Thanks to Andy Sandler who brought to my attention that the IRS EIN/TIN website was back in operation.
One aspect of the site that appears to be different is its treatment of LLCs. When applying for an EIN/TIN for an LLC, for question 8.a., one needs to check the box for the tax classification of the LLC (sole proprietorshp, partnership, or corporation) and then, on the spot in the question 8.a. area marked "Other," state whether the LLC is a single member or multi-member LLC. However, you should not check the box marked "Other."
Got that? Now go there.
Saturday, May 31, 2003
Wednesday, May 21, 2003
A Depressing Opinion
I think that the general public believes that the answers to questions of law, in general, and tax law, in particular, are found by investigating arcane points of case law and statutory construction. Of course, that is often the case. However, just as often, answers turn on facts and knowledge that is outside of the hermetic world of cases and statutes. Oliver Wendell Holmes was right: "the path of law is experience, not logic." This basic precept was ignored by the U.S. Tax Court in the case of Keeley v. Commissioner.
In 1996, Mr. Keeley left a well-paying job because in each of the previous 3 to 4 years at the job his compensation had been cut. He attempted to become a commissioned life insurance agent without success. As a consequence, in 1997 he had a mental breakdown. He suffered from and was treated for moderate to severe depression. His income from employment suffered as a result.
In 1997 and 1998, as a result of this diminution in income, he and his wife had to make premature withdrawals from their qualified retirement plans. In order to avoid the imposition of the 10% penalty on these premature withdrawals, they attempted to invoke the provisions of I.R.C. Section 72(t)(2)(A)(iii). That section provides that a premature withdrawal of funds from a qualified plan is not subject to the penalty if the taxpayer is disabled within the meaning of Code Section 72(m)(7) which provides that "an individual shall be considered to be disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration. An individual shall not be considered to be disabled unless he furnishes proof of the existence thereof in such form and manner as the Secretary may require."
Section 1.72-17A(f)((2)(vi) of the Treasury Regulations gives, as an example of a disability, "Mental diseases (e.g., psychosis or severe psychoneurosis) requiring continued institutionalization or constant supervision of the individual." The Regulations also provide that an impairment that is remediable does not constitute a disability. Specifically, Treas. Reg. Section 1.72-17A(f)(4) provides that: "An individual will not be deemed disabled if, with reasonable effort and safety to himself, the impairment can be diminished to the extent that the individual will not be prevented by the impairment from engaging in his customary or any comparable substantial gainful activity."
The Court concluded that Keeley did not suffer from a mental disease because he did not require continued institutionalization or constant supervision. Additionally, the Court concluded, without any real discussion, that Keeley's condition was not irremediable.
The first part of the Court's conclusion is based on precedent (i.e., logic) not real world experience. Anyone who has walked through the District of Columbia or any other major city should be aware of the mentally impaired homeless who populate the streets. They're there because we have medications available that allow us to dump them there and we thus avoid the expense of "continued institutionalization or constant supervision" of these individuals. Nevertheless, no one would argue that they suffer from mental illness. To pretend otherwise is simply to ignore reality. And, in this case, it was clear from the evidence presented that Keeley actually suffered from mental illness. However, the court applied the restrictive definition of the concept found in the regulations (but absent from the statute).
The court may have reached the conclusion that Keeley's condition was not irremediable based on the fact that, by 1998, he had been able to obtain gainful employment. However, the test of whether the disability is reasonably expected to be of long-continued and indefinite duration should be made based upon the condition of the taxpayer when the withdrawal from the qualified plan is made. In this case, at least in 1997, it seemed clear that Keeley's depression met this standard and there was no evidence to the contrary.
The case is also troubling because the court ties the overly restrictive test for disability set forth in the regulations to the statutory provision in Section 72 that requires the taxpayer to provide "proof of the existence [of a disabling mental illness] in such form and manner as the Secretary may require." Here, the court mistakes the grant of authority to set forth the manner in which the disability must be reported with a grant of authority to the Treasury define what constitutes a long-term disability for purposes of the statute.
The best part of the decision is that it is a summary disposition and cannot be treated as precedent for any other case. Thus, the Court is not bound by the opinion and free to ignore the holding in the future.
In 1996, Mr. Keeley left a well-paying job because in each of the previous 3 to 4 years at the job his compensation had been cut. He attempted to become a commissioned life insurance agent without success. As a consequence, in 1997 he had a mental breakdown. He suffered from and was treated for moderate to severe depression. His income from employment suffered as a result.
In 1997 and 1998, as a result of this diminution in income, he and his wife had to make premature withdrawals from their qualified retirement plans. In order to avoid the imposition of the 10% penalty on these premature withdrawals, they attempted to invoke the provisions of I.R.C. Section 72(t)(2)(A)(iii). That section provides that a premature withdrawal of funds from a qualified plan is not subject to the penalty if the taxpayer is disabled within the meaning of Code Section 72(m)(7) which provides that "an individual shall be considered to be disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration. An individual shall not be considered to be disabled unless he furnishes proof of the existence thereof in such form and manner as the Secretary may require."
Section 1.72-17A(f)((2)(vi) of the Treasury Regulations gives, as an example of a disability, "Mental diseases (e.g., psychosis or severe psychoneurosis) requiring continued institutionalization or constant supervision of the individual." The Regulations also provide that an impairment that is remediable does not constitute a disability. Specifically, Treas. Reg. Section 1.72-17A(f)(4) provides that: "An individual will not be deemed disabled if, with reasonable effort and safety to himself, the impairment can be diminished to the extent that the individual will not be prevented by the impairment from engaging in his customary or any comparable substantial gainful activity."
The Court concluded that Keeley did not suffer from a mental disease because he did not require continued institutionalization or constant supervision. Additionally, the Court concluded, without any real discussion, that Keeley's condition was not irremediable.
The first part of the Court's conclusion is based on precedent (i.e., logic) not real world experience. Anyone who has walked through the District of Columbia or any other major city should be aware of the mentally impaired homeless who populate the streets. They're there because we have medications available that allow us to dump them there and we thus avoid the expense of "continued institutionalization or constant supervision" of these individuals. Nevertheless, no one would argue that they suffer from mental illness. To pretend otherwise is simply to ignore reality. And, in this case, it was clear from the evidence presented that Keeley actually suffered from mental illness. However, the court applied the restrictive definition of the concept found in the regulations (but absent from the statute).
The court may have reached the conclusion that Keeley's condition was not irremediable based on the fact that, by 1998, he had been able to obtain gainful employment. However, the test of whether the disability is reasonably expected to be of long-continued and indefinite duration should be made based upon the condition of the taxpayer when the withdrawal from the qualified plan is made. In this case, at least in 1997, it seemed clear that Keeley's depression met this standard and there was no evidence to the contrary.
The case is also troubling because the court ties the overly restrictive test for disability set forth in the regulations to the statutory provision in Section 72 that requires the taxpayer to provide "proof of the existence [of a disabling mental illness] in such form and manner as the Secretary may require." Here, the court mistakes the grant of authority to set forth the manner in which the disability must be reported with a grant of authority to the Treasury define what constitutes a long-term disability for purposes of the statute.
The best part of the decision is that it is a summary disposition and cannot be treated as precedent for any other case. Thus, the Court is not bound by the opinion and free to ignore the holding in the future.
Monday, May 19, 2003
Update on IRS Web EIN/TIN Applications
Sunday, May 18, 2003
Humpty Dumpty On a Roll
Humpty Dumpty articulated a principle that remains the lodestone of contract interpretation: "When I use a word . . .it means just what I choose it to mean-neither more nor less." The problem that gives rise to most contract litigation is HD’s admonition that: "The question is . . . which is to be master-that's all." (For the complete quote, go here.) A recent LLC case out of Connecticut, brought to my attention by Professor Gary Rosin, illustrates the hazards of not exercising the power of the master.
In Radding v. Freedom Choice Mortgage, LLC, Radding was an at-will employee of Freedom Choice, a mortgage broker. In late 1995, Freedom Mortgage instituted an incentive profit sharing plan for certain of its employees wherein the employees became members of the LLC. The LLC's operating agreement had a provision that no member of the company would be eligible to receive income from the production bonus or profit sharing programs until he or she had been a member for one full calendar year.
The admission of Radding and several other employees as members to the company was memorialized in an amendment to Freedom Choice's operating agreement that was dated December 12, 1995. That amendment stated that Radding and the other employees had become members of the LLC as of that date.
While Radding did not sign the operating agreement until December 28, 1995, he did execute a waiver of workers' compensation benefits on December 22, 1995, asserting that the company did not have to provide workers' compensation insurance coverage on him because he was a member of the LLC.
Radding and the principal owner of the company got into a dispute in late 1996. As a result, Radding was discharged as an employee on December 13,1996.
As a threshold matter, the company argued that Radding was not entitled to any benefits for the 1996 year since he had not been a member of the LLC for a full year. However, the court reviewed the terms of the operating agreement which provided that the date a person becomes a member "shall be stated on Schedule A [to the operating agreement]." The minutes to the meeting of the owners of the LLC, held on December 12, 1995, adopting the revised Schedule, stated that Schedule A was "hereby" amended to include Radding and the others as members. The court's conclusion was fortified by the fact that Radding was holding himself out as a member of the LLC at least by December 22, prior to the December 28, 1995, date that he executed the operating agreement.
