By Jeannette L. Knudsen

This issue of Advisor brings you information on tax strategies related to employment contracts, benefits packages, and the sale of interests in partnerships. Steven Dimengo’s article outlines the effects of a recent decision by the Ohio Board of Tax Appeals on certain contracts for employment services. Cathy Godshall discusses recent changes to Section 457 of the IRS Code. These changes provide for limited exceptions to the unfavorable rules that have governed some types of compensation plans offered to key executives by tax-exempt organizations. Robert Malone’s article discusses ways to minimize tax exposure when selling an interest in a partnership or LLC.

We hope that you find this information helpful. We would welcome further inquiries on any of the topics presented here.

Jeannette L. Knudsen, Esq. is a member of the Business Law, Intellectual Property and Real Estate & Construction Law Practice Groups and can be reached at jknudsen@bdblaw.com or at 330.643.0350.

Sales/Use Tax on Employment Services
By Steven A. Dimengo, Esq.

A recent Ohio Board of Tax Appeals decision may require your immediate attention. Effective January 1, 1993, employment services became subject to Ohio sales/use tax. An "employment service" is defined to include transactions by which personnel are provided under the supervision and control of the purchaser. There are exceptions to this definition, however, which may help you avoid this tax. Among the exceptions are transactions where the personnel are supplied under a contract of at least one year that specifies each employee covered under the contract is assigned on a permanent basis.

In B. J. Alan Company v. Tracy, Ohio BTA Case No. 99-N-196 (March 1, 2002), the Ohio Board of Tax Appeals addressed whether a contract having an initial term of one year and month-to-month extensions (and a clause allowing termination upon fourteen days' notice) qualified for the one-year exception. The Board held that the contract was excepted for the first year since it was still in place after one year; the termination clause had no effect. However, the contract did not qualify for the exception after the first year since it had only monthly terms. As I understand, the decision is being appealed to the Ohio Supreme Court.

Pending a final determination from the Court, all contracts containing extensions that are intended to apply for the exception should be amended to provide for extensions of at least one year, with no ability to terminate without penalty (unless there is a substantial breach of the agreement). Please let us know if you would like additional assistance in structuring your contracts to qualify for the one-year exception or any other available exceptions.

Steven Dimengo is a shareholder and member of the Taxation & Employee Benefits and Business Law Practice Groups. He can be contacted by email at sdimengo@bdblaw.com or 330.258.6460.

Nonqualified Deferred Compensation Plans for Tax-Exempt Employers - IRC Section 457

By Cathy C. Godshall, Esq.
It is much more expensive for tax-exempt entities, including state and local governments, to establish a nonqualified deferred compensation program for their key employees than it would be for a taxable entity to set up the same plan. However, recent changes to Section 457 of the Internal Revenue Code have improved the situation. Tax-exempt employers should definitely take full advantage of these new tax law changes when restructuring or establishing a nonqualified deferred compensation plan.

Background
For key employees of taxable employers, a nonqualified deferred compensation plan can be a significant benefit. If the plan is unfunded, the employee is not generally taxed on the deferred compensation benefits promised to him until he actually receives those payments. This is true even if he is vested in those benefits. The taxable employer receives a tax deduction when the employee is taxed on the benefits.

Tax-exempt employers are at a significant disadvantage when establishing such a plan, however. Section 457(f) of the Internal Revenue Code provides that any deferred compensation benefits promised under a plan established by a tax-exempt employer will be taxed to the employee in the first year he is vested in those benefits; even if, the benefits are unfunded and the employee has not received the benefits and has no right to receive the benefits currently. To avoid current taxation on the deferred compensation benefit, the tax-exempt employer must provide in the plan that the benefits are unvested and are conditioned upon the performance of substantial future services. This means that the plan must provide that the benefit will be forfeited unless the employee works for the employer until some future retirement age. Once that age is reached and the condition lapses, the employee will be taxed on the benefit in full (even if it is paid in installments).

In planning for the receipt of such a benefit, the employer has to be sure that the employee receives enough of a current distribution in cash to pay his taxes on the full value of the benefit. Front-loading the payments in this fashion can be a cash-flow burden to the tax-exempt entity and can push the employee into a higher tax bracket. Front-loading also causes potential problems for the employee and the employer if the date on which the risk of forfeiture is to lapse is postponed because the employee does not wish to retire on that date. The IRS is leery of these so-called “rolling risks of forfeiture.”

