Recent FTC Rule Could Affect Value of Non-Compete Agreements
Non-compete agreements have always been considered a valuable business tool, especially after a merger or acquisition. However, these agreements have become more complicated in the wake of a new and controversial final rule, issued in April 2024, by the Federal Trade Commission (FTC) proposing a ban on noncompete agreements for most employees and independent contractors. The rule would have gone into effect in September 2024.
To counter the FTC’s effort, the U.S. Chamber of Commerce and several business groups filed federal lawsuits challenging the final rule, arguing that the FTC lacked the authority to enact the ban and that it violated the Constitution. By August 20, 2024, they prevailed, and the rule was struck down. The Court concluded that the FTC’s decision was “arbitrary and capricious,” stating that the Non-Compete Rule was “unreasonably overbroad.” The Court was specifically offended by the rule’s “one size fits all” solution to the potential hazards of a non-compete.
This ruling will not impact state laws on non-competes. Several states have already limited their use. Minnesota banned workplace non-competes in July 2023, and New York nearly passed a similar ban before it was vetoed. States like Indiana have also restricted non-competes in specific cases.
Non-compete agreements have been around for decades. Some are required at the get-go, as a prerequisite for employment, and some kick in upon termination of employment. The employer will require an employee to sign a non-compete agreement to protect the employer’s business interests, guard against disclosure of trade secrets, and prevent the employee from poaching customers or clients. These agreements will generally limit employment activities in the same field, for a specified period, and their goal is to protect the employer.
Non-competes also may come into play in business combinations. These agreements typically prevent the seller from competing with the buyer within a specified geographic area for a certain time period (usually five years or less).
A non-compete agreement may be estimated in various circumstances, including legal disputes, mergers, financial reporting and tax matters. The most common approach to valuing a non-compete agreement is the ‘with-and-without’ method. Without a non-compete agreement, the worst-case scenario is that competition from the employee or seller will drive the company out of business. Therefore, the value of the entire business represents the highest ceiling for the value of a non-compete.
The business’ tangible assets possess some value and could be liquidated if the business failed, and it is unlikely that the employee or seller will be able to steal 100% of a business’s profits. So, when valuing non-competes, experts typically run two discounted cash flow scenarios — one with the non-compete in place, and the other without.
The valuation expert computes the difference between the two expected cash flow streams and includes consideration of several other factors:
- The company’s competitive and financial position
- Business forecasts and trends
- The employee’s or seller’s skills and customer relationships
Next, each differential must be multiplied by the probability that the individual will subsequently compete with the business. If the party in question has no incentive, ability, or reason to compete, then the non-compete can be worthless. Factors to consider when predicting the threat of competition include the individual’s age, health, financial standing and previous competitive experience. When valuing non-competes related to mergers and acquisitions, the expert will also consider any post-sale relocation and employment plans.
A critical factor to consider when valuing non-competes is whether the agreement is legally enforceable. The restrictions in the agreement must be reasonable. For example, some courts may reject non-competes that cover an unreasonably large territory or long period of time. What is “reasonable” varies from business to business, and is subject to the particulars of the business, the terms of the agreement, state statutes and case law.
What does this mean for your business? The legal battle over non-competes has drawn attention to their use, prompting the corporate world to reconsider work relationships without restrictive covenants. Non-competes will likely be viewed differently moving forward. As with all business-related legislation, businesses should stay updated and informed of changes and revisions that may affect its employment practices and its bottom line.
This material has been prepared for informational purposes only, and is not intended to provide or be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.
IRS Focuses on High-Income Non-Filers to Recover Millions in Unpaid Taxes
High-income earners who have not been filing their tax returns are in the crosshairs. A recent IRS news release announced an extensive plan to root out high-income taxpayers who have failed to file federal income tax returns in more than 125,000 instances since 2017. The agency estimates that this campaign will involve hundreds of millions of dollars in unpaid taxes.
The IRS hasn’t had the funds to pursue non-filers since 2016, but with the new Inflation Reduction Act, passed into law in 2022, and a directive from Treasury Secretary Janet Yellen, the IRS now has the resources to address this pervasive compliance issue – and it’s pulling out the stops.
