Trademark Law & Champagne Powder

If you love to ski or snowboard, you may have heard of “champagne powder”, the dry, light and fluffy snow we love best.  But, from a meteorological standpoint, what is it?

Well, champagne powder does not actually describe a particular kind of snow crystal or water-density level, nor is it a term much used by meteorologists or snow scientists.

Instead, “champagne powder” owes its fame to ski industry marketing, with one resort in particular, Steamboat Ski and Resort Corporation (Steamboat), leading the charge.

According to Steamboat legend, back in the 1950s, a rancher named Joe McElroy was skiing with friends near the town of Steamboat Springs, Colorado (before the resort was created) and got sprayed in the face with snow.  He told his friends it tickled his nose like champagne – “champagne powder!” The phrase began to spread across the Yampa Valley, and starting in the 1960s, Steamboat the new ski resort started using it in its marketing.

Five decades later, Steamboat took legal steps to claim exclusive rights to “champagne powder.”  It filed a federal trademark application with the U.S. Patent and Trademark Office (USPTO) in 2008.  It also started sending cease and desist (C&D) letters to anyone publishing the phrase, stating Steamboat had obtained common law trademark rights.  In June 2010, the USPTO issued an official registration certificate to Steamboat for CHAMPAGNE POWDER related to “resort lodging services”.

With its C&D letters, Steamboat pursued an aggressive trademark protection strategy aimed at preventing anyone else, including journalists, bloggers and weather professionals, from using “champagne powder” to describe snow or ski conditions at all.

Then in 2014, Steamboat successfully prevented a gaming software company from using “Champagne Powder” for a casino video game.

It is fair to say Steamboat’s early round of C&D letters infuriated the ski community.  Recipients from California to Utah to Montana shared their letters, as well as the name and contact information for Steamboat’s attorney, all over the Internet.  Online forums and message boards pointed out that “champagne powder” had been widely used in the global ski community for decades, not to describe a particular ski resort or mountain, but a certain kind of snow conditions.  In fact, at that time Champagne Powder even had its own Wikipedia page.  This page made no mention of Steamboat.  The introduction only stated:

“Champagne powder is a very smooth and dry snow, which is great for skiing. The term originates from the ski resorts in the Rocky Mountains, which often have these snow conditions. The name derives from the sparkling wine champagne . . . .”

then went on to describe the weather conditions that created the snow.

Meanwhile, at least one business, Unofficial Networks, a “ski bum’s guide to outdoor news and entertainment”, thumbed their noses after receiving their Steamboat C&D letter and revised a certain offending headline to “Sparkling Wine Powder.

Steamboat’s response to the flurry of bad PR around the country was to explain that, under trademark law, they were required to issue a C&D letter whenever they saw a use of “champagne powder” that infringed its trademark rights.

Steamboat was correct.  Trademark law says that if a trademark owner doesn’t adequately monitor its mark and allows others to use (and infringe on) it, the trademark rights can be invalidated.  Enforcement is a required part of trademark ownership.  If you don’t enforce, you potentially give up your rights.

However, it is important to realize that a federal trademark registration does not give you absolute rights to prevent anyone else from using the word or phrase in any context whatsoever.  Trademark law is designed to protect consumers from confusion about the source of products and services.  It is not designed to give trademark owners an exclusive property right to those words, phrases or designs.  That is, it doesn’t let you claim that any use of your trademark by a third party violates the law.

Thus, arguably, Steamboat’s enforcement efforts are appropriate only if it prevents uses of “champagne powder” that are confusing consumers, with the big assumption being that most of us know “champagne powder” as something related to the Steamboat brand.

Is Steamboat’s champagne powder enforcement strategy actually in line with trademark law? The appropriateness of the legal claims Steamboat makes in its C&D letters and its other aggressive trademark protection efforts cannot be determined unless Steamboat finds itself in court.  Then, a judge or jury will be tasked to decide whether its positions are valid under current trademark and unfair competition law.  So far, no one has formally challenged Steamboat to determine how strong its “champagne powder” trademark actually is.

If you have received a C&D letter from Steamboat or anyone else, or have questions about registering your trademark or protecting your brand, contact our Intellectual Property team today!

 

What Can I Copyright?

Copyright is a type of intellectual property that protects “original works of authorship.”

Literary works (poetry, novels, newspaper articles), musical works (songs and their lyrics, orchestral compositions, movie scores), dramatic works (films, plays) and visual arts (paintings, prints, comics, sculptures) easily come to mind when thinking of works that probably have copyright protection.

However, copyright can be a lot broader! U.S. law allows you to claim copyright in software, architecture, fictional characters (for example, Superman), pantomimes and even your business’s logo.  Online, the contents of a website or blog, including its text, graphics and videos, can also have copyright protection.

This broad nature of copyright is no accident.  The Copyright Act acknowledges that future technologies may create new kinds of content that can be protected.  When the founding fathers provided for copyright in the U.S. Constitution more than 200 years ago, they surely could not fathom billion-dollar superhero movie franchises or the Internet!

