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Garrett Sutton, Esq Articles and Resources

The Wyoming DAO LLC

by | Mar 10, 2022 |

Is a Decentralized Autonomous Organization (DAO) Right For You?

A DAO is an organization operated by a smart contract, which is a computer code running within the blockchain. The ‘A’ for Autonomous refers to the self-executing nature of it all. If a condition is met the computer code executes the transaction. There is no need for human managers, with all their failings, to be involved. The contract provides management certainty.

The DAO concept is advocated as a benefit for those from around the world with common goals who may not know or trust each other. You come together for a common project and the smart contract guides the beneficial way.

But there is one big problem with an ordinary DAO: There is no asset protection. Essentially, you and all of your like-minded DAO compatriots are operating as general partners, with unlimited personal liability.

Hence, the Wyoming DAO LLC.

The state of Wyoming is on a mission to be the best jurisdiction for all things blockchain. And in realizing that a DAO had a legal gap, they had their legislature provide a legal solution. A DAO can now be organized as a Wyoming LLC. You and your partners can now autonomously operate with the solid protection of Wyoming’s very strong LLC laws.

The requirements aren’t difficult. You need to have a Wyoming registered agent and pay the annual state fees. Your official LLC name must include the wording ‘DAO LLC,’ as in Betty’s Plumbing DAO, LLC. You can list yourself, a human, as a manager or you can choose to be algorithmically managed. Meaning your DAO LLC can be managed by artificial intelligence – or AI. Who thought science fiction would ever come to corporate governance?

Wyoming DAO Chart

But therein lies the largest detraction to the DAO LLC. By being algorithmically managed via a smart contract (which is your own LLC’s Operating Agreement) you are giving up some privacy.
Smart contracts operate on the blockchain. And the blockchain is out there for all to see. So by knowing the entity name – Betty’s Plumbing DAO, LLC – for example, someone can go online to read Betty’s Operating Agreement. They can access her operational road map and internal strategies.

Many of our clients prefer their entity’s governance to remain confidential. So when it comes to balancing autonomous with anonymous, privacy wins. A human manager following a confidential Operating Agreement is preferred by most.

To date, we have not formed any DAO LLCs due to this privacy limitation. It will be interesting to see if and when the state of Wyoming deals with this gap in an otherwise unique and useful corporate structure.

Has The Time Come For Cyber Bounty Hunters?

by | Feb 28, 2022 |

The Colonial Pipeline shutdown last week raised troubling questions. How vulnerable is our own infrastructure to  cyber attacks? Should cyber pirates be paid, as they were by the Colonial Pipeline authorities?

Most importantly: What can we do to prevent such attacks?

Incentives usually work.

I wrote about this in Chapter 13 of my newest book, Scam-Proof Your Assets: Guarding Against Widespread Deception

A bounty hunter is someone who captures criminals for a “bounty,” a payment for providing a public service.

In the Old West, local sheriffs were sometimes unable to track down outlaws alone. They couldn’t do that and protect their town at the same time. So they put up wanted posters offering rewards for an outlaw’s capture, Dead or Alive. Bounty hunters responded, and tracked down the outlaws for the reward. For example, the reward for the capture of Jesse James was $5,000, an enormous amount of money at that time, equal to over $112,000 in today’s dollars.

Although the term “bounty hunter” evokes images of vigilantes in the Old West, the term “bounty hunter” was not in use in this context in the 1800s. Rather, the term relating to “one who tracks down and captures outlaws” arose around the 1950s in pulp fiction and Hollywood westerns. In 1954, Elmore Leonard published The Bounty Hunters. In the same year, The Bounty Hunter, a 1954 western film was released by Warner Brothers. The movie, starring Randolph Scott, was the first film to feature a bounty hunter as its hero. Have Gun-Will Travel was an American Western series that was broadcast by CBS on both television and radio from 1957 through 1963. The TV series featured Richard Boone as Paladin, a gentleman gunfighter who typically charged $1,000 per job and traveled around the Old West working as a mercenary for hire. Similarly, Wanted Dead or Alive was a CBS bounty hunting Western airing from 1958 through 1961. Recently, Leonardo DiCaprio played Rick Dalton, the fictional TV star of Bounty Law in Quentin Tarantino’s Once Upon a Time…in Hollywood.

In modern times, bounty hunters generally are known as bail enforcement agents, and they mostly carry out arrests of criminal defendants who have skipped bail and failed to appear at their trials. In some states there is no formal training for bail enforcement agents, and they are unlicensed. In other states, there are varying standards of training and licensing. The state of Nevada has very strict statutory and administrative requirements for bail enforcement agents. The risks can be great.

Local law enforcement agencies also offer rewards in high-profile cases. Funding sometimes comes from outside private donors who provide money to help solve specific crimes. As well, some cities and towns have set up Crime Stopper programs for anonymous tips.

Incentives also work in the field of cyber security. Governments and private companies offer “bug bounty” programs where monies are paid to ‘white hat hackers’ to identify weaknesses within a security or computer system.

A white hat hacker, or ethical hacker, is a good guy. They operate with the system owner’s permission to conduct penetration testing, vulnerability assessments and the like. Black hat hackers also harken back to TV Westerns, where the bad guy was easily identifiable by the black hat he wore. Black hatters are motivated by financial gain, anger at the system, the thrill of cybercrime, among other reasons. As we have learned throughout this book, the black hats wreak havoc in every corner of society.

