you expect results from strategic thinking
THE ABC S OF STARTING BUSINESS IN THE UNITED STATES
and also from active listening.
WELCOME TO CROWELL & MORING’S GUIDE TO STARTING BUSINESS IN THE UNITED STATES. WE ARE
PLEASED TO PRESENT THESE MATERIALS AS AN INTRODUCTION TO SOME OF THE MOST IMPORTANT AREAS
OF LAW THAT AFFECT NON-U.S. COMPANIES STARTING TO DO BUSINESS IN THE UNITED STATES.
the ABCS
of starting business in the United States
In this guide, you’ll find brief overviews of the main areas of concern: Business
Entities, Tax, Intellectual Property, Labor and Employment, and Government
Contracts. In addition to these, there are many other legal issues that a nonU.S. company may need to address. Depending upon your areas of business
and the nature of your industry, a variety of federal and state regulations may be
applicable. For example, federal and state securities laws regulate investments
and investors, requiring companies to disclose certain financial information to
the public in an attempt to aid investors in making wise investment choices.
Environmental laws set forth compliance standards to ensure that the business
operations of a company do not adversely affect the environment. Trade
restrictions place certain limits on trade and regulate relations between U.S. and
foreign companies. Immigration laws restrict immigration into the U.S., which
may restrict the ability of non-U.S. companies to transfer employees to their U.S.
operations. Antitrust laws prohibit anti-competitive behavior and unfair business
practices. Consumer protection laws protect U.S. consumers from low-quality
products, deceptive advertising, and other harmful business practices.
This guide is intended to provide a basic outline of some major legal issues that
a non-U.S. company may encounter. It is not meant to serve as a comprehensive
guide to doing business in the U.S., and it is not meant to constitute legal advice.
Even if statements contained herein did constitute advice on federal tax issues,
such statements are not intended or written to be used by any taxpayer for the
purpose of avoiding penalties under federal tax law, and no taxpayer can so
use such statements. If you need further guidance in a particular area, please
consult your U.S. legal counsel.
Let’s get started …
business entities
INT RODUCT IO N
There are many decisions to be made when starting a business, including what type of business entity
to use and where to locate the business. The right choices will depend on the business’s purpose,
relationship to the non-U.S. parent company, and the ownership structure. It is very important
to consider tax issues when choosing the form of business entity and the state of organization.
CH O ICE OF E NT IT Y
Choosing the right entity for a business venture is
one of the first issues for a non-U.S. company to
consider when it decides to operate in the United
States. Different business entities vary in the following
respects: level of formality required in formation
and operation, liability protection for investors and
members, management and control, tax treatment,
financing requirements, and transferability of ownership
interests in the entity. Therefore, we recommend that
a company seek the advice of U.S. corporate and tax
attorneys before forming a new business in the United
States. Some forms of business entities may provide
definite structural and tax advantages for a given
venture.
There are many different choices for business entities.
This is a brief summary of the most common business
types. Please note that not all business entity types are
available in all states.
Sole Proprietorship – A sole proprietorship is an
unincorporated business entity, which is owned and
operated by one person or a husband and wife. The
sole proprietor receives all the profit of the business
directly and is personally liable for the business’s
losses. Taxes are at the individual level.
Partnerships – Formed by two or more individuals
or entities entering into a partnership agreement
(contract). The partners pay taxes on the partnership’s
profits individually.
• General Partnership (GP) – General partnerships
are operated for profit. General partners are usually
all actively involved in the business, and each
contributes money, property, or services to the
venture. General partners share the partnership’s
profits and losses and are personally liable for
the partnership’s debts. Each general partner is
an agent of the partnership; thus, each can bind
the partnership in contracts and loans and hire
employees.
• Limited Partnership (LP) – Limited partnerships have
at least one general partner and at least one limited
partner. Like general partnerships, the general partner
in a limited partnership is actively involved in the
partnership and its management and is personally
liable for the obligations of the limited partnership.
The limited partners invest money or property and
share in the partnership’s profits, but their personal
liability is limited to the extent of their investment
in the partnership. Limited partners cannot be very
active in the limited partnership, and if they are,
they will be treated as general partners and will be
personally liable for the partnership debts.
• Limited Liability Partnership (LLP) — This form of
partnership is a newer entity, and it is not available
in every state. Generally, only certain professions,
such as attorneys and accountants, use this type
of partnership. A limited liability partnership limits
the individual liability of the partners for obligations
to third parties insofar as those partners were not
personally involved in the incidents with the third
party.
• Limited Liability Limited Partnership (LLLP) – Very
similar to the LLP, this partnership arises when the
partners of a limited partnership elect to limit the
liability of the individual partners with respect to third
parties, so long as the partners are not personally
involved in the incidents with the third party.
Joint Venture – Joint ventures are very similar to
partnerships and are treated very similarly by state law.
Generally, in a joint venture, two or more individuals
or businesses join together to engage in a specific
business purpose that they could not accomplish as
successfully on their own. Because the purpose of the
joint venture is limited, so often is the duration of the
joint venture’s existence. Each party to the joint venture
contributes money, property, services, or expertise in
the pursuit of the joint venture. The members share the
profits and losses of the venture according to the joint
venture agreement. Joint ventures are a more informal
and flexible form of business association.
