After all, where was Uncle Sam while you were fixing a tenant’s toilet at 10:00 pm?  Where was Governor Cuomo when your office tenant snuck out in the middle of the night, leaving an unpaid rent bill and a suite full of chaos and damage?  And where was Mayor Bloomberg when you spent 4 hours in tenant’s court  explaining to the judge that the “no pets” provision in your lease includes poisonous snakes and alligators? So when you sell, why should government get a piece of your building when they didn’t share your risk, your hard work and your aggravation?

Good news:  Congress has provided some help for commercial property owners. Using a popular provision in the tax code, many real estate investors have been able to keep the cold hand of government out of their pockets, at least temporarily. Internal Revenue Code Section 1031 allows investors to “defer” their capital gain tax by rolling  their sales proceeds into other real estate. There are some important nuances:

1.  Must Be Investment Property. By its terms, Section 1031 only applies to the exchange of property held for “productive use in a trade or business or for investment.” If the properties are rental houses, great!  If the property is a warehouse used to store business inventory, perfect! If the property is your primary residence, it doesn’t work–no section 1031 soup for you.  See our previous post on Section 121 and count your blessings. And remember, both the property you are selling and  the property you are acquiring must be investment property.

Image via Wikipedia

2.  The Properties Must Be “Like Kind”.  When we’re dealing with real estate, this second requirement is fairly easy to meet. Real estate is generally considered “like kind” to other real estate. It doesn’t matter that you are selling a factory and you want to purchase a condo for rental.  As long as both properties meet the test in point number one above, you’re good to go. But if you want to sell an office building and buy the AC Shelby Cobra pictured to the right, you’ll forever have my envy, but you won’t have a valid exchange. In order to take advantage of Section1031, you must exchange your real estate for other real estate.  Exchanges of automobiles and other personal property are much more restrictive and are outside the scope of this article.

3. You Can’t Touch The Money. For a valid 1031 exchange, the taxpayer must receive property in exchange for other property.  Any cash the taxpayer actually or constructively receives from the sale will be subject to taxation, even if taxpayer subsequently purchases another property. To avoid receiving the funds, you generally need to employ the services of a “Qualified Intermediary” (“QI”) for your exchange.  The QI essentially serves as a middle man through which the sales proceeds flow from the closing of the property being sold to the closing of the property being acquired. The QI keeps the money out of the taxpayer’s control. The most important point of this article: if you plan to do a 1031 Exchange DO NOT close on either property until you have employed a Qualified Intermediary AND signed their agreements!

4. There are Deadlines.  The Treasury Department and the IRS are impatient–you don’t get a particularly long time to complete your exchange. Within 45 days of the closing of the sale, you must identify in writing the property or properties you plan to acquire. You can identify up to 3 potential properties regardless of their value.  If you identify more than 3, additional rules  limit the total value of all the properties you may identify.

If that isn’t convoluted enough, you must close on any of the properties you identified within 180 days  from the closing of the property you initially sold. Both the 45 and 180 day deadlines are hard and fast. With the exception of certain federally declared disasters that affect the region where either the taxpayer or one of the properties are located, extensions of these time-periods are not granted.

5. Talk to Your Accountant.  It is essential that you consult with your accountant before you sell your property to see if a 1031 exchange makes sense for your situation.  A good CPA will help you figure out exactly how much you need to spend to fully defer the capital gain taxes and how much tax you will pay if you do not spend enough.  To fully defer your gain, you must acquire property that is at least as expensive as the property you sold (less certain closing costs), and spend all of the proceeds from the sale.  Just spending your profit is not sufficient. While a good Qualified Intermediary can give you some guidance, ultimately you and your accountant must be on the same page with regard to these calculations.

So now you know enough to be dangerous. The purpose of this article is only to give the basics. Issues like dealing with related parties, ownership by partnerships, limited liability companies and corporations, seller financing, different types of property interests, holding periods and other issues can create problems and cause unintended tax consequences.

No website or blog post is a substitute for professional guidance.  Do your homework, consult with your advisors, and you just may be able to keep your profits working for you in a new more lucrative property.

