What is Estate Planning?

Private Attorney General Act (PAGA) Liability; Still Absurd But Be Prepared 

Adam Chodos, Esq., CPA

California is no stranger to unusual laws, seemingly embracing doing things differently for the sake of being different.  The desire to be “progressive” falls flat and has led California to be the most overturned jurisdiction in the country and confusion of what their laws mean and how they will be enforced.  In keeping with this trend, California’s controversial Private Attorney General Act (PAGA) has gained some momentum lately that should have those operating in California taking notice.

What is PAGA?

The genesis of PAGA comes from a shortage of staff at the Labor and Workforce Development Agency, tasked with enforcing labor laws and labor violations.  Without adequate staff, PAGA empowers employees to bring a class action suit of sorts acting as a “private attorney general” to enforce labor laws and violations since the state cannot do so effectively.

PAGA claims are not the same as class action claims.  A class action is a group of similarly affected victims banding together to mount a lawsuit for efficiency in costs, discovery and resolution.  A PAGA claim is in a representative capacity, where the plaintiff is making a claim on behalf of himself/herself which represents other similarly situated employees but avoids the complicated requirements to be certified as a class action.

PAGA has been in effect for almost twenty years, and more than ten thousand cases have been filed under it.  It is not new but has developed some odd twists recently that make it relevant again.  In the last eighteen months there have been several key cases involving PAGA that have made it a Gordian Knot.  The US Supreme Court reviewed the Viking River Cruises, Inc. case and concluded agreements to arbitrate PAGA claims on an individual basis are enforceable despite the state law.  However, state courts are not bound by federal decisions and the California Supreme Court in Adolph ruled a PAGA claim can go to court despite an arbitration agreement.  This has now created a likely two step process where the court action has to be stayed (paused) while the arbitration is ongoing.  To make matters more confusing, there are disagreements among the California courts.  The appeals court in Wesson ruled courts can strike or limit PAGA claims as part of case management but the Estrada court said managing a case relates to evidence limitations not striking cases.  Even “clarifying” cases (cases meant to resolve splits and inconsistencies in case rulings) failed to clarify; the Saucillo case said any employees not part of a case cannot intervene and become part of a case but the Porras court ruled a few months later that an employee not part of the case could join an ongoing case in some circumstances.

For better or for worse, this law has opened broad doors and has given employees a large sword to wield in debates with employers.  The law is used on a regular basis, but it is presently disorganized leaving employers unsure of what and how PAGA can impact their business.

Liability Exposure.

The labor laws and regulations have not changed, but those seeking to enforce it now work for your company.  Rather than occasional reviews and audits that can be prepared for, companies are concerned the very people they pay every week are the same ones who can look for labor violations and use the same as leverage.

As expected, with every new law we get good and bad.  California has had a flourish of new labor complaints and has suggested this had led to a reduction of underground employers who were not providing the minimum requirements to employees.  It has also led to enterprising employees using the threat of a PAGA claim to get more; whether a better severance package, a raise, a pass on a mistake, etc.

The liability itself has not changed but the landscape it how it is enforced has.  Employers operating in California must be more alert to the risk.

Solutions.

Entities.  Most employers are structured as an entity already, whether a corporation, limited liability company, limited partnership, etc.   The purpose of an entity is to create a distinction between the owner and the business to limit personal liability.  Entities act as a barrier but should not be considered ironclad.  A common misconception is that entities cannot be sued.  While creditors of an owner cannot enforce their judgment against an entity, the entity itself can be sued by its creditors, including employees.  For example, if a business owner has a car accident and is personally sued, the creditor can sue for assets he owns personally but will have great difficulty attaching to his business LLC ownership.  Creditors of an owner are prohibited from accessing the entity.  However, if the business LLC was sued by its employee for a labor violation, the LLC’s assets are at risk.

