Is your LLC Doing Business in California?

Do you use an out-of-state or “foreign” LLC for your real estate investments? Due to recent changes in California law, you may be considered to be “Doing Business” in California, and must register your foreign LLC with the State and pay the $800 tax anyway!

Many people ask me “What state should I register my LLC in?”  “I don”t want to pay the $800 tax in California.  Are there any disadvantages of registering my LLC in another state?”  No matter what, you must register your LLC in any State where you are “doing business.”  Up until recently (2011), this meant – in most cases –  if you were a California resident, had formed a Nevada LLC, and owned an investment property in Arizona, you would only need to make sure you registered your Nevada LLC in the State of Arizona.  Many investors seek to maximize their returns, and avoiding the $800 franchise tax levied by California is a common reason given for forming out-of-state or “foreign” LLCs.  However, in 2011, California changed the rules in 2011 as to how it determines whether or not you are “doing business” in California.  Be sure to review the Examples below – they may surprise you!

California defines doing business as “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit” (R&TC § 23101(a)). In addition, LLCs are considered “doing business” in California if:

•   It is a nonregistered foreign LLC that is a Although you may come across as a superficial person owing to your gemini horoscope Ascendant, you actually seek the true meaning of your life, and you value meaningful interpersonal relations. member of an LLC that does business in California.

•   It is a general partner in a partnership or limited partnership that does business in California.

•    Any of the LLC”s members, managers, or other agents conducts business in California on behalf of the LLC.  (Emphasis added)

For tax years that begin on or after January 1, 2011, a taxpayer is also doing business in California if any of the following apply:

•   The casino online taxpayer is organized or commercially domiciled in California.

•    Sales, as defined in subdivision (e) or (f) of R&TC § 25120, including sales by the taxpayer”s agents and independent contractors, in California, exceed the lesser of $500,000 or 25 percent online pokies of the taxpayer”s total sales.

•   Real or tangible property of the taxpayer in California, exceed the lesser of $50,000 or 25 percent of the taxpayer”s total real and tangible property.

•    The amount paid in California by the taxpayer for compensation, as defined in subdivision (c) of R&TC §25120, exceeds the lesser of $50,000 or 25 percent of the total compensation paid by the taxpayer.

For the preceding conditions, the sales, property, and payroll of the taxpayer include the taxpayer”s pro rata or distributive share of pass-through entities (R&TC § 23101(d)).

Regardless of where LLCs primarily conduct business, if any of their members, managers, or other agents conduct business in California on behalf of the LLC, the FTB considers the LLC as doing business in California (R&TC § 23101). [Go to ftb.ca.gov and search for doing business for more information.]

Example 1

Paul is a California resident and a member of a Nevada LLC. The Nevada LLC owns property in Nevada. The LLC hires a Nevada management company to collect rents and provide maintenance. Paul has the right to hire and fire the management company. He occasionally has telephone discussions with the management company regarding the property. He is ultimately responsible for the property and oversees the management company. Paul conducts business in California on behalf of the LLC. The LLC must file Form 568.

Example 2

Rachel is a California resident and member of an Oregon LLC. The Oregon LLC has a retail store in Oregon. Rachel uses a California address for the LLC”s tax filings and a California accountant to prepare the LLC”s tax returns. Rachel conducts business in California on behalf of the LLC. The LLC must file Form 568.

Example 3

Sara is a California resident and a member of a Texas LLC. The Texas LLC receives royalties from Texas oil wells. Sara maintains a California business bank account and secures financing in California for the LLC”s Texas investments. Sara conducts business in California on behalf of the LLC. The LLC must file Form 568.

(The foregoing is taken from FTB Form 3556 LLC MEO 4-2011.  For more information, go to www.ftb.ca.gov, and consult with your Attorney or tax professional.)

Dual Agency – a Fiduciary Duty Trap

UPDATE:  On November 21, 2016, the California Supreme Court affirmed the ruling of the Court of Appeal, holding that when an associate licensee owes a duty to any party in a real party transaction, “that duty is equivalent to the duty owed to that party by the broker for whom the associate licensee functions.”  (Citing Civil Code Section 2079.13(b). Horiike v. Coldwell Banker Residential Brokerage Co., S218734.

Does a real estate agent representing the Seller owe a fiduciary duty to a Buyer who is represented by another real estate agent?  The answer is “Yes,” if both agents are employed by the same broker. The Second Appellate District has reaffirmed that real estate agents who act as dual agents – representing both the Seller and the Buyer in a transaction – owe a fiduciary duty to BOTH parties. In a recent case, the Appellate Court emphasized that all salespersons working for a single broker acting in a dual agent capacity owe the same fiduciary duty to all parties in the transaction.