In our next post, will wrap up our discussion on capital gain tax by discussing how the primary residence exclusion in IRC Section 121 can work with the tax deferral provisions of IRC Section 1031, potentially giving additional relief to a homeowner who is fortunate enough to have gain in excess of the primary residence exclusion.

Comments are welcome and please subscribe to receive this blog to your email or RSS feed by clicking the links at the top of this post.

Related articles

• Hellwig: The Holding Intent Requirement in § 1031 Exchanges (taxprof.typepad.com)

In our last post, we detailed the several bites that government takes out of the capital gain apple upon the sale of real estate. With combined tax rates approaching 1/3 or more of the total gain,  property owners can’t be blamed for having second thoughts about selling their properties.

The good news is that current tax law offers some relief. In certain circumstances, a taxpayer may be able sell their primary residence and exclude all or part of the capital gain from taxes.  Additionally commercial property owners may be able to defer the capital gain from the sale of their asset if they acquire other “like-kind” property with the sales proceeds. 

We’ll begin by discussing the rules that apply to the sale of a primary residence, and then discuss the relief available to commercial property owners in our next post:

Primary Residence Exclusion

Internal Revenue Code (IRC) Section 121 relates to the sale of a primary residence.  It permits a married couple filing jointly to exclude up to $500,000 of capital gain from the sale and a single person to exclude up to $250,000 of capital gain, provided the house being sold was their principal residence for two of  five years preceding the sale. For a married couple, this must be true for each spouse, though only one spouse needs to be on title to the property.

Additionally, the exclusion can only be taken once every two years, so you can’t play games by shifting your primary residence in the middle of the five years and then selling multiple properties at the same time.

In determining whether a home is the principal residence of the owner, the IRS will look at the owner’s place of employment, the amount of time they have used the property, where other family members live, the location of the owner’s bank, religious organizations and recreational clubs, as well as the address used for the owner’s tax return, driver’s license, car and voter registration, bills and correspondence. 

A residence can include a houseboat, house trailer, and a cooperative apartment.

IRC 121 was enacted in 1997 and replaced IRC 1034, which permitted homeowners to roll-over their gain by buying a new primary residence within two years after their sale, and gave taxpayers age 55 and over a once in a life time exclusion of $125,000 of gain, provided the dwelling was their primary residence for three out of five years prior to the sale.  So even if the provisions of IRC 1034 would be more beneficial to the homeowner, they no longer apply and can not be claimed.

Homeowners who have not lived in their residence for two years may be able to claim a partial exclusion in certain situations.  Section 121(c) was clarified in 2002 under Treasury Decision 9030, permitting a homeowner to claim a partial exclusion when the primary reason for the sale is related to:

1. Health — a physician recommends a change in residence for health conditions affecting the owner or a family member;

2. Employment — if the owner’s new place of employment is at least 50 miles farther from the old home than the old place of employment;

3. Unforeseen Circumstances affecting the homeowner or a member of their household,  including  death, divorce, unemployment, certain negative changes in employment, multiple births from the same pregnancy, certain damage to the residence, and condemnation or other taking of the property.

Any gain in excess of the applicable exclusion will be taxed at the various rates discussed in our previous post. However, as we’ll discuss in a later post, it may be possible to take advantage of both the primary residence exclusion and the 1031 exchange in the same transaction, thereby avoiding paying any tax at the present time.

But first, we will discuss Section 1031 in general in our next post.

But that is not what this post is about. Instead, I’m referring to “taxing” in the literal, Sheriff of Nottingham, sense of the word. When you sell a piece of real estate, Uncle Sam will be checking to see if he is entitled to a piece of the pie. So too will state government, and possibly city government as well! And you may owes taxes even if your property is underwater and is being foreclosed upon or being sold in a short-sale.

Tax Rates

Profits from the sale of real estate are referred to as “capital gain” and face as many as four different levels of taxation. Under the Bush tax cuts that were extended by Congress at the end of 2010, the Federal long term capital gain tax rate is currently 15%, however, that rate is scheduled to reset to 20% beginning January 1,2013. On that date, certain high income taxpayers will also face an additional 3.8% Medicare tax on their capital gains, resulting in a combined federal tax rate of 23.8%.

