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Business Entities: Beware of New Reporting Requirement for Change of Mailing Address, Business Location or Responsible Party

February 20, 2014,

If you are an employer in San Jose, you are most likely aware that on January 1, 2014, the minimum wage increased to $10.15 per hour for your business; California's minimum wage increase was to $9 per hour. In addition to new employment laws, there, there have been other new laws that affect businesses in 2014, such as the all new California limited liability company act. But one law actually applies to all business entities with an Employer Identification Number ("EIN"), including entities such as corporations, partnerships, limited liability companies, and even nonprofit organizations. As of January 1, 2014, any entity with an EIN must notify the IRS of a change of (1) a mailing address, (2) a business location or (3) the identity of a "responsible party." A change in a company's mailing address or business location is pretty clear, but the identity of a responsible party may not be so clear.

If you are not sure who the "responsible party" was initially, check the Form SS-4 application that was filed initially by the organization to obtain its EIN, and it will be the person or entity listed as responsible on that form. Then, look at the instructions to Form 8822-B to determine if your responsible party has changed. The instructions define a responsible party as "the person who has a level of control over, or entitlement to, the funds or assets in the entity that, as a practical matter, enables the individual, directly or indirectly, to control, manage, or direct the entity and the disposition of its funds and assets." If the entity's original responsible party at the time of filing the Form SS-4 is no longer affiliated with the organization or no longer fits that definition, then the entity must use Form 8822-B to let the IRS know.

Form 8822-B must be filed within 60 days of the change. If such a change occurred before January 1, 2014, and the entity has not previously notified the IRS in some other manner, Form 8822-B must be filed before March 1, 2014. If you no longer have a copy of the SS-4 Application or remember who was named as the "responsible party," you may wish to file a Form 8822-B before March 1, 2014.

So, if you are a corporation or LLC making changes on your Statement of Information filing with the California Secretary of State, or if you are amending your LLC operating agreement or your corporate documents, keep in mind that you may also need to notify the IRS of the change. If you are not sure whether your company needs to notify the IRS or other agencies of changes, or if you have questions regarding the "responsible party" for your business, you may wish to consult with a business lawyer or accountant.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Tax Planning Reminders for Businesses Before Year-End

November 7, 2013,

It is that time of year again. Every year in the fourth quarter, businesses in San Jose and all over the United States are looking at the quickly approaching year-end and trying to figure out what they can do now before it is too late to save on taxes for 2013. This is especially true for small businesses, where every dollar of deduction is important because it hits the owner(s) directly in the pocketbook. My law firm is an LLP, so all items of profit and loss flow through to the partners. Therefore, this is the time of year that I look very carefully at how much money is available and what my law firm is going to need or want to buy in the next few months. Do we need a new copier? Do we want to upgrade our software? If so, let's do it in December rather than January and get the deduction this year. With this in mind, here are a few things for business owners to consider before 2013 is over.

Purchase Equipment for Your Business
Make your equipment purchases before year-end. In 2013, up to $500,000 of both new and used assets purchased and actually put in use by December 31st can be expensed. This means you get a dollar for dollar deduction this year, without having to depreciate the asset over its useful life. This is really helpful for partners that want a deduction for every dollar spent so that they do not have taxable profits without available cash for distribution. But this benefit is limited. If you purchase and put in place more than $2,000,000 of assets during 2013, the $500,000 expense is phased out on a dollar for dollar basis. These limits will likely be even lower next year, so take advantage of them now.

Make Tenant Improvements on Your Commercial Property
Another tax break set to expire after his year is the 50% bonus depreciation, which allows companies to write off half the cost of new assets with useful lives of 20 years or less, in the first year. This includes interior leasehold improvements for commercial real estate. The remaining 50% is depreciated as usual. So, if you are planning some nice tenant improvements in your office, do them before year-end, just in case Congress does not get around to extending this tax break.

Purchase an SUV for Your Business
Have you been thinking about a new Sport Utility Vehicle? You can deduct most of the cost of new SUVs that are used 100% for business and weigh over 6,000 pounds, in the year of purchase. First, there is the special $25,000 deduction for new SUVs, add to that the 50% bonus depreciation, plus normal depreciation on top of that, and you end up with approximately $46,000 of a $60,000 heavy SUV being deductible this year.

