Luxury Property | Special Purpose Entities | SPE

Luxury Property Special Purpose Entities

Portions of this article were originally printed in Dallas Bar Association Headnotes, December 2017.

Luxury Property | Yacht | SPE | Special Purpose Entities

When it comes to luxury property, such as beach houses, lake houses, ski condos, hunting leases, aircraft, watercraft, limousines, and the like, two rules almost always apply:  First, they are expensive to own and operate.  Second, they tend to sit dormant much of the time.  In order to spread out costs, decrease waste, and mitigate damage, it often makes sense for multiple owners to combine resources and share ownership of this type of property.

Whether friends or family, parties wishing to maximize these advantages often hold the property in special purpose entities or “SPE”.  But ownership of luxury property involves legal and practical problems that differ from those of the standard, for-profit world.  The tips below will help practitioners recognize and address the problems.

Entity Choice

LLCs are generally the entity of choice for luxury property SPEs in Texas.  General partnerships lack appropriate liability protection, while limited partnerships are more expensive and complicated.  Although double taxation may not be an issue, corporations nonetheless raise tax concerns, such as increased potential for violating the nonrecognition provisions of IRC §351.  Also, LLCs provide a level of privacy which can be valuable.

Usage Rules

Parties to a luxury property SPE must determine how, when, and by whom the property can be used.  Options include reservation systems, drawing lots, or simply a first come, first served rule.  Similarly, guests, family members, pets, and smoking should be addressed. Parties should also expressly permit or forbid outside rental of the property.

Contributions

Rules for sharing costs and expenses are also very important.  Who will determine what expenses are proper?  How and when will contributions be required?  Should costs be shared pro rata, per capita, or otherwise?  Many usage charges are difficult to track, which leads to infighting.  Requiring users to pay for fuel may be appropriate, but allocating a hangar fee may not.  Also, budgeting for expenses well in advance and providing limitations on increases can provide comfort.

Penalties are another important concern.  Unlike for-profit entities, luxury property SPEs require regular cash contributions for upkeep, taxes, and other expenses, so mechanisms are required to hold owners to their obligations. Thus, interest charges, as well as forfeiture of usage, voting rights, or even the ownership interest itself may be appropriate.

Contributions must be carefully defined.  If Uncle Bob takes his favorite recliner to the ski condo for a few years, is it contributed or can he take it back?  Answers to such questions will depend on the circumstances and may change over time.

Management

Especially where many owners are involved, appointing and empowering capable managers is important.  Expecting family factions to agree on a cable package for the old family homestead is unrealistic.

Managers’ powers should provide flexibility because they may need to make quick decisions.  A company agreement can provide broad direction and allow managers to set specific policies and procedures internally, allowing for simpler, quicker amendments.

Ownership and Voting

Permissible owners of luxury property SPEs should be well defined.  Transfers within this class should be easily made, while transfers outside the class should be difficult, but not impossible.  Similarly, assignees’ rights should be clearly defined, particularly in the context of unintended transfers.  For example, should assignees hold usage rights?  Also, it may be helpful to limit ownership by disallowing fractionization of interests.  For example, transferees receiving less than a whole unit might can be made assignees until the entire unit is held by one person.

Voting rights present other problems.  Small luxury property SPEs will likely function better with a per capita voting whereas larger ones work best where votes are cast pro rata.  Also, the threshold for supermajority voting should typically be lower with a luxury property SPE than with a for-profit enterprise because the entity represents a liability to its owners and they should have a more available exit strategy.

To summarize, many of the above considerations either play out differently or simply do not apply in the context of for-profit companies.  Further guidance can be found in the rules applicable to social clubs and fraternal organizations.  Unlike those organizations, however, additional flexibility is required with a luxury property SPE.  If the parties are willing to exercise good planning, show a little patience, and adapt their systems, they will reap great benefits.


Christian Kelso | Farrow-GIllespie & Heath LLP | Dallas, TX

Christian S. Kelso, Esq. is a Senior Associate at Farrow-Gillespie Heath Witter, LLP.  He draws on both personal and professional experience when counseling clients on issues related to estate planning, wealth preservation and transfer, probate, tax, and transactional corporate law.  He earned a J.D. and LL.M. in taxation from SMU Dedman School of Law.

