Jonathan Huber, Attorney At Law

Enforcing the UCC-1

2011-10-11T11:16:00.000-07:00

Over the past few years, I have seen an increasing number of problems encountered by clients in their attempts to collect debts, particularly against secured collateral.

These problems typically arise from the sale of a business in which the seller finances a part of the purchase price and attempts to create a security interest against some of the business’s assets by filing a UCC-1 financing statement with the Secretary of State.

UCC-1 filings are valuable tools in seller financing situations.    However, they are not fool-proof.   The UCC-1 is used to perfect a security interest in collateralized assets and establishes priority of repayment in case the debtor defaults or declares bankruptcy. When a UCC-1 is used, it is very important that the assets used as collateral be clearly and specifically identified.

While courts are generally liberal in construing a UCC-1 to create a security interest, and will generally overlook technical errors, it is imprudent to blindly rely on luck and the good graces of the judicial system.

Let’s look at a hypothetical situation to see how this works. Sam Sellit decides to sell his restaurant, Sam’s Super Subs, to Betty Byett (who will use the assets to open Betty’s Better Burgers, of course).    Betty doesn’t have enough cash for the full purchase price, and her credit isn’t great.   So, Sam agrees to finance $50,000 of the purchase price.   Sam is smart, so he takes a security interest in the restaurant equipment and files a UCC-1 financing statement with the Secretary of State.

Several years later, Betty – whose burgers weren’t better – defaults on her payments.   Sam seeks to recover the equipment under his security agreement.   Unfortunately, when Betty realized her business was finished, she sold all of the equipment at an auction and spent the proceeds.

Sam’s UCC-1 filing states that he has a security interest in “all of the equipment on the premises.” Because the items were not specifically identified, Sam will not be able to recover the items from any third-party purchasers who were unaware that these specific items were covered by Betty’s security agreement.

How should Sam have written his UCC-1 to avoid this problem?   If Sam had used specific descriptions of each asset of significant value, including each asset’s serial or other identifying number, it would have been clear which ice machine, grills, and fryers were covered by his UCC-1.   Accordingly, Sam would be able to enforce his UCC-1 against third-party purchasers with relatively little difficulty.

While this level of specificity is not required by law, it is good business practice.   It requires a little more effort on the front-side, but can save a lot of headache – and money – down the road.

Caveat Venditor.

New Estate Tax Laws

2011-01-18T13:25:00.000-08:00

It has been a while since my post regarding 2010's estate tax uncertainty. Without a doubt, few people - if any - accurately predicted what Congress would do. Not surprisingly, the uncertainty will continue, at least through 2012, when Congress will - hopefully - once again revisit the issue.

In the meantime, here are a few of the highlights from the new legislation:

Default estate tax exclusion for decedents who passed away in 2010 is $5M.
For decedents who passed away in 2010, an option is available to choose "carryover basis" (with step-up of $1.3M) instead of estate tax. Such an option could be useful when a decedent's estate exceeds $5M in value and liquid assets are unavailable to pay estate tax that may be due. However, in the vast majority of situations, taking the default $5M exclusion and the full "step-up" in basis will be the best option.
Portability! The most useful and exciting change to the estate tax laws, in my opinion, is the new "portability" of estate tax exclusion amounts. This allows a married couple two opportunities to access both spouses' exclusion amount. For example, if Spouse A passes away leaving a $3.5M estate, and Spouse B subsequently passes away, leaving a $6.5M estate, neither estate will be subject to estate tax. Why? Because Spouse A has a $5M exclusion. Because Spouse A's estate only used $3.5M of the exclusion, $1.5M was "left over" and will be applied to Spouse B's estate, giving Spouse B an exclusion of $6.5M.
A close runner-up to Portability, as an exciting new change, is the move from a $1M tax-free gifting cap to a $5M tax-free gifting cap (applicable only in 2011 and 2012). This increased gifting cap provides an excellent opportunity for families to reallocate assets to various estate planning vehicles, such as Irrevocable Life Insurance Trusts, Family Limited Partnerships, Grantor Retained Annuity Trusts, and Grantor Retained Unitrusts.

