Authored by Scott Hall; originally published in the Daily Journal, August 16, 2016.

The Federal Aviation Administration’s recently announced rules for commercial operation of small Unmanned Aircraft Systems (UAS or drones), set to take effect later this month, provide long-awaited guidance to drone operators and manufacturers and open the floodgates of opportunity to many businesses that hope to utilize drone technology in various ways in coming years. Indeed, with reports predicting that the expansion of commercial drones could generate more than $82 billion for the U.S. economy and add 100,000 new U.S. jobs over the next decade, numerous companies are evaluating how they can capitalize on the greater availability of drones across many industries, including aerial photography and filmmaking, real estate, precision agriculture, infrastructure monitoring and surveillance and scientific research.

The FAA’s new rules are expected to spark a significant expansion in the commercial use of drones primarily by removing the previously burdensome hurdles needed to obtain FAA approval for nonhobby/non-recreational drone use. Under the new rules, anyone can operate drones for commercial use as long as they do so in accordance with the FAA’s stated rules and conditions. The rules, which restrict drone operation to daytime or twilight hours, impose weight and speed limits (drones must weigh less than 55 pounds and travel no faster than 100 miles per hour), and require that drones not fly over people and stay within the visual line of sight of the operator (who must have, or be supervised by someone having, a remote pilot’s certification), are far less onerous than the previous requirements for obtaining specific FAA authorization for commercial drone use through airworthiness certifications, exemptions or certificates of waiver or authorization.

While the new rules are certain to foster increased use of drones in many industries, they are also notable in terms of what they say (and do not say) about the ongoing struggle — between federal, state and local governments — over who has responsibility and enforcement power over drones. Interestingly, the FAA’s new rules emphasize the necessity of compliance with certain state and local laws in addition to abiding by federal rules and regulations. For example, the rules explicitly inform drone operators that “state and local authorities may enact privacy-related laws specific to [drone] operations.” Additionally, while the FAA’s new rules permit operation of a drone from a moving land or water-borne vehicle in certain circumstances, the rules note that state and local laws, including laws prohibiting distracted driving, may prohibit or otherwise restrict such drone operation. The FAA’s rules unequivocally instruct that drone operators “are responsible for complying with all applicable laws and not just the FAA’s regulations.” Such a statement is in stark contrast to proposed legislation passed by the Senate earlier this year, which would have preempted all state and local laws relating to the design, manufacture or operation of drones. Such preemption language was not included in the version of the FAA Reauthorization Act passed into law last month, but the precise division of federal or state responsibility over drones remains unclear.

Although the FAA asserts broad federal authority over drone operations, it appears to recognize that states have the power to enact — and may be in the best position to address — laws dealing with privacy, trespass, zoning and other areas consistent with a state’s police powers, that involve drones. But such distinctions may not prove workable in the context of the countless anticipated uses of drones, including remote delivery and aerial photography or mapping, to name just a few.

Numerous companies, for example, are currently developing businesses focused around the transportation or delivery of products or objects by drones. Certain states, however, such as Oregon, have passed laws prohibiting drone operation over private property. Such state laws will obviously prove problematic to any attempts by businesses to deliver products by drone, given that drones will almost certainly need to fly over private property to complete their deliveries. Other companies hope to use drones for aerial photography, mapping and other imaging and data collection purposes. But such use may conflict with state laws, including California’s AB 856, that prohibit the use of drones to capture images or other data associated with private property. Moreover, any number of other state or local laws restricting drone operation in some way — based on public safety, zoning, privacy or other areas typically within the power of state governments to regulate — may hinder planned commercial drone businesses. Having to navigate through such a patchwork of inconsistent state laws may deter companies from investing in or expanding commercial drone operations.

Ultimately, where to draw the line in terms of federal and state responsibility over drones may not be as easy as carving out categories such as “privacy” or “public safety” since drone use is certain to raise questions as to the scope and applicability of traditional areas of law that have never been answered before. The FAA’s new rules, while giving a nod to the validity of certain state and local drone laws in combination with federal rules and regulations, continue to leave open the questions that will ultimately need to be confronted regarding preemption. Thus, while the rules are sure to expand commercial drone use, some companies may hold back on fully pursing drone ventures until more of these questions are answered.

Fortunately, the FAA’s new rules maintain flexibility for dealing with drones going forward, which is essential to foster current and anticipated commercial use of drones, while also determining how to most effectively police such use. While the rules for small commercial drones are a positive development for the industry, they are clearly only the first step towards comprehensively regulating the expectedly rapid expansion of the commercial drone industry.

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On August 2, 2016 the U.S. Treasury Department issued proposed regulations addressing transfers between family members of interests in family-controlled entities (e.g., corporations, partnerships and LLCs).  If enacted, these rules will eliminate most valuation adjustments for lack of liquidity and marketability (i.e. “minority interest discounts”) for gift and estate tax purposes.  Hearings on the proposed regulations are scheduled for December 1, 2016, and the final regulations may be effective thirty days later.

Background

Currently, a taxpayer might hold a business, marketable securities or real estate in an entity (e.g., a partnership, LLC or corporation).  A gift or sale of the taxpayer’s non-controlling interest in the entity to his children or grandchildren, or a trust for their benefit, is typically appraised at a value that reflects minority interest discounts.  These discounts arise from the recipient’s inability to control the entity and to freely transfer or “cash out” of the transferred interest.  Under the proposed regulations these minority interest discounts would be largely disregarded for gift and estate tax purposes.