At the start of March 2024, the IRS began its campaign by sending noncompliance letters to more than 25,000 people who earned more than $1 million per year, and 100,000 people with incomes falling between $400,000 and $1 million, who have failed to pay their taxes between 2017 and 2021. All of these cases have shown up on the IRS’ radar through third party sources – like Forms W-2 and 1099s – which show they have earned income but haven’t followed up with a filing. Since the IRS is not aware of any possible credits or deductions these filers may have, they have no clear estimate of the potential revenue that they hope to earn through this initiative. However, the third party information points to financial activity of more than $100 billion and the IRS estimates that hundreds of millions of dollars of unpaid taxes are in question. Conversely, because the IRS does not have all the details of the potential filings in hand, some of these non-filers may not owe the IRS anything at all and may even be due a refund.
The IRS expects taxpayers to take immediate action upon receipt of its compliance letter, formally known as the CP59 notice. Ignoring them means additional follow-up notices, higher penalties, and the potential for stronger enforcement measures. The IRS also advises non-compliant taxpayers to consult with their tax professionals for help filing late tax returns and paying delinquent tax, interest, and penalties. The failure-to-file penalty amounts to 5% of the amount owed every month – up to 25% of the tax bill.
For high-end non-filers, your time may be up. If the IRS’ manhunt applies to you, be sure to reach out to a tax professionals to refile, address your tax balance, and regroup.
This material has been prepared for informational purposes only, and is not intended to provide or be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.
The ‘Personal’ in Personal Finance
Picture this: Two buddies hiking through the woods, when suddenly, out pops a massive bear. One guy takes off like a rocket – survival instincts kicking in. The other, oddly composed, yells after him, “What’s the point? You can’t outrun a bear!” The sprinting hiker retorts, “I don’t need to outrun the bear, I just need to outrun you!”
Sometimes, competition is the key to success. Beating your colleagues in the company fantasy football league makes you the water cooler hero. Getting in on a high-flying stock will make you a star at wedding conversations. Those feel-good victories definitely have their place, and may save your life in a bear attack.
But here’s the twist: When it comes to your personal financial goals, it’s not about beating anyone. It’s not even about the S&P 500. Imagine someone beating the S&P 500 by 10% a year, but at age 83 they’re sitting on a park bench, struggling to pay their electric bill. What did the outperformance bring them? Bragging rights won’t keep the lights on.
So when it comes to your personal finances, remember:
- Your goals, your rules: Whether it’s buying a house, retiring in comfort, or traveling the world, your financial goals are all about you. What your neighbor or coworker is doing is irrelevant. Focusing on your individual needs and aspirations will help create a personalized investment plan rather than chasing someone else’s dream.
- The risk factor: Remember, not all investments are created equal. Trying to “win” by picking riskier stocks might get you those sweet bragging rights…for a while. But if it jeopardizes your long-term financial stability, is it really worth it? Picking investments based on your risk tolerance keeps you focused on the bigger picture.
- Time is on your side: Investing is a long game. Sure, seeing your portfolio outperform the market feels great, but what if those gains come with a side of heart-palpitating-volatility? A slow and steady strategy tailored to your needs sets you up for sustainable, long-term growth.
So, the next time you start comparing your portfolio to your buddy’s, stop. Remember, it’s not a competition. Focus on building a financial future that secures the life you want to live. After all, what good is bragging about outperforming a bear market if you can’t pay your bills?
This material has been prepared for informational purposes only, and is not intended to provide or be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.
Is It Time to Rethink Your Cash Holdings?
As you are already aware, both Silicon Valley Bank and Signature Bank have entered into receivership programs from the federal authorities. Last weekend was a long and daunting one. Companies banking with these institutions were nervous about their unsecured deposits, which were necessary to meet payroll and other basic business functions. The Federal Reserve stepped in, took over the operations of both banks and announced a new program called the Bank Term Funding Program (BTFP) to try and quell the flood of withdrawals from other regional banks. This program allows banks to pledge certain assets that have lost market value due to the dramatic increase in rates as a result of Federal Reserve tightening, which began this time last year.
How much the Fed will be able to cover is still unknown. Should we consider all bank deposits guaranteed, even above the official $250,000 threshold? Will they keep this program for all future bank failures?
Besides the two banks previously mentioned, along with Silvergate – which was shut down earlier last week – there are many other banks in the limelight. Many publicly traded regional banks’ stock prices were down 50% or more on Monday alone – and the market is saying that this is only the start.
The biggest concern is that things are moving extremely fast. Just last week Wednesday, Federal Reserve Chair Jerome Powell testified in front of Congress stating that they aren’t seeing any issues in the banking world from the rate-hiking campaign they have been on over the last year. Since then, three banks with hundreds of billions of dollars of assets had to be bailed out!
