BizLawBuz …. The Power of Know

Proposed “Carried Interest” Tax Purports to Soak Wall Street But Hits Family Businesses

For the time being, the Senate has again abandoned efforts to impose a “carried interest tax” on venture capitalists, investors, and managers of family businesses. The tax would have increased the 15% capital gains tax rate on certain investors’ profits to the top income tax rate, which is scheduled to hit 39.6% on January 1st (H.R. 4213). The share of investors’ profits is called “carried interest.” It might appear at first glance that it’s perfectly fine for investment managers to be taxed at higher rates on their “carried interest.” But venture capitalists and investors don’t reside exclusively on Wall Street. The law was written so broadly that it could have hit approximately 6.5 million people invested in real estate partnerships that own anything from a single dwelling to sizable commercial properties.

The proposed legislation attempts to sway middle America by couching the carried interest tax as imposing a higher rate on “investment management services” and “investment managers” who work for Wall Street houses. In reality, the proposed legislation could have imposed a higher tax rate on any partnerships invested in particular assets. The higher rates would apply to investment gains and also to gains from the sale of the partnership, and therefore, a sale of the family business would not qualify as a capital gains transaction. Family operations are commonly formed as partnerships and managed by a family member. Under the proposed legislation, the managing family member could be subject to the “carried interest tax.” For a family partnership to gain liability protection and also not be subject to the higher taxes, an outsider – not a family member — would have to manage the partnership. The House version of the legislation exempted family farms and ranches held in partnerships. Other family partnerships would have had to wait for the Treasury Department to exempt them through regulations.

Although the proposed legislation is dead for now, it is likely to reemerge as efforts to plug the federal deficit mount. The increased carried interest tax may be reintroduced in some other form. If so, watch carefully to see how the “carried interest” tax will hit families that are well beyond the alleged targets of the legislation, and communicate any concerns to your representatives in Congress.

Heather Brenneman Miles

Recently, many Wright Penning & Beamer clients who own multiple acres of land in northern Michigan have been contacted by petroleum company representatives and offered oil and gas rights leases for their land. While many of these companies are reputable and offer fairly standard terms in their leases, they are generally trying to secure leases that are most favorable to them. The landowner should be aware of provisions that can be included to protect their investment and maximize the owner’s financial return.

Know What Your Oil and Gas Rights are Worth

Most oil and gas leases propose two financial benefits:

The first is the oil and gas lease price per acre. Recently, one major oil and gas company paid up to $5,000.00 per acre for what they had determined to be land located strategically close to what the company believed would be a very fertile and productive natural gas field. While not all landowners will be fortunate enough to garner that type of lease price, it is not unusual for companies to make initial offers at a fraction of the amount they are willing to pay to lease a landowners oil and gas rights. Rarely is the first offer the best offer they are willing to make.

The second financial benefit is the “royalty” to be paid by the oil and gas company in the event their exploration results in the installation of an active well to extract oil or gas. Recently, oil and gas companies negotiated oil and gas leases for thousands of acres of state lands and agreed to pay the state royalties at a rate of 1/6th of the gross revenue resulting from an active well. As a result, landowners should not agree to anything less than the State of Michigan was able to negotiate for its royalty rate. I recently reviewed an oil and gas lease for a client that proposed a 1/10th royalty rate which we easily negotiated to the more favorable 1/6th rate being paid to the State.

Avoid Deduction of “Post Production Costs” From Royalties

Many proposed oil and gas leases will include provisions allowing an oil and gas company to deduct a portion of the company’s “post production costs” (PPCs) which essentially is simply a practice of the companies lowering their overhead and increasing their profits by passing overhead costs on to the landowner to be deducted from royalties. Landowners should be careful to make sure their royalties are to be paid off the gross revenue from a well with nothing other than a proportionate share of applicable government taxes being deducted from the royalty payment.

Require the Inclusion of a “Pugh Clause” in the Lease

A “Pugh Clause” protects the landowner by requiring the oil and gas company to release certain land subject to the lease after termination of the lease term that has not been pooled into the land subject to the royalty payment in the event an active well results from the lease and exploration. For example, an oil and gas company may only pool an apportion of the leased land for royalty purposes and without a Pugh Clause, the companies in some instances can tie up the entire parcel subject to the lease even though they are only paying royalties on a portion of the land.

