How to use stock legends properly to prohibit unwanted transfers of shares

A legend is a statement on a stock certificate that notes restrictions on the transfer of the stock. A great deal of time and thought is put into preparing agreements among shareholders of closely-held companies, especially with regard to the transferability of share provisions. But if the final administrative step at the end is not taken, the restriction may be useless against a third party without knowledge of the restriction.

“Shareholders may agree to restrict the transfer of shares of a company’s stock, but if the restriction is not properly included on the stock certificate, the restriction on transfer could potentially be ineffective,” says Ashleigh M. Morales, an attorney with Semanoff Ormsby Greenberg & Torchia, LLC.

Smart Business spoke with Morales about stock legends and the impact of not properly including them on stock certificates.

Why is a legend important?

Typically, in privately held companies, shareholders will agree to restrict the transfer of stock in the bylaws, a shareholders’ agreement or a buy-sell agreement. Shareholders generally want to restrict the transfer of stock because they want a say in who will be running or owning the business with them. They may not want their fellow owners’ children, spouse or friends running the business with them in the event of an untimely death. In most situations, the other shareholders (or at least a majority of them) have to agree to the transfer of a shareholder’s shares.

What happens if the stock certificate does not include the legend?

Even if all the shareholders agree to a restriction on the transfer of shares, if a third party receives a stock certificate without a legend containing the restriction and without actual knowledge of the restriction, that third party may not be bound by the restriction and may become the owner of the shares against the will of the other shareholders.

Pennsylvania law provides that unless a restriction is noted conspicuously on the stock certificate a restriction will be deemed ineffective except against a person with actual knowledge of the restriction. The legend puts the world on notice that the restriction exists so someone cannot claim they were unaware of the restriction. Most shareholders’ agreements provide that a legend must be included on stock certificates and the legend on the stock certificate should match that language.

How might this affect a company?

Let’s say an owner dies and all of his property passes to his children. And his children find his stock certificates without any legend on them but the deceased owner had agreed to a restriction on the transfer of shares in the shareholders’ agreement. Assuming the children were unaware of the restriction, the restriction would be ineffective as to the children and they would become the owners of those shares. This is a result the deceased owner and his fellow business owners most likely did not intend. And it becomes an even bigger issue if the restriction allowed the company to redeem the shares at a value less than fair market since now the children could demand fair market value for the shares. This could come at a significant cost to the company or the other shareholders in terms of the price to be paid or litigation.

Do shares of a company have to be certificated?

Generally, Pennsylvania does not require shares to be certificated — a company’s Articles of Incorporation will provide whether the shares are certificated or uncertificated. If shares are uncertificated, the company is required to provide the owner of the shares with written notice of the information typically contained on the certificate, including any restrictions on transfer.

Are LLC interests certificated?

Interests in limited liability companies may also be certificated or uncertificated. If certificated, any restrictions on the transfer of a limited liability company interest should be handled like shares of a corporation.

Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC

Treatment of inside salespeople under the Fair Labor Standards Act

The Fair Labor Standards Act (FLSA) establishes minimum wage, overtime pay, recordkeeping and child labor standards affecting full-time and part-time workers in the private sector and in federal, state and local governments. Nearly all employees are covered by the FLSA unless they qualify for one of the exemptions.

Smart Business spoke with Michael B. Dubin, a member with Semanoff Ormsby Greenberg & Torchia, LLC, about the FLSA, why inside salespeople are commonly misclassified as exempt and the consequences of failing to pay overtime to non-exempt employees.

How are salespeople treated under FLSA?

Outside salespeople are exempt from the overtime requirements under the FLSA while inside salespeople are generally non-exempt and are required to be paid overtime for all hours worked over 40 in a workweek.

To qualify for the outside sales exemption:

  1. The employee’s primary duty must be making sales or obtaining orders or contracts for services, or for the use of facilities for which consideration will be paid by the client or customer; and
  2. The employee must be customarily and regularly engaged away from the employer’s place of business. Any fixed site, whether home or office, used by a salesperson as a headquarters or for telephone solicitation of sales is considered one of the employer’s places of business.