FBAR deadline is April 18

The annual due date for filing Reports of Foreign Bank and Financial Accounts (FBAR) for foreign financial accounts has been changed from June 30 of each year to April 15.  This date change was mandated by the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, Public Law 114-41 (the Act).  Section 2006(b)(11) of the Act changes the FBAR due date to April 15 to coincide with the federal income tax filing season.

All United States citizens and permanent residents who own or have signing authority over financial accounts valued in the aggregate at more than $10,000 and located outside the United States must file the annual FBAR report.  Penalties for failing to do so include criminal prosecution and forfeiture of up to 100% of the funds in the foreign account(s).

Extensions

The maximum extension for filing the FBAR is six months, to October 15.  Filers who fail to meet the FBAR annual due date of April 15 will receive an automatic extension to October 15 each year.  Accordingly, specific requests for this extension are not required.

Deadline for 2017

Because of the Washington D.C. holiday that falls in 2017 on April 15, the due date for FBAR filings for foreign financial accounts maintained during calendar year 2016 is April 18, 2017, corresponding to the federal income tax deadline.

For more information, contact Liza Farrow-Gillespie or Christian Kelso.

Digital asset planning

As technology advances over time, the average person owns more and more digital assets. The definition of digital assets is very broad and includes intangible assets ranging from online accounts, such as bank accounts, email accounts, and social media, to digital files stored on a computer or in the cloud.  Traditional estate planning tools have been useful in dealing with comparable non-digital assets, such as by allowing a person’s fiduciary to deal with a bank in person. However, the efficacy of traditional estate planning tools on digital assets is still unclear.

Digital Assets Under Federal Law

While most issues of property disposition are handled by state laws, digital assets are usually controlled at the federal level because of their interstate nature. Original guidance was offered by the Electronic Communications Privacy Act of 1986 (ECPA)’s Stored Communications Act (SCA).  The SCA allows digital asset providers to deny access to anyone, but includes a now-abused “lawful consent” exception.  The exception is not applied uniformly between states and is therefore unclear and unhelpful.

Digital Assets Under Texas State Law

More recently, twenty-three states have passed the Revised Uniform Fiduciary Access to Digital Assets Act (RUFADAA) in some form, which provides specific guidance on how to distribute digital assets upon death. RUFADAA allows a person’s fiduciary, such as an agent or executor, access to online accounts if the person explicitly grants the power in an estate planning document or through a service provider’s own procedures.  RUFADAA also allows the fiduciary to determine how to distribute and manage the assets after the person’s death.  RUFADAA was filed in the Texas Legislature on February 21, 2017 for consideration during the 85th Regular Session.

In states that have not passed RUFADAA, planning for the disposition of digital assets remains unclear. Most digital assets will be governed by the user’s licensing agreements, which vary over time and between assets.  More certainty will likely arise as these assets become more prevalent.

Estate Planning for Digital Assets

Whether or not the Texas legislature adopts RUFADAA, special considerations for digital assets should be included in every estate plan. The attorneys at Farrow-Gillespie & Heath, LLP understand the issues digital assets present and are prepared to help clients address them in a way that is appropriate for each client’s particular situation.

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About the Author

Catherine Parsley is currently (March 2017) an intern at Farrow-Gillespie Heath Witter, LLP.  Ms. Parsley is a law student at SMU Dedman School of Law in Dallas, Texas, where she is a staff editor of the SMU Law Review.  Catherine served as a judicial extern for Chief Justice Nathan L. Hecht, of the Supreme Court of Texas.  She holds a B.S. in communications studies, cum laude, from the University of Texas at Austin.

It’s time to make your 663(b) trust and estate distributions!

Christian Kelso | Farrow-GIllespie & Heath LLP | Dallas, TX

Contact Christian Kelso to guide you through the estate planning process.