Since not everything in life is just black and white there are also grey hat hackers. As an example of their work, they will search for system vulnerabilities without an owner’s permission. If they find an issue, they will ask the owner for a fee to fix it. If the owner won’t pay, they sometimes post the vulnerability for the web to see. While not black hat pernicious in their intent their hat is grey since they didn’t have the owner’s permission to begin with.

 

White hat hackers can be well compensated. In recent years the Department of Defense has paid out over $500,000 annually to white hatters for uncovering thousands of vulnerabilities under the Hack the Army, Hack the Air Force and Hack the Marine Corps programs. The Department of Homeland Security has established a bug bounty program to minimize internet security problems within their own systems.

Private companies also fund their own bug bounty programs. Apple offers a maximum payout of $1.5 million. In 2019, Google paid out $6.5 million to 461 researchers for their vulnerability assessments.

HackerOne is a founding member of Internet Bug Bounty (IBB), a bug bounty program designed for core internet infrastructure projects. IBB was started by hackers and security providers who were interested in making the internet safer. IBB partners with the global hacker community in order to discover security issues for its customers before these issues can be exploited by cyber criminals.

HackerOne claims to be the number one hacker-powered bug bounty platform in the country. They have launched more federal programs, including Hack the Pentagon, than any other service.

If bounty programs work for tech savvy hackers, why not for sophisticated hunters? Incentives work. The government could certainly expand existing bounty programs to bring in cyber criminals. To be certain there are legal issues to be worked out, but when compared to the lawlessness and impunity with which internet crime is committed, the legal issues seem small.

In fact, the U.S. Constitution allows for bounty hunters. Article 1, Section 8 gives Congress the power in Clause 11 to grant Letters of Marque and Reprisal. At the founding many sovereign nations issued such letters, which allowed private parties (or “privateers”) to engage in hostile, for profit acts against state enemies. In many cases, the state and the privateer shared the spoils. The most successful team was Sir Francis Drake, who scored lucrative hits on Spanish shipping, and Queen Elizabeth, who both feigned innocence to other monarchs and gladly took her cut of all the gold and silver. The difference between piracy, a hanging offense, and privateering (or benefitting from private ships of war) was having “letters of marque” sanctioning the bounty.

Article 1, Section 8, Clause 11 is often referred to as the War Powers Clause. It vests in Congress the power to declare war and grant letters of marque and reprisal. So Congress would have to approve the bounties.

But in a new world of extraterritorial threats, including terrorism and cyber havoc, the Constitution clearly allows a mechanism for the country to defend itself using sanctioned private actors. Letters of marque against a broad profile of hostile individuals, organizations and cyber bad actors would save the nation trillions in fighting undeclared wars and occupying countries that don’t want to be occupied. Letters of marque would target bad actors wherever they are found, offering great tactical flexibility. The U.S. has plenty of trained individuals to perform the work, privately defending the country and its citizens for a just reward.

Some commentators are adamantly against the idea of cyber bounty hunters. They note that active hacking, or going on the offense, is illegal under the Computer Fraud and Abuse Act. Even if someone in the private sector has been hit by a black hatter, opposing commentators claim there is no legal authority to hack back. As well, they ask who decides what is ethical, just and legally binding? A cyber bounty hunter with a financial incentive to find and accuse could destroy lives of innocents.

These commentators also argue that the government is already engaged in their own shadow form of bounty hunting. A majority of the personnel at the CIA’s National Clandestine Service are independents. They claim that 80% of the National Security Agency’s budget goes to paying private contractors. Are they privateers?

Governments will not warmly embrace digital vigilantism as they are already engaged in their own covert cyber criminality. A notable example of this, never confirmed, is the American and Israeli use of the Stuxnet computer worm to damage Iran’s nuclear program in 2010. While limiting an angry nation’s access to atomic capabilities seems worthwhile, it was also technically a violation of international law.

China’s military plans do not involve confronting the U.S. military directly. Instead, in what they call ‘systems destruction warfare,’ they will undermine American operations. At this point, no one will be arguing about technical violations of international law.

Christian Brose is the author of The Kill Chain: Defending America in the Future of High-Tech Warfare. In the May 23, 2020 edition of the Wall Street Journal, Mr. Brose wrote:

We must…redefine our objectives. If China continues to grow in wealth, technology and power, it will become a peer competitor to the U.S. Recovering our global military primacy is no longer a practical goal. We must instead pursue a more limited and achievable goal: denying military dominance to China. The U.S. military will have to focus less on projecting power and controlling territory than on preventing China (and other competitors) from projecting power themselves and committing acts of aggression beyond their borders. We must create defense without dominance.

This will require us to think differently about modernizing the U.S. military. The goal cannot be to accumulate more and better versions of traditional platforms in expensive pursuit of a 355-ship Navy or a 386-squadron Air Force. We must focus instead on developing networks of systems that enable U.S. commanders to understand the battle- space, make decisions and act – the process that our military calls “the kill chain” – and to do so better, faster and more dynamically than our adversaries. This battle network, not platforms alone, creates real military advantage.

