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Sunday, June 23, 2019

Due Process Limitations Apply to Limit State Tax of Trust Beneficiaries

States with income taxes have varying rules on when they assert authority to tax income of trusts, based on combinations of contacts with their state of settlors, trustees, beneficiaries, assets, and management activities. In one of the more aggressive assertions of authority to tax, several states assert that they can tax the income of a trust merely because a beneficiary resides in the state. In a challenge to North Carolina’s scheme, the U.S. Supreme Court ruled that the presence of in-state beneficiaries alone does not empower a state to tax undistributed trust income when the beneficiaries have no right to demand that income and are uncertain to receive it.

In the case, the settlor formed a trust for his children in his home state of New York. The trustee of the trust was a New York resident. Trust documents and records were kept in New York, and the asset custodians were in Massachusetts.The trust granted the trustee absolute discretion to distribute assets to the beneficiaries. One of the children moved to North Carolina, and North Carolina sought to tax all the income of a subtrust because that child was a North Carolina resident. The child had no right to, and did not receive, any distributions from the trust.

The Court based its decision on the requirements of the Due Process Clause of the U.S. Constitution, which limits states to imposing only taxes that bear fiscal relation to protection, opportunities and benefits given by the state. Some definite link, some minimum connection, is required so that the income attributed to the state for tax purposes be rationally related to values connected with the taxing state. Applied to beneficiaries, this results in taxation turning on the extent of the in-state beneficiary’s right to control, possess, enjoy, or receive trust assets.

A key aspect was that the beneficiary could not count on necessarily receiving any specific amount of the income in the future. The Court noted that the assets of the trust could end up with others, and that the beneficiary had no power to assign her interest.

Some preliminary thoughts/observations:

     a. The use of a purely discretionary trust to avoid state income tax when a beneficiary resides in a state with an income tax is a valid planning mechanism, so long as no other ties and connections with the taxing state exist. It would appear that a spendthrift clause that prevents a beneficiary from assigning his or her beneficial interest is a necessary aspect of such planning. Of course, such planning has real world consequences, such as limited access to, and rights over, trust assets by the beneficiary.

     b. Would a power of appointment over trust assets in a discretionary trust by the in-state beneficiary give rise to taxing jurisdiction? This was not discussed in the case. If presently exercisable in the subject tax year, then probably yes. If not presently exercisable, maybe not.

     c. Would a right to receive all or a share of trust assets at a given future age give the requisite taxing nexus for an in-state beneficiary? This fact was present in the case. However, in the case there were facts that made this future right contingent which appear to have influenced the court, such as the ability for the trust to be re-written to exclude such a right under decanting provisions of law (which power was actually exercised after the tax years in issue) and that the trustee could exclude one beneficiary to the benefit of another.

     d. The Court noted that tests of nexus are different as to rights of settlors, trustees and beneficiaries. For example, prior precedent confirms that a resident trustee is enough nexus for state income tax, as well as residence of a settlor (at least where the settlor retains rights over the trust assets, such as a power of revocation). I believe there is at least one state that asserts continuing taxing jurisdiction over a trust with no contacts with the state other than the settlor was a resident of the trust at creation – perhaps a challenge to that nexus authority may be forthcoming based on the principles elucidated in this case.

     e. For practitioners in states without a state income tax on individuals, the case is still relevant, since in preparing or advising on a trust in your state you should still be planning for the circumstance of beneficiaries who reside in other states.

NORTH CAROLINA DEPT. OF REVENUE v. KIMBERLEY RICE KAESTNER 1992 FAMILY TRUST (U.S. Supreme Court 2019)

Tuesday, June 18, 2019

Limits on Effects of Order Determining Homestead on Title [Florida]

A recent appellate decision addresses the effect of an order determining homestead vis-à-vis title to the homestead. In the case, a decedent left her homestead by will to her three children. The will also provided a life estate in the property to two of the children. The probate court entered an order determining homestead, which determined that the homestead property was divided in equal shares to the children, but did not mention the life estate provided for in the will. The trial court determined the order determining homestead divested the life tenants from their life estate per the absence of any mention of the life estate (thus allowing partition of the property to proceed on petition of two of the children). Florida’s 5th DCA reversed the trial court, and held that the order determining homestead did not terminate the life estate provided for in the decedent’s will.[1] The appellate court noted that the homestead order did not create new rights, but only explained or clarified the rights that already existed by operation of law.

The appellate court rejected arguments that the children’s consents to the homestead order altered the parties’ individual interests in the estate. It also ruled that the order was not a title transaction within the meaning of Fla.Stats. §712.01(3) noting:

the Homestead Order in this case does not constitute a title transaction, as defined by section 712.01(3), Florida Statutes (2011), extinguishing the life estates in the property. ‘A title transaction within the meaning of this act is defined in section 712.01(3), Florida Statutes, and means any recorded instrument or court proceeding which affects title to any estate or interest in land and which describes the land affected with legal sufficiency.’ Cunningham v. Haley, 501 So. 2d 649, 652 (Fla. 5th DCA 1986). Although the probate and recording of a will constitutes a title transaction within the meaning of section 712.01(3), see Mayo v. Owens, 367 So. 2d 1054, 1057 (Fla. 1st DCA 1979); Kittrell v. Clark, 363 So. 2d 373 (Fla. 1st DCA 1978), Kenneth and Carla point to no authority holding or suggesting that an order determining homestead property constitutes the same.

