Family Law
Avoid the Common Mistake of Commingling Assets
In divorce cases, it is not unusual to find that a client has at some point during the marriage commingled nonmarital assets with marital assets, making it difficult or impossible to prove that the assets should be retained by the client at the time of divorce. In Maryland and the District of Columbia, assets acquired by a spouse prior to the marriage or by gift or inheritance are that spouse’s nonmarital property. Commingling of assets occurs when a marital asset is mixed in with a nonmarital asset. One example of this common mistake is when a client has funds in a bank account that existed prior to the marriage and then begins depositing funds earned during the marriage into that same account. Another example is when a spouse receives an inheritance or a gift during the marriage and commingles the inherited or gifted funds with marital funds acquired during the marriage. In those situations, the separate property can lose the quality of being nonmarital, meaning that the commingled funds might be deemed marital property and divided by the court at the time of divorce. To ensure that nonmarital assets will not be deemed marital property at the time of divorce, the best course of action is to keep them separate during the marriage by maintaining a separate bank account. It is also prudent to execute a prenuptial agreement prior to the marriage identifying which property will remain nonmarital at the time of divorce. To prove that an asset is nonmarital at the time of divorce, retaining documentation is vital. Account statements are frequently used to prove that funds in an account are a spouse’s nonmarital assets. If you have nonmarital assets that you want to remain your separate property, hold on to those old account statements establishing how and when you acquired the assets because they might not be available from banks or other financial institutions 10, 20, or 30 years later when you are getting divorced. It might also be necessary to employ a forensic expert to prove that the assets are nonmarital, depending upon the situation. Everyone goes into their marriage hoping it will last forever, but you would be wise to avoid the common mistake of commingling just in case it doesn’t.
May 16, 2022
Labor and Employment
You Can’t Arbitrate That!
Making an agreement to arbitrate an issue may be a great way to limit expense, save time, and preserve the confidential nature of the dispute. I often consider these when I draft contracts like severance agreements, non-compete agreements, and employment agreements. This has been a tool to keep information that might damage a company’s reputation out of the press. However, a new federal law says that employers can’t force employees to arbitrate claims about workplace sexual harassment or assault, even if they agreed in writing. The Ending Forced Arbitration of Sexual Assault and Sexual Harassment Act had widespread bipartisan support. Employees may now choose (regardless of what they signed) how to bring any sexual harassment or assault claims against a company – in court or through arbitration. They also can’t be forced to waive their rights to join others in a lawsuit claiming sexual harassment or assault, regardless of what they signed. Note that some states also have laws forbidding employers from requiring an employee who’s alleged sexual harassment or assault to sign a non-disclosure agreement. This type of law is pending in a number of states, too. There’s obviously a strong sentiment among lawmakers to discourage an organization’s ability to keep such claims private. For those reasons, employers should consider updating anti-harassment policies and training programs (which are legally required in some states). Employers should also review and revise employment agreements that contain mandatory arbitration clauses and/or joint-action waivers – or just lower expectations of privacy.
May 13, 2022
Business
How to Avoid Derailing Your Sell Side M&A Transaction
There are many items and considerations that can derail your sell side M&A transaction. Active litigation, titling issues to assets and employee/benefit matters all could lead to the quick demise of your sale. Most times, these items are found when due diligence commences in earnest by your buyer. However, the single most item that will tank your deal (or have buyers pass before a deal commences) relates to sloppy financial books and records. A seller’s financial data is generally the first substantive intersection with a buyer. Even before a letter of intent is submitted, a buyer will want to see some financial records of the potential target. If the seller’s records are disorganized and not in accordance with proper standards, most buyers will move on. For all business owners having good financial statements is vital to operating a successful business; for sellers in the market, hoping clean records is a must-have. The inability to show the buyer financial value and clean operations is the foremost deal killer for a seller. Sellers wanting to sell their business should have their books and records scrubbed before going into the marketplace to make certain their finances are clean, normal and what would be expected by a buyer. Failure to do so may prevent a seller from landing that large payday.
May 13, 2022
Family Law
Consider Whether an Expert is Necessary for Your Family Law Case
In “My Cousin Vinny,” arguably one of the best movies of all time, the character Mona Lisa Vito, played by Marisa Tomei, testifies as an automotive expert in a criminal case and provides an opinion about an automotive issue (positraction) that wins the case and results in the acquittal of two young men charged with murder. Experts are often necessary in litigation to provide professional opinions on complex issues in a wide range of cases. In any family law case, one of the strategic decisions a client must make with their attorney at the outset is whether to hire an expert. The following are some of the experts that parties to a family law case should consider hiring depending upon the issues in your family law case: Forensic accountant: Investigates whether a party has hidden assets and income, traces parties’ assets to nonmarital sources such as premarital assets, inheritance or gifts, or rebuts claims by the opposing party that certain property is nonmarital or marital. Business evaluation expert: Determines the economic value of a business owned by one of the parties in a divorce case so that the Court can consider the value of the business in the distribution of marital property. Real estate appraiser: Determines the value of the marital home, vacation homes, commercial properties owned by the parties, and any other real property that may be subject to distribution. Custody evaluator: Makes recommendations as to legal and physical custody of children after interviewing the parties, third parties, and the children, observing the parties and children, reviewing relevant documents, and in some cases performing psychological testing. Vocational expert: In cases involving claims for alimony, testifies as to the ability of a party to obtain and maintain employment and the amount of income the party is capable of earning. Attorneys’ fees expert: A lawyer who has substantial experience practicing family law and opines as to the reasonableness of attorneys’ fees incurred by the parties for the purpose of obtaining an award of attorneys’ fees or opposing a claim for attorneys’ fees. Courts often impose deadlines for the designation of experts early in the case. Failure to designate an expert by the court-ordered deadline can result in a party not being permitted to have an expert testify. An expert will explain complex issues to the Court in the presentation of your case and can rebut the opinions of experts hired by the opposing party. An expert can also provide valuable advice during the discovery process, preparation for trial, and settlement negotiations. That is why it is so important to retain an expert in accordance with the court’s deadline and have the expert begin working on the case. It also helps to have an attorney who knows the expert, has worked with the expert in the past and is confident that the expert will provide compelling testimony and opinions that will be accepted by the court at trial.
May 6, 2022
The Practice of Law
How to Find an Attorney – Regardless of Your Budget
I am sometimes called into situations where clients have hired other attorneys and aren’t happy with their services (or bills). I mean, I’ve heard some loud complaints. Another scenario I’ve encountered: the client comes to me with an employment-related agreement that lacks basic terms (hopelessly vague) or isn’t enforceable. So it becomes obvious to me that either 1) the client found something on the internet and copied it, or 2) prior counsel didn’t know what they were doing or did not do it carefully. What to do? If you’re an individual reading this and you don’t have money for a regular attorney’s rate, you may apply to various state or local agencies for free or reduced-cost help with some types of matters. You may also file certain litigations on your own behalf (although not all) and ask that the Court appoint you free counsel – yes, even in a civil case. Call your state’s bar association, as well; they may have other suggestions, such as working with supervised students at a law school. If you are looking for counsel on a business matter, then as Mama said, SHOP AROUND. Here’s how: Look for a specialist in the particular area(s) of law involved. Don’t call your neighbor because he’s the only attorney you know. Don’t rely on your best friend (that can get messy) or even their recommendations without doing your own research. To find a specialist, you may turn to the web, but don’t defer to the attorneys at the top of the page (they paid Google for the privilege). You could also look in local recent publications for “Best Lawyers” lists, but only those where attorneys are peer-selected. How long have they been practicing in that area? Do they claim so many specialties that it’s a bit suspect? After locating some attorneys who list the area as a specialty, contact several attorneys. Describe your situation, ask how often they handle this type of matter and for how many years. Just like a surgeon, you’re looking for someone who’s handled this procedure many times. Don’t go to the firm your organization “has used forever” unless you are very comfortable with the expertise and experience of the current lawyers at the firm (and their rates; ask). Ask: who will handle the bulk of the work, the experienced partner or the new associate? Get quotes from qualified attorneys. There is a huge range of billable rates for the same work from very similar lawyers. Recently I was on a call with lawyers from a firm (who aren’t as experienced). The two of them on the other end of the phone cost their client almost three times what I charged my client. These might seem time-consuming. But these efforts could save tens of thousands of dollars. Best regards, Katherine
May 4, 2022
Labor and Employment
May Your Business Require Employees Not to Mask?