So, instead of providing an exhaustive list of things that can have copyright, the law simply establishes certain elements that must be met for a work to have copyright protection.

Elements of Copyright

To be copyrightable, a work must:

  • Contain a minimal degree of creativity
  • Be created by a human author

The recent case of Naruto v. Slater[1] confirmed animals are not afforded rights under U.S. copyright law.  This ruling meant “Naruto”, a crested macaque monkey who took a charming and commercially-viable selfie, could not sue to own the copyright of the photograph.

  • And be fixed in a tangible medium

The work has to be captured in a way to that it can be perceived, reproduced, or communicated for more than a short time.

Copyright protection in the U.S. exists automatically from the moment the original work of authorship is fixed.  You do not have to register the copyright, print a copyright notice on the item, or publish the work to have copyright protection!

(But read more about why you should register your copyrights in our blog post here.)

Exceptions to Copyright

Copyright does not protect ideas, procedures, systems or methods of operation.

Copyright also does not protect facts and mechanical, clerical content (for example, a phone book).

Copyright does not protect simple, short phrases.  If you wrote a pop song with only one lyric – “Baby, I really love you…” – you probably wouldn’t be able to copyright this phrase and prevent other songwriters from authoring similar sentiments.

Copyright also does not protect content authored by the U.S. Government.  Thus, you can freely quote federal governmental reports, publications, websites and laws.  Be careful though!  This exception is not true for other governments, such as the U.K.

If you have questions about copyright law, how to register your works with the U.S. Copyright Office, or what to do if you think someone is violating your copyrights, contact our Intellectual Property team today.

[1] 15-CV-04324-WHO (N.D. Cal. Jan. 28, 2016).

Photo Credit: Kelli Tungay on Unsplash

Your Website: Tips to Stay Out of Legal Trouble – Part 2 (Domain Name/Trademark)

An Internet domain name can be vital to branding and marketing, so it’s important for business owners to be familiar with some of the legal rules related to domain names, including the intersection of domain name rights with trademark rights.  This post also reviews actions you can take to dispute domain names that may infringe upon your trademark rights.

A domain name is the primary “address” of a web site, and nearly all website owners want to have a domain name that is identifiable and easy to remember.

If my company is called “Betty’s Plumbing, Inc.” and I have a trademark for “Betty’s Plumbing”, it would be most logical for my website to also be “www.bettysplumbing.com”.  This would be the best way for current and potential customers to find me online.

Domain Names vs. Trademarks

A trademark is a word, name or symbol used in commerce to indicate the source of the goods or services and to distinguish them from the goods or services of others.

Trademarks and domain names are not synonymous, but the two concepts often meet when there is an issue of whether use of the domain name is a trademark violation.

The United States Patent and Trademark Office (USPTO) has made clear: “Registration of a domain name with a domain name registrar does not give you any trademark rights.”  The USPTO also states that simply using a trademark as part of a domain name does not necessary serve the function of “indicating the source” of goods or services.  In other words, using someone else trademark in your domain name is not automatically infringement.  However, additional uses of the trademark by your business beyond your domain name could lead to trouble!

The biggest takeaway is that the issue is not black and white.  Generally, we recommend that before you spend money on acquiring a certain domain name, you do some research to make sure your desired domain name does not contain a trademark belonging to someone else who has not given you permission to use it.  Trademark violations occur when there is “confusion in the marketplace” – when a consumer could confuse the business represented by the domain name with another business represented by a trademark contained in the domain name.

Further domain name registrars such as GoDaddy and Google Domains do not perform any trademark ownership verification before registering a new domain name for you so it is your responsibility to consider intellectual property matters!  If you need any assistance with this, please contact our Intellectual Property team.

Domain Name Disputes

Domain name disputes often involve companies battling over the ownership of domain names from “cybersquatters.” Some cybersquatters register domain names with the intention of selling them at high prices to the companies who own the trademarks. Others exploit domain names by taking advantage of the online traffic that popular brands attract and misdirecting consumers to the cybersquatters’ own websites for such business as selling counterfeit goods, or at worst, websites loaded with viruses, malware, and other malicious content.

The Anti-Cybersquatting Consumer Protection Act (ACPA)

You can file a federal lawsuit to challenge a domain name under the ACPA, a law enacted in 1999.  ACPA allows you to challenge domain names that are similar to your business name and other trademarks.  ACPA makes it “illegal to register, “traffic in” or use a domain name that is identical or confusingly similar to a distinctive or famous.  If a trademark owner successfully wins a claim under the ACPA, the Court will grant an order that requires the domain be transferred back to the trademark owner.  In certain cases, the Court can also award monetary damages.

Uniform Domain-Name Dispute-Resolution Policy (UDRP)

Another (and likely cheaper) way to challenge a domain name is through the Uniform Domain-Name Dispute-Resolution Policy (UDRP), a process created by the Internet Corporation for Assigned Names and Numbers (ICANN), the non-profit corporation that manages and controls domain name registrations. UDRP provides a relatively quick legal mechanism to resolve a domain name dispute by providing a streamlined procedure to transfer or cancel ownership of domain names.

