Authored by Mark Lobb
As we enter June and approach mid-year, there are many updates for business owners which touch on the L&P Four Pillars of Planning: tax optimization, asset protection, estate planning and succession planning. Below are four areas businesses owners need to be aware of for both personal and business planning:
- AI Warning:
AI technology is changing the world and cannot be ignored. Before you take the AI leap as a business owner, make sure you understand the legal significance behind employing any AI tool.
The other day, I noticed a client was using an AI tool to record notes from a Zoom meeting. Does the AI platform implicate the attorney-client privilege? Who has access to the meeting notes? Where is the information stored and can the recording be altered? Can I protect the recorded information from a subpoena?
In the coming years, lawsuits will abound as the result of business owners using AI tools. Likewise, well intended use of AI may lead to disastrous public relations blunders.
One of the many areas business owners are using AI technology is in the employment arena. Can AI be used to assist business owners in making decisions about hiring and firing employees? Although AI may assist in hiring the most qualified employees, hiring the most qualified employees may violate federal and state laws. Alternatively, not following an AI recommendation to hire a certain person may be used as evidence in a discrimination case.
For instance, there are many factors’ employers are legally prohibited from considering when deciding whether to hire an applicant. Every state is different, but all states recognize some of the below factors as discriminatory:
- Discrimination. Federal, state, and some local jurisdictions prohibit employers from making job decisions based on protected characteristics such as age, race, sex, disability, religion, etc. If an employer decides not to hire someone for one of these reasons, the applicant may have a discrimination claim. Does the AI tool take any of the characteristics of a potential employee into consideration?
- Workers’ compensation claims. Most states prohibit employers from refusing to hire applicants for filing workers’ compensation claims with previous employers.
- Criminal records. All states have some form of restrictions on whether, or to what extent, employers can consider criminal history in hiring decisions.
- Credit history. Many jurisdictions have laws prohibiting employers from considering applicant credit reports.
Understanding and controlling the AI environment will be imperative for business owners to avoid liability. As AI evolves, laws will be made and modified regulating AI. These regulations will be a challenge since local, state, and federal jurisdictions will not always be aligned.
As an example, two weeks ago, the Employment Opportunity Commission (“EEOC”), issued guidance in the form of questions and answers on the use of AI in compliance with Title VII of the Civil Rights Act of 1964. This was a follow-up to previously issued guidance by the EEOC on complying with the Americans with Disabilities Act when using AI tools.
According to the EEOC, an employer’s use of the following software, algorithmic, and AI tools (collectively, “AI”) may implicate issues under Title VII:
- Résumé scanners prioritizing applications using certain keywords.
- Employee monitoring software which rates employees on the basis of their keystrokes and other factors.
- “Virtual assistants” or “chatbots” which ask job applicants about their qualifications and reject those who do not meet pre-defined requirements.
- Video interviewing software which evaluates candidates based on their facial expressions and speech patterns.
- Testing software which provides “job fit” scores for applicants based on their personalities, aptitudes, cognitive skills, or perceived “cultural fit” based on their performance on a game or on a more traditional test.
The EEOC is focused on disparate impacts if use of AI results in adverse consequences for protected classes of applicants or employees. From a legal perspective, the AI tool can result in “damned if you do and damned if you don’t” evidence in a discrimination claim. The EEOC states that results for a group of applicants or existing employees from an AI tool which is substantially less than a selection rate for another group will constitute an adverse impact. A selection rate for any race, sex, or ethnic group which is less than eighty percent of the rate for the group with the highest rate can be regarded by Federal enforcement agencies as evidence of adverse impact.
Even where the AI tool is administered on applicants or employees by a third-party software vendor, an employer may still be liable under Title VII for disparate impact according to the EEOC guidance. Employers cannot rely on the vendor’s representations about the tool if they turn out to be incorrect.
Concerns abound about AI tools eliminating jobs. AI will create jobs for lawyers. Business law firms will have AI regulatory specialists. Businesses will need to have AI compliance officers. Plaintiff lawyers will have new avenues to sue businesses. Business owners cannot afford to lag in understanding how to properly employ AI tools.