Inside salespeople are those generally attempting to make sales over the telephone, internet or by mail. These employees are typically non-exempt and are eligible for overtime pay. However, in certain limited circumstances, an inside salesperson may be exempt under the ‘retail or service establishment exemption.’ To qualify for this exemption, an employer must demonstrate that:

  1. The employee works for a retail or service establishment;
  2. The employee’s regular rate of pay is at least one-and-a-half times the minimum wage; and
  3. More than half of the employee’s earnings in a representative period (not less than one month and not more than one year) are derived from commissions on goods or services.

A retail or service establishment is a business where 75 percent of its annual dollar volume of sales of goods or services (or both) is not for resale and is recognized as retail sales or services in the particular industry.

Why do employers misclassify salespeople?

Many employers see no distinction between outside salespeople and inside salespeople since both positions are selling goods or services. As a result, many employers misclassify inside salespeople as exempt employees. When made aware of the misclassification, these employers often ask if they can direct the inside salespeople to go on the road a couple of days a month so they can be characterized as outside salespeople exempt from overtime. The answer is no, because an outside salesperson must be ‘customarily and regularly’ engaged away from the employer’s place of business, which means greater than occasional, but less than constant. Therefore, this attempt to avoid paying overtime will be unsuccessful if challenged.

What is the penalty for failing to pay overtime under the FLSA?

If an employer fails to pay overtime under the FLSA, the employee has a private right of action and can seek any unpaid overtime going back two years from the date of filing the action. If the employee can prove the employer acted willfully in violating the FLSA, they may be entitled to overtime going back three years. The employee may also be entitled to liquidated damages, which can be up to the amount of the back overtime (it doubles the amount owed to the employee), as well as the recovery of attorneys’ fees incurred in the action.

To keep abreast of FLSA requirements, it is prudent to have an attorney experienced in FLSA conduct a wage and hour audit every few years. This process will allow the attorney to review all job descriptions, the actual duties performed and the FLSA classification of each position to determine whether any employees or group of employees are misclassified and to rectify any such misclassification.

Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC

HIPPA and business agreements: what service providers need to know

Anyone who has been to a doctor’s office knows that the Health Insurance Portability Act (HIPAA) protects the confidentiality and security of identifiable patient health information (PHI). Yet, many businesses newly marketing services to the health care industry are not aware of the impact of HIPAA on their business.

“The relationship between health care providers and their service providers who handle PHI requires a written business associate agreement (BAA),” says Jules S. Henshell, Of Counsel at Semanoff Ormsby Greenberg & Torchia, LLC.

Smart Business spoke with Henshell about what to consider when signing a HIPAA business associate agreement.

Who is a business associate?

A business associate is any individual or entity that creates, receives, maintains or transmits PHI in the course of performing services on behalf of a HIPAA-covered entity. The HIPAA Omnibus Rule makes business associates of HIPAA-covered entities directly liable for violations of HIPAA and the Health Information Technology Act (HITECH).

What is a business associate agreement?

A business associate agreement is a written agreement, required by HIPAA, between a covered entity and a business associate that describes the rights and responsibilities of each party with respect to the handling of PHI, compliance with HIPAA and implementing regulations known as the HIPAA Omnibus Rule.

How can a company evaluate whether or not a proposed BAA is acceptable?

Certain elements of every BAA are required by law. Other terms are not expressly required. The latter are potentially negotiable. For example, HIPAA does not require that a business associate agree to indemnify a covered entity in the event of breach of PHI, but a covered entity may want such protection. Similarly, HIPAA requires that a business associate agree that the Secretary of Health and Human Services will have access to its books and records. HIPAA does not require that a BAA include such access by a covered entity, but a health care provider may want to audit HIPAA compliance by the business associate.