As more and more businesses mandate that workers return to the workplace, management is wondering about masking requirements. Some business owners feel strongly that they don’t want to require their employees to wear masks. Others do not want to create the impression that the location isn’t safe for customers and feel that this might be exacerbated by masked public-facing employees. Some feel strongly that it’s their right as an employer to impose a no-mask policy for other reasons. Is that a good idea? If an employee decides to defy the no-mask policy, they may have a legal claim (backed by science) if the business fires them for disobeying the policy. The CDC (Centers for Disease Control) is still recommending public masking. An employee might even bring a whistleblower claim under state law if the employee complains about the safety of the workplace to management and/or health authorities. An employee could also complain to OSHA. Although the Supreme Court struck down the OSHA Emergency Temporary Standard requiring safety measures, OSHA will still enforce a masking policy if it determines that the location is unsafe (at least for certain employees) without masking. Finally, it bears repeating that an employee with a disability who’s protected by the Americans with Disabilities Act (or equivalent state law) and whose healthcare provider advises that masking is required should be allowed to mask. That claim (depending upon the exact facts, of course) would make it past a motion to dismiss and cost the business a lot to litigate. I haven’t seen a case on this topic yet, but for these reasons, I wouldn’t advise a mandated no-mask policy right now. Why not create a mask-optional policy if the business feels strongly? It might yield very similar results. Update on last week’s blog on the no-poach agreement criminal trial: the jury found the defendants not guilty. However, this was a criminal trial, and it’s easier to prove liability in a civil case (remember, O.J. Simpson). It’s still ok to mandate mask-wearing on the job.
April 29, 2022
Bankruptcy
NOW WHAT? The Future of the Small Business Bankruptcy Act
We have all seen and heard of the mega-bankruptcy cases in the news, whether for reasonable economic causes (Forever 21, JC Penneys, GNC) or for attempted strategic advantage (J&J Talc Litigation; Boys Scouts Sexual Abuse claims, or various Religious Dioceses). The costs and expense to the business entities seeking federal bankruptcy protection has become astronomical. The legal and consulting fees are in the millions of dollars each month. The concept of seeking bankruptcy relief was clearly becoming cost-prohibitive for most businesses. Just prior to the unimaginable pandemic, Congress sought to remedy the problem by creating and adopting the Small Business Reorganization Act (“SBRA”). This Act became effective February 19, 2020. The purpose was to make bankruptcy more efficient and affordable to the real-world business community. The Act sought to provide these efficiencies for businesses with less than $2,725,625 in total debt. Literally, 30 days later, we are all in the throes of the modern COVID-19 Pandemic. At the time, no bankruptcy practitioner was truly aware of how SBRA would actually work; however, Congress, with perhaps some fear of small business collapse as a result of global economic shutdowns, adopted at lightning speed the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). This Act was adopted and signed by the President on March 27, 2020- just over a month following SBRA’s effective date. The most critical provision of the CARES Act was the increase of the eligibility threshold for qualifying for a Small Business Bankruptcy from the established $2,725,625 claim amount to the increased sum of $7,500,000. This increase opened up the SBRA benefits to a significant amount of business. Why is this so important? Simply stated- the cost-effective benefits of Debtors in a Small Business Bankruptcy are significant. First, there is no obligation for a Small Business debtor to pay Quarterly Fees to the U.S. Trustee System. In a normal chapter 11 bankruptcy case, a company in chapter 11 is obligated to pay fees to assist in funding government oversight of the bankruptcy process by assessing a fee based on the total dollar amount of disbursements made by the bankruptcy company while it remains in a chapter 11 proceeding. Yes, the company, in addition to paying its regular bills and operation expenses, must pay an additional “fee” just from being in Bankruptcy. For the non-mega case- this obligation alone could, and has, caused the bankruptcy effort to fail. They did not file bankruptcy to be obligated to pay more for normal business operations. SBRA excuses Small Business debtors from paying this fee. A second major benefit is that no creditors committee is permitted to be formed in a Small Business Bankruptcy. In the normal chapter 11 case, quite often, the larger unsecured creditors are permitted to band together and form an official recognized committee to be authorized to negotiate their best treatment from the debtor. Once established, the creditors’ committee is permitted to hire professionals such as a lawyer and accountant to represent the committee. The costs associated with these professional fees, however, is required to be paid by the Debtor. Again, a cost that can torpedo many businesses in their quest to reorganize. SBRA eliminates this exposure by prohibiting creditors committees. The third significant benefit of the Small Business Bankruptcy is the elimination of the application of the absolute priority rule. This rule found under Section 1129 of the Bankruptcy Code provides that a debtor’s plan of reorganization cannot be approved by the bankruptcy court unless it provides that all creditors who hold a higher prioritized claim are first paid in full before a subordinated priority class of claims can retain any interest in the reorganized company. Since unsecured creditors claims hold a higher priority for payment than business owners, a business owner under a regular chapter 11 cannot retain their ownership interest unless some exception can be established. Since most small businesses are owned and controlled often by a few family members, eliminating this requirement goes a long way in promoting the salvation of America’s small businesses. So clearly, there are great benefits under SBRA which gives a majority of small businesses a better chance at survival. The CARES Act extended this benefit to even a wider and necessary breadth of business. Unfortunately- the CARES Act extension of this increased eligibility number was only intended to be temporary. Under the original enactment, the increase was intended to revert to the original lesser eligibility amount in one year- on March 27, 2021. With the COVID-19 pandemic remaining in flux by the early Spring of 2021, U.S. Senator Richard Durbin, a Republican from Illinois, introduced S.473 entitled the COVID-19 Bankruptcy Relief Extension Act of 2021 on February 25, 2021. The Act sought to further extend the increased eligibility for qualifying for a small business bankruptcy for an additional year until March 27, 2022. Remarkably, this legislation again moved through both Houses of Congress and was eventually signed by the President- actually after March 27, 2021- but who is watching. This brings us to present day, and the first question asked- NOW WHAT? See on March 14, 2022, Senator Durbin again introduced legislation in the Senate- S.3823, which without saying much of anything, looks to simply eliminate Section 1113 of the CARES Act. Why is this important- because that section is the section which establishes the sunset provision for the eligibility increase. If this section was eliminated, the increased eligibility threshold of $7,500,000 would become permanent. This certainly is well supported by the Debtor Bankruptcy Bar and the American Bankruptcy Institute. Regretfully the world again gets in the way of this important legislative amendment. On March 14, 2022, S. 3823 was referred to the Senate Judiciary Committee. Everyone was hoping for prompt consideration by Judiciary and then forwarding the Legislation to the full Senate for approval. The Bill is was optimistically anticipated before the expiration on March 27, 2022, as mandated under the current Section 1113. Unfortunately, however, last week, the Senate Judiciary got tied up with a certain Judiciary Hearing questioning some Judge looking to be approved to sit on the Supreme Court. The Committee did not have the time to consider S. 3823. The legislation was not adopted in time, and as a result, on Monday, March 28, 2022, eligibility to qualify for a small business bankruptcy reverted to the lesser $2,725,625. Due to inflationary provisions of the bankruptcy code, on April 1, 2022, the qualification number will be adjusted to $3,024,725, however, this number is a far cry from $7,500,000. Many viable businesses have been left out in the cold. The story- and hope is not all lost. Despite S.3823 remaining before the Senate Judiciary Committee when the higher threshold lapsed, there remains overwhelming support for this very necessary change for small business bankruptcy qualification. With the anticipated significant future increases in lending costs and a further demand on small business, demands of business will become even more pressing. Work remains to be done, but the increase in the qualification amount is favored and will hopefully be reinstated soon. On April 7, 2022, ten days after the expiration of the law, the Senate unanimously approved the legislation with some minor revisions and sent the adopted bill to the House. According to the Congressional website, the Bill was received by the House of Representatives on April 11, 2022, and held at the desk. What happens between now and then is anyone’s guess. For questions about the Small Business Bankruptcy Act, contact Paul J. Winterhalter at pwinterhalter@offitkurman.com.
April 28, 2022
Bankruptcy
Subchapter V Corner – Are Subchapter V Business Debtors at Risk to Fight Non-Dischargeability Creditor Complaints?