Commercial property sales are also subject to depreciation recapture. To the extent the property owner has been entitled to take an income tax deduction by depreciating their cost basis, they must in a sense repay the tax savings on those deductions at a maximum federal rate of 25%.

On top of the federal taxes, the state where the property is located may also collect income tax on the capital gain. While states such as Florida and Texas do not have income taxes, state rates may be as high as 9.3% in states like California and 8.97% here in New York. And believe it or not, even if you own property in a non-income tax state such as Texas, if you reside elsewhere your home state may impose income tax from the sale of that property!

Finally, may cities and local municipalities also impose income taxes on the sale of property located within their fiefdoms. New York city, for instance, imposes income tax as high as 3.648% on all income derived by residents of its boroughs, including the sale of real estate.

Example

To get an idea how these various taxes play out, consider the following scenario: a four-plex in Astoria, New York sells for $1,000,000. The current owner purchased it for $500,000, and has invested another $100,000 in improvements. They have taken depreciation deductions of $150,000 during the time they have owned the property.

The owner’s capital gain would be calculated as follows:

Sales Price:                                                                                 $1,000,000

Cost Basis

            Original purchase price           $500,000

            +Cost of improvements          $ 100,000

              -Depreciation                            ($150,000)

                                                                                                      -$      450,000

                        Capital Gain                                                  $    550,000

   The tax on the Capital Gain would be as follows:

           $400,000 x  15% Federal=       $60,000   

            $150,000 x  25% Federal=        $37,500

            $550,000 x 3.648%NYC=          $20,064

             $550,000 x  8.97% State=         $49,335

                                    Total                                                           -$   166,899

                                     Net Gain (Profit)                               $    383,101

That’s quite a bite, considering Uncle Sam and his cousins in state and local government never paid a dime toward the mortgage, never picked up a plunger to fix a toilet, and never paid a dime to remove graffiti from the outside walls!

Fortunately, our tax laws provide an important tax break to people who are selling their primary residence, and also offer a strategy for commercial property owners to defer the tax that would otherwise be due on their sale.

I’ll write more about these topics in my next posting.

Regardless of the type of entity, the business owners must have an Ownership Agreement between them as to how the business will be run. A business without an appropriate Ownership Agreement is like as a person without a Last Will and Testament: they have decided through inaction to let the state decide how their affairs will be governed. Actually it’s worse, because unlike dying without a will, the business owners who should have entered into an agreement may actually be alive to see the damage inflicted by their inaction.

Why is an Ownership Agreement so important? We’ve all heard the horror stories of  marriages that end in divorce without a prenuptial agreement–lots of drama and fighting, and a small fortune spent on attorneys fees. Business disputes are no different, they can be nasty, expensive, and in the end, the litigants are at the mercy of the court to decide their future.

While no agreement can completely ward off the specter of litigation, a good agreement will narrow the issues that can be disputed and create disincentives for one party to sue the other. The first step to a harmonious business relationship is creating a map to guide the parties through the tough issues. With that in mind, the most important issues a good Ownership Agreement will cover are:

1. Authority.  Who is going to be in charge of the day-to-day operations of the business and make the typical decisions, like the hiring and firing of employees, the signing of checks and the selection of the business’ accountant, attorney and other professionals? The company’s Bylaws or Articles of Organization may provide that the officers or managers of the business will have these powers, but the Ownership Agreement can provide who will be appointed to the officer and manager positions. More importantly, an Ownership Agreement can require that a vote of certain percentage of the owners is required to implement extraordinary actions, like selling or dissolving the company or borrowing money.

2.  Sale of an Ownership Interest. Should the owners of the business be free to sell to their interest to whomever they please? Should the other owners be able to completely block a sale?  Neither would seem to be ideal. In an Ownership Agreement, the owners can determine the appropriate measures to be taken if one of them wants to leave the company.  A common solution is to give the remaining owners a right of first refusal to buy the leaving owner’s interest at either a set price or a price equal to the best outside offer. Such a provision permits the resigning owner to be paid the fair value of their interest, while protecting the remaining owners from having to accept a new owner with whom they are not comfortable.