Beyond offering a quicker dispute resolution process beyond federal court litigation, UDRP proceeds are also nice because it does not matter whether the trademark owner and domain name holder live in different countries.  Filing a lawsuit in U.S. federal court generally comes with jurisdictional issues that are tricky if the domain name holder lives in another country.

If your business needs help with a trademark or domain name issue, please contact us today!

 

Your Website: Tips to Stay Out of Legal Trouble – Part 1 (Copyright)

A good website for your business can be an invaluable marketing tool.  However, if you’re not careful, you could get into trouble for using images, photos, videos and other content in violation of copyright law.

Rights Granted under Copyright

Under the U.S. Copyright Act, the owner of a creative work is granted certain rights, including the right to prevent others from reproducing or copying their work, publicly displaying their work, or distributing their work.

Posting copyrighted material, say, a photograph, on your website arguably violates all these rights!  Moreover, your Internet service provider (ISP) can also be found liable for copyright infringement, even if they played no part in designing or maintaining your website.

All small business owners must therefore be extremely careful about what goes on their website!

Even big companies with sophisticated marketing campaigns get into trouble.  In May 2017, world-renowned luxury brand Tiffany & Co. was sued by photojournalist Peter Gould for using his photograph in an ad campaign for a line of jewelry designed by Elsa Peretti.  The photo at issue was a shot of Ms. Peretti back in the day.  The case was quickly settled and dismissed in July 2017, presumably because Tiffany’s agreed to write a nice fat check to Gould.

Tiffany certainly had the deep pockets to quickly deal with the lawsuit and settle, but your small business may not have these kinds of resources.

Get Permission

As a general rule, we tell our clients to assume any content they may want to use for their website, brochure, promotional video or other project is protected by either copyright or trademark law unless they can confirm otherwise.  A work is not in the public domain simply because you found it up on the Internet already (a common misconception) or because it lacks a copyright notice (another misconception).  Just because you are a local small business with not a lot of revenue and not a great understanding of copyright law does not mean you can claim “fair use” for the content either.  There are no safe harbors in the Copyright Act if you just made a mistake or misunderstood.

Finally, be aware:  If you do see an image or video is affixed with a copyright notice (or “copyright management information“) and choose to remove the info and use it anyway, this makes you liable for additional statutory damages under copyright laws.

Statutory damages range from a few hundred dollars to $25,000 per violation, meaning a mistaken infringement on your website can cost you a lot.

Investigate Infringement Claims Promptly

If someone complains about an unauthorized use on your website, remove the offending material at once and begin to investigate the claim immediately.   If necessary, consult with an attorney on how to handle the investigation and how to respond to the claimant appropriately.

You may find after your research that your use is perfectly legal.  However, you should remove the material while you investigate in order to limit your possible damages should the claimant file a lawsuit.  Continuing to use the infringing material after receiving notice will increase the chances of you being found liable and increase the amount of damages you may have to pay.

Removal of infringing material is also an element of the Digital Millennium Copyright Act (DMCA), a 1998 law establishing that an ISP can avoid liability by following certain rules, including speedy removal of infringing material.  Thus, if you don’t stay on top of copyright infringement complaints about your website, your ISP may get dragged into your mess as well.

IRS Penalties & Small Business

There are many kinds of tax penalties the IRS can assess against a small business, and the facts and circumstances behind when they may be applied are very different.  What they all have in common, however, is they can significantly increase your tax bill!

This post will provide a quick overview[1] of some of the tax penalties you may encounter if you are a small business owner.  This post also provides information on how to abate or waive tax penalties the IRS may have imposed.

Background

The IRS uses tax penalties to “encourage voluntary compliance” with the federal tax system.  However, the tax code and rules are admittedly complex.  Some taxpayers are unable to comply despite their best attempts to do so.  Many small business owners have so much on their plates, they make mistakes.

The good news is the tax code authorizes penalty relief for taxpayers who may have made a mistake.  The bad news is the IRS tends to do a very poor job of administering these tax relief programs in a fair or consistent manner, especially if the taxpayer is not being assisted by a tax professional such as a CPA or attorney.

Understandably, the IRS would rather not waive penalties – it means less money for them!  The IRS is also chronically understaffed, and does not choose to devote much of its limited resources to those certain departments that work on taxpayer penalty abatement requests.

As such, successfully obtaining relief from tax penalties usually requires the assistance of a tax professional who is familiar with the IRS’s various internal offices and administrative procedures.  If you would like to speak with us about your tax penalty problem after reviewing the information below, please do not hesitate to contact us.

Delinquency Penalties

There are 4 kinds of delinquency penalties that frequently hit small businesses:

  1. Failure to File (I.R.C. § 6651(a)(1))

This penalty is assessed when you file your tax return late.[2]  If you properly request for an extension on filing due dates, it can alleviate this penalty.  However, some kinds of returns, such as the quarterly Form 941 employer tax return, cannot be extended.