What no doubt came as even a greater surprise to the principal owners of the company was the conclusion that Radding was still a member of the company even after he was discharged as an employee. The reason was that while the majority owners of the LLC could remove an individual as a member, they hadn’t bothered to formally do so. Thus, the court concluded that Radding remained a member of the LLC through at least 1998.
The lesson of Humpty Dumpty is not merely that one who drafts a contract can be the master of its terms. Humpty Dumpty also teaches that, because one is the master of the terms of a written document, one is bound by the common sense meaning of the words unless a "special meaning" (that is, a meaning defined by the master) is intended.
In Radding v. Freedom Choice Mortgage, LLC, Radding was an at-will employee of Freedom Choice, a mortgage broker. In late 1995, Freedom Mortgage instituted an incentive profit sharing plan for certain of its employees wherein the employees became members of the LLC. The LLC's operating agreement had a provision that no member of the company would be eligible to receive income from the production bonus or profit sharing programs until he or she had been a member for one full calendar year.
The admission of Radding and several other employees as members to the company was memorialized in an amendment to Freedom Choice's operating agreement that was dated December 12, 1995. That amendment stated that Radding and the other employees had become members of the LLC as of that date.
While Radding did not sign the operating agreement until December 28, 1995, he did execute a waiver of workers' compensation benefits on December 22, 1995, asserting that the company did not have to provide workers' compensation insurance coverage on him because he was a member of the LLC.
Radding and the principal owner of the company got into a dispute in late 1996. As a result, Radding was discharged as an employee on December 13,1996.
As a threshold matter, the company argued that Radding was not entitled to any benefits for the 1996 year since he had not been a member of the LLC for a full year. However, the court reviewed the terms of the operating agreement which provided that the date a person becomes a member "shall be stated on Schedule A [to the operating agreement]." The minutes to the meeting of the owners of the LLC, held on December 12, 1995, adopting the revised Schedule, stated that Schedule A was "hereby" amended to include Radding and the others as members. The court's conclusion was fortified by the fact that Radding was holding himself out as a member of the LLC at least by December 22, prior to the December 28, 1995, date that he executed the operating agreement.
What no doubt came as even a greater surprise to the principal owners of the company was the conclusion that Radding was still a member of the company even after he was discharged as an employee. The reason was that while the majority owners of the LLC could remove an individual as a member, they hadn’t bothered to formally do so. Thus, the court concluded that Radding remained a member of the LLC through at least 1998.
The lesson of Humpty Dumpty is not merely that one who drafts a contract can be the master of its terms. Humpty Dumpty also teaches that, because one is the master of the terms of a written document, one is bound by the common sense meaning of the words unless a "special meaning" (that is, a meaning defined by the master) is intended.
Thursday, May 08, 2003
Look Before You Leap
A short opinion recently handed down by Judge Nickerson of the United States District Court for the District of Maryland illustrates the potential dangers inherent in entering into a settlement agreement without complete assurance that the terms of the agreement can be fully consummated.
Under the facts of the case, Columbia Gas Transmission Corp. had brought an action in federal court based upon a federal, as opposed to state, claims. The parties had entered into a settlement agreement that called for the action to be dismissed without prejudice, subject to the right of either party to move to reopen the case within thirty days. If neither party moved to reopen within the thirty day time period, the dismissal became a dismissal with prejudice.
After the thirty day period had expired, Columbia Gas moved to enforce the settlement agreement. The Court rejected the request holding that the settlement agreement was a state law contract that replaced the original claims. Since the settlement agreement was a state law contract and there were no longer any federal claims upon which the court's jurisdiction could be invoked, Columbia Gas's motion was dismissed.
As a consequence, Columbia Gas, which has now lost its previous (presumably greater) claims, must bring a totally new action in Maryland state court to enforce or obtain damages under the settlement agreement. While the state court action will likely be limited (i.e., what were the terms of the agreement, have they been breached, and, if so, what are the damages), Columbia Gas is still exposed to greater costs and will lack the advantage of having the matter heard by the judge who was presumably familiar with the settlement agreement and the underlying dispute. As a practical matter, Columbia Gas might have to make further concessions to the defendant since its upside is likely limited. Not a happy result.
Under the facts of the case, Columbia Gas Transmission Corp. had brought an action in federal court based upon a federal, as opposed to state, claims. The parties had entered into a settlement agreement that called for the action to be dismissed without prejudice, subject to the right of either party to move to reopen the case within thirty days. If neither party moved to reopen within the thirty day time period, the dismissal became a dismissal with prejudice.
After the thirty day period had expired, Columbia Gas moved to enforce the settlement agreement. The Court rejected the request holding that the settlement agreement was a state law contract that replaced the original claims. Since the settlement agreement was a state law contract and there were no longer any federal claims upon which the court's jurisdiction could be invoked, Columbia Gas's motion was dismissed.
As a consequence, Columbia Gas, which has now lost its previous (presumably greater) claims, must bring a totally new action in Maryland state court to enforce or obtain damages under the settlement agreement. While the state court action will likely be limited (i.e., what were the terms of the agreement, have they been breached, and, if so, what are the damages), Columbia Gas is still exposed to greater costs and will lack the advantage of having the matter heard by the judge who was presumably familiar with the settlement agreement and the underlying dispute. As a practical matter, Columbia Gas might have to make further concessions to the defendant since its upside is likely limited. Not a happy result.
Tuesday, May 06, 2003
Update on LLCs & EINs
The IRS website setting forth the directions for obtaining EINs over the web now has been modified to provide additional instructions for LLCs. These instructions make it clear that LLCs can apply for EINs over the web and direct how to do so. The revised web page can be reached by clicking here.
Saturday, May 03, 2003
God Bless The Child Who's Got His Own
Delauter v. Shafer, decided by the Court of Appeals on May 2, is a little outside of my normal haunts, but the facts are somewhat interesting. Going beyond the specific holding of the case, it gives an insight into the dynamics of dispute resolution through the courts.
In 1944, Shafer married one of the daughters of Mr. and Mrs. Deibert. Shafer and his wife lived with his parents until 1968 when then moved to the Deibert family farm. Mr. and Mrs. Deibert had previously moved their personal residence to a parcel across the road that they had purchased, but, even after the Shafers moved in, they were on the farm virtually every working day.
The Shafers paid virtually nothing to the Deiberts over the years. In fact, they had borrowed money from the Deiberts from time to time. The Deiberts paid all of the property taxes on the farm, and, except for certain improvements that the Shafers had made, the Deiberts paid all of the insurance premiums on the farm and its improvements.
Mr. Shafer declared bankruptcy in 1996. He did not list the farm as an asset in his bankruptcy estate.
Mr. Diebert died in 1990 and Mrs. Diebert died in November, 1998. In May of 1998, Mrs. Shafer died. In Mrs. Diebert's will she made a provision with regard to the farm, declaring it to be an "advancement" on the bequest to Mrs. Shafer under the will, with the amount of the advancement being $125.00 times the number of months that the Shafers had lived on the farm from March 1, 1969. Subject to the advancement and some other advancements noted in the will, Mrs. Diebert bequeathed her estate in equal shares to her children.
Trouble had begun brewing even before Mrs. Diebert's death. Shortly before she died, Mrs. Diebert's two other daughters, acting under a power of attorney from their mother, entered into a contract to sell the farm for a little less than $600,000.00 and attempted to get Mr. Shafer to vacate the farm. Mr. Shafer refused to vacate the premises. After Mrs. Diebert's death, these same two daughters, acting as the personal representatives of her estate, brought an ejectment action against Mr. Shafer.
Shafer responded with a counterclaim that a lease had existed for over 20 years, but that no rent had been paid or demanded. Thus, under the provisions of Section 8-107 of the Real Property Article of the Maryland Annotated Code, he argued that the estate could not seek rent or any right of reversion with respect to the property.
The matter was tried before a jury. The jury returned a special verdict in favor of Shafer, finding that a lease existed and that no rent had been paid or demanded for more than twenty years. Consequently, the trial court entered a judgment declaring that Shafer had title to the property.
The Court of Appeals rejected Shafer's position, resting its conclusion on two principles.
First, one of the pivotal issues was whether Shafer's possession of the farm was pursuant to a license from his in-laws or pursuant to a lease. The Court concluded that, because there was no dispute as to the underlying facts, the question of whether the arrangement was a lease or a license was a question of law for the court to determine and should not have been submitted to the jury.
Second, the Court outlined the distinction between a license and a lease. In particular, two elements that would argue that Shafer had leased the farm, the right to exclusive possession and the obligation to pay rent, were not present. Shafer lacked the right of exclusive possession to the farm, since the Dieberts had both been present at the farm virtually every working day, ceasing that activity only when physical infirmity overtook them. Additionally, it was clear that there was never a request or demand that either of the Shafers pay rent. Thus, the Court concluded that the arrangement was a license, not a lease. Consequently, the Court held that the provisions of Section 8-107 were not applicable and it reversed the circuit court.
What are the lessons with respect to dispute resolution?
First, it is likely that, as a practical matter, the case could not be settled since Shafer lacked the financial resources to make a reasonable settlement. After all, for the first 24 years of his marriage he lived at home with his parents. Thereafter, he lived rent free on his in-laws' property. Even then, he had to declare bankruptcy.
