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Neal Cannon & Associates, P.C.

CannonLaw Newsletter - September, 2004


Lost Database Is Not Insured
"If you can't reach out and touch it, it is not insured." That was the gist of a court's ruling in a lawsuit brought by a company that lost a large amount of electronically stored data when an employee inadvertently pressed the "delete" key on a keyboard. The company looked to its insurer to cover the expenses for restoring the data and to recover lost income caused by the disruption. The insurer denied coverage on the basis of policy language that limited coverage to a "direct physical loss of or damage to" covered property.

The language from the policy was meant to be interpreted in its ordinary and popular sense. Thus, "physical" means "tangible" or capable of being touched. The information in a computerized database, in and of itself, has no material or tangible existence, unlike a storage medium for information, such as a disk, tape, or even papers in a file cabinet. The court concluded that when the employee sent the data into thin air with an unintended keystroke, there was no direct physical loss within the meaning of the insurance policy. (The court distinguished this case from another case in which the loss of a computer tape and the data on it were covered under a policy covering "physical injury or destruction of tangible property.")

Recognizing that the dictionary was not on its side, the company that lost its data also argued that public policy should weigh heavily in favor of insurance coverage. After all, loss of information in the same manner as occurred in this case is common, and our economy unquestionably is highly dependent on computers and the intangible information that they contain. However, the court declined to use public policy as an "interpretive aid." There are plenty of useful legal principles for construing insurance contracts, but using public policy to redefine the scope of coverage agreed to by parties to a contract is not one of them. The lesson: Questions of insurance coverage are to be answered solely in the language of the policies and, therefore, careful drafting of policy language is critical.

Got a Gripe? Start a Website
Joseph was planning to buy a new house from a builder until he came to the conclusion that the builder's sales representative had misled him about the availability of a particular model. In an earlier time, he might have been content to vent to a sympathetic neighbor across his backyard fence, but this is the age of cyberspace. Joseph registered an Internet name that was very similar to that of the builder and then created a website as a forum for relating the reasons for his frustration with the builder. He included a disclaimer making it clear that visitors were not on the builder's website. There was no charge to access the site and the site contained no paid advertisements. Once in a while, an e-mail intended for the builder came to Joseph's site, but he promptly forwarded it to the builder.

Also on the website was something Joseph called the "Treasure Chest," a place where readers could exchange information about contractors and tradespeople who had done good work. During the entire time the site was up and running, only one person was mentioned in the Treasure Chest. Although it was nearly empty, the Treasure Chest prompted the builder to sue Joseph under the federal Anti-Cybersquatting Consumer Protection Act (ACPA).

The ACPA only applies to someone who, with "a bad-faith intent to profit," registers or uses a domain name that is identical or confusingly similar to that owned by someone else. Everyone agreed that the part of Joseph's website in which he aired his own complaints against the builder had no profit motive or commercial aspects, but the builder tried to argue that the Treasure Chest was a mingling of commercial activities with personal gripes.

A federal court ruled in favor of Joseph. The facts of the case did not amount to the conduct that the ACPA was meant to address, that is, setting up a business whose sole purpose is to register domain names that closely resemble the names of established businesses, and then attempting to sell the names to those businesses. The fact that Joseph meant to use the Treasure Chest to draw more people to his site to read his story did not convert the site into a commercial undertaking. He took no money either for being listed on the site or for viewing it, and the absence of paid advertising or links to other sites belied any profit motive. The website, especially with its very similar name, was no doubt a source of annoyance to the builder, but it was not a source of damages under the ACPA.

Prosecutions for filing a false Form 706, the federal estate tax return, have been rare. Recently, a federal prosecutor announced a guilty plea by an individual charged with estate tax fraud. The guilty plea may well be a harbinger of a new "get tough" policy by the IRS in an area that up until now has not had a reputation for vigorous criminal enforcement.

The defendant in this case was the executor of her mother's estate. She admitted that she intentionally filed a Form 706 that omitted assets worth about $400,000 that should have been included in the estate. The executor could face a term of imprisonment, followed by a term of supervised release, and a large fine.

Individuals who stand to be affected by the new emphasis from the IRS on using a carrot and a stick include executors, tax return preparers, and essentially anyone responsible for the completeness and accuracy of an estate tax return. It is important to remember that old income tax returns and other documents that the IRS can obtain in an audit often will allow it to discover assets that have gone unreported. The recently publicized guilty plea by an executor is a not-very-subtle warning by the IRS that estate tax fraud can have consequences beyond dollars and cents.

The IRS has established rules for determining the minimum amount that must be withdrawn each year from an inherited traditional IRA. When an individual inherits an IRA, the rules differ somewhat depending on whether the individual was the decedent's spouse. In any case, there is a substantial incentive for following the rules, because the failure to take minimum withdrawals results in a stiff penalty equal to 50% of the shortage. Since complying with the rules can be a convoluted process and a mistake could be costly, it makes sense to be guided by professional advice.

Surviving Spouses
The starting point is the general requirement that minimum withdrawals must begin at the age of 70 1/2. If an IRA owner dies before April 1 of the year after he or she turned 70 1/2, or at any earlier time, the surviving spouse can handle the IRA in any of three different ways. First, the spouse can transfer the account to his or her own name, so that it is treated as if it always belonged to the survivor. If the survivor is substantially younger than 70 1/2, this has the benefit of putting off mandatory withdrawals for years, during which time there will be more tax-deferred growth in the IRA. This choice also has the benefit of using a longer joint life expectancy figure in calculating the minimum withdrawals, meaning less is taken out and taxes are reduced.

Second, the surviving spouse simply can leave the IRA in the deceased spouse's name and begin taking minimum withdrawals when the deceased spouse would have been able to do so. The third approach is to invoke the "five-year rule," which allows the surviving spouse to do whatever he or she wants with the account until December 31 of the fifth year after the year in which the other spouse died. By that date, however, the account must be emptied and the resulting taxes must be paid. The five-year approach is not available if the deceased spouse died on or after April 1 of the year after turning 70 1/2.

Other Individual Heirs
If the deceased individual named a nonspouse beneficiary for the IRA, the beneficiary must begin taking minimum withdrawals over his or her own life expectancy, starting by December 31 of the year after the year in which the account owner died. Additional withdrawals must be taken by December 31 of each successive year. To calculate the minimum amount to be withdrawn, the beneficiary must divide the account balance for the previous year by his or her life expectancy, as given in tables published by the IRS.

As with surviving spouses, an heir can use the five-year rule to liquidate the inherited account by the end of the fifth year after the original owner died, before which time the heir can withdraw as little or as much as desired. Also as with surviving spouses, the five-year rule is not available if the IRA owner died on or after April 1 of the year after turning 70 1/2.

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