To amplify entity ownership, we can “strip” assets out of the entity to limit cross-liability. Limiting cross-liability is an important factor in enhancing protection and accomplished by segregating assets.  The business may own a variety of assets and a claim against the business can threaten all its assets.  In lieu of the business owning all, we create a network of related entities. For example, maintaining the operational company as is, but inventory owned by Inventory LLC with a fulfillment contract with Business LLC.  The trademarks, patents and other intellectual property would be spun off into IP LLC and licensed to Business LLC.  With assets decentralized, a lawsuit against Business LLC would be challenging as the business entity has no substantive assets.  Aggressive creditors may try to attack the business’ revenue, however there are priority creditors first in line – the related entities. 

Sometimes asset segregation is less practical.  For instance, a valuable license must be owned by the business.  In those cases, we engineer a loan to reduce available equity.  When performing case economic analysis, the first questions a litigator asks are (i) can we reach the asset and (ii) is there is enough equity to justify the effort.  For example, a business has a license (e.g., insurance license, taxi medallions, FAA certificate) worth $10M.  We have a separate investment/cash LLC make a $9.5M loan against the business, pledging the license as collateral.  Now the available equity is minor.  While a creditor could claim a related party loan is suspect, if done properly (promissory note, pledge agreement, etc.) the argument falls flat.  In most cases, claims against an unattractive asset aren’t filed as the economic incentive has been reduced.

            Employee Agreements.  Sharp employment agreements are a must for any employer and doubly so for any employers with California employees.  There are multiple other toggles that can help; it is not enough to merely state that all claims must be arbitrated, so as to slow down any PAGA cases and increase effort and cost for the employee.

            Employment contracts should clearly spell out not just hot topics, like salary and job title, but the areas most commonly disputed.  Clear communication can go a long way to discouraging or eliminating liability upfront.  Many times, employees have an idea of what “should be” and confuse that for what is.  For example, an employee may believe the job title has him report to B, his immediate supervisor.  Thus when A follows up with him, employee is resistant.  Even though A may be B’s superior, employee was unaware and unprepared.  Some of the core aspects of an employment agreement include the following: (i) how disagreements are handled, which can be as simple as referred to HR, (ii) what is expected of the employee, who they report to, and that this may change over time (iii) employment is “at will” meaning they can be fired anytime for any reason, (iv) who they can report problems to, (v) refer them to company policies (handbooks, vacation, overtime, etc.) for clarity, (vi) that any intellectual property is for hire and belongs to the company, (vii) arbitration for disputes, (viii) non-raid, non-compete, non-disparage, (ix) confidentiality, and (xi) they have no conflicting obligations.

            Employee Selection.  Before we rely too heavily on the employment contract, we need to rely on common sense.  The aim is to hire the employees who best fit the company culture and are the least likely to be a problem.  Sometimes that is aspirational.  There are times when we merely select the best of the available applicants rather than the best person for the job.  Care to avoid a problematic person is a key skill HR needs to exercise.

Conclusion

California is a very large market, and despite an undulant legal landscape, many employers will have California business and have exposure to its unique liabilities.  Intelligent vetting of employees followed by a strong employment agreement and clear guidelines of the relationship is the right start.  A well thought out business entity structure can limit what a creditor can reach, thereby reducing the chances a claim will even be filed.  

Adam Chodos, Esq., CPA

The “shirtsleeves to shirtsleeves” phenomenon is an age old trend in which the vast majority of family wealth is dissipated by the third generation.  This result is usually rooted in lack of preparation.   

Transferring wealth to others is relatively easy; we have many legal tools.  However, transferring the skills to manage, maintain, and grow family wealth is dramatically more difficult.  Wealth education involves proactive planning and teaching the younger generations core financial skills so they may be capable stewards of a family legacy.   The key risk areas to consider:

            Taxes.  Advance structuring to reduce ongoing taxes (i.e. income and capital gains) and special event taxes (i.e. estate, gift). 

            Overconcentration.  No single asset class is suitable to be the bulk of any family’s investments and measures to diversify and mitigate risk.  

            Overly-Broad Management.  Too many family members in decision-making is unwieldy and strains relationships.  An efficient and manageable board of decision makers is the usual path.

