Corporate and Securities Attorney Tanya Syed Joins Boutin Jones

Corporate and securities attorney Tanya Syed has joined Boutin Jones Inc. She earned both a  J.D. from the University of Pennsylvania Law School and an MBA from the Wharton School of Business. She also earned a B.A. from the University of Southern California.

Tanya will be representing public and private companies on the entire range of corporate transactions. She has guided clients through complicated legal transactions, ranging from initial public offerings, restructuring, debt and equity offerings, mergers and acquisitions and other exit transactions. She has also been active in volunteering her time to a number of pro bono legal programs, and in addition to English, speaks Spanish, Urdu, Hindi and can communicate in American Sign Language.

Tanya Syed

Qualified Opportunity Zones

Want to Defer Gain from the Sale of Your Business? New Act Has Added a Way to Defer Gain

The recent tax act passed in December 2017, formerly known as the Tax Cut and Jobs Act (“2017 Act”), contains tax incentives designed to encourage new investment in low income communities within the United States. The 2017 Act establishes a procedure for the governor of each state to nominate special low income regions within the state called Qualified Opportunity Zones. The state governor’s nominations are then certified by the Internal Revenue Service (“IRS”) as “Designated Qualified Opportunity Zones.” As of the date of this article, California has completed the nomination process and has received a certification from the IRS establishing Designated Qualified Opportunity Zones to encourage new business and investment activity in low income regions. Many other states have also completed the certification process. To learn more about the regions designated in California, see http://dof.ca.gov/Forecasting/Demographics/opportunity_zones/.

An investor’s investment in an Opportunity Zone Fund (defined below) permits an investor to defer paying tax on capital gain realized by the investor in another taxable transaction. For example, if an investor sells real estate, stock or business assets in a taxable transaction, the investor can defer recognition of the gain and avoid paying federal income tax by reinvesting in a corporation, partnership, limited partnership, limited liability company or other business entity in which at least 90% of its assets are located in a Designated Qualified Opportunity Zone (“Opportunity Zone Fund”). To qualify for such deferral, the investor must reinvest the amount of gain for which deferral is sought in an Opportunity Zone Fund within 180 days from the date of the taxable sale or exchange.

Reinvestment in an Opportunity Zone Fund defers recognition of taxable gain from the date of the taxable sale until the earlier of: (i) the investor’s sale or liquidation of the investor’s interest in the Opportunity Zone Fund (“Opportunity Zone Investment”), or (ii) December 31, 2026. Additionally, through a basis adjustment, the deferred gain inherent in the Opportunity Zone Investment is reduced by 10% after the investment has been held for five years, and by an additional 5% after seven years. If the investor holds the Opportunity Zone Investment on December 31, 2026, then, regardless of whether he or she continues to hold the investment, the investor must recognize the deferred gain on that day, subject to any basis increases received for holding the property for five or seven years. If the investor holds the Opportunity Zone Investment after December 31, 2026, and for at least ten years, the investor receives a stepped-up basis in the Opportunity Zone Investment to fair market value and future appreciation is not subject to tax. Subject to the occurrence of the recognition event in December 2026, recognition of deferred gain can be substantially reduced.

To illustrate this concept, assume an investor sells stock or other investment assets which results in a realized gain of $10,000,000 (the proceeds received by the investor in the sale might have been much greater depending on the investor’s income tax basis in the asset when sold). If the investor then decides to reinvest $6,000,000 in an Opportunity Zone Fund within 180 days following the sale, the investor’s recognized gain from the earlier taxable transaction is reduced by the same amount and is deferred. At least initially, the deferred gain is transferred to the Opportunity Zone Investment. The $6,000,000 in deferred gain results a current federal tax savings of $1,200,000 where the deferred gain is computed at the federal long-term rate of 20%.

Continuing the above illustration, the investor would recognize the remaining $4,000,000 in taxable gain in the year of the sale. Had the investor reinvested the entire $10,000,000 of realized gain in an Opportunity Zone Fund, 100% of the gain realized on the investor’s earlier taxable sale would have been deferred. The investor’s deferred gain, now residing in the Opportunity Zone Investment, is reduced by 10% after the investment is held for at least five years, and by an additional 5% after the investment is held at least seven years. For this investor, the $6,000,000 deferred gain would be reduced by $900,000 after seven years. In other words, the $900,000 reduction in deferred gain is forever excluded from tax. As mentioned above, the investor would pay tax on any deferred gain deferred in the Opportunity Zone Investment on December 31, 2026. Thereafter, if the investment is continued three more years (for a total holding period of ten years), the investor’s basis in the Opportunity Zone Investment is stepped up to fair market value, including future appreciation.

There is no analogue for the deferral mechanism provided by the 2017 Act apart from the investor’s death! Unlike the requirements for “like-kind” exchanges under Internal Revenue Code Section 1031 (“1031 Exchange”), the investor may actually receive the proceeds of the taxable sale directly. Any taxable gain resulting from the sale can be deferred with a subsequent investment in an Opportunity Zone Fund, so long as the reinvestment occurs within 180 days of the taxable sale. Although a 1031 Exchange shares the same 180 day reinvestment requirement, all of the sale proceeds received by the investor must be assigned to a qualified intermediary before closing, and all such sale proceeds must be reinvested in like-kind replacement property. Any cash, received by the investor in the exchange transaction, including amounts representing the investor’s unreturned basis in the property sold, trigger recognition of gain. These new rules are much more generous.

