Part I
I am publishing here my article that I wrote back in April 2010 (with assistance from Leia Glasso, a law school student at Cardozo Law School) regarding where to incorporate a business. I decided to compare Delaware, Nevada and Woyming legislation since I have been receiving many inquiries as to how these three states compare in terms of their business legislation. I would like to warn, however, that none of the information below contains any legal advice and that I wrote this piece five months ago, so the laws of these states may have changed since then. That said, I hope you will still find the information below useful!
Introduction
It has become increasingly popular for companies to choose to abandon their home state and decide to incorporate out of state. However, not in all cases incorporating elsewhere represents the best decision for the business. This article discusses some advantages and disadvantages of incorporating in a state other than the home state, specifically focusing on the states of Nevada, Wyoming and Delaware.
Some lawyers are likely to believe that there is less risk of error or surprises when they recommend for their client to incorporate in the home state. This is due to two facts: first, they know the law and the accompanying case law already, and secondly, they are concerned about the cost and inconvenience of litigation in another jurisdiction.1 So when businesses do look out of state, what do they look for? In addition to the types of entities, availability of precedent and reliable court system, incorporation costs, annual fees and taxes, they also check to see how particular states deal with the issues of privacy, managerial liability and antitakeover provisions. This article aims to compare legislation in Delaware, Nevada and Wyoming in each of these areas.
It is commonly known that incorporating in Delaware has numerous advantages (as explained below). However, in recent years, other states have “waged aggressive and successful campaigns to attract corporate charters.”2 Among these states are Nevada and Wyoming. Small Business and Entrepreneurship Council ranked Nevada, Wyoming and Delaware as numbers 2, 3 and 34, respectively, in its Small Business Survival Index 2008, with lower rankings representing the most business-friendly states.3 So, how do these states really compare from the point of view of an entrepreneur?
Types of Entities
More than 882,000 companies are incorporated in Delaware, including approximately 64% of Fortune 500 companies and more than 50% of all public companies.4 In Delaware, one can incorporate a corporation, a close corporation (limited to 30 shareholders), a limited partnership (LP), a limited liability company (LLC), a limited liability partnership (LLP), a limited-liability limited partnership (LLLP)5 and a statutory trust. It is also possible to form a series LLC, where limited liability protection is provided across several “series”, each of which is insulated from the other (like a corporation with subsidiaries).6 Of 121,628 new entities formed in Delaware in 2008, 67% were LLCs, 24% were corporations, 6% were LPs/LLPs and 2% - statutory trusts.7
In recent years the number of companies incorporating in Nevada has skyrocketed: in 1994, 22,704 new companies incorporated in Nevada, whereas in 2006, a total of 84,207 companies incorporated there.8 In Nevada, one can register a corporation, a close corporation (limited to 30 shareholders), an LLC (including a series LLC) 9, an LP, an LLP, an LLLP and a business trust. Out of 84,207 new companies in 2006, 49% were LLCs, 47% were corporations, 3% were limited partnerships and the remaining 1% - limited liability partnerships and business trusts.
In Wyoming, one can form a corporation, a close corporation, an LLC, a close LLC, an LP, a registered limited liability partnership (a general partnership that registers in a limited liability form), an LLLP10 and a statutory trust. Wyoming was the first state to adopt an LLC statute in 1977. Close corporations and close LLCs were created for small or family-owned businesses and, similarly to close corporations, close LLCs include restrictions on interest transfer and withdrawal of capital contributions. 11
In addition to the more traditional entity choices, all three states allow for the creation of LLLPs, and Delaware and Nevada (but not Wyoming) allow creation of series LLCs. Like Nevada and Delaware, Wyoming provides for a formation of close corporations and, singularly, close LLCs, to best protect the interests of small and family-owned businesses.
Part II will compare the states’ court systems.
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1 Keith Paul Bishop, There are Many Benefits to Incorporating in Nevada, But Tax Avoidance Is not One of Them, LA Lawyer (Nov. 2008).
2 Bishop, supra note 1.
3 Small Business and Entrepreneurship Council, Small Business Survival Index 2008 (13th edition), available at http://www.sbecouncil.org/uploads/sbsi%202008[1].pdf (last visited Mar. 25, 2010).
4 Delaware Division of Corporations 2008 Annual Report (June 29, 2009), available at http://corp.delaware.gov/2008AR.pdf (last visited Mar. 25, 2010).
5 An LLLP is a relatively recent form of entity (currently only 18 states have adopted LLLP statutes), where general partners can also enjoy limited liability for debts and obligations of the limited partnership. In a traditional limited partnership, only the limited partners have limited liability and are not responsible for the debts and obligations of the partnership beyond their capital contributions while the general partners are jointly and severally liable.
