operating agreement

Operating Agreement vs. Revocable Trust—Which One Wins?

As a member of an LLC, you have an operating agreement. But as an individual business owner, you may also have a revocable trust. When they don’t agree with or support each other, which one takes precedence in the eyes of the law?

Operating Agreement: One Side of the Equation

Let’s assume that you and a partner have formed an LLC. The two of you draw up an operating agreement to outline the business’s basic structure.

Each of you has 50% membership interest in the LLC. Through your operating agreement, you indicate that your membership interest includes:

  • the right to distributions, allocations, and information
  • the right to vote on matters that come before the members

You also specify that, in the event of a member’s death, all member interest will transfer to the surviving member. Alternatively, that member may bequeath his interest to an immediate family member—and only to that family member.

The Other Side of the Equation: Revocable Trust

Years after the formation of the LLC, your partner has completely forgotten about the operating agreement. Without giving it a second thought, he amends his revocable trust to provide a specific gift of half of the LLC’s distributions to a friend.

Then the partner dies.

His friend, armed with the information he received from the trust, shows up at the business asking for his share of the distributions.

Which has precedence: the operating agreement or the revocable trust?

The Legal Precedence

In a 2011 court case, a situation similar to this occurred. The case went to probate court. That court sided with the friend and determined that the LLC was an estate asset. Therefore, the friend was entitled to half of the distributions.

The deceased LLC member’s children appealed the decision, which was reversed in a district court of appeals.

This court stated that this particular trust provision was nullified to the extent that it was contradicted by the LLC’s operating agreement and contractual provisions.

Protect Your Assets and Business

If you are a member of an LLC, you want to protect your assets. And if you are in an LLC with another member, you want to be sure everyone is on the same page. While your operating agreement needs to be equitable, your revocable trusts should support your goals for the business.

Poulos Law Firm has more than 30 years of estate-planning experience. We ask the right questions to ensure you avoid these challenges. We can work with you, your family, and your business partners to create estate plans to meet your goals, now and into the future. Contact us to schedule your appointment and learn more.

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Ins and Outs of a Business Purchase Agreement

Have you ever thought about buying a business? If you do at some point your going to be asked to sign a purchase agreement. (You will bring it to an attorney for review, correct?)

Often first time buyers or sellers are unfamiliar with what is covered in a typical purchase and sale agreement.

For most people the first time they see such a document is when they are selling their business or buying one for the first time. Like most legal documents reading them without understanding the legal significance of the words can lead to problems down the road. Too often people contact us and tell us the document “seems okay.” Maybe it is…or maybe not.

A Definitive Purchase Agreement (DPA) is a legal document is used to transfer the ownership of a company. In short, a DPA is used when two parties enter into an agreement for a merger, acquisition, divestiture, joint venture or some other form of alliance. This binding contract includes all the terms and condition under which the merger, acquisition, etc. will take place, and includes assets to be purchased, purchase considerations, representations and warranties, closing conditions and more.

There are two types of DPAs — a Share or Stock Purchase Agreement or an Asset Purchase Agreement. In a Share Purchase Agreement, the seller transfers the shares of the company into the name of the buyer. In an Asset Purchase Agreement, the individual assets are transferred to the buyer, rather than the entire company. The seller remains the owner and the buyer merges the assets into his existing company or forms a new company.

You should expect the following clauses to be included in a DPA:

Purchase Consideration — what the buyer will pay to the seller, any adjustments made to purchase price and why, timeline of payment(s), earnest money deposited in escrow, any third-party financing, required working capital, etc.

Representations and Warranties — seller states or represents the true facts about the company and then warrants that the statements are true.

Limitations of Representations and Warranties — the seller can add limitations to the representations and warranties including how long warranty period lasts (the seller won’t represent of warranty past a certain date), disclosure schedules and more.

Indemnification Clauses — this clause says that if the seller has failed to disclose a liability, he or she will pay a huge fee.

Closing Conditions — generally, there is a gap between signing and closing of deal, during which certain conditions must be met by both parties for a successful closing.

Miscellaneous Provisions — may include things like required inventory levels at time of closing, dispute resolution in case of problems, penalties to buyer or seller if deal falls apart, who pays the fees to banker, attorney, etc.

Purchase Agreements can be complicated and certainly require an experienced business attorney to help protect a your interests. Poulos Law Firm has more than 30 years of experience helping individuals navigate through these transactions.

SMALL BUSINESS LAW – We can help you with every aspect of your business including business formation and organization, business negotiations, business planning, transactional business law, purchase and sales of businesses, and business litigation, as well as succession planning with wills, trusts and buy sell agreements.

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Why Quitclaim Deeds Stink!

A quitclaim deed (also known as a quick claim deed) is used transfer title on real property. People on their own use them all the time and almost always create future problems. Quitclaim deeds stink, first and foremost because the deed doesn’t even say whether or not the person even owns the property and offers no guarantees as to his or her ownership interest.