An interesting issue is percolating in the Fourth Circuit right now. This issue is whether, in a Subchapter V case, a creditor may successfully object to the dischargeability of certain debts of a non-individual debtor (as opposed to an individual debtor). The debts in question are the debts described in Section 523 of the Bankruptcy Code. Section 523 is titled “Exceptions to discharge” and describes the types of debts that are not dischargeable by “an individual debtor.” Section 523 includes certain tax debts, debts for fraud, debts for breach of fiduciary duty, debts for willful and malicious injury, and certain debts payable to a governmental unit. In the bankruptcy world, we’ve all been trained that Section 523 does not apply in cases filed by non-individual debtors. That’s because the preamble to Section 523 refers to debts of “an individual debtor.” When I first learned of this issue, I thought it was farfetched that a creditor could object to the dischargeability of the type of debts described in Section 523 in a bankruptcy case filed by an entity. However, if you look at the statutory provisions at issue here, there does appear to be some logic behind it. And because Subchapter V of Chapter 11 has only been around since February of 2020, the statutory provisions are brand new. Why is this important? I mentioned above that a case is pending in the Fourth Circuit on this issue. The case arises in the Cleary Packaging, LLC case (the “Debtor”), which was filed on February 7, 2021, in the U.S. Bankruptcy Court for the District of Maryland (the “Bankruptcy Court”). Prior to the filing, a creditor, Cantwell-Cleary Co., Inc. (the “Creditor”), obtained a large money judgment against the Debtor for intentional interference with contracts and tortious interference with business relations (the “Debt”). After the Debtor filed for bankruptcy, the Creditor objected to the dischargeability of the Debt under Section 523(a)(6) (willful and malicious injury). Ultimately, the Bankruptcy Court held that the Bankruptcy Code limits the application of Section 523 in Subchapter V cases to individual debtors. The Creditor obtained permission to pursue a direct appeal to the Fourth Circuit. Interestingly, the case caught the attention of the United States, which filed an amicus brief in support of reversal, citing several types of debts described in Section 523, including tax debts, certain fines and penalties and criminal restitution debts. Another group of nine interested parties also filed a separate amicus brief in support of reversal because of their interest in enforcing wage theft claims. The Fourth Circuit conducted an oral argument on March 10, 2022, and has not yet issued a decision. The Creditor and the amici curiae argue, among other things, that because Section 1192 of the Bankruptcy Code (which governs discharges in nonconsensual plans in Subchapter V cases) excepts from discharge any debt “of the kind specified in section 523(a) of this title,” and does not differentiate between individual and non-individual cases, it applies equally to both individual and nonindividual debtors. We shall see. For information on this topic, contact Stephen Metz.
April 27, 2022
Estates and Trusts
Leaving Little to Chance — A Trust for Your Financial Legacy
Receiving an inheritance can seem like winning the lottery. A financial windfall lands on your doorstep and promises to change your life for the better. But an inheritance and lottery winnings differ in many important ways, starting with the likelihood of receiving one. You are much more likely to receive an inheritance than win the lottery, especially if you are already well off. About 20 percent of Americans inherit money at some point in their lives, but that number jumps to almost 40 percent for people in more affluent households. Lottery winners, on the other hand, tend to be less well off, and they often have trouble managing their newfound wealth. They may also view their windfall differently. Someone who wins the lottery feels like a “winner” and may show little restraint in spending the prize money. When a sprawling house, luxury cars, and European vacations are all within easy reach, there may seem to be little reason to hold back. Someone who receives an inheritance is a different kind of winner—a person who has earned enough love and devotion to be remembered in someone’s will. Instead of being called a winner, the recipient is a “legatee.” (The word comes from the legal term for an inheritance, a “legacy.”) Whether the benefactor is a parent or grandparent, a partner or spouse, the recipient may well view the gift as that person’s personal legacy. It’s not a prize from government coffers but wealth passed down in love after a lifetime of hard work and careful investing. Viewed in this light, an inheritance is not a license to become a spendthrift. It’s a legacy that carries the implicit obligation to husband the assets in a way that honors the donor and perhaps considers the next generation. An inheritance carries the implicit obligation to honor the donor and consider the next generation. The government has recognized this difference by making lottery winnings taxable to the recipient while inherited assets generally are not. (In Maryland, one exception is the 10% inheritance tax, which applies to a bequest left to anyone who is not a close family member, such as an unmarried partner, niece or nephew, or friend.) One way in which lottery winnings and inherited wealth are the same is that they are both easy to squander. A disproportionate number of lottery winners declare bankruptcy within five years. For those who inherit, the money that had been earned through hard work may be lost through fast living. This is especially true of legacies left to a young person or someone with money-management problems. You can’t guarantee that someone will win the lottery, but you can leave them a legacy designed to last. Speak with an estates and trusts attorney about preparing a will that provides for the people you care about. If they include a young person or someone who struggles with being responsible, ask about including a “spendthrift trust” in your will. This kind of trust can protect your bequest by putting someone responsible, called the “trustee,” in charge of administering the assets. As the gatekeeper, the trustee can ensure that the money held in trust is spent for worthwhile purposes. The principal may also be shielded from your loved one’s creditors. Take care of the people you care about by having your will prepared by an estates and trusts lawyer who understands your needs on a personal level.
April 26, 2022
Business
Tax Considerations when Selling your Business
Most business owners pay their fair share of taxes while running their company. When it comes time to sell the business, most owners are seeking tax strategies to minimize taxes paid on their gain. We know that tax considerations are a major driver of any commercial transaction, especially M&A transactions. So, what should a seller keep in mind when considering a sale? First, before going into the market and soliciting letters of intent (LOI), sellers should update their estate plan and engage in pre-transaction tax planning. Ideally, this planning should be finalized a year in advance of a sale. The closer to the sale, the less tax planning opportunities available. Estate planning strategies including gifting and otherwise transferring interests to reduce wealth received directly by the seller. Pre-tax planning may include reorganizing the structure of the business or changing tax elections. Once the seller receives an LOI, the proposed structure of the transaction becomes paramount for the seller’s tax planning. For example, structuring the transaction as an equity purchase likely could result in long-term capital gains treatment for the seller. An asset sale structure could lead to a mixed result of ordinary income as well as capital gains for the seller, depending on how the purchase price is allocated. Most times, a change in structure that benefits one party is a negative for the other party. Thus, the seller must have competent legal counsel versed in M&A and taxation issues. Further, how a purchase price is paid to the seller may have implications on timing as well as the treatment of the income. Monies paid overtime may lead to tax on the income being deferred to later years. Monies paid in forms such as for employment or consulting services or in consideration of a restrictive covenant likewise could have particular tax implications. In summary, selling a business is most times the largest financial transaction for an entrepreneur. Making certain to understand the tax treatment and implications at the earliest is paramount. After all, for any entrepreneur, the bottom-line net amount is what ultimately counts, not the top-line valuation.
April 20, 2022
Labor and Employment
The Department of Justice Has Cooked Up Criminal Charges for No-Poach Agreements
Here’s yet another reason not to enter agreements with other companies not to hire (poach) other companies’ employees: potential criminal prosecution. In the first-ever criminal trial for labor-related antitrust (Sherman Act) violations, the Department of Justice alleges that former DaVita Inc. CEO Kent Thiry conspired with other healthcare CEOs to limit employee movement to competitors. As of this writing, the federal jury is deliberating. The trial was eight days long. Prosecutors allege that Thiry and DaVita entered “no-poach” agreements with Surgical Care Affiliates LLC, Radiology Partners, and Hazel Health Inc. not to solicit each other’s executives or to ask the executives to tell their bosses before applying for a job with one of the three companies. If so, prosecutors argued that this arrangement had a “chilling effect” on commerce by keeping wages down in the companies’ market. The defendants have admitted that such an agreement existed – but that it had no such effect on business. The DOJ and workers have already brought many civil suits claiming that no-poach agreements adversely affected markets. Apple, Google, Adobe, Pixar, Intel, Intuit, Lucasfilm, McDonald’s, and Jimmy John’s are among those that have been sued.
April 20, 2022
The Weekly Scenario
The Weekly Scenario: Governor Hogan Signed into Law the Maryland Tax Reduction Act on Friday, April 1st.
The act will cut retirement taxes by eliminating all state tax on the first $50,000 of income for retirees making up to $100,000 in federally adjusted gross income. Retirees with Maryland income will pay no state tax up to $50k. This is purported to be the largest tax reduction for Maryland residents in two decades. The tax reductions are scheduled to be phased in over five years, beginning this year. In addition, Governor Hogan will be introducing the Hometown Heroes Act to exempt retired law enforcement, fire, rescue, corrections, and emergency response workers from state tax on all retirement income specific to the profession. In 2017, the Governor exempted the first $15,000 of these employees’ income. He will push to exempt income on these professions and lower the age of eligibility from 55 to 50 years. Specifically, this bipartisan tax relief agreement includes the following provisions for FY23-FY27: Tax Relief for Retirees65 and older making up to $100,000 in retirement income, and married couples making up to $150,000 in retirement income. As a result, 80% of Maryland’s retirees will receive substantial relief or pay no state income taxes at all. ($1.55 billion) The Work Opportunity Tax Creditincentivizes employers and businesses to hire and retain workers from underserved communities that have faced significant barriers to employment. ($195 million) Family Budget Boosters: sales tax exemptions for childcare products such as diapers, car seats, baby bottles and critical health products such as dental hygiene products, diabetic care products and medical devices. ($115.6 million) Signing ceremony later this week! As always, if you have any questions or would like to learn more, please contact Steve Shane at sshane@offitkurman.com or 301.575.0313.
