The IRS has released the Applicable Federal Rate tables for June 2012, and the rates remain very low.  

The annually compounded Short-term (0-3 years), Mid-term (3-9 years), and Long-term (9+years) rates are .23%, 1.07%, and 2.64% respectively, and the Section 7520 Rate (used to value annuities, remainders and reversions is 1.2%.

It continues to be an excellent time to use intra-family loans and estate freeze transactions for income, gift, and estate tax planning.

My wife and I are expecting our third child any day now, so when I saw Erik Canter’s post over at Forbes.com on financial and estate planning for new parents it caught my attention.  It is generally a good article, with solid advice.  He suggests that new parents update their estate plans, which includes their Wills and/or their Revocable Trust documents, powers of attorney and living wills, and any beneficiary designations for retirement accounts and life insurance.  He also suggests that parents re-evaluate life insurance coverage, review the family budget, and begin planning for college expenses.  These are all important steps for new parents.

However, there is one critical error in Erik’s advice.  He appears to suggest that parents should name their child (or children) as a beneficiary of life insurance and retirement benefits directly, which is almost always a terrible idea.  This is because minors are not allowed to manage their own property, and if on the parent’s death a minor child is designated to receive insurance proceeds or retirement benefits directly, a Court will have to appoint a Guardian of the Estate to hold the property for the child until adulthood.  

Having a Guardian of the Estate appointed requires formal legal proceedings which will produce additional legal fees (usually well in excess of the cost of planning to prevent the situation).  Also, the time it takes to obtain an appointment of a Guardian of the Estate may cause delay in the distribution of funds which are often needed for the child’s immediate care.  In addition, in Pennsylvania, a surviving parent may not be appointed as sole Guardian of the Estate (i.e. a co-guardian is required).

Just as troubling, when a child turns eighteen the Guardian is legally required to distribute all of the property to the child directly.  I think that generally speaking, teenagers do not have the life or financial skills required to manage significant wealth.  Also, if life insurance was intended to provide for the child’s higher education, distributing the proceeds (perhaps hundreds of thousands of dollars or more) at age eighteen may have the exact opposite effect.

It is far more advisable to name a trust for the child as the beneficiary.  The trust can be established in the parent’s Will, as part of a Revocable Trust, or even as a stand-alone document.  Using a trust reduces the chance that a Guardian of the Estate will need to be appointed and allows parents to ensure a trusted adult will have control of a child’s inheritance until the child is old enough and mature enough to handle the responsibility.  

It is very important for parents to update their estate plans when they have a child, and beneficiary designations are critical components of a comprehensive estate plan.  That is why parents should make sure their designations name trusts for their minor children as the beneficiaries, and never as the beneficiaries directly.

With summer just around the corner, employers are inundated with requests by students for summer internships. If your company offers such opportunities, taking a few moments to review the applicable regulations will help assure that the program complies with the law.

It goes without saying that a paid intern is an employee and subject to all applicable state and federal employment laws including those pertaining to minimum wage and overtime. Even if the internship is unpaid, failure to follow Department of Labor guidelines could lead to legal liability under the Fair Labor Standards Act.

Department of Labor Guidelines

The Fair Labor Standards Act (the FLSA) provides, of course, that individuals in an employment relationship must be paid for services performed. When is an unpaid intern an employee? According to guidelines published by the Department of Labor, if the following factors are met, there is no employment relationship and the intern need not be paid:

The internship, even though it includes actual operation of the facilities of the employer, is similar to training which would be given in an educational environment;

The internship experience is for the benefit of the intern;

The intern does not displace regular employees, but works under close supervision of existing staff;

The employer that provides the training derives no immediate advantage from the activities of this intern;

The intern is not necessarily entitled to a job at the conclusion of the internship; and

The employer and the intern understand that the intern is not entitled to wages for the time spent in the internship.

If all of these factors are met, the Department of Labor will conclude that an employment relationship does not exist under the FLSA. In such circumstances, minimum wage and overtime provisions do not apply to the intern.