Similarly, the Wall Street Journal reported in their June 2, 2020 edition:

The International Committee of the Red Cross in a letter last week signed by international political and business leaders called for governments to take “immediate and decisive action” to punish cyber attackers.

“There are more and more cyberattacks…on the healthcare sector and unless there are really strong measures taken, they will continue,” said Cordula Droege, chief legal officer at ICRC. “What we’re seeing at the moment are still indications of how devastating it could be.”

The next war or triggered economic collapse will involve taking out critical infrastructure, as well as military capabilities. The electric grid, telecommunications, healthcare, transportation, finance, water and waste water treatment, among other key resources are targets that will be attacked and must be defended. Having a corps of certified and licensed defenders may provide a crucial edge toward military advantage. They may also provide an immediate advantage to every American now suffering from the financial and emotional onslaught of scams.

The scamster in some small country who believes they are free to disrupt and ruin the lives of millions without consequence must see that other cyber criminals are being caught in the act, extradited to the United States, prosecuted and sent to jail for a very long time. When boastful American scamsters learn their friends not only dislike their criminality but like being paid for a tip off or learn that lesser confederates are now more likely to turn on them, a positive disrupting factor is introduced. These criminals must know that the new sheriff is willing to pay millions to trained, sophisticated hunters to bring order and justice to the Wild West of the internet. When criminals have to think twice about their criminality, when they witness other bad actors going to jail, crime does go down.

But the question remains: How can a government act against cyber bad actors when they also engage in cyber bad acts?

Other questions will arise. What if a cyber bounty hunter tries to collect on a government? And what if a government, in failing to pay, turns a white hat to black hat perdition? (Hopefully that last one is just an action adventure movie). To be certain, the issues will be complicated. But they pale in comparison to the billions in losses and social risks of not addressing widespread deception. Failing to act now only allows the monster to grow. Citizens will accept the cognitive dissonance that protecting the country with cyber criminality is different than protecting citizens from cyber criminality. Helping individuals to scam proof their assets is not inconsistent with collectively scam proofing the country. You can do both at the same time.

So either governments admit (as sheriffs in the Wild West did) that they can’t do the job and let the bounty hunters in. Or they step it up and actively protect their citizens from cyber criminality. Whatever course the people’s representatives choose it must be acted upon immediately. The threat to our country is great. The damage being inflicted upon millions of innocent Americans every day hollows out our core.

Cyber bounty hunters (either in house or contracted) will be utilized by all government in the future. Their citizens will demand it. The only question is what will come first: The real thing, or the TV show?

Scam-Proof Your Assets: Guarding Against Widespread Deception

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Bylaws and Operating Agreements

by | Feb 28, 2022 |

Corporations

A corporation must have bylaws. Bylaws are the road mapby which the corporation operates. Bylaws set forth how annual and special meetings are called and held, and how officers and directors are elected or removed. Bylaws provide a framework. A lack of bylaws creates uncertainty in which only the arguing lawyers win.

For good reason, all states require corporations to have bylaws. Corporate Direct provides this important corporate document as part of its incorporation package.

Limited Liability Companies

An Operating Agreement is a key foundational document for your Limited Liability Company. It sets out the rights and restrictions for each owner and provides an operational road map for how to govern your LLC.

Why on earth wouldn’t you have one?

Because there are promoters who want to sell you the cheapest possible package – a bundle of forms that technically set you up as an LLC but leaves you open to a piercing the veil of limited liability claim which, by court order, can lead to your personal liability for everything.

These promoters don’t care about protecting you into the future. They care about getting a few hundred dollars from you today and moving on to the next victim.

How can they get away with this? They assert a single statute without thinking through the larger consequences. Most of these promoters are not lawyers, and therefore in dealing with only one aspect of a statute they fail to appreciate the bigger legal picture.

Many states sought flexibility in setting up their LLC statutes. In doing so they allowed for the Operating Agreement to be optional. The members (owners) could prepare one if they wanted to do so. If they decided not to, then the State’s default rules would apply.

Of course, when you ask the promoters what the default rules are you will either get a blank rabbit in-the-headlights look or a glib, totally nonsensical answer.

The default rules do matter. As filmmaker Louis Mayer once stated, “Oral contracts aren’t worth the paper they’re written on.” Why set yourself up for a bitter battle that is so easily avoided with a written Operating Agreement?

 Many states allow for oral understandings to serve as an Operating Agreement. Can you see the danger in this? Do you know people who conveniently forget important facts? This may be why the state of New York requires a written Operating Agreement.

But for the other states, let’s consider an arrangement where three friends form an LLC. Their oral and unwritten deal is that they will split the profits three ways. One can hope that everyone will live up to the deal.

But what if the oral understanding provides that a departing member will be entitled to earn payouts over a six year period? Or provides for other arrangements performed over one year in length?

A recent Delaware case dealt with this exact issue. The holding is as you would expect: Oral understandings are much better enforced if they are instead written and signed by all parties.

The heart of the matter is the Statute of Frauds – an old English rule which sensibly holds that contracts for real estate transactions and agreements that are to be performed over one year must be in writing.

The point being that those old English judges (and today’s modern judges) don’t want people coming into their courtrooms and arguing there was an oral deal to sell real estate or an oral understanding for a multi-year payout. From a judge’s standpoint, it is very difficult to sort out a “he said/she said” argument. You’d better get your important agreements in writing or you won’t get far in court.

