Letter to Senator Dean Heller

March 1, 2017

Senator Dean Heller
324 Hart Senate Office Building
Washington, DC 20510

Re: A Proposal to Allow Unregistered Finders to Assist Small Businesses Raise Money

Dear Senator Heller:

I write to encourage you to support legislation that would codify the “finder’s exemption” to broker dealer registration under Section l 5(a) of the Securities Exchange Act of 1934 (the “Exchange Act”).

I have practiced law in Silicon Valley since 1991, and prior to that in New York City and Fargo, North Dakota. Throughout my career, I have been focused on service the needs of small and start-up companies. In the recent years, I have seen an entire ecosystem eliminated by regulatory fiat, and I suggest that the senate address by legislation an economically inefficient and harmful regulatory practice.

For many years, the SEC has allowed small businesses to engage unlicensed finders to assist them in raising money. These finders served a valuable role in the fundraising process, putting investors in touch with companies who were seeking capital, typically in transactions that were too small to attract the attention of highly regulated and high overhead broker-dealers. Over the past several years, however, the “finder’s exemption” has been steadily eroded by the SEC to the point where unregistered “finders” no longer exist. Instead, startups and small businesses are on their own if they seek funds of less than the large amounts that broker-dealers require to justify the high costs of doing business. The regulatory repeal of the finder’ exemption has outlawed an entire industry, with no legislative action at all, and for no apparent rational reason.

Entrepreneurs fund their business ventures by finding private investors, known as angel investors, who provide start-up financing in exchange for equity or convertible debt. Entrepreneurs and angel investors often find each other through online crowdfunding platforms or in-person angel forums. Angel forums regularly take a commission for effecting, or at least facilitating, securities transactions. If an unregistered finder accepts a fee based on the success of a transaction, the SEC is likely to find a violation of the Exchange Act regardless of the finder ‘s level of participation.

Section 15(a) of the Exchange Act requires brokers and dealers to register with the SEC unless an applicable exemption is available. A broker is defined as “any person engaged in the business of effecting transactions in securities for the accounts of others.” [1] A dealer is defined as a person that is “engaged in the business of buying and selling securities” as part of a regular business for such person’s own account.[2] There is no definition of finders, or a corresponding exemption, but at one time they were prevalent in the world of start-up financing.

The finder’s exemption originated in the early 1990s from a no-action letter granting relief to Paul Anka [3] This letter’s set of facts, which consisted of the sale of a rolodex by Anka, created the finder’s exemption. Accordingly, the exemption is limited to a narrow set of facts that fail to show sufficient broker or dealer activity requiring federal registration .

The SEC staff has subsequently indicated its disapproval of this no-action position. Its new position finds that one instance of transaction-based compensation may be enough to show a person was “engaged in the business” of broker-dealer activity.[4] This broad definition of broker-dealer activity has all but eliminated the finder ‘s exemption within the SEC’s enforcement division.

Failure to register as a broker-dealer can constitute a violation of Section 15(a) of the Exchange Act. The SEC has the power to impose sanctions (including the rescission of past securities offerings) for Section 15(a) violations.[5] The SEC regularly brings enforcement actions against unregistered finders for receiving transaction-based compensation. The SEC’s brief to the 11th Circuit in the Kramer case provides a summary of the SEC’s current view of unregistered finders.[6] In other words, any commission payment will cause the recipient to be categorized as an unregistered broker-dealer. Courts appear to be more willing to allow for the possibility that someone claiming to be a finder may not, in fact, be in the business of “effecting” transactions in securities. Consequently, there is judicial support for finders to take percentage-based compensation without having to register as brokers or dealers. These courts generally hold something more than just transaction-based compensation is necessary to require broker registration. [7]

[1] Section 3(a)(4)(A), Securities Exchange Act of 1934.
Section 3(a)(S)(A)-( B), Securities Exchange Act of 1934.
See Paul Anka, SEC No-Action Letter (available July 24, 1991).
See Record of Proceedings of 2008 Annual SEC Government-Business Forum on Small Business Capital Formation (Nov. 20, 2008); Brumberg, Mackey & Wall , SEC No-Ac ion Letter (available May 17, 2010) (reiterating that the receipt of transaction-based compensation is the hallmark of broker-dealer activity).
See Section 8A of the Securities Act of 1933, Sections 15(b) and 21C of the Securities Exchange Act of 1934, Section 9(b) of the Investment Company Act of 1940, and Sections 203(f) and (k) of the Investment Advisers Act of 1940.
SEC v. Kramer, 778 F. Supp. 2nd 1320 (M.D. Fla. 2011).
See SEC v. Kramer, 778 F. Supp. 2nd 1320 (M.D. Fla. 201 1 ); see also SEC v. Benger, in the U.S. District Court for the Northern District of Illinois, No. 09 C 676, Memorandum Opinion and Order (Mar. 28, 2013) (rejecting the SEC’s argument that anyone who facilitates any transaction in securities through conduct in the United States must register as a broker under Section 15(a) of the Exchange Act, even if the transaction did not involve the domestic sale of stock); but cf. In re Ambit Capital Pvt . Ltd., Order Instituting Administrative Proceedings, SEC Release No. 34-68295 (Nov. 27, 2012), In re Motilal Oswal Securities Limited, Order Instituting Administrative Proceedings, SEC Release No. 34-68296 (Nov. 27, 2012), In re JM Financial Institutional Securities Private Limited, Order Instituting Administrative Proceedings, SEC Release No. 34-68297 (Nov. 27, 2012), and In re Edelweiss Financial Services Limited, Order Instituting Administrative Proceedings, SEC Release No. 34-68298 (Nov. 27, 2012) (charging four financial services firms based in India for providing brokerage services to institutional investors in th e United States without being registered with the SEC).

Notwithstanding court precedent, the awesome enforcement power of the SEC and its heavy-handed approach to finders has all but eliminated the finder’s exemption. The question remains whether this Congress intends to override or endorse the judicial view regarding the ability of true finders to accept transaction-based compensation.