Eligible 457 Plans
The Internal Revenue Code provides for a limited exception from these unfavorable rules for so-called “eligible deferred compensation plans” that are established by tax-exempt employers. If the requirements of Section 457(b) of the Internal Revenue Code are met, the employee is not taxed on the benefits until they are actually paid to him even if he is fully vested in those benefits.

Prior to 2001, the contribution limits for eligible 457 plans were so low as to make the plans relatively useless as a compensation device. Beginning in 2002, however, the contribution limits of eligible 457 plans have been substantially liberalized. As a result, an “eligible” 457 plan is now a viable option for funding a deferred compensation benefit. Further, if the contribution limits of an eligible plan are still too low, the eligible plan can be used in tandem with another “ineligible” 457 plan (one in which the promised benefits are forfeitable) to achieve the benefits desired.

Further, as long as the plan is properly structured to avoid constructive receipt problems, the deferred compensation payments may be spread out in installments over a number of years without current tax on the entire benefit to the employee. An eligible 457 plan must meet certain requirements, including distribution requirements similar to qualified plans. The plan must also be unfunded and be limited to key employees. We can assist your clients in establishing these “eligible” 457 plans, either on a stand-alone basis or in tandem with the older “ineligible” 457 plans.

Cathy Godshall is a shareholder and member of the Business Law, Taxation & Employee Benefits, Health Law, and Trust & Estates Practice Groups. She can be contacted by email at cgodshall@bdblaw.com or 330.258.6449.

Selling an Interest in a Partnership or Limited Liability Company

By Robert W. Malone, Esq.
Most businessmen and women are familiar with the tax consequences related to the sale or purchase of stock in a corporation. Capital gain or loss is recognized to the extent of the difference between its selling price and cost. Selling the interest (“Interest”) in a limited liability company (“LLC”), however, can be a much more complex transaction. Depending upon the type of assets owned by the partnership or LLC, the sale will result in recognition of ordinary, as well as capital, gain or loss. Taxpayers generally prefer capital gains as they are taxed at a maximum rate of 20% rather than the nearly 40% maximum rate applicable to ordinary income. Addressing this subject in the purchase agreement can generally control the allocation as between capital and ordinary gain or loss. 

From a buyer’s perspective, the purchase of an Interest can have a substantial advantage from a tax perspective over a purchase of stock in the partnership or LLC, if the Interest is purchased at a gain, may increase the basis of the assets of the entity to their fair market value. This basis step-up can increase the buyer’s depreciation and amortization deductions, thereby generating a current tax benefit. 

A purchase of an Interest by existing owners can be structured as either an acquisition by the owners or a liquidation by the partnership or LLC. Although the economic results of such a sale and liquidation are the same, the tax consequences can vary substantially. 

To the extent the gain recognized upon a sale of an Interest to another owner is attributable to straight-line real estate depreciation recapture, the seller must pay tax at a special 25% capital gains tax rate. If the transaction is restructured as a liquidation, this gain will be taxed at the regular 20% (or lower) capital gains tax rate. Similarly, in a sale, all gain attributable to inventory is taxed at ordinary income tax rates whereas, in a liquidation, gain attributable to inventory is treated as ordinary income only if the inventory’s fair market value equals or exceeds 120% of its tax basis. 

The capital gain attributable to a sale of an Interest must be reported pro rata over the period that the payments are received. In the case of a liquidation, gain does not have to be reported until the total payments received exceed the basis of the Interest being liquidated. Another advantage to a liquidation is that for certain personal service organizations, it is even possible to structure payments attributable to uncollected accounts receivable as currently deductible by the organization. 

There are many opportunities for the wary, and traps for the unwary, associated with the sale of Interests in partnerships and LLCs. We can help you take advantage of the opportunities, and avoid the traps, in transactions of this type. 

Robert Malone is a shareholder and member of the Taxation & Employee Benefits, Business Law, and Trust & Estates Practice Groups. He can be contacted by email at rmalone@bdblaw.com or 330.258.6545.