In the Delaware case, the claimed oral understanding was a six year payout for a departing member. The court relied on the rule of the Statute of Frauds, contracts to be performed over one year in length must be in writing, to deny the plaintiff their request for relief.

The lesson is, you should make sure your Operating Agreement is in writing. Then you must make certain that everyone signs it. A written and executed document can easily be reviewed by a court. Or, better yet, you won’t have to go to court because your written agreement will be clear to all.

Another very practical matter is that Banks and Lenders expect to see an Operating Agreement. When you borrow money, the lender is going to want to certify that you are real and properly established. In an area where you want to put your best foot forward, create a good first impression, you want to confidently hand over that Operating Agreement to your lender.

Imagine instead telling the lender that your state statute does not require an Operating Agreement. The lender politely states that may be true but lender policy requires one. You firmly state that the promoter who set up your entity swore you didn’t need one. You argue that you don’t need an attorney and you don’t need an Operating Agreement.

You can see where this is going. Banks and Lenders have their own default rules. Either you do it the right way and have an Operating Agreement or, by default, you don’t get the loan. Is it worth saving a few hundred dollars to be technically right and then lose your financing? Ask yourself – Is it your intent to operate in the real world?

Then, by failing to follow the corporate (or LLC) formalities, a creditor can claim that your entity is a sham and therefore not entitled to protection and may seek to pierce the corporate veil. If the claim is successful (and they are successful almost half the time) all of your personal assets are exposed to satisfy a judgment. It is not a good position to be in. And you will find yourself in it very quickly if you don’t have an Operating Agreement.
Judges can be prickly and juries can be fickle. You can argue that a state does not require an Operating Agreement all you want. To most people, running a business without some sort of agreement or roadmap means you are not a real business. Courts can overrule statutes. And when your veil is pierced for that reason, it means all of your assets are at risk. Are you starting to understand the issues and see the bigger picture?

It is interesting to note that one of the major sources of this idea, that no Operating Agreement is necessary in the U.S., comes from Australia. Many Aussies are now investing in U.S. real estate, which is great. Our doors are open. The Australians are being told they need an LLC to protect their investment real estate and themselves in litigious America. But the promoters are counseling them to file the initial Articles of Organization and that’s it. No Operating Agreement or other supporting paperwork is required, these poor Aussies are told.

It is bad enough to have American non-lawyers counsel the unsuspecting on legal issues. Now we have Australian non-lawyers counseling folks on American law. Has globalization blinded some to the continuing existence of unique legal systems and the need for local counsel?

Any Australian who walks into a U.S. court and testifies that a non U.S. attorney Down Under advised them how to set up their incomplete, bare bones U.S. entity is going to lose. Hands down, you’re done. A good American attorney will have a field day with those facts.

On the other hand, the Australian (or other foreign national) who follows not only the letter, but the spirit of the law, and who runs their business and investments as a business in conformance with American standards, will receive the respect and fairness of both Judge and jury. Doing it right without cutting corners means a lot in this context.

One last point must be made: Some states actually do require a written Operating Agreement. It is a wise position that, over time, other states will also follow this position.

So, do it right at the start. Ensure you have prepared an Operating Agreement for your LLC.

It may be well to note, if you form an entity with Corporate Direct, the appropriate written Operating Agreement is included in your formation fee so everybody in your company will be on the same page from the start. If you are ready to form your company, schedule a free 15-minute consultation with an Incorporating Specialist today!

Schedule a Consultation

Why Manager Managed Instead Of Member Managed?

by | Feb 28, 2022 |

One of the biggest questions we’re asked when clients are forming an LLC is: Should we be manager managed or member managed?

The LLC allows for great flexibility. You can be managed by all the members, which is actually the case in most common business settings. The owners (or members) come together and agree on what is next. But such member managed informality, while suitable for on-the-go entrepreneurs and investors, is not always best from a legal stand point.

By contrast, a manager managed LLC is one in which one or more persons are appointed in the Operating Agreement to serve as management under specific guidelines. The manager(s) may be members or they can be non-owners brought in from the outside to administer operations. But the LLC’s members (either one, all or some) can always be appointed as managers of the LLC. A manager managed LLC, which may managed by the members, is our first choice. We prefer this strategy for three reasons.

First, piercing the veil of protection (whereby someone is owed money by a broke LLC and wants to personally collect from the monied owners) is much easier with a member managed LLC. A standard reason courts allow veils to be pierced is because there is no separation between ownership and management. With a member managed LLC, the owners run the show typically without much formality. The members are the managers without any clear separation between ownership and administration. When the lines are so blurred the courts will pierce the veil of protection and hold the members personally liable for claims against the LLC. This is not the protection you were hoping for when you set up your LLC.

With a manager managed LLC the lines of authority much clearer. The members elect the manager(s) and the managers (whether an owner or not) must adhere to the management requirements of the Operating Agreement. Management is distinctly separate from ownership, which is what courts in a piercing case like to see. Minutes of manager meetings can further highlight the separation, whereby the members have their elected managers guide the LLC and keep a record of such decisions. Courts appreciate such formality.

