Franchising Basics

Before investing in any franchise system, be sure to get a copy of the franchiser's disclosure document, also known as the Franchise Offering Circular. Under the FTC's Franchise Rule, you must receive the document at least 10 business days before you are asked to sign any contract or pay any money to the franchiser. You should read the entire disclosure document and make sure you understand all of the provisions. The following topics will help you to understand key provisions of a typical disclosure document as well as to ask questions about the disclosure. Get a clarification or answers to your concerns before you invest.

Business Background

The disclosure document identifies the executives of the franchise system and describes their prior experience. Consider not only their general business background, but their experience in managing a franchise system. Also consider how long they have been with the company. Investing with an inexperienced franchiser may be riskier than investing with an experienced one.

Litigation History

The disclosure document helps you assess the background of the franchiser and its executives by requiring the disclosure of prior litigation. The disclosure document tells you if the franchiser or any of its executive officers:

Have been convicted of felonies, for example, fraud

Have been convicted of any violation of franchise law

Have been convicted of unfair or deceptive law practices

Are subject to any state or federal injunctions involving similar misconduct

It also will tell you if the franchiser or any of its executives have been held liable or settled a civil action involving the franchise relationship.

A number of claims against the franchiser may indicate that the company has not performed according to its agreements, or, at the very least, that franchisees have been dissatisfied with the franchiser's performance. Be aware that some franchisers may try to conceal an executive's litigation history by removing the individual's name from their disclosure documents.

Bankruptcy

The disclosure document tells you if the franchiser or any of its executives have recently been involved in a bankruptcy. This will help you to assess the franchiser's financial stability and general business acumen as well as predict if the company is financially capable of delivering promised support services.

Costs

The disclosure document tells you the costs involved to start one of the company's franchises. It will describe any initial deposit or franchise fee, which may be nonrefundable, and costs for initial inventory, signs, equipment, leases or rentals. Be aware that there may be other undisclosed costs. Use the following checklist to help inquire about potential costs to you as a franchisee.

Continuing royalty payments

Advertising payments, both to local and national advertising funds

Grand opening or other initial business promotions

Business or operating licenses

Product or service supply costs

Real estate and leasehold improvements

Discretionary equipment such as a computer system or business alarm system

Training

Legal fees

Financial and accounting advice

Insurance

Compliance with local ordinances, such as zoning, waste removal, and fire and other safety codes

Health insurance

Employee salaries and benefits

It may take several months or longer to get your business started. Consider in your total cost estimate for operating expenses for the first year and personal living expenses for up to two years. Compare your estimates with what other franchisees and competing franchise systems have paid. Perhaps you can get a better deal with another franchiser. An accountant can help you to evaluate this information.

Restrictions

Your franchiser may restrict how you operate your outlet. The disclosure document tells you if the franchiser limits: the supplier(s) of goods that you may purchase from, the goods or services you may offer for sale, the customers to whom you can offer goods or services, the territory in which you can sell goods or services, and understand that restrictions may limit the way you want to do your business.

Terminations

The disclosure document tells you the conditions under which the franchiser may terminate your franchise and your obligations to the franchiser after termination. It also tells you the conditions under which you can renew, sell or assign your franchise to other parties.

Training and Other Assistance

The disclosure document will explain the franchiser's training and assistance program. Make sure you understand the level of training offered. The following checklist will help you ask the right questions.

How many employees are eligible for training?

Can new employees receive training and, if so, is there any additional costs?

How long are the training sessions?

How much time is spent on technical, business management and marketing training?

Who teaches the training courses and what are their qualifications?

What type of ongoing training does the company offer and at what cost?

Whom can you speak to if problems arise?

How many support personnel are assigned to your area?

How many franchisees will the support personnel service?

Will someone be available to come to your franchised outlet to provide more individual assistance?

The level of training you need depends on your own business experience and knowledge of the franchiser's goods and services. Keep in mind that a primary reason for investing in the franchise, as opposed to starting your own business, is training and assistance. If you have doubts that the training might be insufficient to teach you how to handle day-to-day business operations, consider another franchise opportunity more suited to your background.

Advertising

You often must contribute a percentage of your income to an advertising fund even if you disagree with how these funds are used. The disclosure document provides information on advertising costs. The checklist below will help you assess whether the franchiser's advertising will benefit you.

How much of the advertising fund is spent on administrative costs?

Are there other expenses paid from the advertising fund?

Do franchisees have any control over how the advertising dollars are spent?

What advertising promotions has the company engaged in?

What advertising developments are expected in the near future?

How much of the fund is spent on national advertising?

How much of the fund is spent on advertising in your area?

How much of the fund is spent on selling more franchises?

Do all franchisees contribute equally to the advertising fund?

Do you need the franchiser's consent to conduct your own advertising?

Are there rebates or advertising contribution discounts if you conduct your own advertising?

Does the franchiser receive any commissions or rebates when it places advertisements?

Do franchisees benefit from such commissions or rebates, or does the franchiser profit from them?

Current and Former Franchisees

The disclosure document provides important information about current and former franchisees.

Determine how many franchises are currently operating (a large number of franchisees in your area may mean increased competition).

Pay attention to the number of terminated franchisees (a large number of terminated, canceled, or non-renewed franchises may indicate problems).

Be aware that some companies may try to conceal the number of failed franchisees by repurchasing failed outlets and then listing them as company-owned outlets. If you buy an existing outlet, ask the franchiser how many owners operated that outlet and over what period of time.

Having a number of different owners over a short period of time may indicate that the location is not a profitable one or that the franchiser has not supported that outlet with promised services.

Use the following questions to help you ask current and former franchisees for valuable information.

How long has the franchisee operated the franchise?

Where is the franchise located?

What was their total investment?

Were there any hidden or unexpected costs?

How long did it take them to cover operating costs and earn a reasonable income?

Are they satisfied with the cost, delivery, and quality of the goods or services sold?

What were their backgrounds prior to becoming a franchisee?

Was the franchiser's training adequate?

What ongoing assistance does the franchiser provide?

Are they satisfied with the franchiser's advertising program?

Does the franchiser fulfill its contractual obligations?

Would the franchisee invest in another outlet?

Would the franchisee recommend the investment to someone with your goals, income requirements, and background?

Be aware that some franchisers may give you a separate reference list of selected franchisees to contact.  Those on the list may be individuals who are paid by the franchiser to give a good opinion of the company.

Earnings Potential

You will want to know how much money you can make if you invest in a particular franchise system. Be careful; earnings projections can be misleading. Insist upon written substantiation for any earnings projections or suggestions about your potential income or sales.

Franchisers are not required to make earnings claims, but if they do, the FTC's Franchise Rule requires franchisers to have a reasonable basis for these claims and to provide you with a document that substantiates them. This substantiation includes the bases and assumptions upon which these claims are made. Make sure you get and review the earnings claims document. Consider the following when reviewing any earnings claims.

Sample Size. A franchiser may claim that franchisees in its system earned, for example, $50,000 last year. This claim may be deceptive, however, if only a few franchisees earned that income and it does not represent the typical earnings of franchisees. Ask how many franchisees were included in the number.

Average Incomes. A franchiser may claim that the franchisees in its system earn an average income of, for example, $75,000 a year. Average figures like this tell you very little about how each individual franchisee performs. Remember, a few very successful franchisees can inflate the average. An average figure may make the overall franchise system look more successful than it actually is.

Gross Sales. Some franchisers provide figures for the gross sales revenues of their franchisees. These figures, however, do not tell you anything about the franchisees' actual costs or profits. An outlet with a high gross sales revenue on paper actually may be losing money because of high overhead, rent and other expenses.

Net Profits. Franchisers often do not have data on the net profits of their franchisees. If you do receive net profit statements, ask whether they provide information about company-owned outlets. Company-owned outlets might have lower costs because they can buy equipment, inventory and other items in larger quantities, or may own, rather than lease, their property.

Geographic Relevance. Earnings may vary in different parts of the country. An ice cream store franchise in a southern state, such as Florida, may expect to earn more income than a similar franchise in a northern state, such as Minnesota. If you hear that a franchisee earned a particular income, ask where that franchisee is located.

Franchisee's Background. Keep in mind that franchisees have varying levels of skills and educational backgrounds. Franchisees with advanced technical or business backgrounds can succeed in instances where more typical franchisees cannot. The success of some franchisees is no guarantee that you will be equally successful.