Corporation – Corporations are legal entities separate
from the individuals who form, run, and own them. As
such, a corporation can sign contracts, own property,
sue, and be sued in its own name. Taxes are assessed
at the corporation level. Any distributions of profit to
the corporation’s shareholders are also taxable to the
individual recipient.
• Stock Corporation – Stock corporations may
issue stock in order to raise capital. Stockholders
contribute money, property, or services to the
corporation in exchange for shares of stock. Stock
corporations are used primarily for “for profit”
businesses.
• Nonstock Corporation – Nonstock corporations may
not issue stock. Nonstock corporations are generally
used for nonprofit purposes.
• Professional Corporation – A professional corporation
is a corporation made up of members authorized
to practice a certain profession, like physicians,
architects, accountants, or attorneys.
Limited Liability Company (LLC) – A limited liability
company is an unincorporated business entity
that allows the limitation of personal liability for its
members. While most states allow single-member
LLCs, most LLCs have two or more members. Other
business entities may be members of an LLC. While
the default tax treatment for a multi-member LLC is
that of a partnership, the tax laws allow LLCs to elect
to have the tax treatment of a corporation.
• Professional Limited Liability Company (PLLC) – A
professional limited liability company is a specific
type of LLC organized to perform professional
services. Only certain professions can form PLLCs,
and all the members of a PLLC must be members of
that profession.
The most common forms of
business entity used by non-U.S.
companies seeking to establish
operations in the United States
are the stock corporation and
the limited liability company.
Therefore, we will discuss these
entities in more depth below.
corporations
Many non-U.S. companies choose to do business through either a branch or a corporate subsidiary of the non-U.S.
company. A branch is not a separate legal entity but may cause the foreign corporation parent to be subject to the
“branch profits tax.” However, the U.S. branch may not be seen as sufficiently separate from the non-U.S. company
to insulate the non-U.S. company from liabilities and lawsuits facing the branch.
A corporate subsidiary is a separate legal entity that may be wholly owned by the non-U.S. company. In general,
it is treated as an entity that is entirely separate from the non-U.S. parent, insulating the parent from liability.
F O RMIN G A CO RPO RATIO N
Corporate law in the U.S. is handled at the state, rather
than the federal, level. The corporate law statutes of
each state govern the formation of a corporation in that
state. In general, the formation requirements are similar
for all states.
First, an adult individual, known as an incorporator,
files the corporation’s “Articles of Incorporation” with
the state agency in charge of business formation
(usually a division of the state’s Secretary of State’s
Office). Depending on the state, the Articles of
Incorporation may also be called the Certificate
of Incorporation or Charter.
At a minimum, the Articles of Incorporation
must contain:
1 The name of the corporation
•
The name of the corporation may not be
confusingly similar to the name of another
corporation in the state and should not be
confusingly similar to another company’s
trademark or service mark.
2 The name and address of the incorporator(s)
3 The business purpose for the corporation
•
In general, a corporation may be organized
for any lawful purpose, and the Articles of
Incorporation need include only a general
description of the purpose.
4 The address of the corporation’s principal office
5 The name and address of the corporation’s
resident agent
•
Each corporation must have an agent who
is located in the state of incorporation; if the
corporation is not located in the state, it may
hire someone to serve as a resident agent.
6 Information regarding the shares of stock: the
number of shares of stock authorized by the
corporation; the par value, if any, of the shares;
and a description of each class of shares
(if there is more than one class)
7 The number and names of the initial directors
The corporation should also adopt its Bylaws.
4 Stock: ownership records and transfer procedures
The Bylaws dictate the basic rules under which the
corporation will operate, and, thus, they must be
considered and drafted carefully. While the Bylaws
are never filed with the state, each state requires a
corporation to adopt Bylaws.
5 Record-keeping
The Bylaws should include information on:
Depending on applicable state corporate law and the
company’s Articles of Incorporation and Bylaws, other
actions of the corporation may be taken by vote of
the Board of Directors or shareholders or by written
resolution in lieu of a meeting of the Board of Directors
or the shareholders.
1 The Board of Directors: creation, election and
operation of the Board of Directors; the duties
of the Board, Board committees, and individual
directors; annual and special meetings of the
Board; indemnification
6 Opening the corporation’s bank accounts
7 Creation of the corporation’s fiscal year
2 The officers: positions and duties
3 The shareholders: annual and special meetings;
voting procedures, including permitted voting by
written consent and by proxies; powers of the
shareholders
BASIC INF O RMAT ION O N C O R P O R ATIO N S
In general, ownership and governance of a corporation
are separate in the United States. A corporation is run
by its Board of Directors. Directors must be individuals,
but they are not required to be U.S. citizens, nor
are they required to be employees or officers of the
corporation. Some states have requirements for
the minimum number of directors, but many require
only one director. Directors owe fiduciary duties to
the corporation and its shareholders – specifically,
the duties of care and loyalty. Other than the initial
directors named in the Articles of Incorporation,
directors are elected by the shareholders (typically
annually) and may be removed from their positions with
or without cause, as set forth in the state’s laws and
the corporation’s Articles of Incorporation and Bylaws.