The new law is silent as to whether the 3.8% Net Investment Income Tax (“NIIT”) is also deferred. Since the NIIT is calculated based on the gain taken into account in computing taxable income for the year, it would seem to be deferred to the same extent that it would be in a 1031 Exchange. There are many other significant open questions for which we expect guidance from the IRS in the future.

Given the new tax deferral opportunity, we expect syndications of Opportunity Zone Funds to significantly increase in the future. Due diligence is necessary to make sure that the benefit will be associated with reasonable investment risks. When considering ways to reduce your gain, keep in mind the economic choices that you are making when investing in Opportunity Zone Funds. We note that a 1031 Exchange out of an Opportunity Zone Investment will likely not be possible when the investment is liquidated. Our attorneys can work with you, your financial advisor and CPA to advise you in connection with the sale of your business or investment assets and can assist you with any decision to invest in an Opportunity Zone Fund.

Please contact Jim Leet at 916.231.4076 (jleet@boutinjones.com) or Jon Christianson at 916.231.4103 (jchristianson@boutinjones.com) if you have questions.

Legal disclaimer: The information in this article (i) is provided for general informational purposes only, (ii) is not provided in the course of and does not create or constitute an attorney-client relationship, (iii) is not intended as a solicitation, (iv) is not intended to convey or constitute legal advice, and (v) is not a substitute for obtaining legal advice from a qualified attorney. You should not act upon any of the information in this article without first seeking qualified professional counsel on your specific matter.

 

 

 

Attorney Emile Khoury Joins Boutin Jones

We are pleased to welcome associate attorney Emile Khoury to our firm. He comes to Boutin Jones after serving as a judicial clerk for the Hon. Barbara Madsen, Washington State Supreme Court. Emile, who will be part of our corporate and securities practice, is a graduate of San Francisco State University and Gonzaga University School of Law.

 

Civil Litigation Strategies: How to Win Your Case Before Trial

Bruce Timm, Shareholder and a member of the Employment Law and Litigation practice groups, is presenting a 1.5 hour course, “Civil Litigation Strategies: How to Win Your Case Before Trial,” on October 12, 2018, from 1:30 p.m. to 3:00 p.m. at the Sacramento County Public Law Library, located at 609 – 9th Street, Sacramento, CA. MCLE credit available. To register, go to www.saclaw.org.

BMT Civil Litigation Strategies

Civil Litigation Strategies

Boutin Jones Inc. and Clear Advocacy, LLC Form Strategic Alliance

Boutin Jones Inc. and Clear Advocacy, LLC have entered into a strategic alliance to provide lobbying and government relations expertise in the California capital to clients of both firms and those of the law firm members of SCG Legal, an international network of independent law firms. Clear Advocacy, LLC is a full service governmental relations practice based in Sacramento. The principals, Peter Kellison, Fred Main and Kevin Pedrotti, each have over 30 years of lobbying experience. The firm represents a broad range of clients in retail, financial services, health care and other businesses.

Boutin Jones is one of the largest law firms in the Sacramento region. The firm represents businesses and individuals in a wide range of matters, including litigation, corporate, securities, real estate, employment, tax, health care, trusts and estates and creditors’ rights. SCG Legal is comprised of 148 independent law firms in 82 countries.

Clear Advocacy partner Fred Main stated, “We look forward to working with the clients of Boutin Jones and those of the member firms of SCG Legal in California’s challenging legislative and regulatory environment.”

Boutin Jones’ managing shareholder, Julia Jenness, remarked, “We are pleased to have formed this strategic alliance with Clear Advocacy. Our clients, and those of the SCG member firms, now have access to the lobbying and government relations services needed to address California’s complex administrative environment.”

For more information about this strategic alliance, contact Jim Leet at Boutin Jones (916) 321-4444 or Fred Main at Clear Advocacy (916) 479-7400.

 

Businesses Using Independent Contractors in the Usual Course of Business Need to Consider Converting to Employees Because of a New California Supreme Court Case

On April 30, the California Supreme Court issued a decision in Dynamex Operations West v. Superior Court, which expands the definition of “employee” and calls into question whether individuals may be properly classified as independent contractors. Although the case deals only with California wage orders, it is almost certain to have far-ranging impacts, including in employment tax worker classification cases. For wage order purposes, at least for nonexempt workers, businesses will need to record hours worked, pay overtime, provide meal and rest periods, reimburse reasonable and necessary business expenses, be responsible for basic working conditions, etc. Exerting this amount of control is likely to result in the reclassification of workers from independent contractors to employees for employment tax purposes.

More importantly, the new Dynamex “ABC” test has retroactive effect and requires businesses to immediately reevaluate their relationships with individuals previously classified as independent contractors. The “ABC” test requires that the hiring entity prove each of three specific factors:

(A) that the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact; and

(B) that the worker performs work that is outside the usual course of the hiring entity’s business; and

(C) that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

If a worker performs work within the usual course of the hiring entity’s business, e.g., driving for a delivery service, or the worker performs services for only the hiring entity, that worker is an employee for purposes of California wage orders. Improperly classifying a worker can lead to liability under the applicable wage order for, among other things, overtime, meal and rest periods, failure to reimburse business expenses, as well as significant statutory penalties.

As a practical matter, it will be very difficult for businesses to treat workers as independent contractors for employment tax purposes and as employees for wage order purposes. If the Dynamex standard applies to California employment taxes, there will be federal employment tax consequences, too, because, as a practical matter, it is very difficult for businesses to treat workers as employees for California employment tax purposes and as independent contractors for federal employment tax purposes.