The case, Horiike v. Coldwell Banker Residential Brokerage Co.,(filed 4/9/2014), the salesperson working with the Seller failed to disclose or misstated the actual square footage of the living space to the Buyer, who was represented by a different salesperson. But both salespersons worked for the same broker – Coldwell Banker. The Court of Appeal overturned the trial court’s finding that the salesperson representing the Seller did not owe a fiduciary duty to the Buyer.

Even though each of these individual salespersons are considered by the Broker to be “independent contractors” for tax purposes, they are both employees for purposes of their representation of the parties. As a result, the Broker becomes a dual agent representing both parties.  The Court noted that the push by the real estate industry to treat licensed salespersons as “independent contractors” for tax purposes has “enhanced the misunderstanding of salespersons that they can deal independently in the transaction.”

It has long been recognized that a Broker’s fiduciary duty to his or her client requires “the highest good faith and undivided service and loyalty.” “The broker as a fiduciary has a duty to learn the material facts that may affect the principal’s decision. The agent’s duty to disclose material information to the principal includes the duty to disclose reasonably obtainable material information.” Assilzadeh v. Calif. Federal Bank (2000) 82 Cal.App.4th  399, at 414-415.

In Horiike v. Coldwell Banker, the Court went on to declare that a fiduciary’s failure to share material information with the principal is constructive fraud, and noted that even a careless misstatement may constitute constructive fraud even though there was no fraudulent intent. Once again, the emphasis is on full disclosure by the fiduciary of all material facts which are known – or should be known.

Here, the listing agent and the selling agent both worked for Coldwell Banker, and therefore were to be deemed employees of the broker. The Court emphasized that the licensed salesperson had a fiduciary duty equivalent to the duty of the broker, and in a dual agency situation, the salesperson acting under the broker has the same fiduciary duty to both the Buyer and the Seller as the broker.

ARE REAL ESTATE AGENTS REQUIRED TO CHECK PERMITS OR ZONING?

Are real estate agents required to confirm the zoning classification of a property? Are they required to check City permits? Are they required to review title reports and surveys for easements? The real answer may surprise you!

Most real estate agents are familiar with the language under Civil Code §2079, which declares that it is the duty of the agent to conduct a reasonably competent and diligent visual inspection of reasonably and normally accessible areas. The CAR AVID form states that California law does not require the agent to inspect:

Areas that are not reasonably and normally accessible

Areas off site of the property

Public records or permits

Common areas of planned developments, condominiums, … etc.

The AVID form lists several limitations on what the agent is required to do, including the following statement:

” By statute, Agent is not obligated to pull permits or inspect public records. Agent will not guarantee views or zoning, identify proposed construction or development or changes or proximity to transportation, schools, or law enforcement.”

These limitations were enacted in the mid-1980s in response to the Court’s decision in Easton v. Strassburger 152 Cal.App.3d 90 (1984), which held that the agent must disclose any known material facts that affect the value or desirability of the property. Since factors such as “value” or “desirability” were inherently vague, the Legislature responded by creating a disclosure form – the Transfer Disclosure Statement, or “TDS” – pursuant to Civil Code §1102, along with the Agent’s Visual Identification Disclosure, or “AVID.” The intended effect of these forms was to shift responsibility for full  disclosure to the actual Seller or Owner of the property, and limit the liability of the agent to the prospective buyer.

However, agents often fail to understand that the duty owed to their own clients is substantially more extensive – it is a fiduciary duty to disclose all material information that the broker knows or could reasonably obtain regarding the property or relating to the transaction. This fiduciary duty is set forth in Civil Code §2079.16, which is reproduced in full on the first page of the CAR AD Form, “Disclosure Regarding Real Estate Agency Relationship.” It is the duty of “utmost care, integrity, honesty and loyalty in dealings” with their client.

In Field v. Century 21 Klowden-Forness Realty, 63 Cal.App.4th 18 (1998), the Court declared:

“Thus, depending on the circumstances, a broker’s fiduciary duty may be much broader than the duty to visually inspect and may include a duty to inspect public records or permits concerning title or use of the property.”  (Emphasis added).