Because there is no need for strong guarantees, plenty of people use them to transfer property into and out of trusts, LLCs, between husbands and wives and family members. That can be a recipe for disaster. For example, a father quitclaim’s a property to his oldest son, then dies a few months later. Upon seeing a notice in the paper, the other owner of the property shows up to claim his share. Unfortunately, the son knew nothing about another owner and now finds himself hip deep in legal problems.

Some people believe that a quitclaim is necessary if a property has lien on it. This is not true. In point of fact, a Warranty Deed and Special Warranty Deed have a “subject to” statement that says all existing claims have been disclosed, which doesn’t prevent them for being used in property transfer. A “subject to” looks something like this:

“SUBJECT TO: Current taxes and other assessments, reservations in patents and all easements, rights of way, encumbrances, liens, covenants, conditions, restrictions, obligations and liabilities that may appear of record.”

That means any liens that are publicly recorded are part of the deed. When you purchase a title insurance policy, the title company will do a search and list every commitment they find during the search.

So we’ve listed a lot of reasons why quitclaim deeds stink, but here’s the nail in the coffin. Title companies hate them! Many title companies won’t accept a quitclaim deed without additional documentation signed by the grantor. The title company has every right to question whether or not the owners actually had legal claim to the property before continuing on with the sale. Naturally, this puts a kink in the escrow process and can hold up the purchase until previous grantors (owners) have been tracked down.

In short, when in doubt, contact an experienced attorney to help you draw up a deed (Warranty Deed or Special Warranty Deed) that won’t gum up the works!

Should you own real estate through an LLC?

With the economy strong, more and more people are investing in real estate. I am getting plenty of questions about whether those properties should be held through a limited liability company — an LLC. So, should you own real estate through an LLC? Well, there are certainly plenty of advantages (and disadvantages) to setting up and LLC to protect your property investments.

Advantages

Privacy — An LLC offers a layer of privacy since the only public information available is the entity name and number, agent of service process plus agent’s address. So looking for your LLC, a searcher might only find a name like Sagebrush Group, LLC, rather than your personal information.

Limit Personal Liability — Legal actions against the properties will be directed at the LLC, rather than the owners of the LLC. However, this is not an absolute rule (see below).

Taxes — If properly structured, the LLC can be set up as a “pass through” entity which allows for certain deductions and allows income tax at the individual rather than the corporate rate. While the new tax law makes changed they are complex and only apply to limited situations. For most homeowners, the new tax law makes no changes.

Management — Delegating management responsibilities is much easier than either the corporation or partnership structure. LLCs can be easily managed by owners or third-party managers.

Fees — In most states, LLCS pay a lower state registration and maintenance fees that corporations. An in Arizona, once your LLC is formed, there are no future filing fees unless you make changes to the basic structure such as new members or address changes.

Flexibility — LLCS offer a tremendous flexibility when distributing profits. Cash flow distributions do not have to be pro rata according to ownership like in an S corporation. That means owners can financially reward the sweat equity of select members through appropriate distributions of available cash flow.

Foreign Ownership — Foreign ownership and investment in U.S. real estate is possible through an LLC.

Transfer of Ownership — LCC owners can easily transfer ownership in real estate holdings by gifting interests in the membership of their heirs each year. Over time, it is possible to pass ownership to loved ones without have to execute a record a new deed on the property. That allows property owners to avoid transfer and recording taxes and fees.

Disadvantages

Yes, there are a few:

“Piercing the Corporate Veil” Just because you set up an LLC does not mean you cannot lose the protection of the entity. Failing to follow corporate formalities (meetings, resolutions, minutes) or using the business bank account as your piggy bank might lead to a loss of the protection. Personal liability applies for negligence.

Your Own Negligence. If you are acting on your own and injury someone or property as a result of your own personal negligence, the LLC form may not help you. For example: failing to have adequate, failing to property conduct a background check on an onsite property manager, or failing to properly or timely repair a dangerous condition on the property.

Insolvency and Bankruptcy. If the LLC is becoming insolvent you cannot make distributions to yourself if that will leave creditors holding the bag. They may be able to come after you personally. Also, if the LLC files bankruptcy based on a 2003 Colorado case, you may lose the protection of the LLC when the Trustee takes over.

Mortgage Issues. Mortgages contain “due on sale” clauses. Transferring a property from your name to an LLC without the lender’s permission could trigger that clause and prompt a call on the loan.

Insurance Issues. If you owned the property in your own name and then transfer it to an LLC there may be an impact on your liability coverage. Some carriers will permit naming the LLC as an “additional insured” on your policy, but others may require the policy to be rated as a commercial policy which can be much more expensive.

Do the Advantages outweigh the Disadvantages? Well, here’s a lawyer’s answer: “it depends.” Probably the answer is yes, but each situation deserves its own analysis. Forming an LLC is easy. Doing it properly and complete is not.

Discussing the process with experienced business attorney is a good idea to avoid any unanticipated consequences.

If you wish to discuss how these issues apply to your investment properties, please call us any time!

You’re Dead. What about your single member LLC?