Different rules apply for governmental agencies and non-profit organizations. Internships offered by governmental agencies, private non-profit food banks and non-profit organizations providing religious, charitable, civic, or humanitarian services are generally permissible so long as the intern volunteers his or her time freely and without anticipation of compensation.

A permissible unpaid internship will include some or all of these features:

1. It is structured around a classroom experience as opposed to the employer’s actual operations;
2. Academic credit is offered by a sponsoring institution;
3. The internship provides the intern with skills that can be used in multiple employment settings as opposed to specific training in the employer’s operations;
4. The intern does not perform the routine work of the employer;
5. The employer is not dependent upon the work of the intern;
6. Job shadowing opportunities that allow an intern to learn certain functions under the close and constant supervision of regular employees, but the intern performs no or minimal work.
7. The internship is of a fixed duration established at the outset of the internship.

Factors which indicate an employment relationship (and trigger the requirement to pay wages) include:

1. The intern is engaged in the operations of the employer;
2. The intern is performing productive work such as, for example, filing, clerical work or assisting customers;
3. The employer uses interns in lieu of hiring additional employees or offering more hours to existing employees;
4. The intern receives the same level of supervision as other employees;
5. The intern is offered employment to begin immediately upon the conclusion of the internship, effectively transforming the “internship” into a trial period of employment.

Summer internships, paid or unpaid, provide valuable experience to students. Employers need only exercise some caution is structuring the internship to avoid running afoul of DOL regulations. The DOL Fact Sheet on summer internships is available at http://www.dol.gov/whd/regs/compliance/whdfs71.htm

Just to add to Tim’s analysis , for those considering using a GRAT, now is the time to act. GRAT’s have been closely scrutinized for years, and there has been some discussion, for quite some time, that new legislation could set a minimum GRAT term, or eliminate the technique altogether. Tim also touched upon the use of valuation discounts to further bolster the benefit of a GRAT. You may not be surprised to learn that valuation discounts have also been closely scrutinized, and the opportunity to use them may be severely curtailed, or eliminated altogether, by new legislation.

Finally, the potential tax savings which could result from the use of the GRAT has been magnified by 2010 tax laws which gave tax payers a 5Million ($5,120,000 in 2012) lifetime gift tax exemption for asset transfers. Immediately prior to this legislation, the lifetime gift exemption had been limited to $1,000,000. Many estate planners believe we may return to a $1 Million lifetime gifting exemption in 2013, which would severely limit the potential tax benefit of using a GRAT in the future when compared to the current opportunity.

A recent post by Deborah Jacobsat Forbes.com discussed Facebook’s founder, Mark Zuckerberg’s possible use of tax planning techniques to make large tax free gifts. Ms. Jacobs’ post points to footnotes, contained in the offering statement, which indicate Zuckerberg and several other Facebook executives are each a trustee of their own annuity trust. Jacobs believes these footnotes suggest each of them have established a grantor retained annuity trust (GRAT), and I think that is a reasonable inference. GRATs can be a very effective wealth transfer tool, particularly where rapidly appreciating assets are used. I think stock in a company which has changed the way a large portion of the population interacts with each other qualifies as such an asset, even more so when the stock will soon be offered in the largest tech IPO in history.

A GRAT, for which there is expressed authority in the tax code, involves the transfer of assets to a trust in exchange for an annuity payment for a set number of years. The value of the annuity interest is calculated based on the size and term of the annuity, along with an imputed interest rate prescribed by the IRS (the section 7520 rate). The difference in value between the assets transferred and the annuity interest retained by the Settlor is a gift, but if the values are the same there is no gift.

This is where the magic comes in. If the assets transferred appreciate at a rate higher than the section 7520 rate, which is currently 1.4%, the trustee can make all of the required annuity payments and all the excess appreciation is effectively transferred with no gift tax liability. Between 1965 and 2005 the average rate of return in the first 21 days following an IPO was 22%.