In addition to review of the terms proposed by the covered entity, the acceptability of a proposed BAA may turn on the following considerations:

  1. Determine if you are a business associate — Will you be creating, receiving or transmitting PHI in the course of performing services? If the services agreement does not entail handling PHI, there is no reason to sign a BAA.
  2. Consider your ability to comply with the BAA commitments — Do you have policies, procedures and safeguards for protecting privacy and security of PHI?
  3. Consider your bargaining power to negotiate — Is the covered entity willing to entertain discussion of the terms of the BAA not required by HIPAA? Contracting officers for large health systems may resist negotiation, but allow for direct discussion between their legal counsel and your lawyer.
  4. Consider whether you will be using a subcontractor to perform — Do you have a subcontractor agreement to ensure that your subcontractor complies with HIPAA? Does it include timeframes that enable you to meet breach notification deadlines in the proposed BAA?
  5. Consider your risk in the event of security breach of PHI.

What is at risk if a business associate violates HIPAA rules?

There are substantial civil monetary penalties for each HIPAA violation. Civil monetary payments totaling $22,855,300 were made to the Department of Health and Human Service’s Office of Civil Rights (OCR) to resolve HIPAA violations last year. In 2016, OCR also announced its first enforcement action directly against a business associate, Catholic Health Care Services of the Archdiocese of Philadelphia. The resolution agreement imposed a $650,000 monetary payment and a corrective action plan, signaling new focus on enforcement against business associates.

Such focus is likely to continue as OCR identifies business associates through ongoing audits of covered entities.

Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC

How to protect your business against wage and hour lawsuits

A worrisome trend for businesses is the explosive growth of wage and hour lawsuits. The Department of Labor reports that it receives nearly 25,000 wage and hour related complaints per year, and the number of lawsuits brought against companies under the Fair Labor Standards Act (FLSA) continues to soar — wage and hour lawsuits against companies for violations of the FLSA have increased 456 percent since 1995. These lawsuits can be expensive to defend, extremely disruptive and often result in the payment of significant settlements.

“The popularity of these lawsuits is explained by the potential for recovery,” says Stephen C. Goldblum, a member at Semanoff Ormsby Greenberg & Torchia LLC. “Even a small wage and hour violation can result in large damages when the claim is brought on behalf of all similarly situated employees.”

Smart Business spoke with Goldblum about wage and hour violations and how companies can steer clear of them.

What types of claims are brought in wage and hour suits?

Although failure to pay overtime wages accounts for nearly 40 percent of wage and hour class action lawsuits, these suits can include a variety of other claims including: misclassification of employees, failure to pay for off-the-clock time, failure to pay for meal breaks, and failure to pay compensable time before and after a work shift. A burgeoning area of concern is the failure to pay employees for the use of email and mobile devices outside of working hours.

How can companies decrease the chance of a wage and hour suit?

An internal audit of wage and hour practices by expert outside counsel can identify and help prevent most violations of the law, thereby helping to avoid a lawsuit. The cost for such a review is substantially less than the fees to defend a single claim.

An effective wage and hour audit will include a thorough review of the company’s policies and practices, including a review of employee classifications, independent contractor relationships, timekeeping and payroll practices, employment policies, overtime calculations, and whether and to what extent managers are properly trained with respect to these issues. If violations are found, counsel can offer strategies to correct them and deal with any potential back pay obligations in ways that reduce the likelihood of litigation. After an effective audit, a company will know and understand any existing risks and can take steps to bring the company into compliance.

How important is it to review and revise wage and hour policies?

One of the most vital things a business can do is to periodically have its wage and hour policies reviewed by an attorney well-versed in this area of the law. For example, handbook policies that notify employees of the company’s expectations regarding off-the-clock work and meal and rest periods are a vital tool in defending wage and hour claims. Moreover, a clear policy that states smartphone use during off hours is only permitted with supervisory approval and must be recorded and reported immediately (i.e., within 72 hours) is recommended, as is a statement that ‘off-the clock work is prohibited.’ Employers should additionally ensure that time cards and electronic recording programs contain language that require employees to confirm that they have recorded all time worked. Finally, clearly articulated meal and rest period policies are now a necessity in employee handbooks.