6 Each LLC may hold its separate assets, have different purposes, incur liabilities, have different members and managers and enjoy limited liability protection, while the series LLC pays one filing fee and files one yearly income tax return. Delaware was the first state to approve a series LLCs, since joined by eight other states. However, the federal tax treatment of a series LLC has not been fully resolved and there are questions as to the treatment of series LLCs in other states that do not statutorily provide for such entity.
7 See Delaware Division of Corporations 2008 Annual Report, supra note 6.
8 Nevada Secretary of State, Filing Statistics, available at http://nvsos.gov/index.aspx?page=147 (last visited Mar. 25, 2010).
9 See NEV. REV. STAT. § 86.1255, Nev. Rev. Stat. § 86.161(1)(e) (2005).
10 See WYO. STAT. ANN. § 17-14-202, 301, 503(c) (1971).
11 The main characteristics of a Wyoming close corporation include: no more than 35 shareholders, limitations on share transfers, buy-out provisions in case of deceased shareholders, and relaxed corporate governance standards (no need for a board of directors or annual meetings). See “Choice is Yours” available at http://soswy.state.wy.us/Forms/Publications/ChoiceIsYours.pdf (Apr. 2009) (last visited Mar. 25, 2010).
Monday, October 11, 2010
Sunday, October 10, 2010
Work-for-Hire: what’s the big deal about it?
A lot has been said and written about why businesses need to have work-for-hire agreements with their freelancers. Yet I find that some of my clients and business owners I meet at networking receptions have no idea what I am talking about and why anyone would need this additional piece of paperwork. I agree, the reason for having work-for-hire agreements is somewhat counterintuitive and it has to do with copyright law. The U.S. Constitution grants the initial copyright in a work to its creator. As usual, there is an exception that applies to work made for hire: (1) if an employee creates the work as part of his or her job, then the copyright vests in the employer, and (2) if the parties expressly agree that the work is work made for hire and it falls within one of nine categories, then the copyright vests in the person/entity that commissioned the work.
So, let’s imagine a scenario where a business owner hires an independent contractor to create website content for his business and pays him for this one-time project. It would be natural to assume that the business owner owns the copyright to the end result since he paid for it. However, this is not automatically the case because the independent contractor has a constitutionally protected copyright to the content that he has created. He is also not an employee, so the first exception does not apply. The only thing that would protect the business owner is a work-for-hire agreement that he has (hopefully) entered into with the independent contractor, in which the independent contractor (the original creator) transferred his intellectual property rights to the business owner. I hope now you see the importance of these agreements.
The U.S. Copyright Act of 1976 defines work made for hire as “(1) a work prepared by an employee within the scope of his or her employment; or (2) a work specially ordered or commissioned . . . . . , if the parties expressly agree in a written instrument signed by them that the work shall be considered a work made for hire.”
One further limitation: a work for hire must come within one of the nine categories listed below: (1) a contribution to a collective work, (2) a part of a motion picture or other audiovisual work, (3) a translation, (4) a supplementary work, (5) a compilation, (6) an instructional text, (7) a test, (8) an answer material for a test, or (9) an atlas.
In all other circumstances, there needs to be an additional assignment or licensing provision to make the assignment effective. There is room for negotiation, of course, as licenses can be made exclusive or nonexclusive, worldwide or limited to a certain geographic location, granted in perpetuity or limited to a certain amount of time, royalty-free or otherwise...
An additional question may arise as to whether the person who created the work was in fact an employee or an independent contractor. But this is a topic for another blog.
So, let’s imagine a scenario where a business owner hires an independent contractor to create website content for his business and pays him for this one-time project. It would be natural to assume that the business owner owns the copyright to the end result since he paid for it. However, this is not automatically the case because the independent contractor has a constitutionally protected copyright to the content that he has created. He is also not an employee, so the first exception does not apply. The only thing that would protect the business owner is a work-for-hire agreement that he has (hopefully) entered into with the independent contractor, in which the independent contractor (the original creator) transferred his intellectual property rights to the business owner. I hope now you see the importance of these agreements.
The U.S. Copyright Act of 1976 defines work made for hire as “(1) a work prepared by an employee within the scope of his or her employment; or (2) a work specially ordered or commissioned . . . . . , if the parties expressly agree in a written instrument signed by them that the work shall be considered a work made for hire.”
One further limitation: a work for hire must come within one of the nine categories listed below: (1) a contribution to a collective work, (2) a part of a motion picture or other audiovisual work, (3) a translation, (4) a supplementary work, (5) a compilation, (6) an instructional text, (7) a test, (8) an answer material for a test, or (9) an atlas.
