This statutory protection—often called a pick your partner provision—acts as a safeguard that provides LLC members with a certain amount of personal asset protection. For example, whereas the creditor of a corporate shareholder could reach and exercise shareholder rights to their full extent, the creditor of an LLC member can reach and exercise only the economic rights associated with membership interests—not the voting or management rights. The recipient of this type of membership interest is called an assignee.

Statutory Provisions – Creditor Action

If an LLC does not specify any transfer provisions, creditor actions are subject to state LLC laws. Each state, in its LLC statute, has provisions limiting what actions a creditor can take against an LLC member for personal debt. Depending on the state, the statutory remedies available to an LLC member’s personal creditors may include:

• A charging order, which is a court order requiring the LLC to pay all the distributions due to the member-debtor from the LLC to the creditor.
• A foreclosure on the member-debtor’s LLC ownership interest.
• A court order to dissolve the LLC.

These remedies protect the other LLC members from the risk of having the creditor of a debtor-member step into the debtor-member’s place and share in the control of the LLC. To a varying degree, they also address the creditor’s right to satisfaction of the debt.

Transfer Provisions – Other Triggering Events

 Transfer provisions are typically specified in the LLC’s operating agreement or in a separate buy-sell agreement. There may be some overlap with creditor actions, as these are often included as triggering events in the transfer provisions.

Examples of triggering events that can be specified in an LLC’s transfer provisions include the following:

• A deceased member’s membership interest passes to a prohibited individual or entity
• A member’s bankruptcy or other involuntary transfer of a membership interest to the member’s creditors
• A member’s separation or divorce, or the transfer to a member’s spouse under property division or under a divorce or separation decree
• A member’s membership interest becomes subject to a valid court order, levy, or other transfer that the LLC is required by law to recognize
• A member’s breach of the LLC’s confidentiality
• A member’s failure to comply with any mandatory provision of the operating agreement
• A member’s failure to maintain a license or other qualification that disqualifies the member from engaging in the LLC’s primary business

If a triggering event occurs, the transfer provisions may prompt a mandatory redemption of the member’s membership interest or a right of first refusal to the LLC or to the other members. If an involuntary transfer does occur, the recipient of the membership interest—the assignee—typically receives only an economic interest in the LLC with no management or voting rights.

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What is a key person?

A key person is someone associated with the business that provides a significant, direct economic benefit. Economic benefit not only includes profits, but also considerations such as cost savings, goodwill, credit access, and customer access.

Business owners—particularly those of a small business—are often key persons. Some additional examples of key persons are:

• A salesperson with well-established or numerous business contacts
• An employee with specialized expertise
• The inventor of the product
• A programmer who wrote the foundational code
• The owner with relationships that result in favorable credit terms

How does key-person insurance help?

Key person insurance compensates the business for any financial loss or cost incurred because the key person suffers an insurable event (death or extended disability).

1. Key person insurance provides financial security.

• Key-person insurance can bridge the gap if the loss of the key person impacts the business’s revenue or affects the business’s creditworthiness.
• If a buy-sell agreement is part of your business succession planning and the loss of the key person triggers a buy-sell event, key-person insurance (in the form of life insurance on each owner) funds the inside purchase of the deceased key person’s ownership interests, protecting both the remaining business owners and the deceased key person’s estate.

2. Key-person insurance buys your business time.

● The cash injection key-person insurance provides can keep the business afloat while a replacement for the key person is recruited and trained.

● If the key person is truly irreplaceable, key-person insurance can provide the funds that enable the business to pay its creditors, wind down the business operations, and dissolve.

Any other benefits to holding key-person insurance?

In addition to the peace of mind key-person insurance provides to business owners, the premium the business pays on key-person insurance may be deductible as a business expense. If proper notice and consent requirements are met, the proceeds from a key-person insurance payout may also be tax-free. The tax implications of key-person insurance are complicated and specific to individual circumstances. It is crucial that you consult with your tax professional about this and other tax-planning strategies centered on key-person insurance before you purchase a policy or sign any documents.

Next steps

We work with businesses to evaluate business needs and goals to ensure that the overall business planning strategy is on target. If you are interested in learning more about key-person insurance and how it may fit into your business plan, please give us a call.

The post Can Your Business Survive the Loss of a Key Person? appeared first on Vanly & NicPA.

The difference between community property and co-ownership of an asset

Let’s take the example of owning a car. If you and your spouse are both on the title to a car, you co-own the car. This means both of you have the right to use the car, sell the car, or do anything you’d like with the car. It also means you are both responsible for paying off any debt or liabilities that arise from the car. If one of you passes away, the survivor automatically becomes the sole owner of the car, without needing to take any additional actions.