So whether you are a partner in a law firm like me, or a partner in any type of business partnership, or a shareholder in a corporation, do not wait until tax time to look at what deductions are available to you. Start planning now for tax savings later.

Source: The Kiplinger Tax Letter, Vol. 88, No. 18, Aug. 30, 2013

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

A Checklist for Closing Down a Business

August 7, 2013,

Small businesses dominate the U.S. economy. According to the U.S. Small Business Administration (SBA), 99% of all independent companies in the U.S. have less than 500 employees. As a small business attorney in San Jose, most of the time I am working with clients to form new businesses. However, as we all know, not all businesses succeed. Recently I was counseling a client with regard to the sale of her retail store. She had worked hard building the store into a business that could support her needs, but it was time to retire. Rather than going through the hassle of selling the business as a whole, she decided to simply sell the inventory to a competitor and shut the doors. However, shutting down a company can still be a hassle, and if you forget to do one thing it could result in a big liability later.

So, what does it take to shut down a small company? Here is just a short to-do list of the basic items common to most small businesses. This list does not take into account the added complexities of a business with multiple owners.

1. Talk to your accountant, attorney, financial advisor and any other professionals that may be able to assist you in a smooth closure of your business.

2. Check your leases and terminate them. If they cannot be terminated, try to negotiate with your landlord. For example, if your real property lease still has a number of years left to run, advanced notice to the landlord may allow time for the landlord to re-rent the space. Or, the landlord may take a lump sum payment of a portion of the total liability to let you out of the lease now. Do not forget smaller leases like your postage machine lease or copier lease. If you have a car lease, talk to the dealer about assigning the lease to you individually.

3. Check your contracts for rights to terminate and any personal liability. If allowed, provide notice of termination. Try to complete contracts if possible. If not, return any unused deposits or payments.

4. Try to sell off as much inventory as possible. Use a liquidator, have a 'going out of business' sale, and contact competitors to see if they want to buy what is left at a discount. Publish a bulk sales notice if required.

5. Liquidate other business assets - furniture, equipment, etc.

6. Collect as much of the accounts receivable as possible - after others hear you are going out of business it may be harder to collect.

7. Notify anyone that may be affected by the closure - especially creditors. Pay or settle your debts as much as possible. Ask each creditor for a confirmation that they have been paid in full, or settled in full satisfaction. Note that there are specific bulk sales requirements for notifying creditors if you sold your inventory. If you cannot satisfy your creditors, contact a bankruptcy or insolvency attorney to help assess your options. A bankruptcy or an assignment for the benefit of creditors may affect your rights to take actions on this list.

8. Tell your employees and give them as much notice as you can. Be ready to pay them their final paychecks, including all accrued and unpaid vacation, on the date of their termination. Notify your payroll company that these are the final paychecks so they can notify the Employment Development Department (EDD), or if they do not notify the EDD, file a DE-24 form yourself.

9. Submit final sales taxes and employment taxes.

10. File all final federal, state and local tax returns.

11. Cancel any business permits or licenses, including sales tax resale permit. File a Notice of Closeout for Seller's Permit (form BOE-65) with the California Board of Equalization,.

12. Close your bank accounts, cancel any line of credit and outstanding credit cards, and shred business checks.

13. Turn off utilities.

14. Forward mail and email accounts.

15. Shut down websites (or post a notice) and turn off any e-commerce accounts.

16. If you have a fictitious business name, file a statement of abandonment with the county.

17. Distribute remaining assets to yourself (the owner), but only after creditors have all been satisfied. It is important to transfer any assets that are currently titled in the name of the business, before the business entity is dissolved.

18. Dissolve your business entity with the Secretary of State.

Businesses with more complex ownership structures may wish to consult with an attorney or tax professional to guide them through the shutting-down process.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

New Corporate and LLC Startups May Find Relief with the Passage of a New Bill in California

July 15, 2013,

In Silicon Valley, home to many large technology corporations and thousands of innovative startups, businesses need to move quickly to stay ahead of the competition. As a small business attorney in San Jose, I have formed countless of limited liability companies (LLCs), partnerships and corporations with the Delaware and California Secretaries of State over the years. And one of the first questions my eager small business clients ask me in our initial meetings is almost always, "How long will it take to form my company?"