3. Death and Disability. What happens when one of the owners dies?  Will the surviving spouse and kids take over and become owners–with full voting rights and decision making authority? What happens if an owner who is also a key employee of the business becomes disabled and can no longer contribute?  Like a Last Will and Testament, an Ownership Agreement can help provide a clear path in tragic times and help ensure that the business is only minimally affected by such circumstances. By integrating life insurance with an Ownership Agreement, the owners can ensure that the surviving owners have the financial means to purchase the deceased member’s interest without unduly taxing the company’s coffers, which also serves the purpose of ensuring that deceased owner’s family is financially protected. 

4. Succession. Who will run the business when the current management either retires or needs to retire but refuses to do so? Will the children of the owners take over?  Will the company be sold? Will independent management be hired? No one wants their business to wind up like the last few years of The Larry King Show–declining in market share, and at the mercy of a key employee whose best years are behind him and who is just going through the motions. An Ownership Agreement can provide for a smooth transition to a new generation of management, providing incentives for younger management to stay on board to reap the benefits of their loyalty.

5. Valuation. How will the company’s value be determined?  Valuation is an integral component of any business and it is particularly important when an owner or an owner’s estate wishes to sell their interest.  By working with the company’s accountant, the owners can establish an appropriate formula for determining the value of the business, such as a multiple of earnings, book value or other measure. By agreeing in advance how the business should be valued, the owners will avoid much grief and potential litigation down the road when it is time for someone to sell.

These are just some of the areas that can be covered in an Ownership Agreement. Others include covenants not to compete with the company, requirements for capital contributions in certain circumstances, and terms of employment for the owners.  While all of these topics are important, perhaps the most important function of an Ownership Agreement comes from the planning that is required to draft and negotiate one. The process forces the owners to take a hard look at their business and determine the future path for their venture.  By doing so, and by reviewing and revising their agreement every few years, business owners can minimize the risk of the unknown, provide a map for continuity and help ensure a peaceful transition to the next generation. Kumbaya!

Recently, I was asked to answer small business contract law questions on AskExperts.com (See http://bit.ly/g3hyaO for some of my answers). It has been a rewarding experience–I get to assist small business owners and provide them with basic guidance regarding their questions and problems.  However, my answers always include the following disclaimer:

This posting is for informational purposes only. It is NOT to be used as a substitute for specific legal advice or opinions, and the transmission of this information does not create an attorney-client relationship between sender and reader. Internet subscribers and online readers should NOT act upon this information without seeking professional counsel.

You might recognize the previous paragraph.  It’s similar to the language you see on the side panel of this blog. The reason for this language is simple: it is impossible for me to provide accurate and complete legal advice without speaking to someone in person and reviewing their specific facts, objectives, documents and circumstances. Likewise, it is unwise for someone to read an article and think that their question has been fully answered and that they can proceed safely. Legal representation involves nuances that can not possibly be captured without the personal touch.

The Internet has made a lot of legal information available non-lawyers. Unfortunately, with the advent of legal form databases, reference websites and message boards, some people think that hiring a lawyer is an expensive luxury that they can avoid.

During my career, I have seen the results of the “do-it-yourself” approach: wills that weren’t witnessed and were therefore invalid, open-ended contracts which were unenforceable, and litigation documents that were essentially letters to the judge which stated everything but a legal basis for the case.  Just like it’s more expensive to hire a plumber after you have ruptured the water line trying to fix a leaking faucet, in most of these matters it was significantly more expensive for the client to fix the problems created by their self-representation than it would have been if an attorney was hired to do the work in the first place. In some cases, the damage was irreparable.

Even worse is the “don’t do it all” approach. Overwhelmed or intimidated by relevant laws, people resort to doing business on a “handshake” without proper written agreements or they choose to ignore the relevant regulations, thinking they will never get caught. Both approaches are recipes for disaster with a side-order of chaos. Just like healthcare, preventive legal services are almost always less expensive than the cost of responding to a legal crisis.

