Legal Considerations for Running a Business from Home

Legal Considerations for Running a Business from Home

The past decade has seen a steady increase of businesses being run from individual’s homes and the changes brought about by the Covid-19 pandemic have only increased this trend. Whether a “side-hustle” or primary source of income, business owners should carefully consider the legal and tax rules at play before opening their homes for business.

In addition to aspects relevant to all businesses, those operating a business from home must consider: (1) relevant property restrictions, (2) home business tax deductions, and (3) special liability and insurance considerations.

Property Restrictions

Property restrictions should be among the earliest factors analyzed, ideally before expenses are invested into the venture, as municipal zoning or private land restrictions may flatly prohibit the at-home business altogether.

Counties and municipalities enforce zoning restrictions which classify large swaths of land under different rules for use. These zoning programs are intended to organize land use in a planned and practical manner. For example, zoning codes may protect the interests of quiet suburbs by prohibiting the construction of multi-unit apartments or noisy factories in the area. While every local government unit has their own approach to zoning, generally, larger communities have more specific, restrictive, and regularly enforced zoning programs than smaller ones. Depending on your local rules, your home may be in an area which prohibits commercial activity. Whether your planned business falls under the relevant rules can only be determined by checking to see how the local codes define and restrict commercial use. Faced with an adverse zoning designation, you may be able to apply for a variance – a special exception to the zoning rule applied for and reviewed on a case-by-case basis.

Your use of the home may also be subject to private land-use restrictions. Most obviously if you rent your home, your lease may restrict your ability to operate a business from the property. If you have a good relationship with your landlord, they may be willing to amend the lease, as the inclusion of commercial use restrictions in the lease is often the result of a landlord using a form document, not their particular objection to you using the property that way.

Homeowners are not necessarily free from private party restrictions, as many properties are subject to restrictive covenants. These documents are essentially private contracts that were put into place by former owners and whose terms automatically pass on to new owners of the property. Some neighborhoods form Homeowner Associations to enforce these covenants. Others do not, but still allow any property owner, also subject to the covenants, to sue for their enforcement. Make sure to read your restrictive covenants carefully before opening a business. In addition to restrictions on business operations, check the rules for signage restrictions and parking and guest vehicle restrictions if clients will be visiting your home office. If the covenants restrict the type of activity you plan to perform, check to see what process is available for amending them.

Taxes

Assuming no land use restrictions prevent you from operating the business from your home, you will want to ensure you are taking maximum advantage of any available tax saving options. When considered during the onset of a new business, these tax rules may influence how you choose to organize running the business from your home.

Businesses are entitled under the tax code to deduct necessary and ordinary business expenses from their taxes. For example, if a business purchases a couch for their waiting room and hires a cleaning service to maintain it, this will typically be deductible as a business expense. If an individual purchases that same couch for personal use and hires the same cleaning crew to clean their home, this expense is not entitled to deduction. Because of a home business’s inherent melding of business and personal use expenses, the rules for home office deductions are somewhat complex. This article will review in broad strokes how these rules operate, but a qualified tax accountant or attorney can help guide you through the nuance of your particular situation. While no substitute to qualified professional advice, Reviewing IRS Publication 587 may also be a good start to understanding the basic rules at play.

The first step towards taking advantage of these tax benefits is to qualify for the deduction. Generally to qualify, a part of your home must be used exclusively and regularly for business purposes. As an example, using your living room couch as a place to sit when you check email is unlikely to qualify. Special variations of the general rules exist for unattached separate structures, space used for storage of inventory, daycare facilities or property used for rental purposes. Like most areas of law, the qualification tests are deceptively simple, and careful attention must be paid to how the rules define each word in a given test.

Assuming you qualify to take the deduction, the next step is to calculate the amount of the deduction. Here, you have a choice for each year you claim the deduction, either use a calculation for actual expenses or elect to use the simplified method offered by the IRS. Whatever your method of accounting for the deduction, make sure to keep adequate records to support your claims if you are challenged by the IRS. Your records should be maintained as long as the facts they support may still be challenged. For tax purposes, this usually is three years following the date that year’s tax return was filed.