For many years my answer was that we could have the filed Articles of Incorporation (for a Corporation), Articles of Organization (for an LLC), or Certificate of Partnership within about a week. When the California Secretary of State slowed down a few years ago, I had to tell clients that it could take as much as several weeks. However, in the last year or so the delays crept up to three months or more for the California Secretary of State to process and return a business filing.

Of course, California does provide a 24-hour expedited filing option, for an additional $350 over the usual filing fees. In my more cynical moments I have had to wonder whether it was the California budget crisis that was causing filing times to slow down because of lack of resources, or if the Secretary of State was purposefully taking longer to return routine filings in order to force virtually everyone to pay the "rush" fees.

Now it seems my cynicism may have been misplaced. Governor Brown just signed a bill (AB 113) which will provide $1.6 million in funding to the California Secretary of State to be used to eliminate the backlog of over 100,000 filings and speed up the business filing process. The stated goal is to reduce waiting times for a business filing to be processed and returned from three months to between 5 and 10 days by November, 2013. [Source: Spidell's California Taxletter, Vol 35.6, June 1, 2013, p.71]

Although I applaud the Governor for trying to do something, I think we need to go a lot further than this. As the home of Silicon Valley, California should be setting the standard for the use of technology in business. Never mind that we can form corporations and LLCs usually the same day by email in Delaware (with no extra fees). I want to be able to form entities immediately on-line, without extra State charges, and without the need to pay extra fees to filing agents in Sacramento to walk my client's filings into the Secretary of State's office to be at the front of the line (processing times for filings by mail are much slower).

If our business owners and inventors can start their business in California faster and less expensively (with no rush fees), this will benefit everyone. The State will collect more franchise taxes and will likely start collecting more payroll taxes and sales taxes from new businesses sooner. With this in mind, I hope the Secretary of State is seriously considering significant investments in technology both as part of the $1.6 million and in addition to the AB 113 funds.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Limited Liability Company Short Form Cancellations

March 4, 2013,

Last November, I was working closely with one of our clients and their real estate lender to purchase a large property in the San Francisco Bay Area. I formed two California limited liability companies for the transaction. One LLC was the investment entity that was going to own the property, and the other was the management entity that was going to hold the sponsor interests in the deal. Both entities had to be properly and fully formed so that we could obtain good standing certificates from the Secretary of State and be in position to issue legal opinions for the lender. During the due diligence period, our client discovered something about the property that was not what had been represented to them by the seller of the property. As a result of this information, the purchase fell through.

Fortunately, despite all of the other costs expended on pursuing this property, the client had not yet paid the $800 franchise taxes for each of the two LLCs we formed. In California, if an LLC meets certain requirements it may cancel its Articles of Organization within 12 months of the filing by filing a Short Form Certificate of Cancellation with the Secretary of State, and avoid paying the first year's franchise taxes. These requirements include:

- The California LLC has no debts or other liabilities (other than tax liability);
- The assets, if any, have been distributed to the persons entitled to them;
- The final tax return has been or will be filed with the Franchise Tax Board;
- The California LLC has not conducted any business since filing the Articles of Organization;
- A majority of managers or members, of if there are no managers or members, then the person who signed the Articles of Organization, voted to dissolve the LLC and
- If the LLC has received any payments from investors for LLC interests, those payments have been returned to the investors.

Source: Spidell's California Taxletter, Vol 34.11, Nov. 1, 2012.

Because our client met all of these requirements, we were able to cancel the LLCs without paying the $1600 ($800 x 2) in California franchise taxes. If, on the other hand, the client had already paid the taxes, we would not have been entitled to a refund. With this in mind, sometimes when forming an LLC it may be better to wait until the last minute before the franchise taxes are due before paying them to make sure the business is going forward, as long as you either pay them before late fees would be imposed, or you are willing to incur late fees in the event your LLC does not qualify for the short form cancellation.

Continue reading "Limited Liability Company Short Form Cancellations" »

Higher Taxes in 2013: The California Wood and Lumber Tax

October 24, 2012,

As 2012 is coming to an end, corporations and individuals alike are already thinking about taxes that they will need to pay at year-end. Every meeting I have with business owners lately somehow comes around to talking about taxes and how much I expect taxes to increase next year. The passage of Assembly Bill 1492 added yet another tax to the mix - the wood and lumber tax. This tax may affect homeowners, contractors and real estate developers.