Any business that uses independent contractors as part of its business model needs to consider whether to adopt an employee business model in order to limit its liability resulting from the Dynamex decision.

If you have any questions about the Dynamex decision, please contact Bob Rubin (916.321.4444; brubin@boutinjones.com ) or Kim Lucia (916.321.4444; klucia@boutinjones.com ).

Legal disclaimer: The information in this article (i) is provided for general informational purposes only, (ii) is not provided in the course of and does not create or constitute an attorney-client relationship, (iii) is not intended as a solicitation, (iv) is not intended to convey or constitute legal advice, and (v) is not a substitute for obtaining legal advice from a qualified attorney. You should not act upon any of the information in this article without first seeking qualified professional counsel on your specific matter.

 

An Attorneys’ Fees Provision Does Not Guarantee Award of Attorneys’ Fees Even if You Prevail

The California Supreme Court recently held that the assertion of a contract as an affirmative defense does not constitute an “action” or “proceeding” for purposes of triggering the attorneys’ fees provision in the agreement. Mountain Air Enterprises, LLC v. Sundowner Towers, LLC, 3 Cal.5th 744 (2017).

Under the American Rule, each party to a lawsuit pays its own attorneys’ fees. California law, however, permits parties to contract out of the American rule by expressly agreeing to an arrangement that allocates those fees.

In Mountain Air, plaintiff sued defendants to, among other things, specifically enforce an agreement to purchase real estate. In response, defendants asserted the affirmative defense of novation, arguing that the purchase agreement was extinguished by an option agreement subsequently entered into by the parties. Defendants prevailed at trial. However, the trial court refused to grant defendants their attorneys’ fees pursuant to the option agreement’s attorneys’ fees provision that authorized fees to the prevailing party if a “legal action” or “proceeding” is brought to enforce the option agreement or because of an alleged dispute, breach, default or misrepresentation in connection with any provision of the option agreement.

The Supreme Court, reversing the Court of Appeal, agreed with the trial court that asserting the option agreement as an affirmative defense did not trigger the option agreement’s attorneys’ fees provision because an affirmative defense, in and of itself, does not constitute an “action” for purposes of recovering attorneys’ fees. The term “action” is generally treated as referring to the whole of a lawsuit rather than to discrete proceedings within the lawsuit. The Supreme Court further concluded that affirmative defenses are not typically “brought” by a party and therefore the inclusion of that word is consistent with a narrow reading of the attorneys’ fees provision.

Ultimately, the Supreme Court granted defendants their attorneys’ fees on a different ground because it found the action was brought “‘because of’ ‘an alleged dispute … in connection with’” the option agreement.

If you have questions, please contact either Bashar Ahmad (bahmad@boutinjones.com) or Mollie Murphy (mmurphy@boutinjones.com) at 916.321.4444.

Legal disclaimer: The information in this article (i) is provided for general informational purposes only, (ii) is not provided in the course of and does not create or constitute an attorney-client relationship, (iii) is not intended as a solicitation, (iv) is not intended to convey or constitute legal advice, and (v) is not a substitute for obtaining legal advice from a qualified attorney. You should not act upon any of the information in this article without first seeking qualified professional counsel on your specific matter.

 

Risks? What Risks? It's a Pot Party … But the Feds Aren't Coming (Or Are They?)

A.     Introduction.

It’s a gold rush! Cannabis business activity in California is booming! And …

All you read in the press … all you see in the media … is that you better jump in with both feet.

We’re business lawyers and we represent business clients. One of our most important duties is to advise our business clients of the legal risks associated with their business ventures.

When it comes to cannabis-related business activity, there are some significant legal risks that nobody is talking about. We think you need to know what they are.

This article summarizes some of the legal risks under federal law associated with engaging in cannabis-related business activities.

B.     Executive Summary.

Despite broad public support for legalization of medical and recreational marijuana, and despite state laws authorizing and regulating medical and recreational cannabis-related business activity, marijuana is not “legal.” Federal law, which applies even in California and other states which have legalized medical and/or recreational marijuana, treats marijuana as a dangerous drug akin to heroin or cocaine. Engaging in, assisting, funding, serving or facilitating marijuana-related activities are fraught with risk, both criminal and civil. Those risks include possible prosecution for commission of a felony, aiding and abetting a criminal activity, conspiracy to commit a felony, and civil forfeiture of assets used in, or received from, illegal activity. In addition, participants in cannabis-related activity may not be able to enforce contract rights, seek redress from state or federal courts, or be entitled to rights afforded to “legal” business activities. In summary:

• Compliance with California marijuana laws doesn’t protect you from federal prosecution.
• The U.S. Department of Justice has rescinded a key element of the prior protections against enforcement of federal marijuana laws against state-compliant medical marijuana activity. No federal protections exist for state-legal recreational marijuana activities.
• Even peripheral involvement, by serving, funding or assisting a cannabis-related activity, may subject you to criminal liability as an aider and abettor, or co-conspirator.
• Your real property and other assets can be seized in a civil forfeiture action.
• Your liability and casualty insurance may not cover you in the event of a loss.
• You may not be able to enforce your contracts in state or federal courts.
• You may not be able to deduct your business expenses on your tax returns.
• Your activity may cause you to be in default under your loan documents or other contracts.
• Your bank accounts may be closed, and you may not be able to open new accounts.
• You aren’t entitled to bankruptcy protection if your business fails.
• Your conversations with your lawyers may not be privileged.
• Your lawyers may become witnesses against you in a federal enforcement action.