There are other concerns that also should be addressed and included in the lease to protect the landowner including where the placement of well will be allowed, where facilities can be constructed on the landowners property and provisions specifying that the companies must restore the land to its original condition after completing various activities on the land.

Be Prepared

There has been a significant increase in the oil and gas activity in northern Michigan in the last six months. Oftentimes the oil and gas leases are presented in a fast and furious fashion. Don’t be afraid to take your time and carefully consider any proposed lease and determine whether there are other companies also interested in the oil and gas rights to your land. A little competition never hurts the process. Also, seeking the advice and input of a qualified attorney to protect your rights as the landowner is also recommended.

Dan A.Penning

“…proper planning in most instances can navigate around any estate tax liability…”

There is a long history of debate regarding the federal estate tax. The implementation of the tax originally was to prevent the build-up of wealth that could lead to a creation of large estates and a permanent class of idle rich that would attempt to impose a monarchy.

While I am generally not in favor of raising taxes or the estate tax in general, there is a valid question as to whether the impact of the existence of the estate tax has any real negative impact on the majority of small business owners and family farms. Previously, President Bush tried to repeal the estate tax in his 2001 Tax Bill. President Bush succeeded to include provisions in the Bill that would phase the estate tax out of existence by the year 2010. The goal of the phase-out included in the Bill was to provide Congress with incentive to affirmatively decide the fate of the estate tax before its repeal in 2010. Now that President Obama has been elected, the fate of the estate tax has taken a different turn.

Under President Obama’s proposed new budget bill, there are provisions that freeze the estate tax at its 2009 level. The 2009 estate tax level provides for individuals with estates of up to $3.5 million to be exempt from estate tax which begins at a 45% tax rate, and married couples, with proper planning, can obtain an exemption of up to $7 million. In addition to using the aforementioned estate tax exemptions, there are additional estate planning tools which can, depending on the assets includable in an individual or married couple’s estate, provide for opportunities to possibly avoid estate tax on estates worth as much as $10 – 12 million or more.

The question then becomes is the estate tax a lion roaring down the path to chew up large pieces of individual’s estates, or is it a lamb in most instances avoidable and of no consequence?

According to a study by The Center on Budget Policy and Priorities, a Washington-based think tank, estate tax does not pose a significant problem to small business owners or individuals with family farms. That study claims that almost no small businesses or farm estates would owe any estate tax under the Obama budget bill. Based on the study’s analysis, fewer than .2% of all estates–2 of every 1000–will be subject to tax in 2009. Of the estates that are taxable, only about 1.3% are small business or farm estates. At the end of the day, the study purposes that only 3 out of every 100,000 people who die this year owning a small business or farm will be subject to any estate tax.

On the other side of the debate, the National Federation of Independent Business (NFIB) runs a separate organization, The Family Business Estate Tax Coalition, which primarily focuses its efforts to obtain a repeal of the estate tax. This organization argues that over the life of a business, the government collects income tax and other taxes. As a result, the group argues that the government has taken more than its fair share in taxes prior to an individual’s death. The organization further argues that the assets of a small business or family farm, including real estate, equipment, machinery and other business property can quickly add up to millions of dollars of value and yet only result in the production of a middle class income for the business or farm owner. While the individual, during their lifetime, may have paid for significant business assets, the group argues that the reality is that the individual only received a nominal return in income when compared to the overall value of the business assets.

The debate regarding estate tax will never cease as long as it is in effect. The lesson to be learned by an individual, small business owner or family farm owner is that proper planning in most instances can navigate around any estate tax liability.

Dan A. Penning
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Know Your Business, Grow Your Business, Protect Your Business

Michigan Governor Jennifer M. Granholm recently signed the last of two bills of a three-bill package paving the way for growth of a previous market for home-grown food products that was unexplainably subject to stricter state limitations than those limitations dictated by federal law. Previous state regulation on bidding to buy Michigan food products limited school districts to only $20,000 per year. Under the new law, that limit was increased to $100,000 per year which is the federal limit.