- Discrimination. Federal, state, and some local jurisdictions prohibit employers from making job decisions based on protected characteristics such as age, race, sex, disability, religion, etc. If an employer decides not to hire someone for one of these reasons, the applicant may have a discrimination claim. Does the AI tool take any of the characteristics of a potential employee into consideration?
- Sales Tax Relief:
This past week, the Assembly in Sacramento passed a bill to relieve manufacturers in California of sales tax on equipment purchases. If this Bill becomes law, it will provide an income tax credit equal to the local portion of the sales tax the taxpayer pays on qualified equipment purchases. Taxpayers are already exempt from the 3.9% state portion of the sales tax, and the credit would cover local levies that can bring total tax to as high as 10.75%. The Senate has until September 14 to send the bill to Governor Gavin Newsom for consideration.
Currently there are 38 states that relieve taxes on qualified manufacturing purchases. The credit will apply in tax years that start on or after January 1, 2024, and before January 1, 2029. Companies can carry forward credits for eight years if the amounts exceed annual state tax liabilities.
- California Double Taxation Trap:
The California Office of Tax Appeals (“OTA”) has held that a California resident’s income tax paid to Massachusetts from the sale of a membership interest in an LLC doing business in Massachusetts was not eligible for California’s state tax credit. The OTA acknowledges this decision will result in the income from the sale of the membership interest being double taxed.
The taxpayer, Mr. Buehler, was one of three managing members of an LLC. The LLC had an office in Massachusetts, providing portfolio management services for pooled investments. Mr. Buehler “was actively involved in” the LLC’s management and operations. Mr. Buehler sold his membership interest in the LLC, and subsequently filed a Massachusetts nonresident tax return, reporting and paying tax on a share of the net gain from the sale of the membership interest under the Massachusetts apportionment factors.
The California OTA focused on the language of California’s “other state tax credit,” which applies to income taxes paid to another state on “income derived from sources within that state.” The OTA determined that under Cal. Rev. & Tax. Code section 17952, the LLC interest was not sourced to Massachusetts because Buehler’s LLC membership interest had not acquired a “business situs” in Massachusetts. The OTA held that Buehler’s activities as a managing member of the LLC did not cause the membership interest in and of itself to be integrated into the business activities of the LLC in Massachusetts. The OTA determined that although Buehler’s services for the LLC as one the managing partners may connect him with the LLC’s Massachusetts business activities, that fact alone does not show that Buehler’s membership interest was localized in Massachusetts.
California residents engaged in multistate businesses through LLCs or partnerships should consider the implications of this ruling when selling intangibles. Proper structuring of control and ownership pre-sale may avoid the double tax issue.
- California Incomplete Non-Grantor Trusts:
As discussed in a prior Lobb Report, incomplete non-grantor trusts (“ING Trusts”) are under attack again by the state of California. Governor Gavin Newsom submitted his proposed budget on January 10, 2023. The budget includes a proposal requiring net income derived from ING Trusts to be subject to California income tax if the grantor of the trust is a California resident. The May 12, 2023, revised budget maintained the proposal to eliminate the tax benefits associated with ING Trusts for California residents. The disallowance of the tax benefits associated with ING Trusts would be effective January 1, 2023, under the current proposal.
ING Trusts are generally treated as taxable trusts. A California resident grantor can establish an ING Trust with a nonresident trustee and transfer assets to that trust. If structured properly, the taxable income of the ING Trust associated with the sale of intangibles, is sourced to the domicile of the nonresident trustee for California income tax purposes. (Revenue and Taxation Code sections 17742, 17743, and 17744.) This allows a California resident to transfer assets to an ING trust, with an out-of-state trustee in a jurisdiction that does not have a state income tax and avoid California state income taxes for certain transactions which would otherwise be taxable.
Neither the budget nor the revised budget provides any details on how the Revenue and Taxation Code sections referenced above will be amended to allow California to tax the sale of intangibles held in out-of-state ING Trusts. The budget is supposed to be in place by June 15 so clarification is on the way. We will provide a detailed update as soon as more information regarding ING Trusts is available.
