Tax Law Changes Go Into Effect On January 1, 2000
LITIGATION
New Jersey Appellate Court Defines Quantum of Proof Needed for an Insured to Prove the Existence and Terms of a Missing Insurance Policy
TRUSTS AND ESTATES
Gallenstein and Tax on Capital Gains
INSURANCE
Court Holds Y2K Act Not Applicable to Insurance Coverage
On September 17, 1999 Governor Whitman signed into law Senate Bill 673 (Ch. 208, L.1999). Among other things, the Law clarified the deadline for filing tax appeals. N.J.S.A. 54:3-21 was amended to require property tax assessment appeals to be filed with the County Board or the Tax Court (if the assessment in contest exceeds $750,000) on or before April 1 of the tax year, or on or before 45 days from the date the bulk mailing of notification of assessment is completed in the municipality, whichever is later. Before amendment, N.J.S.A. 54:3-21 provided that taxpayers had until on or before April 1 of the tax year to file appeals of assessments with either the County Board of Taxation, or the Tax Court (if the assessment in contest exceeded $750,000).
The Freeze Act statutes were also amended by the Law. The Freeze Act was amended to provide that if as of October 1 of the pretax year the subject property has been the subject of an addition qualifying as an added assessment, a condominium or cooperative conversion, a subdivision or a change in zoning, the Freeze Act shall not apply for that year. The Law clarified that the Freeze Act would also not apply in instances where a complete reassessment was implemented by the municipality in a freeze act year. The Freeze Act was also amended to provide that if the municipal assessor increases the assessment during a freeze act year, or fails to reflect an assessment as adjudged by the Tax Court or County Board of Taxation, the burden of proof will be placed on the municipality to establish that the assessor acted reasonably in increasing the assessment. In all cases, the Freeze Act only applies if the judgment upon which it is based is a final judgment which has either not been appealed, or if all appeals have been exhausted. Prior to its amendment the Freeze Act provided that the final judgment of the Tax Court or a County Board of Taxation as to an assessment was conclusive and binding on the municipality for the tax year in contest, and the two subsequent tax years (the freeze act years). The only exceptions were if a municipal wide revaluation was implemented in one of the freeze act years, or if there was a substantial or meaningful change in value as of October 1 of the pretax year.
The Law also amended N.J.S.A. 54:3-27 which now provides that a taxpayer who appeals from an added or omitted assessment must pay all unpaid prior year's taxes and all taxes for the tax year. However, this requirement is exclusive of taxes imposed by the added or omitted assessment which is being contested. The amendment to this statute, as well as a separate amendment to N.J.S.A. 54:51A-3, further provides that if a taxpayer contests the denial of qualification of certain tax exemptions or farmland assessment qualification, the taxpayer will not have to pay unpaid taxes in order to contest the qualification of the property. Prior to amendment the statute provided that a taxpayer who files an appeal from an assessment must pay the total of all taxes and municipal charges due, up to and including the first quarter of taxes and municipal charges assessed for the tax year in question.
N.J.S.A. 54:4-63.11 (governing added assessments) and N.J.S.A. 54:4-63.39 (governing omitted assessments) were likewise amended to provide that such appeals must be made on or before December 1 of the tax year, or 30 days from the date the tax collector completes the bulk mailing of tax bills for added or omitted assessments, respectively, whichever is later. The amendments also permit the taxpayer to file a Complaint to the Tax Court appealing added and omitted assessments if the aggregate assessed value of the subject property exceeds $750,000. All other appeals are made to the County Board of Taxation. Before amendment those statutes provided that appeals of added or omitted assessments had to be made by Petition to the County Board of Taxation on or before December 1 of the tax year.
All of the aforementioned changes are effective as of January 1, 2000, for tax years commencing on or after that date. Hence, it is important to consider them in connection with this year's assessment appeal filings, or Freeze Act applications made for the tax year 2000, or later.