Each of the above risks is discussed in more detail, below.

C.     State Marijuana Law.

The State of California has legalized cannabis-related activities under statutes permitting certain “medical marijuana” business activities, and as as of January 1, 2018, certain recreational marijuana activities. This results in two categories of cannabis-related business activity: (1) businesses operated by Licensees; and (2) businesses operated by third parties who do business with Licensees, including by financing them, selling or leasing buildings or land to them, or providing them with services or products. Such ancillary service providers include investors, bankers, lawyers, accountants, landlords, real estate brokers and vendors.

“Legal” marijuana use in California is big business. On October 9, 2017, the Sacramento Bee published an article entitled “Pot Growers Take Over Warehouse Space in Sacramento.” Among other things, that article stated that more than 100 businesses were seeking special permits from the city of Sacramento to run indoor marijuana growing operations as of July 2017, and some officials predicted that up to 200 might apply before the end of 2017. According to the article, legal pot growers are pushing prices and rents for industrial properties to unheard-of heights in some areas of the city of Sacramento. The Bureau of Cannabis Control, the agency responsible for regulating commercial cannabis Licensees, announced in early January 2018 that more than 400 licenses had been issued and more than 1,800 applications for licenses had been submitted. The legalization in California, under State law, of medical marijuana and certain recreational uses of marijuana, has engendered widespread business activity related to the cannabis industry that has been characterized by some as the “next California gold rush.”

“Legal” marijuana use in California is limited in scope, complicated and fraught with traps for the unwary. Local governments can pursue illegal cannabis operators and their landlords for administrative code enforcement, civil nuisance abatement actions and criminal actions. The remedies available to local governments include recovery of attorneys’ fees and costs associated with abatement, through liens and special assessments against the property of the operator and the landlord. The state can also prosecute and pursue illegal cannabis operators and pot-adjacent parties under various state criminal and civil laws.

D.     Federal Marijuana Law.

          1.     “Legal” marijuana does not exist in the United States. Federal law still broadly criminalizes growing, distributing and/or possessing marijuana, including “medical marijuana.” Knowingly or intentionally growing, distributing or possessing marijuana with the intent to manufacture, distribute or dispense is punishable by up to life imprisonment. 21 U.S.C. § 841(a). All activities involving the cultivation, distribution and/or sale of cannabis remain illegal under the United States Controlled Substances Act. Cannabis is classified as a Schedule I drug under that act, no different from heroin. The fact that a cannabis-related business activity is legal under state law and fully compliant with applicable state law does not make such activity legal under federal law. A number of bills have been introduced in the U.S. Senate and the House of Representatives, each of which addresses, in some form, the criminalization of marijuana under federal law. At present, and notwithstanding broad public support for decriminalization, no bill has the necessary support to become law.

          2.     On January 4, 2018, the Department of Justice took the first step in overriding guidance given under the Obama administration that limited federal enforcement of marijuana laws against “state legal” medical marijuana activities. In October 2013, the U.S. Department of Justice (“DOJ”) promulgated the “Cole Memorandum,” under which the DOJ outlined its marijuana enforcement priorities under the Controlled Substances Act. The Cole Memorandum did not list as an enforcement priority state-legal medical marijuana-related conduct so long as the state regulatory scheme contained “robust controls and procedures on paper” and was “effective in practice.” The Cole Memorandum has been viewed in the cannabis industry as providing a “safe harbor” for medical marijuana business activity operated in strict compliance with state law.

The guidance in the Cole Memorandum was subject to change at any time. In September 2017, Deputy U.S. Attorney Rod Rosenstein signaled a change in the DOJ’s enforcement priorities and has been quoted as saying, “[The Cole Memorandum has] been perceived in some places almost as if it creates a safe harbor, but it doesn’t. And it’s clear that it doesn’t. That is, even if, under the terms of the memo you’re not likely to be prosecuted, it doesn’t mean that what you’re doing is legal or that it’s approved by the federal government or that you’re protected from prosecution in the future.”

On January 4, 2018, Attorney General Jeff Sessions announced the rescission of the Cole Memorandum:

“It is the mission of the Department of Justice to enforce the laws of the United States, and the previous issuance of guidance undermines the rule of law and the ability of our local, state, tribal, and federal law enforcement partners to carry out this mission. Therefore, today’s memo on federal marijuana enforcement simply directs all U.S. Attorneys to use previously established prosecutorial principles that provide them all the necessary tools to disrupt criminal organizations, tackle the growing drug crisis, and thwart violent crime across our country.”

As a result of the rescission of the Cole Memorandum, federal enforcement of marijuana laws now resides in the 93 U.S. Attorneys. The recently appointed U.S. Attorney for the Eastern District of California (Sacramento and 33 other California counties) is McGregor “Greg” W. Scott, a Trump appointee who already held the position under President George W. Bush. While in office, Scott targeted large-scale cannabis operations and developed a reputation for seeking harsh sentences. On January 18, 2018, a Sacramento Bee article quoted Omar Figueroa, a Sebastopol lawyer specializing in marijuana cases: “He used to be a hardcore, anti-cannabis drug warrior. I hope he has evolved.”

Public backlash against the rescission of the Cole Memorandum has been significant. On January 24, 2018, a bi-partisan group of 54 members of Congress sent a letter to President Trump encouraging reinstatement of the Cole Memorandum. Nevertheless, as of the date of this article, the White House has not issued any policy statements addressing the rescission of the Cole Memorandum.