While the 2010 Tax Act brings good news for most moderate and high net worth individuals, the good news is tempered by the fact that Congress, once again, has given us temporary rules. Unless Congress acts again before 2013, the Estate Tax laws will revert to the laws applicable in 2000, with a $1M exclusion and a $1M tax-free gifting cap.

So what does all of this mean?

First and foremost, there are excellent tax planning opportunities during the next two years, that may disappear on January 1, 2013, so taking steps to plan now is highly advisable. The ability to transfer up to $5M tax-free to a tax planning vehicle should not be lightly passed up, as this opportunity may very well be "for a limited time only", and may revert to the $1M limit in 2013.

Second, it is advisable that all Estate Planning documents (particularly Revocable Trusts and Wills) be carefully reviewed to ensure that they continue to meet a client's wishes. Many Wills and Trusts are drafted with so-called "formula clauses". These provide for gifts to heirs based on a specified formula, which is often tied to the Federal Estate Tax laws. Because of the ongoing changes to Federal Estate Tax laws, gifts to heirs could also be changing, unbeknownst to the client!

For these reasons, I strongly encourage everyone who has (or should have) an Estate Plan in place to consult with their Estate Attorney, CPA, and Investment Advisor to ensure that their estate plans are still consistent with their wishes and effectively take advantage of the variety of available tax planning opportunities.

2010 Estate Tax Issues

2010-03-22T10:28:00.000-07:00

This year is a year of "unknowns" when it comes to Estate Taxes. What is the total Gift and Estate Tax Exemption? Will there be a retroactive tax? Will assets receive a step-up in basis? What is the applicable Gift Tax rate? Under the current law, what will the Gift and Estate Tax Exemption be in the future?

Answers to these questions lie primarily with Congress, and I expect that we will have them by the end of the year. However, there is an additional twist that could cause the confusion surrounding these questions to be drawn out into next year or even later. I'm referring to the Constitutional prohibition against ex post facto laws (laws enacted after the fact to apply retroactively). While the Supreme Court has previously upheld laws imposing retroactive taxes, there are many who question whether the current Court will do so in this case.

This uncertainty leaves us in a state of flux. Most tax professionals believe that Congress will enact legislation that will be substantially similar to the estate and gift tax laws which were applicable in 2009. In other words, all assets will be eligible for stepped up basises and the individual estate tax exemption will be in the $3.5M range. Because the vast majority of estates are valued at under $7M (for couples) or $3.5M (for individuals), legislation which retroactively brings back 2009's laws would benefit most estates.

"But wait, I thought there are NO ESTATE TAXES in 2010?" How is a retroactive tax beneficial? Good question. In itself, it isn't. What is beneficial is the Estate Tax's step-sister: the unlimited step up in basis which reduces or eliminates capital gains taxes. Currently, non-spousal beneficiaries of an estate are only entitled to step up $1.3M in estate assets.

What this means is that, in an estate valued at $3.5M, containing primarily highly appreciated assets, the heirs could face significant and unexpected tax liability in the form of capital gains taxes on up to $2.2M!

In light of the current uncertainty, my best advice is to discuss your situation with your attorney, CPA, and financial advisor, and do your best to stay healthy and alive through 2010.

Probate Basics

2009-12-17T16:57:00.000-08:00

"Probate" is a legal process through which assets are passed, typically with at least some court supervision, to a person's heirs. With limited exceptions, Probate is necessary to pass assets which have not otherwise been legally designated to pass to named beneficiaries.

A Probate estate will usually include personal property, such as money in the bank, jewelry or a car. It can also include real property, such as the person's home.

A Will is often used to direct distribution of assets through the Probate process. Where a valid Will exists, the beneficiaries named in the Will are entitled to receive the distributions designated in the Will. Otherwise, the estate will be divided among the person's heirs under California law.

Unfortunately, the Probate process is tedious and time consuming, so having professional assistance (or at least guidance) is practically essential.

"Trust Administration" is the term used to refer to the process of administering a trust. Usually this consists of paying estate debts and distributing assets to the trust's beneficiaries. It is generally considered to be less tedious and less time consuming than formal Probate, though getting professional guidance at the outset is always a good idea.