Ugly title. I know. No one wants to think about dying, especially when just starting up a new LLC, but succession planning (who gets the business once you die) should actually be part of the startup process. An interest in an LLC is an asset. Even if it is a service business only, over time the LLC will have its own good will. Why would anyone want to let the value of asset just dissipate when the are gone?

As an example, let’s assume Jenny James owns a marketing company with two employees. She lives in Phoenix and is married to John James. Her accountant tells her to form an LLC to protect her personal assets from claims against her business if she or one of her employees does something to harm a client or other third party. Jenny wants her husband to inherit the LLC, but she failed to write that down anywhere. So now she has died. What happens to her LLC? If Jenny didn’t address this ahead of time John is either going to let the business also die or is going to end up going through a protracted probate.

Jenny could and should have taken some simple steps as she began setting up her LLC to ensure a smooth transition to John.

Three Possible Solutions

Solutions #1: The simplest and least expensive way for Jenny to secure the inheritance is to create an operating agreement. In the agreement, she would state that her LLC membership will pass to her husband, John, upon her death.

Solution #2: The second way Jenny could have approached the issue is to create a revocable trust. While that is more complex and more expensive, it does mean she doesn’t have to amend her LLC operating agreement if John dies before she does. It also covers many other assets besides the business.

Solution #3: The third way to handle the situation would be for Jenny to create a community property with right of survivorship membership. An LLC started during a marriage is considered community property so the spouse owns a ½ interest in the LLC. That however does not address what happens to Jenny’s half. So it make sense to draft the operating agreement so that it shows that upon Jennies death, John not only gets his half of the community but hers as well. This completely avoids probate upon her death and automatically transfers the business to John upon her death. The operating agreement should clearly state that Jenny will be entitled to manage the LLC as she wishes, and will protect her from having to share management with John unless she wants his involvement.

Note if Jenny does not want John to have any interest in her LLC she would have to get his signature on a disclaimer.

Oh. And don’t get us started about divorce and the LLC. That might be a topic for another post….

If you are concerned about your succession plan you should choose, your best bet is to ask an experience business attorney and have your situation reviewed.

4 Steps to Protect Your Business Name

Your brand is everything … your reputation, your recognition value for your customers, your product, image, service, etc.

So how do you protect your brand and business if a competitor sets up a company that is similar, or even identical to yours? There are 5 steps you should think about to help ensure that your good name will stay that way!

Step 1: Form and File a Business Entity
One of the best ways to protect your business name is to form a business entity (LLC or Corp) and file the entity in your state. No state will allow two businesses with the same name to be filed, and some states won’t allow even similar names. Before getting your heart set on a name, check business name availability. Many states allow you to search for business names online. You should also consider a national search just in case you will be doing business outside of your state.

Step 2: File a DBA or Register Your Business Name
Some organizations have one official name and then a “trade name” they use for their business. For Instance, Tom Smith Pool Cleaning, LLC might have a shop called The Pool Whisperer. That trade name is often called a DBA, which is short for “doing business as.” Registering a DBA lets people know who owns the business and creates a public record of your use of your business name.

Step 3: Trademarks
You can trademark your business name with the U.S. Patent and Trademark Office for nationwide protection if you meet two criteria:
• The name must be distinctive
• It must not cause confusion with other registered trademarks.

Note that while copyrights protect original works of authorship, names and business names are not considered works of authorship and are not eligible for copyright protection.

Step 4: Secure Your Online Identity
You can protect your business name online by registering it as a domain name. That’s the address you type into your internet browser. So www.pouloslawfirm.com is a domain name. Even if you don’t plan on creating a website immediately, buy the name before someone else does. Generally, original names should cost between $8 – $10 to reserve each year. You might consider buying variations on your domain name as well to cover all the bases. So pouloslawfirm.net, or pouloslawfirm.info, for example, are viable options. In addition, register social media accounts under your business name to prevent someone else from establishing a Facebook, LinkedIn, Twitter, Pinterest or other account with your business name.

If you are concerned that you might be treading on another name, you may want to consider an attorney who specialized in this area.

Can you get out of a contract?

What happens if you’ve signed a contract for your small business that you probably shouldn’t have? Or if the circumstances have changed and are you are being asked to perform tasks that you didn’t agree to or are grossly unfair? Is there any way to get out of a contract?

Review the Contract
The first step is to read the contract and study it closely. Does the contract actually obligate you to do what the other party is asking or demanding? Is there a way to terminate the contract? What are the conditions of the contract? Is the other party meeting their side of the contractual agreement?
Read the contract from beginning to end. Have an experienced business attorney review the contract with you and help you understand exactly what is in it and what is required of you.

Is it Enforceable?
The next thing your attorney should do is check to see if the contract is enforceable. In order to be enforceable, a contract must be an agreement between at least two people exchanging something of value (consideration). No consideration, no contract. This is often a legal issue. In addition, the language should be clear and concise. If the language is so muddy or ambiguous that you can’t tell what it means, then the enforcement of the contract is a serious concern.

Is it illegal?
A contract to provide illegal services is void. In addition, there may be something in the contract that is against your state’s public policy, in which case, you can void the contract. Again, a good business attorney will know the details.

