In this tough economy, employers may be tempted to hire workers as “independent contractors” instead of “employees” in order to avoid payroll taxes, requirements under wage and hour laws such as minimum wage, overtime, meal periods and rest breaks, and reimbursement for their workers’ business expenses. Additionally, employers are not required to cover independent contractors with workers’ compensation insurance, and are not liable for payments under unemployment insurance, disability insurance, or social security.

Despite these temptations, employers should be aware that the misclassification of workers now faces enhanced enforcement efforts by federal and state government agencies and increased penalties under California law.  Effective December 21, 2011 through December 21, 2014, the U.S. Department of Labor’s Wage and Hour Division (WHD) and the California Labor and Workforce Development Agency (LWDA) have agreed through a formal Memorandum of Understanding (MOU) to join forces in order to reduce the practice of misclassification,[1] improve outreach, share resources, and enhance enforcement.[2]   Additionally, in September 2011, the federal Department of Labor (DOL) and the Internal Revenue Service (IRS) also agreed through an MOU to work together in order to share information, reduce the incidence of misclassification of employees, help reduce the tax gap, and improve compliance with federal labor laws.

Just as enforcement efforts have been enhanced, the penalty for willfully misclassifying workers has also recently increased.  Effective January 1, 2012, California Governor Jerry Brown signed into law Senate Bill 459, which increases the penalties for the willful misclassification of employees as independent contractors by imposing civil penalties between $5,000 and $25,000 for each violation and by requiring businesses to publicize findings of violations on their company websites.  This legislation is reflected in newly added California Labor Code sections 226.8 and 2753.

In addition to the heightened potential for liability faced by employers, the new California legislation will also likely impact the willingness of third-party advisors, such as financial, accounting, and human resources professionals, to advise employers as to how a worker should be properly classified.  This is because Labor Code section 2753 broadens the range of potential liability, extending joint and several liability for fines and penalties to any person who, for money or other valuable consideration, knowingly advises an employer to misclassify an individual as an independent contractor.

Therefore, employers seeking guidance on how to properly classify a worker should seek counsel from an attorney who can look to the interpretations of the courts and enforcement agencies.  As there is no set definition of “independent contractor,” it is necessary to closely examine the facts of each service relationship and then apply the law to those facts. Although there is a presumption that the worker is an employee, the presumption is rebuttable and the determination of whether a worker is an employee or independent contractor will depend upon a number of factors.

When enforcing wage and hour laws, the California Division of Labor Standards Enforcement (DLSE) uses the “economic realties” test, adopted by the California Supreme Court in the case of S. G. Borello & Sons, Inc. v Dept. of Industrial Relations, 48 Cal.3d 341 (1989).  Under the economic realities test, the most significant factor is whether the employer or principal has control over the worker both as to the work done and the manner and means in which it is performed.  However, even where there is an absence of control over work details, an employer-employee relationship may be found.  Factors that may be considered are:[3]

1. Whether the person performing services is engaged in an occupation or business distinct from that of the principal;
2. Whether or not the work is a part of the regular business of the principal or alleged employer;
3. Whether the principal or the worker supplies the instrumentalities, tools, and the place for the person doing the work;
4. The alleged employee’s investment in the equipment or materials required by his or her task or his or her employment of helpers;
5. Whether the service rendered requires a special skill;
6. The kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the principal or by a specialist without supervision;
7. The alleged employee’s opportunity for profit or loss depending on his or her managerial skill;
8. The length of time for which the services are to be performed;
9. The degree of permanence of the working relationship;
10. The method of payment, whether by time or by the job; and
11. Whether or not the parties believe they are creating an employer-employee relationship.

What is not determinative of independent contractor status is whether a worker has a written agreement purporting to establish an independent contractor relationship, or whether the worker is issued a 1099 form rather than a W-2 form.  Borello, Id. at 349, Toyota Motor Sales v. Superior Court 220 Cal.App.3d 864, 877 (1990).

After considering these factors, employers should seek the advice of an attorney to determine whether a worker should be classified as an independent contractor or employee.

Note that for each worker who is properly classified as an independent contractor, you are required to report specific information to the Employment Development Department (EDD) if the following statements all apply:

• You are required to file a Form 1099-MISC for the services performed by the independent contractor.
• You pay the independent contractor $600 or more OR enter into a contract for $600 or more.
• The independent contractor is an individual or sole proprietorship.

