Death Care Law Blog : Kansas Death Care and Preneed Lawyer & Attorney : Stalter Legal Services Law Firm : Funeral Law, Elder Law : Kansas City

For the past few years, some Kansas cemeteries have been getting nasty grams from their regulator about their care fund trustee’s treatment capital gains taxes. Kansas, like most states, requires a portion of each grave space sale (interment right) to be contributed to a fund or trust for the future care of the cemetery. Kansas law calls that fund a permanent maintenance fund. Missouri law calls it an endowed care trust. In some states it is defined as a perpetual care trust.

Despite what the fund is called, these state laws universally seek to provide the cemetery a source of income to pay for the upkeep of graves (while keeping the contributions in tact). That latter objective, protecting the contributions, brings cemeteries and regulators into conflict when the fund realizes capital gains and losses. The Kansas cemetery regulator has been taking the conflict a step further by interpreting the law to preclude the trustee from paying taxes or fees out of capital gains.

The Kansas regulators (like many of their peers) perceive a ‘looming’ problem with cemeteries: abandonment and the eventual transfer to the municipality or county. Cemeteries are dependent upon the cash flow that comes from space sales (and the accompanying interment fees and marker sales). When a cemetery runs out of spaces, grave maintenance will be completely dependent upon income from the care fund. To minimize the financial burden placed on the county, the Kansas regulator has adopted a very strict interpretation of the law for the purpose of preserving the care fund for the day the cemetery transfers to the government. This interpretation not only precludes the fund from distribution capital gains earnings, but also the trustee’s payment of taxes and fees from the earnings. The regulator reasons that capital gains must be allocated to principal, and the law forbids all distribution of principal.

This puts the cemetery into a bind. The staple of care fund investments, the fixed income security, has been bearing returns of less than 2% for years. When trust expenses are netted from those returns, there is little left to distribute to the cemetery. Necessity has dictated that these funds begin investing in equities. But, the Kansas philosophy would penalize the cemetery. Not only is the cemetery prohibited from using the equity earnings, the cemetery must also pay the taxes incurred on those earnings (reducing what is received from the care fund). The only ‘winner’ is the county. Or is it? If the eventual abandonment takes years, and the cemetery has been deprived income for upkeep and repairs, isn’t the county getting the property in worse shape?
 

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If their preneed contract is trust funded, Illinois consumers should soon be receiving statements from the bank or trust company that administers their account. These statements are one of the new requirements imposed by SB1682. The contents of the statements are governed by Section 2.h of the Funeral or Burial Funds Act.

The Comptroller’s Office sought the consumer statement in part to require accountability for the fees and expenses being charged by the IFDA. The Comptroller has brought legal proceedings to force the Association to refund a portion of the fees charged to the master trust. The California Master Trust faces similar complaints from the Cemetery and Funeral Bureau.

One allegation common to both master trusts was the fact the fees being charged were based on a ‘value’ other than the trust’s market value. The regulators have also challenged the reasonableness of the fees.

Another emerging reform issue that could impact this new Illinois disclosure requirement is whether the fiduciary (or its affiliates) receives a 12b-1 fee.

Consequently, Illinois preneed fiduciaries have cause for being cautious when reporting how much the preneed trust arrangement is costing the consumer (and the funeral home).
 

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California funeral directors face a September 13th deadline that could have substantial financial consequences, including the repayment of trust distributions.

A July 1st letter sent by the California’s Cemetery & Funeral Bureau to funeral homes in the California Master Trust outlined the regulator’s rejection of the Association responses regarding the Master Trust audit. An impatient Bureau gave funeral directors 3 weeks to respond. That deadline was quickly extended to August 11th. Then the week before the August 11th deadline, the Bureau granted another extension to September 13th.  On the eve of the deadline, there is nothing on the Bureau's website to suggest another extension is in the offering.

The Bureau is demanding several significant changes to be made to the administration of the California Master Trust. But one demand that may prove problematic for the Association will be the Bureau’s demand that funeral homes repay to consumers’ trusts the administration fees that have been paid out over the years. The Bureau has rejected the Association’s proposal for prospective procedures to document the fees.

Within the past year, Nebraska preneed sellers were also called upon to replenish trusts for the method in which income taxes were paid. The Nebraska examinations also went back several years, and involved substantial amounts.