How can companies implement effective time-keeping measures?

Employees and former employees often assert in class action lawsuits that the hours paid were not accurate because the hours were under-reported or not reported by the employee. To prevent this type of claim, ensure that time-keeping practices are well documented and that the reported time is verified by the employee. Best practices for accomplishing this include using a standard system to record all time, either electronically or with an actual punch-clock; having each nonexempt employee record, review and sign off on their time each pay period; implement a signed verification that the hours reported accurately include all time worked for the period; and training supervisors to monitor and review employees’ time records.

Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC

Protecting your reputation without using non-disparagement clauses

Businesses understandably care about their reputations, as negative publicity can drive away customer traffic. Many businesses have attempted to forestall negative feedback by putting non-disparagement clauses — also known as gag clauses — in their form contracts.

“However, a new federal law prohibits the use of non-disparagement clauses in certain form contracts entered into by consumers,” says Julia Richie Sammin, an attorney at Semanoff Ormsby Greenberg & Torchia, LLC.

Smart Business spoke with Sammin about non-disparagement clauses, the newly enacted Consumer Review Fairness Act of 2016 (CRFA), and the consequences of violations of the new law.

What is a non-disparagement clause?

Non-disparagement clauses prohibit customers from sharing their opinion of a seller’s goods or services, for instance by forbidding a customer from leaving reviews on websites such as Yelp, Angie’s List and TripAdvisor.

But this attempt to avoid negative publicity can backfire when a business sues a customer to enforce the contract provision, particularly where the review reflects the customer’s honest assessment of a business’s goods or services.

What is CRFA?

On Dec. 14, 2016, President Obama signed into law CRFA, a bill that received bipartisan support. Under CRFA, a provision in a ‘form contract,’ defined as a contract with standardized terms where the consumer does not have a meaningful opportunity to negotiate the terms and conditions, would be void from the inception of the contract if the provision:

  • Prohibits or restricts a consumer from making a statement assessing the seller’s goods or services,
  • Imposes a penalty or fee on a consumer for making such a statement, or
  • Claims ownership of the intellectual property in such a statement made by a consumer.

CRFA will not invalidate the entire contract, just the offending provision. It also does not preempt state law — if a state law regarding non-disparagement clauses is even more protective of the consumer than CRFA, that state law will remain in effect.

CRFA is very broad, even encompassing contractual provisions restricting false and defamatory comments. However, CRFA does not prohibit a business from bringing a civil action for breach of confidentiality, defamation, slander or libel, or from removing reviews from its own site that are defamatory, harassing, obscene, false or misleading, or unrelated to the goods or services offered by the business. A business just cannot attempt to restrict the consumer’s speech before such speech is made. Moreover, CRFA does not apply to employment or independent contractor agreements.

CRFA applies to non-disparagement clauses in effect on or after 90 days from the enactment of the new law, i.e. March 14, 2017, so businesses should act quickly to remove any non-disparagement clauses from their form contracts.

What are the consequences of violating CRFA?

A violation of CRFA is considered a violation of the Federal Trade Commission (FTC) Act’s prohibition against unfair or deceptive trade practices, which can result in a civil penalty of up to $40,000 per violation, among other outcomes. If the violation is ongoing, each day that the conduct continues is treated as a separate violation. The FTC Act, however, does not allow a private right of action, so a consumer could not sue a business directly for a violation of CRFA.

How can a business protect its reputation without using non-disparagement clauses?

CRFA instructs the FTC to begin providing non-binding best practices to assist businesses in compliance with CRFA within 60 days after the passage of the new law. In the meantime, businesses can proactively encourage happy customers to leave public reviews and unhappy customers to contact the business privately. Businesses can also ask review websites to remove reviews that are false or misleading, harassing, obscene, etc. Finally, businesses can still sue for defamation, breach of confidentiality, and other claims that are allowed under CRFA.

Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC

How to avoid common intellectual property missteps

The American legal system provides certain rights and protections for owners of intellectual property (IP). It is crucial that businesses avoid infringement of intellectual property rights.

“Businesses often inadvertently infringe the intellectual property rights of others because of inattention to internal operations, a lapse that comes with a significant price tag,” says Alexis Dillett Isztwan, member, Semanoff Ormsby Greenberg & Torchia, LLC.

Smart Business spoke with Isztwan about the risks and consequences of infringing on intellectual property as well as how to avoid missteps.

What businesses are at risk?

In any business, a multitude of infringement risks exist in daily operations. Since infringement does not require that the infringer knew its activities were infringing, businesses must bear the burden of policing their own operations.

Where are the risks?

The most common risk is the unauthorized use of images, content or music. Businesses often look to the internet or social media as a flexible marketing platform for advertising and promotional campaigns that can be launched quickly and inexpensively. The downside is that employees often equate easy access on the internet to images and music with an unfettered right to use third-party works in advertisements or on company websites.

In reality, use of third-party images, music or content requires a license from the owner and typically a fee, regardless of the significance of the use. While employees may believe the IP owner will never discover the use, many technologies exist that enable IP owners to cast a broad search over the internet to identify unauthorized uses of their works.

Another risk arises with the use of software in excess of permitted use under the business’s license. Unless a license allows for enterprise-wide use, the business must limit its use to the numbers specifically permitted, whether those limitations are per user, per laptop or desktop, per server, or per location.

Employees often believe that a software license is carte blanche for use in the business and will copy a program to additional devices, laptops or desktops without the knowledge of the business owners. This misunderstanding of software rights puts a business at significant risk of infringement claims based on the unauthorized uses. While discovery may seem unlikely, all it takes is one disgruntled former employee to disclose the infringing uses to the software owner.

What are the consequences?

The stakes are high. Typically, once unauthorized use is detected, the IP owner will send a letter demanding payment of damages and immediate removal of the unauthorized use — the clear implication being that failure to comply will invite a lawsuit. Six-figure settlement demands are the norm with IP owners often arguing the infringer must pay three to five times the actual damages so that the settlement amount acts as a deterrent.

Even short of litigation, damages can quickly grow. When coupled with legal fees related to negotiating a settlement, damages may have a substantial financial impact on a business even before considering the resulting operational cost of purchasing the appropriate number of software licenses or replacing the promotional piece.

How can a business avoid missteps?

First, never respond to a demand letter without consulting counsel. If the IP owner took the time to send a letter, the matter will not be resolved with a brief call. More often than not, attempts by business owners to resolve an IP matter without counsel result in increased settlement amounts or a severely compromised negotiating position.

Second, businesses should implement internal processes that minimize the risk of unauthorized use of IP. The policies should state clearly what activities are permitted and by whom, and identify the point person to be contacted for inquiries and approvals.

Third, educate and train employees on avoiding potential infringements and knowing when to ask questions and seek approvals.

Finally, appoint an internal coordinator to oversee use of third-party IP and software in the business’s daily activities.

Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC

The basics of Hart-Scott-Rodino and how to avoid potential pitfalls

Hart-Scott-Rodino Antitrust Improvements Act (HSR) compliance is typically associated with transactions involving mergers, stock or asset acquisitions, joint ventures and acquisitions of a controlling interest in a non-corporate entity. Pitfalls can arise, however, for individuals and companies who are unfamiliar with the coverage of the HSR Act.

HSR also applies to the acquisition of voting securities by individuals, including officers and directors, if the acquisition exceeds the HSR’s threshold amounts, regardless of whether the voting securities were acquired through a stock market purchase, as equity compensation or through the exercise of options or warrants.

“Individuals may not be cognizant of these rules and could unknowingly violate the HSR filing obligations,” says Jill Bellak, a member of Semanoff Ormsby Greenberg & Torchia, LLC. “Under the aggregation rules, each new acquisition of voting securities is aggregated with existing holdings. Once the value of the existing holdings plus the newly acquired voting securities exceeds the HSR thresholds, a filing is required prior to acquisition of the new securities. If the voting securities merely appreciate in value, but no new acquisition is made, a filing is not triggered.”