The purpose of the SEC is to protect investors, not to increase the transaction costs of start-up financing by regulating finders. Registration under these circumstances is not only inefficient but receives inconsistent treatment from the SEC and courts on appeal. The federal securities law should be liberalized to explicitly exclude finders from broker-dealer registration. Appropriate legislation will increase economic efficiency by lowering transaction costs associated with the present law’s uncertainty as well as resolve court splits within the judicial system.

I would be happy to share my experience in this area with any member and am available to testify on any relevant legislation.

Very truly yours,


Roger Royse
Attorney At Law

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The European State Aid Controversy and Silicon Valley

A controversy has been brewing among the tax and economic policy organizations in Europe that may have profound implications for the Silicon Valley and for US tax reform generally. In a highly publicized ruling, the European Commission (EC) determined that Apple owes up to €13 billion in back taxes, plus interest, to Ireland. The EC has since gone after several other companies on the same theory, such as Amazon, Chrysler, and Starbucks.

There is nothing new about the state aid controversy. What is new, however, is how the US can combat it.

By way of background, US companies often negotiate agreements or arrangements (advance pricing agreements or “APAs”) with foreign countries relating to how much tax they will pay to do business in their country. Those APAs will establish a transfer pricing method, which is used to determine the price of a transaction between related companies. The transfer pricing rules are intended to require related companies to set intercompany prices as if the transaction were between companies operating at arm’s length. The APA allows a company to determine the price of a transaction, and thus tax liability, in advance of the transaction.

The state aid rules, however, are meant to prevent countries from creating business subsidies that distort free market competition in the European Union (EU). The EC has ruled that the tax benefits negotiated by companies under APAs are the equivalent of receiving illegal business subsidies. The EC’s position is that lowering transfer prices through APAs is unlawful because the government is providing a “selective advantage” over EU companies operating at arm’s length.

Much has been said about the harm that the EC rulings are causing. American businesses can no longer negotiate new arrangements nor rely upon past arrangements with any confidence due to the threat of the Commission’s retroactive application of state aid rules. Until now, there have been no good solution to the problem.

Enter President-elect Donald Trump and the Republican controlled House and Senate. Under current law, US companies can get a credit their US taxes by the amount of foreign taxes that they pay. If a US company’s foreign subsidiaries pay foreign taxes, the US company gets an “indirect” credit when the foreign funds are paid back or “repatriated” to the US. Thus, the more foreign tax a US based multi national group must pay, the higher the credit, and lower the US tax it will pay. In effect, the US is paying for the EC’s state aid rulings with foreign tax credits.

Do you really think Donald Trump is going to let them get away with that?

It is notable that the Apple decision arose in Ireland, a low taxed jurisdiction (at the time). This is because companies shop for low taxed countries to locate intellectual property and base operations. Trump may make this sort of tax planning moot by lowering the tax rate on American companies.

Typically, a US company can expect to pay a 25% rate of tax on its earnings in Europe. Some jurisdictions will reduce that rate to 20% on intellectual property income. The top US corporate rate is 35%. The comparison is not perfect since the US and Europe countries allow different deductions, but you see the problem.

Trump would lower the US tax rate on business income to 15%. At 15%, a US company would have no incentive to push its mobile income into countries like Ireland. At 15%, the US would itself become a tax haven as opposed to a high taxed jurisdiction. At 15%, the problem solves itself.

Is that likely? The President can propose, but the House and Senate must pass. In fact, there does appear to be a Congressional appetite for reducing corporate rates. The Tax Reform Task Force, a group created by Speaker Paul Ryan (R-Wisc.), released a paper detailing the House Republicans’ plan to lower rates. In December 2014, Senator Orrin Hatch (R-Utah), then ranking member of the Senate Committee on Finance, issued a paper proposing to lower tax rates. Neither the House or Senate plan will go as low as 15%, but they are moving in the same direction.The EU’s authority was challenged by Brexit in 2016. The year 2017 will be another interesting year for the EU, with the revolt this time centering around taxes. Change is almost certain, and the EU is about to again become less relevant.

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Donald Trump’s Billion Dollar Loss: Good Tax Planning, or Dubious Trick?

Donald Trump’s refusal to release his tax returns has led to intense interest in and speculation concerning his tax positions. His dealings relating to his charitable foundation have been perceived as dubious in some circles.[1] Moreover, a month ago, the New York Times[2] discovered he had nearly a billion dollars of net operating loss on his 1995 tax returns, reducing his taxable income for years to come.

Many tax commentators tried to figure out how Trump had received such a huge loss, as he should have had “cancellation of debt” income (discussed below) which would reduce the loss. Some commentators proposed that he used the “qualified real property business indebtedness” exclusion from cancellation of debt income, while others proposed an illegal tax shelter technique[3] and others yet proposed an S corporation technique that clearly worked,[4] but would have been unusual for a real property business to have used (because such businesses were typically organized as partnerships).

Finally, just yesterday, the New York Times[5] discovered the apparent method used, while implying the method was quite dubious. But was it? To answer this, we must first review the facts of the matter, and then we can provide a quick analysis based on the available facts.

Background of the Matter

In the early 1990s, Donald Trump lost considerable money on his real estate ventures, such as the Taj Mahal. He borrowed heavily to finance the projects. These enormous economic losses, by themselves, would have given Trump the losses we now see on his returns.

However, Donald Trump faced a challenge. In order to refinance his debt, Donald Trump demanded and apparently received modifications of his debt. Under normal tax rules, a dollar of cancelled debt is taxed just like any other dollar of income. Thus, it would appear Donald Trump would have received an enormous tax bill for income from the refinancing. This income should have offset any losses he otherwise had. From a policy perspective, this offset result makes sense; you should not be able to deduct losses economically belonging to your creditors. (This result does create some economic hardship, as people receiving cancellation of debt income are often insolvent, but there are rules to ease this pain.)[6]

[1] http://www.vox.com/policy-and-politics/2016/10/31/13474280/trump-foundation-criminal-charges

[2] http://www.nytimes.com/2016/10/02/us/politics/donald-trump-taxes.html

[3] http://brontecapital.blogspot.co.uk/2016/10/some-comments-on-new-york-times-story.html

[4] http://www.businessinsider.com/why-did-trump-pay-so-little-tax-2016-10

[5] http://www.nytimes.com/interactive/2016/us/politics/trump-taxes-loophole.html

[6] Insolvent or bankrupt taxpayers have an exception for reducing their cancellation of debt income, but it forces them to reduce their positive tax attributes, such as their net operating losses; Trump did not use this exception.