            Poor Investing.   Many inheritants are ill prepared to manage significant assets and the intricacies of larger and more sophisticated assets.  The family needs to develop a clear investment plan, goals, risk tolerance, and vision along with management hierarchy and accountability.  

Professional Coordination.  The younger generation needs to its professional team, not just in choosing those familiar with wealth issues, but also in coordinating efforts.  

            Lack of Preparedness.  Many details and daily tasks are handled by others leaving an experiential gap that school and other resources cannot fill. Few people are ready for a leadership role when it is thrust upon them without relevant experience.  On the job learning, especially when stakes are high, can have serious wealth consequences, thus some grooming and practice make success much more likely. 

Wealth education is less of a mini-MBA and more of a broad overview.  Primary goals include understanding what comprises the family wealth, family ideals and goals, and developing a working understanding of core financial concepts.  Core concepts often include (a) limits of family resources, development and management of income and growth, (b) consequences of financial decisions, budgeting and spending, (c) use of reserves and contingencies in planning next steps and how those steps impact other plans and family members, (d) borrowing, (e) investing and asset allocation, (f) risk profiling and mitigation, (g) understanding asset and liabilities and performance; and (h) how to use financial information and professionals effectively.

Preparation.  Expose children early and often to wealth issues so the foundation is in place and all else they learn has context.  A major distinction that takes time to internalize is that wealth is not limited to money but a variety of factors comprising a whole.  

Management.  Management exclusively by family members loses the vital neutral outside view.  Most company boards have members from outside the company, and outside the company product field, specifically to engage a broader and less emotional viewpoint.   

Expect More.  Being part of the family business or management team should come with an expectation of success.  If we expect very little we often get just that.  The bar should be set high to create a healthy climate to succeed and grow.  Not that failure is frowned upon, but rather it is part of the road to better things. 

Wealth education is a continuing process and works best when designed to fit the individual participants.  A variety of tools are available; family mission statement, family meetings, hands-on management roles, and individual coaching.  Business and entrepreneurship can be an excellent platform to teach children business lessons, as it is learning by doing.    Wealth education is also a balancing act, to encourage wealth creators and holders to consciously prepare the next generation for their eventual role as contributors to the family legacy as active, eager participants.  From understanding the problem and raising awareness of the preparation gaps to improving communication, articulating expectations, and understanding risk.   With this business base and experience, children will be empowered to succeed, preserving family legacy through the transition of wealth to the next generation. 

Adam Chodos, Esq., CPA

Confidentiality is a key issue for businesses, families, and many individuals.  Its importance has increased as digitization has made information much more accessible and created new classes of data.  Not all information is national security level confidential, but many times even moderately confidential information, in the proper context, can be severely damaging if it becomes generally known.

More common instances of confidential information include personal data, finances, and business details. Data is arguable the most valuable and sought after asset today.  Companies pay, and make, millions from data analysis to target sales, outmaneuver a competitor, and predict behaviors.   Confidential data is used to compete, sell and profit.  We are protective of our data and confidences, but with ever changing technology and data seeking, how do we protect our confidentiality?

The core issue is so much of our lives is visible through copious amounts of recording whether by digital footprint, photos, videos, or computers.  We are watched in most places – video cameras at intersections, recording at airports, restaurants and malls, being tagged in social media posted photos, even visiting a friend’s house on their Ring doorbell.  We have gotten so accustomed to being recorded and tracked that it is easy to not notice it any longer.

Common Steps.

In general, if we go out in public we have to tolerate recordings in many circumstances.  But there are some common steps people take to provide some level of privacy but they each have flaws.

In business, and some sensitive personal matters, we use non-disclosure agreements.  These are legal contracts in which the person receiving the information agrees to keep it private.  The theory is nice, but it is generally impractical.  Most of the violations of an NDA are very hard to track.  When did the information get out?  Who knows?  The discloser now becomes a private investigator.  Even if we can locate the revealer, how can we take back knowledge and information?  A lawsuit may be able to get a money claim, after enough time and legal expense, but one cannot recover reputation or timing.