A second reason for choosing the manager managed has to do with apparently authority. In a member managed LLC who has the authority to sign a contract? Does every member get to sign anything and everything? Do you want every member to have such a power?

Apparent authority is the ability of a member to act on behalf of the LLC, even though such powers haven’t been formally granted. If a third party learns that an LLC is member managed (which can be easily seen on each secretary of state’s website) and deals with a member who has the apparent authority to act, the third party is protected if the member’s signature did not bind the LLC. Apparent authority means that if a third party could reasonably believe that a member had the ability to bind the LLC then the contract is binding.

For example, XYZ, LLC is a member managed. One member, Bob, wants to lease space at the mall. Bob doesn’t have the authority to sign a lease but the landlord, learning that the LLC is a member managed and that Bob is a member, reasonably assumes Bob does have the authority to sign a lease. Apparent authority protects innocent third parties such that the LLC (even though the other members didn’t agree) can be held liable for the lease. Now assume that XYZ, LLC is a manager managed. The landlord doesn’t have it so easy. They must insure that they are dealing with the correct manager, one who has been granted authority to sign a lease on behalf of the LLC. A manager managed LLC limits the people with authority to just specific managers. A prudent landlord may want to see the manager managed Operating Agreement to make doubly sure they are dealing with the manager with the specific and express authority to sign on behalf of the LLC.

As is clear, a manager managed LLC will help reign in those members you don’t want to imply one iota of authority towards.

Finally, in many states where members are not listed on state websites, a manager managed LLC does not imply LLC ownership. A manager may be an owner or not. Some of our clients prefer the vagueness of a manager managed LLC whereby ownership is not certain.

All in all, when all the factors are considered, manager managed is the superior way for operating an LLC.

California: Pay To Play

by | Feb 28, 2022 |

California continues to fight for its $800 minimum franchise tax. If you live outside the state but passively own real or personal property worth over $50,000 inside California you are doing business in the state. Sayeth California’s Franchise Tax Board: Please pay the $800 or we’ll sue.

In The Matter of the Appeal of Aroyo Investments I, LLC, OTA Case No. 19074982 (July 7, 2020), that’s what happened.

The Facts in Aroyo

Aroyo Investment I, LLC (“Aroyo”) appealed an action by the Franchise Tax Board (“FTB”) denying its claim for refund of the annual $800 limited liability company (“LLC”) tax for the 2016 tax year. The issue was whether Aroyo was doing business in California and, therefore, subject to the $800 LLC tax. Aroyo was a foreign LLC formed in Delaware and based in New York, and it was an LLC that was classified as a partnership for both federal and California income tax purposes. Aroyo was not registered to do business with the California Secretary of State but did acquire a minority, non-managing membership interest in a California parcel owned by 1155 Island Avenue, LLC (“Island”). Island was a board-managed LLC formed in Delaware, and it was also classified as a partnership for both federal and California income tax purposes. Island conducted business in California within the meaning of R&TC section 23101 during 2016.

Island’s LLC agreement provided that the purpose of Island was to, among other things, own, operate, lease, finance, sell, and manage a facility on property that it had acquired from the Thomas Jefferson School of Law in San Diego, California (the “Property”). According to San Diego County real property tax assessment records, Island was the Property’s owner of record. These records indicated the total assessed value of the Property (both land and improvements) was $64,239,943. Aroyo owned a direct profit, loss, and capital interest in Island, consisting of a beginning and ending year percentage of 0.7830849. Aroyo’s membership interest in Island was its sole connection with California.
Initially, Aroyo timely filed a California LLC return (Form 565) and paid the $800 LLC tax. But then, Aroyo then filed an amended return, seeking a refund of the $800 on the basis that it was a limited partner of Island and was not doing business in California. They owned less than 1% of the property and had no active say in its management.
Of course, the FTB denied the claim, asserting that “[n]onregistered foreign LLCs [such as Aroyo] that are members of an LLC doing business in California [such as Island] are considered to be doing business in California.” Aroyo appealed the FTB ruling to the California Office of Tax Appeals (the “OTA”), noted that Aroyo bore the burden of proving entitlement to its refund claim.

The Decision in Aroyo

The OTA ultimately found that Aroyo had not met its burden of proof. They noted that R&TC section 17941(a) provided that an LLC “doing business” in California, as defined in R&TC section23101, must pay the annual $800 LLC tax, and that, under R&TC section 23101(b), a taxpayer is considered to be doing business in California if it satisfies certain bright-line nexus:

“(b) For taxable years beginning on or after January 1,2011, a taxpayer is doing business in this state for a taxable year if any of the following conditions has been satisfied:

“(3) The real property and tangible personal property of the taxpayer in this state exceed the lesser of fifty thousand dollars ($50,000) or 25 percent of the taxpayer’s total real property and tangible personal property. The value of real and tangible personal property and the determination of whether property is in this state shall be determined using the rules contained in Sections 25129 to 25131, inclusive, and the regulations thereunder, as modified by regulation under Section 25137.”

In determining whether Aroyo had exceeded the California property threshold amount, the OTA was required to take into account Aroyo’s pro rata share of California property owned by pass-through entities in which Aroyo held an interest, pursuant to R&TC 23101(d), which provided:

“(d) The sales, property, and payroll of the taxpayer include the taxpayer’s pro rataor distributive share of pass-through entities. For purposes of this subdivision, ‘pass-through entities’ means a partnership….”

