CONGRESS RECENTLY EXTENDED IRC §179 TO INCLUDE DEDUCTIONS FOR REAL PROPERTY BUT ONLY FOR 2010 AND 2011

Usually when you think of §179 of the Internal Revenue Code, you think of deductions available to businesses for depreciable, tangible “personal” property such as equipment, vehicles and computers. However, Congress has given a gift in the Small Business Jobs Act, signed September 27, 2010, by extending the deductions to include up to $250,000 of Qualified Real Property.

What kind of real property will qualify for this favorable tax treatment?

· First: Qualified Leasehold Improvements—typically capital improvements made to an interior portion of a commercial non-residential building.

· Second: Qualified Retail Property Improvements—typically capital improvements to buildings which are open to the general public for the sale of tangible personal property.

· Third: Qualified Restaurant Property—typically, capital expenditures for the improvement, purchase or construction of any building (new or used), if more than 50% of the building’s square footage is devoted to the preparation of, and seating for, the on-premises consumption of prepared meals.

In order to receive the benefit of this deduction for Qualified Real Property, you must place the building or capital improvement in service by the end of your 2011 tax year, so it may take some quick footwork to be able to elect §179 treatment.

Whether you can take advantage of this deduction depends on your individual circumstances and (big disclaimer coming here) you cannot consider the foregoing to be tax advice of any sort. As with anything connected with the Internal Revenue Code, there are tricky issues, so you should consult with your tax planner to guide you as to how best to take advantage of this opportunity. That said, this link will take you to a good first step in understanding the process.

Small Business Resources

As President of the Women Business Owners of Montgomery County, I have the opportunity to learn about various resources and programs aimed at women-owned and small businesses here in Montgomery County. Earlier this month, I attended the launch of the new Rockville Women’s Business Center. RWBC began as an initiative of the non-profit Rockville Economic Development, Inc. (REDI). The Center is located within the REDI offices at 95 Monroe Street in downtown Rockville, and offers tailored training, counseling and technical assistance to help entrepreneurs start and build successful business enterprises that are positioned for long-term growth. The Center is open to all and promises to be a great resource for both start-ups and companies looking to grow and expand.

I also recently attended a briefing by Robert Carpenter of the U.S. Small Business Administration on the new Small Business Jobs Act, and how this legislation affects our small business community.

One change that caught my attention is a provision that will allow some small businesses to refinance their owner-occupied commercial real estate mortgages into the SBA 504 loan program. Regulations implementing this provision should be issued during the first quarter of 2011. The law also sets higher loan limits for the 7(a) and 504 programs ($2 million to $5 million) and expands the number of small businesses eligible for SBA loans by increasing the alternate size standard to those with less than $15 million in net worth and $5 million in average net income.

The briefing, hosted by the Montgomery County Department of Economic Development (“DED”), also included information on the Small Business Revolving Loan Program, administered by DED, which provides “micro” loans of between $5,000 and $100,000 to small businesses which are looking to expand in Montgomery County and may not qualify for traditional private banking financing.

The Small Business Revolving Loan Program recently received a $2 million infusion to provide loans to small businesses whose expansion includes the creation of new jobs or the relocation of existing jobs into the County. Eligible businesses must have gross revenues of less than $5 million annually and fewer than 75 employees. To learn more, go to http://www.montgomerycountymd.gov/dedtmpl.asp?url=/content/ded/financing/small-business-revolving-loan-program.asp.

Why Is Social Media Important to Franchisors and Franchisees?

Since more and more Americans use their connections to Facebook, Twitter and YouTube to guide them in their consumer decisions, they expect the companies they patronize to be accessible on the web. That fact gives franchisors and their franchisees a common interest in having their business develop a dynamic presence on the Internet via the various social media outlets.

Many franchisors have gotten the message and have made budgeting decisions accordingly with respect to their marketing programs. Existing franchisees may ask, “Are the social media programs being adopted by their franchisors more than just trying to get on the bandwagon or simply attracting prospective franchisees and/or investors”? This is because whatever expense the franchisor makes for social media marketing is probably going to be paid for by the franchisees through the advertising or fees they are charged.

It behooves both franchisors and franchisees to develop the best and nimblest social media marketing program that they can so that it will be of interest to, and attract, potential customers/clients. Many businesses have figured out what it takes. Their programs are so well developed that while a customer is sitting in a restaurant wondering why he does not have more corn tortillas, the franchisor’s corporate HQ picks up the Twitter complaint and can inform the local restaurant owner of his customer’s concern.