Online many use a VPN or cloaking software to make web surfing more private at home, on the phone and at the office.  Useful but not impenetrable.  Many VPNs survive by ad revenue and thus share data with their advertisers.  This includes web tracking to better target ads.  VPNs are not immune to malware.  We have kept some eyes off the data but shared it with a different set of eyes.

Limiting who gets access to confidential information is another common tool, and subject to similar pitfalls.  We have fewer suspects but that hasn’t significantly reduced risk, it has just narrowed the field some.

Solutions.

There is no magic technique that resolves all confidentiality issues or makes anyone “ironclad”, but rather there are different tools available that when used in concert can make confidential information more secure.  

Know the Receiver.  Simple but often underutilized.  More than just discussing that only those who need to know get access, there can be tracking to confirm who has access, what they were viewing, and when they used that access.

Limits.  Applying limits to the confidential information when possible.  For instance, physical limits such as the item may not leave the room it is stored in, no phones or other devices permitted in the room.  There can be access limits as well, such as may inspect but may not disassemble.  Digital limits can apply, such as dual authenticated login, and no print and no forward privileges.

NDAs.  Above we discussed that NDAs are imperfect, but that doesn’t mean they do not have some utility.  NDAs do help formalize that the information is confidential.  Well drafted NDAs can also add faster solutions, such as arbitration, to resolve a claim and specified damages for each infraction to discourage a breach.

Dataroom.  A dataroom used to be a physical room filled with documents for review by a potential buyer of a business.  Datarooms are now mostly digital and hosted on convenient web platforms.  More recently they have been applied to host broader ranges of confidential information for day to day use.  The platforms allow one to see who had access, when, and what they viewed, for how long, along with multiple other metrics.  You can control viewing, forwarding, and printing authorities.  Control over data has become much easier in this context.

Passwords.  We all live with many, many passwords in our lives ranging from banks, credit cards, utilities, social apps, and just about everything else in between.  With so many passwords to keep track of, most develop a password style.  Easier to remember but also easier to access multiple accounts once the style has been discovered.  Password managers have become a better solution in that an encrypted software application stores and manages passwords and online credentials which is accessed by a master password.  Some use a physical key file, some biometrics, and others online. 

Ongoing updates.  Confidentiality is not a one time endeavor and does require periodic updates to procedures and review for potential holes.  We also need to plan for backup access if the key person/people are incapacitated, dead, or unavailable.

Quality Recordkeeping.  One of the simplest, but most effective techniques, is maintaining strong records.  All confidential information is labelled and cross referenced.  By way of example, when developing intellectual property, we tracked who was working on the file, dates, times, where it was stored, etc. Each iteration was clearly labelled and referenced to the master tracking sheets.  If there is a break in the confidentiality the records help pinpoint when and by whom.

Analog.  Digital is the method to store most items but going old school hard copy is sometimes easier to protect.  A physical copy is not subject to hacking and requires on site access, which is more easily understood and controlled.  

Looking at specific circumstances and locales, some suggestions to keep in mind:

Home:  Any confidential information to be secured.  Hard items (i.e. jewelry, collectibles, vehicles) typically have security measures, such as geo-trackers, biometric or pin pad access to the room where they are stored, keys/codes issued to limited number of people, alarm systems.  Periodic rotation of codes/passwords is helpful.

Any digital information (i.e. computer access, home systems access, bill payment) secured with a strong password, dual authentication, and limited number of tracked users.  

Anyone with access to the home (guests, vendors, staff, contractors) are background checked and cleared before access is granted.  Crosschecks performed by at least one other person (property manager or the like) and detailed records of who was at the property and for what person, including times and locations.

General monitoring is applied in the form of cameras with local or cloud recording for possible review later to confirm any incidents.

Employees background checked, references verified, and clear written outline of job functions.  Each would sign an NDA and unique access codes/swipe cards.  Access to anything sensitive only by longer tenured employees with an established track record.

Office: 

Hard items (i.e. servers, physical files, some inventory) typically have security measures, such as geo-trackers, biometric or pin pad access to the storage area, keys/codes issued to limited number of people, alarm system.  Periodic rotation of codes/passwords is helpful.