Liability and Insurance

A lawsuit can wipe out years worth of income if proper precautions are not taken by a business owner and running a business from the home introduces unique risks. These risks are compounded if you have business clients or employees of the business meet or work at your home.

Like all business owners, a home business operator should consider forming a Limited Liability Company (LLC), Corporation or other form of limited liability business entity to operate their business out of to shield their personal assets from any suits made against their business.

To the extent possible, anyone entering your home for business purposes should remain in the portion of the property used for the business, as an injury occurring in another part of the home may blur lines between a business contact of your LLC and a house guest to whom you are personally liable for. It may be difficult to argue a personal injury lawsuit should be limited to your LLC when the injury was a result of tripping over a toy left in the living room by your child.

Even with proper limited liability entity planning, the assets of the business inside the entity are still subject to the suit and may be a devasting loss if liquidated to pay a settlement or judgement. Thus, insurance on the business is the first line of defense to maintain your assets, with the limited liability entity planning serving as an emergency flood wall against a disastrous lawsuit wiping out your entire estate. Most homeowner’s carry homeowner’s insurance, but these policies may not cover damages flowing from business use of the property. You should consult with your insurance provider to make sure you are appropriately covered and whether you need a supplemental business insurance policy. In addition to liability coverage, if your business owns expensive equipment or large amounts of inventory stored in your home, consider loss coverage to fund the replacement of those assets in the event of a flood, theft, or fire. Like with liability coverage, homeowner’s coverage for your personal assets will be unlikely to cover the garage full of business inventory that is damaged, destroyed or stolen without additional coverage options. If you have questions, do not hesitate to reach out to one of our business or tax law attorneys.

 

Will You Be My Guarantor?

Will You Be My Guarantor?

One of the questions you may be asked in your lifetime is to be a guarantor. This request may come from a family member or even a friend that needs someone to be a guarantor for a lease, loan, etc. Your first thought may be to agree right away to help that individual but, there are many things you should consider prior to becoming a guarantor.

It is important to understand that as a guarantor you are making yourself financially responsible for the obligations of the individual if they fail to perform. Often the Landlord or Lender requires a personal guarantor to provide an extra level of protection to ensure they are paid what they are owed. This likely means the individual does not meet their rental or loan criteria and is considered high risk. Therefore, the Lender or Landlord is looking to protect their interests by having a more qualified person guarantee to fulfill the financial obligations of the individual in the event they are unable to satisfy the prescribed conditions.

Since you are making the commitment to be financially responsible for the obligations of another, you should consider some of the following items prior to becoming a guarantor. To begin with, you should consider the individual’s financial situation. Are they reliable and dependable? Are they able to handle their own bills? These are questions you will want to consider, because depending on the individual’s financial situation, you may be putting yourself at a greater risk than you are aware of.

In relation to knowing the individual’s financial situation you should also take a second to consider your own financial situation. It is wise to consider whether you would be financially able to fulfill the obligations of the individual in the event they fail to perform. If you would not be able to handle the financial obligations of the individual, then you should not be their guarantor.

Additionally, you should be attentive to the underlying document that you are being asked to guarantee. If you are asked to be a guarantor on a lease, that is typically only a year-long commitment. However, if you are asked to guarantee on a car loan or mortgage, then you could be taking on this extra financial responsibility for seven, fifteen, or even thirty years. It is important to consider the underlying document for the guarantee so that you understand how long you are committing to taking on this additional financial responsibility. Moreover, you should consider how this extra financial responsibility may impact your own debt to income ratio and thus your own ability to get a loan or mortgage in the future.