The Board of Directors must hold an annual meeting
as set forth in the Bylaws, and may hold special
meetings as needed. It is not necessary to hold these
meetings in the United States. After incorporating, the
initial directors must hold an organizational meeting to
complete the process of starting the corporation. At
this meeting, the Board should appoint officers. While
a corporation may have whatever officers it chooses,
there should be at least a president and a secretary.
Other officers may include chairman of the board, one
or more vice presidents, and treasurer. Officers are not
required to be U.S. citizens or residents.
Shareholders are the actual owners of the corporation.
Shareholders contribute money, property, or services
to the corporation in exchange for shares. Shareholder
liability is limited to the amount of the shareholder’s
investment in the corporation. Entities and individuals
may be shareholders, and there is usually no
restriction on non-U.S. individuals and entities being
shareholders. A corporation is required to have an
annual meeting of the shareholders, as set forth in
the Bylaws. In addition, subject to any limitations or
restrictions in the corporation’s Articles of Incorporation
or Bylaws, shareholders may call a special meeting
with proper notice. Shareholders do not have to attend
the shareholders meetings in person; they can vote by
proxy. Additionally, not all action of the shareholders
requires a vote. If the Bylaws provide, the shareholders
can act by written consent in lieu of a vote.
Record-keeping is a very important part of operating
a corporation. Such records must include minutes
of all meetings of the shareholders and directors,
shareholder information, information regarding stock
ownership and transfers, tax records, and accounting
and financial information.
While shareholders and parent companies of
corporations enjoy limited liability for obligations of the
corporation, this limited liability may be lost if corporate
laws are not followed. If the corporation is insufficiently
funded or the directors or officers fail to respect the
corporate form, creditors and other third parties can
seek relief from the parent or affiliated company
or the owners.
limited liability companies
BASIC INF O RMATIO N
A limited liability company enjoys the benefits of both
corporations and general partnerships: members
benefit from limited liability and flexibility in the
business entity, while being able to actively participate
in the operation of the business. An LLC is owned
and operated by its members, who may be individuals
or business entities. Members contribute money,
property, or services to the LLC in exchange for a
membership interest in the LLC. The liability of the
members is limited only to their capital contributions
to the LLC, regardless of their participation in the
operations of the LLC. Therefore, LLC members are
similar to the partners of a general partnership, without
the unlimited liability.
Most states have no limits on the number of members,
so there are single-member LLCs and multi-member
LLCs. LLCs may be managed by members or by a
designated manager or board of managers. If the
LLC is to be managed by one or more managers, the
Operating Agreement should set forth the powers
and obligations delegated to the manager(s) and the
powers and obligations reserved to the members. A
manager need not be a member of the LLC.
F O RMIN G AN LL C
As in the case of forming a corporation, the formation
of an LLC is a matter of state corporate law. The
LLC statutes of each state dictate the rules for
forming an LLC in that state. In general, the formation
requirements are similar for all states.
Filing “Articles of Organization,” or a “Certificate of
Organization,” with the state agency responsible for
business formation, forms an LLC. In general, any
member of the LLC may form an LLC.
The Articles of Organization must include:
1
The name of the LLC
2
The purpose of the LLC
•
Like a corporation, generally an LLC may be
formed for any lawful purpose, so this purpose
may be stated broadly.
3
The address of the LLC’s principal office
in the state
4
The duration of the LLC
5
The name and address of the LLC’s
resident agent
Once the LLC has been formed, the members should
draft and sign an Operating Agreement. An LLC’s
Operating Agreement is comparable to a corporation’s
Bylaws, and it sets forth the terms of the LLC’s
operation, ownership, management, transfer of
membership interests, and other issues. One of the
benefits of forming an LLC rather than a corporation
is the great flexibility state statutes offer in defining
the scope, structure, ownership, management,
economic rights, and other rights and duties of the
LLC’s members and, if applicable, managers. However,
this also makes it crucial for the members to ensure
that the Operating Agreement is comprehensive and
clear in establishing all of the critical terms for owning,
operating, and managing the LLC.
location of a business
Another important decision is where to form the
business. While many federal laws apply to businesses
and employers, business entities are governed by state
law. These regulations vary among the states, but the
basic rules and entity types are very similar throughout
the United States.
Often, companies choose to form their business where
they plan to have the company’s headquarters or the
main part of their business operations. Other clients
may find the particular rules of a state’s corporate
laws to be particularly attractive to their situation and
will choose to form their companies in that state. For
example, Delaware is popular for business formation,
as it has a very well established body of corporate laws
and has a tendency to be pro-management. Forming a
business in one state does not mean that a company
cannot operate in other states or that the company
must operate primarily in its state of formation.
A company, wherever formed, can operate
in any other state it chooses if it qualifies to do
business as a “foreign business” and otherwise
complies with applicable laws for doing business
in that state.
Delaware and Virginia are good states to consider
when forming a business. Delaware has very
favorable corporate laws, but most companies
do not have actual locations in Delaware. Virginia
combines favorable corporate laws with proximity
to a knowledgeable workforce and the resources
of the Washington, D.C. area.