  1. Failure to Pay Tax Shown on Return (I.R.C. § 6651(a)(2))

This penalty is assessed when you don’t pay the entire amount of your taxes showing as due on your returns on time.[3]  If you file your return and make the payment late, you will be hit with both penalties.

Remember, even if you correctly request an extension on a tax return, you do not get an extension to pay your taxes, only an extension to file!

  1. Failure to Pay Tax Not Shown on Return (I.R.C. § 6651(a)(3))

This penalty is assessed if you owe additional amounts after an audit or adjustment on your return, and you do not pay the new amounts within 21 days.  If you owe more than $100,000 after the audit or adjustment, you have only 10 days to pay the bill![4]

  1. Failure to File Informational Returns (I.R.C. § 6721)

This penalty is assessed against a small business that did not file its annual W-2 or 1099 forms.  There are 2 tiers of penalties here:

  • Negligence Standard

The first is similar to the “Failure to File” penalty above.  It is a negligence penalty, meaning you simply forgot or made a mistake.  This is calculated at $100 per return up to a maximum of $1,500,000.  Thus, the more employees or contractors you have working for you, the higher this penalty can be.

  • Willfulness Standard

The second is a willful “intentional disregard” standard, calculated at $250 per return or 10% of the aggregate amount of the items reported on the W-2/1099 forms.   This goes beyond forgetting or making a mistake – you purposefully refused to file the returns or tried to hide information from the IRS.

So, if your total payroll was $500,000 that year, your penalty would be $50,000 – a sum that might be equal to the cost of another employee!  Paying this level of penalty would be unsustainable for many businesses.

In my experience, when the IRS notices a business did not file its W-2/1099 forms, it assumes the “intentional disregard” standard and slaps you with the higher penalty.  Once it has done so, the burden will be on you to prove you did not fail to file the returns willfully.  Usually, simply sending in the missing returns after receiving notice the government is missing them is not enough.  You must submit a statement explaining your late filings were due to a mistake or unplanned accident.

Unfortunately, nothing in the IRS notices or letters informing you of the missing returns or your new Section 6721 penalties will inform you about the lower “negligence” penalty level!  If you have been impacted by this kind of penalty, please contact our tax resolution team at once.

Accuracy-Related Penalties (I.R.C. § 6662)

This penalty comes up after an audit or other adjustment on the tax you reported on your returns.  The policy behind this particular tax penalty system is to make sure taxpayers are taking reasonable and well-researched positions in support of the numbers they list on their returns.  In layman’s terms, if you take a position that is so far out there and completely unreasonable, you will be at risk for this penalty.

The IRS will hit you with a 20% accuracy-related penalty if your incorrect position was due to negligence, a disregard of rules and regulations, or a substantial undervaluation misstatement.

The IRS will hit you with a steeper 40% accuracy-related penalty if your incorrect position was due to gross valuation misstatements or undisclosed transactions or information.

Reasonable Cause

All the tax penalties discussed above can be abated or removed if you can show your delinquency was due to “reasonable cause”.  You must show you exercised “ordinary business care and prudence” in preparing your return,  determining what you owe, and when/how to pay it, but nevertheless, were unable to prepare an accurate return, file it on time, or pay on time with suffering undue hardship, due to circumstances beyond your control.

The internal IRS offices require taxpayers to meet a very high burden under the reasonable cause standard before they will waive penalties.  Undoubtedly, the IRS has heard every excuse under the sun!  You will have to demonstrate your “ordinary business care and prudence” in managing and operating your business, and then carefully document your special set of “circumstances beyond your control.”

Major illness, death, strikes/riots, and natural disasters are surefire “circumstances beyond your control” that will allow for penalty abatement.  Sometimes, a business’s severe economic distress can also justify penalty abatement, but only if this is argued very carefully before the IRS.  For example, perhaps your biggest customer filed for bankruptcy and did not pay you for tens of thousands of dollars of product or service.  If you can carefully draw the line between losing that anticipated income and missing your tax payment deadlines, this may justify abating tax penalties.  (In my experience however, a lot of employees at the IRS will assert financial distress never justifies paying your taxes late, even though this argument is provided by the Treasury Regulations and discussed by many tax court cases!)

Importantly, if you try to blame your tax noncompliance on a bookkeeper, accountant, bad office manager, or any third party who you brought on to help with your taxes, this will never be reasonable cause.  The IRS holds the taxpayer ultimately responsible for compliance, and this is a nondelegable duty.

Unfortunately, convincing the IRS to waive your penalties is generally an uphill battle.  More often than not, you will be summarily denied and will have to file an administrative appeal to get the IRS to actually look at your case carefully.  There are also some tricks and special programs that may help you, but the IRS does not readily provide this information to taxpayers.  If you need any help with a penalty abatement or even understanding if you may qualify for one, contact DTG Law today.

_____________

[1] Please be aware that the tax code is complicated, and this is by no means a comprehensive summary of all the issues and technicalities behind tax penalties!