We have all heard that ordinary federal income tax rates, currently maxing out at 35%, are scheduled to increase to 39.6%. Dividends could lose their special tax treatment and be taxed at this ordinary income tax rate as well. Federal long term capital gains rates will go from 15% back up to 20%. Payroll taxes may go back up from 4.2% to 6.2%. The AMT exemption amount may go back to 2010 levels. And high income earners will have an additional 3.8% Medicare tax. But on top of all that, starting January 1, 2013, those of us in California will also have to pay an additional 1% tax on the sales price of engineered wood and lumber products. (Assembly Bill 1492 (Ch. 12-289)).

Normally I would write this off as minor, but this year my husband and I are actually right in the middle of planning a huge fencing and deck project for our new house. (Did you know there was still residential land in the Silicon Valley that has not been fenced?) So, it was quite annoying to read about how this tax is going to be instituted on lumber, decking, railings and fencing as well as particle board, plywood and other wood building products, and even non-wood but wood-like products such as plastic lumber and decking. Even more so because it is already the middle of October and I'm pretty sure our project won't be completed until early 2013. So, if I buy all the wood before the end of the year, I save 1%... but probably end up with more than I need and the inability to return it. But, if I wait until January to buy it just in time to install it, I am going to hate paying that extra 1%.

The good news is that the tax will not be imposed on furniture or firewood, so at least I can wait to buy the new outdoor table and chairs and fill up the new fire pit.

[Source: Spidell's California Taxletter, Volume 34.10, October 1, 2012.]

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Property Taxes: Sellers Providing Financing Should Beware of Reassessment on Repossession

September 11, 2012,

As a business and real estate lawyer in San Jose, I have been paying special attention to the recovering real estate market. I have noticed an increase in residential and commercial properties transactions in San Jose, Sunnyvale, and Santa Clara. As much as the real estate market has improved, lenders are still cautious when it comes to providing financing, which has affected some of my business and real estate clients.

When the credit market is tight and financing is harder to obtain, sellers of real property may be more willing to provide seller financing to a buyer in order to sell a property. This is even more common when the seller and the buyer have some pre-existing relationship. When representing the seller, I will protect the seller by securing the loan with a deed of trust against the property so that if the buyer does not make the loan payments, the seller can take back the property. This sounds like a low risk proposition for the seller. However, taking back the property may be worse than it sounds. If the value has gone up since the seller bought it, which is usually the case, there is no way to reinstate the seller's former base-year value for property tax assessment purposes. When the seller sells the property to the buyer, the property is reassessed. When the seller repossesses the property, the property will be reassessed again. Since there is no sales price to determine the value when the property is repossessed, an appraisal must be done. Seller, as the new owner, must report the fair market value of the property to the County. Penalties of up to $20,000 apply for failing to report a change in ownership. In my blog, "New Rules for Business Entities Change of Ownership Reporting for Real Property," I talked about the need to report a change of ownership of an entity that owns real property as well.

So, if you are considering providing financing to a buyer on the sale of your property, you may want to think twice about whether you are comfortable with the remedy of repossessing the property with a new property tax value. It may be worthwhile waiting for a buyer who does not require you to assist with financing.

Continue reading "Property Taxes: Sellers Providing Financing Should Beware of Reassessment on Repossession" »

Processing Delays at the California Secretary of State Continue for Business Documents Filings

July 31, 2012,

In the past couple of years, corporations and limited liability companies that were formed or registered in California have had to deal with long delays from the Secretary of State in getting their documents processed. Whether the document that is being filed is a Statement of Information, Certificate of Dissolution or Cancellation, or Articles of Incorporation or Organization, the Secretary of State is taking weeks or even months to process a filing. As a business lawyer in San Jose, I have seen a multitude of problems resulting from such delays.

Statements of Information are experiencing the greatest delays, as the Secretary of State is taking several months to process a filing. This has actually created problems for some businesses that pay the filing fee with a check that contains an expiration or "void-by" date. If the check expires before the Secretary of State is able to process the Statement of Information, the Secretary of State will either reject the Statement or treat the payment as a dishonored payment.