Examples

1. Outright Gifts: Spouses previously formed an LLC with $20 million of assets.  They gift a 20% LLC membership interest to a separate trust for the benefit of each of their 3 children and their descendants.  An independent appraiser applied a 30% minority interest discount to each of the gifted interests in the LLC.Under current law, each gift would be valued at $2.8M (instead of $4M if undiscounted).  Similarly, the remaining 40% held by Spouses would be included in the survivor’s taxable estate at $5.6 million (instead of $8M if undiscounted).  Thus, the total value of the LLC that is subject to gift and estate tax is $14M, which is $6M less than the undiscounted value of the LLC assets.

   This results in a savings of $2.4M in gift and estate tax compared to the tax if no gifting had been done.  Further tax savings may occur as the appreciation and growth on the gifted assets is outside of the Spouses’ taxable estates.

2. Sale: Another way that this transaction can be accomplished is by the sale of each Spouse’s LLC membership interests to a trust in exchange for a promissory note.  In that transaction, the sale would be at the discounted value and the note could be repaid at a low interest rate (e.g., currently as low as 1.18% for a 9-year note).  Spouses may retain the cash flow from the assets in the LLC as the interest and principal is repaid on the note.Again, the potential estate tax savings to the family could be as much as $2.4M.  In this example all of the appreciation and growth above the interest rate on the note will also be outside the Spouses’ taxable estates.

Under the proposed regulations, the minority interest discounts would essentially be disregarded under both examples.  The resulting gifts, or the sales price, would be at the full $20M undiscounted value, and the potential $2.4M in gift and estate tax savings would be unavailable.

Take-Away

Clients who have an appropriate asset profile, and have contemplated lifetime gifts or sales to descendants, or trusts for descendants, should accelerate their consideration of this planning.  The favorable valuation principles under current law may be unavailable as early as the end of 2016.  Several months are often required to properly consider, document and implement such gifts.

Note:  This article is only intended as an information alert, and a general summary of how the new proposed treasury regulations could impact estate planning opportunities.  The application of these proposals in a particular client situation will vary, and should be discussed with qualified advisors to determine if further action is appropriate.

Authored by Scott Hall and David Anderson; First published in the California Real Property Journal, a quarterly publication of the Real Property Law Section of the State Bar of California.

Combined with powerful state-of-the-art cameras and communications technology, drones are capable of efficiently and economically photographing, videotaping, and gathering other information for applications and in manners previously undreamed of. This impressive technological leap forward, however, has been accompanied by numerous documented instances of blatant misuse, which in turn, have prompted calls for state and federal lawmakers—including those in California—to spring into action. The legislative response to drones, however, has struggled to keep up with the technological capabilities and ever-expanding uses of drones. Additionally, lawmakers have failed to provide necessary clarity regarding the rights and restrictions of drone operation in the context of property rights in airspace above private property.

Instead, the limited legislative solutions enacted in response to drones have thus far focused on protecting privacy rights rather than establishing clear property rights. In October 2015, in response to public outcry over growing incidents of drone invasions of privacy, California enacted a widely-applauded law—AB 856—that directly addressed privacy concerns associated with drone use by prohibiting any knowing entrance into the airspace above the land of another person without permission in order to capture images, sounds, or other physical impressions of private activity. While this so-called “Anti-Paparazzi” law may give celebrities additional legal recourse against snooping paparazzi drones, it does little to protect the privacy of non-celebrities who may not have the financial resources or individualized incentives to pursue legal remedies for potential violations. Moreover, despite being technically couched as expanding the scope of unlawful “trespass,” AB 856 focuses on intentional conduct that invades privacy rather than clarifying the parameters of airspace property rights, and, in so doing, fails to provide needed guidance to both property owners and drone operators about what rights each possess when it comes to drone operation above private property.

Indeed, at the same time AB 856 was signed into law, Governor Jerry Brown vetoed other drone legislation that would have created a bright-line rule to protect airspace rights over private property by allowing property owners to prohibit drones from flying below a certain height over their property without their consent. In the wake of these legislative and executive decisions, the continuing lack of clarity regarding the scope of airspace property rights (including where drones may and may not operate) is likely to result in increased confusion about those rights. It may even lead to increased occurrences of property owners taking the law into their own hands. Various incidents around the country involving property owners shooting at drones, or otherwise attempting to prohibit drones from entering airspace above their property, suggest that many believe that the protection of such airspace is as important to the reasonable use and enjoyment of their property as the land itself.

Whether current laws are sufficient to deal with the new and unique issues presented by drones, or whether new drone-specific laws and regulations should be enacted—and what those laws should look like—is currently the subject of heated debate in California and throughout the country. Determining a workable resolution to these issues requires considering both the origins and shortcomings of current laws as applied to drones, as well as the unique capabilities and applications for drones now and in the future. This article briefly reviews the history of airspace property rights and how previously unresolved issues are being raised again in response to expanding drone use. The article then examines whether drone regulation is properly a federal or state issue before discussing recent California drone legislation. The article concludes by proposing that legislation beyond existing law is needed to create bright-line rules for protecting airspace rights up to a specified height above private property. This type of bright-line rule will not only give needed assurances to property owners about their airspace rights, but also facilitate greater support for, rather than opposition to, further development and application of drone technology across a variety of industries.

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