Is it unconscionable?
Courts don’t usually uphold contracts that are grossly unfair to one party. A good example is an energy provider who asks you to sign the contract as-is with no negotiation or you can’t have service. If the provider is the only one in the area and charges you three times the national rate, then likely the contract will be considered unfair (unconscionable) because one party has all the power and the other has none. Keep in mind that this mostly protects consumers. Business people are supposed to read and understand their contracts.

Is the other party backing out?
If the other party gives you some indication that he or she is not going to uphold his or her end of the agreement, that is called an anticipatory breach of contract. With the help of an attorney, you may be able to void the contract.

Is it executed correctly?
In some cases, another party may have forged your signature on a contract, in which case, you are not obligated to hold to the contract.

Is it fraudulent?
In general, both parties must understand what they are agreeing to and each side must perform and deliver as promised. For example, you buy a used car and the dealer tells you the vehicle is in excellent condition. However, when you get it home and the motor mount breaks because it has been broken and soldered back together. The dealer has misrepresented and failed to deliver as promised, so you can get out of the contract and hopefully get your money back. In the business context, if the other party made statements or representations that were not true and they knew it and you can prove that, you have a stronger case for getting out of the contract. Proving fraud is not so easy however. You must have “clean and convincing” evidence which is way beyond a hunch that they lied.

Succession Planning for Businesses

For business owners, figuring out how to pass a business on to heirs can be a tricky business. We’ve all heard stories about business owners who failed to plan and the family ends up embroiled in endless court battles for control of the company.

Let’s look at a hypothetical situation to see some problems that might occur. You own XYZ Widget Company. Your heirs are your wife and three children. The first question you must ask is if your family is capable of taking over the business (and running it) when you leave.
• If you have no heir who is competent to take over running your business, then how to you arrange your estate so your family still receives proceeds from the business, but a competent manager actually runs everything?
• If you have a family member capable of running the business (let’s say your son), how do set up your estate so your wife and daughters still receive a fair share, but perhaps not as much as your son, who will do the actual work.
• It can become even more complicated. In your opinion, your son has the ability to run your business, but your daughters don’t, although they believe they do. They’ll contest the Will or Estate for control of the business.
• In addition, how do your protect and reward valuable employees in the business when someone else is running things.
• What happens if you have a partner or several partners in the business? Should your partners buy out your shares in the company and the proceeds go to the family? Should your child become a partner?
• Should your ownership in the company transfer to a legal entity like a trust?
• What happens to your business if you retire, die, become disabled or incapacitated? What happens if the business goes into bankruptcy or loses its professional license?

Business Succession Steps:
• Find and hire a good business attorney to help with all the legal and paperwork necessary. It is particularly handy if you can find a skilled attorney who can handle both business law and estate planning. Incidentally, at Poulos Law Firm we can handle both aspects.
• Engage your financial advisors and CPA’s in the process.
• Ask yourself lots of hard questions about what you want to see happen to your business, who should inherit, how you want it run, etc.
• Consult with any partners or valuable employees and get their take on what should happen.
• Ask your attorney and CPA about all the relevant laws and tax consequences as you plan.
• Have a valuation completed on your business and the resources.
• Engage a business broker early in the process to help you make changes that will make the business be worth more in a sale.
• Figure out how to transfer to tangible and intangible assets and create a succession plan.

To sue or not to sue, that is the question.

As a business owner, before you sue someone, you need to figure out what you are trying to accomplish. For instance, is this a one-time situation that is unlikely to be repeated? Will your lawsuit discourage others from doing the same thing? Or is this a larger moral issue where your lawsuit will affect others and prevent further damage?

Knowing your goal is important because litigation is time-consuming, expensive and the outcome can be uncertain. The various steps include:
• Creating initial court papers
• Getting the answers from the defendant
• The discovery phase – investigation of each party’s evidence
• The deposition phase – pre-trial testimony
• Special pre-trial requests to make decisions about motions
• Numerous meetings and conference before the trial
• And finally, the trial

The process can take over a year, so is it really worth your time to proceed?

Let’s take a case in point. Someone has breached a contract with you that causes you a financial loss or damage of around $5,000. It was a one-time situation and won’t be repeated. The cost of litigation will be around $15,000. Is it really worth pursuing?

In another instance, someone has breached a contract and is causing on-going harm to your business, and possibly to other businesses. In this instance, you may have no choice but to sue, even if the cost is prohibitive.
There are really 10 steps you should follow when considering pursuing legal action:
• Good Case — do you have a genuine legal claim that the courts will support?
• Final demand — have you taken the time to make a final demand to allow the person or business at fault to make the situation right, rather than going to court?
• Compromise — try looking at the case from the other party’s point of view. Do they have a valid argument? Can you adjust your own position? Can you reduce the damages and reach a compromise?
• Collect Damages — can you actually collect a financial settlement from the party you are you going to sue. If the other party doesn’t have the financial wherewithal the pay damages, what is the point of a lawsuit.
• Finances — do you have the money to pay for an attorney and handle the expenses related to filing a law suit? It may be cheaper to settle.
• Time and Resources — Do you have the time and resources to pursue a lawsuit?
• Statute of Limitations — are you within the statute of limitations (time frame) to pursue a lawsuit?
• Location — if you are suing someone from a different state, which state will have jurisdiction over your case? Suing someone in another state under their jurisdiction will probably be more expensive for you.
• Small Claims Court — can you take your case to small claims court. Many states have small claims courts that will only hear disputes under a certain amount (generally $5,000 or less).
• Represent yourself — you may be able to represent yourself in small claims court (but not if you are a corporation). While you may save attorney’s fees, you still probably want to pay an attorney to coach you how to prepare for the case.