April 15, 2022
The Weekly Scenario
The Weekly Scenario: New FDIC Rule to Simplify Banking for Trusts
On January 21, 2022, the Federal Deposit Insurance Corporation (“FDIC”) approved a new rule (going into effect on April 1, 2024) that will simplify the agency’s deposit insurance coverage regulations (after you can through 20 pages of rules!). For clients with deposits in Revocable and Irrevocable Trust accounts, the FDIC is merging the two deposit insurance categories for revocable and irrevocable trusts and applying simpler coverage rule. The point of the new rules is that they will create a consistent and (perhaps) easier process for bankers and those making deposits. Basically, the new rule is the insuring up to $250,000 for each trust beneficiary (not to exceed five beneficiaries), regardless of whether the trust is revocable or irrevocable, and regardless of any contingencies, the allocation of distributions among beneficiaries; and the maximum deposit insurance coverage of $1,250,000 per insured depository institution for trust deposits. As an example, you create a trust for your son and his three children. The Trustee can make distributions to any of the trust beneficiaries. If this trust deposits $1,000,000 in Bank 1 and $1,000,000 in Bank 2, the deposits in both banks will be protected by FDIC insurance. By contrast, if this trust deposits $1,500,000 in Bank 3, only $1,000,000 ($250,000 x 4 beneficiaries) of this account will be protected by FDIC insurance. The FDIC does not expect most trust depositors to experience any change in coverage when the rule takes effect but will be giving a two-year lead time for banks and depositors to become familiar with the new regulation.
April 1, 2022
Bankruptcy
Lenders Beware
WHEN IS A LENDER CROSSING THE LINE AND ENTERING LENDER LIABILITY WONDERLAND? A 2022 decision out of a bankruptcy court in Texas reminded lenders that an overly aggressive approach to a borrower can result in lender liability[1] and substantial damages. In this case, brought by a Chapter 7 trustee, the bankruptcy court concluded that the lender destroyed the debtor’s enterprise value and future as a going concern and ultimately drove the debtor out of business. The Court found that for the lender’s actions, the debtor would not have failed as a going concern and would not have had to file bankruptcy. As a result, the Court awarded $16,966,928 in damages for breach of contract and breach of the duty of good faith and fair dealing, fraudulent misrepresentation, contractual and business interference, and willful violation of the automatic stay. The lender unsuccessfully tried to argue that the debtor was dead on arrival. [1] As the bankruptcy court put it, “[l]ender liability” is a broad umbrella term often used to describe various theories through which a borrower (or its trustee in bankruptcy) seeks to impose liability (or a remedy of some sort) against a former lender in a lending relationship that has soured.” THE STORY BEHIND THE AWARD Bailey Tool & Manufacturing Company and its subsidiaries and affiliates (“Bailey”) was the debtor/borrower in this tragic story. Republic Business Credit, LLC (“Republic”) was the lender. Before filing bankruptcy, Bailey and Republic entered into a factoring arrangement and an asset-based loan facility in February 2015. Republic performed substantial diligence in late 2014 and early 2015 before entering into the agreements. During the due diligence process, Republic had identified several issues, including unpaid ad valorem taxes, stretched accounts payable, and a major customer (the Department of Defense) that paid on a milestone rather than progressive billing basis. Despite these issues, the underwriter viewed the proposed transaction as a “strong deal” and approved it. Four months after entering into the agreements, Republic refused to advance funds as expected, declared default and made payments to itself from Bailey’s lockbox under the factoring agreement to pay down the ABL (Asset Based Lending) facility. The Court found that Republic took complete and total control of Bailey’s cash. It controlled not only the collections through the lockbox and all disbursements too. All funds advanced from July 2015 forward were sent directly to vendors selected by Republic vendors and a payroll company for the payroll of employees selected by Republic. The Court held that the lender’s handling of disbursement was inconsistent with the parties’ agreements—specifically, the Factoring Agreements contemplated that Republic would “pay to Seller [Bailey] an Advance.” In September 2015, Republic stopped funding altogether. Republic also became involved in replacing management and otherwise micromanaging the Debtor. It forced the Debtor’s Chief Executive Officer to give the Republic a lien on his exempt homestead. THE DECISION In a meticulous 145-page decision, the Court analyzed the Republic’s conduct, including and highlighting numerous internal lender email communications produced in discovery and presented during the trial. The Court adopted the bankruptcy trustee’s theory of the case, i.e. that the lender: (i) refused to advance funds in good faith and in the manner promised almost immediately after the agreements were signed taking a stance that the businesses were in an “over-advanced” position, which was not a defined concept in the agreements and was problematic in light of several weeks of due diligence and awareness regarding certain slow-paying accounts and inventory status; (ii) charged fees, expenses, penalties and other items against “reserves” (contributing to the alleged “over-advanced” position), without any transparency; (iii) exercised excessive control over the businesses by controlling what vendors, employees, and expenses got paid and insisting on direct payments to them by the factoring company rather than funding to the businesses as contemplated by the underlying agreements (i.e., the argument being that this was an improper exertion of control; there were no amendments of documents or forbearance agreements to justify deviating from the underlying agreements). WHAT ACTION TO AVOID AS A LENDER This decision can now serve as a roadmap for borrowers to establish lender liability. In summary, the factors considered by the Court include: Taking over the business function and exercising business judgment – Without the requisite knowledge and experience, Republic approved payments to certain vendors and materials suppliers, reordered the sequence in which different products at Bailey were manufactured, and changed the manufacturing priorities from keeping long-term customers, to doing “quick-turn” projects; Controlling the workforce at Bailey through controlling the payroll and ordering who got paid and who did not and what types or classifications of employees could get paid; Directing vendors of Bailey to pay Republic instead of Bailey under the threat of litigation, destroying the goodwill that Bailey had built up with these vendors; Lack of transparency and misrepresentations as to why: (i) why it considered Bailey to be in default, (ii) the status of funds availability or lack thereof, (iii) application of funds collected and charging numerous fees and expenses. The conduct of the lender, in this case, appears egregious. Still, it is a reminder for lenders to closely review with counsel contractual remedies and exercise caution in implementing these remedies.
March 31, 2022
Real Estate
This Week in Real Estate: Share Equity Agreements
As home prices continue to rise across the county, many homeowners are researching whether to obtain home equity loans to take advantage of the value appreciation and unlock some of the increased equity. I similarly did this research. While researching home equity loans, I came across a vehicle that investors have been using for quite some time but is now available in the residential home consumer market – share equity agreements. Shared equity agreements, sometimes known as home equity investments, enable a home buyer or homeowner to share home equity in exchange for a one-time cash payment from an investor. Such agreements allow you to liquidate part of your home equity for cash or sometimes are used in the home purchasing process to help prospective homeowners with a down payment. Investors give homeowners a lump sum in exchange for a share in the future value of their homes. When the homes are sold (or when the contract term ends), the investors receive their share from the sale. If the value of the house increases, so does the amount the investor receives. If the house drops in value, the investor also shares in the loss. There are no interest rates or monthly payments to worry about. The homeowner doesn’t pay off the investor with monthly payments or interest. Instead, at the end of the contract, the homeowner agrees to pay the investor’s initial investment and a fixed percentage of the change in home value. In a few cases, the investor’s share is based off the overall value of the property at sale. The end of the contract is set for a predetermined date (terms are typically 10 to 30 years) or when the home is sold. You can buy out the investment at any time. Shared equity appreciation agreements give investors a low-risk way to invest in real estate that can also offer them tax benefits. There are a growing number of reputable firms offering these products to consumers. Generally, these firms are partnered with large institutional investors, such as pension funds, who are looking for investment exposure to real estate assets. A shared appreciation mortgage gives an investment company or investor a stake in the home’s future equity. However, the investor won’t have anything to do with the day-to-day running of your home. They can’t make decisions on how you decorate or what remodeling projects you take on. However, they will benefit if your home’s value increases. You will also be responsible for any expenses, taxes, or insurance costs. When your equity sharing agreement contract finishes, the homeowner repays the investing partner the amount they initially loaned to the homeowner, plus a percentage of the appreciation in the home’s value. If the home decreases in value, the investor will receive less money. A shared equity finance agreement isn’t technically a mortgage. It may be easier to qualify for a shared equity agreement than a home loan product. Credit and income requirements are typically more lenient. Next week, we will examine how the shared agreements actually work.