But, there appeared to be a potential way out of Trump’s income offset problem. Once upon a time, if a corporation paid off its debt via issuing equity (i.e., stock), it would not receive any “cancellation of debt” income. By 1993, this technique had been banned specifically for corporations. However, it was (at the time) not clear what would happen if a partnership did the same technique. Perhaps the old corporation trick preventing cancellation of debt income would apply? Trump decided to take the position it would, and planned to issue equity from his real estate investment partnership to pay off the debt.

But there was another major hurdle not discussed in the New York Times article.[7] Specifically, in most circumstances, when entities issued equity to pay off debts and avoid cancellation of debt income, they paid off their own debts.  But in this case, the debt being paid off was debt of Trump’s related financing corporations (guaranteed by Trump’s partnerships), which existed because of New Jersey casino regulations. Still, Trump was undeterred, and took the position that the corporations’ debt was really the partnerships’ debt, as the corporations were mere agents or nominees of the partnerships. This is often a difficult position to sustain in tax law, which is biased towards treating legal entities as separate and holding taxpayers to the form they select for a transaction.

Before taking this debt position, Trump made sure to reinforce his defenses: He requested a tax opinion from the law firm of Willkie Farr & Gallagher.[8] Tax opinions are routinely requested by parties performing major transactions, particularly where there is tax uncertainty present. Such opinions provide various legal benefits, including (importantly here) mitigating potential tax penalties. That is, when someone underpays or misreports their taxes, they will always be liable for missed taxes and some level of interest (as the unpaid taxes are essentially “loans” from the government). The IRS may also apply penalties, intended to scare taxpayers into compliance. However, a tax opinion provides analysis and a confidence level which, if accurate, may help to reduce or eliminate many such penalties. A higher confidence level means more penalties will likely be mitigated. Further, the mere act of obtaining competent-seeming professional advice can help mitigate certain penalties.

The confidence levels expressed by tax opinions translate to the following probabilities:[9]

Confidence level Probability of being upheld
Will 90-95%
Should 70%-75%
More likely than not Greater than 50%
Substantial authority 33%-40%
Reasonable basis 20%-30%
Not frivolous Some amount lower than reasonable basis, but not clear how low
Frivolous Extremely unlikely, to the point special penalties are likely to apply for frivolousness

[7] http://www.taxanalysts.org/content/documents-reveal-dubious-tax-planning-behind-trumps-big-losses

[8] http://www.nytimes.com/interactive/2016/10/31/us/politics/trump-tax-letters.html?_r=0

[9] It should be noted that what these “probabilities” mean is somewhat opaque and uncertain. See http://danshaviro.blogspot.com/2016/11/latest-on-trumps-tax-scam.html?m=1.


In the case of Trump’s transaction, Willkie identified 8 key areas of tax uncertainty. It offered a more likely than not opinion on one issue, and a substantial authority level of confidence for the remainder of the issues. This meant that Trump was highly unlikely to face tax penalties for his position. But it also meant that, for many of Trump’s positions, the law firm thought the most likely outcome was that Trump would lose against the IRS. Some tax experts speculate Trump had opinion shopped to get the most favorable opinion he could, as was common in the 1990s. Opinion practice has since been legally forced to become much more legitimate and thorough than it was in the 1990s. If the Willkie opinion, with its low confidence level, was the best he could do, perhaps his position was even less justifiable than it appears to be.

In 2004, Congress (including Sen. Hillary Clinton) explicitly removed from the Internal Revenue Code the ability to issue partnership equity for debt in order to avoid cancellation of debt income while recognizing a loss. Some see in this amendment an indication that Trump’s position regarding the exchange of partnership equity for debt had some legitimacy, since Congress felt it had to step in to explicitly change the law.

Was Trump Wrong to Act this Way?

The New York Times is unambiguous in its verdict: Trump’s technique was legally dubious, and deserves our scorn.

But there is a different way of looking at it. Trump appears to have made a calculated decision: The tax benefits from his tax position would be enormous, and the Willkie opinion appeared to cover him from the downside of penalties. All he was likely risking was the additional interest he might owe. Trump apparently felt this was worth a shot. While the outcome doubtlessly violated good and fair tax policy, it appears Trump’s position worked out for him in the end.

Even so, was the position too aggressive, and was Willkie wrong for issuing that position? It’s unclear from the facts provided. The fact Congress needed to step in to amend the Code to eliminate the partnership-equity-for-debt rule does suggest this key ambiguity Trump exploited was a real, unforced reading of the law. But we cannot say for all the other ambiguities Trump exploited.

Thus, while we cannot know if Trump’s actions were truly as dubious as the New York Times says, we do know that Trump’s risks and the expiration of the applicable statute of limitations saved him from heavy income taxation and stiff sanctions. Trump’s result, in short, shows what good tax lawyering and ambiguous tax law may allow.

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Letter to Congressional Leaders Re: Impeachment or Censure of IRS Commissioner Koskinen

September 7, 2016

The Honorable Paul Ryan
Speaker of the House of Representatives
U.S. House of Representatives Washington, DC 20515

The Honorable Kevin Brady
Chairman Committee on Ways and Means
U.S. House of Representatives Washington, DC 20515

The Honorable Nancy Pelosi Democratic Leader
U.S. House of Representatives Washington, DC 20515

The Honorable Sander Levin
Ranking Member Committee on Ways and Means
U.S. House of Representatives Washington, DC 20515

Re: Impeachment or Censure of IRS Commissioner Koskinen

Dear Congressional Leaders:

I am a tax attorney based in the Silicon Valley and also an adjunct professor of Taxation at Golden Gate University School of Law in San Francisco.