Some of these issues can be resolved by having good contracts that are specific to you in the first place. A good contract does not mean there will be no problems, but they can limit or control what the effect of a breach of contract is and what it will cost to pursue the other party.

Assuming you do not have a helpful clause in your contract the issue of whether to sue or not is balancing the risk of losing or spending the time, money and emotion on a case versus what you will gain if you go forward.

Finally, if you are pursuing “justice” in a civil case, you better have provable substantial damages because otherwise you are probably “tilting at windmills” (Cervantes’ Don Quixote”) and are unlikely to find what you are looking for.

10 Tips for Getting Your Business Ready for Sale

If you are thinking of selling your small business you’ve got some work ahead of you. A little hard work now, with the help of a small business lawyer, can save you from plenty of trouble later on.

Tip #1: Decide why you are selling
Buyers nearly always want to know why you are selling the business, so figure out what your motivation is … retirement, partnership disputes, illness or death, overworked, ready for a new challenge. Keep in mind that the Buyer is going to be suspicious of whatever reason you give so stick to a supportable claim.

Tip #2: Prepare for the sale
Smart business owners begin preparing for the sale of their business two years in advance and we suggest you do the same. Starting early can help you complete all the steps below — steps which will make your business as attractive as possible and ease the transition for the new buyer. More often the decision to sell is made because of external factors, e.g. health, turn of the economy, etc. which puts you in a disadvantaged position to get the best price.

Tip #3: Business valuation
Have an valuation done on your business to decide what it is worth. The document will bring credibility to the asking price and can serve as a gauge for your listing price. Yes, it can be costly, but not compared to the increase in value your will receive. It can also be used to identify weak spots in your company that you can address before going to market.

Tip #4: Sell by owner or broker
Decide whether you want to find a buyer on your own, or work with a broker. Selling the business by yourself may save you the broker’s commission, but it may mean a whole lot more work for you in an area you know nothing about. You’ll have to decide the best use of your time and money. There are some very good experienced business brokers out there. Interview several.

Tip #5: Sort out your property/space
If you have an interested buyer, one important thing to do is look at the lease on your property. Check the requirements regarding the assignment of the lease to a buyer of the business. Then check with your landlord to see what he or she requires in order to consent to an assignment of lease to your buyer.

Tip #6: Make it profitable
Some owners consider selling the business when it is not profitable, but this can make it harder if not impossible to attract buyers. Consider the business’s ability to sell, its readiness and your timing. There are many attributes that can make your business appear more attractive, including:
• Increasing profits
• Consistent income figures
• A strong customer base
• A major contract that spans several years

In addition, do a search to find out if you have any outstanding liens (on taxes or equipment, for example) and pay them or disclose them to the buyer.

Tip #7: Put your books in order and Review your ongoing contracts
Many small businesses do not a good job of keeping corporate and financial records in order. Before you list the business fix this because an educated Buyer is going to want to examine everything. Also, have your small business lawyer review any contracts you have with vendors, service providers and large customers to make sure nothing stands in the way of your sale. Lastly, if you have been keeping two sets of books, you are committing tax fraud and if a Buyer gets a wiff of that, no sale.

Tip #8: Review assets and tax consequences
Create a list of all your assets and review the list with your accountant and attorney — that way you will know what the tax consequences of the sale of your business will be. There is a tradeoff between income taxes and capital gains each of which can affect how much you will finally net from a sale. Prepare proper financial statements to present to your prospective buyer. You should also consult with a CPA to get advice on potential tax consequences.

Tip #9: House cleaning
Just as if you were putting your own home up for sale, your business needs to look its best. A lot of cleaning and some staging can go a long way to attracting a buyer. This also includes organizing your operations and procedures manuals and making sure everything is running smoothly day to day. Just like a home buyer is attracted to a turn-key home, so a potential buyer is attracted to a turn-key business.

Tip #10: Prepare yourself mentally
You’ve put a lot of blood, sweat and tears into the business, so get ready emotionally for the sale. If you are too attached, this is going to be a very difficult process. Instead, think hard about what you are trying to accomplish with the sale and what your plans will be after the sale. In short, think to the future and don’t dwell on the past.

Last but not least, it may take six months to two years to complete the sale of your business. There will be frustrations and anxiety. Prepare yourself ahead of time to be patient.

