San Diego Business Lawyer Blog

It is said that only two things in life are certain, death and taxes.  While everyone is required to pay local, state, and federal income taxes, business owners are generally subject to an additional burden - the self-employment tax (more commonly known as social security and Medicare taxes).  

Self-employed individuals are generally taxed at a rate of 15.3%.  This rate approximates the combined contributions of a regular employee and employer under the Federal Insurance Contributions Act (FICA), and is divided into two parts: 12.4% for social security on the first $113,700 and 2.9% for Medicare.  Usually, this self-employment tax is assessed on 92.35% of the self-employed  individuals' income.

There are, however, various ways in which business owners can reduce the amount of self-employment tax they are required to pay.

1. Form an S Corporation and Pay Dividends.

The self-employment tax is only applicable to wages or salary - what the Internal Revenue Service defines as "earned income."  The self-employment tax does not, however, apply to distributions or dividends paid by a corporation to its shareholders. This means that a business owner can form an S corporation, draw a reasonable salary (subject to the self-employment tax), and distribute the remaining corporate profits to the owners free from self-employment tax.  The reasonableness of the salary is important because if the IRS determines that a salary is too low, it will disallow all or a portion of the dividends resulting in a higher self-employment tax.  

2. Deduct All Legitimate Business Expenses.

Business owners are permitted to take tax deductions for all "ordinary and necessary" business expenses.  This means that business owners can deduct any expenses that legitimately went towards the generation of income. Common business expense deductions include: office supplies, advertising costs, travel expenses, and the costs of maintaining office space. If a business owner spends $20,000 in legitimate business expenses, he or she can deduct that amount from the business' yearly taxable income.  Assuming the company made $100,000 that year, only $80,000 would be subject to self-employment tax.  Claiming all possible business expenses of course makes sense economically under any circumstance but identifying all possible deductions isn't always so obvious.  Some less common expenses include a percentage of utility expenses for a home office or auto expenses (including mileage) for automobiles or trucks with dual purpose use (business and personal). Working closely with a CPA is the best way to ensure that you have all the tools necessary to accomplish this goal.  

3. Take Advantage Of a Section 105 Medical Reimbursement Plan.

Section 105 of the Internal Revenue Code allows sole proprietors, partnerships, corporations, and limited liability companies to take a full tax deduction for employee medical benefits under Health Reimbursement Arrangements ('HRA").  This deduction may include premiums paid for employee health insurance and medical expenses such as dental care.  Because HRA expenses are 100% deductible, they can reduce an employer's self-employment tax obligation.  However, it's important to note that sole proprietors, partners, owners in s-corporations and owners in limited liability companies that elect to be taxed as partnerships may not set up an HRA for themselves because the owners are employers, not employees.  However, the owners can set up HRAs for their employee/spouses who in turn can have family members covered under their HRA plan including their husband/owners.

4. Defer Income To Reduce Tax Obligations.

Deferring income allows a business owner to reduce his or her tax obligation by falling into a lower tax bracket during a given year.  You can defer income by billing late in the year or waiting until January of the next year to send out newer billings.  Assume that a company expects to earn $90,000 in net income in the 2013 tax year.  By deferring $2,150 or more of said earnings, the owner would fall from a 28% tax bracket (imposed on earnings between $87,850 and $183,250) to a 25% tax bracket (imposed on earnings between $36,250 and $87,850).  This is particularly beneficial if there were unexpected earnings in the current year putting you into an unusually high tax bracket.  

The U.S. Tax Code is complex and can be extremely confusing.  The best way to ensure minimization of your tax burden is to work closely with a tax professional and/or CPA and a San Diego business lawyer.

In today's business world, with so much focus on the bottom line, most individuals and companies are looking for a way to cut operating expenses or at least pass them on to someone else.  For this reason, most commercial leases these days include provisions which require the tenant to pay all or part of the landlord's cost of operating, maintaining, insuring and furnishing utilities for the building (Common Area Operating Expenses).
 
Depending on the type of lease, the tenant may bear all or only a portion of the landlord's expenses.  In a "triple net lease," all of the landlord's operating expenses are passed on to the tenant.  A lease may, however, contain an "expense stop" which establishes a point at which expenses begin to be passed on to the tenant.  In this type of lease, expenses for a "base year" are determined - the expense stop.  Thereafter, the landlord pays expenses equal to the base year and the tenant pays its pro rata share of the rest.  For example, if a lease contained an expense stop at $10,000 ("base year" expenses), and the landlord's operating expenses were actually $11,000, the tenant would pay the $1,000 over the expense stop.

It has become more common in recent years for office leases to contain what's referred to as a "gross up" provision.  Gross up provisions permit landlords to "gross-up", or overstate, operating expenses to simulate the building being at full capacity.
 
Here's how a gross up provision would work in the real world:

Assume the gross up provision states that common area maintenance expenses will be calculated for each tenant as if the building was fully occupied, or at 100% capacity.  Further assume the building is currently only at 50% occupancy.