Since many of my San Jose clients are newly formed LLCs, I frequently see these delays cause another type of problem. Very often, my client's bank will require a copy of the LLC's filed Statement of Information before opening a bank account or approving a loan. Because of the significant amount of time that it is taking for the State to process Statements, I often have to work with my client to take advantage of a relationship with the bank and ask the bank to accept a copy of the Statement that the LLC has submitted for filing.

I can avoid this situation in several ways if I am aware of the need to provide a filed copy of a Statement of Information by a certain date.

For a corporation, we can file the Statement of Information online with the Secretary of State and then request a copy of the record (this option is currently not available to LLCs). This avoids the usual queue. In addition, most regional state offices offer the opportunity for a corporation or LLC to pay an expedited service fee for filing a Statement of Information in person at the Secretary of State's Sacramento office. We can email the document to our agent in Sacramento who actually walks it into the Secretary of State and files it on an expedited basis over the counter. The benefit to using the expedited service is that we can receive a filing confirmation or response within a guaranteed time frame (usually 24 hours).

Continue reading "Processing Delays at the California Secretary of State Continue for Business Documents Filings" »

When the Minimum Franchise Tax is Not the Minimum Franchise Tax

July 25, 2012,

Every corporation, limited liability company and limited partnership, that either forms in California or registers to do business in California must pay an annual minimum franchise tax of $800. However, I just read an article in Spidell's California Taxletter that really annoyed me (Volume 34.7, July 1, 2012, pages 75-76). The article, entitled "Midyear switch from S to C corporation means an extra $800" says that when a corporation files two short year returns for one calendar year, each return is subject to the $800 minimum tax even though the corporation is the same entity for civil law purposes. Because it is changing its tax status, it is two different entities for tax purposes and therefore must pay the minimum tax twice in one year. As a corporate and business attorney, I am sensitive to this issue since many of my clients are small businesses or partnerships in San Jose, Santa Clara and other parts of Silicon Valley, and every dollar counts when you are running a small business.

This could be an issue in many midyear circumstances, including:
• When an S corporation loses its S election
• When an LLC switches from single member to multiple member
• When an LLC switches from multiple member to single member
• When a limited partnership changes into a limited liability company
• When 50% of the ownership of a limited partnership or limited liability company changes hands
• When an LLC elects to be taxed as a corporation, or revokes such an election
• If an entity changes accounting periods resulting in two short-period returns

Although this may look reasonable on the surface of one tax return independently, when you look at both returns together this looks like double-dipping to me. If one entity has to file two tax returns for one calendar year, I think the entity should get credit in the second tax return for any minimum tax already paid for that entity for that year. However, with California's ongoing budget crisis, I know this argument will fall on deaf ears. Therefore, I applaud Spidell's California Taxletter for informing tax practitioners of this tax trap. I'm hoping California business owners, as well as out of state owners with businesses registered in California, will read this blog and avoid inadvertently paying double minimum taxes. As a California business lawyer, I will do what I can to structure deals for my clients to avoid this double tax.

Continue reading "When the Minimum Franchise Tax is Not the Minimum Franchise Tax" »

New Rules for Business Entities Change of Ownership Reporting for Real Property

April 27, 2012,

As a Silicon Valley business lawyer, I have many clients that are limited liability companies, partnerships, and corporations which own real property in California. It is common knowledge that when property changes hands in California, the property will be reassessed (unless an exception applies). However, people often forget that similar rules apply for business entities like corporations, partnerships and LLCs that own real property, when interests in the business entity change hands. As of January 1, 2012 there are some new rules and some higher penalties regarding reporting a change of ownership or control of real property in California. The required period for reporting has been extended from 45 to 90 days. The maximum penalty is now $5,000 for property eligible for the homeowners' exemption and $20,000 for property not eligible for the homeowners' exemption.

A change of ownership can happen in one of two ways:

1. Change in Control of a Legal Entity: If real property is owned by an entity and any person or entity gains control of that entity through direct or indirect ownership of more than 50% of the voting stock of a corporation or a majority interest in a partnership or LLC, the real property owned by that entity is considered to have undergone a change in ownership and must be reappraised.