Financial History

The disclosure document provides you with important information about the company's financial status, including audited financial statements. Be aware that investing in a financially unstable franchiser is a significant risk; the company may go out of business or into bankruptcy after you have invested your money.

Hire a lawyer or an accountant to review the franchiser's financial statements. Do not attempt to extract this important information from the disclosure document unless you have considerable background in these matters. Your lawyer or accountant can help you understand the following.

Does the franchiser have steady growth?

Does the franchiser have a growth plan?

Does the franchiser make most of its income from the sale of franchises or from continuing royalties?

Does the franchiser devote sufficient funds to support its franchise system?

Commercial Lease Basics for Small Business

Your business location is an important decision, and if you will not be starting up in your home, you will need to lease a space to conduct your day-to-day activities. Leasing a commercial office space is one of the largest expenses made by new and expanding businesses. Commercial leases are often negotiated, and there is no standard for commercial leases. It's recommended that you get a lawyer's help to make sure you get the best deal.

Every commercial lease should be in writing and include the following details:

Rent, including any increases (called escalations).

Length of the lease.

Conditions under which the lease may be renewed.

Whether or not the tenant is responsible for paying utilities, such as phone, electricity and water.

Whether or not the tenant is responsible for paying any of the landlord's maintenance expenses, property taxes or insurance costs, and if so, how they'll be calculated.

Any required deposit and whether you can use a letter of credit instead of cash.

A description of the space you're renting, square footage, available parking, other amenities and the condition the facility is in.

A detailed listing of any improvements the landlord will make to the space before you move in.

Any representations made to you by the landlord or leasing agent, such as amount of foot traffic, average utility costs, restrictions on the landlord renting to competitors (such as in a shopping mall), compliance with Americans with Disabilities Act requirements, etc.

Assurances that the space is zoned appropriately for your type of business.

Ability to sublease or assign the lease to someone else, and if so, under what conditions.

How either tenant or the landlord can terminate the lease and the consequences.

Research the going rate for office space in the neighborhood, and talk with other tenants in the area. This will help determine your negotiating price.

Have a good idea of realistic escalations. Escalations should be for specific dollar amounts or tied to a known method of calculation, such as consumer price (cost of living) indexes.

Keep in mind that a shorter lease means less commitment for you, but less predictability for the property owner. Going with a longer lease gives you more negotiating power, but you'll want to be certain you've carefully considered your location. You may want to be prepared to negotiate lower rents for a longer commitment. If you have a month-to-month lease, you'll want to make sure the landlord gives you as much time as possible when terminating the lease. Under what conditions can either party free themselves from the lease and what notice requirements are needed? Also, your landlord may be more willing to make additional improvements if you're signing a longer lease.

Consider negotiating reduction in rent payments for improvements you agree to make to the property.

Check with your local zoning authority to make sure the property is properly zoned for your type of business.

Negotiate the ability to sublease so if the location is not working out, you can move with as little financial pain as possible.

When it comes time to renegotiate your commercial lease, you'll want to document your reasons for a lower rent or more space improvements with hard facts regarding lower foot traffic than represented, a downturn in your industry, and so forth. Some landlords will even be willing to take a percentage of your sales instead of a flat rental fee when economic times are slow.

As a tenant, you have far more leeway when negotiating a commercial lease rather than with a residential lease, which is one reason why having your own lawyer to represent you in negotiations is so important. A lawyer can also research zoning laws and local ordinances, and fill you in on the local real estate market conditions and customs.

Business Registration Requirements

Whether you are starting a new business or expanding an existing business, these basic steps will help ensure that you have all the necessary licenses, permits and registrations to legally operate.

1. Determine and Register the Legal Structure of Your Business

First, you need to organize your business as a legal entity. There are several options to consider, including a limited liability company, a sole proprietor or a partnership, each of which have different legal, financial and tax considerations. As you review your legal structure options, you’ll need to consider a number of factors, including the level of control you want to have, your business' vulnerability to lawsuits and financing needs. Visit the Incorporating Your Business page to learn more.

Once you have determined a structure, read more about how to register and file paperwork your business with state agencies.

2. Register Your Business Name

If you choose to name your business with a fictitious name or name other than your full name, then you will need to register it with the appropriate state government authorities as a “Doing Business As” name.

3. Obtain Your Federal Tax ID

If you have employees or are structured as a business partnership or corporation (and other types of organizations), you’ll need to obtain an Employer Identification Number (EIN) or Employer Tax ID from the IRS for tax reporting purposes. Visit the IRS website to find out if you need an EIN.

4. Obtain State Tax IDs

Just as you must have a Federal Tax ID, you will also need to obtain tax IDs and permits from your state's revenue agency to cover obligations such as sales, income and employment taxes. Visit the State and Local Tax page to learn more about these registration requirements.

5. Obtain Licenses and Permits

Most businesses are required to obtain some type of business license or permit to legally operate. You may also need to obtain a federal license if your business is involved in activities supervised and regulated by a federal agency.

Florida Economic Development Bill

On March 28, 2012, Florida Governor Rick Scott signed legislation that: increases the corporate income and bank franchise tax exemption, allows manufacturers to more easily qualify for a sales tax exemption on machinery and equipment and modifies other sales tax exemptions, eliminates the intangible tax on certain government leases, modifies the tax rate on the severance of phosphate rock, and modifies the application of the oil production tax.

Big Oil Tax Subsidy Update

On March 29, the Senate by a vote of 51 to 47 failed to garner the necessary votes to invoke cloture (i.e., cut off debate) on S. 2204, the “Repeal Big Oil Tax Subsidies Act.” The vote effectively kills the bill, which would have repealed five tax subsidies for the five largest integrated oil and gas companies, and used the resulting revenue to extend expired and expiring renewable energy tax incentives.

Congress Passes Extension to Highway Bill

On March 29, both the House of Representatives and the Senate passed H.R. 4281, the “Surface Transportation Extension Act of 2012.” Thus, the bill is ready for the President's signature. Among other things, the bill provides for a short-term extension of various highway related excise tax provisions. For example, the bill would extend through June 30, 2012, excise taxes on: (1) fuel used by certain buses, (2) certain alcohol fuels, (3) gasoline (other than aviation gasoline) and diesel fuel or kerosene, (4) certain heavy trucks and trailers, and (5) tires. Without Congressional action, these taxes would have expired at the end of March.

Ways & Means Approves Small Business Cut Act

The House Ways and Means Committee votes 21-14 to approve legislation that would give businesses with fewer than 500 employees a tax deduction of up to 20 percent of taxable income, clearing the way for the bill to move to the House floor. The Small Business Tax Cut Act (H.R. 9) was introduced by House Majority Leader Cantor and is being pushed as a way to give a temporary, one-year hiring incentive to businesses, though Democrats have criticized the measure as overly broad and too expensive since it was offered without any way to offset its $46 billion cost.

Utah Life Science &Technology Tax Credit

Effective retroactively for tax years beginning on or after 01/01/2012 , SB 23 makes various changes to the life science and technology credits. The legislation repeals the nonrefundable individual income tax credit for capital gain transactions related to a life science establishment, previously available for transactions occurring on or after January 1, 2011 that resulted in short or long-term capital gains. Regarding the nonrefundable tax credit against the individual income tax for investment in certain life science establishments, the legislation provides that if an eligible claimant is a pass-through entity taxpayer that files a corporate franchise and income tax return, the eligible claimant can claim the tax credit on the corporate franchise and income tax return. Regarding the refundable technology and life science credit for business entities that increase state tax revenues allowed against individual and corporate income tax, the legislation provides that the tax credit for an eligible business entity (EBE) that enters into a qualifying agreement may not exceed: (1) for the tax year in which the EBE business first generates eligible new state tax revenues and the two following years, the amount of eligible new state tax revenues generated by the EBE; (2) for the seven tax years following the last of the three tax years, 75% of the amount of eligible new state tax revenues generated by the EBE. Also, the Office of Economic Development (Office) can only issue a tax credit certificate to an applicant if the agreement with the Office includes a provision that the applicant will make new capital expenditures of at least $1 million in Utah and the applicant makes such expenditures in accordance with the agreement. With regards to the application process for the life science and technology credits, the Office can only issue tax credits certificates to the extent that the legislature expressly authorizes it by statute to issue certificates for a fiscal year. The Office must determine quarterly the tax credit applicants to which a tax credit may be provided and the amount of the credit. If the total amount of tax credit certificates the Office issues in a quarter of a fiscal year is less than the amount of tax credits the Office may issue in that quarter, the Office may issue the remaining amount of the certificates in a following quarter. For fiscal year 2011-12 only, if the total amount of tax credit certificates the Office issues in fiscal year 2011-12 is less than the amount of tax credit certificates the Office may issue for the fiscal year, the Office can issue the remaining amount of the certificates in a later fiscal year. A tax credit applicant can apply to the Office to receive a tax credit certificate by filing an application with the Office on or before the quarterly deadline established by the Office by rule. The Office can issue tax credit certificates for the first tax year in which the applicant enters into an agreement with the office and the nine immediately following tax years (previously two following tax years).