The following is some basic filing and fee information for Delaware and Virginia:
D E L AWA R E
VIRGINIA
State Agency for
Business Filings
Division of Corporations
State Corporation
Commission
Organizational Document
for LLC
Certificate of Organization
Articles of Organization
Organizational Document
for Corporation
Certificate of Incorporation
Articles of Incorporation
Corporation Filing Fee
$89
$25 + $50 for each 25,000
shares or fraction thereof
LLC Filing Fee
$90
$100
Annual Fee/Franchise Tax
for Corporations
$35 for up to 3,000 shares;
$62.50 for 3,001 to 5,000;
$112.50 for 5,001 to
10,000; $62.50 for each
additional 10,000 shares or
portion thereof
$100 for the first 5,000
authorized shares; $30 for
each 5,000 shares thereafter
LLC Annual Fee/Tax
$200 Annual Tax
$50 Annual Registration Fee
Please note that the foregoing is only a brief overview of state corporate laws governing the formation and organization of business entities.
Many other state and federal legal requirements will apply to the establishment of a business in the United States. For example, the United
States and each state have comprehensive and complex bodies of laws and regulations that govern the offer, issuance, and sale of securities,
including corporate stock and interests in an LLC issued in connection with the formation of a business entity.
tax
residency
The United States income taxation of foreign individuals depends on the classification of the individual as
either a resident alien or a nonresident alien. (The taxation of foreign individuals is further affected by any
Income Tax Treaty between the United States and the country of the foreign individual’s citizenship. Treaties
can affect the status of an individual as a resident or nonresident alien and whether income will be subject to
tax in the United States. All statements below may be overridden by tax treaty.)
RE SIDE N CE O F INDIVID U A LS
An alien is considered to be a resident alien if either:
(i) he or she is physically present in the United States
for at least 31 days in the current year and at least 183
days (not consecutive days necessarily) in the threeyear period ending with the current year on a weighted
average basis (the “Substantial Presence Test”); or
(ii) the alien is lawfully admitted for permanent
residence (the “Green Card Test”).
The Substantial Presence Test may be satisfied by
adding up all days of presence in the three-year period
by counting each day of presence in the current year
as one day, each day of presence in the first preceding
year as one-third of a day, and each day of presence in
the second preceding year as one-sixth of a day.
In addition, the Internal Revenue Code (the “Code”)
contains exceptions so that certain days of presence
in the United States do not count under the Substantial
Presence Test.
If an individual is not a resident alien, then he is
considered a nonresident alien under the Code.
TAXAT ION BASE D ON RES ID EN C Y S TATU S
Resident aliens are taxed by the United States on
their worldwide income the same way as U.S. citizens
are. The income earned by a resident alien is taxed
at graduated income tax rates (for 2006, these rates
range from 10% to 35%; these rates are subject to
applicable sunset provisions which may increase the
tax rates). The resident alien is entitled to foreign tax
credits for taxes paid in other countries on foreign
source income. In addition, tax would be imposed
at capital gains rates on capital gain property sold
anywhere in the world, regardless of when it was
acquired by the resident alien. Finally, the U.S. rules
that can result in tax on the earnings and profits of
foreign corporations that are “controlled” by U.S.
individuals would apply to corporations owned by the
resident alien.
In contrast, nonresident aliens are taxed by the United
States only on their U.S. source income. The tax is
generally imposed at a flat rate of 30% on a gross
basis; however, tax is paid at graduated rates on
any net income that is effectively connected with the
conduct of a U.S. trade or business.
Whether an individual is subject to U.S. estate and
gift taxes depends on whether he is domiciled in the
United States, not on the classification of his residency
status. An individual’s domicile is that place where he
has his permanent primary home to which he returns
or he intends to return.
E N T IT Y CL ASSIF ICAT ION
The U.S. tax treatment of an entity depends on its
classification for U.S. tax purposes. However, an
entity’s tax classification in its country of origin is not
necessarily its classification in the U.S. In addition, the
foreign entity may want to do business in the United
States using a separate entity for many reasons,
including liability protection and to protect the
foreign parent from U.S. taxation.
Foreign Corporations
Foreign corporations are taxed on their passive income,
including dividends, interest income, and rent, at a rate
of 30% on a gross basis to the extent not effectively
connected with a U.S. trade or business; their net
income that is effectively connected with a U.S. trade
or business is taxed at regular U.S. income tax rates
for corporations (currently the highest marginal rate
is 35%). An entity may also be taxed as a partnership
or be “disregarded” and treated as a branch of the
parent entity. When an entity is disregarded for tax
purposes, the entity is treated as part of its owner and
the income of the entity is reported on the owner’s
tax return. The classification of an entity is based on
the Code’s “Check-the-Box” rules. Under the Checkthe-Box rules, certain entities are known as “per se”
corporations, meaning that these entities must be
taxed as corporations in the United States. There is no
flexibility in treating them as a different type of entity
for U.S. income tax purposes. The regulations contain
a list identifying which entities are per se corporations.