LITIGATION
New Jersey Appellate Court Defines Quantum of Proof Needed for an Insured to Prove the Existence and Terms of a Missing Insurance Policy
In the first published opinion from a New Jersey court on the issue, the New Jersey Appellate Division defined the quantum of proof needed by a policyholder to prove the terms of lost or missing insurance policies. The issue arises when a policyholder cannot locate a policy under which it seeks to assert a claim. In such circumstances, the insurer may not have a copy of the policy and may deny coverage. If the policyholder litigates the claim against the insurer, the policyholder will have the burden to prove the existence and terms of any applicable policy.
Typically and optimally, of course, the policyholder will have the policy available when there is a coverage dispute with the insurer. However, some policyholders may have discarded or misplaced older policies that could provide valuable coverage for environmental, asbestos or other long-term exposure liabilities, particularly where the claim might not arise until decades after the policy was issued. The insurer likewise may no longer have a copy of the original policy. In such circumstances, the burden is still on the insured to prove the existence and terms of the policy.
Where the original policy cannot be found, the question becomes what amount of other evidence is required for the policyholder to satisfy its burden to prove the terms of the disputed policy. Until recently, courts in New Jersey and elsewhere have disagreed on whether to apply the "clear and convincing" evidence standard or the lower "preponderance of the evidence" standard to this question. The insurers obviously prefer the stricter "clear and convincing" standard, which requires proof that "produces in a judge or jury's minds a firm belief or conviction that the allegations sought to be proved by the evidence are true." This is a very heavy burden that is only slightly lower than the "beyond a reasonable doubt" standard that is applied in criminal cases.
On the other hand, the "preponderance of the evidence" standard, which is the standard generally applied in civil cases, is a much lower burden of proof to meet. To prove an allegation by the "preponderance of the evidence," a party need only convince the judge or jury that the allegation is "probably true". The proponent of the evidence thus need only tip the scales slightly in its favor to satisfy this burden of proof.
In light of the difference between the two standards, the Appellate Division's decision to apply the preponderance of the evidence standard in such disputes is a significant victory for policyholders. In Borough of Sayreville v. Bellefonte Insurance Co., 320 N.J. Super. 598 (App. Div. 1998), the Borough of Sayreville was seeking coverage for environmental liabilities under comprehensive general liability policies that it had purchased in the early 1970's. By the time of the claim, Sayreville could not locate policies for five coverage years that had been issued by CIGNA. In reversing the trial court's dismissal of Sayreville's claims on the missing policies, the Appellate Division adopted a preponderance of the evidence standard as the burden of proof that must be met by a policyholder.
The Appellate Division recognized that courts in other states, as well as courts in New Jersey in unpublished opinions, had applied the higher clear and convincing standard. The Appellate Division, however, agreed with the reasoning applied by a federal district court judge in Delaware in Remington Arms Co. v. Liberty Mut. Ins. Co., 810 F.Supp. 1420 (D. Del. 1992). In Remington Arms, the federal court had observed that the "usual standard" in civil cases was the preponderance standard, and that the standard of clear and convincing was the "exceptional standard" that was applied only in certain limited kinds of civil cases that usually involved unique allegations of fraud. The court concluded that the typical insurance dispute differed from these kinds of cases, and thus deemed it "more practical and fair" to apply the preponderance standard.
The Appellate Division concurred and adopted the preponderance standard for the policyholder's burden in missing policy cases. In fact, after reviewing the evidence that had been offered by Sayreville at the trial level (which included copies of schedules of "underlying insurance" for the missing policy years as well as minutes from Borough meetings stating that the disputed policies were in effect) the Appellate Division said that Sayreville could probably "shoulder" this burden. The Appellate Division also suggested that the parties might undertake further discovery to determine how CIGNA's standard-form CGL policy may have changed, if at all, from the years of the missing policies to later years, and cited other cases where evidence of "specimen" or standard forms of missing policies was enough to satisfy the preponderance burden of proof.