For more information on the independent contractor reporting requirements, you can visit the EDD’s website here: http://www.edd.ca.gov/payroll_taxes/independent_contractor_reporting.htm

Senate Bill 392 (SB 392) changed the law in California – limited liability companies (LLCs) can now be licensed contractors!  The California Contractors State License Board (CSLB) issued the first state contractor license to a limited liability company (LLC) on January 19, 2012.

What You Need to Know

The CSLB is now processing applications for licenses from LLCs.  The following are some key aspects of the law that applicants should be aware of:

• In addition to the $12,500 contractor bond required by the state license law, a $100,000 surety bond is required for the issuance, reissuance, reinstatement, reactivation, and renewal of an LLC license for the benefit of employees to ensure payment of wages, interest, and fringe benefits. Business & Professions Code § 7071.6.5 
• LLCs will be required to maintain and submit proof of errors and omissions insurance coverage in an amount of not less than $1,000,000 for an LLC with five or fewer persons listed as members of the personnel of record, and up to $5,000,000, depending on the number of persons listed on the personnel of record of the LLC. For an LLC with more than five personnel of record, an additional $100,000 of insurance must be obtained for each additional person up to a maximum of $5,000,000 in aggregate coverage. Business & Professions Code § 7071.19 
• Every person who is an officer, member, responsible manager, or director must be listed as personnel of record on LLC applications. Business & Professions Code § 7065 
• If an LLC license is suspended for failing to be registered and in good standing with the Secretary of State, each person within the LLC may be held personally liable up to $1,000,000 million each during the time the LLC is suspended. Business & Professions Code § 7076.2 
• Specific information relating to the LLC’s general liability insurance must be included on the LLC’s home improvement and service and repair contracts. Business & Professions Code §§ 7159 and 7159.10
• Existing license numbers may be reissued to LLCs under certain circumstances. Business & Professions Code § 7075.1
• LLCs may serve as a general partner on a partnership license provided the LLC meets the requirements relating to the additional surety bond and liability insurance. An LLC serving as a limited partner on a partnership license is not required to meet the additional surety bond and liability insurance requirements.

A lot of applications by LLCs for licenses are being rejected due to errors including the following:

• The application must include the LLC registration number issued by the Secretary of State on page 1
• The personnel listed on the application must match those reported to the Secretary of State on the statement of information (Form LLC-12)

Unfortunately, the Secretary of State has a four-month processing backlog on statements of information and the Contractors State Licensing Board cannot process the LLC license application until all information is consistent with Secretary of State records. This can create a delay in securing a contractors license.  The only way to deal wit this is to pay a fee ($350) to the Secretary of State for expedited processing of the statement of information.

Under the new law a dividend is permitted if paid out of retained earnings OR if immediately after the distribution, the value of the corporation’s assets would equal or exceed the sum of its total liabilities.

The Internal Revenue Service today launched a new program that will enable many employers to resolve past worker classification issues and achieve certainty under the tax law at a low cost by voluntarily reclassifying their workers.

This new program will allow employers the opportunity to get into compliance by making a minimal payment covering past payroll tax obligations rather than waiting for an IRS audit.

To be eligible, an applicant must:

• Consistently have treated the workers in the past as nonemployees,
• Have filed all required Forms 1099 for the workers for the previous three years
• Not currently be under audit by the IRS
• Not currently be under audit by the Department of Labor or a state agency concerning the classification of these workers

Employers accepted into the program will pay an amount effectively equaling just over one percent of the wages paid to the reclassified workers for the past year. No interest or penalties will be due, and the employers will not be audited on payroll taxes related to these workers for prior years. Participating employers will, for the first three years under the program, be subject to a special six-year statute of limitations, rather than the usual three years that generally applies to payroll taxes.

Click here for more information.

There are four basic types of intellectual property, each of which is treated very differently, having its own policy justifications, body of law, regulatory framework and procedures, etc.  The four basic intellectual property schemas are (1) trademark, (2) patent, (3) copyright, and (4) trade secret.

TRADEMARK

Branding is of critical importance to all businesses, so I discuss trademarks and service marks (collectively “marks”) here first.  A mark is a word, phrase, image, etc., used to sell and to offer for sale goods and/or services in commerce.  The basic test for whether or not use/protection of a mark is possible or advisable is that two marks used for similar goods and/or services in the same market segment/channel must not be “confusingly similar” to one another.

While it is possible to obtain limited protection for marks under individual state filing systems, or automatically through common law rights based on actual usage, most businesses of any size should seek a federal registration for their mark(s).  The same is true for most web-based businesses which seek to serve a national market (i.e. not limited to a particular city or region).