          3.     Leadership at the DOJ continues to support and lobby for enforcement of federal marijuana laws and funding to do so. Under what was known as the “Rohrabacher-Farr Amendment” to the House appropriations bill of 2015 (currently known as the “Rohrabacher-Blumenauer Amendment”) (the “Rohrbacher Amendment”), the DOJ is presently prohibited from using appropriated funds to enforce federal marijuana laws against “state compliant” medical (but not recreational) marijuana operations. The Rohrbacher Amendment has been extended through March 23, 2018, at which time it will expire absent renewal by Congress or further extension. While there is significant support in Congress for further extension of the Rohrbacher Amendment, the Attorney General and the House Rules Committee have opposed its renewal. If the Rohrbacher Amendment is not renewed, the DOJ will have no restrictions on the use of federal funds for enforcement of federal marijuana laws.

          4.     Federal restrictions under the Cole Memorandum and the Rohrbacher Amendment applied only to state-legal medical marijuana activity, not recreational marijuana activity. Neither the Cole Memorandum nor the Rohrbacher Amendment limit federal enforcement or prosecution against state-legal recreational use of marijuana. No “safe harbor” exists to limit or prohibit DOJ funding for the enforcement of federal law against state-legal recreational marijuana cultivation, manufacturing, distribution or use. Members of Congress proposed an addition to the latest emergency appropriations bill that would have extended the Rohrbacher funding limitations to state-legal recreational marijuana use (the “McClintock-Polis Amendment”), but the McClintock-Polis Amendment did not have sufficient support for inclusion in the latest emergency funding bill.

          5.     Licensees are not the only parties at risk of criminal prosecution. Those who facilitate the marijuana business are also at risk of criminal prosecution. These parties include owners, operators, investors, bankers, landlords or vendors for a marijuana business. It is a separate federal crime to manage or control any place, permanently or temporarily, for the purpose of manufacturing, distributing, storing or using marijuana. 21 U.S.C. § 856. The statute is commonly used to prosecute owners and operators of marijuana-related businesses. A landlord, lender, investor or ancillary service provider (including a lawyer) to a Licensee may also be subject to prosecution under this statute as a principal, co-conspirator, or an aider and abettor. Under federal law, whoever commits an offense against the United States, or aids, abets, counsels, commands, induces, or procures its commission, is punishable as a principal. 18 U.S.C. § 2. Non-Licensee pot-adjacent parties are also at risk for money laundering, financial reporting, and facilitation crimes. For example, Licensees generally don’t have access to banks and must engage in cash or barter transactions. Receipt of large amounts of cash requires financial reporting and failure to report can result in prosecution and fines. 31 U.S.C. §§ 5321, 5322. Receipt of large amounts of cash from a known marijuana business or facilitating a financing transaction to further a marijuana business are subject to prosecution, with punishments of up to 20 years imprisonment. 18 U.S.C. §§ 1956, 1957.

         6.     The federal government can seize your property or your assets in a civil forfeiture action. Even absent prosecution, civil forfeiture remedies are available to federal prosecutors. Civil forfeiture allows the government to seize all the assets involved in operating the marijuana business and any property traceable to the proceeds of the business. 18 U.S.C. §§ 981, 983. This includes vehicles, land used to grow marijuana, buildings used to house marijuana operations, investor capital and profits, and other assets related to the involvement in the illegal activity. Even under the more lenient Obama DOJ, U.S. Attorneys used civil forfeiture against landlords leasing to medical marijuana businesses. For example, in two 2013 forfeiture actions brought against the owner of a retail shopping center in Oakland, and the owner of a retail shopping center in San Jose, each of which housed, as one among several tenants, a medical marijuana facility, the United States sought civil forfeiture against the property owners (who had knowledge of the business of the tenant) of the entire retail project. The government’s theory was premised on the knowing receipt by the landlords of rent payments (proceeds) from illegal businesses (medical marijuana clinics) situated on the landlord’s property, with the landlord’s permission (under a lease). The current administration views civil asset forfeiture as an important tool in combatting crime. In a July 19, 2017, DOJ press release (accompanied by new DOJ Policy Directive 17-1), Attorney General Jeff Sessions stated:

“President Trump has directed this Department of Justice to reduce crime in this country, and we will use every lawful tool that we have to do that. We will continue to encourage civil asset forfeiture whenever appropriate in order to hit organized crime in the wallet. At the same time, we must protect the rights of the people we serve. Law-abiding people whose property is used without their knowledge or without their consent should not be punished because of crimes that others have committed.”¹

          7.    The criminal penalties are stiff. Growing, distributing and possessing marijuana is punishable by up to life imprisonment. First time offenders with 1-50 plants or under 50 kg are subject to a fine of $250,000 to $1 million and imprisonment up to 5 years (Trafficking 21 U.S.C. §§ 841, 960, 962 and 46 U.S.C. § 70506). Mandatory fines and sentences for incarceration increase when multiple offenses and/or increased numbers or weights are involved. In addition to criminal prosecution, civil monetary penalties, civil forfeitures and/or regulatory sanctions can occur without anyone being charged with a crime. For example, even without a criminal case pending, a person who manages or controls a premises for growing, distributing or selling marijuana can be fined up to $250,000 or twice the gross receipts of the business, whichever is greater (21 U.S.C. § 856(d)). Being the owner, operator, financier, banker, landlord or vendor for a marijuana business is illegal. In addition to the potential life felony for dealing marijuana, it is a separate federal crime, punishable by up to 20 years in prison, to manage or control any place for manufacturing, distributing, storing or using marijuana (21 U.S.C. § 856). The mere receipt of a payment of more than $10,000 from a known marijuana business (including payment for services rendered) may be a federal crime punishable by up to 10 years in prison (18 U.S.C. § 1957). Engaging in a financial transaction for the purpose of promoting or furthering a known marijuana business may be a federal crime punishable by up to 20 years in prison (18 U.S.C. § 1956). Aiders and abettors to the foregoing crimes, or co-conspirators in the foregoing criminal activity, are liable to the same extent as the principal.

