REPORT FROM COUNSEL  

FEDERAL TAX RELIEF

On June 7, the President signed into law a $1.3 trillion tax-cut bill. The Economic Growth and Tax Relief Reconciliation Act of 2001 is the largest tax reduction in the last 20 years, although it will not do much for the cause of tax simplification. Taxpayers should bear in mind two time-related characteristics of the Act. First, the tax cuts are phased in over a period of years, with some of the most significant reductions occurring closer to 2010 than 2001. Second, due to arcane federal budget rules, the tax-cut provisions in the Act are set to expire on December 31, 2010, unless Congress takes action before then. This provision is nicknamed the "sunset provision." The effect of the Act's many provisions on individuals and small businesses will have to be sorted out with the help of professional tax advisors, but the following are some of the key components.

The Estate Tax "Repeal"

Like many other aspects of the Act, the reduction and "repeal" of the estate tax is phased in slowly over a period of years. The chart below shows these changes.

If Congress does nothing, the only year there will be no estate tax is 2010. Many national experts have voiced their opinion that the changes to the estate tax will be eliminated, extended, frozen at a particular year's level, or replaced, well before the sunset provision takes effect in 2011. In fact, Congress has done this before, freezing estate tax rates so that a scheduled reduction would be delayed. The name given to this technique is "estate tax freeze." This happened during an economic downturn when revenues fell short and a quick, quiet tax increase (that wouldn't draw much publicity and wouldn't affect everyone at once) was needed. The "sunset provision" makes it even more likely that the law will be frozen at whatever point Congress revisits this. The general feeling is that the repeal isn't really a repeal, but enough to allow politicians to say they voted to repeal the estate tax.

In order to partially replace the revenue lost by estate tax reduction, Congress has also imposed a new tax hidden in these provisions. Beginning in 2009, many inherited assets with capital gains will be income taxed at capital gains rates when sold. This was never the case in the past. The rule has been that capital gains were erased upon death, by giving each asset a "stepped-up" basis to its fair market value. This was a tremendous advantage to families who otherwise couldn't afford to sell stock, a family farm or business, or other asset with large capital gains. It was the reason why so many families would have to wait for a death to sell. Under the new law, the basis will generally be the same for the person inheriting as it was for the person who died, known as a "carryover" basis, although there are some limited exceptions to this rule. To establish what the basis is, extensive new reporting requirements have been imposed. The people who don't keep written evidence of what they paid for a capital gains asset will be the ones who especially lose out. Assets whose basis can't be substantiated will be presumed to have a zero basis, causing all of the proceeds to be income taxed at capital gains rates when they are eventually sold. This provision may be removed because it is complex, difficult to enforce, and because the public will be reluctant to accept any further IRS reporting requirements. In the meantime, however, we are recommending that people begin locating and keeping records to establish tax basis.

Estate planning in this uncertain tax environment will be a challenge. Nationally syndicated columnist Jane Bryant Quinn has written that "people who are worth enough to owe estate taxes today are going to get to know their lawyers really well." Flexibility has now become the preferred approach, since we have no idea what the estate tax law will be at any point in the future. We believe that every estate plan that provides for a marital trust should be revised to avoid undesired results, particularly in view of the downturn in the stock market.

Individual Income Tax

The Act phases in reduction in tax rates, eventually lowering the 28%, 31%, 36%, and 39.6% brackets to 25%, 28%, 33%, and 35%. The existing 15% bracket will be split into 10% and 15% brackets. The creation of the new 10% bracket has generated the retroactive relief that will come to taxpayers this year in amounts ranging from $300 for singles to $600 for married couples.

Before the new law, married couples whose income was split more evenly than 70% to 30% were likely to pay more in taxes than if they were not married. Relief from this "marriage penalty" will come in the form of an increased standard deduction for joint filers to twice that of singles and a widening of the 15% tax bracket for joint filers to twice that of singles.