PATENT†

A utility patent is a government-granted right, for a limited time, to prevent others from using a product or process (or an improvement) which is (a) new, (b) useful, and (c) non-obvious to one with “ordinary skill in the art.”  Businesses with substantial research and development efforts should (in addition to implementing strong trade secret policies, discussed below) implement a policy to regularly – and at least at intervals of every few months – interview their research and engineering staff to learn whether they have either conceived of or “reduced to practice” any inventions satisfying the three-part test for patentability.  Where a promising invention has been conceived of, but not yet reduced to practice, management should strongly consider allocating resources sufficient promptly to reduce the invention to practice and seek a patent for it, to ensure maximum protection.  Likewise, engineers and researchers should be instructed to maintain complete, up-to-date laboratory/engineering notebooks, consecutively numbered, with continuous, dated entries, and no pages (or portions of pages) left blank.  Properly maintained lab/engineering notebooks can serve as strong evidence to establish rights and priority to an invention, in the event of any dispute.

COPYRIGHT

Copyright affects “works of authorship” (which may include works which are literary, musical (including lyrics), dramatic, choreographic (principally dance), pictorial/graphic/sculptural, cinematic, audiovisual/multimedia and architectural, as well as computer software, and “mask works” for integrated circuits).  For over two decades, the United States has been a signatory to the Berne Convention, which ensures that copyright protection attaches to a work of authorship automatically, from the moment of its creation, independent of any official filing, or even inclusion of a copyright notice.  However, authors should include a standard copyright notice on all works of authorship which are of more than ephemeral interest/importance, in the following form:

Copyright © [Year of first circulation/publication] [Name(s) of author(s)]

(Note that audio recordings are technically not “copies” but rather “phonorecords” so that the “Copyright ©” designation should be replaced with “Phonorecord ℗” instead.)

Authors should also consider federal registration with the Copyright Office for certain critical works of authorship.  Federal registration is required before you will be allowed to sue for infringement and/or claim statutory damages, and there are certain other procedural advantages to registration as well.

TRADE SECRET†

A trade secret can be thought of as anything which has economic value, and which is not generally known to the public or (critically) one’s competitors.  As in the case of trademarks, virtually all businesses will have intellectual property which they should attempt to protect as trade secrets.  Even relatively non-“technical” traditional businesses will have trade secrets in the form of customer lists, supplier lists, business plans, internal market studies/projections and strategy documents.  Though virtually all states have passed some form of the Uniform Trade Secrets Act, trade secrets are still largely governed by and dependent on contract law.  That is to say, they rely for their protection on businesses implementing policies requiring that all employees and contractors sign airtight agreements regarding non-use, non-disclosure and assignment of inventions.  It is important to have these in place early on, before any actual work is done or intellectual property created, whenever possible.

* * * * *

† NOTE REGARDING TENSION BETWEEN PATENTS AND TRADE SECRETS – Certain inventions may be subject to protection either through patent registration or as trade secrets.  These two areas of law are quite distinct, and are in many ways diametric opposites of one another, in that trade secret protection requires maintaining strict secrecy for an invention, while applying for a patent generally requires “laying open” the invention to the public, i.e. publication, and this is often (though not universally) true even if the patent application is ultimately rejected.  Please note that while patents can be very valuable, the decision to file for a patent, rather than continue to maintain an invention as a trade secret, should first be explored with competent counsel.

Copyright © 2011 Terry L. Thomas

The IRS has published Notice 2011-43, which provides transitional relief for certain small organizations that lost their tax-exempt status because they failed to file an annual electronic notice for three consecutive tax years beginning in 2007.  Qualifying organizations will be able to file for reinstatement of their tax-exempt status, retroactive to the date the status was lost, and pay a reduced filing fee of $100.

The relief applies to organizations that lost their exempt status because of their failure to comply with Sections 6033(i) and (j) of the Internal Revenue Code, which were added by the Pension Protection Act of 2006.  Section 6033(i) applies to organizations that are exempt from filing annual information returns on Form 990 or 990 EZ because their gross receipts that are normally less than $25,000 (increased to $50,000 for the 2010 tax year).   These organizations are required submit an annual electronic filing on Form 990-N, also called the e-postcard. Section 6033(j) provides that an organization’s exempt status will be revoked if it fails to file the 990-N or other required annual information return for three consecutive tax years. An organization’s annual gross receipts are “normally not more than” $25,000 or $50,000 in a taxable year if its average annual gross receipts for that taxable year and the two taxable years immediately preceding it are not more than $25,000 or $50,000, respectively.