          8.     Your liability and property insurance may not cover you or your activities. Insurance policies routinely contain exclusions for criminal acts. Non-Licensee pot-adjacent parties may not have liability or casualty coverage if sued for conduct related to the marijuana business. This includes malpractice insurance for doctors, lawyers and other professionals aiding marijuana businesses. Property insurance carriers may deny coverage if the premises were used for, or the loss is related to, criminal activity. A typical exclusion from coverage for commercial property insurance is:

Dishonest or criminal act by you, any of your partners, members, officers, managers, employees (including leased employees), directors, trustees, authorized representatives or anyone to whom you entrust the property for any purpose:

1. Acting alone or in collusion with others; or
2. Whether or not occurring during the hours of employment.

More broadly, insurers have successfully denied claims arising from illegal activities on the basis that coverage would violate public policy. The opportunities for large casualty claims arising from a marijuana business are many – fire from excessive electrical requirements, water damage and mold damage from humidification, illness from evacuated production air into other tenant or common areas and explosions from cannabis oil distillation systems.²

          9.     You could lose your professional licenses. Many professional licenses require good conduct and may be subject to revocation if a licensed professional knowingly engages in illegal conduct. Accountants, doctors, general contractors, real estate brokers and similar licensees are at risk.

          10.    Accepting money from, or paying, a marijuana business could be illegal. Most banks will not accept legal marijuana businesses as clients, so these businesses operate extensively in cash. Federal law requires banks, trades, and businesses (including lawyers) to report any cash transaction, or series of transactions, that exceed $10,000. Failing to file these reports could result in monetary fines or prosecution. Federal money laundering laws also apply to certain common financial transactions with legal marijuana businesses. For example, merely receiving a cash payment of more than $10,000 from a known marijuana business may be a federal crime punishable by up to 10 years in prison. Engaging in a financial transaction for the purpose of promoting or furthering a known marijuana business may be a federal crime punishable by up to 20 years in prison. Therefore, a vendor who supplies packaging material or agricultural equipment to a legal marijuana business, knowing that those goods will be used to help the business operate, may be committing a 20-year felony by accepting payment for those goods. Similarly, an accountant who receives payment for maintaining the financial records of a legal marijuana business could be violating the federal money laundering laws.

          11.     Your bank may cancel your accounts and you may have difficulty finding new banking arrangements. Most financial institutions do not accept deposits representing funds generated from cannabis-related business, and will not establish banking relationships with cannabis-related businesses. According to testimony from the director of the Financial Crimes Enforcement Network (FinCEN), in August 2014 only 105 banks nationwide were accepting deposits from marijuana businesses. As of June 30, 2017, that number had risen to only 390 banks and credit unions across the country. The Recorder, a legal industry publication, reported in a December 28, 2017 article, that Umpqua Bank closed the accounts of an attorney representing state-legal cannabis businesses, after learning of the attorney’s connection with cannabis-related businesses and the attorney’s refusal to document for the bank specific information about his marijuana-related clients. One attorney interviewed for the article was quoted as saying “It’s definitely frequent that they kick marijuana businesses out.”

          12.     You may not be able to deduct your business expenses. Section 280E of the Internal Revenue Code prohibits businesses involved in “drug trafficking” from deducting normal business expenses from their gross income. It provides that “[n]o deduction or credit shall be allowed” for expenses related to a trade or business that consists of trafficking in Schedule I or Schedule II controlled substances in violation of state or federal law. In a 2012 case, the U.S. Tax Court denied all business deductions to a California marijuana dispensary. In July 2015, this decision was affirmed by the U.S. Court of Appeals for the Ninth Circuit. You should discuss with your accountant and tax advisors the tax and accounting implications of involvement in a transaction related to the cannabis industry.

          13.     A bankruptcy may not protect you if your marijuana-related business fails. The Tenth Circuit and several bankruptcy courts have ruled that a marijuana business cannot use bankruptcy for protection from creditors. The rulings are supported by the Office of the United States Trustees, a division of the DOJ with oversight responsibilities concerning bankruptcy trustees and bankruptcy administrators. So, even if the federal government does not take all assets of the business in forfeiture or taxes, its creditors might. The same limitations may exist for businesses that facilitate or serve the marijuana industry.

          14.     You may be in default under contracts to which you are a party or which affect your property or occupancy. If you own real property encumbered by a loan, the loan documents typically require that you and the businesses operated on your property comply with federal and state law. Engaging in a cannabis-related business or allowing a cannabis-related business on your property may be a default under your loan. Other types of agreements under which defaults may be triggered by operation of, or in connection with, cannabis-related activity, include leases and rental agreements (and rules and regulations promulgated thereunder), agreements with vendors to your business or companies to whom your supply services or products, distribution and supply agreements, common area declarations and restrictions on use, property CC&Rs, bank or credit agreements, and any agreements providing for federal assistance, funding or support for your business or properties.