March 31, 2022
Bankruptcy
Subchapter V Corner
The $7,500,000 debt ceiling for Subchapter V filings ended in the spring of 2022. With the enactment of Subchapter V of Chapter 11 (Sub V) of the Bankruptcy Code, viable small and medium-sized businesses have a more cost-efficient restructuring mechanism. Who is eligible? – Businesses and individuals engaged in commercial or business activities with no more than $2,725,625 of noncontingent liquidated secured and unsecured debt as of the date of filing or the order for relief. The business or individual cannot have owning of single-asset real estate as its primary activity. The CARES Act, however, increased the debt ceiling to $7,500,000 until March 27, 2021, and further extended it until March 27, 2022, with the COVID-19 Bankruptcy Relief Extension Act of 2021, Democrats and Republicans are now weighing an extension of Subchapter V’s $7.5 million debt limit before it is due to sunset back to the previous amount under the Code. Without another renewal, the increased debt limit applies only to cases filed after the effective date of the CARES Act and before March 27, 2022. What is the advantage of a Subchapter V filing? There are several modifications of the traditional restructuring process that make a Subchapter V proceeding a more straightforward and cheaper path to reorganization: It allows the owner of the business to preserve their equity even when the business is not in a position to pay in full its secured and unsecured creditors (i.e., abrogates the so-called “absolute priority rule”). The creditors’ ability to block confirmation is significantly weakened because Subchapter V eliminates the traditional requirement that at least one impaired class of creditors accepts the reorganization plan. A reorganization plan will be deemed fair and equitable to objecting unsecured creditors if the debtor pays projected disposable income to be received over at least three years. A Subchapter V plan may provide for later payment of administrative expenses (i.e., payment through the plan) as opposed to payment on the effective date of the plan. Only the debtor can file a plan (i.e., eliminates the ability of creditors to propose their own restructuring plan). It eliminates US Trustee quarterly fees and other procedural and reporting burdens. For guidance on this matter, contact Albena Petrakov at apetrakov@offitkurman.com or at 212.380.4106.
March 22, 2022
Labor and Employment
How the Ukrainian Invasion Could Impact U.S.-Based Employees
Russia’s recent invasion of Ukraine—and the related sanctions against Russia— impacts your company’s U.S. employees. How, you ask? First, I don’t need to belabor this point, but limiting Ukrainian and Russian trade puts stress on supply chains, leading to additional U.S. food and other shortages and adding fuel to the inflation fire. Employers might have to consider suspending projects or reducing production, leading to furloughs or layoffs. If the company’s thinking about a layoff of more than a few dozen people, check the federal WARN Act as well as any WARN Act in the states where employees are working for notice requirements, which could be months in advance. If they aren’t planning to lay off workers, employers should be sensitive to the effects of the rising cost of living – consider small raises for valuable employees. Also, if pay issues become too important in the workforce overall, keep in mind that companies might have to fight union campaigns. On the immigration front, over two million people have fled Ukraine; as of the time I’m writing this, many are expected to apply to come to the U.S. Moreover, on March 3, the Department of Homeland Security granted what’s called Temporary Protected Status (TPS) to eligible Ukrainian nationals in the U.S. because of “ongoing armed conflict” and “extraordinary and temporary conditions.” Those eligible for TPS must have continuously resided in the U.S. since March 1, 2022, or earlier. The TPS will last 18 months, and people applying for TPS may also apply for a document allowing them to work in the U.S. for the duration of their TPS status. This could help with labor shortage issues if companies are still hiring. Finally, employers should be sensitive to the emotional impact of the situation. It might not be easy for employees who see colleagues, friends, and their families affected by the war. They might even need access to mental health care. Don’t forget that if the company is subject to the federal Family and Medical Leave Act or similar state statutes, military family leave provisions entitle eligible employees to take FMLA leave for any “qualifying exigency” arising from the foreign deployment of the employee’s spouse, son, daughter, or parent with the Armed Forces. This includes leave to arrange for departures of their loved one. Uncharted territory might lead to legal mistakes on top of all the other problems right now. Make sure to think through your personnel decisions.
March 21, 2022
Intellectual Property
Trademark Law v. The First Amendment – the Saga Continues
In recent years, the US Supreme Court found that two provisions of the US trademark law that date back to the 1940s were unconstitutional because they violated the free speech provisions of the First Amendment. In Matal v. Tam, it was the law prohibiting registration of disparaging trademarks, and in In re Brunetti, it was the law prohibiting registration of immoral or scandalous trademarks. Now the Court of Appeals for the Federal Circuit has reached a similar conclusion in a less obvious case. In In re Elster, decided on February 24, an attorney applied to register the trademark TRUMP TOO SMALL for “T-shirts.” Registration was refused based on a provision that prohibits trademark registration of a name identifying a particular living individual without that individual’s consent (and another ground not ultimately considered on appeal). Elster appealed to the Trademark Trial and Appeal Board (TTAB), which upheld the refusal. Elster then appealed to the Federal Circuit. The federal government argued that the government interest in protecting state-law privacy and publicity rights outweighed Elster’s First Amendment rights. The court noted that Trump, as a public figure, had no right of privacy-protecting him from criticism in the absence of knowingly publishing false information or doing so with reckless disregard for the truth. The court also said, “The right of publicity does not support a government restriction on the use of a mark because the mark is critical of a public official without his or her consent.” The court ultimately concluded that the free speech provisions of the first amendment outweighed the government interest and that “[t]he statute leaves the [US Patent and Trademark Office] no discretion to exempt trademarks that advance parody, criticism, commentary on matters of public importance, artistic transformation, or any other First Amendment interests. It effectively grants all public figures the power to restrict trademarks constituting First Amendment expression before they occur.” And so the court reversed the TTAB’s decision and found the trademark TRUMP TOO SMALL to be registrable. In reaching its decision, the court made clear that it was not concluding that the relevant section of the trademark law is overbroad, saying it was leaving that question for another day. Rather, it was saying that the application of the law to Elster’s trademark was in violation of his First Amendment rights. Still, this leaves the door open for other trademark applicants for such marks that are parody or critical commentary to raise the overbreadth challenge in the future. Are you considering adoption of a trademark that includes the name of a living individual? For guidance on the evolving state of the law as it applies to your situation, contact Laura Winston at lwinston@offitkurman.com or 347-589-8536.
March 17, 2022
M&A Nuggets
M&A Nuggets: Transparency
Suppose you are in the process of selling your business, and you are aware of an existing issue or a new issue arises that you believe could have an impact on a purchaser’s view of your company. Should you disclose the matter to the potential purchaser? The answer depends on where you are in the process of the sale. If you are at the preliminary discussion stage with potential purchasers, none of whom have committed to move forward, then disclosure is probably not called for. Prior to having a committed potential purchaser ready to move forward, many of these issues can be dealt with and disposed of. If, however, you are at the stage at which a potential purchaser is fully committed to move forward to acquire your business, then the answer is yes. You should disclose. The kinds of issues to be disclosed include an existing or new lawsuit, a difficult co-owner or key employee, or a provision in a key third party agreement, such as a right of first refusal, that has to be dealt with. Often, the perception of the severity of an issue is greater than reality. Further, purchasers of businesses are accustomed to hiccups along the way. Some of these kinds of matters may not be able to be resolved before closing and therefore a purchaser will have to deal with them after closing. Being transparent and communicating potential major issues to the purchaser early on allows both sides to determine whether to move forward and, if so, how to address the issue. Waiting to disclose a major issue to a purchaser could cause delays, higher expenses to be incurred and possibly the loss of a deal. A benefit of being transparent is that it engenders in the purchaser a sense of goodwill and fair dealing on the part of the seller. Certainly, throughout negotiations in the sale of a business, there are times when it is best to maintain a poker face and not let the purchaser know your reaction to an issue. In the event of a potentially major issue that the purchaser is likely to be concerned about, however, the chips are off the table and transparency is the better practice. If you have any questions about this or any other M&A issue, please contact Glenn Solomon at gsolomon@offitkurman.com or 443-738-1522.
March 16, 2022
Tax
Excess Compensation and Disguised Dividends – Take Care and Beware!