Another item you should consider is what type of guarantee the Landlord or Lender is expecting you to provide. Is it a limited or unlimited guarantee? If it is limited, then there is usually a set amount that the Landlord or Lender will be able to collect from you as the guarantor. However, if it is an unlimited guarantee then they would be able to recover the entire amount from you as the guarantor. It is very important to understand the type of guarantee that you would be providing before you become a guarantor.

These are just a few items you should consider before becoming a guarantor. In light of the substantial financial responsibility of becoming a guarantor, it is advisable to seek the advice of a business law attorney before executing any type of personal guarantor. An attorney will be able to analyze your situation and the requirements of the personal guarantee, in order to advise you on the risks and best course of action with regards to becoming a personal guarantor.

 

What Does the Indemnification Clause in My Contract Mean?

What Does the Indemnification Clause in My Contract Mean?

Indemnification provisions provide an important tool to parties seeking to allocate the risk of third-party damages and liabilities when contracting. When reviewing a contract, most people understandably first consider things like deadlines, pricing information, and the description of the assets to be transferred or the services to be performed. While these things are of course important, a well drafted contract can do much more. Frequently overlooked as “boiler plate” language, the exact structure and wording of an indemnification clause can become vitally important to protect your interests and limit the impact of creditor claims for actions you had little control over or means to prevent. These clauses should be fully understood and carefully considered before signing an agreement. Some contracts may not use the word “indemnification,” rather phrases like “hold harmless” or agreements to “defend” the other party and are a red flag that something like an indemnification clause may be at play. For such reasons you should always look beyond the heading of a section when interpreting the text at issue.

The assignment of responsibilities for liabilities is often a large part of agreements for commercial transactions. While the parties to a contract have broad discretion to transfer property, obligations and liability between themselves, they are limited in their ability to dictate that third parties – who have not joined into the contract – respect the terms of an agreement they had no say in. This conforms to the broader legal principle that “no one gives what they do not have.” For the same reason you cannot contract to sell something that belongs to another without their consent, you cannot contract to limit the rights of others to make claims they are otherwise entitled to make. Because the allocation of liability for certain causes of action is such an important part of many contractual matters, parties sometimes instead use indemnification provisions to essentially refund, or “indemnify,” the other party if they suffer damages resulting from certain types of issues.

To illustrate this principle, consider the following situation. A business owner rents a storefront from a landlord and agrees in the lease that they can only sue the landlord under certain circumstances. The business owner accepts certain risks or faults with the property they are renting.  For this example, assume the landlord discloses the radiator is not up to code and could cause a burn, so the tenant will take on the responsibility to get it fixed and agrees not to sue the landlord if they get burned by it before it is fixed. On its face, this arrangement seems a valid contractual exchange – the landlord gives up the right to use the property for a set time in exchange for: (1) rent and (2) the tenant’s agreement to limit suit against them from injuries over certain disclosed problems and (3) the agreement by tenant to fix the radiator.

In contrast, the landlord cannot effectively include a provision saying that “none of your customers can sue me if they are injured on the property, because you are responsible for keeping it in good and safe condition.” Despite the landlord shifting responsibility to keep the property in good condition to the tenant, they cannot prohibit third parties from making claims against the landlord if they are injured on the property. If the business owner fails to have the radiator replaced and a customer burns themselves while shopping, the burned customer would be fully within their rights to sue the landlord, despite the landlord’s arrangement with the tenant to fix the issue.

To better protect themselves, the landlord should have included an indemnification provision. Since the parties cannot limit who third parties claim damages from, they instead say “If I am forced to pay a certain type of claim, you agree to pay me back.” Here, the lease could apply indemnification to liabilities arising from the tenant’s negligent maintenance or actions with respect to the rented space, perhaps with specific reference to damages from the radiator if they fail to replace it. If the injured customer sues the landlord, the landlord would pay the claim and then seek to enforce the indemnification provision to recover the costs from their tenant who had agreed to indemnify them under these circumstances.