So, what does this mean for us now? We believe this is a prudent and opportune time to rethink where and how we hold cash deposits. There are the large, ‘too-big-to-fail’ banks that many consider as safe as some government programs. Then there are the local regional banks that each bring along some benefits. The larger institutions offer safety to your assets, while smaller banks can give you higher yields, certain services and respect that only Fortune 500 companies get at the larger banks. The issue is that typically, these two are mutually exclusive. It’s rare to have safety and liquidity, along with higher interest, at the same institution.
Our wealth management partners at Equinum would like you to consider a third option – U.S. Government treasury bonds held in a brokerage account. Not only does this offer both security and higher yields, but it also offers tax advantages in some cases as well. Government treasures are backed by the full faith and credit of the United States Government. This is an assurance that supersedes the ‘too-big-to-fail’ status of some banks, and is on par with FDIC insurance as it relates to security. On top of this, yields are currently in the 4.5% range for short term treasuries. Obviously, for core banking functions and payroll processing, you will still need to have banking relationships. But for larger balances not needed for day-to-day operations, it’s imperative to consider where these assets are being held.
Keep in mind that there’s a key difference between assets held in a bank account versus those in a brokerage account. When you deposit $1,000,000 in a bank account, the bank takes most of that cash and invests the money into other things – mostly in new loans or existing fixed income investments. Your money is effectively mixed together with all the other bank depositors and invested by the bank. The bank has certain requirements as to what percentage of deposits need to be liquid, but that number is really small – currently just 10%. There are other ratios and stress tests that banks must adhere to, but as we all see with last week’s failings, there are obviously still risks out there.
Contrast this with brokerage accounts: When you hold an asset in your brokerage account, it’s in your name. You own the shares of the companies you invest in and can vote your ownership the way you want. You own the bond and receive the interest payments. Each respective client’s assets are in a segregated account held at the custodian in the client’s name. Even if something were to happen to the custodian, client assets are protected and secure. Even creditors would have no claim on client assets.
Each family and company’s situation varies – there’s no silver bullet to cover all circumstances. This is just something to consider in the current unique situation.
Always feel free to reach out to us or to our partners at Equinum.
This material has been prepared for informational purposes only, and is not intended to provide, nor should it be relied upon for, legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.
Use Nongrantor Trusts to Bypass the Salt Deduction Limit
If you reside in a high-tax state, you may want to consider using nongrantor trusts to soften the blow of the $10,000 federal limit on state and local tax (SALT) deductions. The limit can significantly reduce itemized deductions if your state income and property taxes are well over $10,000. A potential strategy for avoiding the limit is to transfer interests in real estate to several nongrantor trusts, each of which enjoys its own $10,000 SALT deduction.
Grantor vs. nongrantor trusts
The main difference between a grantor and nongrantor trust is that a grantor trust is treated as your alter ego for tax purposes, while a nongrantor trust is treated as a separate entity. Traditionally, grantor trusts have been the vehicle of choice for estate planning purposes because the trust’s income is passed through to you, as grantor, and reported on your tax return.
That’s an advantage, because it allows the trust assets to grow tax-free, leaving more for your heirs. By paying the tax, you essentially provide an additional, tax-free gift to your loved ones that’s not limited by your gift tax exemption or annual gift tax exclusion. In addition, because the trust is an extension of you for tax purposes, you have the flexibility to sell property to the trust without triggering taxable gain.
Now that fewer families are subject to gift taxes, grantor trusts enjoy less of an advantage over nongrantor trusts. This creates an opportunity to employ nongrantor trusts to boost income tax deductions.
Nongrantor trusts in action
A nongrantor trust is a discrete legal entity, which files its own tax returns and claims its own deductions. The idea behind the strategy is to divide real estate that’s subject to more than $10,000 in property taxes among several trusts, each of which has its own SALT deduction up to $10,000. Each trust must also generate sufficient income against which to offset the deduction.
Before you attempt this strategy, beware of the multiple trust rule of Internal Revenue Code Section 643(f). That section provides that, under regulations prescribed by the U.S. Treasury Department, multiple trusts may be treated as a single trust if they have “substantially the same grantor or grantors and substantially the same primary beneficiary or beneficiaries” and a principal purpose of the arrangement is tax avoidance.
Bear in mind that to preserve the benefits of multiple trusts, it’s important to designate a different beneficiary for each trust.
Pass the SALT
If you’re losing valuable tax deductions because of the SALT limit, consider passing those deductions on to one or more nongrantor trusts. Consult with us before taking action, because these trusts must be structured carefully to ensure that they qualify as nongrantor trusts and don’t run afoul of the multiple trust rule.