Under this set of facts, a $1,000 expense to the landlord would be multiplied by a gross up factor of 2 (100% (the markup rate) / 50% (the level of occupancy)).  $1,000 x 2 = $2,000 (the grossed up operating expense).  The tenant is required to pay a pro rata share based on the percentage of space it occupies - let's assume 20%.  In this scenario, the tenant's total grossed up obligation would be $400.   

So, what exactly are the advantages and disadvantages of including gross up provisions in a commercial lease?
 
From the landlord's perspective, the most obvious benefit of a gross up provision is being able to pass on the expenses resulting from building vacancies to the tenants.  Gross up provisions are generally viewed as reasonable for certain expenses, such as utilities that are not separately metered, because the landlord will bear that expense for the entire building even though it is only partially leased.  These expenses do not vary by occupancy levels.  
 
Although a gross up provision may seem disadvantageous to a tenant on its face, it can actually benefit the tenant under certain circumstances.  For example, referring back to the lease which includes an expense stop - if a building is not fully occupied during the base year, a gross up provision overstates the expenses based on full occupancy.  This protects tenants from sudden increases in operating expenses when the building becomes fully occupied later.  Essentially, the gross up provision for a property not fully occupied results in a higher expense stop.  In the absence of a gross up provision and less than full occupancy, the tenant's expense stop will be lower resulting in higher increases in future years when the building becomes fully occupied.
 
As demonstrated by the above discussion, gross up provisions can drastically impact the terms of a commercial lease agreement.  Prior to entering into a commercial lease agreement, make sure to consult with a San Diego commercial lease attorney.

The term "fraud" is thrown around a loosely these days.  It is not uncommon for a business client to tell her attorney that she has been defrauded in a business deal because a vender lied, a partner stole from the business, or a supplier failed to deliver an order.  While each of these scenarios can be fraudulent, more times than not, such actions or inactions do not quite rise to that level.  It can be very difficult to prove all the elements of a fraud in court even where it actually exists.  More importantly, there is a general misunderstanding of what fraud is, under the law.

There are four types of acts that can be considered fraud or deceit.  (Fraud technically only applies to contract actions, though the terms fraud and deceit often get used interchangeably.)  They are commonly known as intentional misrepresentation, negligent misrepresentation, concealment, and false promise.  (There is also a fifth "catch-all" fraud category of "any other act fitted to deceive.")  A brief summary of the basics follows:

Intentional Misrepresentation
For an intentional misrepresentation to be considered fraudulent:

• The statement must be an intentionally or recklessly false statement of fact.  It generally cannot be an opinion (though there are some exceptions);
• The injurer must have intended to defraud the victim.  Intent is usually the most difficult element to prove;
• The victim must have reasonably relied on that false statement to change her position.  A victim can't reasonably rely on the statement if she knew or should have known the statement was false; and
• The victim must be able to prove that it caused some type of measurable damage.
  

Negligent Misrepresentation
Negligent misrepresentation is basically the same thing as intentional misrepresentation, except that the injurer doesn't have to know that the statement was false--he must only lack a reasonable basis to believe it was true.  This is generally easier to prove than intentional misrepresentation, but unlike intentional misrepresentation, the victim cannot collect punitive damages.

Concealment
Concealment is when someone who has a duty to disclose a material fact either does not disclose it or conceals it with the intent to defraud the victim.  He has a duty to disclose when he is in a fiduciary relationship with the victim (for example, a business partner).  For concealment to be considered fraudulent, a victim must show the following:

• The injurer intentionally failed to disclose an important fact or disclosed some facts but intentionally failed to disclose another important fact making the disclosure deceptive;
• The victim did not know of the concealed fact;
• The injurer intended to deceive the victim by concealing the fact; 
• The victim reasonably relied on the concealed fact to change her position.
• The concealment caused some type of measurable damage.

Continue reading "When Lies Become Fraud" »

One of the most important decisions individuals wishing to start a business face is how to organize the new venture under the laws of the state in which it is located.  Two of the most common ways to organize a business is as a corporation or a limited liability company ("LLC"), each of which has distinct benefits and disadvantages.  For the purposes of this article, it's important to distinguish between the C-Corporation and the S-Corporation.  The C-Corporation is subject to double taxation (a tax on corporate profits and a second tax on dividends to shareholders as income).  Like LLCs, the S-Corporation is taxed as a pass through entity (the company's profits are passed on to the owners as income - a single tax).  The distinction is important because businesses looking for pass through taxation opt between the S-Corporation and the LLC.  This article does not address the more complicated tax picture associated with C-Corporations.  

In California, the decision whether to form an S-Corporation or an LLC is often guided by the expected impact the state's tax scheme will have on the business.  Under California law, both S-Corporations and LLCs are required to pay an annual minimum franchise tax of $800.  LLC's, however, are also subject to an additional tax burden known as the gross receipts tax.

