Month: February 2017

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ESTATE PLANNING FOR FAMILY HELD BUSINESSES: AN UPDATE ON THE NEW IRS PROPOSED REGULATIONS TARGETING “DISCOUNTING”

Last August, the IRS launched its latest offensive against parents who want to transfer closely held family-owned business interests to younger family members free from estate tax.

Here is the typical scenario: Mom and Dad inherited and then successfully grew a small business, “Soup to Nuts”, a small town hardware store with a small bakery and popular lunch counter. Mom and Dad’s three children work for the company, operating four other “Soup to Nuts” in their hometowns, one in Pennsylvania, one in Arlington and two in Hampton Roads, Virginia. Mom and Dad recently visited with their family lawyer, Christie, who informed them that because business has done so well they now have estate tax exposure.  The value of the business, which includes the real estate for the stores, is $12,980,000. She tells them that currently (in 2017) Mom and Dad may each transfer $5,490,000 to their children, free from transfer taxes (either gift or estate taxes), for combined exemptions of $10,980,000.  Christie tells them that the $2,000,000 “excess” value of their business could cost their family $800,000 (current estate tax rate is 40%).  Mom and Dad are not pleased. Christie explains the exemption amount is “indexed” for inflation, but Dad points out the business has been growing faster than inflation, and thus they will have increased estate tax exposure every year. What can Mom and Dad do?

Christie advised Mom and Dad that a common strategy is to give minority shares of stock or LLC interests to family members in various amounts using “market valuation adjustments”. These adjustments take into account the fact that the fair market value of a small percentage of “minority stock”, which cannot control the decision-making in the company, is worth less than a controlling interest. The same valuation reality means that “non-voting” stock is worth less than voting shares.  Christie recommends Mom and Dad make gifts of “discounted stock” to their children, which may serve to eliminate the estate taxes. Mom and Dad are pleased with this option, however, Christie warns: HURRY, THIS OPPORTUNITY IS CLOSING, QUICKLY.

Christie is concerned with the new IRS proposed regulations under Internal Revenue Code 2704, which if finalized may significantly reduce the opportunities for “discounting” family gifts. The regulations, released on August 4, 2016, say the IRS will ignore when valuing Mom and Dad’s gifts, any restrictions on the transferability of the stock that reduce the value of the family-owned business.  Specifically, the proposed regulations provide that a restriction may be disregarded if it: 1) limits the ability of the owner of the interest (e.g. the child) to liquidate the interest (e.g. sell the interest back to the company); 2) pays the owner an amount less than a minimum value (“full value”); 3) defers the payment of the interest for more than 6 months; or 4) allows the company to pay the interest on certain non-cash, non-property obligations.  In addition, the IRS could disallow the discounts if the taxpayer dies within 3 years after making these gifts.

Christie is concerned because discounts for such transfers, in amounts up to 30%-50%, have been accepted by many courts over the last 20 years. She indicates the changes are too broad and it is overstepping by the Treasury. If the regulations are finalized and not successfully challenged, family-owned businesses may be faced with tax bills they cannot pay and be forced to liquidate their businesses.

The effective date of the regulations will be 30 days after the final regulations are published in the Federal Register. The Treasury Department held a hearing on the regulations on December 1, 2016.  As expected, opposition was significant. More than 3,800 family-owned businesses and trade groups have asked the Treasury Department to withdraw the regulations.  Will the new Administration pull back the proposed regulations?  On Friday, January 20, 2017, the President put a freeze on new regulations and temporarily postponed the implementation of existing published regulations that have not taken effect. We don’t know what the final result will be. There is a significant risk that the regulations will be left untouched as the new Administration shifts its concerns to a broader based tax cut.

BOTTOM LINE:  If you want to avail yourself of the opportunity to avoid or help minimize your estate tax exposure with tax-advantaged gifts to younger family members, act now, this window appears to be closing.

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“ALTERNATIVE” DISPUTES RESOLUTION: THE MEDIATION AND ARBITRATION OPTIONS

Disagreements are always best resolved at the earliest stage. Construction disputes are no exception to that, and the earlier the better. Unresolved disputes can adversely affect not only the time and cost of performance; but also, and sometimes worse, relationships. And while the best dispute is one that never occurs, construction disputes can happen even for the best designed or well-run project.

Hopefully, when construction project disputes do occur they can be resolved by the job-site teams. The next best stage is resolution at the next level; typically, the project managers or project executives affiliated with the team members involved in the dispute. But when those efforts fail, the two most common next steps are mediation or arbitration of the dispute or both. So what’s the difference?