An organization that had its tax-exempt status revoked under section 6033(j) must apply for reinstatement with the IRS, even if it was not originally required to file an application for recognition of exempt status (Form 1023).  If the organization applying for reinstatement of tax-exempt status can show reasonable cause for its failure to file, its tax-exempt status may be reinstated retroactive to the date of the automatic revocation.  Reinstatement is at the Secretary of the Treasury’s discretion, however, the IRS has set a very low bar for determining whether a small organization has established reasonable cause for its failure to file.

The IRS will treat an organization as having established reasonable cause if it meets each of the following criteria:

• The organization was not required to file Form 990 or Form 990-EZ for the taxable years beginning before 2007.

• The organization was eligible to file a Form 990-N in each of its taxable years beginning in 2007.  Organizations (other than private foundations and       most section 509(a)(3) supporting organizations) with annual gross receipts that were normally not more than $25,000 would generally have been eligible to file the Form 990-N.

• The organization submits its application for reinstatement to the IRS on or before December 31, 2012.

An organization must apply for reinstatement on the form used to apply for recognition of exempt status, even if it was not originally required to file. Thus, an organization seeking reinstatement under section 501(c)(3) would file Form 1023, and an organization seeking reinstatement under section 501(c)(4) would file Form 1024.  The organization must write “Notice 2011-43” on the top of the form and on the envelope in which it is mailed.  The organization must also attach the following statement to its application:

[Name of Organization] was not required to file annual information returns for taxable years beginning before 2007; was eligible in each of its taxable years beginning in 2007, 2008 and 2009 to file a Form 990-N e-Postcard; and had annual gross receipts of normally not more than $25,000 in each of its taxable years beginning in 2007, 2008 and 2009.

Organizations that had their exempt status revoked for failure to file under Section 6033(j), but do not qualify for the relief described above, must also file the application for recognition of tax exempt status and pay the normal user fee.  The application must include a request for retroactive reinstatement that conforms to requirements set out in IRS Notice 2011-44.

The committee’s letter states, “As currently drafted, the Bill includes among the permitted special purposes those charitable and public purpose activities that may be carried out by a nonprofit public benefit corporation. It does not include reference to religious purpose activities that may be carried out by religious corporations. Although the California Corporations Code has separated nonprofit public benefit and religious corporations into parallel statutory schemes, the purposes of religious corporations are traditional charitable purposes just as much as those public and charitable purposes of public benefit corporations. Religious purposes encompass activities which may even be identical to those conducted under charitable purposes. There are a significant number of social welfare type of organizations that are incorporated as religious organizations. By leaving out the reference to purposes of religious corporations, the Bill excludes the activities of a large segment of the social welfare and charitable community and unnecessarily restricts the special purposes which could be included for this type of organization.”

In contrast, the California Association of Nonprofits, along with California Church Impact, California Society of Association Executives, and the Blood Centers of California, have written a letter opposing the bill.  They express the following concerns (quoted from their letter):

• What are the consequences for the quality of social, environmental, cultural, and educational services used and needed by California residents if for-profits are provided with enhanced capacity to compete with nonprofits for government grants and contracts, financial and human capital and the definition of the form and scope of practices for delivering social benefits?

• Some SB 201 proponents maintain that the capital pool for existing nonprofits and Flexible Benefit Corporations are mutually exclusive. What is the evidence to substantiate that claim? How can we be sure that investments in FPCs are not being made in lieu of charitable contributions?

• Although the single largest source of revenue for nonprofits is earned income, nonprofits are likely to find themselves at a competitive disadvantage with FPCs with access to capital simply unavailable to governmental and charitable entities. What are the likely outcomes of that situation?

• By all accounts, public benefit is difficult to evaluate and measure. How will nonprofits and investors be protected from misrepresentations by management and directors accountable only to their shareholders and not to standards established in many areas of nonprofit practice by existing nonprofit professional associations?

• There may be lessons to be learned from the UK, where there is a highly developed system for assessing public benefit outcomes of Community Interest Companies, a hybrid similar to that proposed in SB 201 and in existence since 2005. In the legislation, this core principle is achieved through the “community interest test.” A company satisfies the community interest test if a reasonable person might consider that its activities (or proposed activities) are carried on for the benefit of the community. Many community interest companies use independent social auditors, whose audits provide the basis for evaluations by social audit panels.  Through this audit system, the UK approach requires accountability not only to the shareholders but also to the stakeholders, such as recipients of social services, who are the purported beneficiaries of the companies’ activities.