Far from being the “standard provision” they are often dismissed for, indemnification provisions can vary widely in scope, application and duration. Depending on the bargaining power of the parties, all such points may be negotiated.

The scope of an indemnity governs what circumstances are covered under it. A common scope provision might provide damages fall under the indemnity if they are a result of a breach of the agreement, inaccuracy of any representations or warranties made by the indemnifying party. Before agreeing to indemnify another party, consider what type of actions would fall under the described scope, whether any ambiguities exist regarding the scope of coverage and whether you have any control over preventing or reducing the risk of those types of claims. Ideally, you should not be agreeing to indemnify a party for liability resulting from the actions, errors, or omissions of their own or of a third party you have no control over. Wisconsin law permits broad indemnification clauses, but Wisconsin courts tend to strictly construe them, meaning they will not generally stretch the interpretation of the clause to bring an ambiguous situation under the indemnity. Wisconsin also has special rules for the scope of indemnification in construction contracts.

The application of an indemnity relates to how an indemnity will mechanically be triggered, calculated, and resolved. This includes important provisions on the required notices and timelines associated with various aspects of the indemnification procedure. A party seeking to rely on the clause should carefully comply with these technical requirements as the party obligated to pay under it will likely be looking for ways to get out of it if it is triggered. The provision may also place limits on the amounts required to be paid under the clause, or require certain steps are taken to ensure damages are mitigated or funds are available to comply with the indemnification requirements. The parties may require each other to carry insurance policies designed to cover these costs during the term of the indemnity to ensure it is effective. This is important because an indemnification right against a party with no collectible assets does not offer much protection. In the example used earlier of the landlord and tenant, the landlord’s indemnity will not be useful if the tenant has no assets from which to recover or if all of the assets are separated from the limited liability entity which granted the indemnity and thus very difficult to reach.

The duration of the indemnity governs how long the agreement to provide indemnity lasts. Contracts for purchase and sale transactions often have the bulk of the agreement terms end following the transfer of goods and payment, but indemnification provisions are often among the terms separated out and assigned a longer period of “survival.” These terms usually are tied to the statute of limitations for the claims they are being applied against but may still vary.

If you have questions on how an indemnification clause in a contract you are considering will operate, you should speak to a business law attorney to help you review, understand and potentially negotiate alterations to the agreement.

 

Completing LLC Organization Through Agreements

Completing LLC Organization Through Agreements

You have made the decision to start your own small business. That is great news! But what steps should you take now to properly organize your limited liability company?

In Wisconsin, the first step of limited liability company formation is to decide on a name and file Articles of Organization with the Wisconsin Department of Financial Institutions. The articles establish your business with the State of Wisconsin and specify whether your business is managed by members or managers, who will serve as your registered agent, and the principal location of your business.

Many individuals file articles online, but do not complete the other steps to best protect their business and to take full advantage of the limited liability protection provided for by a limited liability company.

The next step is to develop and execute an Operating Agreement for your limited liability company. An Operating Agreement guides how your new business will function. You will draft your Operating Agreement to determine voting rights and duties of members, management terms of members or managers, member ownership interest, and meeting requirements. The Operating Agreement, when fully executed, protects the members from personal liability for actions of the limited liability company. This point is important because without the executed Operating Agreement, the members will likely be subject to personal liability as they would be if they operated with a sole proprietorship or partnership. Resolutions by the organizers, members, and/or managers adopting the Operating Agreement and member lists should be executed at the same time.

The final step to develop your new limited liability company is to determine whether to draft a Buy-Sell Agreement. This agreement is very important to limit conflict when a limited liability company has multiple owners. The terms of this agreement determine the process for transferring business ownership and anticipates various scenarios which will likely lead to conflict. Such scenarios include the determination of the fair market value of the business and a selling member’s interest, what happens to the shares of a member in the event of death or divorce, how shares are transferred when a member retires, and who has the option to purchase ownership in the limited liability company.