Yesterday I wrote about a case involving constructive dividends. Today it is disguised dividends. The issue in Clary Hood, Inc. v. Comm.,T.C. Memo. 2022-15, was whether the salary and bonus paid to the company’s president (Mr. Hood) was excessive under IRC 162(a)(1) and was therefore a disguised dividend. Recall that compensation, if reasonable and not excessive, is a deductible business expense for the company, but dividends are not. In this case the company was a C-corporation, which, because of the double layer of taxation (first at the corporate level, then again at the shareholder and employee level), had every incentive to characterize the payment as compensation, not as a dividend. The company’s story is the great American success story, and the opinion is well worth the read for this story alone. Starting with little money and used equipment in 1980, the company, largely through the efforts of Mr. Hood, who, together with his wife owned all the stock and were the only directors of the company, became a multimillion-dollar company by 2016 with revenues in excess of 60 million dollars. Along the way Mr. Hood did what many small business owners do when starting out – he often did not draw a salary, so the business had enough money to pay its other employees and creditors. When things finally began to turn around, Mr. Hood and his wife, as the company’s directors, decided to pay a bonus to Mr. Hood in the company’s 2015 and 2016 fiscal years. For the 2015 bonus, the company engaged its outside accountants to perform a salary survey. Based on the accountants’ recommendations, the company paid Mr. Hood a bonus of 5 million dollars in 2015. The company paid Mr. Hood the same bonus in 2016 but did so without engaging the company’s accountants to perform another salary survey. Without going through the math, the difference in the Hoods’ pocket between the company declaring and paying a dividend to the Hoods for 5 million (not deductible by the company) or paying the Hoods a 5 million bonus (deductible by the company) was about one million dollars. The substantial increase on Line 12 of the company’s return caught the watchful eye of the Service. Audits and notices of deficiencies promptly followed, including accuracy related penalties under 6662 for substantial understatement of income. The company put on several experts to demonstrate Mr. Hood’s bonus was calculated reasonably and the Service put on one expert. Based on deficiencies in their reports, the Tax Court placed little value in the company’s experts. On the other hand, the Service’s expert’s report did not have the same deficiencies and the Tax Court found that expert (who concluded Mr. Hood’s bonus was excessive) credible. The Tax Court determined reasonable compensation for Mr. Hood was $3,681,269 for tax year 2015 and $1,362,831 for tax year 2016. Further the Tax Court abated the substantial understatement penalty for 2015, based on the company’s engagement of and reliance upon its outside accountants, but did not waive the penalty for 2016 because the company essentially relied on the 2015 accountant report and performed no new study. Among the issues the Tax Court considered in ruling the bonus was excessive and therefore a disguised dividend, were the following: (1) Mr. Hood had no employment contract with his company; (2) other company executives did not receive bonuses comparable to Mr. Hood’s bonus and the company had no policy in place for setting non-shareholder employee compensation; (3) Mr. and Mrs. Hood were the sole shareholders and sole directors of the company, who, as such, had sole authority to review and approve the bonus amount; and (4) in its entire history, the company had never paid a dividend to its shareholders. Although every tax case is highly fact specific, things the company and Mr. Hood could have done differently that might have affected the outcome include: (1) had a written employment agreement with Mr. Hood specifying how salary and bonuses would be determined; (2) had a written compensation and bonus eligibility policy for all employees (and followed it); (3) had outside directors and perhaps even an independent compensation committee that reported to the board; (4) had a history of paying some dividends as approved by the board of directors. For practitioners, this case has an excellent discussion of the “independent investor” test versus the “multi-factor” test for excessive compensation. It also provides a detailed road map for what expert reports should include to be deemed credible. Offit Kurman counsels business owners on strategic business, tax, and risk management techniques, including the design and implementation of executive compensation packages. The views expressed herein are solely those of the author’s and do not constitute and are not intended as legal or tax advice.
March 11, 2022
Tax
S-Elections Gone Wrong
The IRS just released four separate Private Letter Rulings (“PLRs”) addressing the inadvertent termination of a taxpayer’s S-election. It is often said the devil is in the details, which is demonstrated aptly by these four PLRs. Fortunately for the taxpayer, in each case the Service found that the terminations were inadvertent, which means the taxpayer was allowed to correct the issues and be treated as though the S-election was never terminated, likely saving the taxpayer untold thousands of dollars in taxes, penalties, and interest. Although PLRs may be relied upon only by the taxpayer who obtained the PLR and may not be cited by other taxpayers in similar positions, PLRs reveal how the IRS approaches certain issues, in this case inadvertent termination of S-elections. Recall, a small business entity (100 or fewer equity owners) may elect to have the entity taxed as a S-corporation, rather than the default classification of partnership, corporation (meaning C-corporation), or disregarded entity). Depending on the revenue flow, it is often advantageous for a limited liability company (“LLC”) that would otherwise be taxed as a partnership or disregarded entity to elect to be taxed a S-corporation. This would permit the entity to receive the asset benefits of being structured as a LLC, and receive the tax benefits of being taxed as a S-corporation. Similarly, small businesses that are set up as corporations may wish to be taxed as S-corporations, not C-corporations, which is the default classification assigned by the Service (C-corporations have two layers of tax-one at the corporate level and one at the shareholder level, while S-corporations have just one level of tax-the shareholder level). In either case, the taxpayer and the taxpayer’s owners must qualify and make an affirmative election by filing certain forms in a timely manner with the Service. In PLR 2022090001 the taxpayer was a corporation that converted to a LLC, but failed to read or did not understand the operating agreement it adopted. This happens with some regularity, typically with DIY entities or when done by an advisor who simply relies on “a form” operating agreement without reading or understanding the tax provisions contained in the operating agreement. In this case the taxpayer’s operating agreement was one designed for a LLC taxed as a partnership, the provisions of which created interests with different rights, which violated the single class of stock rule applicable to all entities taxed as S-corporations (a S-corporation may only have one class of stock so every owner has the same dividend and liquidation rights. Non-voting shares are permitted if the non-voting shares have the same dividend and liquidation rights). The Service noted the operating agreement “included provisions in contemplation of Company being treated as a partnership for federal income tax purposes (inclusion of capital account rules under Treas. Reg. § 1.704(1)(b))(analysis supplied); however, the applicability of those provisions was not limited to such a situation…,” meaning that even though the entity was not seeking to be taxed as a partnership, it could under its operating agreement. In this case the taxpayer failed to make sure the operating agreement was drafted correctly for an entity to be taxed as a S-corporation (failure to remove the capital account provisions among other things). PLRs 202209003 and 202209005 each concerned trusts as owners of S-corporation stock that failed to make appropriate and timely elections. Only certain types of trusts may be S-corporation shareholders, and one of the steps a trust must take to be an eligible shareholder include making the affirmative election to be an electing small business trust (ESBT) under the requirements set forth in IRC § 1361(e). In PLR 2022090003, the trust at issue failed to do that. Similarly, in PLR 2022090005, the trust qualified as an ESBT within the meaning of § 1361(e), but the trustee failed to make an election under § 1361(e)(3) to treat the trust as an ESBT. In other words, make sure you dot your “I” and cross your “T.” Finally, PLR 2022090010, which also involved a LLC that sought to be taxed as a S-corporation, the entity’s owner (there was only one) failed to sign the required consent to be taxed as a S-corporation. As noted above, to be taxed as a S-corporation the entity and its owners must make an affirmative election to be taxed as a S-corporation. Here it appears the entity signed and timely submitted the requisite consent to the Service, but the entity’s owner failed to sign the consent. Although PLRs never mention specific dates actions were taken, it is possible that the S-election was submitted near the end of the allotted time for making the election so by the time the taxpayer became aware of the oversight the time for electing S-corporation treatment for that tax year had passed. PLRs are highly fact specific, and there is no assurance the Service would come to a taxpayer friendly resolution in a different case. To avoid making similar mistakes, business owners should make sure their business advisors understand the tax ramifications of the business documents being used, and are aware of the steps that must be taken and the time for taking those steps for the entity to make a valid S-election. Offit Kurman counsels business owners on strategic business, tax, and risk management techniques, including the design and implementation of executive compensation packages. The views expressed herein are solely those of the author’s and do not constitute and are not intended as legal or tax advice.