Second, the circuit court had abdicated its role when it allowed a jury to make the legal conclusion that the property was held by Shafer pursuant to a lease. To the extent that trial judges allow basic legal questions (as opposed to factual questions) to be resolved by a jury, litigation becomes a crap shoot. Litigants such as Shafer, who feel that they have nothing to lose, thus have an incentive to go to the legal gaming table.
In 1944, Shafer married one of the daughters of Mr. and Mrs. Deibert. Shafer and his wife lived with his parents until 1968 when then moved to the Deibert family farm. Mr. and Mrs. Deibert had previously moved their personal residence to a parcel across the road that they had purchased, but, even after the Shafers moved in, they were on the farm virtually every working day.
The Shafers paid virtually nothing to the Deiberts over the years. In fact, they had borrowed money from the Deiberts from time to time. The Deiberts paid all of the property taxes on the farm, and, except for certain improvements that the Shafers had made, the Deiberts paid all of the insurance premiums on the farm and its improvements.
Mr. Shafer declared bankruptcy in 1996. He did not list the farm as an asset in his bankruptcy estate.
Mr. Diebert died in 1990 and Mrs. Diebert died in November, 1998. In May of 1998, Mrs. Shafer died. In Mrs. Diebert's will she made a provision with regard to the farm, declaring it to be an "advancement" on the bequest to Mrs. Shafer under the will, with the amount of the advancement being $125.00 times the number of months that the Shafers had lived on the farm from March 1, 1969. Subject to the advancement and some other advancements noted in the will, Mrs. Diebert bequeathed her estate in equal shares to her children.
Trouble had begun brewing even before Mrs. Diebert's death. Shortly before she died, Mrs. Diebert's two other daughters, acting under a power of attorney from their mother, entered into a contract to sell the farm for a little less than $600,000.00 and attempted to get Mr. Shafer to vacate the farm. Mr. Shafer refused to vacate the premises. After Mrs. Diebert's death, these same two daughters, acting as the personal representatives of her estate, brought an ejectment action against Mr. Shafer.
Shafer responded with a counterclaim that a lease had existed for over 20 years, but that no rent had been paid or demanded. Thus, under the provisions of Section 8-107 of the Real Property Article of the Maryland Annotated Code, he argued that the estate could not seek rent or any right of reversion with respect to the property.
The matter was tried before a jury. The jury returned a special verdict in favor of Shafer, finding that a lease existed and that no rent had been paid or demanded for more than twenty years. Consequently, the trial court entered a judgment declaring that Shafer had title to the property.
The Court of Appeals rejected Shafer's position, resting its conclusion on two principles.
First, one of the pivotal issues was whether Shafer's possession of the farm was pursuant to a license from his in-laws or pursuant to a lease. The Court concluded that, because there was no dispute as to the underlying facts, the question of whether the arrangement was a lease or a license was a question of law for the court to determine and should not have been submitted to the jury.
Second, the Court outlined the distinction between a license and a lease. In particular, two elements that would argue that Shafer had leased the farm, the right to exclusive possession and the obligation to pay rent, were not present. Shafer lacked the right of exclusive possession to the farm, since the Dieberts had both been present at the farm virtually every working day, ceasing that activity only when physical infirmity overtook them. Additionally, it was clear that there was never a request or demand that either of the Shafers pay rent. Thus, the Court concluded that the arrangement was a license, not a lease. Consequently, the Court held that the provisions of Section 8-107 were not applicable and it reversed the circuit court.
What are the lessons with respect to dispute resolution?
First, it is likely that, as a practical matter, the case could not be settled since Shafer lacked the financial resources to make a reasonable settlement. After all, for the first 24 years of his marriage he lived at home with his parents. Thereafter, he lived rent free on his in-laws' property. Even then, he had to declare bankruptcy.
Second, the circuit court had abdicated its role when it allowed a jury to make the legal conclusion that the property was held by Shafer pursuant to a lease. To the extent that trial judges allow basic legal questions (as opposed to factual questions) to be resolved by a jury, litigation becomes a crap shoot. Litigants such as Shafer, who feel that they have nothing to lose, thus have an incentive to go to the legal gaming table.
Monday, April 28, 2003
An All Bright Opinion
I've always believed that most legal concepts are fairly simple. A corollary to that belief is my feeling that the prevalence of bad writing, both among members of the bar and the bench, is a product of muddled thinking. It is a happy day when one comes across a judicial opinion that is both well written and well reasoned. Today was such a happy day because I came across the opinion of the United States Bankruptcy Court for the District of Colorado in the case of In re Allbright.
Allbright was the sole owner and member of an LLC that owns real estate in Colorado. The trustee in Allbright’s bankruptcy asserted the ability to take over the LLC, liquidate its property, and then distribute the proceeds pursuant to the bankruptcy proceeding. Allbright contended that "at best, the Trustee is entitled to a charging order and cannot assume management of the LLC or cause the LLC to sell" its assets.
The court noted that, under Colorado law, an interest in an LLC is personal property. By virtue of the bankruptcy filing, all of Allbright's personal property, including her interest in the LLC, was transferred to the bankruptcy trustee. Brushing aside Allbright's attempt to parse the difference between the right to manage the property and the right of a member to distributions from the LLC, the court went to the nub of the matter and said: "[T]he charging order, as set forth in [the Colorado LLC Act] exists to protect other members of an LLC from having involuntarily to share governance responsibilities with someone they did not choose, or from having to accept a creditor of another member as a comanager. A charging order protects the autonomy of the original members, and their ability to manage their own enterprise. In a single-member entity, there are no non-debtor members to protect. The charging order limitation serves no purpose in a single member limited liability company, because there are no other parties’ interests affected."
In a footnote, the court provided a common sense guide to future cases involving multi-member LLCs, when it stated: "The harder question would involve an LLC where one member effectively controls and dominates the membership and management of an LLC that also involves a passive member with a minimal interest. If the dominant member files bankruptcy, would a trustee obtain the right to govern the LLC? Pursuant to [the Colorado LLC Act], if the non-debtor member did not consent, even if she held only an infinitesimal interest, the answer would be no. The Trustee would only be entitled to a share of distributions, and would have no role in the voting or governance of the company. Notwithstanding this limitation, [the provision of the Colorado LLC Act dealing with charging orders] does not create an asset shelter for clever debtors. To the extent a debtor intends to hinder, delay or defraud creditors through a multi-member LLC with 'peppercorn' co-members, bankruptcy avoidance provisions and fraudulent transfer law would provide creditors or a bankruptcy trustee with recourse. 11 U.S.C. Sections 544(b)(1) and 548(a)."
There are numerous charlatans who contend that there is some secret hocus-pocus inherent in charging orders. Somehow, against common sense, they argue that if one puts assets in an LLC, the setup will has the same effect on the creditors of the members of the LLC as garlic does to vampires. They contend that not only are the assets themselves beyond the reach of the creditors, but the creditors can get allocated taxable income without the benefit of receiving cash to pay the resulting tax. (If you don’t believe me, punch the term "charging order" into any search engine.)
By contrast, Allbright is short, clear, and well-reasoned. It's message is surprisingly simple: What a debtor controls, belongs to his or her creditors, unless there are others who hold legitimate interests with legitimate expectancies that, unless they gave their consent, they would not have to deal with third-parties. This holding is consonant with such well-reasoned Maryland cases such as 91st Street Joint Venture v. Goldstein, 114 Md. App. 561 (1997). It ain't rocket science.
Allbright was the sole owner and member of an LLC that owns real estate in Colorado. The trustee in Allbright’s bankruptcy asserted the ability to take over the LLC, liquidate its property, and then distribute the proceeds pursuant to the bankruptcy proceeding. Allbright contended that "at best, the Trustee is entitled to a charging order and cannot assume management of the LLC or cause the LLC to sell" its assets.
The court noted that, under Colorado law, an interest in an LLC is personal property. By virtue of the bankruptcy filing, all of Allbright's personal property, including her interest in the LLC, was transferred to the bankruptcy trustee. Brushing aside Allbright's attempt to parse the difference between the right to manage the property and the right of a member to distributions from the LLC, the court went to the nub of the matter and said: "[T]he charging order, as set forth in [the Colorado LLC Act] exists to protect other members of an LLC from having involuntarily to share governance responsibilities with someone they did not choose, or from having to accept a creditor of another member as a comanager. A charging order protects the autonomy of the original members, and their ability to manage their own enterprise. In a single-member entity, there are no non-debtor members to protect. The charging order limitation serves no purpose in a single member limited liability company, because there are no other parties’ interests affected."
In a footnote, the court provided a common sense guide to future cases involving multi-member LLCs, when it stated: "The harder question would involve an LLC where one member effectively controls and dominates the membership and management of an LLC that also involves a passive member with a minimal interest. If the dominant member files bankruptcy, would a trustee obtain the right to govern the LLC? Pursuant to [the Colorado LLC Act], if the non-debtor member did not consent, even if she held only an infinitesimal interest, the answer would be no. The Trustee would only be entitled to a share of distributions, and would have no role in the voting or governance of the company. Notwithstanding this limitation, [the provision of the Colorado LLC Act dealing with charging orders] does not create an asset shelter for clever debtors. To the extent a debtor intends to hinder, delay or defraud creditors through a multi-member LLC with 'peppercorn' co-members, bankruptcy avoidance provisions and fraudulent transfer law would provide creditors or a bankruptcy trustee with recourse. 11 U.S.C. Sections 544(b)(1) and 548(a)."