Utah Alternative Energy Development Act

Effective generally 05/08/2012 and as noted, SB 65 repeals the Alternative Energy Development Act, which created renewable energy development zone tax credits, and enacts the Alternative Energy Development Tax Credit Act and Alternative Energy Manufacturing Tax Credit Act providing alternative energy entities a nonrefundable alternative energy development tax credit and a nonrefundable alternative energy manufacturing tax credit, respectively. The credit under either program is in the amount listed on a tax credit certificate issued by the Governor's Office of Economic Development and cannot exceed 100% of new state revenues expected to be generated by the activity by the applicant. Either credit may be carried forward for a period that does not exceed the next seven taxable years. “Alternative energy entity” means a person that conducts business within Utah and enters into an agreement with the Governor's Office of Economic Development that qualifies the person to receive the tax credit. An alternative energy entity includes pass-through entities. “Alternative energy” means biomass energy, geothermal energy, hydroelectric energy, solar energy, wind energy, or energy that is derived from coal-to fuels, nuclear fuel, oil-impregnated diatomaceous earth, oil sands, oil shale, or petroleum coke. “Alternative energy manufacturing project” means a project produced by an alternative energy entity if the project involves a new or expanding operation in Utah of a new or expanding alternative energy entity and the manufacturing of machinery or equipment used directly in the production of alternative energy. The new credits are effective retroactive to taxable years beginning on or after January 1, 2012.

Utah Reduces R&D Tax Credit

Effective generally retroactive to 01/01/2012, Utah has reduced the additional tax credit for qualified research expenses to 7.5% of the taxpayer's qualified research expenses for the current taxable year from 9.2%. The basic research tax credit of 5% of a taxpayer's qualified research expenditures is unaffected.

Exemption Allowed for Elderly Housing in Michigan

Effective 03/27/2012, HB 4618 allows the Michigan Department of Treasury to grant for 2012 and the three preceding years an exemption allowed for nonprofit housing for the elderly or disabled, if the property would have qualified for the exemption if the property owner had timely filed in 2010 the required application form. If the granting of the exemption under this provision results in an overpayment of tax, a rebate, including any interest paid, must be made to the taxpayer by the local tax collecting unit or county treasurer (whichever has possession of the tax roll) within 30 days of the date the exemption is granted. The rebate would be without interest.

Deregulation of Wall Street - The JOBS Act

The Jumpstart Our Business Startups Act is a bipartisan bill that will drastically alter the landscape of equity investment and ease the registration and compliance requirements with the Securities and Exchange Commission.  Principally, there are three significant provisions of the JOBS Act that are purported to spur company growth and create jobs through ease of equity investment and securities deregulation.

First, the JOBS Act opens up opportunities for equity investment. Though crowdfunding was not previously illegal, it had limitations, namely that someone wanting to put money into a new venture had to do so either gratuitously or in exchange for some product or service. The JOBS Act effectively removes these limitations and allows small businesses to crowdfund equity investments, which should draw more investors into the trend.  I suppose, more equity investors provide more startups access to capital and enable more startups to move products and services towards commercial deployment; but the likelihood of investor abuse is significant.

Second, the JOBS Act also eases rules on public disclosures. Previously, private companies with over 500 shareholders and $10 million in assets were required to comply with SEC public disclosure rules.  The JOBS Act increases that number to 2,000 shareholders, which should give companies the ability to seek more funding and time to plan for an IPO.  While this provision will exempt many companies from some SEC regulation, it will also exempt many companies from SEC regulation.  While the SEC is not perfect, it can act as an agent for the protection of investors.  Removing a significant segment of companies from this type of oversight and these reporting requirements has the potential to lead to more cases of securities fraud.

Finally, going public is easier under the JOBS Act. The JOBS Act creates "emerging growth companies", those businesses with less than $1 billion in revenue. Emerging growth companies that wish to go public are exempt from some Dodd-Frank rules, and have fewer financial reporting requirements when filing an IPO.  I have always been under the assumption that going public was something to help in rather high regard.  The JOBS Act, on some level, compromises the exclusivity of Wall Street, which I guess is the intended result; but lessening the compliance burden on publicly traded companies in the wake of the collapse of the capital markets may not be the best way to reach that objective.

House Passes JOBS Act

The House overwhelmingly approved a measure Tuesday designed to make it easier for growing companies to attract investors and comply with securities laws. The bipartisan measure, strongly backed by both parties and the White House, passed 380 to 41.

The Jumpstart Our Business Startups Act, or JOBS Act, first passed the House earlier this month with wide bipartisan margins and the Senate approved it last week after adding amendments that provide additional safeguards on “crowdfunding” to prevent credit scams. The House needed to approve the changes before sending it to the White House for President Obama’s signature.

Utah Governor Signs LIHTC Bill

Utah Gov. Gary Herbert last week signed H.B. 75 to require low-income housing tax credit (LIHTC) property owners to annually provide certain information to county assessors. Under the new law, owners must provide rent rolls and a financial operating statement for the prior year, a signed statement that the property continues to meet LIHTC requirements, and financing terms and agreements for the property. Owners who fail to provide this information before April 30 of each year will be subject to a penalty equal to the greater of $250 or 5 percent of the tax due on the property for that year. The law will take effect on January 1, 2013.

IRS Announces Tax Credit Ceilings

On March 26, 2012, the Internal Revenue Service (IRS) released its 2012 Calendar Year Resident Population Estimates. These figures are used to determine states' 2012 low-income housing tax credit (LIHTC) ceilings and tax-exempt private activity bond caps. Each state's LIHTC ceiling in 2012 is equal to the greater of $2.20 multiplied by the state population or $2,525,000; a state's tax-exempt bond volume cap will be the greater of $95 multiplied by the state population or $284,560,000. Notice 2012-22 includes the population estimates for each state, territory and insular area.

Ohio Approves Loan to Abbot

Ohio development leaders approved a $1.5 million loan for Abbott Laboratories, which it plans to put toward machinery and equipment for its upcoming Tipp City plant, the pharmaceutical giant's first Dayton-area operation.

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Amazon Creating 1,000 Jobs

Online retailer Amazon.com Inc. will bring more than 1,000 jobs to the Louisville area as it builds a fulfillment center in Jeffersonville, Ind.  The facility will represent a $150 million investment. It will open next fall, and employment is expected to reach 1,050 by 2015, according to a news release.

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Army to Invest $7 Billion in Renewables

The U.S. Army reported on March 19 that it will partner with industry to invest up to $7 billion over the next 10 years in renewable energy sources, including wind, solar, biomass, and geothermal energy. The military department has released a draft request for proposal (RFP) that could allow multiple projects to begin nationwide. The draft RFP indicates that the Army intends to primarily purchase renewable-generated electricity through power purchase agreements with the project developers.

The investment will help the Army reach its goal of having 25% of its estimated 2.5 million megawatt hours come from renewable sources by 2025. In addition to energy conservation, installations will strive to establish alternative forms of energy that will allow them to "island" or continue to operate should the power grid fail.

The Army's Energy Initiatives Task Force (EITF) serves as the central managing office to plan and execute large-scale renewable energy projects of greater than 10 megawatts (roughly enough to power 30,000 homes) on Army installations, which will be accomplished by leveraging private-sector financing. A renewable-energy project guide will be issued for comment later in the spring.

The task force has been working closely with the U.S. Army Corps of Engineers to develop a request for proposal under the Multiple Award Order Contract (MATOC). The MATOC provides a two-step process. In the first step, companies submit initial proposals and qualifications that are not project-specific.