This kind of 24/7 social media coverage can be expensive. Given the size of certain chains, they may not be able to respond within minutes to a customer’s complaint. However, that should be a goal towards which each franchisor aims and it is certainly a marketing sophistication level that any prospective franchisee should expect.

If a franchisor cannot provide such “hands on” response time for their social media marketing campaigns, what would be a reasonable standard to expect?

The Virtues of Joint Venturing

Small businesses face multiple hurdles new and old, from identifying lucrative contact opportunities to determining how best to use limited resources to penetrate new markets. In this post, I will extol the virtues of joint venturing or teaming with equals or larger companies to gain a competitive advantage and multiply earning potential.

As a lawyer, I see companies, particularly closely held businesses, grapple with subcontracting agreements and similar contractual arrangements in which they have little leverage to shape the final terms. The scenario usually involves me reviewing a subcontract with terms such as: “the subcontractor shall not be paid unless and until the owner approves of all work performed …” and “in the event that the owner does not pay the prime for any reason, the prime shall have no obligation to pay the subcontractor.” Another favorite: “as a condition precedent to final payment, the subcontractor shall execute and deliver to the prime a release of all claims against the prime and the owner arising under or by virtue of this agreement.” I promptly revise the most offensive terms, the other party or their counsel objects citing their reasons, and in the end the parties have a finished product that reflects their unequal bargaining positions.

Joint venturing, which is simply forming a strategic alliance with one or more other businesses, could be a powerful weapon for these businesses and a more advantageous alternative to the traditional subcontracting arrangement. In the case of a small business teaming with another small business, the advantages are evident:
(1) each company maintains their autonomy (making teaming a superior alternative to mergers);
(2) the companies collaborate to compete for business they could not otherwise hope to win on their own; and
(3) most importantly, they equitably split the rewards of their labor.

Incidentally, government contracting officials and others with a vested interest in small businesses winning their fair share of contracting opportunities often report that small businesses would be much better positioned to win and successfully perform contracts if they simply joined forces with one another. What’s more, the value and potential of both companies suddenly expand manifold.

The big guys are adept at this. In a recent issue of Business Week, for example, an article about Thermax, Ltd., an Indian power equipment maker, noted the company’s market value rose to its highest in seven weeks after it merely announced a joint venture with Houston-based Babcock & Wilcox Power Generation Group, Inc. The deal is expected to add $30 billion to Thermax’s sales by March 2015. Its CEO was quoted as saying: “We no longer need to be a part of any consortium to bid for projects. We will be able to compete with bigger rivals now.”

Joint ventures are in, and if you're not utilizing this powerful tool, chances are your competition is, or will soon be. The trick is knowing when it makes sense to collaborate with your peers on a project. First, consider whether a prospective joint venture partner has an accommodating culture with compatible broader business strategies. Second, don’t overlook the importance of having a carefully drafted legal document (the joint venture agreement) that describes what each party brings to the joint venture in detail. Finally, and more important than the process itself, is the execution of the joint venture—start with a full-fledged joint business plan, including (very important) an exit strategy.

Choosing a Business Entity: Common Legal Entities

In my last post, I talked about the benefits of forming a separate legal entity for your business. Once you’ve decided to set up a separate entity, you’ll need to figure out which type of entity makes the most sense. While not exhaustive, the following are some of the most common forms of business entities. Each type varies in terms of its ease in creation and maintenance and the tax consequences to the owners.

Corporation:
The corporation has, until recently, been the most traditional form of business entity. A corporation is owned by one or more stockholders who are issued shares of stock in return for their investment. Although in small businesses and family-run corporations, the stockholders may have a role in running the business, their role as stockholders is strictly economic. Absent extreme circumstances, such as fraud, a stockholder of a corporation is not personally liable for the acts or obligations of the corporation.

The corporation is managed by a Board of Directors, which is elected annually by the stockholders. The Board appoints the corporation’s officers, including a President, Treasurer and Secretary, who are responsible for the day-to-day business affairs of the corporation.

A corporation is taxed as a separate entity, meaning that it files its own tax return and pays taxes without regard to the tax status of the individual shareholders. However, if the corporation distributes a portion of its after-tax income to its shareholders in the form of dividends, each shareholder will pay a separate tax on the dividend received. This “double taxation” can be avoided if the corporation makes an election under subchapter S of the Internal Revenue Code. It is critical to consult with a tax professional for the rules and requirements relating to corporate taxation.