There are numerous charlatans who contend that there is some secret hocus-pocus inherent in charging orders. Somehow, against common sense, they argue that if one puts assets in an LLC, the setup will has the same effect on the creditors of the members of the LLC as garlic does to vampires. They contend that not only are the assets themselves beyond the reach of the creditors, but the creditors can get allocated taxable income without the benefit of receiving cash to pay the resulting tax. (If you don’t believe me, punch the term "charging order" into any search engine.)
By contrast, Allbright is short, clear, and well-reasoned. It's message is surprisingly simple: What a debtor controls, belongs to his or her creditors, unless there are others who hold legitimate interests with legitimate expectancies that, unless they gave their consent, they would not have to deal with third-parties. This holding is consonant with such well-reasoned Maryland cases such as 91st Street Joint Venture v. Goldstein, 114 Md. App. 561 (1997). It ain't rocket science.
Sunday, April 27, 2003
A Crafty Bash
In U.S. v. Craft, 535 U.S. 274 (2002), the Supreme Court held that a federal tax lien against one spouse attaches to the interest of that spouse in property held with the other spouse that is titled as a tenancy by the entirety. The Craft opinion gave no direction as to the manner in which that interest should be valued. In In re Basher, the United States Bankruptcy Court for the Eastern District of Pennsylvania gave one answer.
Mark Basher owned his residence with his wife as a tenancy by the entirety. The property had a net equity of $101,000.00. The IRS held a tax lien against him (but not his wife) in the amount of $285,000.00. As part of a "cram down" proceeding in a Chapter 13 bankruptcy proceeding, the court had to assign a valuation to the interest to which the lien attached.
Basher claimed that the value of the property to which the lien attached was zero since he had no power, due to the tenancy by the entirety interest, to force a sale of the property. The Court rejected that approach to valuation based on a line of bankruptcy cram-down cases which held that valuation of property that a debtor elects to retain in a cram down proceeding is based upon the value of the various interests to be retained by the debtor, here, Basher's right to the use and enjoyment of the property and his survivorship interest in the property. The court specifically rejected the use of a foreclosure valuation.
The Service contended that the value of Basher's interest was 50% of the net equity value of the property. The court rejected this approach as well, since Basher, who was 46, had a shorter life expectancy than his wife, who was 45. Without determining the precise allocation factors, the court noted that the valuation had to "give . . . consideration to the impact of the [husband's] survivorship interest vis a vis [his wife's]."
Basher will inevitably be cited for the proposition that one merely applies actuarial tables to properly allocate the value of tenancy by the entirety property as between spouses. It is not clear to me that the opinion goes quite that far. Moreover, numerous other factors may affect the determination of the value of the tax debtor's "interest" in tenancy by the entirety property. By way of example, in Basher, the court was specifically able to point to the stability of Basher's marriage. Assume a case in Maryland where that stability is not present. Can the non-debtor spouse argue that part of the value of the property is non-marital under Maryland law, thus further reducing the value of the interest of the debtor spouse? Even the procedural issues are not as clear-cut as the Basher court would indicate, since a good argument could be made that the non-debtor spouse is a necessary party to any proceeding. This would be a particularly significant issue if the proceeding between the debtor spouse and the IRS took place against a background of domestic strife.
Basher is merely the first in what will become a torrent of opinions attempting to fathom the meaning of Craft.
Editor's Note: This weblog now has a "comment" capability. That is, one can post comments in response to any posting. I just discovered that those of you who receive postings via e-mail may not be aware of this, since the posting message is apparently not sent out via the e-mail. If any e-mail subscriber wants to post a comment, simply go to the weblog for that posting and click on the link at the bottom of the posting.
Mark Basher owned his residence with his wife as a tenancy by the entirety. The property had a net equity of $101,000.00. The IRS held a tax lien against him (but not his wife) in the amount of $285,000.00. As part of a "cram down" proceeding in a Chapter 13 bankruptcy proceeding, the court had to assign a valuation to the interest to which the lien attached.
Basher claimed that the value of the property to which the lien attached was zero since he had no power, due to the tenancy by the entirety interest, to force a sale of the property. The Court rejected that approach to valuation based on a line of bankruptcy cram-down cases which held that valuation of property that a debtor elects to retain in a cram down proceeding is based upon the value of the various interests to be retained by the debtor, here, Basher's right to the use and enjoyment of the property and his survivorship interest in the property. The court specifically rejected the use of a foreclosure valuation.
The Service contended that the value of Basher's interest was 50% of the net equity value of the property. The court rejected this approach as well, since Basher, who was 46, had a shorter life expectancy than his wife, who was 45. Without determining the precise allocation factors, the court noted that the valuation had to "give . . . consideration to the impact of the [husband's] survivorship interest vis a vis [his wife's]."
Basher will inevitably be cited for the proposition that one merely applies actuarial tables to properly allocate the value of tenancy by the entirety property as between spouses. It is not clear to me that the opinion goes quite that far. Moreover, numerous other factors may affect the determination of the value of the tax debtor's "interest" in tenancy by the entirety property. By way of example, in Basher, the court was specifically able to point to the stability of Basher's marriage. Assume a case in Maryland where that stability is not present. Can the non-debtor spouse argue that part of the value of the property is non-marital under Maryland law, thus further reducing the value of the interest of the debtor spouse? Even the procedural issues are not as clear-cut as the Basher court would indicate, since a good argument could be made that the non-debtor spouse is a necessary party to any proceeding. This would be a particularly significant issue if the proceeding between the debtor spouse and the IRS took place against a background of domestic strife.
Basher is merely the first in what will become a torrent of opinions attempting to fathom the meaning of Craft.
Editor's Note: This weblog now has a "comment" capability. That is, one can post comments in response to any posting. I just discovered that those of you who receive postings via e-mail may not be aware of this, since the posting message is apparently not sent out via the e-mail. If any e-mail subscriber wants to post a comment, simply go to the weblog for that posting and click on the link at the bottom of the posting.
Wednesday, April 23, 2003
Miracles Do Happen
As of today (finally), the IRS now will issue applications for Federal Tax ID/EIN numbers over the Internet. You can go to the site by clicking here.
While the IRS calls the number that is given a "provisional EIN," it is actually the permanent EIN, subject only to being voided if the name and social security number of the principal officer (or, as the IRS's site calls it, the "principle [sic] officer") do not match Social Security Administration’s records or the business has already been assigned an EIN.
Third parties may request EINs via the Internet on behalf of their clients. Third parties must maintain in their files a copy of the Form SS-4 signed by the client.
I applied for an EIN this morning and found the site incredibly easy to use. A few small nits: If you use commas or periods, the application will not be accepted. Thus, "Acme, L.L.C." will be rejected until the application is resubmitted as "Acme LLC." Also, the size of some of the blocks for inputing information may be too small, particularly the block for the address.
Although I will miss listening to the selection from Swan Lake ad nauseam while I’m holding on the phone, the site represents a major improvement in service.
While the IRS calls the number that is given a "provisional EIN," it is actually the permanent EIN, subject only to being voided if the name and social security number of the principal officer (or, as the IRS's site calls it, the "principle [sic] officer") do not match Social Security Administration’s records or the business has already been assigned an EIN.
Third parties may request EINs via the Internet on behalf of their clients. Third parties must maintain in their files a copy of the Form SS-4 signed by the client.
I applied for an EIN this morning and found the site incredibly easy to use. A few small nits: If you use commas or periods, the application will not be accepted. Thus, "Acme, L.L.C." will be rejected until the application is resubmitted as "Acme LLC." Also, the size of some of the blocks for inputing information may be too small, particularly the block for the address.
Although I will miss listening to the selection from Swan Lake ad nauseam while I’m holding on the phone, the site represents a major improvement in service.
Tuesday, April 08, 2003
All Things Must Pass
Thanks again to Evelyn Pasquier who has provided the following quick analysis of two tax bills, HB 753 and HB 935, which passed the Maryland General Assembly in its waning hours. Stay tuned, however, because the Governor is threatening to veto one or perhaps both of these bills.
HB 753:
A 2% insurance premium tax on HMOs and managed care organizations.
A surcharge on Maryland taxable income of a corporation equal to 10% of the normal 7% tax (i.e., a tax rate of 7.7% on corporate taxable income), effective for tax years beginning after December 31, 2002, but before January 1, 2006 (i.e., this provision will sunset in three years).
Authority to allocate income, deductions, etc., among related entities (Section 482 authority) (enacted without the exception for financial institutions that had been included in the House version). Note that the retroactivity provision in the original version were not included in the version as finally enacted. These provisions, therefore, will go into effect July 1, 2003, and the Comptroller will not be able to exercise this authority with respect to previous years, regardless of whether they are still open for other purposes.
The anti-Delaware Holding Company ("addback") provisions as enacted by the House, but with an exemption for intangible expenses incurred in the biotechnology industry to purchase, license, develop, or protect patents, trade secrets, copyrights, or trademarks.
Allocation to Maryland of non-operational income of a corporation whose principal place of directing or managing its trade or business is in this state.