Gerald B. Chattman, Shareholder-in-Charge of the Buckingham Cleveland^SM office has been selected as the recipient of the 2002 Golden Mile Award for his leadership and dedication to saving babies. The Golden Mile is the final mile in the WalkAmerica journey and symbolizes the celebration of lives saved by the March of Dimes in partnership with heroes such as Gerald B. Chattman. He will be honored by the March of Dimes Ohio Chapter at a ceremony on May 2, 2002.

Electing Shareholders is one of the most important responsibilities of our Firm for its future. We are happy to report that five outstanding attorneys were elected Shareholder in February.

Thomas R. Brule
Business Law and Mergers & Acquisitions Practice Groups - Buckingham Cleveland^SM
Tom has more than 20 years’ experience in franchising and also practices in the areas of commercial law and litigation, distribution, trade regulation, retail, acquisitions and divestitures, real estate and litigation.Prior to joining Buckingham, he served as the United States franchise and litigation counsel for Kentucky Fried Chicken (KFC); was a member of senior management at PepsiCo’s KFC; and was the senior vice president and general counsel of two national retail franchise companies.

Alan P. DiGirolamo
Litigation and Creditors’ Rights Practice Groups - Buckingham Cleveland^SM
His areas of expertise include creditor bankruptcy, creditors’ rights, secured transactions, banking law, transportation law, foreclosures, construction law, consumer protection law and general commercial litigation. He has a B.S. degree, cum laude, from Arizona State University and a J.D. from Case Western Reserve University School of Law.

Christopher S. Humphrey
Medical Malpractice Defense and Litigation Practice Groups - Buckingham Canton^SM
His legal experience includes medical malpractice litigation defense, defense of adult and long-term care facilities, commercial litigation, insurance defense and general litigation. He represents clients in trial courts and courts of appeal throughout the State of Ohio.

Louis F. Wagner
Intellectual Property Practice Group - Buckingham Akron^SM
His area of expertise includes patents, trademarks, copyrights, trade secrets and intellectual property. He has 13 years’ experience in the oil/polymer/catalyst industry and 12 years’ experience in the intellectual property field, both as in-house and outside patent counsel specializing in chemistry and polymer science as well as intellectual property Internet issues. He is the inventor on three U.S. patents.

Ronald F. Wilt
Medical Malpractice Practice Group - Buckingham Cleveland^SM
Mr. Wilt's entire legal career has been devoted to defending physicians and hospitals against claims of medical negligence. He has handled several hundred cases from inception to closing and has won numerous jury verdicts in catastrophic cases. He has successfully defended cases involving a multitude of medical issues including infant birth injuries, wrongful death, medical and radiological misdiagnosis, surgical complications, and pharmacologically induced brain damage and death. He represents or has represented physicians and hospitals from nearly every medical specialty.

Jason M. Baasten, Associate Attorney
Employment Law Practice Group
Jason was previously an Associate General Counsel and General Counsel of FirstGroup America, Inc. in Cincinnati, Ohio. He counseled managers on employment law issues, negotiated collective bargaining agreements, and litigated grievance arbitrations. In addition, he defended against National Labor Relations Board labor practice charges, EEOC discrimination charges and Department of Labor Complaints. Also, he managed and directed outside legal counsel, supervised and instructed insurance claims investigators, presented labor and employment law training classes for managers and managed immigration of expatriate employees. He has also clerked for Ryder Public Transportation Services, Inc. in Cincinnati and Green, Haines, Sgambati, Murphy & Macala, LPA in Canton.

Save The Date for these Upcoming Presentations:
On March 27, 2002 in Canton, Ohio, Jeffrey A. Halm (Buckingham Canton^SM) will speak on “Basic Estate Planning Strategies” at the complimentary seminar, “The Financial Decisions I Make Today Will Affect How I Live Tomorrow” sponsored by David A. Noyes & Company. Please contact William Clements or Nicole Rowland of David A. Noyes & Company at 330.896.3798 or toll-free at 1.877.348.3798 for registration and additional information.

On March 27, 2002, Gerald B. Chattman and Dale A. Nowak (Buckingham Cleveland^SM) will be speaking at a Risk Management Training Seminar sponsored by The Reserves Network. Please contact Brandon Thimke at bthimke@reservesnet.com or 440.779.6604 for registration and additional information.