The FTB contended that Aroyo’s distributive share of Island’s Property, situated in California, exceeded $50,000, therefore, Aroyo was doing business in California and subject to the $800 LLC tax. Although the OTA noted that the evidence in the record was somewhat limited, that evidence, together with the reasonable inferences that might be derived therefrom, were sufficient to support FTB’s determination.

We previously wrote about Swart Enterprises v. FTB, which held that an out of state entity was not doing business in California. So what did the state do in response? They changed the law.

R&TC section 23101 has been amended to add new quantitative “doing business” tests. If any of these tests are met, then the taxpayer is deemed to be “doing business” in California. In Aroyo Investments, the OTA found that the Island property was worth $61,500,000; that the value of Aroyo’s share in the Island property under R&T sections 23101(b) and (d) was $481,000, which was significantly more than the $50,000 threshold; and that, therefore, Aroyo was “doing business” in California and subject to the payment of California’s Minimum Franchise Tax of $800.

In California you must pay to play.

Corporate Transparency Act Update

by | Feb 28, 2022 |

Are you aware of the new filing nearly EVERY Corporation and LLC must file beginning in 2022?

The Corporate Transparency Act (“CTA”) passed by the Senate and House now requires annual reporting of an entity’s beneficial owners to the U.S. Treasury’s Financial Crimes Enforcement Network (“FinCEN”) database. The new law defines a beneficial owner as any individual who directly or indirectly (i.e., through a second entity) exercises substantial control and holds at least 25% interest in an entity.

A few exceptions to the filing requirement do exist. Publicly traded companies subject to SEC requirements don’t have to file. Neither do Companies with more than 20 full time U.S. employees and over $5 million in gross sales. Presumably the IRS knows enough about such companies anyhow.

The rest of the country, small S-Corp operators, investors owning real estate LLCs and everyone else not excepted, a huge number of many millions entities, will have a new annual filing requirement.

The final regulations for this consequential increase in reporting have not yet been released. (We will let you know as soon as they are).

But the penalties for not filing are known. And they are serious.

An individual who doesn’t report can face civil penalties of up to $500 per day. Providing false information or willfully failing to report can result in criminal fines up to $10,000 and/or imprisonment for up to two years.

What information must be reported to the FinCEN database? So far it is known that the following information for each beneficial owner must be reported:

  • Full name
  • Date of Birth
  • Current residential or business address; and
  • A unique government issued ID number, such as a passport or driver’s license

Are you concerned about the privacy of this information? After all the public hacks of tax payer records (in which no one is even held accountable) your concerns are prudent. The law states that the FinCEN database shall be subject to limited access, but open to federal agencies (e.g., the FBI), state and local law enforcement agencies with a warrant, and foreign law enforcement agencies (e.g., Interpol).

Here at Corporate Direct we are concerned about helping our clients meet this requirement. The penalties, as mentioned, are significant for not doing so. Of course, you can handle this filing on your own. But many of our clients prefer our assistance (such as with annual state fillings and minute preparations to avoid a piercing of the veil), so they can do what they do best – manage their business and investments. In the coming months (as we learn the new regulations) we will provide you with information on how Corporate Direct can assist to meet the CTA’s annual filing requirements.

The Five Ws in Every Good Business Plan

by | Feb 14, 2022 |

You may be in a hurry to put together your business plan.  But don’t confuse the frenetic blur of activity with thoughtful preparation.  There are some major issues to discuss in your plan, and you’ve got to think them through.

Winning business plans map out the major Ws of your proposed business – who, what, when, why and where – to help you figure out that all important H – how. Be thorough, but don’t let writing a business plan become too complicated.

Who?

Who are the major players? Who are the owners, personnel, advisors, customers, competition, even the target audience for the plan itself?

What?

What do you want to achieve? What is your sustainable advantage? What do you offer? What do you produce?

When?

When do you want to meet particular goals? When did (will) the business start?

Why?

Why would customers want your product or service? Why are you in business?

Where?

Where is the business located? Where is the target audience? Where are the new opportunities located? And finally, how do you get from where you are now to where you want to be?

Answer all of these questions, and you will see your plan taking shape.

A good business plan can help you determine what you need to make your business a success – from personnel to financing, location to advertising.

But to truly make your company succeed, you must pay attention to what you find during plan preparation. Be thoughtful. Don’t do the plan, figure out you need $300,000 and then try to wing it on $150,000. Be realistic in your planning. Then be just as realistic in following the plan.

The hardest part of crafting a good business plan (or even a bad one, for that matter) is overcoming inertia. Most people have a great idea and fail to take action because of fear of failure.

Inertia is what keeps a body at rest (along with a comfy couch, a good TV night, high-speed internet, whatever). Kick inertia in its thermodynamic behind, get off your couch and get started. Now.

Just as you must overcome inertia to construct a business plan, you might also have to overcome fear. A business plan sounds complicated. But it shouldn’t be. A complicated business plan is often worse than no business plan at all.

Your plan should be understandable in its language (overly technical terms are not welcome). It should summarize where appropriate (leave the details for the appendices). It should truly describe your business (leave the boilerplates for metal shop).