The gross receipts tax requires LLC's to pay an additional fee, in addition to the minimum franchise tax, calculated based on the company's gross revenues.  An LLC's gross receipts tax is calculated based on the following scale:

$0 to $249,999 Gross Revenue = $0
$250,000 to $499,999 Gross Revenue = $900
$500,000 to $999,999 Gross Revenue =$2,500
$1,000,000 to $4,999,999 Gross Revenue = $6,000
$5,000,000+ Gross Revenue = $11,790

In California, S Corporations are taxed at a rate of 1.5% tax of net income earned, whereas LLC's are taxed based on gross receipts pursuant to the above scale.  This means that depending on the amount of gross receipts and profit a business generates, the company will benefit differently by operating as a S-Corporation or an LLC.

As an example of how this might work in the real world, take the following hypothetical:

Assume a computer company has 2012 gross receipts in the amount of $2,000,000, and profits of $100,000.  If the company is organized as an S-Corporation, it must pay 1.5% of the $100,000 in profit in taxes for a total tax obligation of $1,500.  If, on the other hand, the company is organized as an LLC, it must pay in accordance with the sliding gross receipts tax scale.  Because its gross receipts fall between $1,000,000 and $4,999,999, its tax liability would be $6,000.

If, however, the same computer company increased its gross receipts to $5,000,000 and profits to $1,000,000, as an LLC it would only be required to pay the maximum $12,590 ($11,790 plus $800.00) gross receipts tax.  As an S-Corporation though, the company would pay 1.5% of $1,000,000, or $15,000 in taxes.

Obviously, businesses with high revenues and low profit margins and businesses generating losses will benefit substantially by organizing as an S-Corporation.  As demonstrated by the above examples, the benefits and disadvantage of electing to incorporate or to form an LLC are dependent on several factors which must be carefully considered for any new business entity.

A careful weighing of these issues is helpful in making the determination, but it remains advisable to consult with an attorney and a CPA before making a final decision as to the manner in which a new business will be organized.  If you have questions about your new business venture, make sure to consult with a San Diego business attorney before moving forward.

Maybe you've formed a business partnership with high hopes, only to later realize that it just isn't working out. Circumstances change and people move on. You might want out, your partner might want out, or maybe you both want out. Whatever the reason and whatever your goal, you have options.

Dissolving the Partnership
If partners voluntarily agree to dissolve a partnership, the partners can collect the partnership assets, inventory them, and sell them to pay off creditors. They then divide any surplus between themselves. In addition, a statement of dissolution needs to be filed with the California Secretary of State. This isn't a very difficult process, but it is a good idea to consult with a San Diego partnership attorney for guidance. A partnership attorney will ensure that the statement of dissolution is filed properly and that the partnership is wound down efficiently. The attorney will also draft a dissolution agreement.  A dissolution agreement is a contract that spells out the terms of the dissolution in the event of a future dispute between the partners.

A voluntary dissolution agreed to by all partners can become a little tricky, but it is the best possible outcome when it comes to dissolving a partnership. The results can be disastrous in cases where one partner disagrees about the terms of the dissolution or refuses to cooperate in dissolving the partnership, In such cases, partners are left with few options. They can opt for mediation, but this option is not likely where an unwilling partner buries his head in the sand and refuses to participate. In such cases, the unwilling partner would often rather see the business go under than to see any surviving partners succeed on their own.

If an informal resolution cannot be reached, partners may be left with no choice but to sue each other. This option is costly, time consuming and emotionally taxing for most people. In such cases, a judge will ultimately determine how the partnership assets will be divided. Only then will the partnership finally be dissolved. It typically takes more than a year, sometimes more than two years to fully litigate a partnership dispute. Obviously, drawn out litigation is not good for business, and often the underlying goodwill that goes along with the partnership's assets does not survive the process.

When considering whether or not to dissolve a partnership, it's important to understand every aspect of the partnership's business before moving forward. Are there contracts or commercial leases involved? Will the partnership remain liable to customers or suppliers? Does insurance adequately protect the partners from future lawsuits stemming from the partnership business? Does the partnership own trademarks, copyrights or patents? Is there goodwill that can be sold along with the partnership assets and will that goodwill survive dissolution. Working with an experienced partnership attorney is the best way to ensure that all of the partnership's interests are protected.

Continue reading "Ending Bad Partnerships" »

It is common for commercial landlords and tenants to have disputes over needed repairs.  Most commercial leases require tenants to make needed repairs to the leased premises while repair and maintenance to the structural elements of the commercial center and its common areas are left to the landlord.  Moreover, even though the landlord maintains the structural elements of the center, those costs are most often passed on to the tenant as common area maintenance expenses (CAMs).   

Problems arise where either the landlord or the tenant misconstrue respective responsibilities.  When this happens, commercial tenants are tempted to make the needed repairs and simply deduct the cost from their monthly rent.  Unfortunately, this commonly referred to "repair and deduct" remedy is not available to commercial tenants unless the remedy is specifically provided for in the lease.  Even if the repair and deduct remedy is provided for under the lease, commercial tenants need to be careful about what repairs the landlord is legitimately responsible for under the terms of the lease.  Commercial tenants that mistakenly withhold rent for repairs that weren't the landlord's responsibility or where the lease doesn't specifically provide for the "repair and deduct" remedy risk being evicted (unlawful detainer).  