On August 28, several tax law professors (the “Professors”) delivered to you a letter urging you to oppose any resolution to impeach or censure John Koskinen, the Commissioner of the Internal Revenue Service (“IRS”). The Professors teach the tax law and note that they also teach students respect for the law and for the IRS. The Professors believe that impeachment or censure would disrupt the IRS and weaken the tax collection function. They also fear that impeachment may be a distraction from much needed tax reform.

While I know many of the Professors who are signatory to that letter, and I respect and admire them for their scholarship and devotion to the teaching of tax law, I believe that an inquiry is warranted. As academic professionals, the Professors have presented a theoretical argument. As a practitioner, I believe that the situation on the front lines of tax practice is very different. Not since the days of Nixon has there been so much distrust and antipathy towards the IRS. The targeting of groups for denial of tax exemption based on their political views weakens respect for the law and the IRS, and the more the IRS abuses the law, the more the legitimacy of the law is threatened. Our tax system relies on voluntary compliance. When an agency loses its legitimacy, taxpayers will not follow its rules. It is hard to imagine a scenario in which strict compliance with the law and a public perception of fairness is more important.

Commissioner Koskinen was in charge of the IRS when important records were destroyed. If I, as an attorney, were to lose documents under subpoena, I would face serious consequences affecting my career. Formal discovery and compliance is that important, even in the private world. I expect that our appointed officials to be held to at least the same standard, and the failure to comply with a Congressional subpoena should carry severe penalties, even if that failure was one of omission rather than commission.

I have no reason to believe that Commissioner Koskinen knowingly made false statements to Congress regarding the destruction of emails, and I doubt he is personally responsible for any impropriety. However, it is hard to imagine any legitimate reason that any responsible person would delete emails while under a federal investigation or the threat of an investigation. This happened on Commissioner Koskinen’s watch, and we need to know why. Although the Commissioner may have had no direct involvement, our leaders should avoid even the appearance of impropriety in matters of public trust, and should be held accountable for creating or suffering a bureaucracy that conveniently allows the obstruction of justice with impunity.

Finally, like the Professors, I also do not want to delay tax reform. Reform is urgently needed to reverse the damage of the last, lost decade of obsolete tax policy. Current law forces companies offshore and discourages innovation, and the effects are being felt in our nation’s weak recovery and inadequate full time job growth. However, IRS reform must be a part of tax reform, and that reform should start with holding agency personnel accountable.

I urge Congress to investigate Mr. Koskinen’s role in the destruction of data and to take appropriate action if warranted.

Very truly yours,

Roger Royse
Attorney at Law

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A Different Kind of Republican Debate

Last Tuesday, on September 22, five GOP Presidential candidates participated in a forum in Silicon Valley. At our forum, you would not have heard questions such as “Do you think Carly is pretty?” or “Would you trust Donald to have his finger on the button?” or anything else that makes for good reality television and lousy elected officials. Instead, we discussed real issues that are important to Silicon Valley and, for that matter, to the whole country.

RoyseLaw Presidential Candidates Forum was designed to focus on the big three issues: Technology, Tax and Immigration. “The Supreme Court has taken social issues off the table,” I told a reporter shortly before the forum, and that means that Silicon Valleys’ issues are the nation’s issues.

This summer, Secretary Clinton stumbled badly when she took a shot at the “gig” economy, warning that we must protect worker’s rights. She was no doubt talking about Uber when she made those comments and, coincidentally, venture backed Homejoy threw in the towel due to worker classification lawsuits soon after. It took Governor Bush about a nanosecond to respond via a long form LinkedIn blog post. I spoke to Jeb the day that post ran, and (thinking that he had some aide write his blog posts) was quite surprised at how knowledgeable Jeb is about the new economy and what an archaic regulatory environment can do to this entire movement. The battle lines are drawn on the peer to peer economy – on one side is a protectionist approach that props up old, outdated and highly regulated businesses and on the other side is an approach that favors innovation, independence and entrepreneurship at its most grass roots level. This is classic Silicon Valley.

We spoke at our forum about net neutrality (does the regulator always know best?), patent reform and the problem of trolls. Governor George Pataki of New York took the argument beyond my moderated questions and spoke about climate change, science and the role that a technology and science President could play in our country’s future. Even the San Francisco Chronicle noted the alignment between our candidates’ views and startup gospel.

Hardly any topic generates more interest in the business community than taxes. If you happen to be a Fortune 500 company, your tax rate is about 15%, because you have been wisely counseled by someone like me on how to move income offshore. If you are one of my middle market or closely held clients, however, you are subject to the highest rate of tax in the world. High taxes have pushed technology, jobs and revenues offshore and led some to call the last ten years a “lost decade” of economic opportunity. Nonetheless, Senator Bernie Sanders would like to raise the rate and has voted consistently. He recently commented that he has no problem with a 90% marginal income tax rate.

90 percent!

Like the current President, the Democratic candidates have not put much energy into tax reform. Almost every candidate in the GOP field, however, has a tax plan. One candidate, Mark Everson, is the former director of the Internal Revenue Service, and thus can be expected to understand the problem extremely well. Setting aside the details of the various tax plans one question concerns building consensus, reconciling so many competing ideas and actually passing something that is revenue neutral. Senator Rick Santorum reminded us that he had been able to make deals, and has co-sponsored four bills with California’s Democratic senator. The Silicon Valley was built on cooperation, not conflict, and the audience was pleased to hear talk of consensus building on this important issue.

Finally, the audience asked about immigration reform and what could be done to fix a problem that has long vexed the Valley. Shortly before the forum, I asked one of my immigration attorneys what she would change if she were queen for a day, and the result is that there is not enough time in a day to cover all the problems with the system. At a high level, the H1-b system makes no sense at all for reasons that have been widely reported. A startup visa program would legitimize current practices, and would probably resolve a lot of the undocumented worker problems. One candidate even expressed his support for a path to citizenship.