If an entity is not listed as a per se corporation, it is
possible to elect its U.S. tax classification.
Foreign Entities (Other Than “Per Se” Corporations)
With a Single Owner
A foreign entity that has a single owner may elect to be
disregarded as an entity separate from its parent for tax
purposes. This would result in the owner being treated
as doing business directly in the United States.
Although there may be reasons this would be
desired for tax and other planning, this could result
in the owner being treated as having a “permanent
establishment” in the United States that could prevent
the owner from taking advantage of certain favorable
treaty provisions. A foreign entity that has a single
owner may also elect to be taxed as a corporation in
the United States. If an election is not made for a
single-owner entity within the time prescribed, the
default classification is that of a disregarded entity
if the owner does not have limited liability, and a
corporation if the owner has limited liability.
Foreign Entities (Other Than “Per Se” Corporations)
With Multiple Owners
A foreign entity that is not a per se corporation and
has more than one owner may elect to be taxed as a
partnership. This would result in the individual owners
being taxed on the U.S. income of the entity directly.
This could also result in certain withholding obligations
by the partnership on a non-U.S. owner’s share of
U.S. source income. If an election is not made for the
foreign entity within the time period prescribed, and all
owners of the entity have limited liability, then the entity
would be taxed as a corporation. If at least one owner
does not have limited liability then it will be classified
as a partnership, by default.
Limited Liability Companies
Limited liability companies (LLCs) are classified
depending on the number of owners. If the LLC has
more than one owner, it is either a partnership or
taxed as a corporation. If the LLC has only one
owner, it is either disregarded for tax purposes or
taxed as a corporation.
choice of business entity for tax purposes
When starting a new technology business, it is
important to consider the form that the entity will
take. Essentially, most start-up businesses have three
options: (1) C corporation; (2) S corporation; and (3)
limited liability company. The most tax flexible form
of entity for starting a business is a limited liability
company. Unless the entity elects otherwise, a
domestic limited liability company with more than one
member is taxed as a partnership. As a partnership,
all of the income is passed through to the partner
and generally is subject only to one level of tax,
although the branch profits tax, discussed below, may
result in an additional tax. Therefore, a partnership is
considered a “pass-through entity.” In comparison,
a C corporation is subject to two levels of tax: one
at the corporate level on income earned and one at
the shareholder level on cash or property distributed
from the corporation. Sometimes, these two levels
of taxation are referred to as “double taxation.” An S
corporation also is a pass-through entity that results in
one level of tax. Nonresident aliens and corporations
(domestic or foreign) may not own shares in an S
corporation.
However, there are tax differences between an S
corporation and a partnership that may make the
partnership the preferred taxable entity for a new
technology venture. All three entities provide liability
protection to their owners. While some venture
capitalists may be reluctant to invest in entities other
than C corporations, technology start-up companies
should not immediately abandon the idea of using
a limited liability company until there are no better
options. When discussing partnership taxation below,
it is important to remember that partnership tax
treatment will apply to a limited liability company and
its owners, unless the limited liability company elects
to be taxed otherwise.
To begin with, there is no tax to a partner upon the
contribution of property to a partnership in exchange
for an interest in the partnership. In a corporation
(S or C), a contribution of property in exchange
for stock is tax-free only if all of the shareholders
contributing property receive an aggregate of at least
80% of the stock in the corporation. Furthermore,
there are immediate tax consequences on the receipt
of stock in exchange for services. This is especially
significant in a technology company because there
is frequently at least one organizer who is receiving
an interest for services. If services are provided by
one of the organizers and property is contributed by
the other organizer, the stock received by the service
provider does not count toward the 80% ownership.
Therefore, unless the property contributor receives
80% of the stock, his property contribution would be
taxable. There is no such restriction in a partnership. In
addition, property (other than cash) may be distributed
to partners tax-free, whereas the distribution of
property in a corporation triggers gain (which could
result in two levels of tax in a C corporation setting)
with no cash to pay the tax on the recognized gain.
In a technology venture that fails, this is important
so that any property that has been developed by the
company may be distributed back to the partner who
created the technology without any tax imposed.
There are other tax consequences to service providers
with equity that make the partnership more attractive.
Technology companies frequently seek to reward and
provide incentives to employees in the form of equity.
In a corporation, the receipt of stock by a service
provider is taxable as compensation. However, the
grant of a partnership interest to a service provider in
a partnership may be structured so that it is tax-free
to the service provider. As long as what the partner
receives is what is known as a “profits-only” interest,
then there would be no tax on the receipt. As a profitsonly interest, the service provider would only have an
economic interest in the operations of the partnership
from the time of his receipt of the interest. In addition,
the limited liability company provides great flexibility in
structuring interests for employees.
The partnership is also an attractive entity for the
potential exit strategies of a technology company.