[2] The FTF penalty is assessed at a rate of 5% of the tax due on the late tax return up to 25%.

[3] The FTP penalty is assessed at 0.5% per month update to 25% of the amount of tax that was not paid by the due date.

[4] This penalty is assessed at 0.5% per month update to 25% of the amount of tax that was not paid by the due date.

Independent Film Finance

Filmmaking is rarely a cheap endeavor.  Even a “budget” independent film may require tens or hundreds of thousands of dollars to produce, market and distribute.  Here are the most common ways an independent filmmaker can finance his or her project:

Studio Financing

 This is where a studio agrees to pay for the costs of the film in exchange for the right to distribute the film.  It is difficult to get this type of funding without some proven money-making element attached to the film, for example, a well-known director, screenwriter or actor, or valuable story rights to a bestselling novel, comic book or game.

Investor Financing

This is where the film is financed by one or more persons who either buy shares of the company through which the film will be produced, or execute some form of “investment contract” related to the future revenues of the film.

Be VERY aware of state and federal securities laws that may kick in, depending on the form of your production entity or the number of investors involved.  Even if you plan to finance your film with friends and family investors, reviewing state and federal securities laws with a knowledgeable attorney is mandatory.  Consequences of violating securities laws can include rescission (meaning you must legally give all the money back, even if you’ve already spent it!), civil fines, or even criminal liability.

Crowdfunding

This is becoming a more common and more popular avenue for film financing.  Spike Lee raised nearly $1.5 million via Kickstarter to produce his film, Da Sweet Blood of Jesus.  The team behind 1998 cult classic SLC Punk also raised money for the sequel, Punk’s Dead:  SLC Punk 2, through Indiegogo.  If you go this route, be sure you review individual website rules carefully to ensure compliance.

Self-Funding

 You may just be lucky enough to have a significant amount of spare cash or disposable income to devote to your independent film.  If so, the tales you may have heard about Hollywood’s creative accounting aside, keep in mind that only about 20% of all films actually turn a profit.  Hollywood’s multibillion dollar production companies play a numbers game – hoping a few hits can cover all the other films that lost money that year.  You probably don’t have the business model or resources to follow a similar plan.

If you do decide to proceed with self-funding however, consider taking advantage of local film tax credits. Numerous states offer tax credits for productions made, at least in part, in their state. Such tax credits can also be sold to a third party, typically at a discount, to raise cash for the production or marketing of the film.

The Colorado Office of Film, Television & Media, for example, offers a 20% cash rebate program for up to $100,000 of eligible production costs.  Nevada’s revamped film tax credit law took effect in 2014 and allocated $80 million in credits to be issued to qualifying productions over a 4-year period.  Other states offering tax incentives include California, New York, Louisiana, Georgia, and New Mexico

Limit Your Liability!

Keep in mind that, as with most other business ventures, you should ultimately work through a corporate shield for protection from personal liability.  The form and timing of establishing this shield (typically an LLC) will depend on your particular circumstances.

However, if you’ve already started some activity for your independent film, make sure that all the contracts you have already entered into (or are imminently about to enter) are freely assignable.  That way, you can assign those contracts to your new entity without problem.

If you need assistance with any of the legal issues discussed here, please do not hesitate to contact our Arts & Entertainment team at DTG!

Entity Formation Basics: The Cooperative

Strategic business planning should involve thoughtful consideration of what form of business entity to use – whether a C corporation, S corporation, limited liability company (LLC), partnership, non-profit, or some other type of business entity.

This post is about one useful form of business entity that is frequently overlooked by business advisors and attorneys – the cooperative!

A cooperative or “co-op” is a type of legal entity that is distinguishable from standard, for-profit corporations, LLCs, and partnerships.  Co-ops offer a flexible business model that can be used by any group of people who are interested in creating a democratic decision-making company that benefits all members.  In other words, co-ops strive to be patron- or member-oriented, rather than investor-oriented like traditional corporations or LLCs.

At their core, co-ops are formed by a group of people who either work or shop there (a brewery co-op or a food co-op), use its services (a credit union or health insurance co-op), or product goods and items for it (a food producers co-op).  Co-op members are not to be held liable for any debt, obligation or liability of the co-op.

The International Cooperative Alliance, a global membership association of co-ops and co-op support organizations, has established Seven Cooperative Principles including Democratic Member Control and Concern for Community, among others.

The “common purpose” of individuals wishing to form a co-op can include a number of things, including employee-ownership, group marketing, or group purchasing.  Some of the most nationally well-known co-ops include Ace Hardware and REI, as well as dozens of successful agricultural co-ops such as Land-O-Lakes, Sunkist, and Ocean Spray.

Today, artist and freelancer co-ops are becoming more common due to the rise of the “sharing economy” and the realization of individual artists, photographers, software developers and other freelancers there can be great benefits to pooling resources, infrastructure or ideas.

Colorado Cooperatives

Colorado cooperative law has developed cumulatively over more than five decades.