There were other eye openers at our forum. Dr. Ben Carson spoke about generic drugs and described the science behind his surgeries in great technical detail. Senator Rand Paul reminded us that there are significant systemic problems with the way Washington is run. And Governor Pataki established himself as a strong environmental candidate in any party.

When I reached out to invite the GOP field to participate in our forum, I told them that they should come to Silicon Valley because “this is where the best idea wins.” Carly Fiorina challenged me on that statement, noting that the best idea does not always win. On reflection, I think she is correct. Sometimes the best idea is burdened by tax, regulated out of existence or driven offshore by our immigration laws. It is clear that the Presidential candidates at our forum would like government to allow the best ideas to win.

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Letter to the Hon. Philip Ting in Support of AB 799

May 16, 2015

The Honorable Philip Ting
Chair, Assembly Committee on Revenue and Taxation
Legislative Office Building, 1020 N Street, Room 167A
Sacramento, CA 95814

Re: AB 799

Dear Assembly Member Ting:

I write in support of AB 799.

Unlike the laws of every other state, California imposes an $800 per year minimum tax on certain entities that are organized under the laws of the state of California, are qualified to transact business in the state or are doing business in the state. Limited liability companies (LLCs) may elect (and usually do so elect) to be taxed as a pass-through, in which its members instead of the LLC pay tax on the LLC’s income. Nevertheless, LLCs are subject to the minimum tax.

Recent developments in the market and in federal securities law have resulted in a new model for startup investing. Investors may now pool their funds into special purpose entities (SPEs) for the purpose of investing in early stage startup companies. The tax law evidences a strong policy in favor of such investments as evidenced by providing favorable tax treatment of gains from the sale of “qualified small business stock.” See section 1202 of the Internal Revenue Code of 1986, as amended. The securities laws have similarly caught up with the demand for seed stage pooled investment vehicles. Section 506 of Regulation D under the Securities Act of 1933 provides for an exemption from registration for certain private placements of securities. The JOBS Act recently expanded Rule 506 to allow for public solicitation in some cases. Furthermore, a series of Securities and Exchange Commission (SEC) “no action” letters have provided important guidance for investment advisors and broker dealers who raise money through online portals.

As a result of the above changes, startup companies regularly raise seed stage funding though small SPEs designed to invest in one single offering, as small as $100,000. Despite their small size, those funds are subject to the same
$800 minimum tax as a $100 million fund. In a model that has each investment in an SPE, $800 per year per investment is enough to result in (i) moving fund management out of California, (ii) simply not reporting or complying with the law, or (iii) not making the investment. I regularly see companies apply all three strategies.

We believe that the minimum tax was designed to ensure that companies that avail themselves of the protections of California by doing business in the state pay their fair share, and was not designed to impose relatively large taxes on small funds. We also believe that the effect of the law under the current market conditions has been to adversely affect capital formation in the state and impact business decisions in irrational ways. We also believe that the minimum tax, when applied to investment SPEs has lost much of its legitimacy by virtue of non-compliance.

AB799 goes a long way towards remedying the problems created by the minimum tax by including LLCs in the class of companies that are exempted from the minimum tax when its only activity is holding securities. Legislation like AB 799 is necessary and appropriate to allow and encourage early stage capital formation in California.

Thus, for the above reasons, we support AB799.

Very truly yours,
Roger Royse Founder
Royse Law Firm, PC

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Roger Royse Joins the Letter in Support of the Trade Promotion Authority (TPA) Legislation

Dear Member of Congress,

Technology companies of all sizes are using international trade to power the American economy by relying on 95% of world’s population outside of the U.S. to sell their goods and services. The global supply chain, digital delivery, and the Internet have made it possible for small and medium-sized businesses in the United States to take advantage of international trade to create jobs and grow our economy.

Whether through direct exports, reaching new users for our products and platforms, or supplying our goods and services to larger U.S. companies that export, we rely on international trade to grow our businesses. The trade agreements currently being negotiated represent a tremendous opportunity to open new markets in the technology sector and set the rules for the 21st century digital economy. They also have the potential to eliminate barriers to integration in global supply chains and simplify and harmonize processes, regulations, and standards that can be onerous and costly obstacles to trade for small and medium-sized businesses. Setting the rules for digital trade will open doors to global markets for small and medium-sized businesses across all sectors.

In order for American companies to continue growing and innovating, we need to ensure any trade agreements will allow U.S. companies of all sizes and across all sectors to compete on a level playing field. The first step to creating that level playing field is for our elected representatives in Congress to give US negotiators new, clear directions for future trade agreements that reflect the priorities of small and medium sized businesses in the rapidly changing innovation, digital, services, and Internet economy.

Trade Promotion Authority (TPA) is the mechanism to do just that. TPA empowers Congress to set the Administration’s negotiating objectives for trade agreements. It also provides an assurance to our negotiating partners that Congress has already set the parameters for what the United States views as a successful trade package. In short: TPA strengths our country’s negotiating position and provides our negotiating partners the confidence they need to give us their best offers – resulting in the strongest possible agreements for American businesses and workers.

We need a gold standard framework for global trade that is reflective of today’s digital economy and the growing importance of the companies of all sizes in the technology and Internet sectors. The first step for accomplishing this is to pass an updated TPA bill that recognizes the realities of the 21st century economy and provides guidance to negotiators on achieving this modern trade framework. The second step is to evaluate each trade deal on its individual merits and whether it reflects America’s trade priorities. We urge Congress to swiftly pass updated TPA legislation to support the almost 300,000 small and medium sized businesses that export and ensure that our trade policy is ready for the 21st century.

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Letter from the President of the Palo Alto Area Bar Association

Letter from the President of the Palo Alto Area Bar Association.

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Prospects for a Direct (or Indirect) Tax on Wealth

What are the chances of a new wealth tax in the United States?