Along with an accountant, an insurance broker and a banker, among others, every business owner should include an attorney on their team of professionals. By doing so, they can ensure that their legal issues are properly addressed, that their assets are properly protected and that their business is in compliance with all relevant regulations.  And with the proper team of professionals behind them, business owners are free to focus on what they do best: growing and making their business more profitable.

Sleep well at night – hire an attorney before the flood.

Our trust has been shaken as we have watched financial conglomerates collapse under the weight of management’s recklessness and greed.  Prodded for decades to invest our life savings and retirement funds in Corporate America, we have watched as one institution after another has failed us…our governments, our banks and in many cases, our employers.  Stock values are unpredictable, taxes continue to go up, and jobs are hard to find and even harder to keep.

As we contemplate the last few years, one thing becomes clear: we all need to be in control of our own destinies. We can’t count on being employed by the same company for 30 years and retiring with a gold watch and nice pension. Nor should we depend only on IRA’s and  401Ks filled with a mix of Dow stocks and laddered bonds to fund our Golden Years.  And if you’re relying on Social Security, your odds might be better playing the lottery.

So what is the prudent course of action in these desperate times?  Where can you invest and receive a guaranteed return? Invest in yourself.  

Your stock is far more valuable than Berkshire Hathaway or Google. Any dollar or minute spent on discovering and fulfilling your true potential will never be wasted. Education, exercise and therapy will all provide benefits far in excess of their cost. The dividends may be monetary: a college degree at any level can increase your earning potential.  Or the benefits may be less tangible: improved health, increased self-confidence, or overcoming an addiction are all improvements of immeasurable value.

And who knows? You might just find a passion that fulfills and transforms you. You just might start a business.

Entrepreneurs are the foundation of our country. Virtually every private sector job can be traced back to a business that was originally started by a small number of people who had an idea, brought it to market, and then sold the hell out of it. The richest people in the United States are either individuals whose passion and drive lead them to start successful businesses, or people who were fortunate enough to inherit their wealth from individuals who did so.

Notably absent from Forbes 400 are people who worked 9 to 5 jobs until they were eligible to receive their pension, take distributions from their retirement accounts, and collect Social Security.

This is not to say you should stop saving and investing a portion of your income. Over time, stocks, bonds and mutual funds remain solid investment options, and 401Ks and IRAs are important retirement savings vehicles. Nor should you necessarily quit your job for the first speculative venture that presents itself.

But if you rely exclusively on other people to make your fortune, you will be at the mercy of market swings, questionable accounting practices, golden parachutes, and executive shenanigans. By contrast, with careful thought, proper planning and realistic expectations, you can start now to build a business that is financial rewarding and spiritually fulfilling. You can be in control of your destiny. 

Every journey starts with the first step. Take yours today.

Most businesses start off as either a sole (one owner) or a partnership (several owners). Legally, sole proprietorships and partnerships are treated no differently than the individuals that own them. A judgment against either of these business structures can be collected from any of the business owner’s assets, including their personal assets, like their homes, their savings accounts and their flat screen televisions. In most cases, partners are jointly and severally liable, meaning a judgment against the partnership can be collected solely from the assets of any one partner, leaving them to seek contribution from the other partners.

The better alternative is to set up either a corporation or a limited liability company (LLC). These entities are treated as “persons” separate from the people who own them. Corporations are owned by “shareholders”, LLCs are owned by “members”. For the most part, shareholders and members are insulated from the liabilities of the entity, meaning a judgment won against the entity can only be collected against the assets actually owned by that entity. The individual assets of the shareholders and members are protected from the liabilities of the entity–they get to keep their house  if someone slips and falls on business property.

However, there are some important exceptions to the entity liability “umbrella”:

1. Personal Guarantees. 

New businesses and  established businesses that own very few assets are not the best credit risks. So it’s not unusual for lenders to require the owners to personally guaranty the entity’s obligations. As a result, despite the protection offered by either an LLC or a corporation, many transactions will require the members or shareholders to effectively waive the entity shield, and agree to subject themselves to personal liability for the debts of the business.