Any digital information (i.e. computer access, systems access, payroll/bank access) secured with a strong password, dual authentication, and limited number of tracked users.  Often dual signature access for most users.

Key areas, such as customer contracts, intellectual property, merger and acquisition information, access is limited.  Not all participants receive full access to all facets.  Each would sign an NDA which also contains agreement to security protocols and procedures.  Crosschecks performed by at least one other person (department manager or the like) and detailed records of who was at the office and for what person, including times and locations.

General monitoring is applied in the form of cameras, particularly an inventory storage and server room, with local and cloud recording.  Company email monitored and reviewed.

Employees background checked, references verified, and clear written outline of job functions.  Each would sign an NDA and issued unique access codes/swipe cards.

Children/Family:  Children are unwittingly the cause of many security breaches as their perception of confidentiality and consequences are skewed.  They have been known to allow friends to access restricted areas, display items and inadvertently demonstrate access.  Some have been plied by a potential romantic interest to show off something of value (e.g. collectible, car, jewelry, aircraft) and compromise confidentiality in the process only to be confused later when a breach occurs.  Like manners when they were small, constant reminders of expected behavior is helpful to entrench proper protocols.

Conclusion

Maintaining confidentiality is a balancing act of risk and manageability.  Developing a program, reviewing the program periodically, and troubleshooting on a regular basis can go a very long way in helping a successful family feel, and be, more secure with confidential information.

About the Author:

Adam Chodos, Esq., CPA, is the managing member of Chodos & Associates, LLC, a boutique private client law firm, with offices in Boca Raton, FL and Greenwich, CT, focusing on wealth consulting, asset protection, wealth preservation, business succession, and advanced estate planning.  Previously, Mr. Chodos practiced law at the New York headquarters of Sidley Austin Brown & Wood and with Ernst & Young, LLP as a certified public accountant.  He holds a B.A. in economics, summa cum laude, from the University of Pennsylvania and a J.D., high honors, from Duke University.  Mr. Chodos is a member of the New York, Connecticut, and Florida Bars.  mail@adamchodos.com

Please note that the information contained in this article is for informational purposes only and should not be construed as legal advice on any subject matter and does not create an attorney-client relationship. No reader should act, or refrain from acting, on the basis of any content without seeking appropriate legal or other professional advice based on their particular circumstances. As laws and rules change frequently, this article contains general information and may not reflect the most current legal developments. The author expressly disclaims all liability in respect to actions taken or not taken based on any or all the contents of this article.

© 2022 Chodos & Associates, LLC, all rights reserved.  This article, and any excerpts thereof, may not be reproduced in any fashion without the prior express written consent of the author. Unauthorized use prohibited.

Adam Chodos, Esq. CPA

Millions reside in high tax states because of traditional advantages; higher earning potential, quality employees and service providers, major airports, culture, great schools, and strong real estate markets.  That has shifted dramatically in the last few years, accelerated by the recent tax trends.  More high net worth people, and their businesses, are relocating to low/no tax states as the effective cost of high tax states has escalated, tipping the scales.

Tax loads have risen with high tax states taxing even deeper into their remaining resident base.  This is exacerbated by the fact that state and local taxes are not fully deductible anymore; currently capped at $10k.  The deduction limit raises the true cost of living in a high tax state.  For example, a family in Greenwich, Connecticut with taxable income of $1M (state tax liability of $70k) and real estate taxes of $45k.  When fully deductible the true cost was $69k.  With only $10k deductible, the true cost rises to $110k.  

While most would like lower taxes, there is a practical limit to how far one will go.  There are tax incentive plans for U.S. territories (U.S.V.I and Puerto Rico) promising major tax savings if you relocate, hire locals, and invest locally.  Some tax averse families have gone as far as expatriating, voluntarily giving up U.S. citizenship, to move to a low/no tax nation. But these programs are extreme as it requires a dramatic life shift.  For a business, many of the current employees would not be willing to change to a new territory or country.  Obtaining high quality business support is a challenge in these regions (lower quality employees, less reliable infrastructure, less reliable government).  The recent natural disaster in Puerto Rico was a stark example of how lesser developed regions are ill-prepared to cope and have fewer resources.  While it may seem alluring to move to a Caribbean island, few active businesspeople can tolerate the slow pace for long. 