Biomass Research & Development Initiative Announced

Recently, President Obama announced up to $35 million over three years to support research and development in advanced biofuels, bioenergy and high-value biobased products. The projects funded through the Biomass Research and Development Initiative (BRDI), a joint program through the U.S. Department of Agriculture (USDA) and the U.S. Energy Department (DOE), will help develop economically and environmentally sustainable sources of renewable biomass and increase the availability of renewable fuels and biobased products that can help replace the need for gasoline and diesel in vehicles and diversify our energy portfolio.

For fiscal year 2012, applicants seeking BRDI funding must propose projects that integrate science and engineering research in the following three technical areas that are critical to the broader success of alternative biofuels production:

Feedstock Development: Funding will support research, development, and demonstration activities for improving biomass feedstocks and their supply, including the harvest, transport, preprocessing, and storage necessary to produce biofuels and biobased products.

Biofuels and Biobased Products Development: Research, development, and demonstration activities will support cost-effective technologies to increase the use of cellulosic biomass in the production of biofuels and biobased products. Funding will also support the development of a wide range of technologies to produce various biobased products, including animal feeds and chemicals that can potentially increase the economic viability of large-scale fuel production in a biorefinery.

Biofuels Development Analysis: Projects will develop analytical tools to better evaluate the effects of expanded biofuel production on the environment and to assess the potential of using federal land resources to sustainably increase feedstock production for biofuels and biobased products.

Integrating multiple technical areas in each project will encourage collaborative problem-solving approaches, enable grantees to identify and address knowledge gaps, and facilitate the formation of research consortia.

Subject to annual appropriations, USDA and DOE plan to contribute up to $35 million over three years for this year's BRDI solicitation. This funding is expected to support five to seven projects over three to four years.

Stock Redemptions

Although dividends are taxable to noncorporate taxpayers at capital gains rates, the advantage of structuring the redemption properly is that you are only taxed on the “gain,” i.e., you are not taxed on the portion of the cash attributable to your basis in the redeemed stock. The safest approaches for doing this are to structure a redemption that satisfies either the “substantially disproportionate redemption” test or the “complete termination of interest” test, as described below. In contrast, if you do not satisfy either of these tests, everything you receive (without subtracting your basis in the stock that is redeemed) may (depending on whether the redemption otherwise qualifies as not “substantially equivalent to a dividend”) be taxable as a dividend (at capital gains rates).

The purpose behind the substantially disproportionate redemption and the complete termination of interest tests is to provide safe-harbors for redemptions where the shareholder who receives cash from the corporation has a meaningful decrease in his or her stock ownership in the corporation.

Substantially Disproportionate Redemptions. For a redemption to qualify as substantially disproportionate: (1) your interest after the redemption (in both all voting stock and all common stock) must be less than 80% of your interest before the redemption and (2) you must possess less than 50% of the voting power of all voting stock after the redemption. Thus, if you owned 50% of the only class of stock of the corporation before the redemption, the test is satisfied if, after the redemption, your interest is less than 40% (80% times 50%). (Note that the arithmetic can be tricky. If, for example, you started out with 50 of 100 shares of the corporation's only class of stock and twelve shares (24%) were redeemed, your interest would not be reduced below 80% of the original 50% interest, as required, because the number of shares outstanding would also be reduced, so that you would own 38 of 88 shares, or 43% of the outstanding shares.)

Even if a redemption reduces your interest below 80% of your pre-redemption interest (the first part of the test), you won't satisfy the second part of the test unless your voting stock is reduced to less than 50%. Thus, for example, if you owned 70% of the corporation's one class of stock and a redemption reduced your interest to 55% (i.e., less than 80% of the original interest) you still wouldn't satisfy the second (less than 50% of voting power) test.

In applying the tests for a substantially disproportionate redemption, attribution rules discussed below apply.

Complete Termination of Interest. A redemption is also treated as giving rise to a sale, rather than a dividend, if it completely terminates your interest in the corporation. Although at first blush this appears to be a more difficult test to satisfy than the substantially disproportionate redemption test, the requirements for a complete termination can be satisfied by a waiver of family attribution, as described below. (However, other attribution rules are not waived.)

The attribution rules. In determining how much stock is owned before and after a redemption, “attribution” rules apply. These treat a shareholder as owning shares owned by certain family members as well as entities in which the shareholder has an interest. Thus, even if your actual ownership is sufficiently reduced by a redemption to qualify under one of the safe-harbor tests, you may fail to qualify if shares owned by other persons or entities are attributed to you.

1. Family attribution. A shareholder is treated as owning shares held by his spouse, parents, children, and grandchildren. Note that neither siblings nor grandparents are on this list.

However, in applying the complete termination of interest test (but not the substantially disproportionate test) family attribution won't apply if immediately after the redemption you don't have any interest in the corporation as a shareholder, officer, director or employee. (You can, however, retain an interest solely as a creditor.) You must also not acquire such an interest within ten years of the redemption (other than by bequest or inheritance). In addition, you must agree to notify IRS if you acquire an interest, certain records must be kept, and a special limitations period applies. Also, if you have transferred stock to family members from whom the stock is attributable to you (e.g., to children) within ten years of the redemption, the attribution rules will not be eliminated if income tax avoidance was a principal purpose of the transfer. (IRS has generally ruled that the tax avoidance rule does not apply where the transfer relates to a shareholder's plan to retire and turn the business over to family members.)

2. Entity attribution. A shareholder is treated as owning shares owned by a partnership, S corporation, trust, or estate, in proportion to his interest in the entity. Stock is also attributed through a regular (“C”) corporation if 50% or more of its stock is owned directly or indirectly by (or for) the shareholder.

3. Options. A person who owns an option to acquire stock (or a series of options) is treated as owning the stock.

4. Other rules. Stock owned by reason of applying one attribution rule may, under certain circumstances, be treated as actually owned for purposes of applying another attribution rule.

Nondeductibility of expenses. Keep in mind that no deduction is allowed to the corporation for any amount paid or incurred in connection with the reacquisition of its stock or the stock of any related person. This includes transactions treated as redemptions. However, interest and other fees on debt incurred to finance the redemption are deductible.

Stock Options

Many employees receive stock options as part of their compensation packages. From a tax standpoint, there are two kinds of options—statutory and nonstatutory. “Incentive stock options,” or ISOs, as they are commonly known, are statutory options, because they are specifically provided for in the Internal Revenue Code and are subject to numerous qualification requirements. Options that don't meet these requirements are nonstatutory stock options or NSOs (also known as nonqualified stock options or NQSOs).

Both kinds of options have tax advantages, but there are quite a few differences between them. Here's some basic information on the taxation of compensatory stock options that may help you better understand how best to benefit from them.

Option grant: If you have ISOs, you are not taxed on option grant. The same is generally true of NSOs. An NSO is taxed at grant only if it has a “readily ascertainable” fair market value (FMV), which is seldom the case. IRS rules say that an option doesn't have a readily ascertainable value at grant unless: (1) the option is actively traded or (2) (i) the option is immediately transferable; (ii) the option is fully exercisable; (iii) the option and the option stock are unrestricted; and (iv) the value of the “option privilege” is readily ascertainable. In the unlikely event that an NSO is taxable at grant, you have compensation income at that point.

The deferred compensation rules under Code Sec. 409A—which tax deferred compensation to the extent not subject to a “substantial risk of forfeiture” unless specific requirements are met—don't apply to the grant of an ISO. However, these rules can apply to the grant of an NSO, unless the exercise price can never be less than the underlying stock's FMV on the date the option is granted and certain other conditions are met.

Option exercise: No regular income tax is owed on the exercise of an ISO, but the alternative minimum tax (AMT) may apply. The bargain purchase element at exercise, which is the difference between the value of the ISO stock (i.e., stock acquired through the exercise of an ISO) at exercise and the lower price you pay for it, is considered to be income when figuring your AMT. Even if you're usually not subject to the AMT, exercising ISOs may push you into its range. (If you are subject to the AMT in the year you exercise ISOs, then you may be entitled to an AMT credit carryover for use in some later year.)

Any remuneration that arises when stock is transferred on the exercise of an ISO isn't subject to FICA or FUTA taxation.

When you exercise an NSO that wasn't taxed at grant, you're taxed at ordinary income rates on the difference between the value of the option stock at that time and the price you paid for it (plus any price you may have paid for the option, although generally that will be zero). This is compensation income that is subject to payroll taxes and income tax withholding. Taxes may be withheld from your salary or other compensation income, or you may have to sell some of the stock to cover the withholding or make some other arrangement with your employer.