Where a landlord clearly breaches the lease by failing to make repairs it is obligated to make under the express terms of the lease and there is no "repair and deduct" clause in the lease, commercial tenants are left with the unfortunate and expensive task of suing the landlord seeking declaratory relief (an order forcing the landlord to perform) or damages to compensate the commercial tenant for losses associated with the breach.  See Realities of Pursuing Breach of Contract Actions.  Ideally, San Diego business owners will negotiate with their landlords and look to resolve any outstanding issues amicably.  Otherwise, the costs of battling a commercial landlord in court can be extensive.  

Before making any decisions, the commercial tenant should carefully review its lease regarding the parties' respective obligations and determine whether a "repair and deduct" clause is included.  Understanding the terms of the lease is the best way to ensure that a proper remedy to is sought. Ultimately, consulting with a San Diego commercial lease lawyer is best.

Modern technology has revolutionized the way we do business.  Digital copies of documents are emailed instantly, faxes are sent via on-line services, fillable digital forms make transferring information simple and efficient, mobile phones allow business people to field calls almost anywhere and a vast array of information is instantly accessible via the internet.  These conveniences reduce the need for receptionists, secretaries and other staff, and as a result reduce the need for physical office space.  Many San Diego business owners find it practical to work from home without the need for any office space, virtual or otherwise.  However, some businesses necessarily require client contact and in such cases it is more important to have an actual office.  Lawyers, accountants, architects, doctors and other professionals must consider the client's first impression.  Meeting at home might convey a host of negative impressions whether real or imagined.  While the home office is becoming more and more accepted, there remains a stigma that professionals in new business ventures seek to avoid.  Yet, the cost of leasing an office can be prohibitive especially for new and growing businesses.

The virtual office provides an economical alternative while simultaneously conveying a professional impression on clients.  Moreover, in today's business climate, customers and clients are developing a healthy respect for businesses that are able to keep overhead low.  They recognize that a virtual office results in savings that are passed on to them.  There is a variety of virtual office space available throughout San Diego offering diverse services including the use of offices and/or conference rooms, shared receptionists and secretarial support, phone and internet services and in some cases actual support staff.  

Typically, young professionals are offered a fixed number of hours (say 30) for the reservation of an office or conference room.  They pay a relatively low monthly rent and perform most of their work at a home office.  The virtual office provider can answer the phone for them, take messages and/or transfer calls.  Their mail and deliveries are sent to the virtual office.  When the time comes to meet a client, the professional sets an appointment with the client and reserves an office or conference room through the virtual office provider.  When the client appears for the meeting, he or she is greeted by a receptionist without ever really knowing that they are meeting at a virtual office.  Coffee and other refreshments may be offered, and most of the virtual offices available in San Diego are at prime locations like downtown, Mission Valley or La Jolla.  In short, clients are treated to maximum professionalism for a minimal cost.  The level of service offered by the virtual office provider will depend on the rent agreed to but the rent is always affordable when compared to leasing permanent commercial space.

Twenty to thirty hours of reserved office space is significant client time for most new businesses.  When twenty to thirty hours is no longer sufficient, many of the virtual office providers offer permanent office space.  The rent remains significantly better than most office space by taking advantage of the shared receptionist, conference rooms, scanners, copiers and other office support.  Some providers, such as Intelligent Office in La Jolla offer enhanced services including on-site virtual assistants that will actually help with business tasks.

Ultimately, new business owners are provided maximum flexibility with the virtual office concept.  Most of their work is done at home while clients are treated to a professional environment.  In fact, the home office is now portable.  With a laptop, the new professional can work just about anywhere.  They can even save on day care and take their kids to places like Kid Ventures where parents have access to the internet while their kids are entertained.  Kid Ventures is expanding and considering separate office space with printers, copiers, fax capabilities, phones and yes a virtual office.  The technological possibilities are endless.

It is common for entrepreneurs to get excited about new business ventures.  They often move forward with forming a formal business entity such as a California Limited Liability Company ("LLC") believing that all of the elements of success are in place.  They hire a San Diego business lawyer to set up their LLC and file Articles of Organization with the California Secretary of State.  Sometimes, however, unanticipated changes or barriers stop the fledgling business in its tracks (partners back out, expected funding falls through or needed capital  equipment becomes unavailable).  Suddenly, the organizers of the LLC find themselves faced with the task of dissolving the company and aren't sure what steps to take.  Some will simply ignore the situation assuming that no steps are necessary given that the company hasn't conducted any business - no income is generated so no taxes are due.  This may or may not be true depending on the circumstances.  California LLCs are subject to a minimum franchise tax of $800.00.  This is true whether or not the LLC generates revenue.  Presently, it does not appear that the California Franchise Tax Board is interested in pursuing individuals for an LLC's taxes so the organizers are not held personally liable in most cases.  Nonetheless, it makes sense to formally cancel or dissolve an LLC to ensure that any taxes due are paid and no outstanding obligations or liabilities come back to haunt organizers.  