March 10, 2022
Tax
Ipads, iPhones, and Barter Transactions
From the hardly noticed case of Sherwin Community Painters, Inc. v. Commissioner, T.C. Memo. 2022-19, come some interesting tidbits. First, just the facts. Sherwin Community Painters, Inc. is a C-corporation with a single shareholder. As its name implies, Sherwin was a painting contractor. The case arose from the Service’s disallowance of certain business deductions claimed by Sherwin and the Service’s attempt to characterize the disallowed deductions as a constructive dividend. The Service also asserted accuracy related penalties against both taxpayers under IRC 6662(a) and a late filing penalty against the shareholder under IRC 6651(a)(1). All issues were limited to the taypayers’ 2016 tax year and returns for that year. Among the deductions Sherwin claimed were deductions for office equipment (iPads, iPhones, a speaker, accessories, and service contacts), office supplies, gas, entertainment (remember this was 2016 and entertainment expenses were deductible back then), and a business deduction for a coding course the company paid for that was taken by the shareholder’s soon to be son-in-law. After the coding course the soon to be son-in-law, using the skills acquired in the course, updated Sherwin’s website and made numerous changes to the website. PSA No.1 – File a timely request for an extension. The shareholder’s 2016 return was filed on October 12, 2017, three days before the automatic extension deadline of October 15, 2017 (actually four days because that year October 15th fell on a Sunday). Had the taxpayer timely filed an extension for the 2016 return, with the extension the return would have been timely filed and no late filing penalty would have been asserted. PSA No.2 – iPads, iPhones, speakers, and accessories are deductible provided they are ordinary and necessary under IRC 162(a). The Tax Court wasted little time in allowing this deduction noting the taxpayer properly substantiated the deduction. PSA No. 3 – Document your barter transactions! Sherwin argued that its tuition payment to the educational institution for the coding course was essentially a barter transaction in exchange for website design services. The Tax Court did not dispute Sherwin’s assertion that the soon to be son-in-law performed web design services, but did take issue with the lack of any documentation. The Court noted the soon to be son-in-law was not an employee of Sherwin and there was no agreement that the web design services were in consideration of payment of the tuition. It seems Sherwin was arguing an after-the-fact quid pro quo. Had Sherwin documented (in writing) the arrangement contemporaneously, that deduction would probably have been allowed. Finally, the Service attempted to argue the disallowed deductions were constructive dividends to the shareholder, which if true, would have been includible in the shareholder’s gross income under IRC 61(a)(7). Apparently the Service thought Sherwin made a loan to the shareholder and this was the basis for its constructive dividend claim. The records showed just the reverse-a loan from the shareholder to Sherwin. Refusing to give up the constructive dividend claim, the Service then argued the disallowed business expenses were a constructive dividend. You can almost see the Court scratching its head looking at counsel for the Service and saying “REALLY!?” Noting “Respondent [IRS] refuses to concede his error and instead argues on brief that the disallowed business expenses should be treated as a constructive dividend,” the Court held there was no relation between disallowed business expenses and a constructive dividend. All taxpayers should make sure they file an extension request in a timely manner to avoid a late filing penalty. All business owners should make sure expenses they deduct are ordinary and necessary, and are properly substantiated in case those expenses are later challenged. Finally, in the gig economy barter transactions have become more prevalent. To make sure businesses can deduct these expenses, businesses need to be sure to document such arrangements in writing, contemporaneously. Offit Kurman counsels business owners on strategic business, tax, and risk management techniques, including the design and implementation of executive compensation packages. The views expressed herein are solely those of the author’s and do not constitute and are not intended as legal or tax advice.
March 10, 2022
M&A Nuggets
M&A Nuggets: Listen, Listen, Listen
In the first M & A Nugget five years ago, I discussed the importance of “Think Win-Win”, which is Habit 4 in Stephen Covey’s book “The 7 Habits of Highly Effective People”. Habit 5 from that book is “Seek First to Understand, Then to be Understood”. This Habit is equally important in an M & A transaction. While both sides in a transaction often communicate early on what each side wants to achieve, it is important for the buyer and seller to first understand what the objectives and motivations of the other side are. This is crucial at an early stage, to determine whether the merger has the chance to succeed. For example, from the seller’s standpoint, what are the buyer’s short and long term plans for the target company, what is the buyer’s intention with respect to the employees of the target company post-closing, and what does the buyer want out of the owner of the target company post-closing? From the buyer’s perspective, what involvement with the business does the seller’s owner want to have post-closing, is the seller at a stage of life in which the seller desires to participate in an equity rollover and have a second opportunity to share in a future sale of the business, and what are the plans post-closing of the seller’s key management team? Understanding the other side’s answers to these questions goes a long way to help the listener decide whether to proceed and whether it makes sense to make any adjustments in the listener’s thinking about how to proceed with the transaction before and after closing. If the parties decide that it is mutually beneficial to move forward after listening to each other, the detailed negotiations will follow. As the myriad of important legal, operational, financial and tax issues arise, understanding one side’s viewpoint and overall objectives in the transaction is extremely productive in resolving these issues in a way that satisfies both sides. So, remember to listen first, and to then think and respond. If you have any questions about this or any other M&A issue, please contact Glenn Solomon at gsolomon@offitkurman.com or 443-738-1522.
March 9, 2022
Labor and Employment
Is Your Company Keeping Records as Legally Required?
A client just asked me in the course of moving offices what employee files the company needs to retain. What I’ve unearthed indicates that this is complicated. (Be sure to check with a lawyer to confirm that these requirements are in effect at the time the company is deciding this issue. Never rely on the internet for legal advice … I have stories.) Here are some requirements: IRS regulations dictate that companies retain all employee files reflecting payments for at least four years after the employment tax came due or was paid, whichever is later. The Department of Labor requires employers to retain 14 different types of documents! The Department of Labor regulations requires companies to retain all payroll records and collective bargaining agreements for three years. All-time cards and piece work tickets, wage rate tables, work and time schedules, and records of additions to or deductions from wages must be kept for two years. Form I-9s for every employee must be retained for three years after the employee was hired or one year after termination, whichever is later. Employers must retain employment applications and related documents, records regarding transfers, demotions, layoffs, selection for apprenticeships or training, and requests for accommodations under state or federal law (such as for disabilities) for at least one year from the date of making the record or the action reflected in the document. In the case of terminated employees, the records must be kept for one-year post-termination. Where a charge of discrimination has been filed under Title VII, the ADA, or GINA, or where the EEOC or the Attorney General has sued the employer under those laws, the employer must retain all records related to the charge or action until final disposition of the charge or action. The date of final disposition is 91 days of the complaining employee’s receipt of a Right to Sue Notice from the EEOC or the date on which the litigation ends. Keep benefits records such as plan documents, 401(k) forms, COBRA documentation, benefits election forms, plan termination records, and other such documentation for six years following the employee’s termination. There are more requirements if the company has had any workers employed by immigration visa or the company has been a federal contractor … I won’t go there today. Good luck organizing your documents! Ask me about document retention policies and why a company should or should not retain documents for longer than legally required.
March 9, 2022
The Weekly Scenario
The Weekly Scenario: Planning for Diminished Capacity
There are numerous decisions that must be made when considering an estate plan. One decision to think about is who will decide things for me from a financial standpoint if I am not able to decide for myself. This could be in a temporary or permanent situation or a situation of ‘cognitive decline’ or ‘diminished capacity.’ A financial Power of Attorney (POA) is a legal document where an individual can set up a series of legal protections to deal with the contingency of incapacity. The individual, as the “principal,” can designate an “agent” to act on his behalf. Most financial POAs are durable in nature, meaning they stay in effect until the principal either recovers or dies. Some states allow springing powers, where the POA only springs into being when the principal is incapacitated. Other states don’t permit this power, so the principal’s jurisdiction is an important consideration. While many POAs are indeed broad and grant a number of powers, it is important to clarify what powers the principal wants their agent to have. For example, do they want their agent to be able to make gifts on their behalf or change a beneficiary designation on a retirement plan account? A POA is a powerful tool, but all parties should be clear about expectations. Trusts are another tool for dealing with the issue of diminished capacity. A revocable or living trust allows the person to be the grantor, beneficiary and Trustee of the trust. Thus, the individual remains in charge of the trust assets so long as they’re willing and legally competent. If the individual can no longer serve as Trustee (due to incapacity or otherwise), the successor trustee will take over and act on her behalf. A trust offers a great deal of flexibility without forcing a person to give up any control upfront. Guardianship pre-designation: For most individuals, guardianship (called “conservatorship” in some states) is a situation that generally should be avoided because it is both cumbersome and expensive. However, in many states, the individual at least can influence who would be appointed as their guardian. These states allow the individual to pre-designate or pre-plan who they would want to act as their guardian. For many states, you can pre-designate a guardian in an advance medical directive. Representative payee: An important complement to many retirees’ personal retirement assets is their Social Security. The Social Security Administration (SSA) does not accept financial POAs; instead, the SSA requires a separate designation, called a Representative Payee, to act as the agent to manage Social Security benefits in the event of incapacity. If the Social Security beneficiary hasn’t designated a desired Representative Payee in advance, in the event of loss of legal capacity, the SSA will appoint one for them. While not fun to think about, these are important issues that should be addressed in every estate plan. As always, if you have any questions or would like to learn more, please contact Steve Shane at sshane@offitkurman.com or 301.575.0313.
