Monday, March 31, 2003

Six Degrees of Separation

Today's New York Times had a story on the case of Norton v. Glenn regarding the issue of "reportage privilege."

Under the facts of the case, a member of the Parkesburg Borough Council characterized the Borough Mayor and the Borough Solicitor as "queers" and "child molesters" and referred to the Borough Solicitor as a "shyster Jew." The statements were reported in the local paper. The Mayor and Borough Solicitor brought suit against not only Glenn, the council member who made the statements, but against the reporter and newspaper as well.

The trial court had applied the so-called "neutral reportage privilege" to the case, based evidentiary rulings upon that privilege and gave jury instructions based upon it. The jury returned a verdict exonerating the reporter and the newspaper.

In essence, the privilege applies the standards of New York Times v. Sullivan, 376 U.S. 254 (1964). It allows reporting of newsworthy statements without fear of being sued for defamation, unless the plaintiff can show that the publication by the reporting organization was made with "actual malice." That is, the plaintiff must prove that reporting organization knew that the statement was false or reported the statement with reckless disregard of whether it was false or not.

The intermediate appellate court rejected the doctrine and the case is now on appeal to the Pennsylvania Supreme Court. Amicus briefs have been filed by numerous press organizations, including the Times.

The case has obvious ramifications for weblog authors. After all, a significant portion of weblog reportage consists of brief mentions of stories that appear in more traditional publications or even references to weblog references to weblog references (and so on) to articles that appear in more traditional publications. If there is no "neutral reportage privilege," the chain of potential defendants could be as long as the number of links to a particular story.

(Note: The quotes of the councilman that are set forth above were contained in the appellate court's opinion, which quoted from the trial court's opinon, which quoted from the evidence adduced at trial, which quoted from the allegedly offending news story, which quoted the councilman. I don't think that I can be sued for defamation for reporting about a court's opinion discussing a trial about an alleged defamation, but ya' never know.)

Tuesday, March 25, 2003

Hey, Let's Be Careful Out There!

One might think that maintaining a weblog is not a risky proposition. Speaking as a lawyer, I have to offer a lawyerly, "That depends."

There are weblogs that focus on hotly debated issues of public policy. It is not beyond the realm of possibility that a by-product of these debates might be a lawsuit for defamation. By way of example, Richard Perle is apparently bringing a lawsuit against Seymour Hirsh for a story authored by Hirsh that appeared in The New Yorker. The lawsuit is being brought in England, which is extraordinarily liberal in allowing recoveries for alleged defamation.

One can easily foresee the possibility of a similar lawsuit growing out of a weblog posting. In that regard, it is notable that the law is unclear as to where such a lawsuit can be brought. There is a case in Australia that holds that jurisdiction over a claim for an alleged defamatory statement can be exercised in that country over Dow Jones & Company, located in New York, for publishing Barron's Online. The theory is that the publication of the defamatory statement took place in Australia when Australian web surfers clicked on the site. Although I've heard that Australia's a nice country, I wouldn't want to defend a lawsuit there.

While The New Yorker has deep pockets and, most likely, an insurance policy that provides coverage for defamation claims, I doubt that many bloggers carry insurance policies that are specifically designed to provide such coverage. Let me suggest, however, that bloggers may, in fact, have such coverage in many cases.

Many, if not all, homeowner policies include within the definition of "personal injury," an injury caused by defamatory comments. Umbrella policies generally mirror that coverage. At the least, weblog authors should make certain that their homeowner's policies provide coverage. Additionally, since umbrella coverage is relatively cheap, they should consider acquiring an umbrella policy with significantly higher limits.

However, be aware that such policies generally contain exclusions for business activities. Thus, if a weblog is designed for what might arguably be considered to be a business purpose (such as a weblog by an attorney offering legal commentary), make certain that your business policy provides such coverage and has sufficient limits of coverage.

This brings me to the case of Applied Signal & Image Technology, Inc. v. Harleysville Mutual Insurance Co., decided last week by Judge Blake of the United States District Court for the District of Maryland. Under the facts of that case, Applied Signal was sued for, among other things, allegedly placing the plaintiff in a "false light." Harleysville agreed to defend the case under a reservation of rights. That is, it agreed to underwrite the costs of defense, but reserved the question of whether it had an obligation to contribute to any settlement or judgment obtained by the plaintiff.

At the end of the day, Harleysville contributed $25,000.00 toward a settlement of the case. It balked, however, at reimbursing Applied Signal for the total defense costs of $88,000.00, arguing that these costs should have been apportioned between those allocable to the covered claim and those allocable to claims that were outside of the policy's coverage.