Newly formed LLCs may formally cancel the LLC and avoid California's minimum franchise tax if the following requirements are met:

1.    A Form LLC-4/8 Certificate of Cancellation is filed within 12 months from the date the Articles of Organization were filed with the California Secretary of State;

2.    The LLC has no debts or liabilities;

3.    The known assets of the LLC have been distributed to persons entitled thereto, or no assets have been acquired;

4.    The final tax return or a final annual tax return has been or will be filed with the Franchise Tax Board;

5.    The LLC has not conducted any business from the time of filing the Articles of Organization;

6.    A majority of the managers or members, or if there are no managers or members, the person or a majority of the persons who signed the Articles of Organization, voted to dissolve the LLC; and

7.    all investments received from investors for membership interests have been returned to those investors.

This is good news for those that have recently formed an LLC and want to dissolve before transacting any business.  The LLC-4/8 Certificate of Cancellation is relatively simple to fill out and file.  However, it is important not to forget to timely file a final tax return.  Consult with a San Diego business lawyer to ensure that your LLC is properly canceled or dissolved.

Contractual disputes are a regular part of doing business but this fact is rarely recognized by business owners.  This is because the vast majority of disputes are resolved informally before attorney involvement becomes necessary.  Every time discounts are offered because of delayed delivery or because a product is defective, every time a partner agrees to sell his interest in a business because the partners want to take the business in different directions or every time a commercial lease is renegotiated because of a problem between the landlord and tenant, contractual disputes are resolved.  The list of examples is endless.  The lesson is that most business owners are reasonable and seek efficient solutions to problems and in fact reach efficient solutions.  This is because experienced business owners understand that litigation is time consuming, emotionally draining, risky and expensive.  The purpose of this article is not to dissect the legal elements of a breach of contract cause of action.  Rather, its purpose is to provide some guidance to business owners faced with a breach of contract while simultaneously conveying some of the pitfalls inherent to contract litigation.  

It is common for business owners to call their attorneys abruptly with a passionate plea for justice relating in great detail just how badly they have been wronged.  Attorneys listen of course because they know it's good for their clients to vent.  However, attorneys are internally sizing up the practical realities of the case.  Attorneys ask themselves very simple questions.  What are the damages (how much money is involved)?  Playing devil's advocate, what will the other side claim?  Is this situation specifically addressed in the contract?  How much will it cost my client to fight this battle?  In fact some lawyers make it even simpler.  They only want to know what the damages are.   If the damages are small, then it is likely that their client will have to spend more money litigating the case than they can win - assuming they can and will win.  Unfortunately, even the most practical business owners sometimes find themselves faced with a breach of contract that cannot be worked out despite significant efforts.    

While every situation is different and consultation with a business litigation attorney is best, the following serves as a helpful guide in deciding how to proceed when a contractual dispute arises:

1.    Determine how much money is involved.  If it is less than $10,000, pursuing a small claims action in California is probably your best bet.  However, even small claims actions require some commitment from the business owner.  If the damages are a couple of hundred dollars, it's probably better to send letters and continue to pursue the matter informally.  The "I am not going away" tactic is often successful.  If the amount is greater than $10,000 but below $25,000, consider consulting with a lawyer about an aggressive letter and phone call campaign.  This can be done for a relatively low cost and is often successful.  Depending on the circumstances, this tactic can be extended into filing a civil complaint for breach of contract.  The purpose is to put pressure on the other side hoping that it brings them to the negotiating table.  If it doesn't, you can instruct your attorney to dismiss the case before it costs you more than $25,000 in attorney fees and litigation costs.  Ultimately, the advice you receive will depend on the strength of your case.  

2.    Forget about Punitive Damages and Contingency Fee Agreements.  It is only in extraordinary cases where independent torts exist (fraud, physical harm, etc) that punitive damages are awarded.  If the actual damages are high and the case involves egregious actions you will certainly want to discuss the potential for punitive damages with an attorney.  If litigation is pursued in high damage cases, attorneys will plead numerous causes of action seeking all potential relief.  However, most business disputes do not rise to this level and even if punitive damages are sought, they are rarely awarded in disputes between businesses.  It might be different of course if you were harmed by Microsoft and can show egregious action but this is not the typical scenario that is the subject of this article.  The same is true regarding contingency cases.  Attorneys will rarely handle business disputes on a contingency basis.  If they do, it's because the case is extremely valuable and the facts are so one-sided that they have high confidence in winning and collecting.  It cannot be stressed enough that these types of scenarios are rare.  It doesn't hurt to consult with several lawyers, but it is better not to expect that a lawyer or law firm will assume the risk for you.

Continue reading "Realities of Pursuing Breach of Contract Actions" »

Under California law, a commercial tenant's options when a landlord fails to perform under a lease are generally limited by the terms of the commercial lease.  San Diego businesses often find themselves without a practical legal remedy because the terms they originally agreed to prevent them from withholding rent or terminating the lease.  Tenant's are forced in these circumstances to seek a remedy through litigation which is of course costly and time consuming.  