          15.     You may not be able to enforce your rights under contracts with marijuana-related businesses. Contracts with marijuana-related businesses may not be enforceable in state or federal courts. In a recent case of great note, Arizona private-party lenders loaned a Colorado medical marijuana dispensary $500,000. After the dispensary failed to make payments, the lenders commenced an action in state court in Arizona to collect on their promissory note. Despite both Arizona and Colorado recognizing legalized marijuana, the trial court granted the defendant’s motion to dismiss because the contract was void for illegality and against public policy. After quoting from the loan agreement which stated that “Borrowers shall use the loan proceeds for a retail medical marijuana sales and grow center,” the court held:

“The explicitly stated purpose of these loan agreements was to finance the sale and distribution of marijuana. This was in clear violation of the laws of the United States. As such this contract is void and unenforceable. This Court recognizes the harsh result of this ruling. Although Plaintiffs did not plead any equitable right to recovery such as unjust enrichment, or restitution, this Court considered whether such relief may be available to these Plaintiffs. Equitable relief is not available when recovery at law is forbidden because the contract is void as against public policy….[O]ne who enters into such a contract is not only denied enforcement of his bargain, he is also denied restitution for any benefits he has conferred under the contract.”

          16.     Your conversations with your lawyer may not be privileged. Confidential communications between a lawyer and client are generally privileged and not subject to discovery by a third party. However, what is known as the “crime-fraud” exception to confidential communications with a lawyer does not apply to communications with a lawyer in furtherance of illegal activity. Therefore, an adverse party – either the government or a third party – could assert that all attorney-client communications about the operations and transactions of the state-legal marijuana business are not privileged and are discoverable in litigation.

          17.     Your lawyer’s advice may not provide you a criminal defense and your lawyer may be compelled to be a witness against you. One defense to state or federal criminal prosecution is that the client relied on the advice of counsel. The advice-of-counsel defense requires that before taking an action the client fully discloses its plans to its lawyer and thereafter complies with its lawyer’s advice. The advice-of-counsel defense negates the element necessary to many crimes of “specific intent to commit a crime.” However, the advice-of counsel defense would not protect the client from drug crimes which merely require knowledge that the client is interacting with a marijuana business, i.e., a “general intent” crime that does not require proof of willfulness. See, e.g., 18 U.S.C. § 841. In addition, the mere assertion of the advice-of-counsel defense waives the attorney-client privilege. If the client’s lawyer complied with its ethical rules and advised the client that the marijuana business is illegal under federal law, the lawyer could be called as a damaging witness in a federal drug prosecution case.

¹California property owners will encounter difficulty asserting an “innocent owner” defense to federal forfeiture actions because state law requires property owners to provide written consent to cannabis activity before the tenant obtains a license. Bus. & P C §26051.5(a)(2).

²Such explosions are increasing in frequency, with 32 such blasts in Colorado in 2014. See, New York Times, Odd Byproduct of Legal Marijuana: Homes That Blow Up, Jack Healy, January 17, 2015.

Please contact Doug Hodell at dhodell@boutinjones.com, or Mark Gorton at mgorton@boutinjones.com, if you have any questions regarding this article.

 

Legal disclaimer: The information in this article (i) is current only as of the above date, (ii) is a broad overview provided for general informational purposes only and does not address every risk or the nuances of each risk, (iii) is not provided in the course of and does not create or constitute an attorney-client relationship, (iv) is not intended as a solicitation, (v) is not intended to convey or constitute legal advice, and (vi) is not a substitute for obtaining legal advice from your own, qualified attorney. You should not act upon any of the information in this article without first seeking qualified professional counsel on your specific matter.

Printable Copy: Risks – What Risks – It’s a Pot Party – But The Feds Aren’t Coming Or Are They

Printable Copy: Risks - What Risks - It's a Pot Party - But The Feds Aren't Coming Or Are They

The Gift and Estate Tax Exemption Has Been Doubled – But for a Limited Time Only?

New tax legislation, known as the Tax Cuts and Jobs Act (the “Act”), doubles the gift and estate tax exemption (the “exemption”), which is the amount that an individual may transfer free of tax either by gift during lifetime or at death.

In 2017 the exemption was $5,490,000. The Act temporarily doubles the exemption to approximately $11,180,000* per individual (or $22,360,000 for married couples). This temporary increase expires on December 31, 2025, and then the exemption reverts to its current level ($5,000,000 per person, adjusted for inflation).

Of course, future legislation could reduce the exemption prior to 2026, or extend the higher exemption beyond 2026.

The Act directs that Treasury issue regulations to address the treatment of gifts made when the exemption is at a high level (during 2018 to 2025, for example) if the donor dies when the exemption is dropped to a lower amount (for example, if the donor dies in 2026 or later years). We will be reviewing these Treasury regulations when issued; however, many commentators believe that these regulations will provide that tax savings associated with prior gifts will not be reduced if the exemption is decreased in the future.

The increased exemption available between 2018 and 2025 presents significant opportunities for some clients to make additional tax free gifts.

In addition, adjustments to existing estate plans may also be necessary given the higher exemption. For many clients, estate taxes may not be a concern, and estate plans should be reviewed to take advantage of a step up in income tax basis of assets on death.