In other words, the agent’s duty to their own client is substantially greater than the duty owed to a prospective buyer. Further, in a recent decision, the Court ruled that when the prospective buyer and the seller were represented by the same broker in a dual-agency relationship, the dual-agency broker owed a fiduciary duty to both the buyer and the seller.  Horiike v. Coldwell Banker (2014). In that case, the buyer and seller were each represented by a different salesperson who were working for the same broker – Coldwell Banker – and the Court made it clear that as a consequence, the broker’s fiduciary duty extended to each of the agents. Moreover, the Court pointed out that in these circumstances, the salespersons were considered employees of the same broker, even if they were considered to be “independent contractors” of the broker for tax purposes.

Noting that there was a misunderstanding in the real estate industry, the Court went on to declare that the failure of a fiduciary to share material information with the principal – in this case the failure of the seller’s agent to disclose material information to the buyer – amounted to constructive fraud, which means that no intent needed to be established.

Whenever I ask a group of real estate agents whether they are required to check permits, most will respond “No.” After the decision in Horiike v. Coldwell Banker, I anticipate a lot of brokers will be providing some new training!

STOP! Don’t Sign that Arbitration Clause! (Until you’ve considered the consequences!)

UPDATE:  Earlier this week, the United States Supreme Court granted Certiorari to consider whether or not an arbitrator acts within his powers under the Federal Arbitration Act or in excess of those powers by determining that the parties had affirmatively agreed to authorize class arbitration simply on the basis of broad contractual language that required arbitration of any dispute arising under the contract as a precondition to litigation.  Oxford Health Plans LLC v. John Ivan Sutter M.D.  This development is further evidence of the need to carefully consider the consequences when signing arbitration clauses without considering the range of consequences!

Most contracts nowadays contain an “Arbitration Clause,” which the parties often unwittingly sign without considering the consequences. After all, if a dispute arises under the contract, would it not be better to resolve the dispute in an efficient manner that is faster and more cost-effective than going to court?  It could take years for a case to get to trial, and then there”s post-trial motions, appeals, and on and on. With arbitration, the matter could be submitted, argued, and decided by a experienced judge or lawyer with specialized knowledge of the subject area and selected by the parties themselves! What could go wrong?

Ever since Calvin Coolidge signed the Federal Arbitration Act (FAA) in 1925, parties to a dispute could utilize arbitration as a method of “alternative dispute resolution” or “ADR” as these types of proceedings are often called. Designed to allow the parties to resolve their disputes without the usual delays – and costs – of a lengthy trial, the arbitration process steadily grew more popular over the years. According to a recent article in the California Real Property Journal (Vol 30, No 3 2012), authors Paal, Block and Roland note that by the late 20th Century, all 50 states had adopted arbitration statutes.  They note that concerns over court congestion and runaway jury verdicts raised interest in arbitration.

However, Paal, Block and Roland note that arbitration procedures have become more formal and “judicialized,” but lacking the court”s procedural and evidentiary rules, the arbitration process has become as “uncertain, costly, and time consuming as ever.” (Citing Thomas J. Stipanowich, “Arbitration: The “New Litigation.”” 2010 U. Ill. L. Rev.1). The Journal article goes on to note that at the 2009 National Summit of Business-to-Business, “seven out of ten participants believed that arbitration [fell]short of expectations in terms of efficiency and economy at least 50% of the time.”

There are several practical reasons that individuals considering contracts in real estate transactions should not agree to mandatory arbitration. For example, the judicial relief afforded by a Lis Pendens – a Notice of Pending Action – is online casino not available under an arbitration clause. Neither is injunctive relief.  Or an action in Unlawful Detainer – which affords a landlord a relatively prompt, judicial process to evict a defaulting tenant.  In some instances, arbitration actually could take longer and end up costing much more than if the matter had simply proceeded through the litigation process.  It should be noted that almost all State and Federal Courts require that parties to litigation attempt one Det har gjort att manga svenska casinon anvander spel enbart fran Net Entertainment. or more of several alternative dispute methods as part of the litigation process, ranging from Early Neutral Evaluations to Mediation and both binding and non-binding Arbitration – all under the  jurisdiction and time limitations imposed by the Court.

For better and worse, the Courts have upheld the enforceability of the contractual provisions of an arbitration clause, even if the applicable statutory law would yield a different result if tried in Court. In a recent decision by the United States Supreme Court, the noncompetition provison in a contract with an arbitration clause had been ruled invalid by a State Court, but the high Court ruled that subject to the terms of the contract, only the arbitrator could make the determination,  not the State court. (Nitro-Lift Technologies LLC v. Howard).  The Court noted that the Federal Arbitration Act “declare[s] a national policy favoring arbitration,” and provides that a “written provision in … a contract [providing for arbitration] shall be valid, irrevocable, and enforceable.”  In other words, if the contract declares that an issue in that contract is subject to arbitration, the parties must resolve the issue through arbitration.