The "throwback" rule bringing a corporation's sales of tangible personal property to an out-of-state purchaser into the numerator of the apportionment fraction if the corporation is not taxable in the state of the purchaser, and clarifying that a corporation is considered taxable in a state that has jurisdiction to subject it to a net income tax regardless of whether the tax is actually imposed. (Note that where a corporation does no more in a state than solicit sales of tangible personal property, that state does not have jurisdiction to impose an income tax on it.)
HB 935
HB 935, which originally was a straight budget reconciliation bill, now includes a number of items that were in the original corporate tax and "compliance" bills, to wit:
The provisions requiring tax clearance certificates from the Comptroller to renew licenses issued under the following articles: Business Occupations and Professions, Business Regulations, Environment, Health Occupations, Natural Resources, Tax-General, and Transportation (excluding in the last, motor vehicle registration and drivers' licenses).
Entity filing fees for Corporations, LLCs, LPs, LLPs: The annual report fees will be $300, and all other filings have also been increased.
Provisions moving up dates for payment of withholding taxes under certain circumstances.
Lowering from $20,000 to $10,000 the amount for which the Comptroller may require electronic payment of taxes.
Electronic versions of the bills have not yet been posted. I will provide an update when they are and when the Governor either signs or vetoes the bills.
HB 753:
A 2% insurance premium tax on HMOs and managed care organizations.
A surcharge on Maryland taxable income of a corporation equal to 10% of the normal 7% tax (i.e., a tax rate of 7.7% on corporate taxable income), effective for tax years beginning after December 31, 2002, but before January 1, 2006 (i.e., this provision will sunset in three years).
Authority to allocate income, deductions, etc., among related entities (Section 482 authority) (enacted without the exception for financial institutions that had been included in the House version). Note that the retroactivity provision in the original version were not included in the version as finally enacted. These provisions, therefore, will go into effect July 1, 2003, and the Comptroller will not be able to exercise this authority with respect to previous years, regardless of whether they are still open for other purposes.
The anti-Delaware Holding Company ("addback") provisions as enacted by the House, but with an exemption for intangible expenses incurred in the biotechnology industry to purchase, license, develop, or protect patents, trade secrets, copyrights, or trademarks.
Allocation to Maryland of non-operational income of a corporation whose principal place of directing or managing its trade or business is in this state.
The "throwback" rule bringing a corporation's sales of tangible personal property to an out-of-state purchaser into the numerator of the apportionment fraction if the corporation is not taxable in the state of the purchaser, and clarifying that a corporation is considered taxable in a state that has jurisdiction to subject it to a net income tax regardless of whether the tax is actually imposed. (Note that where a corporation does no more in a state than solicit sales of tangible personal property, that state does not have jurisdiction to impose an income tax on it.)
HB 935
HB 935, which originally was a straight budget reconciliation bill, now includes a number of items that were in the original corporate tax and "compliance" bills, to wit:
The provisions requiring tax clearance certificates from the Comptroller to renew licenses issued under the following articles: Business Occupations and Professions, Business Regulations, Environment, Health Occupations, Natural Resources, Tax-General, and Transportation (excluding in the last, motor vehicle registration and drivers' licenses).
Entity filing fees for Corporations, LLCs, LPs, LLPs: The annual report fees will be $300, and all other filings have also been increased.
Provisions moving up dates for payment of withholding taxes under certain circumstances.
Lowering from $20,000 to $10,000 the amount for which the Comptroller may require electronic payment of taxes.
Electronic versions of the bills have not yet been posted. I will provide an update when they are and when the Governor either signs or vetoes the bills.
Wednesday, April 02, 2003
Is That Reasonable?
Previously, I have commented on the growing number of controversies over whether owners of closely held businesses are paying themselves unreasonably low salaries in order to avoid FICA tax liabilities. The U.S. Court of Appeals for the First Circuit just issued an opinion that imposed heavy penalties on a closely held business for paying unreasonably high salaries.
The case is notable because the court adopted a multi-factor test to determine whether the compensation was reasonable, specifically rejecting the "independent investor" test articulated by Judge Posner of the Seventh Circuit in Seventh Circuit, Exacto Spring Corp. v. Commissioner, 196 F.3d 833 (1999).
The case is Haffner's Service Stations, Inc. v. Commissioner (Case No. 02-1761, March 31, 2003) and a copy of the opinion can be obtained through the First Circuit's website.
The case is notable because the court adopted a multi-factor test to determine whether the compensation was reasonable, specifically rejecting the "independent investor" test articulated by Judge Posner of the Seventh Circuit in Seventh Circuit, Exacto Spring Corp. v. Commissioner, 196 F.3d 833 (1999).
The case is Haffner's Service Stations, Inc. v. Commissioner (Case No. 02-1761, March 31, 2003) and a copy of the opinion can be obtained through the First Circuit's website.
The Law Will (Sometimes) Protect a Volunteer
In a recent opinion, the Bankruptcy Court for the Middle District of Pennsylvania relieved the president of a non-profit organization of any responsibility for unpaid employee withholding taxes.
The individual in question became president of a social club at a time when its financial affairs were already in turmoil. During the early stages of his tenure in office, the organization continued to fail to pay withholding taxes on employee wages. However, the court accepted the taxpayer's assertion that he did not know that the taxes were not being paid and that, once he discovered the problem, he ordered the payroll service to be certain that all payroll taxes were properly withheld and paid over.
One fact clearly colored the court's approach to this case--the taxpayer did not profit from the failure to pay over the taxes. As the court noted, he was "an unpaid officer of a non-profit organization [who] had nothing to gain by keeping the club afloat while putting himself at great risk of substantial tax liability."
The underlying rationale of the opinion is found in a footnote where the court quotes from another case dealing with proposed Section 6672 claims against officers of a non-profit organization: "This matter portrays the government at its heartless, rigid, and Orwellian bureaucratic worst. The plaintiffs in this action were engaged in selfless, dedicated charitable activity. They gave of their time and themselves to assist those in need. They received no personal gain other than the satisfaction derived from their charitable endeavors. The compassionate federal government, and particularly the well known, warmhearted Internal Revenue Service, has chosen to reward them with personal liability for the nonpayment of withholding taxes."
The name of the recent case is In Re: E. Harry Lartz. The opinion is not publicly available on the web, but I will supply a copy upon request.
The individual in question became president of a social club at a time when its financial affairs were already in turmoil. During the early stages of his tenure in office, the organization continued to fail to pay withholding taxes on employee wages. However, the court accepted the taxpayer's assertion that he did not know that the taxes were not being paid and that, once he discovered the problem, he ordered the payroll service to be certain that all payroll taxes were properly withheld and paid over.
One fact clearly colored the court's approach to this case--the taxpayer did not profit from the failure to pay over the taxes. As the court noted, he was "an unpaid officer of a non-profit organization [who] had nothing to gain by keeping the club afloat while putting himself at great risk of substantial tax liability."
The underlying rationale of the opinion is found in a footnote where the court quotes from another case dealing with proposed Section 6672 claims against officers of a non-profit organization: "This matter portrays the government at its heartless, rigid, and Orwellian bureaucratic worst. The plaintiffs in this action were engaged in selfless, dedicated charitable activity. They gave of their time and themselves to assist those in need. They received no personal gain other than the satisfaction derived from their charitable endeavors. The compassionate federal government, and particularly the well known, warmhearted Internal Revenue Service, has chosen to reward them with personal liability for the nonpayment of withholding taxes."
The name of the recent case is In Re: E. Harry Lartz. The opinion is not publicly available on the web, but I will supply a copy upon request.
Monday, March 31, 2003
Six Degrees of Separation
Today's New York Times had a story on the case of Norton v. Glenn regarding the issue of "reportage privilege."
Under the facts of the case, a member of the Parkesburg Borough Council characterized the Borough Mayor and the Borough Solicitor as "queers" and "child molesters" and referred to the Borough Solicitor as a "shyster Jew." The statements were reported in the local paper. The Mayor and Borough Solicitor brought suit against not only Glenn, the council member who made the statements, but against the reporter and newspaper as well.
The trial court had applied the so-called "neutral reportage privilege" to the case, based evidentiary rulings upon that privilege and gave jury instructions based upon it. The jury returned a verdict exonerating the reporter and the newspaper.
In essence, the privilege applies the standards of New York Times v. Sullivan, 376 U.S. 254 (1964). It allows reporting of newsworthy statements without fear of being sued for defamation, unless the plaintiff can show that the publication by the reporting organization was made with "actual malice." That is, the plaintiff must prove that reporting organization knew that the statement was false or reported the statement with reckless disregard of whether it was false or not.
The intermediate appellate court rejected the doctrine and the case is now on appeal to the Pennsylvania Supreme Court. Amicus briefs have been filed by numerous press organizations, including the Times.
The case has obvious ramifications for weblog authors. After all, a significant portion of weblog reportage consists of brief mentions of stories that appear in more traditional publications or even references to weblog references to weblog references (and so on) to articles that appear in more traditional publications. If there is no "neutral reportage privilege," the chain of potential defendants could be as long as the number of links to a particular story.