Jacobs suggests that Zuckerberg transferred a little over 3.6 million shares at a value of $0.83/share for a total value just above $3 Million. She assumes that the Facebook stock appreciates 3.6% for 4 years, and in year five the company goes public at $40/share. At the end of a five year GRAT term, Zuckerberg’s trust could hold more than $37 Million worth of stock, without incurring gift tax, a potential $17 Million in tax savings for his heirs.

But you do not need to be worth $17.5 Billion (Zuckerberg’s estimated wealth) to make a GRAT work for you, and you don’t have to own the next Facebook. At AMM we have helped clients who own companies whose stock is expected to appreciate in the near to mid-term use GRATs with great effectiveness.

As a general illustration, let us take a corporate executive (unmarried with a net worth of $8 Million), who over the course of several years has received stock grants as part of his compensation for a privately held company. The stock, valued at the IPO offer price, is worth $1,000,000. If that executive transferred his stock into a GRAT this month and took back approximately $150,000 for 7 years, there would be no gift on the transfer. If the Trustee then cashed out the stock interest in the first three weeks following the IPO, invested the proceeds and earned 5% a year, at the end of the GRAT term the trust would own assets worth $470,000, a potential $211,000 in tax savings.

In addition, the estimated tax savings do not include the possibility of a lower valuation if the transfer is done several years before the IPO is planned, and if the Trustee thinks the originally held stock will out-perform the market (maybe it is Facebook stock) there is no requirement to liquidate and diversify. Also, the estimated tax savings do not take into account possible valuation discounts which may be available on transfers of minority interests in private companies (which can easily be 30% or more). With respect to the above example, $211,000 is probably a conservative estimate of the savings produced by a well designed GRAT.

Moreover, you don’t need to be looking at an impending IPO to use a GRAT. Any asset which is expected to appreciate at a rate above 1.4%, or an asset which currently has a depressed value, but is expected to rebound, may also be good. Closely-held stock, real estate, and even a portfolio of publically traded securities are assets which can be used to fund a GRAT.

The GRAT is one of many tax planning techniques that can be used by wealthy taxpayers to reduce their tax burden. By Ms. Jacobs’ estimates, Mark Zuckerberg and his colleagues may have used GRATs to transfer almost $205 Million dollars without tax; potentially saving them nearly $92 Million in taxes. All wealthy taxpayers have this same opportunity, now that is something to “Like”.

My colleague, Alan Wandalowski, has some additional commentary on opportunities with GRATs, here.

Earlier this year, manufacturers (including importers of record) became subject to several new children’s product safety rules: the lead substrate, phthalate and ASTM F963 mandatory toy safety standards. These standards join the small parts and lead paint rules, which have been in effect for some time. Several recent actions by Congress and the CPSC, however, provide limited relief for certain manufacturers from these standards.

The CPSC approved a component testing rule as a response to industry concerns about the burdens of product testing and duplicative testing. The component testing rule, which went into effect in December 2011, permits manufacturers to obtain certificates from suppliers of component parts and to rely on those certificates, as long as the manufacturer uses “due care” to justify such reliance. This is critical, since the manufacturer is still responsible for its product’s compliance with the underlying safety standards. Therefore, manufacturers have to be vigilant in maintaining extensive documentation, including copies of the certificates on which they rely, along with the third party test reports.

In August 2011, Congress enacted H.R. 2715, which amends the CPSIA and the CPSA. H.R. 2715 offers a reprieve for small businesses that manufacture a limited quantity of products. As a result of H.R. 2715, the CPSC is required to develop alternative, low-cost testing requirements for small manufacturers. In response, the CPSC promulgated a rule that provides that small batch manufacturers are exempt from certain third party testing requirements for covered products. To be considered a “small batch” manufacturer, a business must have no more than $1 million in gross revenue from sales of consumer products in the previous calendar year. “Covered products” are those of which the manufacturer made no more than 7,500 units in the previous calendar year. To qualify for the exemption, a manufacturer must first register with the CPSC as a small batch manufacturer (go to www.SaferProducts.gov). Following this registration, the manufacturer will be exempt from some, but not all, third party testing requirements. The exemption applies to the lead content, phthalate, and ASTM F963 mandatory toy safety standards. It does not provide relief from the lead paint rule, children’s metal jewelry standard or rules relating to infant and toddler products. While the exemption provides relief from certain third party testing requirements, the manufacturer is still required to certify that products comply with the underlying safety standards.