However, if the option stock is nontransferable or subject to a substantial risk of forfeiture, then you aren't charged with compensation income until those restrictions no longer exist. In that case, you can choose to pay tax on exercise so that all gain from that point on would be capital gain.

Sale of option stock: When you sell ISO stock, you generally are taxed at favorable long-term capital gain rates on the difference between the price you paid for the stock and the amount you realize on its sale. However, if you sell the stock within two years of the option grant or within one year of the option exercise, you're hit with compensation income to the extent of your bargain element at exercise. The balance of your gain is capital gain, which will be taxed at favorable rates if you've held the stock for more than one year on the sale date.

It's important to know how long you need to hold the stock to qualify for long-term capital gain rates on the difference between the price you paid for the stock and the amount you realize on its sale or, if you don't hold the stock long enough for this favorable tax treatment, how much additional compensation income will be attributed to you. We can determine this from information on a statement from your employer. You should have received this statement by Jan. 31 following the close of the year in which you exercised the ISO.

If the option was exercised after Oct. 22, 2004, any income on disposition of the stock isn't subject to FICA or FUTA taxation. Additionally, any income resulting from a disqualifying disposition of stock acquired under an ISO isn't subject to withholding.

When you sell stock acquired by exercise of an NSO, you have capital gain if you were subject to tax either at option grant or exercise, or when restrictions on your option stock lapsed. Otherwise, you have compensation income at the time of the sale.

Gifts of options: Some people would like to give stock options to family members as part of their overall estate planning. Transferring property before it increases in value helps lower or eliminate estate and gift taxes.

This can't be done with ISOs, because they can't be transferred during the optionee's lifetime and can't be exercised by anyone but the optionee during his or her life.

NSOs have an edge here if the option plan allows options to be transferred to family members, as many plans now do. However, the IRS has ruled that an option transfer isn't complete for gift tax purposes until the option is no longer conditioned on the performance of future services. That usually means that the gift will be subject to gift tax at a time when the option's value has increased.

The IRS also has issued some complicated rules for valuing gifts of NSOs. For income tax purposes, a gift of NSOs to a family member isn't a disposition that triggers tax. Instead, the employee will be taxed when the transferee exercises the options.

Deducting Rent Paid to an Affiliate

In general, of course, rent paid on business or investment property is deductible. In fact, the tax code doesn't even specifically state that the rent must be “reasonable,” as it does for other deductions. However, transactions between “related parties” typically come under close scrutiny by IRS. And if rent paid to a related party is found to be “unreasonable,” the deduction will be reduced. In many such cases, the rent found to be excessive is recharacterized as a distribution of profits, or a gift, as the case may be. You will be in a better position to show that the rent paid in your transaction is reasonable if you take specific steps at the inception of the rental arrangement to support it.

Establishing fair rental value. A recommended way to establish that the rent in your transaction is reasonable is to show that it's in line with rent paid by unrelated parties for property that is comparable to yours. Accordingly, you should contact independent realtors or brokers to get appraisals based on comparable properties. The more, the better.

If the fair rental values you get in this fashion are below the amount you seek to set for your transaction, carefully document why your particular property should be valued higher. This may be the case for any number of reasons: improvements made to the property, special features or location, etc.

Rent is often viewed as a combination of a property's value with a reasonable rate of return. You may be able to justify setting a higher rent by showing that rates of return for your particular industry or investments run higher than elsewhere.

Percentage rentals. Taxpayers sometimes seek to set rent as a percentage of profits. This is a perfectly acceptable technique and can be used to protect against inflation or other risk factors. Where this approach is taken, however, there is a greater possibility that rents will reach unusually high levels, i.e., in particularly high income years. To protect against a potential IRS disallowance in such years, it's important to show that the percentage rental arrangement was reasonable when it was established. Accordingly, advance planning is even more strongly advised in these instances.

Where it's a usual practice to use percentage rentals for similar transactions, be sure to keep your arrangement in line with industry standards. Again, document through independent appraisals and analyses that the terms of your transaction are market-based when you initiate the arrangement. In this fashion, you will be in a far stronger position to justify any unusually high rents that arise in the future. Remember, in most cases with percentage rentals, it will be easier to establish that a particular period's rental amount is reasonable if you can show that the original rental arrangement was arrived at reasonably.

Formal lease. Be sure that your rental arrangement is set down in a formal written lease and is properly executed. Corporations should also take all appropriate formal action related to the transaction. Taxpayers often feel they can relax where the party they are dealing with is related and they don't anticipate future legal challenges. From the tax standpoint, however, it's even more important to undertake the proper formalities for these transactions in the event IRS seeks to disregard them. In several cases, rent paid to a related party has been disallowed because it wasn't required under a formal lease.

What is Reasonable Compensation?

As the owner of an incorporated business, you're probably aware that there's a tax advantage to taking money out of the corporation as compensation (salary and bonus) rather than as dividends. The reason is simple. A corporation can deduct the compensation that it pays, but not its dividend payments. Thus, if funds are withdrawn as dividends, they're taxed twice, once to the corporation and once to the recipient. Money paid out as compensation is taxed only once, to the employee who receives it.

However, there's a limit on how much money you can take out of the corporation in this way. The law says that compensation can be deducted only to the extent that it's reasonable. Any unreasonable portion is nondeductible and, if paid to a shareholder, may be taxed as if it were a dividend. As a practical matter, IRS rarely raises the issue of unreasonable compensation unless the payments are made to someone “related” to the corporation, such as a shareholder or a member of a shareholder's family.

How much compensation is “reasonable”? There's no simple formula. IRS tries to determine the amount that similar companies would pay for comparable services under like circumstances. Factors that are taken into account include: the employee's duties; the amount of time required to perform those duties; the employee's ability and accomplishments; the complexities of the business; the gross and net income of the business; the employee's compensation history; and the corporation's salary policy for all its employees.

There are a number of concrete steps you can take to make it more likely that the compensation you earn will be considered “reasonable,” and therefore deductible by your corporation. For example, you can:

Use the minutes of the corporation's board of directors to contemporaneously document the reasons for the amount of compensation paid. For example, if compensation is being increased in the current year to make up for earlier years in which it was too low, be sure that the minutes reflect this. (Ideally, the minutes for the earlier years should reflect that the compensation paid in those years was at a reduced rate.)

Avoid paying compensation in direct proportion to the stock owned by the corporation's shareholders. This looks too much like a disguised dividend, and will probably be treated as such by IRS.

Keep compensation in line with what similar businesses are paying their executives (and keep whatever evidence you can get of what others are paying—e.g., salary offers to your executives from comparable companies—to support what you pay if you are later questioned).

If the business is profitable, be sure to pay at least some dividends. This avoids giving the impression that the corporation is trying to pay out all of its profits as compensation.

Shareholder Guarantee of Loan in Close Corporation

Before you agree to act as a guarantor, endorser, or indemnitor of a debt obligation of your closely held corporation, you should be aware of the possible tax consequences if your corporation defaults on the loan and you are required to pay principal or interest under your guarantee agreement.

If you are compelled to make good on the obligation, the payment of principal or interest in discharge of the obligation generally results in a bad debt deduction. The deduction may be either a business bad debt deduction or a nonbusiness bad debt deduction. If it's a business bad debt, it's deductible against ordinary income. A business bad debt can be either totally or partly worthless. If it's a nonbusiness bad debt, it's deductible as a short-term capital loss, which is subject to certain limitations on deduction of capital losses. A nonbusiness bad debt is deductible only if it's totally worthless.

In order to be treated as a business bad debt, the guarantee you enter into must be closely related to your trade or business. If the reason for guaranteeing the loan of your corporation was to protect your job, it's considered as closely related to your trade or business as an employee. But employment must be the dominant motive for the guarantee. If your annual salary exceeds your investment in the corporation, this fact tends to show that the dominant motive for the guarantee was to protect your job. On the other hand, if your investment in the corporation substantially exceeds your annual salary, that's evidence that the guarantee was primarily to protect your investment rather than your job. For example, where a shareholder-employee's salary was $13,300 and his investment in the corporation was $1,000,000, his guarantee of the corporation's loan wasn't primarily for business-related reasons.

Except in the case of guarantees to protect your job, it may be difficult to show the guarantee was closely related to your trade or business. You would have to show that the guarantee was related to your business as a promoter, for example putting together oil deals between your corporation and others, or that the guarantee was related to some other trade or business separately carried on by you.