Trusts and estates often pay more tax than individuals in like circumstances.  This is not because they are taxed at higher rates, but rather because the same rates applicable to individuals are “compressed,” meaning that each marginal rate increase happens at a lower level of income than it does for individuals.  For example, the highest rate of income tax for both trusts and individuals for 2016 was 39.6%, but whereas this rate only applies to income over $415,050 for single individual filers, for trusts and estates, this rate applies to all income over $12,400.  Other tax burdens, such as the 3.8% Net Investment Income Tax (a/k/a the “Obamacare Tax”) and higher rates of capital gains tax follow suit along similar lines.  Obviously, these add up to a significant potential tax burden.

Fortunately, there is a way to mitigate this tax burden.  Trusts and estates may take a deduction for “distributable net income,” which is generally the amount of income that is distributed from the trust to a beneficiary.  When this happens, the income is effectively shifted from the trust to the beneficiary, who simply adds it to their personal return and pays at whatever rate is applicable to them (including the distributed trust income, of course).

Since large amounts of unnecessary tax can be avoided by shifting income to beneficiaries in this manner, it is common practice for trustees to make distributions for this purpose, assuming, of course, that such distributions are permissible and proper under the terms of the trust.  But there is a problem:  How does the trustee know how much income to distribute from a given trust before the close of a given tax year?  Unfortunately, it is impossible, to know exactly how much income a trust has until after the tax year has closed, at which point, it’s too late to distribute all the income.

Enter IRC §663(b).  Under this special provision, a trust or estate may elect to treat any distribution made within the first 65 days of a given tax year as having been made on December 31 of the previous year.  In other words, the trustee gets 65 days after the actual close of the year to calculate how much income should have been distributed and then actually make that distribution.  The trustee then makes an election on the trust or estate’s income tax return (Form 1041) and voila, the problem is solved!

Although §663(b) distributions may provide a significant benefit, the can also represent a significant danger to trustees.  On the one hand, any distribution from a trust should only be made if and to the extent it is proper under the terms of the trust.  Even if such a distribution is permissible, it may not be in the best interests of a given beneficiary, as taxes are only one of many considerations.  On the other hand, a §663(b) distributions can save a significant amount of tax, so failing to make such a distribution, if permitted, could subject a trustee to liability for waste.

Making the right decision requires careful analysis.  The fiduciary attorneys at Farrow-Gillespie Heath Witter, LLP are well-versed with the applicable law and have the practical experience to understand the nuanced process that is involved with make the right decision.  If we can help you with this, please don’t hesitate to call.

The trust and estate planning attorneys at Farrow-Gillespie Heath Witter LLP, located in downtown Dallas, serve all of your trust and estate planning needs, including:

  • Estate planning for small estates
  • Estate planning for large, taxable estates
  • Trust review and modification
  • Trust and estate administration
  • Trust litigation
  • Will contests
  • Probate
  • Heirship proceedings
  • Guardianships

Family Governance Arrangements: Putting the SUCCESS into succession planning

Christian Kelso | Farrow-Gillespie & Heath LLPBy Christian Kelso
June 4, 2016

It is a little known fact, but the über-rich have a trick for both keeping the peace in their families and preserving their vast fortunes. They participate in something called family governance planning.  Most of us are unfamiliar with this concept, but it’s not difficult to grasp on a fundamental level.  Put simply, family governance has two parts:  First, it involves identifying and agreeing on specific goals which a family can actively pursue.  Second, it involves establishing rules by which those goals will be pursued and what each family member will contribute in the furtherance of that pursuit.  In other words, family governance charts a course for the family unit and provides clarity and transparency among and between the individual family members so that they can function more cohesively as a group.

Most families fail to conduct any family governance planning whatsoever. And they often pay for it in the form of costly legal disputes, intra-familial discord and lasting, emotionally-charged feuds.  Family governance seeks to minimize this negativity by addressing some or all of the following:

  1. Expectations regarding wealth;
  2. Caring for elderly family members;
  3. Employment within the family business;
  4. Investment and management of family assets;
  5. Procedures for resolving grievances;
  6. Spousal issues;
  7. Enfranchisement and training of younger generations; and
  8. Charitable giving.