Mediation is a non-binding, facilitative approach to dispute resolution. The parties agree upon a third-party neutral who listens to the various arguments and, non-judgmentally (typically), works with the parties to help facilitate an agreed resolution, without imposing the mediator’s view. There are times though when, with agreement of the parties, the mediator may provide the parties with a view on the anticipated outcome; but even so the parties are not bound by the mediator’s view.

Arbitration is not facilitative. The arbitrator takes the place of judge or jury, and after hearing the evidence presented determines the outcome. While arbitration can be (but rarely is) non-binding (why do it if it’s not binding) or binding, it is typically binding with very little basis for appeal to a higher authority. Arbitration processes and other related aspects are typically part of the parties’ contract, and most states have statutory provisions allowing for arbitration and addressing related legal aspects.

For construction cases, mediators and arbitrators are typically subject matter experts, with extensive, practical construction project experience – typically being architects, engineers, construction consultants, or construction attorneys. Much thought should be given to the experience, and personality, of potential mediators or arbitrators; as both can directly correlate to outcomes. Both can be very effective, and cost-efficient tools for resolving disputes either individually or conjunctively; although each has its pros and cons.

For more information about disputes resolution, or other construction or government contracts related matters, please contact the author or any of the Vandeventer Black Construction and Government Contract team members.

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U.S. Department of Labor Issues final Rule on Mandatory Paid Sick Leave for Federal Contractors

In September 2016, the U.S. Department of Labor (DOL) issued its Final Rule implementing President Obama’s Executive Order 13706, “Establishing Paid Sick Leave for Federal Contractors (EO).” The EO requires that for federal contracts issued on or after January 1, 2017, federal contractors and subcontractors must provide their employees “not less than 1 hour of paid sick leave for every 30 hours worked on or in connection with covered contracts,” up to 56 hours of paid sick leave per year. In the Final Order, DOL describes the rules and restrictions regarding the accrual and use of paid sick leave.

So far, President Trump has taken no steps to change the EO’s requirements.   Therefore, this law remains in full force and effect for most federal contracts and task orders that are renewed or newly issued in 2017.

The EO’s paid sick leave requirement applies to work on or in connection with “covered contracts,” meaning federal contracts and subcontracts subject to the Davis-Bacon Act (DBA) and the Service Contract Act (SCA), as well as federal contracts for concessions and for services on federal property.  There also is a list of federal government contracts that are not covered by this EO. See link below. If their government contracts are covered, employers must provide the paid sick leave to both FLSA-exempt and non-exempt employees. Recognizing that employers typically do not track exempt employees’ hours worked, the EO provides that the employer may assume that, for purposes of calculating paid sick leave, its exempt employees worked 40 hours on or in connection with a covered contract each week.

Significantly, the paid sick leave required by the EO is in addition to the contractor’s obligations under the SCA and DBA. The contractor will receive no credit toward its fringe benefit or prevailing wage obligations under those laws for providing the paid sick leave mandated by this EO. A contractor’s existing paid time off policy may satisfy the requirements of the EO only if the paid time off meets all of the EO’s requirements for paid sick leave.

Under the EO, any unused paid sick leave must carry over from one accrual year to the next up to a maximum accrual of 56 hours. A contractor is not required to pay out unused paid sick leave upon termination of employment or at the end of the year.

The employee is entitled to use the paid sick leave for: their own illnesses and other health care needs; the care of a family member or loved one who is ill or needs health care; or purposes resulting from being the victim of domestic violence, sexual assault, or stalking, or to assist a family member or loved one who is such a victim. The EO broadly defines the relations for whom an employee may use paid sick leave to include the employee’s child, parent, spouse, domestic partner, or “any other individual related by blood or affinity whose close association with the employee is the equivalent of a family relationship.”

An employee who wants to use accrued paid sick leave should make a request at least 7 calendar days in advance, if the need for leave is foreseeable, or as soon as practicable if the need is not foreseeable. The employer can require that the employee provide information to establish that the absence qualifies for paid sick leave, and if feasible, the anticipated duration of the leave. However, the employer may not require certification from a health care provider or documentation to prove a claim of domestic violence, sexual assault, or stalking unless the employee uses 3 or more full days of leave consecutively.

The DOL has published a notice that covered employers must post notifying their employees of their rights to paid sick leave. In addition, the EO requires that employers notify their employees of their accrued paid sick leave balances at the end of every pay period or each month, whichever is shorter.

The Final Rule implementing the EO has many other, detailed requirements not covered by this Legal Alert.  Therefore, we recommend consulting the DOL’s Fact Sheet at https://www.dol.gov/govcontracts/eo13706/PaidLeaveFS.htm, and/or consulting a labor and employment lawyer for advice.

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