(Note: The quotes of the councilman that are set forth above were contained in the appellate court's opinion, which quoted from the trial court's opinon, which quoted from the evidence adduced at trial, which quoted from the allegedly offending news story, which quoted the councilman. I don't think that I can be sued for defamation for reporting about a court's opinion discussing a trial about an alleged defamation, but ya' never know.)
Under the facts of the case, a member of the Parkesburg Borough Council characterized the Borough Mayor and the Borough Solicitor as "queers" and "child molesters" and referred to the Borough Solicitor as a "shyster Jew." The statements were reported in the local paper. The Mayor and Borough Solicitor brought suit against not only Glenn, the council member who made the statements, but against the reporter and newspaper as well.
The trial court had applied the so-called "neutral reportage privilege" to the case, based evidentiary rulings upon that privilege and gave jury instructions based upon it. The jury returned a verdict exonerating the reporter and the newspaper.
In essence, the privilege applies the standards of New York Times v. Sullivan, 376 U.S. 254 (1964). It allows reporting of newsworthy statements without fear of being sued for defamation, unless the plaintiff can show that the publication by the reporting organization was made with "actual malice." That is, the plaintiff must prove that reporting organization knew that the statement was false or reported the statement with reckless disregard of whether it was false or not.
The intermediate appellate court rejected the doctrine and the case is now on appeal to the Pennsylvania Supreme Court. Amicus briefs have been filed by numerous press organizations, including the Times.
The case has obvious ramifications for weblog authors. After all, a significant portion of weblog reportage consists of brief mentions of stories that appear in more traditional publications or even references to weblog references to weblog references (and so on) to articles that appear in more traditional publications. If there is no "neutral reportage privilege," the chain of potential defendants could be as long as the number of links to a particular story.
(Note: The quotes of the councilman that are set forth above were contained in the appellate court's opinion, which quoted from the trial court's opinon, which quoted from the evidence adduced at trial, which quoted from the allegedly offending news story, which quoted the councilman. I don't think that I can be sued for defamation for reporting about a court's opinion discussing a trial about an alleged defamation, but ya' never know.)
Tuesday, March 25, 2003
Hey, Let's Be Careful Out There!
One might think that maintaining a weblog is not a risky proposition. Speaking as a lawyer, I have to offer a lawyerly, "That depends."
There are weblogs that focus on hotly debated issues of public policy. It is not beyond the realm of possibility that a by-product of these debates might be a lawsuit for defamation. By way of example, Richard Perle is apparently bringing a lawsuit against Seymour Hirsh for a story authored by Hirsh that appeared in The New Yorker. The lawsuit is being brought in England, which is extraordinarily liberal in allowing recoveries for alleged defamation.
One can easily foresee the possibility of a similar lawsuit growing out of a weblog posting. In that regard, it is notable that the law is unclear as to where such a lawsuit can be brought. There is a case in Australia that holds that jurisdiction over a claim for an alleged defamatory statement can be exercised in that country over Dow Jones & Company, located in New York, for publishing Barron's Online. The theory is that the publication of the defamatory statement took place in Australia when Australian web surfers clicked on the site. Although I've heard that Australia's a nice country, I wouldn't want to defend a lawsuit there.
While The New Yorker has deep pockets and, most likely, an insurance policy that provides coverage for defamation claims, I doubt that many bloggers carry insurance policies that are specifically designed to provide such coverage. Let me suggest, however, that bloggers may, in fact, have such coverage in many cases.
Many, if not all, homeowner policies include within the definition of "personal injury," an injury caused by defamatory comments. Umbrella policies generally mirror that coverage. At the least, weblog authors should make certain that their homeowner's policies provide coverage. Additionally, since umbrella coverage is relatively cheap, they should consider acquiring an umbrella policy with significantly higher limits.
However, be aware that such policies generally contain exclusions for business activities. Thus, if a weblog is designed for what might arguably be considered to be a business purpose (such as a weblog by an attorney offering legal commentary), make certain that your business policy provides such coverage and has sufficient limits of coverage.
This brings me to the case of Applied Signal & Image Technology, Inc. v. Harleysville Mutual Insurance Co., decided last week by Judge Blake of the United States District Court for the District of Maryland. Under the facts of that case, Applied Signal was sued for, among other things, allegedly placing the plaintiff in a "false light." Harleysville agreed to defend the case under a reservation of rights. That is, it agreed to underwrite the costs of defense, but reserved the question of whether it had an obligation to contribute to any settlement or judgment obtained by the plaintiff.
At the end of the day, Harleysville contributed $25,000.00 toward a settlement of the case. It balked, however, at reimbursing Applied Signal for the total defense costs of $88,000.00, arguing that these costs should have been apportioned between those allocable to the covered claim and those allocable to claims that were outside of the policy's coverage.
Harleysville lost. The Court held that the policy provision that required Harleysville to "defend any 'suit' seeking . . . damages [covered by the policy]" was a covenant that was independent of its obligation to indemnify Applied Signal from any loss. The Court pointed out that Maryland requires an insurer to defend when there is a "potentiality that the claim could be covered by the policy" (emphasis by the Court). Furthermore, the Court awarded Applied Signal the reasonable attorneys' fees and costs it incurred in having to bring the action to force Harleysville to reimburse it for the attorneys' fees incurred in the defamation action.
The Moral: An ounce of insurance protection is worth a pound of litigation cure.
There are weblogs that focus on hotly debated issues of public policy. It is not beyond the realm of possibility that a by-product of these debates might be a lawsuit for defamation. By way of example, Richard Perle is apparently bringing a lawsuit against Seymour Hirsh for a story authored by Hirsh that appeared in The New Yorker. The lawsuit is being brought in England, which is extraordinarily liberal in allowing recoveries for alleged defamation.
One can easily foresee the possibility of a similar lawsuit growing out of a weblog posting. In that regard, it is notable that the law is unclear as to where such a lawsuit can be brought. There is a case in Australia that holds that jurisdiction over a claim for an alleged defamatory statement can be exercised in that country over Dow Jones & Company, located in New York, for publishing Barron's Online. The theory is that the publication of the defamatory statement took place in Australia when Australian web surfers clicked on the site. Although I've heard that Australia's a nice country, I wouldn't want to defend a lawsuit there.
While The New Yorker has deep pockets and, most likely, an insurance policy that provides coverage for defamation claims, I doubt that many bloggers carry insurance policies that are specifically designed to provide such coverage. Let me suggest, however, that bloggers may, in fact, have such coverage in many cases.
Many, if not all, homeowner policies include within the definition of "personal injury," an injury caused by defamatory comments. Umbrella policies generally mirror that coverage. At the least, weblog authors should make certain that their homeowner's policies provide coverage. Additionally, since umbrella coverage is relatively cheap, they should consider acquiring an umbrella policy with significantly higher limits.
However, be aware that such policies generally contain exclusions for business activities. Thus, if a weblog is designed for what might arguably be considered to be a business purpose (such as a weblog by an attorney offering legal commentary), make certain that your business policy provides such coverage and has sufficient limits of coverage.
This brings me to the case of Applied Signal & Image Technology, Inc. v. Harleysville Mutual Insurance Co., decided last week by Judge Blake of the United States District Court for the District of Maryland. Under the facts of that case, Applied Signal was sued for, among other things, allegedly placing the plaintiff in a "false light." Harleysville agreed to defend the case under a reservation of rights. That is, it agreed to underwrite the costs of defense, but reserved the question of whether it had an obligation to contribute to any settlement or judgment obtained by the plaintiff.
At the end of the day, Harleysville contributed $25,000.00 toward a settlement of the case. It balked, however, at reimbursing Applied Signal for the total defense costs of $88,000.00, arguing that these costs should have been apportioned between those allocable to the covered claim and those allocable to claims that were outside of the policy's coverage.
Harleysville lost. The Court held that the policy provision that required Harleysville to "defend any 'suit' seeking . . . damages [covered by the policy]" was a covenant that was independent of its obligation to indemnify Applied Signal from any loss. The Court pointed out that Maryland requires an insurer to defend when there is a "potentiality that the claim could be covered by the policy" (emphasis by the Court). Furthermore, the Court awarded Applied Signal the reasonable attorneys' fees and costs it incurred in having to bring the action to force Harleysville to reimburse it for the attorneys' fees incurred in the defamation action.
The Moral: An ounce of insurance protection is worth a pound of litigation cure.
HB 753 Update
HB 753 has apparently been approved, but in a heavily amended form, by the Senate Budget & Taxation Committee. While business entity filing fees and yearly registration fees are still raised, the increases are not as radical as those in the version passed by the House. Furthermore, the provision imposing recordation and transfer tax on entity transfers has apparently been stricken.
I have not yet seen a copy of the bill as amended in the Senate, but I will post a more complete summary as soon as possible.
I have not yet seen a copy of the bill as amended in the Senate, but I will post a more complete summary as soon as possible.
Monday, March 24, 2003
If This is Athens, Where's the Acropolis?
Evelyn Pasquier of Piper Rudnick has authored a summary of HB 753, a budget bill that has just passed the Maryland House of Delegates. She terms the bill "Draconian." Perhaps, "Draconian" is a little over the top, but it's a bad bill.
HB 753 dramatically increases the annual fees that all business entities registered in Maryland must pay. By way of example, all business entities would have to pay at least $400.00 a year. Currently, the annual fee is $100.00 for corporations and nothing for LLCs and partnerships. The fee rises to as much as $20,000.00, depending on the number of employees a business entity has. The fee will have a significant negative impact on the use of multiple entities to lower the liability profile of a business.