Corporations must comply with many formalities (which, to the detriment of many shareholders, are often overlooked), including annual meetings of the stockholders, election of directors, keeping of minutes and a stock transfer ledger, all of which are typically set forth in the corporation’s bylaws. Some of the corporate formalities may be dispensed with if the corporation is set up as a “close corporation” pursuant to the provisions of Title 4 of the Maryland Corporations and Associations Act.

Limited Liability Company:
In recent years, an increasingly-popular alternative to the corporation is the limited liability company (“LLC”). An LLC is an unincorporated business organization with at least one “member.” Members may be individuals, corporations, partnerships, or other LLCs. LLCs have gained favor, especially among small businesses, because they offer the limited liability of a corporation but with fewer record keeping requirements and other formalities and, like a corporation, can be managed by non-member employees.

An LLC offers the same liability protection for its members as a corporation does for its stockholders. This means that, absent fraud, self-dealing and the like, a member is not responsible for the debts, liabilities and obligations of the LLC.

An LLC can consist of only one member. However, where there are multiple members, it is critical for the members to enter into an “Operating Agreement” which sets forth the relative rights and obligations of the members regarding contributions, distributions, allocations of profits and management of the business.

LLCs are also favored because they offer the streamlined “pass-through” tax benefits of a partnership. This means that the entity is not taxed separately but rather passes through its income, deductions, credits, as well as other items, to its members. Your tax advisor can provide you with more information on the tax implications of operating as an LLC.

Limited Partnership:
A limited partnership is a partnership which includes one or more general partners, who are responsible for the management of the business, and limited partners, who have an economic interest in the partnership, but take no part in the management of the business. Limited partnerships are most commonly used in real estate ventures (although, in recent years, LLC’s are becoming favored alternative entities). Limited partnerships must comply strictly with the provisions of the Maryland Limited Partnership Act, Md. Code Sec. 10-101, et seq.

General partners are personally liable for the obligations of the partnership. Limited partners, like corporate shareholders, are not liable for partnership obligations beyond their financial contributions. Unlike shareholders, however, except in unique circumstances, limited partners may not participate in the management of the partnership’s business –- another reason why LLC’s are becoming favored alternatives. There is no legal prohibition on the role of members in the management of the LLC’s business –- even if those members are merely passive investors.

Limited partnerships are treated the same as partnerships for tax purposes.

Again, this list is not exhaustive. There are other entities, such as professional corporations, limited liability partnerships and others, that may be more suitable for your business activities. A business attorney, working together with your tax advisor, can help you decide which form is most appropriate for your business.

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Choosing a Business Entity

Whether you are just starting a business enterprise or you’ve been running your existing business as a sole proprietor or as a partnership, you should consider whether it makes sense to form a separate legal entity for the business. This is important for accounting purposes, as well as insulating your personal assets from the liabilities, debts and obligations of the business.

If you are operating your business as a sole proprietor, then from a legal and tax perspective, you, as the owner, are inseparable from the business. Since a sole proprietorship and its owner are considered one and the same, taxes on a sole proprietorship are determined at the personal income tax rate of the owner. In fact, a sole proprietor simply reports all business income or losses on an individual income tax return.

Similarly, because they are the same entity, a sole proprietor is personally responsible for any liabilities, obligations and debts of the business.

If you have a partner, then you have formed a general partnership, which is defined under the Maryland Code as “an association of two or more persons to carry on as co-owners a business for profit.”

Each partner is personally liable to third parties for all the liabilities, obligations and debts of the partnership, as well as the other partners. In this context, the only difference between a sole proprietorship and a partnership is that a partner could find him/herself liable for liabilities, obligations or debts created by another partner in the business. The partnership is not taxed as a separate entity. Instead, taxable income, losses, deductions, and credits are passed through on a pro-rated basis to each of the partners. Each partner is taxed directly on his/her share of the partnership’s net income, whether that income is distributed or not.

Why Form a Separate Entity?

Most of us carry casualty insurance, which protects our business from the loss of assets in the event of a casualty (e.g., a fire) and liability insurance (which, by the way, should always include contractual liability coverage), which protects your business from liabilities asserted by third parties for acts such as negligence (e.g., a fire caused by your -- or your employee’s -- negligence in your leased space which damages or destroys the landlord’s premises). But there could be situations where the insurance proceeds either don’t cover the claim being asserted or where the limits of coverage are insufficient to cover the entire amount of the claim being asserted. Also, business and economic cycles could create financial pressures on your business operations, making it necessary to negotiate with lenders, landlords and other creditors.