In all other circumstances, there needs to be an additional assignment or licensing provision to make the assignment effective. There is room for negotiation, of course, as licenses can be made exclusive or nonexclusive, worldwide or limited to a certain geographic location, granted in perpetuity or limited to a certain amount of time, royalty-free or otherwise...
An additional question may arise as to whether the person who created the work was in fact an employee or an independent contractor. But this is a topic for another blog.
Tuesday, October 5, 2010
Proposed IRS Regulations on Series LLC
What is a series LLC?
A series LLC is a relatively new entity form that provides for the creation of multiple LLCs under the umbrella of one organization, like a corporation with multiple subsidiaries. This entity form was first enacted in Delaware in 1996, and is sometimes known as Delaware LLC. Creating a series LLC allows for limited liability protection across all “series” or “cells”, thus protecting each cell from the liability that may arise in another cell. It is commonly used in real estate, where each property can be held in a separate LLC cell, whereas the owner owns just one company. So far, nine states (Delaware, Illinois, Iowa, Nevada, Oklahoma, Tennessee, Texas, Utah, Wisconsin) and Puerto Rico have adopted legislature providing for the creation of series LLC. Although all these states provide for a significant degree of separateness for individual cells (each cell can own its distinct business purpose, assets, liabilities, different managers and members), most do not provide for all attributes of a separate entity. Therefore, cells are ordinarily treated as a single entity for state law purposes (typically, a series LLC would pay just one filing fee).
What do proposed regulations say?
On September 13, 2010, the IRS released proposed regulations governing the federal tax treatment of cells within a series LLCs. The main question that the IRS aimed to clarify was whether for Federal tax purposes each cell of a series LLC should be treated as a separate entity or whether the series LLC (including all its cells) should be treated as a single entity (like under state law).
The proposal is to treat each cell as a separate entity formed under local law, regardless of whether or not the state law treats such cell as a separate legal entity. The tax treatment of each cell will be determined by check-the-box regulations. So, for example, if a series LLC has two cells, one with two partners and the second one with one partner, the first cell will be treated as a partnership for the federal tax purposes, whereas the second cell will be treated as a disregarded entity.
IRS proposed regulations can be found here: http://www.journalofaccountancy.com/Web/20103328.htm.
How will the proposed regulations affect series LLC as the entity choice going forward?
Once adopted, the regulations will provide much needed guidance and clarity for the tax payers. At the same time, the regulations add additional complexity for LLC series owners since each cell will be required to file its separate tax returns and annual information statements with the IRS. However, it seems that despite this added complexity, the series LLC will remain an attractive option for those business owners who want to form multiple limited liability companies while paying only one filing fee.
A series LLC is a relatively new entity form that provides for the creation of multiple LLCs under the umbrella of one organization, like a corporation with multiple subsidiaries. This entity form was first enacted in Delaware in 1996, and is sometimes known as Delaware LLC. Creating a series LLC allows for limited liability protection across all “series” or “cells”, thus protecting each cell from the liability that may arise in another cell. It is commonly used in real estate, where each property can be held in a separate LLC cell, whereas the owner owns just one company. So far, nine states (Delaware, Illinois, Iowa, Nevada, Oklahoma, Tennessee, Texas, Utah, Wisconsin) and Puerto Rico have adopted legislature providing for the creation of series LLC. Although all these states provide for a significant degree of separateness for individual cells (each cell can own its distinct business purpose, assets, liabilities, different managers and members), most do not provide for all attributes of a separate entity. Therefore, cells are ordinarily treated as a single entity for state law purposes (typically, a series LLC would pay just one filing fee).
What do proposed regulations say?
On September 13, 2010, the IRS released proposed regulations governing the federal tax treatment of cells within a series LLCs. The main question that the IRS aimed to clarify was whether for Federal tax purposes each cell of a series LLC should be treated as a separate entity or whether the series LLC (including all its cells) should be treated as a single entity (like under state law).
The proposal is to treat each cell as a separate entity formed under local law, regardless of whether or not the state law treats such cell as a separate legal entity. The tax treatment of each cell will be determined by check-the-box regulations. So, for example, if a series LLC has two cells, one with two partners and the second one with one partner, the first cell will be treated as a partnership for the federal tax purposes, whereas the second cell will be treated as a disregarded entity.
IRS proposed regulations can be found here: http://www.journalofaccountancy.com/Web/20103328.htm.
How will the proposed regulations affect series LLC as the entity choice going forward?
Once adopted, the regulations will provide much needed guidance and clarity for the tax payers. At the same time, the regulations add additional complexity for LLC series owners since each cell will be required to file its separate tax returns and annual information statements with the IRS. However, it seems that despite this added complexity, the series LLC will remain an attractive option for those business owners who want to form multiple limited liability companies while paying only one filing fee.
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