• To the limited extent that they are regulated, what’s to prevent a Flexible Purpose Corporation from enjoying the same “light touch” from regulators received by their UK counterpart, the Community Interest Company, as reported in a recent article “Wrong Way Corrigan and Recent Developments in the Nonprofit Landscape: A Need for New Legal Approaches,” by James J. Fishman Pace, University School of Law?

• Given that they are engaging in “charitable and public purpose activities that could be carried out by a nonprofit public benefit corporation,” should FPCs be subject to some specific form or degree of oversight or accountability similar to the requirements for nonprofits from the California Attorney General, Internal Revenue Service, Franchise Tax Board, Board of Equalization, and Secretary of State?

• What assurances do we have that FPCs will continue to provide needed services when the economy is faltering when there are decisions to be made about shareholder returns? Nonprofits must maintain their vision and mission regardless and face scrutiny by taxing authorities and the California Attorney General.

• What is likely to be the impact of FPCs and similar measures on service and volunteerism, which up to now have been key component of our way of life in both California and the nation? Will the mixing of for-profit with charitable motives send a message that undermines the efforts of religion, nonprofits and government to encourage individuals, families and communities to unselfishly “take action that changes the world,” in the words of the mission statement of the Points of Light Foundation.

• In addition the proposals already pending in the Legislature, there are other available methods, some that have been in place for decades, to blend public and private purposes in single or related corporations. What are the relative merits of each type from the perspectives of potential abuse, impact on nonprofits, and impact on existing businesses? Will they erode or enhance the capacity of existing nonprofit entities under current law and in which both the public and private sectors have invested immense amounts of time and dollars?

by Levy Barr Group, LLP

With all the recent publicity about audits by the Internal Revenue Service (IRS), we are getting many calls regarding the fear that all expenses of medical cannabis dispensaries and cultivators may be disallowed. We want to reassure everyone that we feel this fear is not warranted.

First, it is well established by a Senate Committee, the United States Court of Appeals and the U.S. Tax Court (many times) that at least Cost of the Goods Sold are certainly allowable as a deductible expense against the gross receipts.

Second, the definitions of Cost of Goods Sold from both an accounting and tax viewpoints is relatively complex, and includes the allocation of many indirect costs as well.  Therefore, what becomes deductible will likely be decided case-by-case.  For every single one of our clients, we have presented some non-deductible expenses based on specific analyses based on their specific situations.  Of our hundreds of clients, no one yet is being audited on this issue.

Third, many dispensaries which are being audited – all of whom are not our clients – have had returns prepared which have not attempted to present any expenses which are non-deductible.  We feel these clients have tax preparers who are either unaware of the law, or who are simply choosing to ignore its implications.  At this time, as long as the law exists, we feel this is an unreasonable position and is likely to draw attention by the IRS.

Fourth, read what our friend, Henry Wykowski has told the press last week regarding his representation of clients.

Fifth, please be aware that some dispensary operators who are being audited may be using their audit in a political way, in order to more dramatically make the point of the Federal government’s opposition to the legal nature of medical marijuana.  In our opinion, this is a legitimate position, but out of context it is creating undue anxiety.

Sixth, be aware that some of the recent news about taxes is about Sales Taxes, not Income Taxes. In this regard, we feel that some dispensaries have consciously decided that sales taxes in California should not be paid, and are therefore not paying or collecting them. We feel this position is not reasonable.

Seventh—and this is the most important thing—YOU MUST KEEP GOOD RECORDS.  If there is anything to be concerned about, we feel this is it.  We will be communicating with all of our clients and friends as soon as our busy tax season is over regarding what policies and procedures we feel you should have to help you through an audit, if it should come.

In the meantime, please feel free to reach out to any of us.

Contacts:

Hank Levy, hank@hanklevycpa.com

Anthony Barr, anthony@hanklevycpa.com

Carrie Sheret, carrie@hanklevycpa.com

Just days before the busy Valentine’s Day shopping weekend, the California Supreme Court announced its decision that vendors cannot ask customers to provide their zip codes in credit card transactions. Pineda v. William-Sonoma, S178241.  Jessica Pineda brought the case after Williams-Sonoma obtained her zip code in a credit card transaction and used it to find her address and send her a catalog.  Ms. Pineda claimed that the retailer’s actions violated the Song-Beverly Credit Card Act of 1971 (Civ. Code, § 1747 et seq.) (the “Credit Card Act” or “Act”) and breach of privacy claims.  The Credit Card Act protects California consumers against use of their personal information by prohibiting its collection in credit card transactions.