If the reason for guaranteeing your corporation's loan isn't closely related to your trade or business and you are required to pay off the loan, you can take a nonbusiness bad debt deduction if you show that your reason for making the guarantee was to protect your investment, or you entered the guarantee transaction with a profit motive. For example, suppose you guarantee payment of a bank loan to your corporation and your corporation defaults on the loan. If you make full payment, you will be able to take a nonbusiness bad debt deduction because you entered into the guarantee to protect your investment in the corporation.

In addition to satisfying the above requirements, a business or nonbusiness bad debt is deductible only if: (1) you have a legal duty to make the guaranty payment, although there's no requirement that a legal action be brought against you; (2) the guaranty agreement was entered into before the debt becomes worthless; and (3) you received reasonable consideration (but not necessarily cash or property) for entering into the guaranty agreement.

Any payment you make on a loan you guaranteed is deductible as a bad debt in the year you make the payment, unless the guarantee agreement (or local law) provides for a right of subrogation against the corporation. If you have this right, or some other right to demand payment from the corporation, you can't take a bad debt deduction until these rights become partly or totally worthless.

No bad debt deduction is allowable, however, for any payment you make as a guarantor, endorser, or indemnitor of your corporation's loan if the payment is actually a capital contribution to your corporation. Whether or not a shareholder's guarantee of his corporation's debt is considered a capital contribution is determined on the basis of the facts at the time the obligation to guarantee was entered into. If your corporation couldn't have obtained the loan without your guarantee, the payment may be considered a contribution to capital.

If your corporation is organized as an S corporation, you may deduct your pro rata share of the corporation's losses and deductions, but only to the extent of your basis in the corporation's stock and any indebtedness of the corporation to you. Although one court has held that an S corporation shareholder is entitled to a basis increase for this purpose if he guarantees his corporation's loan, other courts disagree.

You should also consider the following before entering into the guarantee agreement:

If you pay interest under your obligation as guarantor, you may not take an interest deduction, but must treat the payment as a business or nonbusiness bad debt. However, you may be entitled to an interest deduction if you pay interest that accrued after you became primarily liable for the debt, either because the creditor demanded payment from you after the corporation became insolvent or because the corporation's debt was discharged in bankruptcy, leaving you as the primary debtor. Treating the payment as interest won't be to your advantage if the interest is considered personal interest, which is nondeductible. For example, interest is personal if it's allocable to your trade or business as an employee.

If the debt you guarantee is discharged or forgiven, it has been held that only your corporation has cancellation of indebtedness income. That income can't be attributed to you.

If life insurance is taken out on your life as additional security for the loan and you pay the premiums, you won't be able to deduct the premiums because you are considered an indirect beneficiary of the insurance.

Only tax issues involving a guarantee by a shareholder of his corporation's loan are discussed above. There are, however, certain nontax issues that you may want to take into account, such as the extent of your liability under the guaranty where you jointly guarantee the corporation's loan along with other shareholders, or whether you can limit your liability under the guarantee.

Virginia Telework Corporate Tax Credit

Effective 07/01/2012 and applicable to tax years beginning on or after 01/01/2012, HB 551extends the telework expenses credit through tax years beginning before January 1, 2017. Prior to this legislation, the credit was scheduled to apply through tax years beginning before January 1, 2014. The legislation also clarifies that an employer is ineligible for the telework expenses credit if the employer claims another income tax credit based on jobs, wages, or other expenses for the same employee. Prior to this legislation, an employer was ineligible for this credit if any other income tax credit was claimed.

Utah Tax Credit for Employing Veterans

Effective for tax years beginning on or after 01/01/2012, HB 312 allows a nonrefundable tax credit for employing a “recently deployed veteran,” on after January 1, 2012, who is collecting (or is eligible to collect) unemployment benefit or within the last two years, has exhausted the unemployment benefits and works for the employer-claimant at least 35 hours per week for not less than 45 of the 52 weeks following the recently deployed veteran's start date for the employment. The credit amount is: (1) for the first taxable year, equal to $200 per month of employment not to exceed $2,400 for the taxable year for each recently deployed veteran; and (2) for the second taxable year, equal to $400 per month of employment not to exceed $4,800 for the taxable year for each recently deployed veteran. Any unused tax credit may be carried forward a tax credit for a period that does not exceed the next five taxable years. “Recently deployed veteran,” means an individual who was mobilized to active federal military service (either in an active or reserve component of the U. S. Armed Forces) and received an honorable or general discharge within the 2-year period before the date the employment begins.

Senate Democrats Offer Small Business Tax Cut to Spur Economic Growth

Employers that add payroll in 2012 would be eligible for a 10 percent tax cut, under a plan by the Senate Democratic leadership. Under the Small Business Jobs and Tax Relief Act of 2012, the tax cut would be available for income in excess of a company's 2011 payroll, and would be capped at $500,000 per employer. Senate Majority Leader Reid says the proposal also would extend 100 percent bonus depreciation on qualified capital through 2012 for all employers to encourage investment. Without the provision, businesses could only deduct 50 percent for the year.

Senate Votes to Proceed on Repeal of Tax Breaks for Oil Companies

The Senate votes 92-4 to limit debate and move toward a full floor vote on legislation that would repeal $21 billion in oil industry tax breaks and temporarily extend 18 tax incentives aimed at the use and production of clean or renewable forms of energy. While Republicans oppose the goals of the bill (S. 2204), aides and lobbyists say they supported the cloture vote so they can spend more time on the Senate floor to argue that the bill will only result in higher oil and gasoline prices—which are already approaching their highest level in nearly 4 years.

Colorado Property Tax Exemption

Effective 91 days after adjournment of the 2012 session, a county personal property tax credit will be given to taxpayers who establish a new business facility.  The credit will offset the amount of the taxes levied by the county on the taxable personal property located at or within the new business facility and used in connection with the operation of the new business facility for the current property tax year. Previously, the credit was limited to 50% of the amount of taxes levied.

Tennessee Nexus Bill Signed Into Law

On March 26, 2012, Tennessee Governor Bill Haslam signed into law L. 2012, H2370, which results from a compromise between the state and Amazon.com regarding affiliate nexus. Federal case law establishes that a seller must have sufficient connections, or nexus, with Tennessee in order for the state constitutionally to subject a seller in the state to sales and use tax collection responsibilities. This law provides requirements for determining whether affiliates have physical presence in Tennessee sufficient to establish nexus with the state.

Missouri License Fee on Gaming Machines

The Missouri Department of Revenue ruled that a mandatory license fee charged to a casino operator by a gaming machine manufacturer for the use of a ticket technology owned by another is subject to sales and use taxes. The license fee that the other company charges the gaming machine manufacturer to enable it to sell a gaming machine utilizing the other company's patented technology to its customer is a cost incurred by gaming machine manufacturer in manufacturing and selling each gaming machine with this technology. Although separately stated on the invoice, the license fee is a gross receipt for the sale of tangible personal property subject to sales tax and is part of the sales price of tangible personal property subject to use tax.

Virginia Extends Coalfield Employment Enhancement Tax Credit

Effective 07/01/2012, Virginia extends the coalfield employment enhancement credit through tax years beginning before January 1, 2017. Prior to this legislation, the credit applied to tax years beginning before January 1, 2015.

Wisconsin Business Tax Incentives

The Wisconsin Department of Revenue has issued a publication providing an overview of tax credits available to businesses for 2011. The publication provides information about Wisconsin tax incentives that may be available to corporations, tax-option (S) corporations, partnerships, limited liability companies, and sole proprietorships doing business in Wisconsin for taxable years beginning in 2011. Five new tax incentives are available for taxable years beginning in 2011: (1) super research and development credit, available for taxable years beginning on or after January 1, 2011; (2) community rehabilitation program credit, available for taxable years beginning on or after August 1, 2011; (3) beginning farmer and farm asset owner tax credit, available for taxable years beginning on or after January 1, 2011; (4) relocated business credit/deduction, available for taxable years beginning on or after January 1, 2011; and (5) job creation deduction, available for taxable years beginning on or after January 1, 2011.

Savings from Repeal of Oil & Gas Subsidies

The savings from repealing oil and gas tax subsidies would more than offset the cost of extending 18 other tax provisions directed more toward clean and renewable fuels, netting the treasury an additional $12.3 billion over 10 years, the Joint Committee on Taxation said March 23.