The child tax credit gradually will be increased from its current level of $500 to $1,000 in the year 2010. The child credit will continue to phase out above $75,000 for single individuals and those filing as head of a household, and above $110,000 for married couples filing jointly.

Education provisions in the Act are intended to help families and individuals through direct tax and savings incentives. For example, the exclusion from gross income for employer-provided educational assistance, which would have expired after 2001, has been extended permanently. Contribution limits for individual retirement accounts for education have been increased from $500 to $2,000. There is a new deduction for qualified higher education expenses, but taxpayers may not take this deduction and the Hope or Lifetime Learning credits in the same year with respect to the same student. The deduction of student loan interest has been expanded beyond the first 60 months in which interest payments are required.

Businesses

The Act could well have been called the Economic Growth and Individual Tax Relief Reconciliation Act, because 99% of the benefits from the Act will go to individuals. There are, however, a few provisions that will directly affect businesses. As noted above, the Act should simplify pension law, and it makes permanent the exclusion from gross income for employer-provided educational assistance, while expanding it to cover graduate studies. Employers can receive a tax credit equal to 25% of qualified expenses for employee child care (such as facility costs) and a credit equal to 10% of qualified expenses for child-care resource and referral services. Finally, the Act delays the due date for certain corporate estimated tax payments.

Retirement Savings

The Act makes changes affecting both individual participants in retirement plans and employers that sponsor such plans. For individuals, the benefits are increased limits on contributions to plans, greater security for funds in the plans, and more flexibility concerning withdrawals, rollovers, and continuation of plans. As for businesses, the Act encourages the establishment of retirement plans, increases the deductibility of contributions, and generally makes the administration of plans more streamlined. Similar changes are in the Act for plans overseen by state and local governments, tax-exempt organizations, and colleges and universities.

TO COMPETE OR NOT TO COMPETE

It is nothing new for employers to require employees to sign noncompetition agreements, but such agreements are now more commonly used by all types of employers and for a broader range of employees. They are especially popular among high-tech and Internet businesses, where the risks of being at a competitive disadvantage are most significant when a departing employee exploits the former employer's "trade secrets." In these fields, the traditional criteria used by the courts in judging the reasonableness of an agreement--the geographic and time limits of the restrictions--may have reduced relevance. As a result, the strategies used by employers to protect their interests, and by employees to protect theirs, are still evolving.

Employers can enhance the prospects for court approval of a noncompetition agreement by customizing it to fit the particular business and job in question. The agreement should restrict the former employee no more than is necessary to protect the employer's legitimate business interests. Requiring noncompetition agreements only of employees with access to sensitive information may also improve their enforceability. Given the variation in the states' treatment of such agreements, employers with a presence in more than one state should draft agreements very carefully.

The scope of a noncompetition agreement generally depends on its terms. Courts in some states, however, have accepted the argument that, even if an employee is not barred from working for a competitor by the language in the agreement, such competition should be prohibited on the ground that the employee inevitably will make use of a trade secret of the former employer. Other courts have been less willing to make that assumption. For example, in one case a court held that an agreement did not apply to a departed employee because the new employer was not a "competitor" as defined in the agreement. Finding no prohibition against the former employee's new job in the noncompetition agreement itself, the court refused to rewrite the agreement or to let the former employer "make an end-run" around the agreement in the guise of preventing the disclosure of trade secrets.

From an employee's perspective, the argument can often be made that a noncompetition agreement should be enforced for a shorter time period than used to be considered reasonable. This is especially true in information technology, where the technology itself and the competitive dynamics change rapidly. As for the secrets that the employer may be attempting to protect by enforcing the agreement, the employee sometimes can counter that the information is already in the public domain, giving the former employer no right to prevent the former employee from using it in a new job.

BEWARE OF IDENTITY THEFT

Intent on taking a free ride on the good name and reputation of others, identity thieves obtain personal information and then essentially impersonate their victims as they open credit-card accounts, make purchases, or take out loans. It can take a while for the victim to know that he has been wronged, and even longer to sort out and to clean up the damage. In the meantime, the innocent party may be denied financial and employment opportunities.