The simplest option became the plan for most – move from a high tax state (New York, New Jersey, Connecticut, Illinois, California, Massachusetts, Oregon) to a low/no tax state (Florida, Texas, Nevada, South Dakota, Wyoming).  The most popular destinations are Florida, Texas, Nevada and Arizona (not the lowest tax state but much less than the high tax states).  Some of the low/no tax states have not received much attention as the sophistication and business needs are not present (South Dakota, Wyoming).  The advantages of the high tax states have been lost over the years as many of the destination states (Florida and Texas in particular) have caught up in terms of refinement, good schools, quality employees and service providers, favorable homestead laws, international airports, restaurants, arts and cultural centers, and much better climates. 

Years ago, Texas and Florida were considered retirement locations and perhaps nursing home havens.  Over the past decade, they have become fully developed destinations with no state income tax.  Rather than coming for the sun, people come for the tax relief.  The sun doesn’t hurt though.

Adam Chodos Esq.

(c) Chodos & Associates, LLC

Adam Chodos Esq., CPA

After a lifetime of asset accumulation, death taxes can be a rude reality for families.  Currently federal death taxes are 40%.  Several states impose their own death taxes for an additional 3% to 12%.  The federal death tax does not apply until assets exceed $12.06 million, however, the Biden administration has made clear they wish to reduce the exemption to a lower level; likely in the $4m dollar range.

            The general objectives of estate planning are to minimize estate taxes, limit exposure to creditor claims, position our assets in the control of those best suited to manage them, and to protect loved ones by prearranging asset management for their benefit.  For well informed families, there are a wide variety of strategies available to achieve these objectives. 

Lack of preparation can have a heavy cost to the remaining family, including the forced sale of assets, loss of control of the family business, and shrinkage of income producing assets. An estate has just nine months to pay the estate tax bill.  During this transitory time vital decisions must be made as to how to create liquidity for tax payment, business continuity, and generally redistribute and manage assets.

A well structured plan usually employs tools such entitization (owning assets in LLCs, LPs, trusts) to achieve estate tax discounts, gifting programs, and opportunity shifting (lending funds to finance an opportunity likely to appreciate so growth occurs in younger generations hands). 

For the taxes that must be paid, the cost of paying estate taxes with the owner’s funds is the least efficient path.  Even if liquid assets are set aside for estate taxes, the earmarked fund is itself taxable bringing the trust cost much higher (close to double with combined estate tax rates at 50%).  The fund would also be income taxable, subject to creditor’s claims, and it is not practical to maintain such a high level of liquidity.

Since death triggers the tax obligation, we don’t truly need estate tax funding until the second death (the later death of the husband or wife). Survivorship life insurance policies insure both husband and wife, creating liquidity by paying out proceeds at the second death which coincides with when estate taxes are due.  Survivorship policies cost approximately half that of insuring each spouse individually, and if owned properly, the proceeds are free of income tax, estate tax, creditor claims, and probate. The cumulative premium invested in a survivor life policy for a healthy 60 year old married couple is approximately 10% of the death benefit produced (the cost is lower for a younger couple and higher for an older couple). 

Policy ownership is an important consideration; if the policy is owned individually or in a trust that was poorly designed, that can expose the proceeds to estate taxes.  Entities can offer control and flexibility while being tax efficient.

            The estate planning team uses available techniques and tools to reduce a family’s estate taxes to the lowest practical level given the family’s comfort.  For the estate taxes that remain, life insurance can act as an effective tool to assure family control over assets and deeply discount estate taxes.  If discounts are available through structured planning why would anyone pay full price?

Adam Chodos, Esq., CPA

(c) 2022 Chodos & Associates, LLC