Harleysville lost. The Court held that the policy provision that required Harleysville to "defend any 'suit' seeking . . . damages [covered by the policy]" was a covenant that was independent of its obligation to indemnify Applied Signal from any loss. The Court pointed out that Maryland requires an insurer to defend when there is a "potentiality that the claim could be covered by the policy" (emphasis by the Court). Furthermore, the Court awarded Applied Signal the reasonable attorneys' fees and costs it incurred in having to bring the action to force Harleysville to reimburse it for the attorneys' fees incurred in the defamation action.

The Moral: An ounce of insurance protection is worth a pound of litigation cure.

HB 753 Update

HB 753 has apparently been approved, but in a heavily amended form, by the Senate Budget & Taxation Committee. While business entity filing fees and yearly registration fees are still raised, the increases are not as radical as those in the version passed by the House. Furthermore, the provision imposing recordation and transfer tax on entity transfers has apparently been stricken.

I have not yet seen a copy of the bill as amended in the Senate, but I will post a more complete summary as soon as possible.

Monday, March 24, 2003

If This is Athens, Where's the Acropolis?

Evelyn Pasquier of Piper Rudnick has authored a summary of HB 753, a budget bill that has just passed the Maryland House of Delegates. She terms the bill "Draconian." Perhaps, "Draconian" is a little over the top, but it's a bad bill.

HB 753 dramatically increases the annual fees that all business entities registered in Maryland must pay. By way of example, all business entities would have to pay at least $400.00 a year. Currently, the annual fee is $100.00 for corporations and nothing for LLCs and partnerships. The fee rises to as much as $20,000.00, depending on the number of employees a business entity has. The fee will have a significant negative impact on the use of multiple entities to lower the liability profile of a business.

Maryland is the "corporate domicile" of many real estate investment trusts. This results in a good deal of money flowing into the state without any significant burden on governmental resources. Apparently determined to kill the goose that is laying this golden egg for the state, HB 753 imposes a $10,000.00 filing fee on REITs.

HB 753 also imposes transfer and recordation taxes on transfers of controlling interests in entities if the underlying real property owned by the entities is worth at least $1,000,000.00. I've commented in the past on the deficiencies of this tax, both legal and economic, and I won't repeat the criticisms here.

HB 753 also makes significant changes to the corporate income tax in Maryland. In essence, these changes extend the reach of Maryland's taxing authority over income that previously escaped taxation.

Ironically, HB 753, which places burdens on business activities in Maryland, has its roots in political rhetoric (mostly, but not exclusively, Republican) that condemns taxes. Voters have been told time and time again that they are heavily taxed. In general, and particularly in Maryland, this is not the case. As a consequence, elected officials in Maryland are unable (or, perhaps, unwilling) to state the obvious: The cuts in the Maryland income tax over the past few years were unwarranted and should be repealed. Attempting to patch the state's leaky fiscal ship by enacting "non-taxes" in the form of dramatically increased business fees will ultimately cost the state dearly in terms of economic development.

Sunday, March 16, 2003

I Don't Want to Get Off on a Rant Here, But . . .

In general, this weblog is directed to discussing "technical" issues pertaining to tax and business law. In the course of these commentaries, it is impossible to avoid discussion public policy issues. After all, in some sense, the law is the articulation of public policy. However, I have avoided topics that are of a more general nature. Thus, I have not offered my opinions on, say, broader issues of tax policy such as tax rates, etc.

My approach has been driven by my view that this weblog is a semi-scholarly endeavor. If my postings were to deal with issues that are the subject of partisan debate, the weblog might be perceived as having a focus that is different from its original intent--to highlight and discuss technical developments in the field.

Readers can assume that I have a political bias. However, their assumptions as to the nature of that bias are often incorrect. For instance, because my work is, to a large degree, devoted to helping my clients minimize the taxes that they pay, there is often an assumption that I am anti-tax. Somewhat conversely, after hearing my opinions as to the necessity of increasing the audit capability of the I.R.S. and the Maryland Comptroller's Office, people sometimes conclude that I’m merely trying to bend public policy to indirectly drum up more business for myself (i.e., more audits, more clients). Neither of these assumptions are correct.

