and all references are in endnotes. If there are citations, however, whether to the case you are writing about, or in endnotes, they should be in proper Bluebook format to allow the reader to find the material. Certainly you may include hyperlinks to materials as well.

Can I revise my article after it is accepted for publication?

While we do not encourage last minute changes, it is possible to make changes since we work on Word documents until right before publication when all articles are converted to pdf format for publication.

What is your editing process?

Our Editor and either the Trust and Estate Editor or the Real Estate Editor work together to finalize your article. The article and the style are yours, however, and you are solely responsible for the content and accuracy. We will just help to polish the article, not re-write it. Our authors have a huge variety of styles and we embrace all variety in our publication.

Do I get to provide feedback on any changes that you make to my article?

Yes. We will email a final draft to you unless we have only made very minor typographical or grammatical changes.

Will you accept an article for publication if I previously published it elsewhere?

YES! This is another unique feature of eReport. We bring almost 17,000 new readers to your material. Therefore, something substantive published on your firm’s or company’s website or elsewhere may be accepted for publication if we believe that our readers will benefit from your analysis and insight. In some cases, articles are updated or refreshed for eReport. In other cases, we re-publish essentially unchanged, but logos and biographical information is either eliminated or moved to the end of the article.

How quickly can you publish my article?

Since we publish quarterly, the lead time is rarely more than two months. If you have a submission on a very timely topic, we can publish in under a month and present your insights on a new topic in a matter of weeks.