Is there an alternative to this “alternative dispute resolution” process?  Paal, Block and Roland suggest that Mediation is fast becoming more popular, and “has, for all intents and purposes, replaced arbitration as the preferred method of dispute resolution.” [Citation] Certainly, there are many advantages, not the least of which is that the proceedings are subject to confidentiality.  In Mediation, the parties are encouraged to work out their own, final resolution of the dispute, with the assistance of the Mediator. The process is conducted informally, and the process is subject to strict confidentiality. In Mediation, the parties can restructure the deal and fashion remedies that are not available through the judicial process.

Some newer contracts contain “Mediation Clauses” that provide that the parties first attempt to mediate a dispute prior to initiating litigation. Some contracts also require arbitration if the parties are unable to resolve the dispute through mediation. In some instances, especially in real estate matters, it would be prudent to carefully consider the consequences of agreeing to mandatory arbitration before signing the contract. As always, consult with an attorney before you make the commitment.

HOW TO GET FREE LEGAL ADVICE

Let’s face it – everyone objects to paying for advice; after all, our parents probably provided more than we ever wanted to hear when we were younger. Conversely, very few object to paying for emergency care after a disaster has struck. It is human nature to ignore or downplay the warning signs when you start your hike into the wildnerness; it is also human nature to spare no expense demanding a helicopter rescue when you’re trapped in a ravine with a painful broken leg, night is falling and so is the snow.

Here’s a critical fact that most people fail to grasp:  the hourly rate your attorney charges doesn’t change. However, the number of hours of legal service that you will require can be dramatically different, depending whether you are meeting with your attorney in his office before the transaction takes place, or in the courtroomafter the transaction went sour! Like the injured hiker stuck in a canyon with a broken leg, the cost to extract you from a legal mess is of secondary importance to the need for an immediate rescue. So, if it costs less to get the advice in advance, is it possible to get relevant legal advice for free?

The answer is a qualified “yes.” It is important to distinguish “legal advice” from “investment” and other forms of advice. Recently, I saw an article titled “How to Avoid Drowning,” and quipped: “Don’t go near the water.” Accurate, guaranteed, and free advice, but neither helpful or practical.  Good legal advice is designed to put you into the best position – from a legal perspective – to protect your interests while allowing you to achieve your objectives. Staying away from the water will protect them from drowning, but does little to help them achieve their objective of having a fun day sailing, surfing or swimming. By analogy, the answer to the question “How can I protect myself from risk in a real estate investment?” would be “Don’t invest in real estate.”  Again, accurate but useless advice.

For real estate investors, there is no shortage of “advice” provided in books, articles, seminars, workshops, and classes, as well as a virtually unlimited amount available on the Internet. You already knew that, or you wouldn’t be reading this!  If you take the time to review this material, attend courses, and identify your investment objectives, learn how to accurately calculate return on investment and account for expenses, and develop a plan that is designed to achieve your personal and financial objectives, you will drastically reduce the range of variables that need to be considered when assessing your legal risks. Further, understanding the importance and value of assembling a team of professionals: brokers, contractors, property managers, insurance agents, and accountants, you will develop decision-making methodologies designed to optimize your personal situation while identifying and – hopefully – minimizing the degree of risk involved.

In addition to assembling a team of professionals, you should join a local Real Estate Investment (REI) association that meets regularly and features guest speakers on different topics related to real estate investing. By listening carefully to these speakers, as well as interacting with like-minded individuals who attend the meetings, you will learn a lot more than you can imagine! Stick to REIs that offer educational programs, and steer clear of those that sell books, investment packages, etc. However, when you meet someone who specializes in selling certain types of real estate investment products, remember you are the customer. You can ask questions, check references, and do your due diligence to further minimize your risks. Make certain you get all agreements in writing. After a careful and objective analysis, if the proposed investment appears to help you achieve your personal and financial objectives, you will have accomplished the single, largest and most important element of reducing your exposure to liability or loss. Ignoring or postponing this analysis could be extremely expensive and, in most instances, futile.

And that, dear reader, is very relevant, practical — and free — legal advice. But it only works if you use it!