This brings me to the subject of this posting. With the exception of the impending Iraq invasion and, perhaps, the Korean situation, the most heated debates in this country today are over tax policy. The public generally tends to ignore the nitty-gritty of tax policy, since tax policy discussions can cause even the eyes of insomniacs to glaze over. As a consequence, there is a vacuum in public discussions that tends to be filled with "cranks and charlatans." (The term is the appellation applied by the current president's chief economic advisor to the proponents of supply side economics. That being the case, I wonder what he really thinks about the President's tax proposals.) In this category are those who argue that the federal or state budget is bloated and that taxes could be cut and governmental deficits disappear if this bloat were properly attacked.

Access to the facts that refute this argument as it pertains to the federal budget are widely available. Thus, one need look no further than the budget proposed by the White House (which is easily accessible on-line) to discover that the non-military discretionary spending proposed by the White House is only 19.24% of the total proposed spending package. (Non-military discretionary spending is everything other than entitlements, such as Social Security and Medicare, and interest on the federal debt. It represents the cost of operating virtually every governmental agency from the State Department, to the Justice Department, to the FAA, to the FDA, to the costs of running the White House.) This is less than the “off-budget deficit” (the amount that is spent on all items other than designated trust fund programs such as Social Security). In other words, even if non-military discretionary spending were cut to zero, the federal government would still be running a deficit with respect to its current operations. And, this would be the case even before any costs of a war on Iraq are factored in.

It is often more difficult to find similar analyses of state spending, particularly with respect to relatively small states such as Maryland. A recent op-ed piece in The Baltimore Sun by Steve Hill, director of the Maryland Budget and Tax Policy Institute helps to fill this void. The article points out that (i) Maryland government is lean–it has fewer employees per capita than all but nine other states, (ii) that the higher education system in Maryland is underfunded when compared to the systems in other states, and (iii) that state and local governmental spending reflects a smaller share of our economy than in every other state but three.

I disagree with some of the Institute's suggested remedies to balance the state's budget. By way of example, in one paper addressing three alleged loopholes, the Institute urges the passage of the entity transfer tax bill, a step that I have opposed for a number of years. On the whole, however, the Institute and its website are a powerful resource with which to battle Maryland's cranks and charlatans.

Saturday, March 15, 2003

Joseph K. Meets the Internal Revenue Code of 1986

In a recent opinion, the defendants opposed to the I.R.S. characterized their plight as being "Kafkaesque." The court, while admitting that the facts "tend[] to support that view," nonetheless denied relief.

The case, U.S. v. Ripa, involves a claim involving an assessment dating back to 1983 (that’s not a typo). The opinion was handed down on March 12 and the case is number 01-6099. It can be downloaded off of the Second Circuit's website.

In 1983, Romano attempted to enter Canada from the U.S. with $359,000.00 in U.S. currency in his trunk. The cash was the proceeds of "wildly successful, albeit illegal, gambling activities." Unfortunately, Romano had failed to complete the required currency reporting form. As a result, the cash was immediately seized by U.S. Customs officials.

More significantly, the I.R.S., later that same day, made a "termination assessment" against Romano. That is, the Service terminated his tax year as of that date and calculated the tax due. Under such circumstances, the tax becomes immediately due and payable and the I.R.S. files a tax lien. Ultimately, Romano was found to owe $169,981.00 in taxes on his gambling winnings. By 2001, due to interest and penalties, this assessment had grown to over $750,000.00. It is perhaps worthy of note that Romano had total tax liens of over $1.5 million by the time of the trial in this matter, thus the tax due with respect to the seized monies was not the only obligation he owed the I.R.S.

Over many years, Romano, represented by his attorney, Ripa, pressed his efforts in opposition to the Government's efforts to declare that the funds would be forfeited to the Government. Ultimately, he prevailed and, in 1997, the Federal District Court ordered the Government to refund to Romano $491,236.69, representing the monies seized and interest thereon.

In the case before the Second Circuit, Ripa, Romano's attorney, claimed that he was entitled to receive his legal fee for representing Romano in the forfeiture action, equal to one-third of the award, because the legal fee represented a lien with "superpriority," with priority over the tax liens. In general, an attorney's fee constitutes a lien on assets with superpriority if the legal fee was incurred in a successful effort to obtain a judgment that produced the assets. However, there is an exception to the superpriority rule when the judgment arises out of "a claim or . . . a cause of action against the United States."

Ripa argued that because the money never belonged to the Government, there was no judgement "against the United States." In fact, an earlier district court opinion out of Massachusetts supports this position. Two other district court opinions, out of Georgia and Kentucky, had reached the same conclusion as the Second Circuit here. The Second Circuit's decision was based upon its analysis that the purpose of the statute granting superpriorty status was to encourage the realization of assets that could be applied to pay taxes due. Since the monies returned by Romano would have been in the coffers of the Government in any event, the Government was no better off by dint of Ripa's efforts.