The business attorneys at Anderson O’Brien are happy to provide you with personalized guidance on the topics covered in this post, as well as decisions regarding the nuances of the tax elections, management decisions, proper record-keeping, and other steps to formalize your new limited liability company.

 

TIF – A Development Tool for New and Expanding Businesses

TIF – A Development Tool for New and Expanding Businesses

My litigation practice has taken me into many areas of law in my career, including handling matters for both municipal and business clients that involve tax incremental financing (TIF.) Despite these turbulent economic times, new and existing businesses as well as municipalities are still searching for ways to move forward. TIF may be one very useful tool for a successful public-private partnership.

TIF is a mechanism for financing development from taxes that are generated from a tax incremental district (TID.)  TIDs, governed by state law, have been in existence for decades. In simple terms, a TID is a geographic area that is created to advance development within the district for a limited time. The tax revenue generated on property within the TID at the time of creation will continue to be shared with overlying tax entities. However, tax revenue generated from new development within the TID will be retained entirely by the TID to finance further development during its life.

Financing can come in many forms. Cash grants to new and expanding businesses to incentivize development may be one such form. Pay-as-you-go incentives, which involve developers retaining tax revenue generated by their own specific development, may be another form. Hybrid arrangements of these two financing tools are another potential.

For new businesses especially, TIF can serve as added security for a lender. Moreover, TIF may often work in combination with private financing, other state incentives and gap financing to make a new business venture a reality and a win-win for business and local taxpayers in the long run.

However, a win-win situation starts with understanding the options available, the typical municipal processes to go through and ultimately structuring a strong development agreement.  Poorly drafted development agreements can lead to litigation from both sides.  Securing TIF advice from municipal counsel early in the process can pay dividends and avoid problems on either side down the line.

 

The First Ruling on Issue Finds No Insurance Coverage for Business Interruption Due to COVID-19

The First Ruling on Issue Finds No Insurance Coverage for Business Interruption Due to COVID-19

This article is a follow-up to my article of May 4, 2020, which addressed litigation and claims involving business losses as a result of COVID-19. Hundreds of lawsuits have been filed throughout the country by business owners who have been forced to close their doors or restrict their operations due to mandated governmental orders and closures due to the spread of the COVID-19 virus.

On July 2, 2020, the first court to make a substantive ruling on these insurance coverage issues held in favor of the insurance company and denied coverage under the business owner’s insurance policy under the “business interruption” coverage provision. In Gavrilides Management Company, et al. v. Michigan Insurance Company, the owner of the Soup Spoon Café and The Bistro in Lansing, Michigan filed a $650,000.00 claim with its insurance company for damages it incurred as a result of the government mandated closure of the inside dining in its restaurants due to COVID-19.

The restaurant owner argued that the government order restricted the operations of the restaurant and this amounted to a “direct physical loss” under the terms of the policy because the order blocked public entry to the property. The restaurant owner also argued that the “virus exclusion” in the policy did not apply because the loss of access was caused by the government order, not the virus. The Michigan court rejected both arguments and held that there has to be something that physically alters the integrity of the property and there has to be some tangible, physical damage to the property in order for it to be a “direct physical loss” which could provide coverage. The court further held that the virus exclusion in the policy excluded coverage caused by the impact of COVID-19.

While this case is not binding precedent on Wisconsin courts, because it is the first court to address the substantive provisions of business interruption insurance coverage in light of the COVID-19 virus, this case will likely be cited by insurance companies in all of the other pending cases throughout the country. Only time will tell if other jurisdictions will follow the reasoning of the Michigan court, or if it will take an alternative approach. It should be noted that each insurance policy must be evaluated based upon its particular language that is in effect, as well as the particular facts of the business owner’s circumstances. Therefore, simply because one court ruled in favor of the insurance company does not mean that this will be the same result in every other claim brought by a business owner who suffered losses as a result of the mandated government closures during the COVID-19 pandemic.

 

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