2. Cumulative Transfers by Original Co-Owners: If real property is owned by an entity and over time voting stock or ownership interests representing more than 50% of the total interests are transferred by the original co-owners (in one or more transactions), the real property owned by that entity is considered to have undergone a change in ownership and must be reappraised.

There is no change of ownership when the direct or indirect proportional interests of the transferors and transferees do not change.

For legal entity transfers, the Form BOE-100-B Statement of Change in Control and Ownership of Legal Entities must be filed with the Board of Equalization in three circumstances. The personal or legal entity acquiring control of an entity must file when there is a change in control and the legal entity owned California real property on the date of the change. The entity must file when there is a change in control and it owns California real property. An entity must file upon request by the Board of Equalization. Source: Spidell's California Taxletter, Volume 34.2, February 1, 2012

Continue reading "New Rules for Business Entities Change of Ownership Reporting for Real Property" »

Contractor State License Board Now Issues Licenses to Limited Liability Companies in California

February 27, 2012,

As a Silicon Valley small business attorney, I am regularly helping new clients with choosing their form of entity. Almost as often, I am asked to help new clients complete entity formations that they did themselves on-line. Much too often I have to tell these small business owners that their intent to save money by forming the entity on-line is going to cost them a lot more money because they picked the wrong entity for their business and we need to dissolve it and form a new one. More than once I have had licensed California contractors come to me to complete the California LLCs they formed, only to have to tell them that they are not eligible to be LLCs. There was even more confusion when the LLC law changed as of January 1, 2011 to allow LLCs to be licensed as contractors, but the Contractor State License Board was not licensing LLCs.

Back in January 2011 I wrote about the change to the California Limited Liability Company Act to allow contractors to operate as LLCs. However, until now contractors could not actually form as LLCs because the California Contractor State License Board had not yet changed their rules to allow the issuance of licenses to LLCs. Finally, the Contractor State License Board is now authorized to issue a contractor's license to an LLC.

Keep in mind that if you are going to operate as a licensed contractor in an LLC, your business will be subject to additional liability and insurance requirements. A contractor-LLC must either have a $1,000,000 insurance policy, or put $1,000,000 in cash into an escrow or deposit account. If the contractor-LLC has more than five employees, it must have an additional $100,000 of insurance or deposits for each employee (not including the first five), up to a maximum of $5,000,000.

It is also crucial to make sure your contractor-LLC stays in good standing with the California Secretary of State. In the event the licensed contractor-LLC is suspended at any time, each member who is a licensed contractor will be personally liable for up to $1,000,000 in damages as a result of the licensed activities of the LLC during a time in which it is suspended. Since one of the main reasons you would operate in an LLC is to insulate the members from personal liability, make sure you have a good LLC lawyer, or a business lawyer that is very experienced with forming and maintaining LLCs, that will remind you to file your statement of information when due, and a good accountant who will make sure your California income tax returns are filed on time and the LLC's franchise taxes and gross receipts fees are paid when due.

Source: Spidell's California Taxletter, Feb. 1, 2012, vol 34.2 p 16.

Continue reading "Contractor State License Board Now Issues Licenses to Limited Liability Companies in California" »

Employee Terminations

October 24, 2011,

Whether your company is a large manufacturer corporation in San Jose or a small service partnership in Los Gatos, you will eventually be forced to deal with terminating an employee. Terminations can be especially daunting because they are one of the most common reasons companies are sued. Therefore, whenever possible, it is important to plan and prepare for a termination before actually firing the employee.

I recently helped an LLC in Santa Clara set up a progressive discipline plan for their company in order to set up systems to assist management and employees before someone gets to the termination stage. Before an employee is fired, many companies use a form of progressive discipline when dealing with employee problems. Under progressive discipline an employee receives greater disciplinary measures when employment continues to be unsatisfactory. It is imperative that all disciplinary actions are documented in writing. If a system of progressive discipline is used, all managers should be trained on that system. If managers are not properly trained, a disgruntled employee may have a stronger claim for wrongful discharge than if the system had not been used at all. Whether a system of progressive discipline is used or not, it is critical that all disciplinary actions be documented.