For Romano, the horror does not end here. After all, the total amount due, including interest and penalties, with respect to the taxes on money seized was more that Romano received when the Government's forfeiture claim was denied. The reasons are that the Government was not forced to pay any penalty with respect to its misguided efforts and the interest charged on delinquent tax obligations is greater that the interest allowed on the contested fund during the time the forfeiture action was pending. The Court denied Romano equitable relief with respect to this claim.

I'm wondering whether Romano was dealt one final insult. After all, he received just over $140,000.00 in interest on the returned funds. It is entirely possible that the Service could have or did seek to tax that income in 1997, the year of receipt.

Monday, March 03, 2003

Saving Your S

The ability of a corporation to retain its status as an S corporation is hedged by a variety of requirements. One of those is found in I.R.C. Section 1362(d)(3)(A)(i) which provides that an election under section 1362(a) is terminated if the corporation has accumulated earnings and profits at the close of each of 3 consecutive taxable years and has gross receipts for each of such taxable years more than 25 percent of which are passive investment income. PLR 200309021 shows how an S election can be retained even though the principal business of the corporation would otherwise cause it to run afoul of Section 1362(d)(3)(A)(i).

Under the facts of the ruling, the S corporation's primary source of revenue was rental income from leasing office space. This income was clearly passive investment income for the purposes of Section 1362(d)(3)(A)(i). See I.R.C. Section 1362(d)(3)(C)(i). However, the corporation purchased interests in three limited partnerships that were apparently engaged in the business of purchasing, gathering, transporting, trading, storage, and resale of crude oil, refined petroleum, and other mineral or natural resource. These sorts of business activities will not constitute passive investment income as defined by I.R.C. Section 1362(d)(3)(C)(i).

The ruling held that the corporation's distributive share of the gross receipts of the three partnerships that it purchased will be included in its gross receipts for purposes of Section 1362(a). Apparently, the amount of the corporation's distributive shares of partnership gross receipts from the three partnerships were sufficient to fall below the 25% threshold that would have put it in violation of Section 1362(d)(3)(A)(i). Just as importantly, this result holds even though there may have been little net income from the partnerships or even losses generated by them.

This ruling opens the way for some creative planning in situations where an S corporation has low basis assets that it wants to dispose of with minimal income tax impact or assets which may be subject to double tax because the corporation had been a C corporation that elected S corporation status within the previous ten years. I will post illustrations of these planning possibilities in the coming weeks.

Sunday, March 02, 2003

All of Me, Why Not Take All of Me

In Rev. Rul 2003-28, the Service considered three different factual scenarios involving the contribution of rights in a patent to a charitable organization. In only one instance was the contributor allowed a charitable deduction.

In the first situation described, the taxpayer contributed a non-exclusive license for the patent to a university, retaining the right to grant other licenses. The Service held that Section 170(f)(3) requires that the taxpayer contribute an undivided portion of its entire interest in the patent. The ruling equated the non-exclusive license with the rent-free lease and the partial interest in the film rights to a motion picture, both of which are discussed in the regulations under Section 170. The regulations make it clear that no charitable deduction is allowed under these circumstances.

The Service's analysis of the first set of facts makes it clear that there would be no charitable contribution if the donor had retained any substantial rights. Thus, a contribution of the patent rights for one geographic area would not give rise to a charitable deduction if the donor had retained the rights to license the patent in other geographic areas.

In the second factual scenario, the patent rights would revert to the donor if a particular named professor was no longer a member of the faculty at the donee institution. The remaining life of the patent was 15 years and the Service determined that the possibility of the professor's leaving the institution before the expiration of the 15 year period was not "so remote as to be negligible." The ruling held that a charitable deduction was not allowed under this set of circumstances because it violated the rule set forth in Treas. Reg. Section 1.170A-7(a)(3) that a charitable contribution is not allowed if the transfer may be defeated by the performance of some act or happening of some event.

In the third case, however, a charitable deduction was allowed. There, the transfer to the institution was conditioned only upon the donee institution not further transferring or licensing the patent for the first 3 years after the initial transfer. However, the ruling warned that the restriction would reduce the value of the charitable deduction.

Rev. Rul. 2003-28 makes it clear that in making a charitable deduction, the whole is indeed greater than the sum of its parts.