For more general information on the Probate process, I recommend reviewing the Sacramento County Superior Court's discussion, found at http://www.saccourt.ca.gov/probate/decedent-estate.aspx.

The Buy-Sell Agreement: An Essential Tool for Jointly-Owned Small Businesses

2009-11-10T14:29:00.000-08:00

One of the most common scenarios in business is for the owners part ways. This can occur under a variety of circumstances, ranging from disagreement over the continued management and direction of the business, to incapacity or death. Due to a lack of planning, this transition is rarely smooth.

Fortunately, a contingency plan can be created in advance by using what is known as a "Buy-Sell agreement". A well-planned and well-drafted Buy-Sell agreement is an excellent tool for business owners who seek to avoid disruption of a business upon the departure of one or more of its owners.

A Buy-Sell agreement is useful regardless of the entity form being used (LLC, corporation, etc.), and can be flexibly structured to meet a business's needs.

Most Buy-Sell agreements restrict the sale of an owner's business interest to an outsider. In a "cross-purchase" arrangement, the remaining business owners may be required to purchase the departing owner's interest for a fixed price, or for a price to be determined based on an appraisal or stated valuation formula. Purchase payments may be made in one lump sum, or may be structured over time.

As an alternative to a mandatory purchase arrangement, business owners may choose to utilize either a purchase option or a right of first refusal. A purchase (or "buy-out") option gives the remaining owners the option to purchase the departing owner's interest for a predetermined sum. A right of first refusal, on the other hand, gives the remaining owners the right to beat any third party's purchase offer.

A "stock redemption agreement" (also known as an "entity-purchase agreement") is another common form of a Buy-Sell agreement. In this type of agreement, the entity itself purchases the ownership interest of the departing owner. This type of Buy-Sell agreement is well suited for businesses with many owners.

Regardless of whether a cross-purchase, entity-purchase, or a hybrid of the two is used, cash will invariably be needed to purchase the departing owner's interest. Life insurance is commonly used for this purpose, but for obvious reasons is only available in the event of the death of an owner.

When using a stock redemption agreement, a business may choose to fund the buy-out with accumulated earnings and corporate profits. If this type of arrangement is utilized, care should be taken to avoid any unecessary and unexpected tax consequences.

Ultimately, business relationships really are much like romantic relationships. They require a lot of skill and a lot of effort to succeed. Even if the owners are on the best of terms, an unexpected death can really leave a business in a lurch. In the absense of a Buy-Sell agreement, the decedent's estate (i.e. spouse or children) will take over his or her ownership interest. Generally, the decedent's heirs lack the skills or the temper necessary to competently assume the decededent's ownership responsibilities. By using a Buy-Sell agreement, existing owners can effectively maintain valuable control over who they will be doing business with in the future. Of course, the Buy-Sell agreement also works to the benefit of the decedent's heirs, in that they will receive the purchase monies due upon the transfer of the decedent's ownership interest.

These are just a few of the many reasons I strongly encourage anyone who owns a business with others to consider the use of a Buy-Sell agreement. If you would like more information related to Buy-Sell agreements or other small business issues, please feel free to contact us.

Estate Planning Basics

2009-10-29T10:33:00.000-07:00

The idea of planning one’s estate is daunting for most. However, with the help of qualified professionals, the process can actually be enjoyable. While planning for death does remind us of our mortality, it should also remind us of our life and the good things around us, including our family and friends. And, it’s for our family and friends that we plan.

I have seen countless estates administered, some with pre-planning in place, others without it. Without exception, estates without planning in place are costly, time-consuming, and generally stressful to administer. Estates that have been properly planned, on the other hand, can be administered much more easily, much more quickly, and nearly always less expensively.

In addition to time and cost savings, some of the benefits to planning one’s estate include:

The ability to name the people to whom you wish to give your assets and know that your wishes will be carried out;
The ability to arrange your estate so that it pays as little in estate taxes as possible; and
The satisfaction of knowing that your financial affairs are in order and that you’re not bequeathing a costly administrative nightmare to your loved ones.

Having a basic estate plan in place is important, regardless of your net worth. Such a plan ensures that your family and financial goals are met after you die.