Forming a Business: LLC vs. S Corp

One of the first questions facing you as a small business owner is to decide what type of entity you want to create — stay as a sole proprietor or form an LLC or a corporation. Once you have done that the question is whether to file with the IRS as an S corp. For some businesses, particularly very small or low risk businesses it may be okay to stay as a solo. In most cases it is not.

An LLC (Limited Liability Company) is a business structure that combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation. As a member of an LLC, the profit goes directly to you, you are not paying yourself a salary.

An S Corp is a corporation business structure that issues stock and is governed as a corporation. IT IS NOT AS MANY THINK AN ACTUAL TYPE OF CORPORATION. It is a tax election status. The owners are called shareholders and have the same protection from liability as shareholders of a C Corp. An LLC and a C Corporation can each file under S Corp tax election. However, like a sole proprietorship or partnership, an S Corp passes through most of its income and loss items to shareholders. Unlike a regular corporation, there is no double taxation (once at the corporate level and again at the individual shareholder level). Each shareholder is subject to his or her own individual tax rate on the income or losses passed through to him or her. A big plus of either entity is that if structured and operated properly you can protect your other assets from claims against the business.

So how do you know which entity is right for you? Let’s take a look at a few more differences between each of the entities.

  • Filing Cost — It is generally about the same cost to file to form an LLC and S Corp license.
  • Tax Consequences — Tax consequences depend upon the income of the business, of course, but in general, each business entity has about the same personal and business tax expenses.
  • Self-Employment Taxes — An S. Corp can provide savings on self-employment or Social Security and Medicare taxes. It also allows owners to offset non-business income with losses from the business.
  • Ownership Restrictions — An LLC has no restrictions on the number of owners the business can have. An S Corp can have no more than 100 owners and owners cannot be “non-resident aliens.” S Corps cannot be owned by C Corps, LLCs, and other S Corps or by some non-qualified trusts.
  • Business Losses — The S Corp allows business owners to use business losses on their personal tax returns.
  • Paperwork — an S Corp does require more upkeep in the form of annual paperwork and ongoing tax filing responsibilities than does an LLC.

For questions specific to your particular situation, it is best to seek the advice of an attorney and CPA to help you make the best decision for your business model.

6 Legal Blunders to Avoid in Business Agreements

A client recently called and asked to have a legal agreement reviewed before signing it. Excellent! However, the client confused “reading” an agreement with “understanding the legal effect” of the words in the agreement. The client stated he “did not see any red flags.” Well, they were there; the client just did not understand what they were. This particular client did not want to pay for a legal review – preferring to save pennies and risk dollars. I hope that all will go well.

Legal Blunder — Anyone can make a blunder in entering into legal agreement. Yes, even lawyers. If all goes well in a business relationship, the agreement becomes almost irrelevant. The trouble is that if something goes wrong, the first place everyone will look is to the agreement to see what their rights and remedies are. That is a very bad time to realize you blundered in signing the agreement. Here are some simple steps you can take to avoid those blunders.

Blunder #1 – Get it in Writing
The first and biggest blunder is not getting the agreement in writing. The Gentleman’s Code or Simple Handshake agreement can cause all kinds of trouble, especially since each party will most likely interpret the agreement to his or her own advantage.

Blunder #2 – Use Clear Language
Make sure the agreement is written in a clear understandable language. If you can’t understand it, then most likely the agreement has ambiguities that can lead to conflicts later on. Make sure all definitions are used correctly and consistently throughout the document.

Blunder #3 – Include all Crucial Elements
Make sure all the crucial elements are clearly spelled out in the contract — due dates, financial responsibility, buy/sell options, what happens upon the death of one party, etc. If there is a disagreement, how will the disagreement be settled? In a court of law? By arbitration? Try to think of anything that might happen to your agreement and provide for covering all possibilities.

Blunder #4 – Include a Governing Law Clause
If you are doing business out of state, you need to include a Governing Law Clause which state’s laws your agreement will be governed by. Even if you are both doing business in Arizona, it is still a good idea to write the Governing Law Clause into the agreement so you don’t end up in a court somewhere else.

Blunder #5 – Get a Properly Executed Copy of the Agreement
It is not uncommon for there to be only one original agreement. Either make sure that you are the one holding it or get a copy. If you don’t have one, it is very difficult to prove that you actually did create it. Make sure both parties’ signatures are included (and witnessed, if necessary). In addition, make sure any attachments, exhibits or amendments are included. Be especially cautious to make sure the parties in the agreement are properly identified.

Blunder # 5 – Read It!
How many contracts have you signed without reading them? People sign contracts without reading them all of the time. Often experienced business people don’t read their agreements. The law is that if you sign it, you will be held to not only have read it but to have understood it. After the fact complaints are meaningless. You should do this even if you hire a lawyer to review it. It is your agreement and you had better understand it.

Blunder #6 – Don’t Hire a Lawyer
You are the expert in your field. A lawyer could probably not do what you do. Are you trained in reading and understanding legal terms and their consequences? Probably not. Lawyers read and write agreements for a living. With your business and money at stake, take advantage of a lawyer’s years of experience and get them to review any business agreement for you. While good agreements are not insurance that nothing will go wrong, a good agreement is certainly better than one based on blunders.