There are typically three exit strategies: (1) going
public; (2) tax-free reorganization; (3) taxable sale. In
terms of going public, it is necessary for the entity
to be a C corporation. However, a partnership may
be able to convert to a C corporation prior to going
public with no tax consequences. In addition, the
entity would have to be a corporation (C or S) in order
to participate in a tax-free reorganization. Although it
is more problematic, a partnership could convert to a
corporation prior to the reorganization. The problem
is with timing. If the conversion occurs too close in
time to the disposition or after there is a contract, or
under other circumstances indicating that the “step
transaction” doctrine applies, the transaction would
be taxable. Most important for start-ups is that in
the evolution of the business, the limited liability
company (taxed as a partnership) can often convert
tax-free to one of the other structures if necessary or
desirable for business and tax planning. In comparison,
changing from a corporate tax structure (especially a C
corporation) to a more favorable tax structure is often
very costly. Finally, there are circumstances where, to
maximize tax planning, multiple entities each with a
specialized tax purpose can be used to construct the
optimum tax and business model.
Note: a partnership having foreign partners is subject
to a special withholding tax on the effectively connected
taxable income allocable to such foreign partners.
source of income
The source of income is important for all foreign
entities or individuals irrespective of residency
status or classification although it is most important
for nonresident aliens and foreign corporations. It
affects the foreign tax credits that may be used by a
resident alien and the income subject to taxation of a
nonresident alien. Foreign corporations have similar
issues depending on whether they are doing business
in the United States or not. In most cases, the source
of income rules are dependent on the type of income
at issue. The list below represents the general rules for
certain common types of income.
Compensation for Personal Services
Interest
Real Property
Generally, interest is sourced to the residence of the
payor. Therefore, interest paid by a U.S. resident is
U.S. source income, whereas interest paid by a foreign
resident is foreign source income. It is important to
note that certain types of interest paid to nonresident
aliens is exempt from United States income tax even
though paid by a U.S. resident.
Gain from the sale of real property is generally sourced
to where the real property is located.
Dividends
Generally, the source of dividends depends on the
status of the payor as a foreign or U.S. corporation.
If the corporation paying the dividend is a U.S.
corporation, then the dividends would normally be U.S.
source income. However, there is a rule that requires
certain dividends paid by a foreign corporation to be
considered U.S. source income if 25% or more of
the corporation’s gross income for the 3-year period
ending with the current year was effectively connected
with a U.S. trade or business.
The source of income for personal services is where
the services are performed. However, there is an
exception from U.S. source income for income earned
by an individual who was temporarily present in the
U.S. for no more than 90 days in the year, who received
no more than $3,000 for the services, and who was
working for a non-U.S. person.
Rents and Royalties
Generally, the source of income is where the property is
being used or is located.
Personal Property
Generally, income from the sale of inventory property
is sourced to where the title to the property changes
hands. Most other personal property income is
sourced based on the residency of the seller. However,
if property is sold through a foreign office or a fixed
place of business it is sourced outside of the United
States, as long as the foreign country collects a tax of
at least 10% on the income. Similarly, property sold
by a foreign resident through an office or a fixed place
of business in the United States is sourced to the
United States. Gains from intangible property may be
treated as royalties if the gains are contingent on the
productivity, use, or disposition of the property.
passive income
Passive income includes dividends, interest income,
and rent. Generally, passive income is subject to a
tax at a flat rate of 30%. The Code refers to the type
of income taxed as fixed or determinable annual or
periodical income. In contrast, income that is related
to a U.S. trade or business is taxed at the regular
graduated income tax rates.
The statute identifies the following types of income
as fixed or determinable annual or periodical
income (“FDAP”):
Interest, dividends, rents, salaries, wages,
premiums, annuities, compensations,
remunerations, and emoluments.
Certain gains relating to the disposition of
timber, or coal or domestic iron ore.
A portion of the gain on original issue
discount obligations.
The statute also provides a default provision for
other fixed or determinable annual or periodical
gains, profits, and income.
Other items that have been found to be FDAP
include royalties, awards and prizes, alimony,
and gambling winnings.
Tax on FDAP is generally collected through
withholding.
Most United States taxation of income of nonresident
aliens occurs through withholding. Withholding
obligations are generally imposed on any payor of
U.S. source income to a nonresident alien or foreign
corporation. Under the Code, withholding is generally
at the flat 30% rate. This withholding tax is applied
to gross items of FDAP. This rate may be reduced
by Treaties.
Note: a partnership having foreign partners is subject to a
special withholding tax on the effectively connected taxable
income allocable to such foreign partners.
U.S. business income
Net income that is effectively connected with a
U.S. trade or business is subject to tax at the normal
graduated rates of tax, including the alternative
minimum tax. In addition, if the foreign entity
chooses to operate in the United States through a
branch, instead of establishing a separate taxable
entity, it would be subject to the branch profits tax.
The branch profits tax is an additional 30% tax on
after-tax retained earnings.
There are two tests used to determine whether
investment income is effectively connected. The asset
test considers whether the income, gain, or loss is
derived from assets used in or held for use in the
conduct of a trade or business. The business activities
test considers whether the taxpayer’s business
activities in the United States were a material factor
in the realization of the income.
There are certain record-keeping and information
return requirements imposed on domestic corporations
owned at least 25% by foreign owners and foreign
corporations engaged in business in the United States.
foreign ownership of U.S. real estate
There are two tax issues with respect to the ownership
of U.S. real estate. The first issue is how the income
from the operations of the real estate is taxed. The
second issue is how the income from the disposition
of the real estate is taxed. The method of taxation also
depends on the form of ownership of the real estate.