Maryland is the "corporate domicile" of many real estate investment trusts. This results in a good deal of money flowing into the state without any significant burden on governmental resources. Apparently determined to kill the goose that is laying this golden egg for the state, HB 753 imposes a $10,000.00 filing fee on REITs.
HB 753 also imposes transfer and recordation taxes on transfers of controlling interests in entities if the underlying real property owned by the entities is worth at least $1,000,000.00. I've commented in the past on the deficiencies of this tax, both legal and economic, and I won't repeat the criticisms here.
HB 753 also makes significant changes to the corporate income tax in Maryland. In essence, these changes extend the reach of Maryland's taxing authority over income that previously escaped taxation.
Ironically, HB 753, which places burdens on business activities in Maryland, has its roots in political rhetoric (mostly, but not exclusively, Republican) that condemns taxes. Voters have been told time and time again that they are heavily taxed. In general, and particularly in Maryland, this is not the case. As a consequence, elected officials in Maryland are unable (or, perhaps, unwilling) to state the obvious: The cuts in the Maryland income tax over the past few years were unwarranted and should be repealed. Attempting to patch the state's leaky fiscal ship by enacting "non-taxes" in the form of dramatically increased business fees will ultimately cost the state dearly in terms of economic development.
HB 753 dramatically increases the annual fees that all business entities registered in Maryland must pay. By way of example, all business entities would have to pay at least $400.00 a year. Currently, the annual fee is $100.00 for corporations and nothing for LLCs and partnerships. The fee rises to as much as $20,000.00, depending on the number of employees a business entity has. The fee will have a significant negative impact on the use of multiple entities to lower the liability profile of a business.
Maryland is the "corporate domicile" of many real estate investment trusts. This results in a good deal of money flowing into the state without any significant burden on governmental resources. Apparently determined to kill the goose that is laying this golden egg for the state, HB 753 imposes a $10,000.00 filing fee on REITs.
HB 753 also imposes transfer and recordation taxes on transfers of controlling interests in entities if the underlying real property owned by the entities is worth at least $1,000,000.00. I've commented in the past on the deficiencies of this tax, both legal and economic, and I won't repeat the criticisms here.
HB 753 also makes significant changes to the corporate income tax in Maryland. In essence, these changes extend the reach of Maryland's taxing authority over income that previously escaped taxation.
Ironically, HB 753, which places burdens on business activities in Maryland, has its roots in political rhetoric (mostly, but not exclusively, Republican) that condemns taxes. Voters have been told time and time again that they are heavily taxed. In general, and particularly in Maryland, this is not the case. As a consequence, elected officials in Maryland are unable (or, perhaps, unwilling) to state the obvious: The cuts in the Maryland income tax over the past few years were unwarranted and should be repealed. Attempting to patch the state's leaky fiscal ship by enacting "non-taxes" in the form of dramatically increased business fees will ultimately cost the state dearly in terms of economic development.
Sunday, March 16, 2003
I Don't Want to Get Off on a Rant Here, But . . .
In general, this weblog is directed to discussing "technical" issues pertaining to tax and business law. In the course of these commentaries, it is impossible to avoid discussion public policy issues. After all, in some sense, the law is the articulation of public policy. However, I have avoided topics that are of a more general nature. Thus, I have not offered my opinions on, say, broader issues of tax policy such as tax rates, etc.
My approach has been driven by my view that this weblog is a semi-scholarly endeavor. If my postings were to deal with issues that are the subject of partisan debate, the weblog might be perceived as having a focus that is different from its original intent--to highlight and discuss technical developments in the field.
Readers can assume that I have a political bias. However, their assumptions as to the nature of that bias are often incorrect. For instance, because my work is, to a large degree, devoted to helping my clients minimize the taxes that they pay, there is often an assumption that I am anti-tax. Somewhat conversely, after hearing my opinions as to the necessity of increasing the audit capability of the I.R.S. and the Maryland Comptroller's Office, people sometimes conclude that I’m merely trying to bend public policy to indirectly drum up more business for myself (i.e., more audits, more clients). Neither of these assumptions are correct.
This brings me to the subject of this posting. With the exception of the impending Iraq invasion and, perhaps, the Korean situation, the most heated debates in this country today are over tax policy. The public generally tends to ignore the nitty-gritty of tax policy, since tax policy discussions can cause even the eyes of insomniacs to glaze over. As a consequence, there is a vacuum in public discussions that tends to be filled with "cranks and charlatans." (The term is the appellation applied by the current president's chief economic advisor to the proponents of supply side economics. That being the case, I wonder what he really thinks about the President's tax proposals.) In this category are those who argue that the federal or state budget is bloated and that taxes could be cut and governmental deficits disappear if this bloat were properly attacked.
Access to the facts that refute this argument as it pertains to the federal budget are widely available. Thus, one need look no further than the budget proposed by the White House (which is easily accessible on-line) to discover that the non-military discretionary spending proposed by the White House is only 19.24% of the total proposed spending package. (Non-military discretionary spending is everything other than entitlements, such as Social Security and Medicare, and interest on the federal debt. It represents the cost of operating virtually every governmental agency from the State Department, to the Justice Department, to the FAA, to the FDA, to the costs of running the White House.) This is less than the “off-budget deficit” (the amount that is spent on all items other than designated trust fund programs such as Social Security). In other words, even if non-military discretionary spending were cut to zero, the federal government would still be running a deficit with respect to its current operations. And, this would be the case even before any costs of a war on Iraq are factored in.
It is often more difficult to find similar analyses of state spending, particularly with respect to relatively small states such as Maryland. A recent op-ed piece in The Baltimore Sun by Steve Hill, director of the Maryland Budget and Tax Policy Institute helps to fill this void. The article points out that (i) Maryland government is lean–it has fewer employees per capita than all but nine other states, (ii) that the higher education system in Maryland is underfunded when compared to the systems in other states, and (iii) that state and local governmental spending reflects a smaller share of our economy than in every other state but three.
I disagree with some of the Institute's suggested remedies to balance the state's budget. By way of example, in one paper addressing three alleged loopholes, the Institute urges the passage of the entity transfer tax bill, a step that I have opposed for a number of years. On the whole, however, the Institute and its website are a powerful resource with which to battle Maryland's cranks and charlatans.
My approach has been driven by my view that this weblog is a semi-scholarly endeavor. If my postings were to deal with issues that are the subject of partisan debate, the weblog might be perceived as having a focus that is different from its original intent--to highlight and discuss technical developments in the field.
Readers can assume that I have a political bias. However, their assumptions as to the nature of that bias are often incorrect. For instance, because my work is, to a large degree, devoted to helping my clients minimize the taxes that they pay, there is often an assumption that I am anti-tax. Somewhat conversely, after hearing my opinions as to the necessity of increasing the audit capability of the I.R.S. and the Maryland Comptroller's Office, people sometimes conclude that I’m merely trying to bend public policy to indirectly drum up more business for myself (i.e., more audits, more clients). Neither of these assumptions are correct.
This brings me to the subject of this posting. With the exception of the impending Iraq invasion and, perhaps, the Korean situation, the most heated debates in this country today are over tax policy. The public generally tends to ignore the nitty-gritty of tax policy, since tax policy discussions can cause even the eyes of insomniacs to glaze over. As a consequence, there is a vacuum in public discussions that tends to be filled with "cranks and charlatans." (The term is the appellation applied by the current president's chief economic advisor to the proponents of supply side economics. That being the case, I wonder what he really thinks about the President's tax proposals.) In this category are those who argue that the federal or state budget is bloated and that taxes could be cut and governmental deficits disappear if this bloat were properly attacked.
Access to the facts that refute this argument as it pertains to the federal budget are widely available. Thus, one need look no further than the budget proposed by the White House (which is easily accessible on-line) to discover that the non-military discretionary spending proposed by the White House is only 19.24% of the total proposed spending package. (Non-military discretionary spending is everything other than entitlements, such as Social Security and Medicare, and interest on the federal debt. It represents the cost of operating virtually every governmental agency from the State Department, to the Justice Department, to the FAA, to the FDA, to the costs of running the White House.) This is less than the “off-budget deficit” (the amount that is spent on all items other than designated trust fund programs such as Social Security). In other words, even if non-military discretionary spending were cut to zero, the federal government would still be running a deficit with respect to its current operations. And, this would be the case even before any costs of a war on Iraq are factored in.
It is often more difficult to find similar analyses of state spending, particularly with respect to relatively small states such as Maryland. A recent op-ed piece in The Baltimore Sun by Steve Hill, director of the Maryland Budget and Tax Policy Institute helps to fill this void. The article points out that (i) Maryland government is lean–it has fewer employees per capita than all but nine other states, (ii) that the higher education system in Maryland is underfunded when compared to the systems in other states, and (iii) that state and local governmental spending reflects a smaller share of our economy than in every other state but three.
I disagree with some of the Institute's suggested remedies to balance the state's budget. By way of example, in one paper addressing three alleged loopholes, the Institute urges the passage of the entity transfer tax bill, a step that I have opposed for a number of years. On the whole, however, the Institute and its website are a powerful resource with which to battle Maryland's cranks and charlatans.