Those tenants that entered into leases without review or who were unable to negotiate better terms often find themselves dealing with landlord breaches.  Some withhold rent immediately not realizing that they might be held in breach of contract.   Others just abandon the premises and end up getting sued afterward.  Whether or not a commercial tenant can do these things for the most part depends upon the actual terms of the lease.  Is it silent as to landlord's defaults?  Does it allow the tenant to make needed repairs and then deduct the cost from rent (repair and deduct)?  Or does it have specific language limiting the tenant's remedies to court action.  For instance, a lease clause might state, "in no event shall the tenant have the right to terminate this lease as a result of landlord's default and tenant's remedy shall be limited to damages and/or an injunction."  

The best way to avoid this peril is to negotiate better terms in the first place.  However, negotiating better terms is dependent on a party's bargaining power.  In most cases, San Diego businesses have little bargaining power because they are new or unknown entities.  In addition, competing businesses are willing to enter into a lease with the landlord under any terms, leaving the more savvy entrepreneurs a difficult tight rope to walk.  Many landlords approach lease negotiation from a "take it or leave it" perspective. This does not mean that San Diego businesses have absolutely no bargaining power, but landlords typically stand strong when it comes to limiting a tenant's remedies.  Nonetheless, a prospective tenant should never shy away from negotiation better lease terms no matter how limited their bargaining power.  Every landlord is different, and the issues that are important to one landlord may not be as important to another.

Ideally, those tenants currently facing landlord defaults which cannot be resolved through informal discussions will consult a commercial lease lawyer.  Of course, paying for an attorney is not always practical.  In such cases, the first step is to review the operative lease and its amendments carefully.  Look for language that limits, or relates to in any way, tenant's remedies upon landlord breaches including language limiting the tenant's ability to terminate the lease, seek consequential damages, seek declaratory relief, withhold rent or any other limitations on tenant's remedies.  Once the tenant has gained a basic understanding of its limitations, it can determine whether seeking legal assistance is necessary.  If there are limitations, consulting a commercial lease lawyer is highly recommended.

Continue reading "Tenant's Options After Landlord Breach of Commercial Lease" »

As with most business decisions, the decision regarding which legal entity is best suited for your San Diego business depends on a variety of important factors. Most San Diego business owners interested in the benefits of a formal business organization without the burden of the double taxation that accompanies the C Corporation, turn to either the California Limited Liability Company (LLC) or the S Corporation. Both offer owners protection from unlimited liability and both offer pass through taxation (no double taxation). The question then becomes which is better, the S Corporation or the LLC. The decision is best made with the guidance of a San Diego business entity lawyer and a tax professional. However, with fewer restrictions on the allocation of ownership and profit interests and greater management flexibility, the LLC seems to be the better option although this doesn't mean it is the better option for every business.

The most significant benefit of the S Corporation is the ability to limit self employment taxes (social security and Medicare taxes). The benefit is available to stockholder/employees who minimize their salary (subject to self employment taxes) and then distribute excess profits as dividends (not subject to self employment taxes). In certain circumstances, this can be a valuable tool. For example, assume an S Corporation is owned entirely by two stockholder/employees (each owning 50% of the stock). The corporation's profits for the last taxable year were $200,000 of which each salaried stockholder received $50,000 in wages. Each owner would pay self-employment taxes on $50,000 and each would receive a dividend for $50,000 free from self-employment taxes. Based on the current social security and Medicare rates, each owner would save $7,650. However, this benefit is limited by two important factors. First, the IRS requires that salaries paid to owner/employees of corporations be reasonable. There is no guarantee that the IRS will accept the $50,000 incomes in this example, and it has recently become more aggressive in ensuring that stockholder/employee salaries are not too low. It may instead consider the dividend distributions to be wages subject to self-employment taxes. Second, most of the self employment tax is the social security portion which is currently capped when wages reach $106,000. This means that stockholder/employees who earn an annual salary above $106,000 only save 2.9% percent (the Medicare portion) for all dividends paid above their salary.

California LLCs are also subject to a gross receipts tax. The tax is relatively small when compared to the revenues that trigger the tax. The gross receipts tax is $900 for gross receipts between $250,000 and $499,999, $6,000 on for gross receipts above $1,000,000, and $11,790 for gross receipts in excess of $5 million. Profitable businesses will barely notice this tax. For unprofitable businesses or for businesses with a very low profit margin, the gross receipts tax can be problematic since the tax is on gross revenue and not on profits.

For the stockholders in the above example, the tax savings seem to make sense. In fact, tax savings no matter how small always make sense. Nonetheless, the S Corporation suffers from several statutory limitations and lack many of the benefits LLCs offer. First, the S Corporation cannot be owned by another corporation or LLC; it cannot be owned by a foreign person; it cannot have more than 100 shareholders; it cannot issue different classes of stock; and it must distribute profits in equal proportion to ownership interests. While one owner in the example above could pay himself a higher salary for taking on greater responsibility, he would still have to take 50% of the dividends distributed. All distributions must be made simultaneously and on a pro rata basis. If one of the owners above preferred to purchase his interest in the S-Corporation directly from his existing LLC, he couldn't. The LLC suffers from none of these limitations. The LLC members are free to allocate profits however they like, make contributions however they like and are able manage the company with the greatest flexibility.