“Slim to none” is the sort answer, and this would be a very short blog post if not for the recent publication of a book by the French economist, Thomas Piketty, entitled “Capital in the 21st Century.” If you have a year or so of your life to spare, you can read the 900 page book for yourself. Or you could have learned about it by attending a panel of law professors, one economist and one tax lawyer (me) at the American Bar Association Tax Section meetings in Denver on September 19.

By way of background, President Obama laid the groundwork for this debate during the last election when he chose to make inequality a campaign issue. In fact, inequality in the United States has been increasing (especially in the top 1% and .1%) and the statistics are quite staggering. Currently, in the US, the top 10% own 70% of the wealth. The top 1% own 35% of the wealth and receive 22.5% of the total income. The bottom half, however, own only 5% of the wealth and the richest 85 individuals in the US own more than the 3.5 billion poorest people in the world combined.

Closer to home, a typical CEO’s salary is about 200 times the average employee’s salary in that same company (compared to 50 times average in the 1970s). You can partially blame me for that, as the wealth of CEOs in Silicon Valley is directly tied to equity compensation programs, such as the kind you can find on our Legal Wizard website.

Mr. Piketty’s book points out that income and wealth inequality is an essential feature of capitalism and it will always continue to increase, eventually creating political instability. For example, income from labor in the US has decreased from 68% to 62% of total income from 1970 to 2012. Piketty maintains that when the rate of economic growth is low, wealth accumulates faster from capital than labor, and inequality increases. He expresses the idea as the relation: r>g, where r = return on capital and g = income or output. Simply put, when the rate of return on capital exceeds the economy’s growth rate, capital income rises faster than wages, concentrating more wealth in fewer people.  Thus, the majority of people become poorer and crises results.

To solve this problem, Piketty proposes a global wealth tax and a high (80%) upper income tax. The wealth tax would be levied like a property tax, but on wealth instead of property which, unlike a property tax, nets out liabilities from the tax base. If a wealth tax reduces r below g, inequality would not increase. Mr. Piketty emailed me last week and described how he would deal with this issue in the United States:

“In my view, the right approach to wealth tax reform in the US might be to start from the existing wealth tax system, namely the property tax, which raises a lot of tax revenue in the US (as compared to other developed countries). My proposal would be to keep the tax revenues constant, but to transform the property tax into a progressive tax on net wealth. In effect, this would reduce significantly the tax burden of the bottom 90% of US households who have very little net wealth. Everybody would clearly see that the primary objective is to increase wealth mobility and access to wealth, not to tax the rich per se (although this would imply taxing the rich more). The point is that it makes no sense to tax heavily indebted households as much as those with huge financial wealth! The problem is simply that the property tax was created at a time when financial assets and liabilities did not matter as much as they do today. Of course I understand that this is constitutionally impossible to do such a property tax reform at the federal level. But (i) this was the same [problem] with the creation of the federal income tax a century ago, and finally it happened; (ii) state [governments] can move in this direction if they so wish.”

Obviously, the idea of a national wealth tax has attracted some criticism, and some proponents. Our ABA Panel had the following thoughts on the subject.

Professor Richard Lavoie of the University of Akron School of Law likes the idea of a wealth tax. Professor Lavoie believes that the wealth tax should be used as a tool to directly curb wealth inequality and notes that inequality has been rising since the “greed is good” 1980’s.  Although John F. Kennedy may have said that a rising tide lifts all boats, the actual experience has been that the wealthiest boats rise more that the boats in the lower percentiles. For example, from 1978 to 2011, the S&P 500 increased by 349% while CEO pay rose at twice that rate.

Economic studies show that high inequality at the start of a decade negatively impacts economic performance in the ensuing period. This trend has both political and social ramifications. Politically, the fact of having great wealth can influence the political process because the power to spend may threaten the actions of elected officials. This, the wealthy can use the mere existence of wealth (without actually spending anything) to influence the process.

Socially, the divergence of society between rich and poor undermines social cohesion and the shared values necessary for a well-functioning economy and democracy. Social mobility decreases as inequality rises and classes become more stratified.

To address these issues, Professor Lavoie proposes an equality tax. The Equality Tax would be aimed at directly reducing inequality rather than revenue raising. Revenue from the tax would be used to reduce the roots of inequality via education and retraining programs. The tax would be levied at a rate of 5% tax on net worth over $100 million, increasing to a 10% on net worth over $500 million. Anticipating the potential objections to such a tax (unworkable, un-American, unconstitutional and un-thinkable), Professor Lavoie notes that the tax would affect relatively few who would not leave the country because of it, and concludes that Atlas would likely not shrug if the US adopted an equality tax.

Professor John Plecnik of Cleveland-Marshall College of Law points out that similarly situated individuals should be taxed similarly. By that standard, the income tax is not fair. For example, a taxpayer who sells an appreciated asset will recognize a taxable gain. If that taxpayer borrows against that asset instead of selling it, he does not have a taxable gain, even though the taxpayers are similarly situated. Further, at death, a decedent’s tax basis in his assets is stepped up to fair market value so that the gain inherent in the assets may never be taxed.  There may be an estate tax at death, but the step up in basis costs the US Treasury more in taxes than it earns though the estate tax. Warren Buffet, for example, need never pay taxes as long as he simply borrows against his appreciated assets.

The sales tax may seem fair because it is a flat rate across the board. However, the sales tax is very regressive and, since it is based on consumption, does not tax pre-existing wealth. A very wealthy person might pay very little sales tax if he does not consume very much. Think of Ebenezer Scrooge.  A person’s ability to pay has nothing to do with their consumption. Oddly, liberals and conservatives both like consumption taxes, albeit for different reasons. Conservatives often promote the flat tax, for example, and the value added tax (VAT) is a liberal idea. Professor Plecnik believes that both groups have it wrong, but for different reasons.

A tax on wealth, however, is fairer than a tax on either income or consumption because it falls most heavily on those who derive the greatest benefit and have the greatest ability to pay. It is also pragmatic and necessary because it reaches the largest and most obvious source of revenue – pre-existing wealth.