Another significant change could provide a respite from the tracking label requirement for some manufacturers. The CPSC now has the authority to exclude certain products from this requirement or to provide alternative labeling requirements if the statutory tracking label requirements are determined not to be practicable for those products.

Two guys are sitting at a bar discussing how they are going to quit their current jobs and start their own business. A lawyer sits next to them, overhears their happy ramblings and pipes in, as lawyers always do, that their mutual promise to devote 100% of their working energy to the new biz has to be reduced to writing. You know this joke, right?

Well, maybe not, and maybe it’s not such a knee slapper anyway. Under Delaware’s Limited Liability Company Act (the “Act”), a person may be admitted to a LLC as a member and may receive a LLC interest without making a contribution or being obligated to make a contribution to the LLC. If an interest in a LLC is to be issued in exchange for cash, tangible or intangible property, services rendered or a promissory note or obligation to contribute one or more of these items, however, the LLC’s operating agreement can and should, identify that obligation. The Act goes further and makes it clear that the operating agreement may provide that a member who fails to perform in accordance with, or to comply with the terms and conditions of, the operating agreement shall be subject to specified penalties or consequences, When a member fails to make any contribution that the member is obligated to make, the operating agreement can provide that such penalty or consequence take the form of reducing or eliminating the defaulting member’s proportionate interest in a LLC, subordinating the member’s interest to that of nondefaulting members, a forfeiture of that interest, or a fixing of the value of his or her interest by appraisal or by formula with a forced redemption or sale of the LLC interest at such value.

If only our clients made it easy on us by letting us write agreements with such detail! A more common scenario is the member who wants us to get rid of the 50% member, formerly a dear buddy, who walked out the door for whatever reason after a few months (or, even worse, walks in and plays on the computer all day doing nothing that needs to be done). Unfortunately, without an operating agreement that clearly identifies expectations with respect to contributions of services and remedies for breach, it is a challenge to argue the defaulting member forfeits his or her interest for failure of consideration as s/he might for failure to “pay” for the interest with cash or property.

While I continue to look out for case law in support of the idea of forfeiture in the context of LLCs, a recent Kansas case did address alternative remedies for breach of obligations with respect to contributions of cash.   In Canyon Creek Development, LLC v Fox, the court struggled with the appropriate remedy available to a LLC when a member failed to satisfy a required capital call. The defaulting member, Fox, argued that he should not be held personally liable for the nonpayment of a post-formation capital contribution where the only remedy set forth in the operating agreement was a reduction of his ownership interest. Interpreting a statute that appears to be similar to the Act, the court ultimately agreed with Fox, making a distinction between the initial contributions (which could be in the form of cash or services, measured by their “net fair market value”) and later capital infusions which had to be in cash (unless the manager otherwise consented). The court concluded that the statutory default rule that a member is obligated to perform any promise to contribute cash or property or perform services, even if a member is unable to perform, supports the proposition that a member may be required, at the option of the LLC, to contribute an amount of cash equal to the agreed value of any initial, unmade, contribution. The court stated this was the law even where the LLC may have other rights against the noncontributing member under the operating agreement or other law. Turning to subsequent capital calls, however, the court found it significant that the remedy of cash damages, the most fundamental remedy for breach of contract, was conspicuously absent from the provisions of the operating agreement. Thus, the court concluded that the failure to include such a fundamental remedy as damages when a member fails to contribute additional capital after the LLC’s initial capitalization was not an oversight, but rather expressed a clear intent that damages are not recoverable from a member who failed to contribute additional capital after the venture was up and running. In the Fox case, the right to reduce the breaching member’s LLC interest was all that the LLC could do to punish the breaching member. No divorce, but better than a non-collectable judgment for a sum certain from my perspective.

