NO NOL CARRYOVER TO SUBCHAPTER ‘S’ ESBT TRUST

A trust that owns stock in a Subchapter S corporation can elect to be taxed as an "electing small business trust" or "ESBT." Such an election is one method of avoiding the prohibition on trust ownership of Subchapter S corporation stock.

After making the ESBT election, the portion of the trust that owns the Subchapter S stock is taxed separately from the remaining portion of the trust. Code Section 641(c)(2)(C) limits the deductions and losses of the ESBT share to those that pass through to it as a shareholder of an 'S' corporation, losses from the disposition of the 'S' corporation stock, and a share of trust administration expenses.

What happens if the trust had a net operating loss attributable to the pass-through of 'S' corporation stock as of the time of its ESBT election? The Code is not entirely clear on whether the ESBT can deduct that NOL.

Code Section 642(h)(1) indicates that on the termination of a trust, the net operating losses of the terminating trust carry over to the beneficiaries receiving the assets of the terminating trust. Arguably, then, such losses should carry over to the ESBT trust as successor to the pre-ESBT trust. Since the losses came from the 'S' corporation, the limits under Code Section 641(c)(2)(C) on losses that are deductible by an ESBT perhaps should not apply.

In a recent Chief Counsel Advice, the IRS has indicated that the NOL cannot be carried over to the ESBT (although it can be used by the non-ESBT portion of the trust). The rationale of the Advice is that the Code Section 641(c)(2)(C) list of allowable ESBT deductions is the exclusive list of deductions, and that a Code Section 642(h)(1) NOL carryover is not included in that list (even though one could argue that it is included via Code Section 641(c)(2)(C)(i), relating to Subchapter S items described in Code Section 1366)).

Unless they feel strongly that the Advice is erroneous, practitioners should count as a "cost" to electing ESBT status the possible loss of prior NOL's attributable to the 'S' stock, unless those losses can effectively be used by the non-ESBT portion of the electing trust.

CCA 200734019 -- 08/24/2007

ENFORCEABILITY OF COHABITATION AGREEMENTS IN FLORIDA [FLORIDA]

A recent article in the Estate Planning Journal provides some recommendations on drafting cohabitation agreements for unmarried couples (Goffe, Wendy S., Preparing Effective Cohabitation Agreements for Unmarried Couples). Such agreements are similar to the prenuptial and post-nuptial agreements entered into by their married counterparts. Such cohabitation agreements typically address expense sharing, how income will be shared or separated, how assets will be titled, and what happens to property upon termination of the relationship.

As noted in the article, what may come as a surprise to many is that cohabitation between unmarried persons, if there is a sexual relationship involved, is illegal in the State of Florida. More particularly, Florida Statutes Section 798.02 provides: "If any man and woman, not being married to each other, lewdly and lasciviously associate and cohabit together, or if any man or woman, married or unmarried, engages in open and gross lewdness and lascivious behavior, they shall be guilty of a misdemeanor of the second degree…"

This raises the question whether a cohabitation agreement is enforceable in Florida, since arguably it is void as against public policy or because it is based on illegal consideration (the illegal relationship described in the above law).

This issue has not been fully resolved in Florida. The principal case in the area is Poe v. Levy's Estate, 411 So2d 253 (4^th DCA 1982). That case holds that if there is valid consideration (promises or other amounts paid) for an agreement between cohabitating parties aside from sexual relations, then the agreement will not be void. Therefore, if a Florida cohabitation agreement includes consideration outside of the sexual arena, then enforceability should not be an issue. However, there are not a lot of cases on the issue, so even though Poe supports this rule, if it comes up in other Florida appellate districts, a different result is possible.

NEVADA ENACTS CHARGING ORDER PROTECTION FOR CORPORATE STOCK

Nevada recently enacted unique legislation that will enhance the use of its corporations for asset protection purposes. More particularly, it became the first state to enact legislation that provides that a charging order will be the sole remedy for creditors of stockholders of certain Nevada corporations in regard to those shares.

The concept of a "charging order" comes from the partnership and LLC arena. If a debtor owns an interest in a partnership or LLC, and a creditor of that debtor obtains a "charging order" against that interest to collect its debt, the creditor does not become a full owner of the interest. Instead, the creditor's interest is limited to receiving distributions from the entity to the extent that the entity otherwise makes distributions to its owners. If other persons control the entity, this wait for a distribution can be quite lengthy. Further, once the creditor is paid off with distributions, its interest in the entity terminates and the debtor owner thereafter receives back its full ownership rights. Therefore, obtaining a charging order is not as good a remedy for a creditor as being able to force a judicial sale of the interest of the debtor. If the creditor can force a judicial sale, the creditor immediately gets the sale proceeds from the interest – or if it purchases the interest with its debt, it gets full ownership rights forever in the entity and the debtor loses all rights.

Some jurisdictions limit a creditor's rights to a charging order. By doing so, debtors receive creditor protections because the creditor can no longer force

Until the new legislation in Nevada, the charging order remedy had no application to stock in a corporation. By providing that a charging order will now be the sole remedy for creditors of Nevada corporation stockholders as to their shares, Nevada is now providing a significant (and presently unique) method of asset protection.

The new legislation does not apply to all Nevada corporations. For example, the corporation must have more than 1 stockholder and less than 75 stockholders. It cannot be a subsidiary of a publicly traded entity, nor a professional corporation. It will also not apply to any liabilities arising from an action filed before July 1, 2007. Contractual remedies offered by a stockholder to a creditor will not be overriden by the new law.

What happens if the debtor stockholder lives outside of Nevada – will the protection apply? The question of whether the law of Nevada or the law of the residence of the debtor stockholder will apply is unknown – indeed, this is an issue that applies to all the various asset protection statutory protections offered by the various states. Until the issue is resolved, a reasonable approach for persons outside of Nevada is to adopt the attitude of "what do I have to lose" by using a Nevada company, since the possibility that it could work will provide negotiating leverage with creditors. The answer to what is lost by using a Nevada corporation instead of a corporation in one's home state is mostly just the increased costs involved, such as payment of registered agent fees for a local Nevada registered agent, the costs of a service to assist with formation, other Nevada fees, and possibly the need to register the company to do business in a different state.