Mullins v. Mullins, No. 5D18-1672, 2019 WL 2396753, at *4 (Fla. Dist. Ct. App. June 7, 2019)noting

Sunday, June 09, 2019

Electronic Notarization Comes Alive in Florida, and Electronic Notarization and Witnessing of Wills and Trusts Comes Along for the Ride [Florida]

A 78 page bill on the subject of electronic and remote notarization and witnessing of documents was approved by the governor two days ago. Here is some info to start to get you up to speed.

General Provisions:

  • In addition to the statute, the Florida Department of State will adopt rules that online notaries will need to follow.
  • Online notarization is conducted through and requires audio-video communication technology.
  • Notarial certificates should indicate whether they are notarizing in person or online. Sample certificates are in the new statute.
  • The online notary must confirm the identify of the principal, either by personal knowledge or all of the following: remote presentation of identification, credential analysis of identification provided, and identity proofing based on knowledge-based authentication or similar method. Credential analysis involves a third party aiding the notary in affirming the validity of government-issued identification credentials. Identify proofing involves a a third party affirming the identity of an individual through use of public or proprietary data sources, including knowledge-based authentication (question and answer systems) or biometric verification.
  • Errors and omissions insurance is required by the notary, his or her employer, or a remote online notarization (RON) service provider.
  • A notary can notarize even if the principal or any witnesses are located outside of Florida.
  • A notary can serve as an online notary only after taking a course of study.
  • A notary will need to work with a RON services provider to use their communication technology and processes for credential analysis and identity proofing.
  • A notary will need to provide a $25,000 bond.
  • A notary will have to keep an electronic journal of online notarizations, and keep them secured and backed up. The record will have to record various information about the notarization.
  • The notary will have to retain an copy of the recording of the audio-video communication relating to the notarization.
  • The notary may not charge more than $25. It may also charge for copies provided of electronic records, subject to caps and restrictions.
  • The notary can also supervise the witnessing of documents online in a similar manner to notarizing the signature of the principal signor. The witness need not be in the physical presence of the signor or notary. A remote witness must be a resident of and physically located within the U.S. or a territory of the U.S., presumably to make them available to court proceedings if necessary.

Special provisions for wills, trusts with testamentary aspects, health care advance directives, waivers of spousal rights, or powers of attorney authorizing certain types of acts:

  • The notary must ask certain questions of the principal signor relating to impairment or disability if the witnesses are not in the physical presence of the principal signor. If they are not properly answered, then remote witnessing is ineffective.
  • If the principal signor is a “vulnerable adult” as defined in Fla.Stats. §415.102, the witnesses must be in the presence of the principal signor. If they are not, the witnessing is invalid.
  • If witnesses are not in the physical presence of the signor, then additional questions are asked of the principal signor for thelvideo/audio record are undertaken by the notary.
  • An electronic will or codicil is revoked by deleting or obliterating an electronic record, with the intent to revoke, as provided by clear and convincing evidence.
  • Remote witnessing requires that the witness hear the signer acknowledging the signer’s signature.
  • Self-proof affidavits for wills can be electronically witnessed and notarized, if the electronic record that contains the will is held by a qualified custodian at all times before being offered to probate.
  • The electronic will can be admitted to probate if filed through the e-filing portal, and is deemed to be an original of the electronic will. A paper copy of an electronic will which is certified by a notary public to be a true and correct copy can also be admitted to probate as an original will.

Some preliminary thoughts/questions of mine:

  • How much will RON service providers charge?
  • How many notaries will go through the hassle of qualifying to be an online notary and meeting all the requirements for qualification and online notarizations (including the storage and delivery of recordings and the electronic documents that are notarized) – or will such services end up being provided almost exclusively by companies engaged in the business of providing online notarization? The Act has 70+ pages of rules and requirements, and of course more will be coming by regulation.
  • What happens when electronic records are inadvertently destroyed or are not available? Of course, paper records can suffer the same fate – but think about ransomware and other electronic hacking that the has the potential to void and destroy hundreds of thousands of electronic documents at one time.
  • If remote witnessing is not available for a will or similar document (e.g., the signor is a vulnerable adult), testators and signors of such documents may think they have a valid document when they in fact do not.

Good thing? Bad thing? Probably both, but it doesn’t really matter since it is now the law of the land (subject to a delayed effective date). The old way of doing things is still valid – it remains to be seen how widespread the use of electronic notarization and witnessing (and how widespread any resulting fraud and other problems)  will be. My gut instinct is that taking a process that is fairly straightforward (notarization) and subjecting it to a multitude of rules, regulations, costs, and new business interests suggests that perhaps the old ways may be the better way, especially as to testamentary documents.

The foregoing is based on a preliminary read of the new law only. There will be a lot of real ink and electronic ink spilled on this subject for sure. Let the articles, seminars, books, and litigation commence!

Read the new law here.