Generally, if the income from operations is effectively
connected with a U.S. trade or business, then the
net income would be taxed at graduated rates. If it
is simply rents that are not connected with a trade or
business, then the gross income would be subject to
withholding as FDAP.
In addition, tax is imposed on the disposition of
the real estate. If the real estate is owned through a
United States corporation, then a tax is imposed on
the disposition of the interest in the corporation if the
corporation is a “United States real property holding
corporation.” More complicated rules apply in the case
of partnership interests. Withholding is required on
the amount realized from the disposition of a United
States real property interest at a rate of 10%. There are
certain exceptions and limitations to the withholding
requirements. For example, provided that the
appropriate requests are filed with the IRS, the amount
withheld may not exceed the maximum amount of the
taxpayer’s tax liability.
state taxes
The following are the major taxes imposed by Virginia and Delaware as of 2006.
There are two tax issues with respect to the ownership
Income Taxes
Invididuals: Individuals are taxed on their income at graduated rates as follows:
V I R GI N I A
D E L AWA R E
Up to $3,000
2%
$2,000 - $5,000
2.2%
$3,000 - $5,000
3%
$5,001 - $10,000
3.9%
$5,001 - $17,000
5%
$10,000 - $20,000
4.8%
$17,001 and up
5.75%
$20,001 - $25,000
5.2%
$25,001 - $60,000
5.55%
$60,000 and up
5.95%
Corporations: Generally, corporations are taxed on their income at a rate of 6% in Virginia and 8.7% in Delaware.
Sales and Use Taxes
Property Taxes
Sales of tangible personal property, and certain
services, are taxed at a combined rate of 4.5% in
Virginia. Delaware does not have state or local sales
taxes. Instead, Delaware imposes license fees and
gross receipts taxes on goods and most services.
“Gross receipts” generally means the total receipts of a
business, without deductions for the cost of goods or
property sold, labor costs, interest expense, discounts
paid, delivery costs, state or federal taxes, or any other
expenses. The license fee and level of tax depends on
the type of good or service provided, but the license
fees are generally $75 to $100 for each place of
business, and the gross receipts tax rate ranges from
0.077% to 1.536% (for 2006) but are generally well
under 1%.
In Virginia, there are no state property taxes. Real and
personal property, including motor vehicles, are taxed
at the local level, and the rate varies by county or city.
In Delaware, localities impose property tax, but the
state does not. Real property taxes are very low, and
for 2006 the total local taxes range from approximately
$1.38 to $5.50 per $100 of assessed value, but
because the assessed value is just a small percentage
of the market value, the effective tax rate per $100 of
market value ranges from $0.38 to $1.60.
Recordation and Transfer Taxes
In addition to the above income, sales, and property
taxes, there may be recordation taxes and transfer
taxes imposed by the state and the locality upon the
transfer of property or recording of documents.
intellectual property
IN T RODUCT IO N
Assessment and protection of intellectual property are key concerns when starting a business in the
United States. “Intellectual Property” covers all of a company’s intangible assets and is protected by
patent, copyright, trademark, and trade secret law. It is important for a non-U.S. company starting
a business in the United States to have its technology and other assets reviewed by counsel in order to
determine what intellectual property protection may be available and advisable in the U.S.
PAT E NT S
A patent is a government grant of the right to exclude
others from making, using, or selling an invention
in the United States and the right to prevent others
from importing the invention into the United States.
In exchange for this exclusive government protection
for the invention, the inventor must fully disclose the
invention to the public in his patent application and
patent. Patent rights extend only to inventors or those
taking title to the invention from the inventors. There
are no age or citizenship requirements for obtaining
a U.S. patent. Patents applications are reviewed and
patents are granted by the U.S. Patent and Trademark
Office (PTO).
A patent does not guarantee that the invention is
worthwhile, valuable, or practical. It does not grant
the inventor the rights to make, use, sell, and import
his invention; it only allows him to prevent others from
engaging in such activity. Furthermore, in the event
that someone infringes the inventor’s patent rights,
the inventor is responsible for enforcing his patent
rights, not the U.S. government.
T YPE S OF PAT E NT S
There are three types of patents:
utility, design, and plant.
Utility patents are the most common type of patent,
and they are usually simply called “patents.” Utility
patents are available for inventions or discoveries of
new processes, machines, articles of manufacture,
and compositions of matter. A “process” includes
processes, acts or methods. “Articles of manufacture”
are those articles that are made. “Compositions of
matter” are chemical compositions, including mixtures
of ingredients and new chemical compounds. A utility
patent term lasts for 20 years from the date of filing the
patent application.
Design patents are granted for new and original
aesthetic or ornamental designs for articles of
manufacture. Design patent protection lasts for 14
years from the date the design patent is granted.
Plant patents are available for the invention or
discovery and asexual reproduction of new varieties of
plants. Plant patents have a 20-year term, beginning
with the filing date of the plant patent application.