Smart Business spoke with Bellak about the thresholds under HSR, the applicable filing fees, the filing parties and the penalties for failure to comply with the filing requirements.

What are the current thresholds under HSR?

A filing may be triggered through the act’s size of transaction test if acquisitions of voting securities or assets have a value in excess of $78.2 million. If this threshold is reached, the size of person test must be analyzed.

The size of person test is satisfied if one party to the transaction, including the party’s parent and subsidiaries, has annual net sales or total assets of at least $156.3 million and the other party to the transaction has $15.6 million or more in annual net sales or total assets.

A filing under HSR is required if both the size of transaction and size of person tests are met and no exemptions are available. If the acquisition of voting securities or assets has a value in excess of $312.6 million, HSR applies and a filing is required, regardless of the size of person test.

These thresholds are adjusted annually. The relevant date for determining value is the closing date of the transaction, not the date the acquisition agreement is signed.

What are the filing requirements and review period?

Under HSR, a notification and report form, together with the acquisition agreement and other relevant documents, is required to be filed with the Federal Trade Commission and the Department of Justice.

Once a filing is made, the regulators have a 30 calendar day period in which to review the transaction and request additional information or documentation. Early termination of this 30-day waiting period is usually requested by the filing party and often granted by the regulators.

What are the filing fees under HSR?

The filing fees payable under HSR are quite steep, ranging from $45,000 for acquisitions with a value exceeding $78.2 million to $280,000 for acquisitions with a value of $781.5 million or more. Typically, the buyer pays the fee, but it may be the subject of negotiation between the buyer and seller.

Who are the filing parties?

Both the buyer and the seller must file. Typically, the filings are made contemporaneously by their respective counsel. The filing person, referred to as the Ultimate Parent Entity (UPE), may be an individual or an entity, depending upon a detailed analysis of who controls the buyer and seller parties, respectively. For this purpose, the holdings of a spouse and minor children are aggregated with the holdings of an individual UPE.

What are the penalties for failure to file?

The penalty imposed for failure to comply with the filing obligations is $16,000 per day for each day that the filing is delinquent. If a violation has occurred, it is important to notify experienced counsel immediately and take steps promptly to rectify the failure to file.

Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC

The rules are about to change the way family businesses are valued

The IRS has released proposed regulations that will significantly change the way family businesses are valued by discontinuing valuation discounts. At this time, however, there is still the opportunity to use valuation discounts to reduce the tax burden when transitioning family-owned entities, at least for a couple more months.

“If you have any interest in gifting or business transition planning, now is the time to do it,” says Peter J. Smith, a member at Semanoff Ormsby Greenberg & Torchia, LLC.

Smart Business spoke with Smith about the changing rules, the importance of moving forward quickly and how an attorney can aid in the process.

How do you anticipate the gifting rules will change?

Historically, when the owner of a closely held business wants to transfer an interest to the next generation through gifting, bequest, or through a generation-skipping transfer, the asset has to be valued for purposes of gift or estate taxes.

Normally, the interest can be discounted up to approximately 35 or 40 percent for various reasons including lack of marketability or if a minority interest is being transferred.

On Aug. 4, 2016, the IRS published proposed regulations that will have the effect of doing away with the discounts.  There is a 90-day public comment period followed by a public hearing scheduled on Dec. 1, 2016.

At this time, it is expected that the regulations will become final. When the discounts are removed, it will become much more costly to gift and transfer interests in closely held businesses or real estate companies.

How does business succession planning work?

Business succession planning comes in many shapes and sizes. Nevertheless, the general principals are the same – to take advantage of the annual gift tax exclusions and lifetime exemptions to transfer assets tax-free.