Different families will apply family governance strategies to varying degrees depending on a number of factors, such as size of the family, relative ages of the family members, assets held by the family, status of existing family relationships and quite a few more. Thus, every structure is necessarily bespoke and it is usually quite helpful to have a professional guide who can provide guidance, technical clarity and an unbiased third-party perspective.

At the highest levels, comprehensive family governance planning may include some or all of the following:

  1. Regular family assemblies
  2. Family mission statement;
  3. Family constitution;
  4. Formalized narrative of family history and traditions;
  5. Family counsel tasked with dispute resolution;
  6. Various committees (i.e. Investment, Education, Administrative, Charitable, etc…);
  7. Trustees;

Typically, larger, wealthier families will employ more of these components while families of more modest means will employ less. At a minimum, however, regular (usually annual) family assemblies are necessary to identify the extent to which various components are needed and flesh them out.  These assemblies often take the form of a family vacation or reunion where participants are encouraged to both work and play.  A typical family assembly agenda (which in certain circumstances can even be deductible for income tax purposes) might look like this:

A family assembly will usually begin with an initial session to set the tone for the assembly, as well as the goals and ground rules. Steps should be taken to avoid disillusionment by family members because participation by all relevant players is crucial.  Therefore, the patriarch or other organizer should avoid talking down to the other family members and focus on listening to their thoughts and opinions.  That said, it should be clear from the start that the purpose of a family assembly is not to voice grievances, assign blame or point fingers.  Rather the focus should be on moving forward towards a common goal.  At the end of the day (or weekend or week), the primary goal should be for everyone in the family to “get on the same page” about family business, relationships and expectations.

After setting the initial tone and ground rules, the family may benefit from some exercise designed to promote what the military calls “unit cohesion.” That is, a discussion designed to get the family pumped up about its own history and traditions.  Discussions of family heritage, retelling of family lore and recognition of individual accomplishments (i.e. since the last family assembly), may help motivate the family to proceed with the work ahead.  The family should also acknowledge the extent to which it was able to meet its goals as set out in the previous family assembly.

At this point, the family mission statement should be restated and evaluated. Note that this is done before the new goals are set out because the adoption of new goals will be guided by the family mission statement.  That is, goals that do not fit within the mission statement probably should not be adopted.

Often times, this discussion is best had over dinner with a little (but not too much) drink. It also provides an opportune time to incorporate and educate spouses.  Remember, the directive to have fun at a family assembly is just as important as the conduct of business.

The next step is to report on the status of family affairs and set expectations. This will often be the point at which the patriarch does the most talking.  He or she should describe with appropriate specificity the outlay of the family’s assets and liabilities.  An accurate description of his or her estate plan is also germane to this part of the meeting and should be made in front of all relevant family members with complete transparency.  The implications, tax and otherwise, of any estate planning techniques should also be explained to each expectant beneficiary so that they can have clear expectations of what is to come and avoid being blind-sided by confusing legal jargon and unintended consequences when the time finally comes.

When discussing his estate plan, a patriarch should make sure to declare his intentions regarding how beneficiaries are to enjoy their inheritance and put them on notice of any restrictions on the use of property. Clarity with regard to the enjoyment of property held in trust can go a long way to reduce friction between beneficiaries and trustees.  Thus, the patriarch should state whether he or she intends for future generations to enjoy the estate assets liberally, as a nest egg, or only as a safety cushion.  Some mention should also be made regarding the ability of spouses to benefit from the estate.  Finally, there will almost always be tax-based restrictions placed on assets held in trust.  These along with any others (for example promoting certain behaviors) should be made clear.

This portion may be the most difficult for the patriarch. For starters, discussing wealth remains extremely taboo in our society.  However, in controlled circumstances, these discussions can literally save future generations from ruin, so it may be helpful to view openness as a lesser evil.  One way to mitigate apprehension in this regard is to set clear expectations for family members with regard to keeping family matters confidential.  Also, clear policies for when and how such information may be brought up with younger family members will likewise provide comfort.  In any event, a balance must be drawn between the need to promote family unity and the desire to avoid embarrassment (or worse) if details are made public.