The aforementioned action exhibits that the legislature and governor can provide leadership in creating positive business opportunities. Unfortunately, our lawmakers and governor are inconsistent when it comes to enhancing and expanding the business environment for certain growing industries within the state. One such example was the passage of Bill 6644 in December, 2008 substantially restricting the shipment of wine by Michigan retailers directly to Michigan customers. The passage of that law will only stifle the expansion of the distribution and sale of Michigan wines and related businesses supporting the wine-making industry. The farm-to-school bill gives some hope for our state and its governmental leaders that the right decision to support business in Michigan can be made. We now need to work to make this behavior more consistent to grow Michigan’s economy.

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Dan A. Penning

PROPOSED LAW BANNING DIRECT SHIPMENTS BY IN AND OUT-OF-STATE
WINE RETAILERS IS BAD LAW AND BAD FOR MICHIGAN

Prior to the holidays, the Michigan Legislature hustled a poorly crafted piece of
legislation through the system to allegedly protect the public’s best interest by
making it almost impossible for in and out-of-state wine retailers to ship directly
to customers. The senate modified Bill 6644 previously passed by the House of
Representatives by allowing wine deliveries by retailers to consumers but only if
the product is delivered by employees of the retailer.

The Bill supporters will cite factors such as loss of state tax revenue from
diminished sales by Michigan liquor distributors and without the new law,
alcohol sales to minors would sky rocket out of control.

Basically, the Bill’s proponents argue that alcohol, unlike other products, needs to
be strictly regulated based on the potential harm to the public because of abuse,
addictions, and the products intoxicating effects. They argue that the current
system with minor modifications has served its purpose well for 75 years so why
change it. Maybe the Bill’s proponents fail to notice the internet, computer, and
fax machine in their home or office which was not there 20 years ago, let alone 75
years ago when a substantial portion of the law that still governs alcohol
distribution and sales was created by the legislature.

The rush to pass legislation directly resulted from a recent federal district court
case Siesta Village Market, LLC vs. Granholm where the judge ruled that the State
of Michigan was prohibited from banning out-of-state wine retailers from selling,
delivering and shipping wine through commerce direct to Michigan customers.
Michigan’s law and certain provisions of the state’s liquor code prevented that
activity by out-of-state wine retailers and that law was challenged by the Plaintiff
in the Siesta Village Market case. Various legislative analysis agencies such as
House Fiscal Agency in summary reported the following as an argument in
support of the bill:

“Passage and enactment of the bill, on the other hand, would give time for
the case (Siesta Village Market, LLC vs. Granholm) to be litigated and for the
commission and lawmakers to examine the issue and see if a regulatory
structure could be developed and implemented that would be equal
treatment to in-state and out-of-state retailers yet still protect the public
from unscrupulous business owners, and that would create a mechanism
by which to collect appropriate taxes. In the meantime, the bill would
protect the three tier system, ensure that laws prohibiting sales to minors
are adhered to . . . “

If the legislature is serious that the law is in place to allow further work to be
done in order to develop regulations to manage the alleged downside of the fall
of the three tier system, then who should be expected to lead the charge?
Presumably, the legislature has dealt with many of these issues with respect to
the fact that out-of-state wineries have been allowed to ship to customers in the
State of Michigan for the past several years and there already exists a regulatory
system with respect to taxes on those sales by out-of-state wineries to Michigan
residents.

In the meantime, small retailers who are located in tourists destinations with
local wineries such as Leelanau County, Michigan will be negatively impacted in
that it is economically impossible to dispatch employees all over the state to
deliver wine to consumers who previously placed orders for more of various
wines of the region they may have first noticed and purchased while visiting the
area on vacation.

In conclusion, it is clear that the law passed by the legislature is an act of
protectionism for the powerful Michigan Beer and Wine Wholesalers Association
and their lobbyists who seek to anchor the wine industry and the sale of related
alcohol products in an archaic system which ultimately will be bad for business
and bad for Michigan residents.

For historical information about how House Bill 6644 evolved and different articles about House Bill 6644 please visit www.SuttonsBayDepotLegalNews.com
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Dan A. Penning

We welcome your comments. Please post your comment and opinions about House Bill 6644.