Today, a standard co-op should be formed under Article 56 of Title 7 of the Colorado Revised Statutes.  Article 58 contains the “Colorado Uniform Limited Cooperative Association Act”, recently enacted in 2011.  Also, Article 33.5 of Title 38 is a special Colorado code section for housing co-ops.

Interestingly, Colorado law explicitly prohibits the ability to use the word “cooperative” or any abbreviation or derivation of as part of your business name, trade name, trademark or brand unless you are actually formed as a co-op under these statutes, so be careful if you are loosely using the term “co-op” or “cooperative” in your business!

Under Colorado law, co-op members and those on a co-op’s Board of Directors are protected from personal liability from the activities of the company, similar to corporations and LLCs.  Co-ops are also allowed to limit membership only to persons engaged in a particular business, persons who will use the goods or services of the co-op, and other membership conditions stated in the co-op’s Articles of Incorporation or Bylaws.  Because they are so member-oriented, Colorado law requires a co-op to keep detailed membership lists with contact info.

Limited Cooperatives

Under the newer Limited Cooperative Association Act, a co-op can have investor members who do not participate as much in the common purposes of the company.  This kind of co-op would have “patron members” who fully own and participate in the co-op and “investor members” who participate in the co-op on a more limited, financial basis.

Because the Article 58 was designed with maximum flexibility in mind, a co-op’s Bylaws and Membership Agreements can set forth all kinds of rules and arrangements for the patron members and investor members as far as how the company is run, how patron member votes versus investor member votes are counted towards certain decisions, and how allocation and distributions are made to these different kinds of members.

Cooperatives and Securities Laws

Both Articles 56 and 58 state that any unit or evidence of a membership interest in a co-op is exempt from the Colorado Securities Act or our state’s “Blue Sky” laws.  This means a co-op can offer and sell its membership interests without needing to registered as a broker-dealer, unlike the ownership in a corporation or an LLC.  This takes a lot of legal headache and expense away from co-ops who are looking to have dozens or even hundreds of members.

Nevertheless, if your co-op needs to raise a lot of capital and wants to do so by securing many membership fees or contributions, we strongly recommend this is done through a Regulation D private placement offering under the federal Securities and Exchange Commission’s (SEC) rules.

Worker Cooperatives

Worker co-ops (i.e., employee-owned companies) are gaining traction like never before as the socially-conscious business movement and sharing economy continue to gather momentum.

The common purpose of the worker co-op is each member’s livelihood – their job and income – as it relates to the success and sustainability of the company as a whole.  In a worker co-op, the employees democratically control the management and operations of the company, with each employee-owner having an equal vote.

Generally, this means that all employees, no matter their salary, job title, or years of employment, are entitled to one vote per person on all matters brought before the membership of the company.  However, this does not mean all employees have to be involved in every company decision.  A worker co-op should still have a Board of Directors, and can also have other officers (for example, a President or a CEO) to set policies, manage day-to-day operations of the company, and determine when important decisions should be put to the members.  Of course, the members vote for who is on the Board and can also vote for who the President or CEO is to be.

Taxation of Cooperatives

Co-ops have unique income tax structures governed by Subchapter T of the Internal Revenue Code.  This tax structure is similar to partnership taxation, but with some different terminology.  Profits of a co-op are called “net margins”.   The members of a co-op are deemed “patrons”.

Under Subchapter T, net margins are not taxed a the co-op level, but are instead allocated to the patrons on an annual basis similar to a partnership distribution.  Unlike a partnership distribution however, co-op allocations are based on a patrons use of the co-op rather than their investment.  For example, in an agricultural co-op, if Farmer A uses 3,000 acres of the co-op’s land and Farmer B uses 10,000 acres, Farmer B had more “patronage” of the co-op and should expect a larger allocation.

Subchapter T states at least 20% of the allocation to a co-op’s patrons must be in cash.  The remaining 80% can also be distributed in cash, or in can be retained on the books of the co-op as “patronage equity”, to be redeemed sometime in the future.  Consequently, patronage equity allows a member of a worker co-op to build personal assets and net worth by having an equity account that can be redeemed when he or she retires or leaves the company.

Each patron should receive a Form 1099-PATR from the co-op every year reporting the allocation (both cash and non-cash).  Then, each patron is responsible for paying his or her own income taxes based on the reported allocation.

If you would like to form a co-op or have a question related to an existing co-op, contact our offices today!

 

 

 

 

 

 

Should I Form My Company in Delaware?

Many savvy startups have heard they should form their corporation in Delaware.  Indeed, more than half of public and Fortune 500 companies are incorporated in this state.

Delaware advertises its General Corporation Law as one of the most advanced and flexible in the country for business entities.  In reality however, nearly all states have now modeled their own corporate laws to mimic the provisions of Delaware’s in order to provide the much-touted “business friendly” legal landscape for companies.