Saturday, March 15, 2003
Joseph K. Meets the Internal Revenue Code of 1986
In a recent opinion, the defendants opposed to the I.R.S. characterized their plight as being "Kafkaesque." The court, while admitting that the facts "tend[] to support that view," nonetheless denied relief.
The case, U.S. v. Ripa, involves a claim involving an assessment dating back to 1983 (that’s not a typo). The opinion was handed down on March 12 and the case is number 01-6099. It can be downloaded off of the Second Circuit's website.
In 1983, Romano attempted to enter Canada from the U.S. with $359,000.00 in U.S. currency in his trunk. The cash was the proceeds of "wildly successful, albeit illegal, gambling activities." Unfortunately, Romano had failed to complete the required currency reporting form. As a result, the cash was immediately seized by U.S. Customs officials.
More significantly, the I.R.S., later that same day, made a "termination assessment" against Romano. That is, the Service terminated his tax year as of that date and calculated the tax due. Under such circumstances, the tax becomes immediately due and payable and the I.R.S. files a tax lien. Ultimately, Romano was found to owe $169,981.00 in taxes on his gambling winnings. By 2001, due to interest and penalties, this assessment had grown to over $750,000.00. It is perhaps worthy of note that Romano had total tax liens of over $1.5 million by the time of the trial in this matter, thus the tax due with respect to the seized monies was not the only obligation he owed the I.R.S.
Over many years, Romano, represented by his attorney, Ripa, pressed his efforts in opposition to the Government's efforts to declare that the funds would be forfeited to the Government. Ultimately, he prevailed and, in 1997, the Federal District Court ordered the Government to refund to Romano $491,236.69, representing the monies seized and interest thereon.
In the case before the Second Circuit, Ripa, Romano's attorney, claimed that he was entitled to receive his legal fee for representing Romano in the forfeiture action, equal to one-third of the award, because the legal fee represented a lien with "superpriority," with priority over the tax liens. In general, an attorney's fee constitutes a lien on assets with superpriority if the legal fee was incurred in a successful effort to obtain a judgment that produced the assets. However, there is an exception to the superpriority rule when the judgment arises out of "a claim or . . . a cause of action against the United States."
Ripa argued that because the money never belonged to the Government, there was no judgement "against the United States." In fact, an earlier district court opinion out of Massachusetts supports this position. Two other district court opinions, out of Georgia and Kentucky, had reached the same conclusion as the Second Circuit here. The Second Circuit's decision was based upon its analysis that the purpose of the statute granting superpriorty status was to encourage the realization of assets that could be applied to pay taxes due. Since the monies returned by Romano would have been in the coffers of the Government in any event, the Government was no better off by dint of Ripa's efforts.
For Romano, the horror does not end here. After all, the total amount due, including interest and penalties, with respect to the taxes on money seized was more that Romano received when the Government's forfeiture claim was denied. The reasons are that the Government was not forced to pay any penalty with respect to its misguided efforts and the interest charged on delinquent tax obligations is greater that the interest allowed on the contested fund during the time the forfeiture action was pending. The Court denied Romano equitable relief with respect to this claim.
I'm wondering whether Romano was dealt one final insult. After all, he received just over $140,000.00 in interest on the returned funds. It is entirely possible that the Service could have or did seek to tax that income in 1997, the year of receipt.
The case, U.S. v. Ripa, involves a claim involving an assessment dating back to 1983 (that’s not a typo). The opinion was handed down on March 12 and the case is number 01-6099. It can be downloaded off of the Second Circuit's website.
In 1983, Romano attempted to enter Canada from the U.S. with $359,000.00 in U.S. currency in his trunk. The cash was the proceeds of "wildly successful, albeit illegal, gambling activities." Unfortunately, Romano had failed to complete the required currency reporting form. As a result, the cash was immediately seized by U.S. Customs officials.
More significantly, the I.R.S., later that same day, made a "termination assessment" against Romano. That is, the Service terminated his tax year as of that date and calculated the tax due. Under such circumstances, the tax becomes immediately due and payable and the I.R.S. files a tax lien. Ultimately, Romano was found to owe $169,981.00 in taxes on his gambling winnings. By 2001, due to interest and penalties, this assessment had grown to over $750,000.00. It is perhaps worthy of note that Romano had total tax liens of over $1.5 million by the time of the trial in this matter, thus the tax due with respect to the seized monies was not the only obligation he owed the I.R.S.
Over many years, Romano, represented by his attorney, Ripa, pressed his efforts in opposition to the Government's efforts to declare that the funds would be forfeited to the Government. Ultimately, he prevailed and, in 1997, the Federal District Court ordered the Government to refund to Romano $491,236.69, representing the monies seized and interest thereon.
In the case before the Second Circuit, Ripa, Romano's attorney, claimed that he was entitled to receive his legal fee for representing Romano in the forfeiture action, equal to one-third of the award, because the legal fee represented a lien with "superpriority," with priority over the tax liens. In general, an attorney's fee constitutes a lien on assets with superpriority if the legal fee was incurred in a successful effort to obtain a judgment that produced the assets. However, there is an exception to the superpriority rule when the judgment arises out of "a claim or . . . a cause of action against the United States."
Ripa argued that because the money never belonged to the Government, there was no judgement "against the United States." In fact, an earlier district court opinion out of Massachusetts supports this position. Two other district court opinions, out of Georgia and Kentucky, had reached the same conclusion as the Second Circuit here. The Second Circuit's decision was based upon its analysis that the purpose of the statute granting superpriorty status was to encourage the realization of assets that could be applied to pay taxes due. Since the monies returned by Romano would have been in the coffers of the Government in any event, the Government was no better off by dint of Ripa's efforts.
For Romano, the horror does not end here. After all, the total amount due, including interest and penalties, with respect to the taxes on money seized was more that Romano received when the Government's forfeiture claim was denied. The reasons are that the Government was not forced to pay any penalty with respect to its misguided efforts and the interest charged on delinquent tax obligations is greater that the interest allowed on the contested fund during the time the forfeiture action was pending. The Court denied Romano equitable relief with respect to this claim.
I'm wondering whether Romano was dealt one final insult. After all, he received just over $140,000.00 in interest on the returned funds. It is entirely possible that the Service could have or did seek to tax that income in 1997, the year of receipt.
Monday, March 03, 2003
Saving Your S
The ability of a corporation to retain its status as an S corporation is hedged by a variety of requirements. One of those is found in I.R.C. Section 1362(d)(3)(A)(i) which provides that an election under section 1362(a) is terminated if the corporation has accumulated earnings and profits at the close of each of 3 consecutive taxable years and has gross receipts for each of such taxable years more than 25 percent of which are passive investment income. PLR 200309021 shows how an S election can be retained even though the principal business of the corporation would otherwise cause it to run afoul of Section 1362(d)(3)(A)(i).
Under the facts of the ruling, the S corporation's primary source of revenue was rental income from leasing office space. This income was clearly passive investment income for the purposes of Section 1362(d)(3)(A)(i). See I.R.C. Section 1362(d)(3)(C)(i). However, the corporation purchased interests in three limited partnerships that were apparently engaged in the business of purchasing, gathering, transporting, trading, storage, and resale of crude oil, refined petroleum, and other mineral or natural resource. These sorts of business activities will not constitute passive investment income as defined by I.R.C. Section 1362(d)(3)(C)(i).
The ruling held that the corporation's distributive share of the gross receipts of the three partnerships that it purchased will be included in its gross receipts for purposes of Section 1362(a). Apparently, the amount of the corporation's distributive shares of partnership gross receipts from the three partnerships were sufficient to fall below the 25% threshold that would have put it in violation of Section 1362(d)(3)(A)(i). Just as importantly, this result holds even though there may have been little net income from the partnerships or even losses generated by them.
This ruling opens the way for some creative planning in situations where an S corporation has low basis assets that it wants to dispose of with minimal income tax impact or assets which may be subject to double tax because the corporation had been a C corporation that elected S corporation status within the previous ten years. I will post illustrations of these planning possibilities in the coming weeks.
Under the facts of the ruling, the S corporation's primary source of revenue was rental income from leasing office space. This income was clearly passive investment income for the purposes of Section 1362(d)(3)(A)(i). See I.R.C. Section 1362(d)(3)(C)(i). However, the corporation purchased interests in three limited partnerships that were apparently engaged in the business of purchasing, gathering, transporting, trading, storage, and resale of crude oil, refined petroleum, and other mineral or natural resource. These sorts of business activities will not constitute passive investment income as defined by I.R.C. Section 1362(d)(3)(C)(i).
The ruling held that the corporation's distributive share of the gross receipts of the three partnerships that it purchased will be included in its gross receipts for purposes of Section 1362(a). Apparently, the amount of the corporation's distributive shares of partnership gross receipts from the three partnerships were sufficient to fall below the 25% threshold that would have put it in violation of Section 1362(d)(3)(A)(i). Just as importantly, this result holds even though there may have been little net income from the partnerships or even losses generated by them.
This ruling opens the way for some creative planning in situations where an S corporation has low basis assets that it wants to dispose of with minimal income tax impact or assets which may be subject to double tax because the corporation had been a C corporation that elected S corporation status within the previous ten years. I will post illustrations of these planning possibilities in the coming weeks.
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