Unless your business is a separate legal entity, your home and other personal assets could be at risk. Establishing a separate legal entity, maintaining its separate existence and using the entity’s name on your marketing materials, invoices, etc. will help protect your personal assets.

There are also tax and accounting benefits associated with establishing a separate legal entity. Each type of entity has different tax and legal implications so it is critical that you consult with your attorney and a tax advisor before forming a separate legal business entity.

Next week I will discuss the various types of common legal entities.

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Alternatives to Lease Guaranties

You’re a landlord who is about to sign a lease with a tenant that is a corporation or limited liability company with no long-term operating history or few assets, and you want to be able to reach the principal of the tenant in the event of a default. The easiest way is to ask for a Lease Guaranty.

But if you’re the principal being asked to give the Lease Guaranty you don’t want to subject your personal assets to the risks associated with the possible failure of your business so you are reluctant to give the Landlord the Lease Guaranty. A failed business venture – especially in these times – should not necessarily result in a significant reduction of your lifestyle or possible loss of your house or other significant assets.

How do you resolve these conflicting interests in a manner that provides security for the landlord and is a reasonable but not life-changing risk to the tenant?

There are several alternatives to the Lease Guaranty. The simplest is for the tenant to provide more than the customary one month security deposit and one month advance rent. Looking at the local rental market, the landlord should “guestimate” how long it would take to relet the premises following a termination of the lease for default. If, for example, the landlord thinks it will take six months, then the landlord should ask for a security deposit equal to six – or maybe even seven – months’ basic rent. If the tenant defaults and the landlord relets the premises in less than the six (or seven) month time frame it will earn an unexpected windfall; if it takes longer, then the landlord can chalk that up to the typical risk of doing business.

Another alternative to a Lease Guaranty is a letter of credit in an amount equal to a prescribed number of months of rent. But, given that there are fees associated with the issuance of a letter of credit and that most issuers will require a significant amount of collateral to back up the letter of credit, this may not be as attractive to the tenant as posting the cash with the landlord.

Whether cash or a letter of credit is used, the landlord could also agree that after an agreed default-free period, a portion of the security will be released. For example, if the term of the lease is five years, then after two years the landlord could agree to reduce the security deposit by an amount equal to one month’s rent; after three years, the security deposit could be further reduced by an amount equal to two months’ rent leaving the landlord with a security deposit equal to two months of rent. In a ten-year lease the reduction might be one month after two years, one month after three years, one month after four years and two months after five years.

If the security deposit is paid in cash and it is a significant amount (e.g., equal to four months basic rent), the tenant should insist – and the landlord should agree – that the security deposit be held in a separate interest bearing escrow account. For small amounts, it is not typical that the security deposit will be segregated or bear interest but, in such cases, the landlord should be obligated to transfer the security deposit to any subsequent owner of the property and should not be released from liability until that occurs.

These are some examples of how we work with parties to address legitimate but sometimes competing interests. We are skilled in working with clients – in this example, landlords and tenants – to solve legal problems and balance the needs of all parties to a transaction.

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Free Money? SBA Offers Help for Small Businesses

You may have read the recent Washington Post article (July 11, 2009) about the White House proposal to use bailout funds to increase the amount of “working-capital” loans the Small Business Administration (SBA) provides small businesses under its popular 7(a) loan program.

However, a program is already in place at the SBA which aims to offer relief to small businesses in the total amount of $35,000.00. If a firm is eligible to receive the loan from a commercial bank, then the SBA will fully guarantee the loan and waive its typical fees. These “ARC loans” are interest-free to the borrower for the life of the loan. Repayment of the principal can be deferred for 12 months after the last disbursement of proceeds. Repayment of the total balance of the loan can extend for up to five years.

To be eligible, the borrower must have been in business for at least two years and be able to show that it was profitable at least one of the two years. If the firm was open for less than two years, it needs to have been profitable all of the time it was open.

You may ask, “Why would a business need a loan if it was “profitable?” Well, the answer is that the SBA is offering to help businesses with a bit of “relief funding” to help them get over the hump due to slowing sales that may make it harder to meet existing loan payments, vendor payments or even payroll.

So, if you think this may be of interest to you or a small business owner you may know, contact Barbara Berschler at Press, Potter & Dozier, LLC, (301) 913-5200. She will give you more particulars and put you in contact with a local bank that is interested in participating in this special loan program.

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