It needs to be short and to the point. Keep it simple, but make it complete. Treat your plan as if it is the only information a potential investor, lender or manager will have before making a decision enabling the success of your business.

Writing Winning Business Plans 4Learn more about writing successful business plans from Garrett Sutton’s Book, Writing Winning Business Plans. To win in business requires a winning business plan. To write a winning business plan requires reading Garrett Sutton’s dynamic book on the topic. Writing Winning Business Plans provides the insights and the direction on how to do it well and do it right.

Rich Dad/Poor Dad author Robert Kiyosaki says: “The first step in business is a great business plan. It must be a page turner that hooks and holds a potential investor. Garrett Sutton’s Writing Winning Business Plans is THE book for key strategies on preparing winning plans for both business and real estate ventures.”

Crisply written and featuring real life illustrative stories, Writing Winning Business Plans discusses all the key elements for a successful plan. Topics include clarifying your business vision, understanding your financials and analyzing your competition. Also covered are how to wisely use your business plan as a tool, and how to attract funding for your new or existing businesses.

As business plan competitions become more popular around the world Writing Winning Business Plans also discusses how to enter and how to win these ever more lucrative contests. How to quickly interest a potential investor, also known as the elevator pitch, is explained. In addition, as opportunities arise around the world, how to present your plan in various countries is explored.

Tax Advantages of Incorporating Your Business

by | Feb 14, 2022 |

You finally came up with an amazing name for your business, your business plan is carefully written and you’re ready for take-off! But as you read up on starting your business you stumble across a word that just keeps coming up: incorporating.

Then, at your networking event, people keep asking you if you have decided to incorporate or not. You try not to panic as you swiftly explain that you are still considering your options.

You run to the library, checking out all of the books you can possibly find on this very subject, but you’re still slightly confused, especially when it comes to talking about “taxes and numbers”.

We get it, it can be a lot to take in. We’ll give you the best reasons for incorporating your new business based on tax benefits and give you the information you need to incorporate. And don’t worry, we know it can be complex and we’ve made it easy to understand so you can make the best choice is for your business.

What Does It Mean to Incorporate?

If you’re thinking of incorporating your business, it’s important to know exactly what “incorporating” means. When you incorporate a business you are officially making it legal in the eyes of the state in which you reside. It becomes its own entity, separate from you as an individual owner.

It’s relatively simple to become incorporated, all you have to do is fill out an application with your state. This application asks for information about your business, including the business name, your personal contact information, the purpose of your business, and whether or not you will be providing stock options. By incorporating your business, your business can go on without an expiration date, which means that even if you pass away your business still exists.

Remember to consult a professional if you are considering incorporating your business. A professional can help you understand the benefits and drawbacks of each type of incorporation and understands what it takes to set your business up for success.

Incorporate Today: 7 Tax Advantages

When making the decision to incorporate your business, you want to think about what it will look like to run your business. Ultimately, one of the best reasons for incorporating your business is because it keeps your company and its assets separate from your personal ones, which helps to protectg you in teh event of a lawsuit, but there are great advantages when it comes to the big “T” word too.

Here’s a list of the top 7 tax advantages you receive from incorporating your business:

1. Spreading Out Tax Losses

As a business, you’ll likely have some losses, especially at first — most businesses do. Unlike filing your taxes as an individual, a business can spread out their tax losses over time. As an individual, you’re forced to take the loss right away, but as an owner of an incorporated business, you can defer your taxes. More specifically, if as an individual you have a high marginal tax rate and you personally don’t need the funds, you’re able to leave money for your business and take back the money at a later date when your personal tax rate levels out.

2. Business Expense Deductions

Keep track of all your costs. This includes start-up costs, operating costs and capital expenses (land, business equipment, commercial property, etc.). These expenses can be deducted during tax time and can add up to big money for your business. And as a bonus, you’re at a lower risk of being audited as an incorporated business.

3. Social Security Tax Deductions

By incorporating your business, you’ll only have to pay social security taxes on the income salary that you personally receive. This saves you a big chunk of tax money and allows you to separate your social security tax from your entire business income.

4. Benefit Deductions

Incorporated businesses are able to deduct the benefits they pay their employees too. As an unincorporated business who has outside people helping you, you’re unable to deduct those benefits.

Another deduction included is the insurance you provide to employees.

5. Protect Personal Assets

It’s always a wise idea to keep your business and personal assets separate. This includes bank accounts, property, etc. As an incorporated business, you’re able to protect your personal assets — it’s critical to have this asset protection in the unfortunate case that something goes wrong in your business.

For example, if you’re sued as an incorporated business, you’re not personally being sued, only your business is liable. Since incorporating your business classifies it a separate entity, your businesses’ assets are in jeopardy, not your personal home, vehicle or property.

6. Credibility

When your business is incorporated, you’re more likely to be taken seriously as a business owner. You become more credible in the community and in the tax world. When that’s the case, you’re more likely to earn money from people who trust you and your business. You are also far less likely to be chosen for an audit if you are incorporated.

7. Income Flexibility

Another tax advantage of incorporating is that you can lower your tax bill by taking income in dividends rather than salary, which allows you to be flexible with your income decisions from your own company. With income flexibility, you’re able to run your business in a more creative way and can meet a diverse set of needs that may be necessary, especially when you’re just starting out.