Would a wealth tax be constitutional? The Apportionment Clause of the US Constitution provides that “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.” In other words, taxes must be imposed among the states in proportion to each state’s population in respect to that state’s share of the whole national population. Income taxes are not subject to this apportionment due to the 16th Amendment, which expressly allows income taxes without apportionment.

Is a wealth tax a direct tax, subject to apportionment? There are a few arguments that could be advanced in support of a wealth tax. The wealth tax could be recast as an income tax, which is expressly allowed. That would be a risky form over substance argument. Or the wealth tax could be conceded to be a direct tax but then apportioned to the states in accordance with Article 1, Section 9.

Diana Furchtgott Roth is a Director, Economics, and Senior Fellow at the Manhattan Institute for Policy Research and her paper is entitled “Piketty’s Inequality Conclusions Inaccurate, Recommendations Impossible” lest there be any confusion as to where she stands on the issue. Her main points are that a wealth tax would slow worldwide economic growth and hurt rather than help, lower income individuals.  Ms. Roth disputes Mr. Piketty’s data and believes that his conclusions are exaggerated. More specifically, Mr. Piketty uses the terms wealth and capital interchangeably whereas they are not the same, and taxing capital and taxing wealth are two very different things.

Another problem is that there is no single rate of return, r, on capital (or wealth). The rate of return on T-bills is less than the return on stocks, and the return on some risky assets may even be negative. Most Americans will have capital during their lives, in the form of retirement plans, which would be diminished by a wealth tax.

Mr. Piketty contends that inequality has increased since the 1970’s. That conclusion suffers from some problems. First, the Tax Reform Act of 1986 resulted in a movement of income away from corporations and onto individual returns, because individual rates were lowered. Secondly, Mr. Piketty measures income before taxes. The top 1% wealthiest persons pay 35% of all income tax. The top ½ pay about 98% of taxes and the bottom half pay about 3%. A more accurate measure would be based on after-tax numbers.

Mr. Piketty does not take into account the movement of women into the workplace in the 1980s. This has changed demographics. The size of households has also changed – more are one person or non family households and tend to be in the lower quintile. Also, the data ignores mobility between quintiles (which is substantial) and focuses on the extremes.

Professor Alice Abreu of Temple University Beasley School of Law believes that we should look to the income tax, not the wealth tax, to address inequality. In other words, tax labor less. Proponents advocate for a wealth tax over an income tax for two reasons. First, a tax on wealth would incentivize wealthy people to maximize returns. This is a weak argument.  Secondly, an income tax can never go far enough because income is a small percentage of wealth. Those arguments also assume the income tax as it exists. Practical and policy reasons support considering a differently designed income tax. It is hard to add a new tax to the system and there is little support even for expanding the estate tax.  Taxing accretions to wealth (rather than taxing wealth) is the “devil we know” (and prefer).

The Camp proposal basically adopted the alternative minimum tax (AMT) as the tax base. It was scored revenue neutral (with dynamic scoring) and reduced the tax at all brackets with the greatest reductions in the lowest quintile and the smallest at the top 1%. At the top quintile, all of the reduction would have gone to the top 1% (and particularly the top 0.1%).

At the other end of the stick is the social security tax – a tax on labor, not capital, which is a cause of rate disparity between the top and low income earners. It would be the easiest tax to cut (we have done it recently with the 2010 holiday). Professor Abreu suggests reducing the employee rate (which can be recouped by increasing the cap) and using the 2010 payroll tax holiday as a model. It is likely the most achievable means of addressing tax inequality through the tax system.

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Negotiation: Fishing in New Waters