With new reporting requirements, Missouri funeral homes will also have to explain trust and joint account shortages. Some Missouri funeral directors have failed to appreciate how Missouri law distinguishes between trusting and joint accounts. Missouri’s old preneed law allowed sellers who used trusts to retain 20% of the consumer’s payments, and to withdraw income (subject to the mark to market) requirement. Those provisions don’t apply to joint accounts. With regard to the new Missouri law, sellers also need to grasp that the 10% sales expense is permitted only with regard to trust contracts that are guaranteed. With regard to Pre-SB1 trusts, sellers could be held accountable for income, taxes and expense distributions that cause the trust to drop below aggregate deposits.

Illinois preneed sellers have a similar limitation on their claim to the 5/15% permitted under their preneed law. While the lawsuits that have embroiled the IFDA claim about 1/3 of the master trust’s contracts were non-guaranteed, it’s not clear the funeral homes made that distinction when claiming their ‘administrative fee’.

For those funeral directors who participate in a master trust, the California drama is worth watching. While the Association is crucial to negotiating a resolution, the Bureau has taken its fight to the individual funeral homes. Will other state’s regulators follow suit?
 

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The Special Deputy Receiver for NPS recently reported the company’s “negative net worth” to be just short of one billion dollars. Rightfully, regulators are looking at the NPS fiduciaries for culpability in the losses that will be sustained by consumers and funeral homes in the years to come. In the meantime, Missouri state officials are working with industry representatives to reform Chapter 436. As they consider how to better safeguard consumers’ funds, regulators and legislators need to appreciate that preneed sellers and fiduciaries have overlapping responsibilities that are affected by a state’s trusting requirements. 

In states with lower trusting requirements, the preneed seller typically assumes responsibility for individual preneed contract accounting. Besides the ability to report to consumers, this function is also crucial to the fiduciary’s income tax reporting. In states with higher trusting percentages, the trust often assumes greater responsibilities for the accounting and reporting functions. 

Historically, preneed laws have restricted preneed trust expenses to the fee that was typically charged by banks or trust companies for estate planning business. Some state laws also restrict the trustee’s ability contract with the preneed seller for administrative services.   While restrictions are needed to avoid a circumvention of the trusting requirements, more latitude should be afforded the fiduciary. In exchange, preneed sellers and fiduciaries should be required to make disclosures about those who provide the trust services, and the fees paid for the various services. 

The Texas Department of Banking and the Texas Funeral Directors Association broached these issues ten years ago.    In Opinion 98-15, the TDOB found that the preneed trustee fees could be used to pay for marketing expenses, outside recordkeeping for preneed contracts, and investment advice. (It is generally recognized that the trustee can incur expenses for trust accounting, legal expenses and tax reporting on behalf of the trust.)

 Eventually, Texas may review its preneed law in light of the fraud committed on its consumers and funeral directors by NPS. I suspect NPS exploited the Texas provisions allowing for a depository.   Before eliminating the authority to use the depository arrangement, the Texas legislature needs to appreciate the difficulty the industry has in attracting quality fiduciary services.   

Allowing the trust to bear the expense of compliance does not come without the risk of abuse. Services must be necessary to the trust, and reasonable in cost. One check against such abuse would be the requirement that services must be performed pursuant to a contract with the fiduciary. Transparency of the relationships among the parties, and the fees paid could serve as another check.   The IRS will likely require such transparency within the next few years as fiduciaries are required to ‘unbundle’ their fees for income tax reporting purposes.

Eventually, we may see death care fiduciary fees being broken down by the following services:

Asset management (investment)

Sub account administration

Tax reporting

Legal (contracts/compliance)

Legal (liability/litigation)

Custodial services

Regulatory and consumer reporting

Marketing

Ten years later, the TDOB opinion may be dated in terms of what constitutes a reasonable fee. Sub account administration can run as high as 85 basis points. Asset management fees will differ on the manager’s expertise, and 50 basis points is a fairly common fee. Tax reporting expenses can differ substantially based on the diversification of the trust assets.   Distribution oversight may require periodic examinations, and the expense that accompanies on-site reviews. Periodic statements to consumers and regulators will require administrative enhancements. However, economies of scale are crucial to minimizing these costs, and pooled administration will be key to providing the requisite economies of scale. Several years ago, the Office of the Comptroller of Currency recognized the role national banks could play in meeting the needs of the death care industry.

The death care trust is a different breed of animal from a bank’s staple trust business of estate planning.   Consequently, legislators need to allow fiduciaries to contract for those services crucial to enhancing the compliance that the preneed transaction so desperately needs.

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