While there is no way to have complete protection against identity theft, these common-sense measures can decrease the odds of becoming a victim:

• Jealously guard personal information like your Social Security number and account numbers and passwords, divulging it only in a communication that you initiate. Use this information sparingly online and only if it will be encrypted.

• Keep your wallet from becoming a gold mine for potential thieves by carrying the minimum in checks, credit cards, or other bank items, and do not keep your Social Security number there.

• Retrieve your mail promptly and do not leave outgoing mail in your doorway or home mailbox.

• Tear up private papers like bank statements, receipts, and credit-card applications before throwing them away. It is not just archaeologists who sift through old garbage in search of valuable information.

• Store valuable financial information at home in a place that is not available to prying eyes.

• Review bank account and credit-card records regularly, as well as your own credit report prepared by a credit bureau, so that you can pick up the first signs of trouble, such as a missing payment or an unauthorized withdrawal.

TOWNS VS. TOWERS

When it passed the Telecommunications Act of 1996, Congress intended to expand wireless services and increase competition among providers by reducing the regulatory burden. At the local level, this meant limiting the traditionally broad powers of local governments to restrict land use through the zoning power. Under the Act, local governments retain some control over the placement of "personal wireless service facilities," the most controversial of which are tall telecommunications towers for cell phone service. However, Congress placed limits on that authority. For example, local authorities may not unreasonably discriminate among providers of similar services, nor prohibit personal wireless services in their localities. They must respond with reasonable speed to any request to build facilities. If an application is denied, the denial must be in writing and must be supported by substantial evidence in a written record.

When a provider of wireless telecommunications services was denied permission by a town zoning board to build a 150-foot-high telecommunications tower, it sued the town in federal court. The provider argued that the town exceeded its authority under the Act by basing its decision on citizens' statements of general opposition to cell towers, not "substantial evidence." The court ruled in favor of the town, allowing it to prohibit the tower even though the decision was based largely on an aesthetic judgment.

The tower stirred opposition because of its location. It was to be built on top of a 50-foot hill in the middle of a cleared field, in the geographic center of the small town. Visible during all seasons, the tower would be seen daily by about one quarter of the town's population. It was close to three schools and two residential subdivisions.

The telecommunications provider argued to no avail that the town could not deny the application without showing that there was a suitable alternative site with less visual impact. However, the unmet burden had been on the provider to prove the absence of any other feasible site in the town, in which case the provider might have been able to win by showing that the town's denial effectively prohibited personal wireless services in the area.

(OVER)REGULATION OF WETLANDS

The federal Clean Water Act authorizes the Army Corps of Engineers to require permits for the discharge of dredged or fill material into "navigable waters." Under the "migratory bird rule," the Corps asserted its jurisdiction over even isolated intrastate waters if they provided a habitat for migratory birds.

A consortium of municipalities mounted a challenge to the legality of the migratory bird rule when it posed a hurdle for the consortium's plan to use an abandoned sand and gravel pit for a solid waste disposal site. The site was far from any navigable waterway, but migratory birds used some trenches that had evolved into permanent and seasonal ponds. The U.S. Supreme Court ruled that the Corps had overstepped the limits of its regulatory authority. No longer may the Corps regulate the development of isolated wetlands and waters that are not adjacent to navigable waterways. By some estimates, such isolated wetlands constitute 20% of all wetlands in the country, and thousands of applications pending before the Corps could be affected by the ruling.

Landowners and developers with isolated wetlands on their lands should pause, however, before firing up the bulldozers. Questions remain about whether the Corps retains jurisdiction over smaller streams, creeks, and tributaries that do not empty directly into a navigable waterway. In addition, the Supreme Court ruling was confined to federal law, and some states and local governments have their own restrictions on development of wetlands.