2. Professional Malpractice.  Professionals who set up their practices as LLCs or corporations will still be personally liable for their own malpractice. Depending on state law and the type of entity, they may also be liable for the malpractice of their partners and their employees.  Accordingly, for doctors, lawyers, accountants and other professionals, malpractice insurance is essential regardless of the entity they choose!

3.  Wages and Payroll Taxes. Depending upon state law, a corporation or an LLC might not insulate a business owner for unpaid employee wages. New York’s Business Corporation Law specifically holds the ten largest shareholders of a closely held corporation jointly and severally liable for unpaid wages.

Likewise, a shareholder or member who is deemed by the IRS to be a “responsible person” could also be held personally liable for unpaid federal employment withholding taxes.  These individuals might also face criminal charges.

4. Veil Piercing. Due to the formalities that must be followed with the corporate structure, veil piercing is more common with corporations than it is with LLCs.  In certain instances, a court may look through the “corporate veil” and allow a business creditor to enforce a corporate judgment against the shareholders.  While courts are reluctant to “pierce” the corporate veil, they may do so where they determine it is warranted, including cases where:

 –Corporate formalities are not followed. Failing to maintain corporate records, (ie. the “black book” is blank), hold shareholder and director meetings, and vote major corporate actions may lead a court to find that the shareholders are not entitled to corporate protection

 –Business and corporate funds are commingled. If money is flowing back and forth from the corporation to the shareholder, or if the shareholder is personally paying the corporation’s expenses and vice versa, a court is more likely to find that the corporation is merely the “alter ego” of the shareholder with no true separate existence. Corporate and personal funds should be maintained in separate accounts and expenses should be paid by the party that incurred them.

 –The business is undercapitalized. When a corporation is merely a shell, with no funds or assets, and no reasonable means or expectations to pay its debts, a court is more likely to look to the shareholders to pay a judgment creditor.

4.  Litigation Costs.  While it’s true that shareholders of corporations and members of limited liability companies are not liable for most of the debts and obligations of their businesses, they may still be sued individually. A common tactic for a litigation plaintiff is to sue anyone who might have the ability and desire to pay to settle the case. As mentioned in previous posts to this blog, defending a lawsuit can be expensive.  Even a frivolous lawsuit needs to be defended. The liability shield offered by a corporation or an LLC may discourage a plaintiff from suing the owners, but it won’t protect owners from having to defend the lawsuit if they are sued.

These exceptions are fairly narrow and shareholders and members will be protected from the majority of liabilities their businesses will incur. Additionally, the cost to form and maintain corporations and LLCs is nominal in comparison to the protection these entities provide.

While corporations and limited liability companies offer similar protections, there are important differences in the two entities.  Accordingly, a business owner should always consult with an attorney in deciding which entity is right for their business.  Additionally, they should consult with an accountant, since there can be tax benefits in choosing one entity over another.

And remember–neither entity is a substitute for proper insurance, since a judgement can still be enforced against the assets owned by the business. When the thunder clouds of litigation begin to mass, you can never have too many umbrellas.

That’s where insurance comes in. Proper insurance coverage is a key part of every business plan. Insurance policies reduce risk.  In addition to covering at least a portion of your potential liability, many insurance policies also cover the cost of defending a lawsuit, including attorney’s fees. As a business owner, you should make sure you have the following policies, at a minimum:

1. General Commercial Liability Insurance. This policy will cover damages suffered by customers and others from injuries that occur while visiting a  business location. Most commercial property leases require the tenant to carry this type of policy and also require that the landlord be named as an additional insured. Since personal injury cases are amongst the most common, general commercial liability insurance is a must.

2. Motor Vehicle Insurance. If employees use  motor vehicles in the course of their work, the business owner must ensure that adequate insurance coverage is obtained. Most states require that a vehicle be insured in order to be registered. However, the coverage an employee has on their own vehicle may not be sufficient to protect the business should the employee have an accident while on duty. Investigate what motor vehicle coverage your business needs to be adequately protected.