For policyholders in New Jersey, the Appellate Division's decision quite simply makes it easier to prove the existence and terms of the policy even when the policy cannot be located. A policyholder who has lost or misplaced an insurance policy can still prove the policy where it can establish the terms of the missing policy by a preponderance of the evidence.
TRUSTS AND ESTATES
Gallenstein and Tax on Capital Gains
Joint tenancy with right of survivorship is a popular form of property ownership between husband and wife. Possession of an interest in a joint tenancy at death has major estate and income tax implications. The value of the interest is includable in the decedent's estate, and results in an adjustment to the tax cost basis for capital gains tax purposes of the asset held by the surviving joint tenant.
Determining the amount included in the estate and the related basis adjustment depends upon the application of Internal Revenue Code Section 2040 a provision that has undergone considerable change over the years. In a case of first impression in 1992 (975 F.2d 286 (6th Cir. 1992)), the Sixth Circuit in Gallenstein v. United States of America, addressed the issue of valuing certain spousal joint interests created prior to 1977.
Statutory Backdrop
As originally enacted, Section 2040 prescribed that the entire value of jointly held property was included in the estate of the decedent/joint tenant except to the extent that the survivor could show that he or she had acquired an interest for full and adequate consideration.
The Tax Reform Act of 1976 amended Section 2040 to provide that, in the case of a spousal joint tenancy, 50% of the value of the jointly held property would be included in the estate of the first spouse to die, regardless of the actual amount contributed by either joint tenant/spouse. Hence, only 50% of the value of the property would receive a step-up in basis for income tax purposes.
There were a number of subsequent amendments to Section 2040, some of which left open some uncertainty concerning whether to use the so-called "contribution" test or the 50% rule when valuing spousal joint tenancies created prior to 1977 for estates of decedents dying after 1981.
Facts of Gallenstein
In Gallenstein, the taxpayer and her husband purchased real property in Kentucky in 1955. The entire purchase price of $38,500 was derived from the husband's earnings. The couple held the farm property as joint tenants with right of survivorship until the husband died on 12/12/87. In July 1988, the taxpayer sold some of the farm property for approximately $3.6 million. After an amended estate tax return included the entire property in her husband's estate, the taxpaper/wife claimed that $3.6 million was her basis in the property. The Internal Revenue Service, however, took the position that the basis of the property sold should reflect only the step-up in basis for one-half of the property to the fair market value at the date of death, as shown on the original estate tax return.
Holdings of the Courts
In upholding the taxpayer's position, the District Court examined the history of Section 2040. Originally, Section 2040 required a contribution test to determine whether and to what extent the value of jointly held property would be included in the estate of a decedent/joint tenant.
The Service in Gallenstein argued that the legislative history indicated that Congress intended to adopt an easily administered rule for spousal joint interests that would eliminate the burdensome tracing requirements under Section 2040(a).
In rejecting the Service's argument, the District Court first noted that, in general, the doctrine of implied repeal is inappropriate where the plain language of the statutes at issue is not in conflict. The court reasoned that when the language of two statutory provisions is unambiguous, resorting to the legislative history to interpret that language would be unnecessary and improper. In addition, a strong judicial policy disfavors the implied repeal of statutes.
Sixth Circuit's Analysis.
On appeal, the Sixth Circuit affirmed the District Court's holding. Before the appellate court, the Service argued theories of express and implied repeal. The Service contended that by changing the definition of qualified joint interest in Section 2040(b)(2), Congress expressly changed the effective date of Section 2040(b)(1). In rejecting this argument, the Sixth Circuit noted that when Congress wanted to repeal a particular section of the estate tax code (such as subsections (c)-(e) of Section 2040), it did so expressly. Thus, the Court declined to provide by judicial interpretation what Congress did not expressly enact.