The Senate is expected to vote March 26 to limit debate on the bill (S. 2204), allowing senators to begin consideration of the Democrats' latest attempt to extend tax incentives for clean-energy goods and production.

The repeal of tax subsidies for the major integrated oil companies would save taxpayers nearly $24 billion over a 10-year period, JCT said in its estimate of the bill.

The energy-related tax provisions to be extended would cost about $11.7 billion over 10 years.

Some of the provisions that would be extended include incentives for biodiesel and renewable diesel, the production credit for refined coal, and the renewable electricity production tax credit.

The bill would prohibit the oil companies from claiming the tax code Section 199 domestic production deduction for their oil, natural gas, or other primary products; end deductions for drilling and development costs; and stop the companies from using the percentage depletion allowance for oil and gas wells.

Amazon Sales Tax Exemption in Tennessee

Online retailer Amazon.com will be exempt from collecting and remitting Tennessee sales taxes until 2104 under legislation (H.B. 2370) signed into law by Gov. Bill Haslam (R) March 23.

The new law codifies a deal Amazon reached with state officials that was announced in October 2011 (195 DTR H-1, 10/7/11 ). The deal and codifying legislation stem from efforts by state and local government officials to encourage Amazon to construct new facilities in Tennessee.

The new law provides that a company that invests at least $350 million and creates a minimum of 3,500 jobs in the state by Jan. 1, 2014, will be exempt from collecting and remitting sales and use taxes until that date. The exemption becomes void if those and certain other conditions are not met, or if federal legislation covering such transactions is enacted prior to 2014.

According to fiscal notes accompanying H.B. 2370, Amazon is the only taxpayer that meets the requirements outlined in the legislation.

What Small Business Should Know About the JOBS Act

The JOBS Act increases opportunities for equity investment. Though crowdfunding was not previously illegal, it had limitations. The JOBS Act removes those limitations. Most importantly, the JOBS Act allows small businesses to crowdfund equity investments, which should draw more investors into the trend.

The JOBS Act also eases rules on public disclosures. Previously, private companies with over 500 shareholders and $10 million in assets were required to comply with SEC public disclosure rules. Startups often felt forced to file an IPO. The JOBS Act increases that number to 2,000 shareholders, which should give companies the ability to seek more funding and time to plan for an IPO.

Going public is easier under the JOBS Act. The JOBS Act creates "emerging growth companies" -- those businesses with less than $1 billion in revenue. Emerging growth companies that wish to go public are exempt from some Dodd-Frank rules, and have fewer financial reporting requirements when filing an IPO.

Georgia Passes Law Imposing Tax on Online Purchases

The Georgia Senate unanimously approves a $262 million tax reform bill (H.B. 386) that would address an array of state taxes—including requiring internet retailers to collect Georgia sales tax on purchases made by the state's residents. The 54-0 vote comes two days after the House approves the measure 155-9. H.B. 386 now heads to the desk of Gov. Deal, who has pushed for the measure.

Reid Files Motion to Limit Debate on Big Oil Tax Subsidies Act

Senate Majority Leader Harry Reid (D-Nev.) filed a motion March 22 in an attempt to limit debate and begin floor action on a bill that would extend several tax incentives for the clean or renewable energy industries while repealing tax breaks for major oil producers.

The bill (S. 2204), the Repeal Big Oil Tax Subsidies Act, is expected to get a procedural vote March 26 and will require the support of 60 senators to allow it to advance toward a final vote in the Senate.

Senate Republicans, however, said action beyond that cloture vote is unlikely since previous efforts to repeal oil industry tax incentives, as well as to extend the clean energy incentives, have failed.

Republicans noted that a similar amendment to the FAA Modernization Act (S. 223) received only 44 votes in 2011 as seven Democrats, including Senate Energy and Natural Resources Committee Chairman Jeff Bingaman (D-N.M.), rejected the idea.

Ways & Means to Examine Expired Tax Cuts

The House Ways and Means Committee has begun an examination of the merits of dozens of expired tax cuts affecting individual and corporate taxpayers, the panel's leadership said in a March 22 joint statement.

The list of tax breaks that expired at the end of 2011 include the popular research and development tax credit, a handful of energy-related cuts such as the credit for the purchase of energy-efficient appliances, the deduction for state and local general sales taxes, and the allowance for tax-free distributions from individual retirement plans for charitable purposes.

Utah LIHTC Reporting Requirement

Utah House Bill 75 requires the owner of property subject to a low-income housing covenant to annually provide certain information to a county assessor, including, a signed statement that the project continues to meet the requirements of the low-income housing covenant, a financial operating statement and rent rolls for the property for the prior year, and federal and commercial financing terms and agreements. If the information is not provided, then the assessor is authorized to value the property with information at hand, and the owner must pay a penalty of the greater of $250 or 5% of the tax due on the property for that year, but it may be waived if reasonable cause is shown.

Oregon Renewable Energy Tax Credit

Oregon House Bill 4079 clarifies provisions governing renewable energy tax credits. The law clarifies provisions governing the transportation credit, including how it is claimed over five years, the definition of a “transportation project,” and direction on how the Department of Energy is to manage the credit cap. Technical clarification to the residential energy tax credit is made, such as allowing third-party installers to “reserve” tax credits. In addition, the biomass credit is limited to one tax credit per unit of biomass and the program cap is removed. The law clarifies the expiration date of pre-certifications under the old business energy tax credit program, which was replaced with three separate credits: a conservation credit, a renewable energy contribution credit, and a transportation credit.

Indiana Capital Investment Tax Credit

Indiana House Bill 1002 provides that a tax credit may not be awarded for a capital investment made after December 31, 2016; however, a taxpayer can carry over an unused tax credit attributable to a taxable year beginning before January 1, 2017 to a taxable year beginning after December 31, 2016. This credit expires January 1, 2020. Additionally, for purposes of the computer equipment donation credit, the bill defines “buddy system project” as a statewide computer project placing computers in homes of public school students and any other educational technology program or project jointly authorized by the state superintendent of public instruction and the governor.

Small Business Tax Cut Act

On March 21, House Majority Leader Eric Cantor (R-VA) introduced the “Small Business Tax Cut Act,” which would allow qualified small businesses (those with fewer than 500 employees) to claim a new 20% deduction. In general, the deduction, which would be similar to the Code Sec. 199 domestic production activities deduction (and would be coordinated with that deduction), would be equal 20% of the lesser of:

(1) qualified domestic business income (generally, domestic business gross receipts less cost of goods sold allocable to such receipts, less other expenses, losses or deductions allocable to such receipts); or(2) taxable income (without regard to the new deduction) for the tax year.

The new small business deduction couldn't exceed 50% of the greater of: (a) W-2 wages paid to non-owners of the business; or (2) W-2 wages paid to non-owner family members of direct owners, plus W-2 wages paid to 10%-or-less direct owners. In some cases, distributions paid to partners could be treated as W-2 wages.

Exemptions from SEC Registration Requirements

Your company's securities offering may qualify for one of several exemptions from the registration requirements. We explain the most common ones below. You must remember, however, that all securities transactions, even exempt transactions, are subject to the antifraud provisions of the federal securities laws. This means that you and your company will be responsible for false or misleading statements, whether oral or written. The government enforces the federal securities laws through criminal, civil and administrative proceedings. Some enforcement proceedings are brought through private law suits. Also, if all conditions of the exemptions are not met, purchasers may be able to obtain refunds of their purchase price. In addition, offerings that are exempt from provisions of the federal securities laws may still be subject to the notice and filing obligations of various state laws. Make sure you check with the appropriate state securities administrator before proceeding with your offering.

A. Intrastate Offering Exemption

Section 3(a)(11) of the Securities Act is generally known as the "intrastate offering exemption." This exemption facilitates the financing of local business operations. To qualify for the intrastate offering exemption, your company must: be incorporated in the state where it is offering the securities; carry out a significant amount of its business in that state; and make offers and sales only to residents of that state.

There is no fixed limit on the size of the offering or the number of purchasers. Your company must determine the residence of each purchaser. If any of the securities are offered or sold to even one out-of-state person, the exemption may be lost. Without the exemption, the company could be in violation of the Securities Act registration requirements. If a purchaser resells any of the securities to a person who resides outside the state within a short period of time after the company's offering is complete (the usual test is nine months), the entire transaction, including the original sales, might violate the Securities Act. Since secondary markets for these securities rarely develop, companies often must sell securities in these offerings at a discount.

