Lobb Report – July 2023 Monthly Legal Updates

Authored by Mark Lobb

“Play by the rules but be ferocious.” (Phil Knight). This edition of the Lobb Report provides you with some new rules.

In the dynamic world of commerce, laws concerning businesses and business owners are evolving, impacting how closely held companies operate. As a responsible business owner, staying abreast of changes in the law is not only crucial for compliance but also essential for safeguarding the longevity and success of the enterprise.

Welcome to another month of our legal updates tailored specifically for business owners. Here, we aim to provide you with timely and relevant information on recent legal developments that may impact your business operations, responsibilities, and overall legal landscape.

The information presented here seeks to serve as a valuable resource to help you navigate through the complexities of the legal world. From shifts in labor laws, taxation updates, intellectual property regulations, data protection measures, to corporate governance guidelines – our goal is to keep you up to date.

While the information provided here is comprehensive and accurate to the best of our abilities, it should not be considered as legal advice, but rather guidance so you can seek legal advice if you see any new rule or rule change specific to your situation.

PAGA Update and Guidance: On July 17^th the California Supreme Court provided employers with some clarity on how to create a defense against PAGA claims in the case of Adolph v. Uber Technologies, Inc. The take aways from Adolf are as follows:
- Employee arbitration agreements are enforceable and should be utilized by employers.
- PAGA plaintiffs can be required to arbitrate their “individual” claims based on Labor Code violations they allege to have personally suffered.
- Plaintiffs have standing to pursue non-individual, representative PAGA claims on behalf of violations alleged to have been suffered by other, alleged aggrieved employees in court, evidently afterarbitrating the individual PAGA claims.
- The requirements for standing under PAGA are: (1) the plaintiff is an employee; and (2) the employee “sustain[ed] a Labor Code violation committed by his or her employer.”
- If the representative plaintiff in a PAGA action is subject to an arbitration agreement, the defendant employer should file a motion to compel arbitration and stay the underlying litigation pending the outcome of the arbitration.
- If the representative plaintiff loses in arbitration, to the extent the plaintiff has not sustained a Labor Code violation by the employer, the plaintiff does not have standing under PAGA to act as a representative.
PAGA took effect on January 1, 2004, deputizing “aggrieved” employees to act on behalf of the state of California to bring claims for violations of the California Labor Code on behalf of other alleged aggrieved employees. PAGA allows employees to collect civil penalties on behalf of themselves and others with 25% of the collective penalties distributed to alleged aggrieved employees and the other 75% distributed to the state of California.
In Adolph, the California Supreme Court places limits on litigating representative claims when there are arbitrable individual PAGA claims. The Court states that if the arbitrator determines the plaintiff is not aggrieved, the plaintiff can “no longer prosecute non-individual claims due to lack of standing.” The arbitrator must first find a PAGA plaintiff is an “aggrieved employee” before a case may proceed on a representative basis in the trial court. If a plaintiff loses the individual PAGA claim in arbitration, the plaintiff should lose standing to pursue that claim in a representative capacity in the trial court. Employers in California should seek to have all employees sign arbitration agreements and enforce and compel arbitration of individual PAGA claims under properly drafted arbitration agreements.
Lobb’s Comments: PAGA does not exist to protect or make whole employees. The employees receive very little out of a PAGA settlement. PAGA is a disguised tax on employers. The state of California has no interest in limiting the impact of this tax on employers and although the courts may provide periodic assistance to employers through certain decisions, PAGA will continue to drive employers out of California which certainly has an impact on employees. Adolph provides a tool for employers to combat the PAGA tax, but only through the voter initiative process will any real relief be provided.