Many sophisticated tax observers were, to put it mildly, surprised by the Gallenstein decision, and expected or predicted either that other federal circuits would decline to accept its rationale, leading to a U.S. Supreme Court reversal, or that the Service would prevail upon Congress to "fix" what appeared to be an error or oversight. That has not happened. Instead, other courts have adopted the Gallenstein rationale and conclusion. (See Patten v. United States, 116 F.3d 1029).
And, as time goes by, the frequency of an estate owning property acquired before 1977 continues to diminish, and the Service appears to have turned its attention and resources to more pressing matters.
Tax Planning Considerations
Gallenstein holds promise for a surviving spouse who inherits property held in a spousal joint tenancy that was created before 1977. Based on the result in the case, the surviving spouse can receive a step-up in basis to the full extent of the contribution of the first spouse to die towards the purchase of the property, but there should be no increase in estate tax on the death of the first spouse because of the marital deduction. Under pre-1977 law, 100% of the value of jointly held property was included in the estate of the first spousal joint tenant to die except to the extent that the surviving joint tenant spouse could show that he or she had contributed to the purchase of the property. In most instances, it is likely that the holding in Gallenstein will work to the surviving spouse's advantage as it is typically the older spouse who contributed all of the purchase price and dies first. Thus, the surviving spouse's tax basis in the property should be 100% of the property's fair market value. If the property is sold shortly thereafter, no capital gains should be realized.
INSURANCECourt Holds Y2K Act Not Applicable to Insurance Coverage
As we approached the end of last year, "Y2K" assumed a central role in virtually every facet of modern society. Experts warned of widespread computer failure that would affect everything from transportation to commerce to communications to military affairs. Fortunately, January 1, 2000 has come and gone with little to no disruption. Nevertheless, industry spent countless resources before January 1, 2000 ensuring Y2K compliance and many dollars were invested in insurance policies in order to protect against possible Y2K maladies. The courts are currently grappling with the question of whether Y2K compliance costs are reimbursable under various types of insurance coverage.
In American Guarantee and Liability Insurance Company v. Xerox Corporation, the Supreme Court of the State of New York recently determined that the federal Y2K Act (the "Act") did not apply to insurance coverage disputes. In limiting the Act's applicability to "damage directly resulting from a Y2K failure," the court took a significant step toward limiting the nature and the number of lawsuits governed by the Act.
American Guarantee, a New York insurer, provided first-party property insurance to Xerox and its subsidiaries around the world. The policy covered property throughout the United States and the world. Xerox submitted a notice of claim seeking reimbursement for its "Y2K remediation expenses and/or damages." American Guarantee, seeking to avoid coverage, sought a court declaration that the costs submitted by Xerox were "ordinary business expenses" and as such were not covered by its insurance policy. Xerox, in turn, argued that American Guarantee was obligated to reimburse it pursuant to the American Guarantee policy and that its claim qualified as a pre-litigation notice under the Act, thereby implicating the Act.
The court rejected Xerox's contention that the Act applied to the facts of this case. According to the court, the Act was a response by the federal government to the threat of potentially enormous civil litigation resulting from Y2K failures. The plain language of the Act, and its underlying legislative history, indicate that the Act applies only to disputes involving damages that result directly from a Y2K failure, not to collateral actions such as insurance coverage disputes. The dispute before the court did not pertain to a Y2K failure but instead concerned only whether an insured had provided timely notice of a claim under an insurance policy and whether the policyholder's Y2K expenses were reimbursable. Thus, the Act was not applicable.
By limiting the Act's applicability to "Y2K failures," the New York Supreme Court has forced parties seeking redress related to Y2K insurance coverage to rely upon traditional breach of contract theories. A number of clients have recently asked us to review their insurance policies to determine whether coverage claims may be asserted. This case represents only one state's interpretation of this federal statute. Future cases from other states' courts or the federal courts may take a different view of the Act. Therefore, it is best to consult with counsel in order to understand what options are available.