As a kid growing up in the Midwest, there wasn’t much to do with our spare time other than fish. For many years, we would wander down to the river, tie a wire leader to our line, bait our hook with a minnow, and wait. We had moderate success with that system and saw no reason to change, until some of us heard that fish didn’t like wire leaders, and we would probably do better without them. That tip turned out to be very useful, but some traditionalists did not change. After all, they reasoned, wire leaders have worked well for years. “If it ain’t broke, don’t fix it.” Later, some of us discovered that nightcrawlers were more effective than minnows. Again, the traditionalists saw no reason to try anything new. And on and on it went with each new discovery. Fishing ahead of a cold front was more effective than after. The traditionalists didn’t care. Fishing near underwater structures worked better than open water. The traditionalists stayed in the deeper open waters. Those of us who stacked and adopted these fishing tips were likely better fishermen than we would have been otherwise. The traditionalists never knew the difference, since they never tried anything new.
A lot of professional negotiators are like those old fishermen. They have found a system that seems to work and, with nothing to compare it to, they stick with that system. It also doesn’t help that conventional wisdom teaches that we should play to our strengths instead of working on our weaknesses. For example, company CEOs who are strong on leadership but not so much on operations will surround themselves with good operational people rather than put a lot of effort into developing that skill themselves. In the world of those of us who negotiate for a living, this “Strengthfinder” concept creates a self-perpetuating limitation, as negotiators who are naturals at one aspect of persuasion don’t bother with other methods or techniques. For example, the lawyer that has always been able to get results mostly by being good at establishing rapport may be a little light on strategic thinking. Similarly, the brilliant strategist may not be able to communicate as effectively as he should. For these people, adding a few techniques to what-has-always-worked will often have exponential results. Here are a few tools that negotiators can combine to become more effective.
Everyone knows the importance of establishing rapport. Rapport implies trust, cooperation and a desire to reach a resolution. People are more likely to concede points to people that they like and trust. They are more likely to offer up compromises and solutions. Some people are naturals at it; the rest of us will have to learn it, and those who understand rapport will find that better results are easier to come by.
Although there are “naturals” in the field, rapport is a skill that can be learned. The field of neuro-linguistic programming (NLP), for example, has developed sophisticated tools and techniques to maintain rapport in a wide variety of settings. Some techniques include leading, pacing, tonality, mirroring, echoing, suggestion and others that every negotiator should be familiar with. Some negotiators, however, are so good at establishing rapport that they rely on being likeable a bit too much. That one quality may get them to a resolution, but it may not be the optimal resolution. Because we who negotiate are all human (at least at the time of this writing), rapport may be the most important aspect of some types of negotiations (anything that requires a face to face meeting) but it is rarely sufficient all by itself. Another element of a negotiation is strategy.
It is somewhat surprising how often parties walk into a meeting with very little forethought as to what they expect to happen. To give the process some structure, every plan should start with three questions: who am I dealing with, what do I want, and how will I get it?
“Who am I dealing with?” The “who am I dealing with” question may be the most overlooked part of the strategic process. It is often said that a person cannot NOT communicate, and one of the most telling communications is the identity of the person your counter party assigned to your negotiation. If (as has happened to me many times) the opposing party is a very high ranking executive or highly credentialed attorney, I know that we have something very valuable. You can’t Not communicate.
“What do I Want?” Modern psychology teaches us that the mind doesn’t do very well with ambiguous goals. Going into a negotiation with the goal of getting “as much as I can” is almost always bound to render a dissatisfactory result. Setting a range of acceptable outcomes in advance is a far better idea. More importantly, those goals should be targeted to each interaction. What do I want from this call?, for example. It may be nothing more than some information. Every interaction should have a goal.
“How do I get it?” There are strategies, macro strategies and micro strategies. A complex matter is likely to have numerous small goals to achieve along the way as opposed to one “big bang” resolution. Attorneys are often inclined to get what they want with a hammer of litigation. That is a card which may have to be played, but should be done at the right point in the negotiation. Litigation is almost never an opening gambit, and even the threat of litigation too early can damage the process.
In the information age, no one need ever go into a negotiation without knowing quite a lot about the opposing party. Public companies must publicly disclose to the SEC how past deals have been structured, how litigious they are and how active they are in a space. Get to know your “opposing party” before meeting them. In the information age, a quick Google search can result in documents, SEC filings, financials, litigation history, news items and biographical information from which you can anticipate the opposing party’s hot buttons, priorities, personality, reputation and objectives. If knowledge is power, anyone with an internet connection can be powerful.
Preparation goes beyond research, however. Top athletes regularly engage in visualization techniques and top negotiators should too. Even if you think you are good on your feet, preparation is key.
Psychologists have devised numerous personality tests that are useful in negotiation, including the Myers Briggs Indicator, Jungian analysis, and the Enneagram. The most useful of these may be the DISC method, which places people into four categories. If we know which category a person is in, theoretically, we can then predict how they will respond to different approaches. The “D” for example (dominant) will demand concessions (rather than explaining the rationale for them). My experience is that most attorneys are type D type negotiators. An “I” (Influencer), however, will take a more cooperative (but active) approach, looking for win-win solutions (if there is such a thing).
The S (Steady) and C (Compliant) categories refer to more passive participants, who will either be overly accommodating in trying to reach agreement or stubbornly refuse to move from a position. S’s and C’s should probably not be at the negotiating table in the first place. If you are negotiating with an S or a C, be prepared to adopt your style. If you are an S or a C, get over it.
Sometimes a D will respect nothing but a D approach and they often require a bit more finesse than the other types. When dealing with an I, you might present arguments for why a solution is optimal; conversely, you will more often have to establish “hard no’s” with a D. Alternatively, you may choose hard facts and solid reasoning to support your positions when you push back or make your own demands.
While DISC negotiating makes for an elegant theory, in practice, top professionals will “shape shift” among the different styles and use what is most effective. That is why you need to be flexible.
Skilled negotiators know that they have to try things, and will draw out the style of an opposing party by mixing up their approach until something works. For example, they may start out being aggressive and borderline obnoxious. If that doesn’t work, they may switch to a more cooperative style of interaction. If that doesn’t work, they may drill down into facts and supporting data (the baffle them with BS approach). Everyone should be prepared to try different approaches and if you should find yourself feeling like you are dealing with a Sybil set of personalities across the table, watch out – you are being tested.
The movie “Little Big Man” depicts a suspicious Custer questioning a scout played by Dustin Hoffman (who he suspects of being an Indian spy) as to whether he should lead his troops into the Little Big Horn. The scout tells Custer that thousands of Indian warriors await just over the hill, and if he does enter the valley below, he will be flanked and massacred. Custer then says: “You want me to think that you don’t want me to go down there but the subtle truth is you really don’t want me to go down there.” We all know what happened next.
Custer’s last stand, nuclear deterrence, battlefield strategies and the prisoner’s dilemma are examples that negotiators should be familiar with. A negotiation often requires the parties to engage in a tedious game of “what if” that may arrive at results that are not immediately obvious. Fortunately, there are tools and models that place enough structure around game theory that anyone can pick it up and apply it in practice.
Some models assume that the players act perfectly rationally and with a known (if not identical) amount of knowledge. The Nash equilibrium, for example, assumes that each party will choose the best response to the other strategies. The various outcomes can be charted and a lowest cost or highest value outcome determined. One problem with these models, however, is that rarely does anyone act with similar knowledge and even more rarely do they act perfectly rationally, especially when the outcomes are weighted solely by monetary values. Game theory is, nevertheless, an important arrow for the strategist’s quiver.
It is often said that the sign of a successful negotiation is that everyone goes away dissatisfied (the point being that everyone has compromised). That is the mantra of an unskilled persuader, who will rarely get what they want. A good persuader, however, will get what they want, but a highly skilled persuader will get what they want and make everyone feel good about it. One of the easiest ways to do this is to make sure that the opposing party has a part (or believes they have a part) in any proposal. In other words, make them think it was their idea. It is difficult for the human mind to reject an idea that it thinks it came up with; and even more difficult to accept an idea that someone else is trying to impose on it.
There is no one single set of skills that can define a negotiator. Instead, there are numerous aspects to a negotiation. Because of our natural tendency to stick with what we know best, many negotiators will rely (successfully) on only one or two skills. Like the fisherman that picks the right times, the right places and the right baits to catch more fish, acquiring and combining some of the above skills can have exponential results.

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