The annual exclusion is $14,000 per person, per year. If you are married, your spouse can also gift up to $14,000, even if the asset is not titled in his or her name. Such gifts incur no tax and have no filing requirement. You can also use your lifetime exemption. The lifetime exemption is $5.45 million per person and $10.9 million with a spouse using what is called “portability.” While this may sound like a lot, there is no guarantee this will remain either.

In President Obama’s 2017 budget, he is seeking to reduce the exemption amounts for estate and generation-skipping transfer taxes to $3.5 million, reduce the lifetime gift tax exclusion to $1 million and increase the top federal tax rate from 40 percent to 45 percent. With an uncertain political future ahead, we can never be certain what the lifetime exemption amounts will be.

How can an attorney help with the process?

An attorney can help coordinate estate planning with business succession planning and a gifting plan to maximize use of the exemptions and minimize taxes.

For example, they can help secure the documentation necessary to take advantage of the valuation discounts. Normally, an attorney with their client will retain a valuation expert to perform a formal valuation of the company or the real estate asset.

Based on the valuation and applying the types of discounts described above, assets can be transitioned without incurring any taxes and with minimal use of your lifetime exemption.

If you wait until after the IRS regulations become final, you will lose the benefit of the discounts.

Why is it important to move forward quickly with gifting or business succession plans?

A portion of the proposed regulations become effective 30 days after they become final. Now is the time to take advantage of the valuation discounts. It might not be a transition of an entire interest; perhaps only a small or partial interest. But if you wait, it could cost you a lot more.

Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC

Not used to use tax? How to make sure you’re paying your fair share

Everyone is familiar with sales tax, but few know of use tax, which is typically imposed on the purchase and use of items and services that are subject to sales tax but for which no sales tax was collected.

Use tax issues often arise in connection with out-of-state purchases. A resident of a state with use tax may purchase taxable goods in another state that doesn’t impose sales tax or may buy such goods from an online retailer that doesn’t collect sales tax. In either instance, the customer has a duty to pay use tax.

“Use tax is a complement to sales tax,” says Andrew P. Sonin, an attorney at Semanoff Ormsby Greenberg & Torchia, LLC. “It’s like a safety net, albeit with some sizeable holes.”

Smart Business spoke with Sonin about use tax, who has to pay it and how it’s collected.

Where is use tax in effect?

Nearly every state, including Pennsylvania, New Jersey and Maryland, has a sales tax and a compensating use tax. Delaware does not have a general sales or use tax — a fact which Delaware businesses advertise to residents of neighboring states. The other states currently without a statewide sales or use tax are Alaska, Montana, New Hampshire and Oregon.

What is the rate?

The use tax rate usually matches the sales tax rate. Pennsylvania has a statewide sales tax rate of six percent, so the use tax rate is also six percent. However, there is an additional one percent local sales tax in Allegheny County and an additional two percent tax in Philadelphia. So if you acquire property subject to use tax, you will owe seven percent in Pittsburgh or eight percent in Philadelphia.

Who has to pay it?

Use tax falls on whoever uses the product or service, with the responsibility for reporting and payment resting squarely on the purchaser. It affects both individuals and businesses.

Online sales have brought use tax to the forefront. After years of resistance, several online retailers, such as Amazon, have recently reached deals with various states to collect sales tax on online purchases. If an online retailer does not collect sales tax, most buyers will owe use tax on the purchase and use of any taxable goods from that retailer.

How is it collected?

It’s a difficult tax for revenue authorities to collect because there is no surefire way to know when and what people are buying. States generally rely on self-reporting and provide forms for that purpose. That is problematic, however, because most people aren’t aware of use tax and even if they are, they have little motivation to analyze their receipts, calculate the tax and pay it.

States have dealt with this in different ways. Pennsylvania has a line on its individual income tax return for reporting use tax. Businesses may be audited for use tax compliance if they are already collecting and remitting sales tax.

How is it enforced?