If you have any questions, please feel free to schedule an initial call with Greg Poulos to discuss this and other business law concerns Schedule a Call.

This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

Employees or Independent Contactors: Are you in Compliance?

Businesses today use diverse workforces to accomplish their goals, including full- and part-time employees as well as independent contractors. The trouble is, many business misclassify employees as independent contractors and end up in trouble.

According to the American Business Bureau, “By some estimates, contingent or temporary workers could reach 30-50 percent of the U.S. workforce. A federal study contends that an estimated 3.4 million employees are classified as independent contractors when they should be reported as employees. A 2009 study by the treasury inspector general estimated that misclassification costs the United States $54 billion in underpayment of employment taxes and $15 billion in unpaid FICA and unemployment taxes.”

Employee vs. Independent contractor
Let’s start with a definition of that will help clear up the difference between and employee and an independent contractor. Some of the questions you might ask yourself to distinguish and employee versus a general contractor include:
• Can the person choose to work without fear of losing employment?
• Can he or she be discharged or dismissed at any time?
• Does the person supplies his or her own equipment, materials, tools or computer?
• Does the person control the hours they work?
• Do you or the person supply all materials needed to complete the job?
• Is the work temporary or permanent?

Here are a couple examples of independent contractors:
• A web maintenance person who works a few hours a month on your behalf on your website but has many other clients.
• A freelance bookkeeper who works a few hours a month to handle your billing and budgeting and who works on behalf of many other businesses.

Here are a couple of examples of employees:
• A full time sales person who hours that you set – 30 hours per week or more – selling goods or services on behalf of your business and does not work for other employers.
• An office manager who works more than 30 hours per week and does not provide these services to other employers.

Keep a few things in mind.
• There is no such thing as a 1099 employee.
• An employee who is given a W-2 must undergo screening under the Legal Arizona Workers Act and complete an I-9.
• Independent contractor status is difficult to prove these days.
• One of the greatest risks is that a contractor will be injured working for you and claim you as his or her employer.

The trouble with misclassifying workers is that employees are often denied access to critical benefits and protections they are legally entitled to, including minimum wage, overtime compensation, family and medical leave, unemployment insurance and safe workplaces. Here’s the really tricky part … it also means the IRS and State are receiving lower tax revenues, so they tend to look VERY closely at worker classifications. In fact, the federal government has increased the number of auditors working to weed out these misclassifications and penalties can be severe for businesses found to not be in compliance with the law.

Here are some the recent court cases that show just how severe penalties can be:
• Vizcaino v. Microsoft, which resulted in a settlement of $97 million
• Estrada v. FedEx, which brought a verdict for drivers, $5 million compensation and $13 million in attorneys’ fees

Once the federal government gets involved, cases of misclassification can take years to settle. For example, FedEx was under scrutiny for many years before a decision was reached… the IRS found the company misclassified employees, owed $319 million in back taxes and penalties for tax years 2004-2006. The decision was later rescinded but it resulted in plenty of time and money lost for the company.

If you are interested, you can read more about the issue at:
Fair Labor Standards Act “Suffer or Permit” Standard
IRS website

Keep in mind that these laws are set in stone, so if you have questions regarding the status of a worker, or are preparing to hire a new worker, talk to an HR professional or a business attorney like me before making any final classifications.

Asset Protection Basics

What is Asset Protection Anyway?

Asset protection planning is about protecting your assets in good times, so you can walk away with those assets if something goes wrong financially. The people who use asset protection plans most commonly are people likely to get sued, such as real estate developers and investors, physicians and business owners whose business involves liability or lawsuit risks. But even an average Joe or Jane can get caught up in a difficult situation, so if you have something to protect then asset protection should at least cross your mind.

Be Careful!

Many people are concerned about having their assets taken from them by creditors. This is about planning for future claims not current ones. If there are already existing claims against you it is too late. There is no strategy that will protect you against an existing creditor at that point. If you attempt to move assets to avoid paying a claim, you risk being liable for a “fraudulent conveyance” and that is a big no-no. Not only can the transfer be undone, in most states, including Arizona, it can be a misdemeanor or felony crime! Clients ask lawyers about transferring assets after they learn about a claim all of the time. The correct and appropriate advice is that you should do your best to defend and settle the claim. If you are being told to hide your assets, run away.

There is a trade-off The challenge in estate planning is that you cannot always have your cake and eat it, too. The more asset protection you get, the more it will cost you and less flexibility you will have. So the first question is determining what level of asset protection you need for you and your assets.

Not everyone has creditors lurking at their doorstep, but the potential is always there. Figure out whether you might face such creditors at some point as a starting point.