The Act provides that:

(a)…no person, firm, partnership, association, or corporation that accepts credit cards for the transaction of business shall do any of the following:

(1) Request, or require as a condition to accepting the credit card as payment in full or in part for goods or services, the cardholder to write any personal identification information upon the credit card transaction form or otherwise.

(2) Request, or require as a condition to accepting the credit card as payment in full or in part for goods or services, the cardholder to provide personal identification information, which the person, firm, partnership, association, or corporation accepting the credit card writes, causes to be written, or otherwise records upon the credit card transaction form or otherwise.

(3) Utilize, in any credit card transaction, a credit card form which contains preprinted spaces specifically designated for filling in any personal identification information of the cardholder.

Cal. Civil Code 1747.08.

The case hinged on whether zip codes were personal information.  The court decided they were personal information and that Williams-Sonoma had violated the Act.  The case was remanded to the Appellate Court for further proceedings consistent with its decision.

What does the Williams-Sonoma decision mean for businesses that use credit card processors, such as Pro Pay, that require zip codes to process credit card transactions?

First, most online and telephone sales orders are excluded under section 1747.08(c) (4) of the Act, which permits the collection of personal information if “personal identification information is required for a special purpose incidental but related to the individual credit card transaction, including, but not limited to, information relating to shipping, delivery, servicing, or installation of the purchased merchandise, or for special orders.”  These exclusion arguably would not extend to the online sale of an ebook or downloadable PDF that did not require delivery, however, a federal district court has concluded that the Act does not apply to internet transactions.  Saulic v. Symantec, 596 F. Supp. 2d 1323 (C.D. Cal. 2009).

The ruling’s application to in-person sales is less clear.  The most helpful exception to the Act’s requirements states that its prohibition on collecting personal information does not apply “When the person, firm, partnership, association, or corporation accepting the credit card is contractually obligated to provide personal identification information in order to complete the credit card transaction…”  Civil Code Sec. 1747.08(c)(3).  A processor’s requirement that vendors collect the information is arguably a contractual requirement, even if not set forth explicitly in the processor’s service agreement.  This position is bolstered by dicta in an earlier appellate court case, Florez v. Linens and Things, Inc., in which the court discussed the effect of a retailer’s request for customers’ phone numbers on all transactions: “a policy of obtaining more information than credit card companies require to complete a transaction creates a conflict with credit card company rules prohibiting a retailer from refusing a sale if a consumer refuses to provide this additional information on a credit card transaction form.”  108 Cal. App. 4th 447 (2003).

What to do?

It seems reasonably certain that collecting zip code information, where required by your credit card processor, falls within the “contractual” exception described above.  However, vendors would be advised to seek out credit card processors that do not require the collection of zip codes or other personal information.  In the interim, avoid writing or asking customers to write down their zip codes.  For example, Pro Pay, which requires zip codes, provides for telephone credit card processing.  A business could use this feature and ask the customer to enter his or her own zip code into the phone.

Also, be sure to keep any collection of email addresses or other mailing list information separate from sales transactions.  Even if customers provide this information voluntarily, requesting it in connection with credit card transactions could run afoul of the Act.

The Supreme Court has said that the following will be considered a security: “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”

So what if someone invests in a venture with the expectation of receiving a beautiful gift basket at the end of one year – could that be considered an “expectation of profits”?

Unfortunately, this issue has not been addressed directly by the courts.  Crowdfunding web sites like IndieGoGo and Kickstarter are based on the assumption that giveaways would not be considered “profit” and therefore subject to securities regulations.

At what point might a reward be valuable enough that it could be seen as a financial return on investment?  Just because it is not paid in cash surely could not be the determining factor – that would be a loophole big enough for a mack truck!

The Supreme Court has already held that the initial investment does not have to be in cash – it could be in the form of goods or services.  Can the decision that profits can be in the form of goods and services be far behind?

Because of this uncertainty, if you are conducting a non-securities funding campaign and providing giveaways to your donors, it is best to structure it so that the primary motivation is not the giveaway but other intangible benefits of supporting a wonderful venture.