The Bottom Line on Incorporating

Incorporating a business might be a great choice for you. In addition to tax advantages, incorporating your business opens up many doors and opportunities and also protects you from unlimited personal liability.

Need help incorporating? Contact us today to get started!

Schedule a Consultation

Employer Identification Number (EIN)

by | Feb 14, 2022 | ,

EIN stands for Employer Identification Number. The IRS requires that you have such a number when you incorporate or form an LLC. Think of an EIN as a Social Security number for your business. You will file all your tax returns using this number and you will need this number to open a bank account for the business.

Once you’ve filed your incorporation papers and they’ve been approved by the Secretary of State, your corporation needs to file for an Employer Identification Number, or EIN. An EIN is a permanent number assigned to your business, which is used for official corporate business such as opening bank accounts and paying taxes.

How Do I Get an EIN?

You can apply for the EIN yourself on the IRS.gov website for free; however, some people find this confusing and/or do not wish to spend the time doing it themselves. If this is the case for you, Corporate Direct can obtain one for you for a small service fee. Whichever way you choose, know that it required for your business.

The IRS allows businesses to apply for an EIN either online, by phone, fax or mail. If applying online, the EIN is assigned immediately upon completion of the interview-style application that walks you through type of business, identity of business, authentication, addresses, details and confirmation of the new EIN number.

Even though receiving the number is immediate, it can take up to two weeks to be added into the IRS database and until it is added, the number can’t be used for filing returns. In order to avoid any issues, be sure to obtain your EIN as soon as possible.

C Corporation

by | Jan 5, 2022 | , , ,

What is a C Corporation?

illustration of a storefrontCorporations have been used for over 500 years to limit owners’ liability and thus encourage business investment and risk taking. Their use for this purpose continues to this day. 

You will hear about both C Corporations and S Corporations. Both are corporations with charters granted by the state of organization. You can organize in Nevada for the best asset protection laws, for example, and qualify to do business in California. In that case, you will have one corporation paying annual fees in two states (which many people do). While we like and often use S Corporations, we keenly appreciate the advantages of C Corporations. They certainly have their merit and a place in your entity structure strategy.

The C and the S refer to IRS Code Sections. C corps feature a double taxation – one tax at the company level and another tax on profits distributed to shareholders. This double tax is why many people consider S corps, which has only one level of tax. But there are restrictions on ownership of S corps, where as there are no such limits on C corps.

Here is a quick list of C Corporation advantages:

  • They can have an unlimited amount of shareholders, from anywhere in the world.
  • For Nevada and Wyoming corporations, officers and directors can reside anywhere in the world. This can be a boon for foreign investors. 
  • They can have several different classes of shares.
  • They have the widest range of deductions and expenses allowed by the IRS (more on this below).
  • They are the most widely recognized business entity in the world, and are the premier entity for going public.
  • In Nevada and Wyoming, nominee (or stand-in) officers and directors can be utilized, adding extra levels of privacy.
Image Link to download full c-corporation guide pdf

Tax Advantage: Wide Range of Deductions and Expenses

A C Corporation has the widest range of deductions and expenses allowed by the IRS, especially in the area of employee fringe benefits. A C Corporation can set up medical reimbursement and other employee benefits, and deduct the costs of running these programs, including all premiums paid. The employees, including you as the owner/shareholder, will also not pay taxes on the value of those benefits.

This is not the case in a flow-through entity, such as an S Corporation, LLC or LP. In each of those cases the entity may write off the costs of the benefits, but any employee/shareholder who owns more than 2% of the entity will pay taxes on the value of their benefits received. So, if having the maximum deductions and all of the employee fringe benefits on a tax-free basis is important to you, a C-Corp may be your entity choice.

Which type of business works well as a C Corp?

C Corporations are great for a business that sells products, has a storefront and employees, and may or may not have a warehouse where it keeps its inventory. C-Corps don’t work well with businesses that want to hold appreciating assets, such as real estate, because of the tax treatment on the sale of these assets.

Tax Disadvantage: Double Taxation Issues

The most often-cited disadvantage of using a C-Corp is the “double-taxation” issue. Double-taxation happens when a C-Corp has a profit left over at the end of the year and wants to distribute it to the shareholders as a dividend. The C-Corp has already paid taxes on that profit, but once it distributes the profit to its shareholders, those shareholders will have to declare the dividends they receive as income on their personal tax returns, and pay taxes again, at their own personal rates.

How to Avoid the Double-Taxation Scenario

There are many things you can do to avoid the double-taxation scenario:

  • Structure the C-Corp so that there are no profits left over – use all of the write-offs and deductions allowed by the IRS to reduce the C-Corp’s net income.
  • Offer great benefit plans!
  • Pay higher salaries to yourself and the other owner/employees than you would if you were using a flow-through entity such as an S-Corp. Yes, you will have to pay payroll taxes and personal income taxes on those monies, but you would pay personal taxes on dividends paid to you anyway. And it may be that in the big picture, the savings on one side outweigh the additional taxes paid on the other side.

The decision as to what entity is best for you really does, in so many cases, hinge on taxes, and that is why, with any corporate-related decision, you are wise to seek the advice and assistance of a good CPA.

Corporate Direct along with your CPA can help you decide which corporation is best for you.

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