Businesses sometimes face liability when they least expect it. There was a case in New York a few years ago involving a major delivery company that had a practice of giving shipping supplies to its current and potential customers for free. The items bore the company’s logo and clearly were provided for marketing purposes. The New York authorities did not see it that way, though, and imposed use tax on the company’s purchase and distribution of the supplies. After years of expensive administrative wrangling, the company ultimately required intervention by New York’s appellate courts to confirm it had no use tax liability under an exception for promotional materials.

Since enforcing individual compliance is an even greater challenge, revenue authorities tend to concentrate on big-ticket purchases to get more bang for their buck. In one instance, a man bought a boat ‘tax free’ in Delaware and decided to dock it occasionally in New Jersey. The New Jersey Division of Taxation eventually learned of the situation and, assuming the man to be a New Jersey resident, sent him a use tax assessment with interest and penalties 20 years after the purchase — an example of the state’s perseverance in pursuit of a dollar.

Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC

Self-settled trusts: How to make sure your trust works for you

A self-settled trust is a type of trust in which the trust creator or “settlor” is also the person who is to receive economic benefits from the trust during his or her lifetime. The simplest type is the standard Revocable Living Trust (RLT). There, the same person is the trust’s settlor, trustee and a beneficiary.

RLTs are typically created as part of an estate plan to manage assets during the settlor’s lifetime, avoid the necessity of a guardian if the settlor becomes incapacitated and ultimately avoid probate upon the settlor’s death. Some settlors want to enhance these benefits by structuring the trust to exempt its assets from the claims of their creditors.

Smart Business spoke with Brian R. Price, an attorney at Semanoff Ormsby Greenberg & Torchia, LLC., about self-settled trusts, their advantages and disadvantages, and the importance of working with an experienced attorney when establishing such a trust.

What should be included in a self-settled trust?

It’s important to include the terms upon which various individuals can receive funds. That should include the trust creator as well as the terms for the ultimate disposition of the trust funds at some point in time, whether before or after the creator’s death. Designating successor trustees is also a crucial component of any trust.

How should a spendthrift provision be utilized?

A spendthrift provision typically prohibits a trust beneficiary from selling, assigning or otherwise disposing of his or her interest in the trust and at the same time prohibits the trustee from honoring claims by third parties to satisfy the settlor’s/beneficiary’s legal obligations from the trust assets.

Can a self-settled trust’s assets be exempt from claims of the settlor’s creditors?

At least 15 states have enacted legislation to permit settlors to create a trust from which they may receive discretionary distributions while exempting the trust assets from the claims of some, but not all, creditors.

To qualify for creditor protection under these states’ laws, the trust generally must be irrevocable, administered by a trustee in the state adopting the protective legislation and created at a time when there are no pending or threatened legal actions against the settlor/beneficiary.

Even in these jurisdictions, the trust assets are not protected from claims for spousal or child support and alimony, or from certain tort or governmental claims. And even if properly formed and administered under a state’s asset protection trust laws, such a trust may not be exempt from claims in a bankruptcy proceeding against the trust’s settlor/beneficiary.

What are some disadvantages?

The possibility that a federal bankruptcy court may ignore the state laws makes the use of such trusts a risky proposition.

It is an open secret that states with favorable self-settled trust laws hope to attract trust business, and their compensation comes from the creators and the trust’s funds. A cottage industry of specialists promotes the concept and they need to be paid as well.

Do some of these trusts actually provide benefits to the settlor/beneficiaries?

The promoted benefits are attractive to many people who believe that because they have amassed a certain degree of wealth, they are the targets of predators. In this regard, trusts of this sort may provide psychological benefits to the trust settlors.

Additionally, the mere existence of such a trust may intimidate creditors who don’t want to pay the costs of trying to extract money from the trust. This is particularly true if the trust is created in a far away place where obtaining jurisdiction over the trust makes matters even more difficult.

How should someone go about creating a self-settled trust?

Anyone interested in creating such a trust should ask what type of benefits he or she can reasonably expect from the trust. Many self-settled trusts are created either by non-legally trained individuals or trustees who aren’t well-versed in the area. It’s important to seek an attorney who is experienced with the technicalities of self-settled trusts.

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