Once family members have been apprised of the family’s overall status, they can go about setting goals for the future. This may be a tricky part of the program, because family members may not understand what options are available as family goals or the extent to which their eventual achievement might be realistic.  But this part can also be the most fun because it affords the individual family members the opportunity to think outside the box and provides them with the opportunity to plan with hope in their hearts about the future.  The nature and extent of the particular goals will vary widely from family to family.  Within a family, the goals will likely change over time as well.  To the extent there is a large family business, a stronger focus on business objectives will be needed.  These might include some discussion of:

  1. Goals relating to growth;
  2. Acquisition or divestiture of assets;
  3. Development of new products or services;
  4. Employee matters (including hiring family members or others);
  5. Tax matters.

Other families, however, might focus more attention on personal goals such as:

  1. Family members’ education (i.e. high school, college and/or professional degrees);
  2. Identifying charitable beneficiaries the family should support;
  3. Family members’ personal goals (i.e. weight loss, writing a book or promotion at work); and
  4. Setting standards for the care of elderly or disabled family members.

Setting goals necessarily requires the family to assess its own definition of success. Some measures of success can be objective.  For example, determining an amount the family intends to give to charity may be straightforward.  On the other hand, success may also manifest itself more as a path than a destination.  That is, the continuance educational goals developing new familial relationships (i.e. through marriage or the birth of children) are more subjective.

Once the goals have been laid out, the family can map out a path to success. Typically, they will do this by first brainstorming ideas for achieving their goals and then by developing (and memorializing) clear steps each will agree to take in furtherance of each goal.

There are a few keys, however, to doing this effectively. First, larger tasks must be broken down into progressively smaller ones until they become realistically achievable for the individuals responsible for their completion.  Thus, the creative gives way to the practical.  Also, it is important that all family members are encouraged to avoid creating work for others.  Some families have rules effectively stating that the person who mentions some new task should be in charge of seeing to it that the task, if adopted, is completed.

Second, it is very important to avoid disenfranchising any family member. The input of all family members, once they meet certain general criteria, should be valued.  Thus, the tasks assigned to younger family members will be very different than those assigned to older family members, but they should not be described in terms that portray relatively less value.  For example, a family may choose to enfranchise children at age 16.  At that age, however, the child’s primary focus should be finishing high school with the best possible grades and beginning the next phase of life (be that military service, technical school, college or something else).  While young family members may work at the family business in the summer, they will not be responsible for the successful deployment of the new marketing push for the coming fall.  Similarly, adult family members with diminished capacity or those who simply are not interested in participating in the family business should be provided with some opportunity to contribute, no matter how trivial that contributions might seem.  This is because the very essence of family is promoted by each individual’s opportunity to contribute and their ability to “own” some task.

Third, it is absolutely critical that deadlines be placed on each step of the plan. Like it or not, it is a reality of human nature that the road to hell is often paved with good intentions.  A family will have done itself no good if it fails to implement the plan, no matter how masterful.  By providing deadlines, individual family members can be motivated to take the necessary steps towards realizing the family’s stated goals.  Of course, the deadlines (like the individual steps themselves) must be realistic.  This may take several attempts to get right—that is, several years’ worth of family assemblies—so families should not allow themselves to be put off by this.  Rather they should adjust their expectations accordingly.  And to the extent possible, individual family members should avoid criticism of others who missed their deadlines.  Giving a family member less responsibility for the coming year because failed to meet deadlines in the past is criticism enough for most.

After setting out the path towards achieving its goals, the family may wish to revisit operational documents and procedures and amend or adjust as needed. Are the nepotism rules for the family business sill relevant and just?  Does the constitution adequately address methods for resolving conflict?  Does the policy for loaning money to family members need adjustment?  Likewise, appointments to the family council and any committees should be made at this time.  Note that this may not be something that all family members at the assembly participate in.  Depending on the particular family’s circumstances, this may be the exclusive purview of the family council.

The final agenda item for most family assemblies is to recognize a job well done by all. It can be hard work to map out the family’s year, so thanks and congratulations all round are in order, particularly if and to the extent that the family has been able to conduct its business peacefully and on schedule.