It will be difficult for your company to rely on the intrastate exemption unless you know the purchasers and the sale is directly negotiated with them. If your company holds some of its assets outside the state, or derives a substantial portion of its revenues outside the state where it proposes to offer its securities, it will probably have a difficult time qualifying for the exemption.

You may follow Rule 147, a "safe harbor" rule, to ensure that you meet the requirements for this exemption. It is possible, however, that transactions not meeting all requirements of Rule 147 may still qualify for the exemption.

B. Private Offering Exemption

Section 4(2) of the Securities Act exempts from registration "transactions by an issuer not involving any public offering." To qualify for this exemption, the purchasers of the securities must: have enough knowledge and experience in finance and business matters to evaluate the risks and merits of the investment (the "sophisticated investor"), or be able to bear the investment's economic risk; have access to the type of information normally provided in a prospectus; and agree not to resell or distribute the securities to the public.

In addition, you may not use any form of public solicitation or general advertising in connection with the offering.

The precise limits of this private offering exemption are uncertain. As the number of purchasers increases and their relationship to the company and its management becomes more remote, it is more difficult to show that the transaction qualifies for the exemption. You should know that if you offer securities to even one person who does not meet the necessary conditions, the entire offering may be in violation of the Securities Act.

Rule 506, another "safe harbor" rule, provides objective standards that you can rely on to meet the requirements of this exemption. Rule 506 is a part of Regulation D, which we describe more fully on page 24.

C. Regulation A

Section 3(b) of the Securities Act authorizes the SEC to exempt from registration small securities offerings. By this authority, we created Regulation A, an exemption for public offerings not exceeding $5 million in any 12-month period. If you choose to rely on this exemption, your company must file an offering statement, consisting of a notification, offering circular, and exhibits, with the SEC for review.

Regulation A offerings share many characteristics with registered offerings. For example, you must provide purchasers with an offering circular that is similar in content to a prospectus. Like registered offerings, the securities can be offered publicly and are not "restricted," meaning they are freely tradeable in the secondary market after the offering. The principal advantages of Regulation A offerings, as opposed to full registration, are:

The financial statements are simpler and don't need to be audited;

There are no Exchange Act reporting obligations after the offering unless the company has more than $10 million in total assets and more than 500 shareholders;

Companies may choose among three formats to prepare the offering circular, one of which is a simplified question-and-answer document; and

You may "test the waters" to determine if there is adequate interest in your securities before going through the expense of filing with the SEC.

All types of companies which do not report under the Exchange Act may use Regulation A, except "blank check" companies, those with an unspecified business, and investment companies registered or required to be registered under the Investment Company Act of 1940. In most cases, shareholders may use Regulation A to resell up to $1.5 million of securities.

If you "test the waters," you can use general solicitation and advertising prior to filing an offering statement with the SEC, giving you the advantage of determining whether there is enough market interest in your securities before you incur the full range of legal, accounting, and other costs associated with filing an offering statement. You may not, however, solicit or accept money until the SEC staff completes its review of the filed offering statement and you deliver prescribed offering materials to investors.

D. Regulation D

Regulation D establishes three exemptions from Securities Act registration. Let's address each one separately.

Rule 504

Rule 504 provides an exemption for the offer and sale of up to $1,000,000 of securities in a 12-month period. Your company may use this exemption so long as it is not a blank check company and is not subject to Exchange Act reporting requirements. Like the other Regulation D exemptions, in general you may not use public solicitation or advertising to market the securities and purchasers receive "restricted" securities, meaning that they may not sell the securities without registration or an applicable exemption. However, you can use this exemption for a public offering of your securities and investors will receive freely tradable securities under the following circumstances:

You register the offering exclusively in one or more states that require a publicly filed registration statement and delivery of a substantive disclosure document to investors;

You register and sell in a state that requires registration and disclosure delivery and also sell in a state without those requirements, so long as you deliver the disclosure documents mandated by the state in which you registered to all purchasers; or,

You sell exclusively according to state law exemptions that permit general solicitation and advertising, so long as you sell only to "accredited investors," a term we describe in more detail below in connection with Rule 505 and Rule 506 offerings.

Even if you make a private sale where there are no specific disclosure delivery requirements, you should take care to provide sufficient information to investors to avoid violating the antifraud provisions of the securities laws. This means that any information you provide to investors must be free from false or misleading statements. Similarly, you should not exclude any information if the omission makes what you do provide investors false or misleading.

Rule 505

Rule 505 provides an exemption for offers and sales of securities totaling up to $5 million in any 12-month period. Under this exemption, you may sell to an unlimited number of "accredited investors" and up to 35 other persons who do not need to satisfy the sophistication or wealth standards associated with other exemptions. Purchasers must buy for investment only, and not for resale. The issued securities are "restricted." Consequently, you must inform investors that they may not sell for at least a year without registering the transaction. You may not use general solicitation or advertising to sell the securities.

An "accredited investor" is: a bank, insurance company, registered investment company, business development company, or small business investment company; an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million; a charitable organization, corporation or partnership with assets exceeding $5 million; a director, executive officer, or general partner of the company selling the securities; a business in which all the equity owners are accredited investors; a natural person with a net worth of at least $1 million; a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or a trust with assets of at least $5 million, not formed to acquire the securities offered, and whose purchases are directed by a sophisticated person.

It is up to you to decide what information you give to accredited investors, so long as it does not violate the antifraud prohibitions. But you must give non-accredited investors disclosure documents that generally are the same as those used in registered offerings. If you provide information to accredited investors, you must make this information available to the non-accredited investors as well. You must also be available to answer questions by prospective purchasers.

Here are some specifics about the financial statement requirements applicable to this type of offering:

Financial statements need to be certified by an independent public accountant;

If a company other than a limited partnership cannot obtain audited financial statements without unreasonable effort or expense, only the company's balance sheet, to be dated within 120 days of the start of the offering, must be audited; and

Limited partnerships unable to obtain required financial statements without unreasonable effort or expense may furnish audited financial statements prepared under the federal income tax laws.

Rule 506

As we discussed earlier, Rule 506 is a "safe harbor" for the private offering exemption. If your company satisfies the following standards, you can be assured that you are within the Section 4(2) exemption:

You can raise an unlimited amount of capital;

You cannot use general solicitation or advertising to market the securities;

You can sell securities to an unlimited number of accredited investors (the same group we identified in the Rule 505 discussion) and up to 35 other purchasers. Unlike Rule 505, all non-accredited investors, either alone or with a purchaser representative, must be sophisticated - that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment;

It is up to you to decide what information you give to accredited investors, so long as it does not violate the antifraud prohibitions. But you must give non-accredited investors disclosure documents that generally are the same as those used in registered offerings. If you provide information to accredited investors, you must make this information available to the non-accredited investors as well;

You must be available to answer questions by prospective purchasers;

Financial statement requirements are the same as for Rule 505; and

Purchasers receive "restricted" securities. Consequently, purchasers may not freely trade the securities in the secondary market after the offering.

E. Accredited Investor Exemption - Section 4(6)

Section 4(6) of the Securities Act exempts from registration offers and sales of securities to accredited investors when the total offering price is less than $5 million.

The definition of accredited investors is the same as that used in Regulation D. Like the exemptions in Rule 505 and 506, this exemption does not permit any form of advertising or public solicitation. There are no document delivery requirements. Of course, all transactions are subject to the antifraud provisions of the securities laws.

F. California Limited Offering Exemption - Rule 1001

SEC Rule 1001 provides an exemption from the registration requirements of the Securities Act for offers and sales of securities, in amounts of up to $5 million, that satisfy the conditions of §25102(n) of the California Corporations Code. This California law exempts from California state law registration offerings made by California companies to "qualified purchasers" whose characteristics are similar to, but not the same as, accredited investors under Regulation D. This exemption allows some methods of general solicitation prior to sales.

G. Exemption for Sales of Securities through Employee Benefit Plans - Rule 701

The SEC's Rule 701 exempts sales of securities if made to compensate employees. This exemption is available only to companies that are not subject to Exchange Act reporting requirements. You can sell at least $1,000,000 of securities under this exemption, no matter how small your company is. You can sell even more if you satisfy certain formulas based on your company's assets or on the number of its outstanding securities. If you sell more than $5 million in securities in a 12-month period, you need to provide limited disclosure documents to your employees. Employees receive "restricted securities" in these transactions and may not freely offer or sell them to the public.