There are still some benefits for incorporating in Delaware.  First, if you have to go to court to settle a dispute, Delaware has a special Court of Chancery that focuses solely on business law, and decisions there are rendered by judges instead of juries.  This means your company’s legal fate will be in the hands of a well-trained business law expert instead of laypeople who might struggle to understand complex legal concepts.  Second, since Delaware’s corporate law is one of the oldest, there is a vast amount of case law that your company can rely on. Thus, most Delaware corporations do not end up litigating disputes because their professional advisers examine this case law and can construct deals to avoid lawsuits.

Despite these benefits, by no means should a startup believe forming is Delaware is the “default” rule.  More often than not, for administrative ease, forming your corporation in the state where you will reside and, at least initially, carry out most of your business activities is probably the state in which you should incorporate.  It lessens the risk of having to travel out of court for legal disputes.  Nevertheless, the fact that so many large, public companies choose Delaware should indicate that large, public companies tend to benefit the most from incorporating in Delaware.

Finally, one may argue if you incorporate in Delaware, you send a message: “This is a national company.”  You send a signal to investors that you understand their preferences and are serious about receiving investments.  From a marketing perspective, this may be important for customers and vendors as well.

Note:  Even if you incorporate in a foreign state like Delaware, your company may still be subject to registration as a “foreign entity” and compliance with the laws of states you transact business in.

If you’re considering starting a business or revisiting a current one, contact us today.

Entity Formation Basics: The S Corporation

Strategic business planning should involve thoughtful consideration of what form of business entity to use – whether a C corporation, S corporation, limited liability company, partnership, non-profit, or some other type of business entity.

This post is about a very common form of entity for smaller companies – the “S corporation.”

A corporation is defined as an independent legal entity that is owned by shareholders.  A corporation can have just one shareholder or, as may be the case for a large publicly-traded company, millions of shareholders.  Shareholders are protected from liability because the corporation, not the shareholders, is held legally liable for the actions and debts the business incurs.

While corporations are owned by shareholders, they are supposed to be managed by a Board of Directors and operated by officers (President, Secretary, Treasurer, CEO, etc.).  If you are a smaller, closely-held corporation, the same individuals may serve in these different capacities, meaning one person might concurrently be a shareholder, a member of the Board, and the President.  Understandably, this may get confusing!  However, it is important to realize each role carries its own duties and responsibilities under the law.  As such, understand the differences in these roles if you are hoping to create and operate a corporation of your own.

Today, maintaining a corporation tends to be more complex than other business structures because of various administrative, tax, and legal requirements, some of which are discussed here.  If you are interested in forming a corporation, we strongly advise consulting with a business attorney who can help identify and prepare you for the many legal requirements and decisions you will run into (for example, do any of the founders need to make an 83(b) election?).

Forming an S Corporation

A corporation is formed under the laws of the particular state in which it is registered.  To register, you need to file certain documents, typically Articles of Incorporation, with the Secretary of State office.  The individual who actually files these formation documents is usually called the “Incorporator”.

Immediately upon filing the Articles of Incorporation, the corporation should identify its shareholders, and the shareholders should then elect the Board of Directors.  Again, all major management decisions in a corporation are made by the Board, and one of the first management decisions should be to appoint officers, the individuals who can perform the necessary acts for the business to actually get off the ground (for example, opening a bank account, hiring employees, signing a lease, negotiating with vendors, etc.).

After the corporation, the IRS by default will treat it as a C corporation unless or until you file Form 2553 with the IRS.   In other words, an S corporation is really just a special type of corporation created through an IRS tax election.

“Pass Through” Taxation

 Taxation is often considered the most significant difference for small business owners when evaluating “C corporations” versus “S corporations” or other entity types.  (For a discussion of C corporations, click here.)

Traditional C corporations are separately taxable entities who pay taxes at the corporate level, and then shareholders who receive dividends pay taxes again at the individual level.

In contrast, S corps are pass-through tax entities. They file an informational federal return (Form 1120S), but no income tax is paid at the corporate level.  Instead, the profits and losses of the business are “passed-through” to the owners to be reported on their personal tax returns.  Any tax due from company profits are thus paid at the individual level by the owners, not the company.

If you are a small business owner contemplating receiving regular payments from your corporation’s net profits, ensuring your Form 2553 is filed right away is crucial.

Ownership Restrictions

An S corporation can have only one class of stock.  Therefore, there can’t be different classes of investors who are entitled to different dividends or distribution rights, which is a strategy that might be desired if you are looking to have investor shareholders with less management and dividend rights than the company’s founders.  Additionally, the one-class-of-stock restriction also means an S corporation cannot easily allocate losses or income to specific shareholders, as is allowed in a partnership or LLC.

With some limited exceptions, a shareholder in an S corporation cannot be another entity; a shareholder can only be an individual.  Also, there cannot be more than 100 shareholders.  For this reason, startups who are seeking to fundraise through equity financing or going public might find they quickly hit the 100 shareholder limit.

Finally, foreign ownership of an S corporation is prohibited.  Every shareholder in an S corporation has to be a U.S. citizen.

Accounting Issues

 Bookkeeping and accounting issues for an S corporation may be more complex than other entity types.