Please contact Kent Silvester, Stuart List or Stacey Brennan if you have any questions regarding this article, or if you would like to discuss the impact the Act may have on your estate plan and the opportunities it may present to you.

 

*Approximate because the IRS needs to compute and announce the actual inflation adjusted exemption amount.

 

 Legal disclaimer: The information in this article (i) is provided for general informational purposes only, (ii) is not provided in the course of and does not create or constitute an attorney-client relationship, (iii) is not intended as a solicitation, (iv) is not intended to convey or constitute legal advice, and (v) is not a substitute for obtaining legal advice from a qualified attorney. You should not act upon any of the information in this article without first seeking qualified professional counsel on your specific matter.

New Reduced Tax Rate for Qualified Business Income

The legislation formerly known as the Tax Cuts and Jobs Act (the “Act”) adds section 199A to the Internal Revenue Code (the “Code”). The provision provides a new deduction that reduces the effective tax rate on qualified business income (“QBI”) for owners of businesses taxed as sole proprietorships, partnership, limited partnership, limited liability company, S corporation and similar pass-through entities (herein after “pass-through entity”).

Qualified Business. Most businesses owned and operated by a pass-through entity within the United States, including real estate rental and investment activities, will satisfy the qualified business requirement. However, certain “specified service businesses” including health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services and any other trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees, are subject to more significant limitations. Firms providing engineering or architectural services are not treated as specified service businesses even though they would seem to meet the foregoing definition.

Qualified Business Income. QBI is defined as the net amount of items of income, gain, deduction and loss attributable to each qualified business conducted by a sole proprietor or pass-through entity. QBI excludes wages and reasonable compensation by an owner received from an S corporation, and guaranteed payments received by a partner for services provided to a partnership’s business. Also excluded are specified investment-related items including capital gains or losses, dividends, interest income, qualified REIT dividends, qualified cooperative dividends or qualified publicly traded partnership income. The amount of QBI allowed as a deduction is subject to the limitations discussed below.

Allowable QBI Deduction. An owner or investor in a qualified business may deduct up to 20% of QBI, subject to the following limitations:

W-2 Wage Limitation. The QBI deduction may not exceed the greater of: (i) 50% of W-2 wages paid to employees of the qualified business during the taxable year, or (ii) the sum of 25% of W-2 wages plus 2.5% of the unadjusted basis (usually, the original acquisition cost) of qualified property. “Qualified property” means tangible, depreciable property, including tangible property and real property improvements, used in the qualified business for the production of income, and for which the depreciable period has not ended before the close of the tax year.  Under an exception to this limitation, the W-2 wage limitation does not apply to reduce the amount of the full QBI deduction until an owner’s taxable income exceeds $157,500 or $315,000 for joint filers (the “Threshold Amount”). In other words, the full 20% QBI deduction is allowed for owners with taxable incomes under the Threshold Amount. The W-2 wage limitation is phased in for taxable income over the Threshold Amount and is fully applicable for taxable incomes which exceed the Threshold Amount by $50,000 for individuals and $100,000 couples (i.e., $207,500 for individuals, and $415,000 for joint returns).

Specified Service Businesses. Owners of specified service businesses (as described above) with taxable income below the Threshold Amount are eligible for the full 20% QBI deduction. Unfortunately, the QBI deduction is phased out and eliminated for owners with taxable incomes in excess of $207,500 for individuals, and $415,000 for joint returns.

Trusts and Estates. Trusts and estates are eligible for the 20% deduction under Code section 199A. Rules similar to the rules under present-law Code section 199 (as in effect on December 1, 2017) apply for apportioning W-2 wages and unadjusted basis of qualified property between fiduciaries and beneficiaries.

Example:   Taxpayer owns an office building that has an unadjusted basis when purchased of $10,000,000, of which $8,000,000 is allocated to a depreciable building.  Taxpayer has four employees with a total W-2 wages paid of $300,000.  Taxpayer’s net income from the building is $1,000,000.

Information Needed to Calculate the QBI Deduction:

20% of qualified business income: $200,000

50% of W-2 wages: $150,000

25% of W-2 wages: $75,000

2.5% of the unadjusted basis of depreciable property: $200,000

The lesser of: (i) $200,000 (QBI) or (ii) the greater of: (a) $150,000 (50% of W-2 wages) or (b) $275,000 (25% of W-2 wages plus 2.5% of unadjusted basis of depreciable property).

Answer: The maximum QBI deduction is allowed since $200,000 is less than $275,000 which results from the combined wage and depreciable basis calculation. The result would remain the same if the taxpayer in the above example had no employees since 2.5% of $8,000,000 is $200,000, an amount equal to $200,000. If the value of the unadjusted basis of the building is reduced to $7,000,000 and there are no employees, the QBI deduction would be limited to $175,000 (which is 2.5% of $7,000,000).

Sunset: The Section 199A provisions discussed above expire on December 31, 2025, unless Congress extends or eliminates the sunset date.

If you have questions, please contact either Jim Leet (jleet@boutinjones.com) or Jon Christianson (jchristianson@boutinjones.com) at (916) 321-4444.

 

Legal disclaimer: The information in this article (i) is provided for general informational purposes only, (ii) is not provided in the course of and does not create or constitute an attorney-client relationship, (iii) is not intended as a solicitation, (iv) is not intended to convey or constitute legal advice, and (v) is not a substitute for obtaining legal advice from a qualified attorney. You should not act upon any of the information in this article without first seeking qualified professional counsel on your specific matter.