But let’s say only one spouse has his or her name on the title. That spouse is the only owner of that car and is the only one (with certain exceptions) with rights and responsibilities attached to the car. When the owner spouse dies, the car would have to be transferred to the surviving spouse via the applicable estate plan or post-death or probate proceeding; it isn’t already owned by the other spouse like in the previous example.

However, ownership of the vehicle may look a little different depending upon your state of residence. In many states, such as New York, there are rules that make most assets acquired during the marriage “community property” of the married couple. In this situation, each spouse has rights to the property, no matter whose name is on the title. All assets that are considered community property are split up equally between the divorcing parties. In our car example, if the car is considered community property, it’ll be put into the big pot of community property and split evenly. That can result in either one party getting the car and the other spouse getting something of equal value to offset it, both parties splitting the ownership of the car, or the car being granted to both parties but one buys out the other’s share. The main point of community property is that the parties get an even split for assets acquired during the marriage.

Community property rules apply to all assets owned by either spouse, including ownership of a business. Spouses can co-own shares of a business, and, in fact, there may be legal and tax benefits for doing so. However, in the typical case of one spouse being involved with the business while the other is not, it usually does not make sense for the spouses to co-own the shares. Alternatively, if one spouse owns the shares individually, the other spouse may still have a community property interest, even if they’re not an owner.

How to fill out your Form 2553 S Corp Election

If your corporation or LLC decides to be taxed as an S corp, you must file a Form 2553 with the Internal Revenue Service (IRS). The tax code states that anyone with a community interest in the stock must consent to the tax election, and Form 2553 asks for a list of all owners. If the business owner’s spouse has a community property interest, it seems as though he or she must be listed on the form as well. However, he or she is not an owner, so they shouldn’t be listed as an owner, right? Be warned, if you list your spouse as an owner of the business when he or she is not, there could be serious consequences down the road. So how do you comply with the conflicting rules?

The answer is to list your spouse in the shareholder section, but note that he or she is not a shareholder. As you list all of the owners and their information, do include your spouse in the list, and do get his or her signature. However, unlike the actual owners, you will not list any ownership percentages or shares, or any dates those shares were acquired. Instead, you should note that the spouse is a “consenting spouse,” and you can also note that he or she owns 0% or zero shares of the business. This way, you are satisfying both requirements: you are getting affirmative consent to the tax election, but you are not claiming that they are an owner when they are not.

Special considerations for professional corporations

If you are forming a professional corporation, properly completing Form 2553 is especially important. The rules governing professional corporations vary from state to state, but generally, the rules will dictate that only members of that particular profession may be owners of the company. For example, if you’re starting a professional veterinary corporation, only licensed veterinarians can be owners of the business (or may have to own a majority of the business). If a non-professional is an owner, the status of the company can be put in jeopardy, and you could lose your entire business entity.

It is of the utmost importance that you comply with the ownership requirements in your state in order to be considered a professional corporation. If you incorrectly complete Form 2553, you’re putting your entire entity at risk. So professional corporations, be warned: If you are considering electing S corp status, make sure you consult with a professional. You are quite vulnerable if the form is filled out improperly. Problems are easier to prevent than solve!

The post Making an S Corporation Election as a Married Business Owner appeared first on Vanly & NicPA.

Defining Non-Exempt & Exempt Employee Status

Before looking at how non-exempt versus exempt status has become muddled, let’s define each.

Non-Exempt:

Non-exempt employees are generally entitled to minimum wage and overtime and have jobs that do not meet the requirements of the FLSA’s exemption tests: 

• Minimum Wage.  Non-exempt employees must be paid the minimum wage or    The current federal minimum wage is $7.25 per hour.  Some states have rates that are higher or lower than the federal rate and employees are entitled to whichever is greater.  If an area has a living wage (a wage that is high enough to maintain a normal standard of living and which is generally much higher than either the federal or state rate), the living wage prevails.
• Overtime Pay. Non-exempt employees are entitled to overtime pay (time and a half) for any time worked beyond 40 hours in a given week.  Some states, such as New York, Nevada and Alaska, require overtime after working eight hours in one day.  Others, such as Colorado, require overtime pay if an employee works more than 12 hours in one day.
• Type of Work. Contrary to popular belief, the type of work an employee performs is not generally a defining factor of a non-exempt  Instead, employers should look at exempt classifications.  If the employee’s duties don’t fall into one of the exempt categories (listed below), then the employee is likely non-exempt.

Exempt:

Exempt employees are not entitled to overtime pay. They generally tend to perform higher-level jobs within an organization that are either executive, professional, or administrative.  To qualify as exempt, certain FLSA tests must be met.