 Money distributed to a S corporation shareholder can be in the form of distributions or a salary (assuming the shareholder is also running the company as an officer).  There are more burdens with taking a salary (higher tax rate, employer tax obligations, preparing a W-2 form, etc.), so the savvy S corporation owner may try to take as much of his or her income from the S corporation as distributions.  Of course, this ultimately means less tax money for the IRS, and so this is a hot button issue for them!  The IRS scrutinizes the payments an S corporation makes to its shareholders to make sure the characterization conforms to reality.   If the IRS targets your business, wages may be recharacterized as dividends, costing the corporation a deduction for compensation paid.  Conversely, dividends may be recharacterized as wages, which subjects the corporation to employment tax liability.

 Also, as discussed above, the allocation to shareholders of an S corporation’s income and loss is governed by stock ownership, and there are complex rules for how this is to be done.  As such, maintaining an S corporation’s books properly can be cumbersome.  Having a good accountant to assist with this aspect of your business is absolutely essential!

If you’re considering starting a business or revisiting a current one, contact us today.

 

Entity Formation Basics: The C Corporation

Strategic business planning should involve thoughtful consideration of what form of business entity to use – whether a C corporation, S corporation, limited liability company, partnership, non-profit, or some other type of business entity.

This post is about the standard corporation, also called the “C corporation”.

The corporation is one of the oldest forms of business entity, with predecessors identified both in ancient Rome and ancient India.  Complex societies needed a way to allow groups of people to form an independent body that had the right to own property, make contracts, sue and be sued, and perform various other legal acts.

Today, a corporation is defined as an independent legal entity that is owned by shareholders.  A corporation can have just one shareholder or, as may be the case for a large publicly-traded company, millions of shareholders.  Shareholders are protected from liability because the corporation, not the shareholders, is held legally liable for the actions and debts the business incurs.

While corporations are owned by shareholders, they are supposed to be managed by a Board of Directors and operated by officers (President, Secretary, Treasurer, CEO, etc.).  If you are a smaller, closely-held corporation, the same individuals may serve in these different capacities, meaning one person might concurrently be a shareholder, a member of the Board, and the President.  Understandably, this may get confusing!  However, it is important to realize each role carries its own duties and responsibilities under the law.  As such, understand the differences in these roles if you are hoping to create and operate a corporation of your own.

Today, maintaining a corporation tends to be more complex than other business structures because of various administrative, tax, and legal requirements, some of which are discussed here.  If you are interested in forming a corporation, we strongly advise consulting with a business attorney who can help identify and prepare you for the many legal requirements and decisions you will run into (for example, do any of the founders need to make an 83(b) election?).

Forming a Corporation

A corporation is formed under the laws of the particular state in which it is registered.  (Read our post on incorporating in Delaware here.)

To register, you need to file certain documents, typically Articles of Incorporation, with the Secretary of State office.  The individual who actually files these formation documents is usually called the “Incorporator”.

Immediately upon filing the Articles of Incorporation, the corporation should identify its shareholders, and the shareholders should then elect the Board of Directors.  Again, all major management decisions in a corporation are made by the Board, and one of the first management decisions should be to appoint officers, the individuals who can perform the necessary acts for the business to actually get off the ground (for example, opening a bank account, hiring employees, signing a lease, negotiating with vendors, etc.).

Double Taxation

Taxation is often considered the most significant difference for small business owners when evaluating “C corporations” versus “S corporations” or other entity types.   (For a discussion of S corporations, click here.)

Traditional C corporations are separately taxable entities with the IRS and nearly all state Departments of Revenue (corporate income tax rates range from 4% in North Carolina to 12% in Iowa).  C corporations file a corporate tax return (Form 1120 for the IRS) and pay taxes at the corporate level.  They then may face the possibility of double taxation if corporate income is distributed to the shareholders as dividends, because then tax is paid again at the individual Form 1040 level.

If you are a small business owner contemplating receiving regular payments from your company’s net profits, this double taxation issue could be very costly, and thus should be avoided.

Raising Capital

So then why do so many companies accept double taxation and form a C corporation anyways?

C corporations have no restrictions on ownership.  A shareholder can be an individual, another corporation, a trust, or any other type of legal entity.  Also, a shareholder in a C corporation does not have to be a U.S. citizen or a U.S.-based entity as in some other entity types.

Probably the biggest reason however is that C corporations can have multiple classes of stock.  This means a company can have “Class A” preferred stock with priority dividend payments, more voting rights, and a higher position on the priority ladder in the event of a liquidation or bankruptcy, and then “Class B” common stock that is lower-ranked and much more prevalent for equity financing, the process of raising capital through the sale of stock to outside investors.

Thus, if you are planning to seek venture capital or to go public one day, the C corporation is probably the better choice. VC firms prefer the familiar structure and management of a conventional corporation and are well-versed in Delaware corporate law.    Similarly, many investment bankers insist a company be incorporated in Delaware before they take it public through an Initial Public Offering (IPO).

If you’re considering starting a business or revisiting a current one, contact us today.