If a termination is inevitable, you should have a plan in place before firing an employee. However, there are times when you must fire an employee immediately, without any prior planning, because he has done something that poses a threat to other employees, your company or your clients. Prior to termination, you should review any termination procedures in the employee handbook, to the extent they exist, to ensure that your company is following its own procedures. If you are worried about an employee making a claim against the company upon termination and you want to request the employee release the company from all claims, you should contact an attorney to assist you in preparing a severance agreement.

On termination, you must provide the former employee with the final paycheck including any accrued but unused PTO or vacation pay, a change of status notice, and the EDD pamphlet "For Your Benefit, California's Programs for the Unemployed." If the employee is a shareholder or option holder, you should review all applicable documents prior to the termination for notices or deadlines related to termination of employment. However, do not give the employee legal or tax advice regarding those documents or their rights.

When conducting a termination, conduct it in a neutral, private place such as a conference room. Have the final paycheck and change of status notice ready for the meeting. If you are offering a severance agreement, have that agreement prepared as well. Many employees will not sign the severance agreement immediately so be sure to give them the allotted time in the agreement to sign it and don't give the employee any severance payments until the severance agreement has been signed, or 8 days later if the employee is over 40 and therefore subject to age discrimination rules.

You should always have two managers present during a firing. During the meeting, tell the employee within the first few minutes that he is being fired and tell the employee why he is being terminated. Although you do not need a reason to fire an at-will employee, you may not do so for the wrong reason (e.g. discrimination), so be careful in what you say. Also, if you say the termination is a result of restructuring, but the reason is really poor performance, the inconsistency may be used against you if the company is sued. Do not argue with the employee and do not be so complimentary that the employee wonders why he is being terminated. You are not required to give employees a written reason for termination. However, if you decide to, be sure that your legal counsel reviews those reasons. Avoid any reference to anything that could be considered evidence of discrimination, especially if you are terminating someone who is in a protected class. Always be courteous to the employee. You should also explain any benefits, such as COBRA, that the employee may receive. Have someone take notes during and after the termination to document the process and what was said at the meeting. Lastly, you should remind the employee of any continuing obligations to the company, such as confidentiality.

Once an employee has been terminated, be sure to get any company keys, cell phone or laptop that the employee had. Also be sure to change phone codes, computer passwords, alarm codes or other passwords that the employee may have had access to.

Continue reading "Employee Terminations" »

Choice of State for a New Corporation

June 6, 2011,

I recently did a blog about California clients wanting to form LLCs outside of California in order to avoid California franchise taxes, and how the Franchise Tax Board has been steadily trying to eliminate those possibilities. In response to that blog, I was asked about other non-tax considerations for choosing a state for the formation of a business. So, here is a brief analysis of some of the things I consider when helping my clients choose the right jurisdiction for their new corporation.

When a client comes into my office in San Jose and asks about forming a business entity outside of California, the most common jurisdictions they are considering are either Delaware or Nevada. Delaware has traditionally been the favorite jurisdiction, and Nevada is gaining in popularity.

Why incorporate in Delaware?

• Delaware is a leader in making incorporating easy for founders, including accepting Certificates of Incorporation by e-mail and fax and without signatures, providing for expedited filings in one hour, and allowing Boards to hold meetings electronically.
• Delaware's corporate laws allow for limitations on personal liability and indemnification of the officers.
• Delaware law is well established and it has a special court, the Court of Chancery, to deal solely with corporate matters.
• Venture Capitalists are familiar with Delaware and their forms are based on Delaware law.
• A majority of companies on the NYSE are incorporated in Delaware.
• A majority of Fortune 500 companies are incorporated in Delaware.

Why incorporate in Nevada?

• Nevada does not have a franchise tax and it does not tax corporations for income earned in Nevada. (Of course, this does not get a company out of California franchise and income taxes if it is doing business in California, but a lot of people don't realize that.)
• Nevada caters to smaller, private companies.
• Protection for corporate management is very strong. Directors and officers are not compared to an objective standard of behavior, making it harder for them to be held personally liable for acts that may have otherwise been determined to not be in the best interest of the company.

Why (or why not) incorporate in California?

• For companies doing business in California, California usually makes the most sense as a jurisdiction since California law often applies to foreign entities anyway if they are doing business here.
• Franchise taxes are high in California, but forming outside of California will not exempt a business from California franchise taxes if it has a presence here.
• California does allow telephonic and electronic meetings of the board of directors.
• The California Secretary of State, despite usually long waits for filings, does have expedited filings for a fee.
• California corporate laws often protect shareholders over management - such as requiring shareholder approval for loans to officers or directors and providing for cumulative voting rights.