California Taxation: Governor Gavin Newsom signed SB 131 into law in mid-July. The bill includes the creation of the California Code, Revenue and Taxation Code section 17082. Under the new law, California will treat incomplete non-grantor trusts (“INGs”) as grantor trusts and tax trust income in certain situations. Particularly, California residents will no longer be able to fund incomplete non-grantor trusts with stock and have the trust sell the stock to avoid California tax. The new law seeks to tax all transactions which have occurred with such trusts starting January 1, 2023.
There are still reasons to use INGs, but there are few states left where INGs can be used to avoid state tax. For instance, if you own C corporation stock, under certain circumstances, you can substantially avoid paying federal tax using INGs. INGs are asset protection trusts and are valuable estate planning tools. If you are interested in using INGs, they still provide value. If you have an ING you should consult with us to determine the future use of the ING. Also, the new law does not eliminate the use of a complete gift non-grantor trust to eliminate California state tax.
Executive Compensation: This issue always seems to be an item of confusion for
owners of closely held corporations. Decisions regarding the structuring of compensation require detailed consideration.
A recent Tax Court decision addressed a corporate deduction for bonuses paid to its CEO [Clary Hood, Inc. v. Commissioner, No. 22-1573 (4th Cir. May 31, 2023)]. In Clary, the Tax Court disallowed a portion of a corporation’s IRC section 162 deduction for bonuses paid to the CEO. The Tax Court applied a multifactor test to determine that not all of the CEO’s compensation was attributable to personal services. The court noted that the corporation had never paid dividends and compared the compensation against that paid to executives at other companies. (The appellate court vacated and remanded the Tax Court’s imposition of an underpayment penalty, finding that the reasonable-cause defense should have applied based on advice received from third-party accountants).
Executive compensation issues can be complicated and there are many factors to consider when determining how that compensation should be taken by stakeholders working in the company.
Pure Captives and Conservation Easements: California taxpayers participating in syndicated conservation easements or micro-captive insurance companies have a four-month window to settle with the Franchise Tax Board to avoid some or all state penalties. As I have written in the past, the Internal Revenue Service considers both transactions possible illegal tax shelters and on multiple occasions has listed both transactions as a part of the “Dirty Dozen.”
To qualify, taxpayers must enter into closing agreements and pay all tax, interest, and reduced penalties between July 10 and November 17. The amount of reduced or eliminated penalties depends on how far taxpayers are in contacts, audits, assessments, or resolutions with the FTB or IRS regarding the transactions.
Under the settlement resolution notice, taxpayers completing a closing agreement would avoid the non-economic substance transaction understatement penalty, which is 40% of the understatement, or 20% if it is adequately disclosed. They will not get hit with fraud penalties, reportable transaction accuracy-related penalties, or increased interest. They will have to deal with California’s large corporate understatement penalty, if applicable along with previously imposed penalties for failure to include reportable transactions information on their tax return, but retain the ability to file a claim for refund of that penalty or ask the FTB chief counsel for penalty relief.
The following should be noted:
- Taxpayers not contacted by the FTB or the IRS about the transactions can participate in the settlement initiative and face no penalties.
- Taxpayers who have received a notice of proposed assessment from the FTB and already settled with the IRS will owe interest-based penalties.
- Those contacted by the FTB or IRS without yet receiving a proposed assessment will face a 20% accuracy-related penalty.
If you have a micro-captive insurance company, California’s settlement offer may not be the best option if the company is not being audited or in the dispute process. No matter what, having a strategic wind-down process is important.