What Asset Protection is Not
If you ask people what they think asset protection is, most will say it is a way to shield all of your assets from creditors or some “off-shore” thing. While shielding your assets is the goal, the actuality is that asset protection planning is a way to minimize the extent that assets are available to creditors or to discourage them from pursuing a claim. Look at it this way: if no asset protection is in place then 100% of your assets are available to the creditor. So, while asset protection may not be a total shield, any legitimate efforts made to reduce the extent of claims against you assets is a victory. Any settlement of a claim for less than the claim is really the goal of asset protection planning.

Basic Asset protection steps
1. Liability Insurance. This is the first line of defense. Not only should you have basic coverage you should obtain an “umbrella” policy on your homeowners policy. It is relatively inexpensive for the coverage and is well worth it.
2. Business Liability coverage. If you own a business this is a must. Discuss with your agent what types of coverage you need for the risks involved in running your business. Even if a claim is made that has no merit, most policies will cover the cost of defense which is a huge benefit if you are sued.
3. Take advantage of the Homestead Exemption for your home. If you have cash (I know, not everyone does…) use it to make improvements on your home or to pay down the mortgage to the level of your homestead exemption.
4. Retirement Plans. If covered by Federal law and under some states laws, these accounts are exempt from creditors.
5. Life Insurance. Many states, including Arizona, have exemptions that protect life insurance and annuities from creditors.

Business Asset Protection
1. Create an LLC or other entity. Stop running your business as a sole proprietor because that puts all of your assets at risk, both business and personal.
2. Divide your business into multiple entities. It may be possible to split up your business into separate entities and protect them from claims against the other. For example, you might consider holding real estate in one entity and the operations of the business in another.
3. Caution: Using a business entity does not provide protection against personal guarantees or your own negligence or intentional misconduct. Also the protection of the entity is usually from a “charging order.” That is like a lien against the income and assets that cannot be used until there is a distribution. So, while your creditor cannot get the income or a distribution – neither can you.

More Complex Strategies
If you are in a profession or business where the exposure to risk is higher, then you may need to explore more complex asset protection strategies. The cost of developing and implementing these strategies is much higher and involve giving up some level of access or control of your assets. The theory of asset protection at this level is if you do not have access, then neither do your creditors. It is all about moving assets as far from you as is feasible.
1. Create Irrevocable Trusts for family members. As long as the transfer or gift to an irrevocable trust cannot be considered a fraudulent conveyance, this puts assets out of your hands although it may be subject to the claims against the beneficiary’s interests.
2. Keep all or some of the benefits of an irrevocable trust. If you transfer all of your interest in an asset to an irrevocable trust, it is not available to the creditors. There are other trusts that allow you to keep some interest in such a trust. Examples include a “qualified personal residence trust” (“QPRT”), charitable remainder trust (“CRT”), and a grantor-retained annuity trust (“GRAT”) or a Special Power of Appointment Trust (“SPAT”).
Domestic Asset Protection Trust. This type of trust is created for your own benefit. A handful of states allow protection even when the person who forms the trust is a beneficiary. The most common used states are Nevada and Delaware. Specific rules apply to these trusts. The law on these trusts for non-residents is still unsettled so creating carries the risk they just may not work. While most legal advisors believe there is good reason to believe the courts will honor these trusts, constitutional issues are implicated particularly when the person who creates the trust is not a residence of the state where the trust is formed. Again, the mere fact that such a trust is created may be enough to discourage all but the biggest and well-funded creditors.
4. Marital Agreements. If one spouse is in a profession or business that carries a high risk of liability, one option is to divide the assets between the spouses. The business assets to one spouse and the investment assets to the other. This has implications in community property states and creates potential divorce and income tax basis issues.
5. Foreign Trusts. If you are reading this blog, this probably is not a viable or reasonable option for you.

Conclusion
For most people, the basic steps of asset protection should be sufficient. If your level of risk is higher because of your business or profession, using a combination of trusts and business entities provides more protection. These steps require a detailed analysis of your particular situation and advice from your legal advisor.

For more information about Poulos Law Firm asset protection planning contact:
Gregory C. Poulos
Poulos Law Firm, PLLC
Work: 623-252-0292
Email: gpoulos@nullrjdcreative.com

Business Exit Strategy

Most business owners are so focused on short-term issues that they forget to make decisions and plans for how they will exit their business. But every business owner needs a business exit strategy.

Many assume that the decision to exit the business is voluntary. Most often, however, an owner is forced to leave the business because of incapacity or death. It is not enough to build your business and create value. You must have an exit strategy to get that value out of the business to benefit your retirement or your family when and how you want.

IF YOU ARE LIKE MOST BUSINESS OWNERS:

  • Your wealth is tied up in your business.
  • Your income is also dependent upon your business.
  • The business is dependent upon you for its continued success.

If this sounds familiar, there are strategies available that you can use to help you transfer and protect your business wealth. This type of planning, also commonly referred to as “business succession planning”

No matter what particular exit strategy you chose, the best exit strategy is one that is planned and the sooner an exit strategy is chosen, the better. An exit strategy can take years to execute successfully.

The Poulos Law firm can help you get started on your exit plan with strategies including buy-sell agreements, preparation and documentation for selling the business, key employee incentive agreements, and drafting your estate planning documents such as wills and trusts.