In a recent case that may not bode well for the enforcement of noncompete agreements in Pennsylvania and New Jersey, the Virginia Supreme Court reversed twenty years of Virginia precedent relating to noncompetes, agreements pursuant to which an employee agrees not to compete with an employer for a period of time after the termination of employment. Until this recently, Pennsylvania, New Jersey and Virginia had similar laws relating to noncompetes. Historically, courts in all states have not looked favorably on such agreements, and have used various tools to limit or deny enforcement of noncompetes. Prior to the court’s decision in Home Paramount Pest Control v. Shaffer, the law in Virginia was similar to Pennsylvania law: a Court could re-write overbroad noncompete agreements so that the document was consistent with the employer’s protectable interests. In Home Paramount Pest Control, the court stated that it would no longer re-write such provisions, and that it was free to refuse to enforce a noncompete that was overly restrictive.

The former employee in Home Paramount Pest Control signed a noncompete agreement that prohibited him from competing with his former employer’s fumigation business in any manner, in any geographic area where he worked for Home Paramount Pest Control for a period of two years after his termination. Prior to this case, it was well settled that if the court found the restrictions of the noncompete broad, it could rewrite the document and enforce more reasonable provisions. The court generally exercised its re-writing power to limit the geographic or temporal scope of the document, or to find that specific conduct did not violate a noncompete if the employer could not articulate a protectable interest in prohibiting the conduct, even where the clear language of the agreement prohibited the competitive conduct. Generally speaking, “protectable interest” means that the employer has provided something to the employee that it has the right to protect, such as access to trade secrets, or specialized training. If the restriction on future employment did not match a protectable interest, the court would not enforce the restriction.  

In Virginia at least, this is no longer the case. The Virginia Supreme Court noted that it had “incrementally clarified” the law relating to noncompetes so dramatically over the past two decades that it was free to find the noncompete unenforceable in this case. Most interestingly, the court focused on language that lawyers generally believe is good drafting. The agreement in question contained a list of prohibited activities designed to address every conceivable kind of competition, as well as the ubiquitous “in any capacity whatsoever” catch-all for good measure. The court found that the employer could not articulate a protectable interest that would justify such a sweeping prohibition. Specifically, the court was looking for a nexus between the employee’s job duties, and the prohibitions imposed by the noncompete.

In the good old days, the court would simply have revised the agreement to remove whatever restrictions were too broad, such as the “in any capacity whatsoever” language. Or, the court may have found that there was no protectable interest in prohibiting the employee from engaging in his current employment. But the Virginia Supreme Court refused to do so, noting that incremental changes in the law required a different result. I will not bore the reader with the court’s very interesting discussion of how the doctrine of stare decisis applies to the case, except to note that the court recognized its decision as a departure from well-settled law.

While this case does not apply in Pennsylvania or New Jersey, many states have seriously limited the enforceability of noncompetes. We are making sure to discuss these issues with our clients, and draft noncompetes as narrowly as possible.   We are also thinking creatively about other solutions to the problem of competition, trade secrets and specialized training, such as non-solicitation provisions. The Virginia Supreme Court has given us new reasons to draft carefully.

The IRS has released the new applicable federal rate tables for March 2012, and they remain the same as they were in February.  The Short Term (0-3 years) rate is .19%, the Mid-Term (3-9 years) rate is 1.08% and the Long Term (9+ years) rate is 2.65%, with annual compounding. The I.R.C. § 7520 Rate, used to calculate the value of annuities, life interests, and remainders, remains at 1.4%See Rev. Rul. 2012-9.

It continues to be a favorable environment for Federal Estate, Gift, and Generation-Skipping Transfer tax planning, as the use of many common estate freeze techniques including grantor retained annuity trusts (GRATs) and installment sales to grantor trusts (IGTs) work best when interest rates are low.