3. Worker’s Compensation Insurance. If a business has employees, by law it must carry worker’s compensation insurance. This insurance covers medical treatment for job-related injuries and illness, as well as payments to an employee for temporary and permanent disabilities caused by such injuries and illness. Worker’s compensation insurance will also protect the employer against most lawsuits that could arise as a result of employee workplace injuries.

4. Property Casualty Insurance.  Damage and loss of  business property due to fire, theft and many other hazards can be covered by property casualty insurance. While this coverage may not protect you from litigation (the topic of this post), a business owner would be remiss if they didn’t protect their business assets with this coverage. Additionally, if a business is involved in storing or holding customers’ property (ie. a dry cleaner or automobile mechanic), a policy should be obtained to cover damage or loss to such property, despite any disclaimers you may post on your walls.

5. Product Liability Insurance. If a business manufactures or sells products, it should secure product liability insurance. A simple, scalding hot cup of coffee resulted in a judgment of over $2 million against Mc Donalds. (the award was reduced, see http://www.lectlaw.com/files/cur78.htm).  Liability can result not only from injuries caused by a defective product, but also injuries caused by products that do not contain sufficient warnings or instructions. And you don’t have to be a manufacturer to sued–merely selling a faulty product can result in liability.

6. Malpractice/Errors & Omissions Insurance. Business professionals, such as doctors, therapists, attorneys and accountants, must obtain insurance to cover damages that could result from their mistakes. Medical malpractice can result in physical injury to a patient, while legal and accounting malpractice can cause a client to suffer financial losses. In either case, a professional is morally obligated to maintain insurance coverage to compensate their clients for such losses and injury. Additionally, professionals have a responsibility to themselves and to their own families to ensure that their mistakes don’t result in their own financial ruin.

Many other types of insurance are available and may be desirable, including coverage for business interruption,  identity theft, directors and officers liability, and death or disability of a key employee. Accordingly, it is critical that business owners add an insurance expert to their team of advisors. While the cost of insurance isn’t cheap, the cost of not being adequately insured can be staggering!

If you are an insurance professional and you have useful information you would like to add to this post, please feel free to comment.

We reserve the right to remove any material which, in our sole judgement, is not suitable for this forum.

It’s a painful fact of life that some people are just not honorable; they will not meet their obligations regardless of what they put on paper. In that case, the only true protection is running away as fast as your legs can carry you!

But how do you know who can be trusted and who can not? How can you increase the odds that you will not wind up in litigation? While no measures are foolproof, you should:

1. Trust Your Gut.

Often you can tell right away that a situation doesn’t pass the smell test. Your first impression of your counterpart is negative. They express values or strong opinions that don’t mesh with yours. They bad-mouth their competition or acquaintances. Their initial proposal is completely one-sided and border-line insulting.  These are all flashing beacons warning you to change course! 

Rarely will you go wrong if you trust your gut feeling. However, when your gut is sending you missed messages, consider investigating the other party.  Use background checks, review their financial statements, check out their Dun & Bradstreet reports, and contact the Better Business Bureau. Ask them for references and then actually call to verify them. Even a simple Google search may set your mind at ease. In business, the devil you know is definitely better than the devil you don’t know.

2.  Beware of Low Bids.

It’s almost cliché to say it, but if a deal is too good to be true, it probably is. Just as an onerous one-sided proposal in your counterpart’s favor is a warning sign, so too is a proposal that overly favorable to you. If the other party seems generous to a fault, it may be because they have no intention to deliver what they promised. Even with the best of intentions, if the transaction is not economically viable for the other party, they will have less incentive to honor their obligations.  They may also cut corners and deliver shoddy results in order to stem their losses.

Beware of bids that are far lower than others. Court dockets are full of lawsuits against people who have over-promised and under-delivered.

3. Put An End to Endless Negotiations.

When two parties’ differences are so great that they can only reach an agreement after arduous and protracted negotiations, chances are these differences will continue to flare despite the signing of a contract. Look at Israel and Palestine:  after over sixty years of negotiations and despite the signing of several agreements, they still have not achieved a lasting peace.  If you have to negotiate even the simple points to your agreement, you may be better off agreeing not to agree and doing business with someone else.