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Authored by Mark Lobb

“Play by the rules but be ferocious.” (Phil Knight). This edition of the Lobb Report provides you with some new rules.

PAGA Update and Guidance: On July 17^th the California Supreme Court provided employers with some clarity on how to create a defense against PAGA claims in the case of Adolph v. Uber Technologies, Inc. The take aways from Adolf are as follows:
- Employee arbitration agreements are enforceable and should be utilized by employers.
- PAGA plaintiffs can be required to arbitrate their “individual” claims based on Labor Code violations they allege to have personally suffered.
- Plaintiffs have standing to pursue non-individual, representative PAGA claims on behalf of violations alleged to have been suffered by other, alleged aggrieved employees in court, evidently afterarbitrating the individual PAGA claims.
- The requirements for standing under PAGA are: (1) the plaintiff is an employee; and (2) the employee “sustain[ed] a Labor Code violation committed by his or her employer.”
- If the representative plaintiff in a PAGA action is subject to an arbitration agreement, the defendant employer should file a motion to compel arbitration and stay the underlying litigation pending the outcome of the arbitration.
- If the representative plaintiff loses in arbitration, to the extent the plaintiff has not sustained a Labor Code violation by the employer, the plaintiff does not have standing under PAGA to act as a representative.
PAGA took effect on January 1, 2004, deputizing “aggrieved” employees to act on behalf of the state of California to bring claims for violations of the California Labor Code on behalf of other alleged aggrieved employees. PAGA allows employees to collect civil penalties on behalf of themselves and others with 25% of the collective penalties distributed to alleged aggrieved employees and the other 75% distributed to the state of California.
In Adolph, the California Supreme Court places limits on litigating representative claims when there are arbitrable individual PAGA claims. The Court states that if the arbitrator determines the plaintiff is not aggrieved, the plaintiff can “no longer prosecute non-individual claims due to lack of standing.” The arbitrator must first find a PAGA plaintiff is an “aggrieved employee” before a case may proceed on a representative basis in the trial court. If a plaintiff loses the individual PAGA claim in arbitration, the plaintiff should lose standing to pursue that claim in a representative capacity in the trial court. Employers in California should seek to have all employees sign arbitration agreements and enforce and compel arbitration of individual PAGA claims under properly drafted arbitration agreements.
Lobb’s Comments: PAGA does not exist to protect or make whole employees. The employees receive very little out of a PAGA settlement. PAGA is a disguised tax on employers. The state of California has no interest in limiting the impact of this tax on employers and although the courts may provide periodic assistance to employers through certain decisions, PAGA will continue to drive employers out of California which certainly has an impact on employees. Adolph provides a tool for employers to combat the PAGA tax, but only through the voter initiative process will any real relief be provided.
California Taxation: Governor Gavin Newsom signed SB 131 into law in mid-July. The bill includes the creation of the California Code, Revenue and Taxation Code section 17082. Under the new law, California will treat incomplete non-grantor trusts (“INGs”) as grantor trusts and tax trust income in certain situations. Particularly, California residents will no longer be able to fund incomplete non-grantor trusts with stock and have the trust sell the stock to avoid California tax. The new law seeks to tax all transactions which have occurred with such trusts starting January 1, 2023.
There are still reasons to use INGs, but there are few states left where INGs can be used to avoid state tax. For instance, if you own C corporation stock, under certain circumstances, you can substantially avoid paying federal tax using INGs. INGs are asset protection trusts and are valuable estate planning tools. If you are interested in using INGs, they still provide value. If you have an ING you should consult with us to determine the future use of the ING. Also, the new law does not eliminate the use of a complete gift non-grantor trust to eliminate California state tax.
Executive Compensation: This issue always seems to be an item of confusion for
owners of closely held corporations. Decisions regarding the structuring of compensation require detailed consideration.
A recent Tax Court decision addressed a corporate deduction for bonuses paid to its CEO [Clary Hood, Inc. v. Commissioner, No. 22-1573 (4th Cir. May 31, 2023)]. In Clary, the Tax Court disallowed a portion of a corporation’s IRC section 162 deduction for bonuses paid to the CEO. The Tax Court applied a multifactor test to determine that not all of the CEO’s compensation was attributable to personal services. The court noted that the corporation had never paid dividends and compared the compensation against that paid to executives at other companies. (The appellate court vacated and remanded the Tax Court’s imposition of an underpayment penalty, finding that the reasonable-cause defense should have applied based on advice received from third-party accountants).
Executive compensation issues can be complicated and there are many factors to consider when determining how that compensation should be taken by stakeholders working in the company.
Pure Captives and Conservation Easements: California taxpayers participating in syndicated conservation easements or micro-captive insurance companies have a four-month window to settle with the Franchise Tax Board to avoid some or all state penalties. As I have written in the past, the Internal Revenue Service considers both transactions possible illegal tax shelters and on multiple occasions has listed both transactions as a part of the “Dirty Dozen.”
To qualify, taxpayers must enter into closing agreements and pay all tax, interest, and reduced penalties between July 10 and November 17. The amount of reduced or eliminated penalties depends on how far taxpayers are in contacts, audits, assessments, or resolutions with the FTB or IRS regarding the transactions.
Under the settlement resolution notice, taxpayers completing a closing agreement would avoid the non-economic substance transaction understatement penalty, which is 40% of the understatement, or 20% if it is adequately disclosed. They will not get hit with fraud penalties, reportable transaction accuracy-related penalties, or increased interest. They will have to deal with California’s large corporate understatement penalty, if applicable along with previously imposed penalties for failure to include reportable transactions information on their tax return, but retain the ability to file a claim for refund of that penalty or ask the FTB chief counsel for penalty relief.
The following should be noted:
- Taxpayers not contacted by the FTB or the IRS about the transactions can participate in the settlement initiative and face no penalties.
- Taxpayers who have received a notice of proposed assessment from the FTB and already settled with the IRS will owe interest-based penalties.
- Those contacted by the FTB or IRS without yet receiving a proposed assessment will face a 20% accuracy-related penalty.
If you have a micro-captive insurance company, California’s settlement offer may not be the best option if the company is not being audited or in the dispute process. No matter what, having a strategic wind-down process is important.