Continue reading "California Limited Liability Company versus the S-Corporation " »

Protecting proprietary information and processes is important to San Diego business owners. Trademarks, Patents and Copyrights provide companies protection for inventions, artistic works, symbols, names, images, and designs which are made public. As the name implies, "trade secret" law provides businesses protection for secret information. A trade secret is a process, formula, practice, design or compilation of information including customer lists which is/are not generally known or reasonably ascertainable and from which a business obtains economic advantage over competitors. Tension between public policies favoring protection of trade secrets and public policies promoting competition have left California businesses in a tenuous position when it comes to protecting their trade secrets. It is often difficult to distinguish between an employee who has stolen a trade secret from one that has merely used his experience and personal knowledge to obtain new employment. In addition to consulting a San Diego business lawyer, there are important steps business owners can take to reduce the risk of theft.

California's Uniform Trade Secrets Act prohibits misappropriation of trade secrets. "Misappropriation" is defined as "(1) Acquisition of a trade secret of another by a person who knows or has reason to know that the trade secret was acquired by improper means; or (2) Disclosure or use of a trade secret of another without express or implied consent by a person who: (A) Used improper means to acquire knowledge of the trade secret; or (B) At the time of disclosure or use, knew or had reason to know that his or her knowledge of the trade secret was: (i) Derived from or through a person who had utilized improper means to acquire it; (ii) Acquired under circumstances giving rise to a duty to maintain its secrecy or limit its use; or (iii) Derived from or through a person who owed a duty to the person seeking relief to maintain its secrecy or limit its use; or (C) Before a material change of his or her position, knew or had reason to know that it was a trade secret and that knowledge of it had been acquired by accident or mistake." "Improper means" is defined to include "theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means".

Significantly, California's trade secret act defines a trade secret as "information, including a formula, pattern, compilation, program, device, method, technique, or process, that: (1) Derives independent economic value, actual or potential, from not being generally known to the public or to other persons who can obtain economic value from its disclosure or use; and (2) Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy." In order for a San Diego business to ensure that its information will be considered a trade secret under California law, it needs to take reasonable steps to keep it secret. Secrecy is critical. First, the information must have some independent economic value, and second, there must be some effort to maintain secrecy. If a San Diego business doesn't consider the information important enough to maintain secrecy, neither will California courts.

There are several relatively simple measures businesses can take to maintain adequate levels of security. Physical security is the most obvious measure. Keeping secret information under lock and key with limited access to employees and marking documents "Confidential" serve as a constant reminder that the information within is intended to be kept secret. Similar physical measures can be taken with electronic information. Computer files should be password protected as well as marked confidential, and the passwords provided only to necessary personnel. The more limited the access, the better.

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One of the first decisions new San Diego business owners make is whether or not to incorporate or form some other formal business entity. The decision often seems daunting and turning to a San Diego Business Lawyer and tax professional are important first steps. If the business owner opts for a limited liability company ("LLC") or an S-Corporation (which is taxed like a partnership as opposed to the C-Corporation subject to double taxation), double taxation is not an issue. Thus, the first way to avoid double taxation is to choose a business entity that is not double taxed. This includes forming a California Corporation and then electing S-Corporation status with the IRS. Many small business owners have nonetheless formed corporations without electing S-Corporation status. This may be because a tax professional recommended it or because the business owner simply didn't consider the various business entities available when forming the corporation. Whatever the reason, the choice of a C-Corporation for small businesses isn't inherently a bad one. It does, however, become imperative that these C-Corporations take steps to avoid or at least limit double taxation.

The easiest way to avoid double taxation is to elect to be taxed as an S-Corporation with the Internal Revenue Service. However, to qualify for S-Corporation status the IRS requires that your corporation be a domestic corporation, issue only one class of stock, distribute profits and losses in proportion to shareholder interests and have no more than 100 shareholders who are natural persons and U.S. citizens. Another corporation or LLC cannot own stock in an S-Corporation nor can foreign nationals. If opting for S-Corporation taxation, it is important to timely file Form 2553 with the IRS - no later than the 15th day of the third month following the date of incorporation. If a business is already incorporated, it can still opt for S-Corporation taxation the following year by filing Form 2553 by December 31st. However, it's important to consult with a tax professional before doing so especially where the company was initially advised not to elect S-Corporation status.

If you are a small corporation and do not elect S-Corporation status, the following is a short list of legitimate ways to minimize double taxation:

Accumulate Earnings: Leaving profits in the corporation avoids double taxation since there are no dividends to tax. Saving is advantageous so long as the money is eventually re-invested toward growth. It is a good short term plan. However, if too much profit is retained, the corporation can face an additional Accumulated Earnings Tax (a substantial penalty in addition to the regular corporate tax). The goal is to prevent corporations from accumulating profits for the sole purpose of avoiding income tax. The IRS looks to see if the corporation is accumulating earnings and profits beyond the reasonable needs of the business. Generally, accumulated earnings up to $250,000 ($150,000 for some personal service corporations) are considered reasonable. For earnings in excess of this amount, corporations may still show the IRS that the retained earnings are reasonable based on the needs of the business. If you choose to retain earnings, consult with your tax professional.