Also beware if you receive hard-fought concessions from your counterpart. If they concede to these terms under protest or because they feel they have no choice, you might be in a worse situation than if they never agreed at all. Resentment, anger, and economic distress all become “reasons” for them not to fulfill their obligations. Hollow promises fill court houses.

 4. Get Paid Up Front.

The more time you give the other party to pay for your services or products, the less likely your are to receive full payment. There’s no law that says your payment terms have to be “net 30 days.”  Get paid as much as possible on the delivery of your work. 

If you are not in the banking industry, you should not be acting as your customer’s lender. Let someone else finance the transaction.  I hear complaints that, in today’s credit environment, loans are hard to obtain and that “seller financing” is often the only possible way to get a deal done.  But think about it:  if the banks–with all their investigative resources, analysis and underwriting requirements–determine that your customer is not a good credit risk, why would you decide otherwise? Is any deal worth doing if there’s a good chance you won’t be paid?

But if you insist on being a lender, at least act like one.  Know your borrower (see Rule 1), and charge sufficient interest to justify the risk. Just be aware of your state’s usury laws and the Applicable Federal Rate (AFR) in setting your rate.

When you reach a fair agreement with a party you know and trust, and get paid on delivery, your written agreement becomes a sword you can leave in its sheath.

Picture taken by me in 1991 from the Brooklyn Heights Promenade

A little departure today, as 9-11 is on my mind, as it is for all of us. Much has been written this past week about that tragic day and what has transpired in the nine years since then. I have avoided these stories, having no desire to relive the horror and panic I felt during that time. Yet this morning, as I finished my morning run, the impact of the day fell upon me.

I did not lose anyone close to me on September 11, 2001. Some of my family and friends were at or near the Twin Towers, but survived the attack. While they were shaken-up and we were worried for their safety, we were all certainly lucky in the context of the day. Like most people, I did not need to go far outside my circle to find stories of tragedy–the president of our soccer club who got to work early so he could be home in time for practice, the neighbor of my in-laws, father of two young daughters, who didn’t make it home that night. Many of our friends and relatives in the  law enforcement and  fire department communities worked grueling hours searching for survivors. They then spent the next few months attending funerals and memorial services for their many lost friends and colleagues. It was a time of impenetrable sadness.

But looking back I also remember the positive energy that appeared in the days that followed. Dickens had it right when he wrote of “the best of times” and “the worst of times.”  During the weeks after 9-11, in our sadness and in our grief, we as a nation came together in a way I had never witnessed in my life time. Old Glory flew from poles extending from houses, stores and cars alike. Together, adults and children gathered clothes and food for those combing the debris field that became known as Ground Zero. We watched the news with hearts open and full of sympathy as family members of the victims posted pictures and frantically sought information about their loved ones. We honored the courage shown by the passengers and crew of Flight 93 who they gave their lives to thwart an attack on a fourth target. Overall, it seemed we were a kinder and more patient people. I was never more proud to be an American.

As time passed, so too did the sadness and so too did our common bond. Conspiracy theories about the attacks abounded. Once again, motorists started honking at street-crossing pedestrians. The political parties renewed their partisan squabbles. We returned to being a nation of blue states vs. red states, rich vs. poor, citizen vs. immigrant, union vs. management. Overall, it became us vs. them.

As I sit here at my keyboard, remembering the loss of the almost 3,000 people who died in the attacks, the almost 7,000 coalition soldiers and countless civilians who have since died in Iraq and Afghanistan, and the untold number of first responders who have died or suffered debilitating illnesses as a result of their self-less actions, I also mourn the loss of civility and purpose we had during the months that followed that day.

The most fitting memorial for those we have lost is to find that common ground once again, this time not in tragedy, but in the earnest desire to do better as a nation and as a world. Our problems are too complex for there to be full agreement on the solutions. But our differences need not be grounded in hatred, fear and anger or upon the talking points our pundits feed us in convenient sound bites. Let’s work together selflessly, earnestly and passionately to make the world a better place. Let’s work together to truly honor the memory of 9-11.