Here’s a look at those tests:

• Executive Exemption. To qualify for the executive employee exemption, all of the following tests must be met:
  • The employee must be compensated on a salary basis (as defined in the regulations) at a rate not less than $455 per week;
  • The employee’s primary duty must be managing the enterprise or managing a customarily recognized department or subdivision of the enterprise.
  • The employee must customarily and regularly direct the work of at least two or more other full-time employees or their equivalent; and
  • The employee must have the authority to hire or fire other employees or the employee’s suggestions and recommendations as to the hiring, firing, advancement, promotion or any other change of status of other employees must be given particular weight.

• Administrative Exemption. To qualify for the administrative employee exemption, all of the following tests must be met:
  • The employee must be compensated on a salary or fee basis (as defined in the regulations) at a rate not less than $455 per week;
  • The employee’s primary duty must be the performance of office or non-manual work directly related to the management or general business operations of the employer or the employer’s customers; and
  • The employee’s primary duty includes the exercise of discretion and independent judgment with respect to matters of significance.

• Professional Exemption.  There are two types of professional employee exemptions, the creative exemption, and the learned exemption.
  • To qualify for the creative professional employee exemption, all of the following tests must be met:
  • The employee must be compensated on a salary or fee basis (as defined in the regulations) at a rate not less than $455 per week;
  • The employee’s primary duty must be the performance of work requiring invention, imagination, originality, or talent in a recognized field of artistic or creative endeavor.
  • To qualify for the learned professional employee exemption, all of the following tests must be met:
  • The employee must be compensated on a salary or fee basis (as defined in the regulations) at a rate not less than $455 per week;
  • The employee’s primary duty must be the performance of work requiring advanced knowledge, defined as work which is predominantly intellectual in character and which includes work requiring the consistent exercise of discretion and judgment;
  • The advanced knowledge must be in a field of science or learning; and
  • The advanced knowledge must be customarily acquired by a prolonged course of specialized intellectual instruction.

Note:  There are also exemptions for outside sales positions, computer-related occupations, and others which have their own FLSA requirements.

Misclassifications Cost Employers Cash

Employers who misclassify employees may be liable for back pay, retroactive benefits (such as healthcare, 401(k), memberships) and more.  The issue can become exacerbated when more than one employee or department is involved, which is generally the case. In fact, it can affect thousands of employees if a national company has wrongly classified employees.

Case in point: Walmart.  The retail giant misclassified 4,500 managers and coordinators as exempt at stores nationwide.  In fact, they were actually non-exempt and were entitled to $5.3 million in penalties, damages, and back wages for overtime violations at stores nationwide.

What to Do Next

As part of our legal services for business owners, we’re happy to guide you in ascertaining whether your employees are exempt or non-exempt as well as provide guidance with other day-to-day business operations matters. Please call the office to schedule a meeting.

The post Employee Misclassification: The Fine Line between Non-Exempt & Exempt Employees appeared first on Vanly & NicPA.

Here are four steps you can take to keep trade secrets safe:

1. Make a list: The first step in protecting trade secrets is knowing that you have them. Look across your business and think about any types of information you possess that are both confidential and critical to your success. Trade secrets could be product designs, customer lists, marketing plans, sales forecasts, or processes. For software developers, proprietary code obviously needs protection and for restaurants and food stores, it’s the secret recipe. Conduct a “trademark audit” to identify the information you have a legal right to keep private and wouldn’t want your competitors to find out.
2. Stake your claim: Once you know what your trade secrets are, it’s essential to start treating them like secrets. Stamp or watermark “confidential” on sensitive documents. Get confidentiality and non-disclosure agreements in place with employees and vendors. These will put the people who learn your secrets on notice not to usurp them and lay the basis for a legal claim, if necessary.
3. Lock it up: Take whatever steps are reasonably available to you to secure your trade secrets from access. Digital files and systems should be encrypted and password protected. Physical files should be kept locked. Establish rules around access to sensitive files. If possible, use a badge system to control access to your facility and posted signs to designate areas where access is controlled.
4. Train your troops: Many disclosures of trade secrets are inadvertent slips by an employee who simply did not know better. That may make it easier to forgive, but the negative impacts on your business are still there. Prevent this with good training and education for your employees on what your company considers confidential and what employees’ obligations are. Back the training up with strong written policies. And when an employee leaves, take steps to shut down their access to your files and systems right away to ensure that your secrets don’t leave with them.

Whether your trade secret is a treasured family recipe, a brilliant string of code, or a closely guarded customer list, it won’t be a secret for long unless you are careful. Taking the steps above is a great first step toward a solid trade secret strategy. For even further assurances of security, consider retaining counsel for a professional security audit. Business attorneys like us can be great partners in protecting your trade secrets and your business.

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