March 4, 2022
Labor and Employment
Warning: Audit Your Worker’s Pay
This week I wanted to address a news item about the women’s U.S. national soccer team. These players have very high earning potential (depending upon their performance in the World Cup.) Unfortunately for their employer, the U.S. Soccer Federation, the men’s national team has even higher earning potential (depending upon various issues mentioned below.) This brings up that compensation specter: the Equal Pay Act. The Equal Pay Act provides that those performing equal work requiring equal skill and effort must be equally paid. The Federation settled an Equal Pay Act and sexual discrimination lawsuit filed by the women’s national team players by paying them $24 million (in total; $22 million is paid outright to the women and their lawyers). The settlement is contingent upon the players entering into a new collective bargaining agreement with the Federation and court approval. This is the real headache: the Federation still has to reconcile the current pay structures to ensure equity. At the moment, male players get $407,608, and a woman makes $110,000 if their team wins the World Cup. Women receive $37,500 for making a World Cup team; men receive $67,000. The men’s team receives pay even if they lose to a team outside the top 25 in the FIFA rankings and a bonus of $9,375 for winning. Women receive nothing for losing and $5,250 if they win. It really doesn’t matter if the women’s team deserved this win. It was very expensive for the Federation, cast it in a very negative light, and they ended up paying a lot of money to get rid of these expenses and ensure the women will play. So audit your company to ensure that those who are performing the same or very similar jobs are receiving the same money and benefits under the same working conditions (guaranteed by Title VII). And remember, the amount someone is making is NOT confidential information. Prohibiting workers from discussing pay violates the National Labor Relations Act. So people can compare notes. Tell me about your experiences with equal pay issues, or contact me for more information on audits.
March 2, 2022
The Weekly Scenario
The Weekly Scenario: Qualities to Look for When Choosing a Guardian for Minor Children
When you are nominating the guardian of your minor children, the goal is to provide each child as little disruption to his or her life as possible. To accomplish that, you want to choose someone who will raise your children the same way you would raise them if you were still alive. The guardian should have similar philosophies to yours about raising children, about education, about discipline and about religious or spiritual matters. A good indicator of how someone might raise your children is how they are raising their own children. If you are choosing a married person, you will need to decide whether to name just one individual (like a relative) or if you are naming the couple. You should consider what will happen if the guardians you appoint get divorced after your children have moved in with them. You will also want to consider the economic wherewithal of the guardian so that you don’t saddle them with responsibility that will overwhelm them financially. If you have more than one child and want to keep your children together, you’ll have to name a guardian that is willing and able to take all of them. All of this assumes that the person you name agrees to take your children. You should always check with them ahead of time to be sure they are willing and then name backup guardians in case circumstances change and the person who agreed in advance is unable to take the children at the actual time of your death. As always, if you have any questions or would like to learn more, please contact Steve Shane at sshane@offitkurman.com or 301.575.0313.
February 24, 2022
M&A Nuggets
M&A Nuggets: Exclusivity
One important component of the letter of intent for the sale and purchase of a business is the exclusivity paragraph. In that paragraph, the seller agrees to deal only with the interested purchaser for a specified period of time. This exclusivity is important to purchasers, because they will be devoting significant time, resources and money to investigate the seller, conduct due diligence and determine the final terms of the transaction to present to the seller. The exclusivity obligation is therefore almost always a requirement. However, sellers should be wary that the exclusivity paragraph is not too restrictive. The exclusivity language should always contain the period of time the seller agrees to negotiate only with the interested purchaser. That period of time needs to be thoughtfully considered. A seller’s business is not on the market during the exclusivity period. Too long of a period could result in missed opportunities if the deal contemplated by the letter of intent falls apart. Exclusivity periods of ninety days are common. The first drafts of exclusivity paragraphs presented by buyers usually contain a requirement that the seller notify the buyer of any other offers received, the names of the party submitting the offer and the terms of the offer. The problem with this language is that offers are often submitted on a confidential basis. So, while it is not problematic for a seller to notify the other party to the letter of intent that another offer has been received, the name and terms of the offer should be not be disclosed and the exclusivity paragraph should be modified accordingly. The bottom line here is that an exclusivity paragraph in a letter of intent is necessary, but it should be modified to accommodate the needs of the buyer while not unduly restricting the seller. If you have any questions about this or any other M&A issue, please contact Glenn Solomon at gsolomon@offitkurman.com or 443-738-1522.
February 22, 2022
Labor and Employment
Vaccination Exemption Guidelines
I’m getting more and more questions about exemptions from COVID vaccination/booster mandates. I thought I’d offer reminders about the legal analysis in these situations. As you know, the exemptions are for disability-related reasons and religion-based reasons. Here goes, I tried to cut the legalese. Disability Under the ADA, employers may require all employees to meet a qualification standard that is job-related and consistent with business necessity, such as a safety-related standard requiring vaccination. If an employee can’t meet such a safety-related standard due to a disability, an employer may not require that employee to comply unless it can show that the person would pose a “direct threat” to the health or safety of others at work. The federal regulations define a direct threat as “a significant risk of substantial harm to the health or safety of the individual or others that cannot be eliminated or reduced by reasonable accommodation.” This determination consists of two steps: (1) is there is a direct threat and, if so, (2) assessing whether a reasonable accommodation would reduce or eliminate the threat. To determine if an employee who’s unvaccinated due to a disability poses a “direct threat” in the workplace, an employer first must assess the employee’s present ability to safely perform the job’s essential functions. Consider: (1) the duration of the risk; (2) the nature and severity of the potential harm; (3) the likelihood that the harm will occur; and (4) the imminence of the harm. I advise my clients that the determination that an employee poses a direct threat should be based on the most current medical knowledge about COVID-19. Whether there’s a direct threat also depends on the work environment, such as whether the employee works alone or with others and where; the available ventilation; the frequency and duration of direct interaction the employee typically will have with others; the number of partially or fully vaccinated individuals already in the workplace; whether other employees are wearing masks or undergoing routine screening testing; and the space available for social distancing. If a person with a disability who isn’t vaccinated would pose a direct threat to self or others, an employer must consider whether providing a reasonable accommodation, absent undue hardship, would reduce or eliminate the threat. If there is undue hardship – expense, changing jobs, displacing other personnel, etc. – then the vaccination exemption might not be reasonable. Religion Once an employee presents evidence of a sincerely held religious belief, practice, or observance that prevents them from vaccinating, an employer must provide a reasonable accommodation unless it would pose an undue hardship. Courts define “undue hardship” (in this religious context) as more than minimal cost or burden on the employer. Considerations relevant to undue hardship may include, among other things, the proportion of vaccinated employees and the extent of employee contact with non-employees with unknown vaccination status. Ultimately, if an employee cannot be accommodated, employers should determine if any other rights apply under equal employment opportunity laws or other federal, state, and local authorities before taking adverse employment action against an unvaccinated employee. Just take all of the individualized circumstances into account each time. No two situations are the same, and you don’t want to be sued.
February 17, 2022
M&A Nuggets
M&A Nuggets: How Will Your Company Be Valued
Up until the early 2000s, the valuation of a privately held company was determined largely by following the guidelines of a 1959 revenue ruling issued by the Internal Revenue Service, which focused on earnings. A lot has changed and a lot has remained the same since then. How will your company be valued in the market? Presently, the most common valuation methodologies are (1) a multiple of earnings before interest, taxes, depreciation and amortization (“EBITDA”), and (2) a multiple of gross revenues. The multiple of EBITDA method remains the most commonly used method of valuation. Earnings, or profits, before the deductions for depreciation, interest, taxes and amortization are determined for anywhere from the most recent one year to most recent three year period. The earnings are then adjusted, or smoothed out, to eliminate unusual variances that will not be recurring, such as one-time gains on sales of assets or one-time losses. The average adjusted earnings are then multiplied by a cap factor. The cap factor used ranges widely, depending on the industry. A more recent valuation phenomena, which is now commonly used, is the multiple of revenue method. By this method, gross revenues are simply multiplied by a number. As with the EBITDA method, the range of multiples can vary widely, again, depending on the industry. The revenue multiple method is not for every company. Younger companies with no profits or companies which have very fast growth prospects are often valued using the revenue multiplier method. Not surprisingly, that method is now common for technology companies. Under either the EBITDA or the revenue multiplier methods of valuation, a gem looked at and favored by buyers is recurring revenue, meaning revenue that is expected to continue in the future. Today, most companies that desire to increase value should focus on adding recurring revenue. Before looking for a purchaser for your company, it is important to understand how your company will be valued. The above nugget offers a brief explanation of that. If you have any questions about this or any other M&A issue, please contact Glenn Solomon at gsolomon@offitkurman.com or 443-738-1522.
February 15, 2022
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