On April 25, 2002, Steven A. Armatas (Buckingham Canton^SM) will present “Copyright Basics, Distance Learning Guidelines and Educational Multimedia Guidelines” at Distance Learning and Copyright: Legal Issues sponsored by Lorman Educational Services in Pittsburgh, Pennsylvania. Please refer to www.lorman.com or 713.833.3959.

Betsy J. Houchen (Buckingham Columbus^SM) will be participating in the following events for the health care industry:

March 27, 2002, she will present “Laws Governing the Practice of Nursing in Ohio” at the Teleconference for the Ohio Council for Home Care and Ohio Hospice & Palliative Care Organization. Please contact Barbara Russell at bjr@homecareohio.org or 614.885.0434 ext. 208 for additional information.

May 13, 2002, her speech to the Visiting Nurses Association Coalition will cover “HIPAA Privacy Standards for Home Health Agencies.” Please reference www.vnaa.org for additional information.

May 21, 2002, she will speak on “HIPAA Privacy Standards for Home Health Agencies” to the Northwest Ohio Regional Home Health Agencies. Please contact your local Home Health Agency for registration information.

May 7, 2002 Betsy J. Houchen and Thomas W. Hess (Buckingham Columbus^SM) will speak at the Ohio Health Care Association, Spring 2002 Convention. Reference www.ocha.org or 614.436.4154 for additional information.

June 24, 2002, Betsy’s topic will be “Assisted Living Facilities and Home Health & Hospice Service” at the Ohio Assisted Living Association Convention. Please reference www.ohioassistedliving.org or 614.481.1950 for additional information.

The Ohio State Bar Association/Continuing Legal Education Institute is sponsoring a series entitled “Implementing Strategies to Minimize the Risk of Mechanics’ Liens and ‘Paying Twice.’” The presenters, dates and cities are as follows:

John P. Slagter and Robert A. Hager on April 5, 2002 in Toledo, Ohio;
Kenneth A. Fisher on April 12, 2002 in Cincinnati, Ohio;
John P. Slagter and Robert A. Hager on May 3, 2002 in Cleveland, Ohio;

 Please reference www.ohiocle.org for additional information.

On April 24, 2002, Patrick H. Reymann (Buckingham Akron ^SM), Jeffrey T. Royer (Buckingham Cleveland^SM) and Joseph J. Feltes (Buckingham Canton ^SM) will be presenters at Lorman Education Services’ “Advanced Physician Practice In Ohio.” The topics will be “10 Major Physician Billing/Coding Problems,” Medicare/Medicaid Denials and Appeals,” and “Managing HIPAA Issues in an Advanced Practice Group.”

On June 4, 2002, Donald B. Leach, Jr. (Buckingham Columbus^SM) will present “Ohio’s Mechanics’ Lien Law: The How’s and Why’s of the Paperwork - General Contractors, Owners.” Please refer to www.bx.org for registration information.

Out and About - Recent Presentations:

Business Law Practice GroupSteven A. Armatas (Buckingham Canton^SM) presented “Evolving Rules of Copyright in Distance Learning” to the Walton College of Business - University of Arkansas on January 10, 2002.

Health Law Practice Group
Donald A. Antrim (Buckingham Columbus^SM) published “HIPAA and the New Privacy Regulations” in the Pennsylvania Optometric Association’s - Keystoner and The Michigan Optometrist, November and December 2001 issues.

Thomas W. Hess (Buckingham Columbus^SM) was a presenter at the Ohio Health Care Association seminar and his topic was “Living Wills, Health Care Power of Attorney and Other Good Stuff.” He also presented “How to Survive a Medicaid Audit” to the Ohio Association of Medical Equipment Services and “Survey Appeals and IDR” to the Ohio Health Care Association/Long Term Care Regulatory & Financial Conference.

Betsy J. Houchen (Buckingham Columbus^SM) spoke to the Ohio Assisted Living Association Fall Meeting on “HIPAA, Electronic Transactions, and Assisted Living” and presented “Nursing Home Licensing Rules” to the Ohio Health Care Association District Meeting. In addition, she gave a speech on the “HIPAA Privacy Regulations” at the Regional Meeting of the Organ Organizations and Transport Centers.

Litigation Practice Group
Patrick J. Keating (Buckingham Akron^SM) spoke at the Greater Akron Chamber Small Business Council Breakfast Meeting on March 1, 2002 and his topic was “Bankruptcy Pitfalls for Small Business Owners.”