Of course, these choices are also impacted by the business of the company and its strategic plan for the future. In addition, choice of state is only one of many informed decisions that must be made by the founders, their business lawyer, and their CPA before jumping into the formation of a new company.

Professional Corporations for California Doctors

May 23, 2011,

I was recently working with some doctors who co-owned their Sunnyvale medical office building. They were concerned about the liability of having the property in their own names, so we worked with their lender and transferred the property into an LLC. Then, I suggested forming a professional corporation to operate their medical practice. Although doctors cannot avoid personal liability for their own malpractice, the corporation will limit their vicarious liability for the acts of their professional partners.

The California Professional Corporations Act allows licensed professionals in the fields of law, medicine, dentistry and accountancy to conduct business in a corporation, through the licensed individual shareholders. The Articles of Incorporation must include special language about the professional corporation. In addition to registering with the California Secretary of State, the corporation must also follow the naming and registration rules of the professional agency. The shareholders must be licensed, and transfers may only be to other shareholders or back to the corporation.

If a shareholder dies, the shares must be transferred within six months. If a shareholder is no longer qualified to practice medicine, the shares must be transferred within 90 days. For these reasons, I always recommend a shareholder buy-sell agreement to give the corporation or the remaining shareholders time to pay for the shares so it does not create financial difficulties for the company. Ideally, the corporation will also obtain life insurance on the professionals to fund a cash buy-out of a deceased shareholder's shares.

My clients were concerned because they had heard that professional corporations were taxed at a high flat rate. I explained that they were correct in understanding that professional corporations are taxed at a flat 35% tax rate on all of the income. However, taxable income can be avoided for the professional corporation by either paying out all of the gain in salaries, or by electing S corporation ("S-corp") status. I also recommended they put special language in their agreements with patients to avoid being subject to the personal holding company rules.

Based on my advice and joint consultation with their accountant, the doctors now hold their medical office building in their limited liability company, and are operating as a professional corporation. In addition to their malpractice insurance, these planning measures took away a lot of their liability concerns.

Owners of Single Member LLCs Doing Business in California Must Also Be Registered in California

May 2, 2011,

I was recently asked by a Cupertino real estate investor whether he should form his limited liability company in Nevada or some other state in order to avoid California taxes. I had to tell him that if anything, this would just increase his overall costs and taxes.

California franchise taxes can be much higher than taxes in other states, and include a minimum tax of $800 per year. As a result, companies often do not want to be classified as doing business in California. One way to avoid this classification used to be to form your entity in another state, and not register it in California. Some of my clients have numerous Delaware LLCs or Nevada LLCs. Often, those LLCs own other LLCs, which own property in California. In order to avoid the California minimum franchise tax for multiple entities, they just register the entity that actually owns the property in California.

However, a new ruling says that if the entity is doing business in California, owns property in California, or is managed by people in California, this exemption is no longer available at the parent LLC level.

The California Franchise Tax Board just issued FTB Legal Ruling 2011-01, stating that activities of a disregarded entity will be attributed to the entity's sole owner. A disregarded entity is a single member LLC or a Qualified Subchapter S subsidiary ("QSub") which is disregarded for income tax purposes so that its income passes through to its parent for tax reporting purposes. Therefore, if the disregarded entity is doing business in California, the 100% owner will be considered to be doing business in California and, if it is an entity, will have to register with the Secretary of State in California. This is true even if that owner entity has no other activities in the state, other than owning the disregarded entity.

This ruling is in addition to a previous California Franchise Tax Board ruling that an entity will be considered to be doing business in California if its managing person(s) are in California, even if all of its other activities are out of state.

For real estate investors, lenders often require a special purpose entity ("SPE") to hold the property, which is structured as a single member Delaware LLC. Under these new Franchise Tax Board rulings, the single member LLC holding the property must be registered in California, and its 100% owner parent company must be registered in California as well. The bad news is that both entities are required to pay the $800 minimum franchise tax to California. However, the LLC gross receipts tax is not incurred twice on income that flows through from one LLC to another.

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