An estate plan has several elements: a will, power of attorney, and an advance healthcare directive (medical power of attorney). For most people, a trust and life insurance also make sense.

The first step in planning your estate is to take an inventory of your assets. Your assets include your investments, retirement savings, insurance policies, and real estate or business interests. Once you have done this, decide how you would like your estate distributed and whether you would like to place any restrictions or conditions on the distributions.

If you have minor children, it is always wise to have a Will, even if you have a Trust as well, as a Will is the best place to name your children’s guardians.

In addition to the basic estate planning documents that everyone should have, Living Trusts (also known as Revocable Trusts) are also wise to consider. Living Trusts are legal mechanisms that let you put conditions on how and when your assets will be distributed upon your death. Unlike Irrevocable Trusts, Living Trusts allow you to continue to have complete management power over and access to your assets during your lifetime. Upon your death, the terms of your Trust will govern the distribution of your assets. By using a Living Trust, your heirs will most likely save significant time and money in administering your estate.

If you would like more information regarding setting up an estate plan, please give us a call to schedule an appointment for a free consultation.

Irrevocable Life Insurance Trusts

2009-09-23T08:13:00.001-07:00

Life Insurance is an investment. Like other investments, its value is included in the total value of an estate when an individual passes away. Where the value of an estate exceeds the available estate tax exemption (see below), the excess amount will be taxed at up to 45%!

Therefore, if an individual has a large life insurance policy, he or she may unwittingly cause a significant tax liability to his or her estate.

In order to avoid having one's estate pay unnecessary estate taxes, an "Irrevocable Life Insurance Trust", commonly known as an "ILIT" (pronounced "eyelet"), should be considered.

An ILIT is an irrevocable trust, which means that once it established, it cannot be undone (revoked). It must be established for the benefit of someone other than the trustor (the person creating it) or the trustor's spouse. Most often, the trustor's children are named as beneficiaries. During the trustor's lifetime, regular contributions may be made to the ILIT. The contributions will be used to pay for the life insurance policy which is owned by the trust. If structured properly, these contributions will be treated as gifts, but will not be subject to Gift Tax. Upon the trustor's death, the ILIT will be paid to the named beneficiaries, but will not be subject to any estate tax!

*The available estate tax exemption in 2009 is $3.5M. However, this exemption is currently scheduled to revert to $1M in 2011.

Property Tax Implications of Grandparent-Grandchild Transfers

2009-09-21T14:36:00.000-07:00

It is commonly understood in California that, since 1986, property transfers between parents and children have enjoyed an exclusion from property tax reassessments. While there are some limitations, the vast majority of parent-child transfers of real property qualify for this broad exclusion.

While it would be natural to assume that this parent-child transfer exclusion applies equally to transfers between grandparents and grandchildren, the law is actually much more restrictive for such transfers. There is a grandparent-grandchild exclusion from property tax reassessment, but it is subject to the requirement that all parents of the grandchildren who qualify as children of the grandparent(s) be deceased at the time of the transfer; otherwise, the transfer is subject to property tax reassessment.

So, who qualifies as a "child of the grandparent(s)"?

Revenue & Taxation Code Section 63.1 defines a "child" as: 1) a child, 2) a stepchild or spouse of stepchild, 3) a son-in-law or daughter-in-law, 4) an adopted child if adopted before reaching 18 years of age, or 5) a foster child of a state-licensed foster parent.

Let's look at a hypothetical scenario to see how this works. Upon his death, Grandpa Jones wants his residence to pass to his grandson, Jimmy. Jimmy's father, Brian, was Grandpa Jones' son, but he is deceased. His widow, Janice, has not remarried. If Janice is still living and has not remarried at the time of Grandpa Jones's death, the property transfer to Jimmy will be subject to a property tax reassessment because Janice qualifies as a living child of Grandpa Jones. However, if Janice remarries or predeceases Grandpa Jones, the transfer to Jimmy will not be subject to property tax reassessment because after Janice's remarriage she no longer qualifies as a "child" of Grandpa Jones.

There are many potential pitfalls to be avoided when transfering property to a family member. Therefore, if you are considering a parent-child or grandparent-grandchild transfer of real property, it is highly recommended that you seek the advice of a competent attorney prior to the transfer.