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At first glance, the differences between triple net leases (NNN), gross leases and modified gross leases seem complicated. Many of the definitions found on the internet are convoluted and even experienced real estate professionals have trouble figuring out what some bloggers are trying to say. The differences, however, are not that complicated. In the simplest terms, commercial leases can be separated into two major categories: those where the tenants pay all of the property's expenses (NNN leases) and those where the landlords pay all of the property's expenses (gross leases). A base year lease, or modified gross lease, calls for existing expenses to be paid by the landlord, but any annual increases in expenses to be assumed by tenants. A base year lease is somewhere in between the NNN lease and the gross lease.

Most retail leases are triple net leases and the common area maintenance expenses (CAM expenses) that the tenants pay for include just about every imaginable cost for the operation of the property including in most cases property taxes, utilities, maintenance, insurance and management fees. Each tenant is responsible for its pro rata share of the CAM expenses. The actual terms in NNN leases vary widely from lease to lease and how favorable the terms are to the tenant depend on the tenant's negotiating power. Gross leases are less common but still used today. This is largely because landlords are reluctant to take on the risk of increased costs over time. A base year lease or modified gross lease eliminates this problem by transferring the risk of increased costs to the tenants. The base year lease provides landlords security by passing on increased costs to tenants.

Most office leases are some variant of a base year lease. In a base year lease, a base year is selected (usually the first year of the lease). The landlord agrees to pay the property's expenses for the base year. The landlord continues to pay the property expenses at the base year level and the tenant agrees to pay its pro rata share of any increases in property expenses. If the property expenses for the base year (say 2010) are $40,000 and the expenses increase to $50,000 for the year 2011, a tenant with 20% of the square footage would pay $2,000 (20% of the $10,000 increase) in 2011 in addition to the tenant's base rent (with a NNN lease, the tenant would pay its pro rata share of the entire $50,000 in 2011 or $10,000 in addition to the base rent). Each year thereafter, the tenant pays its pro rata share of the property's expenses but only to the extent that those expenses exceed the $40,000 established in the base year. In most cases, the annual increase in expenses is estimated at the start of each year and tenants pay monthly to spread out the cost over the year. In the above example, if at the beginning of 2011 the landlord over estimated the increase in property expenses at $12,000, the tenant would pay monthly payments of $200 (20% of 12,000 divided by 12 months) totaling $2,400. The tenant thus overpays $400. At the end of 2011, the landlord would perform an expense reconciliation resulting in the extra $400 being credited back to the tenant.

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Most people are generally familiar with the concept of double taxation. Corporate attorneys and accountants regularly raise the issue when asked by entrepreneurs about choosing the right business entity for a new company (or for an existing company looking to grow and insulate its owners from personal liability). Moreover, double taxation remains a hot button political issue. Whatever political side one falls on, double taxation is real and new and existing business owners need to be informed as they make critical business decisions regarding incorporation or the creation of some other formal entity.

The concept of double taxation itself is simple enough - the Internal Revenue Service (IRS) and state taxing authorities tax corporations based on their profits. In addition, when those profits are distributed to the corporate shareholders in the form of dividends, the individual shareholders are taxed again creating a significantly higher actual tax rate on the corporate profits. Say a corporation generated profits of $100,000 in a given tax year. The federal corporate tax rate on profits of $100,000 is currently 34% so the corporation owes a tax of $34,000. If you and a co-owner each own 50% of the stock in the corporation and issue yourselves each a $50,000 dividend, you will each add the $50,000 to your income for the tax year. Assuming you both end up in the 35% tax bracket, each of you will both pay an additional $17,500 in taxes. In effect, the $100,000 in corporate profits is hit with a total tax bill of $69,000 or an actual tax rate of 69%. While this picture is much more complicated for most corporations, the concept remains the same - corporate profits are taxed twice.

The most common reason business owners incorporate is to insulate themselves from the liabilities of the business. This goal can be accomplished in ways that avoid double taxation, including the formation of a Limited Liability Company (LLC) or, if a corporation meets certain qualifications, by electing to be taxed as an S-Corporation. S-Corporations are taxed the same as partnerships (pass-through taxation). The profits are divided amongst the individual shareholders who are then taxed as individuals. The Corporation's profits are not taxed separately. If an S-Corporation election is not made, then the entity is considered a C-Corporation and is taxed accordingly (double taxation).

The question then becomes, why would anyone ever wish to form a C-Corporation? A comprehensive answer is beyond the scope of this article. Businesses choose the C-Corporation for varied and complicated reasons most often with the guidance of a San Diego Business Attorney and tax professional. Larger entities planning on going public don't typically qualify for the S-Corporation election and the LLC is still a relatively unknown entity to be an attractive business in the public market. There are also ways for smaller corporations to avoid double taxation and it is common for them to do so. See How to Avoid Double Taxation for Small Corporations.