Obviously, not every family will follow this exact plan, but it should illustrative as to how family governance can be implemented. Some families may wish to adopt a paired down version of this plan while others may wish to add to it.  For example, workshops can be added to help keep up to date with market trends or other matters relevant to the family business, as well as legal, tax, financial, insurance and other things.

Regardless of how the family governance is implemented, it is very important that the family continues to meet periodically. Most families will chose to meet annually, but bi-annual or quarterly meetings are also standard.  Less frequent meetings, however, may not provide the necessary continuity or guidance.  Indeed, a lot can happen in a year!

To the extent that family assemblies are deductible, they can also provide a patriarch or matriarch with an excellent avenue for shifting wealth. In other words, a family assembly is not much different than a corporate retreat, so they provide an opportunity to give family members something nice (a trip) without any estate or gift tax consequence.

Also, the importance of seeking professional assistance cannot be overstated. A third-party facilitator provides numerous benefits.  First, they can make arrangements for the family assemblies by coordinating with family members, booking hotel rooms, securing meeting spaces, preparing agendas and much more.  Next, facilitators provide unbiased perspective to aid in the decision-making process.  To this end, they can provide guidance with developing family goals, as well as breaking tasks down into achievable parts.  Similarly, they can help keep the family on track.  Family assemblies can easily devolve into chaos without someone who is willing and able to provide the requisite guidance.  Furthermore, a facilitator can assume the role of the “bad guy” and help avoid negativity between family members.  Finally, a professional facilitator may be able to provide clarity and answer questions regarding legal and other documents.  Not only will this help promote realistic expectations, but it will also provide the patriarch an opportunity to communicate his or her thoughts and feelings without being the one who is actually talking.  In other words, it affords the opportunity to talk without the appearance of talking down.

Successful families of means use family governance to achieve their goals and preserve wealth. This can be a very involved (and therefore expensive) prospect.  Fortunately, however, the same principles developed by and for the very rich can also be adapted for families of more modest means.  By seeking the guidance of a professional to help develop a family governance plan and facilitating family assemblies, the family can compound the benefit derived.

While the benefits of goal-setting in the family business context may be easier to grasp, an example will illustrate how family governance can provide great benefits in other areas as well:

Assume Family consists of Dr. Patriarch (a successful physician), Mrs. Matriarch (a homemaker), Junior (an MBA working for a large corporation), Daughter (an art history major working as a docent at a local museum) and Baby (a high-school senior trying to decide on the right college). Assume that Family has a net worth of $7mm.  At their annual family assembly in the Texas Hill Country, Junior expresses a desire to strike out on his own doing the same thing he has been doing at his large company.  Similarly, Daughter expresses her desire to write a book about art collections of Upper Bavarian monasteries in the mid-1290’s.  Baby, on the other hand is debating whether or not to attend an expensive private school or a state school.  Finally, Mrs. Matriarch has joined the board of prestigious local charity that raises money for medical research.

At their assembly, the family might determine it will lend Junior the funds he needs to start his business and the specific terms on which that loan will be made. The family might also determine to purchase equity in the new company.

Additionally, the family may agree to support Daughter by encouraging her to meet set deadlines for certain portions of her book. In this manner, they can increase Daughter’s motivation to accomplish her goals.  She is less likely let herself down if doing so would also mean letting her loved ones down.  Finally, the family might agree to hold their next family assembly at a location that is relevant to Daughter’s work.

Next, since all the family members are together, they will all be able to provide guidance to Baby with regard to his college decision. Also, the financial impact of his final decision will be out in the open for everyone to see.  If Baby decides to attend the expensive college, it may be appropriate for him to enter into a loan agreement with Patriarch to cover the additional tuition, particularly if the other two children attended significantly less expensive schools.

Regarding charitable activities, the family can determine an appropriate amount that it will give away in the coming year. They might further agree that Mrs. Matriarch’s charity will be the charitable recipient and that they will purchase a table for all the family members (along with a spouse or date) at the charity’s annual gala.

Family governance provides clarity of purpose, guidance for achieving specified goals and unity among family members. At the end of this day, this translates into increased family happiness.  Of course, both time and money must be invested, but the rewards will generally exceed the costs by a wide margin.  After all, what price can a family put on its own happiness?