RE Q UIRE ME N T S FOR A PATEN T
Patent law requires that an invention be new, useful,
and nonobvious. “Nonobvious” means the invention
would not have been obvious to a person having
ordinary skill in the art based on information and
inventions already available. Patents are not available
for algorithms, laws of nature, abstract phenomena,
mere ideas or suggestions. The patent application
must contain a complete description of the invention
and provide sufficient guidance so that a person
possessing skill in the field of the invention would
know how to use or make the invention.
T H E PAT E NT PRO CE SS
Unlike some foreign patent systems, the U.S. system
gives priority to the individual who is “first to invent,”
not “first to file.” However, an inventor has only one
year within which to file an application after his first
public use, offer for sale, or public disclosure of the
invention.
Before applying for a patent, an inventor or his patent
counsel should conduct a patentability or “prior art”
search (i.e., a search of patents, published applications,
scholarly materials, relevant publications, and other
information to determine everything publicly known
about an invention prior to date of the invention).
An inventor may file a provisional patent application
with the PTO, which allows the inventor to establish
an early effective filing date for the patent application.
While there is no need to file a provisional patent
application, it is inexpensive and informal, and it does
not require formal patent claims, oaths, declarations,
or prior art disclosures. The PTO does not examine
provisional applications on their merits. An inventor
may use “Patent Pending” on his invention once he
has filed a provisional application (or upon filing a
utility application). The inventor has one year from filing
the provisional application within which to file a utility
patent application. This one-year term is not included
in the 20-year patent term.
A utility patent application is a much more detailed
document. It must contain:
• A specification that includes a detailed description
of the invention;
• The claims (i.e., the subject matter for which the
inventor seeks patent protection);
• An oath or declaration of the inventor(s) that he
believes himself to be the original and first inventor
of the subject matter of the invention;
• A detailed drawing or set of drawings if necessary;
and
• The filing fee.
Once the application has been filed, the PTO carefully
reviews the application to determine whether it is
complete and to ascertain that the invention meets the
requirements for a patent. Generally, this “prosecution”
of the application involves a considerable exchange of
correspondence between the PTO examiner and the
inventor’s patent counsel (or the inventor). Once the
requirements for a patent have been met, the PTO will
grant a patent.
There are PTO fees at every stage of the patent
process, including fees to file a provisional application,
a non-provisional application, amendments to an
application, and fees upon issuance of the patent.
Additionally, there are maintenance fees due at 3.5, 7.5,
and 11.5 years after the date of issue. If maintenance
fees are not paid within the prescribed periods, the
patent will lapse.
As the patent process is very complex, it is
recommended that individuals and businesses seek
assistance from experienced legal counsel who is
admitted to practice before the PTO.
IN T E RNAT IONAL PAT E N T P R O TEC TIO N
A United States patent does not offer any protection
outside the United States and its territories. Therefore,
companies should consider filing for patent protection
in other countries. Depending on the company’s goals
and scope of its international business, the company
can choose to file an international patent application
or one or more national or regional applications. A
national application seeks patent protection in only
one country. A regional application allows the company
to apply for a patent in a group of countries in the
area served by the application, such as the countries
of the European Patent Convention. An international
patent application is an application under the Patent
Cooperation Treaty (PCT), a treaty ratified by the United
States and over 100 countries. The PCT provides the
basis for national or regional patent protection for the
signatories to the PCT. A company can choose to
apply for patent protection in as few or as many of the
participating PCT countries as it desires.
BE N E F IT S O F PAT E N T S
Patents are beneficial as they help companies:
• Form strategic alliances – Patents facilitate the
transfer of technology because they clearly define
rights in inventions and technology. These rights may
be licensed.
• Protect their business investments – Patents grant
exclusive rights for a long patent term, allowing a
company to recover its investments in research
and development, marketing, and other business
expenses.
• Protect against competitors – If a business patents
its technology, it may block or reduce a competitor’s
chance of patenting similar technology, or it may
protect the business from its competitor’s patents.
Furthermore, patents offer protection against loss of
market share to competitors.
As patent protection is so strong, patent infringement
lawsuits often result in large monetary awards. In
addition to considering whether patent protection
is available for its technology, before entering the
U.S. market, a non-U.S. company should consider
whether its technology infringes any U.S. patents
or applications.
• Build their businesses – Strong patent protection and
patent portfolios can signal to investors, business
partners, and the market that a company is strong
and has earning potential.
T RADE MARKS
A trademark includes any word, name, symbol,
number or device, or any combination thereof, used
by a provider of goods or services to identify the
origin of those goods or services. Trademarks include
brand names (identify a particular good), service
marks (identify a particular service), collective marks
(indicate the goods/services/members of a collective
organization), certification marks (identify the goods/
services meet certain standards), and trade dress (the
general appearance associated with goods, including
their shape, color, and packaging – e.g., the Coke
bottle design).
A trademark has no legal significance apart from the
good will of the product or service it identifies; thus,
a trademark is property only in the sense that it is
a symbol of good will. Protection for a company’s
trademarks exists only for those goods and services
in the same general business area as the company.
However, if a mark is sufficiently famous, such as
“Coke,” other uses of the mark in any business area
may be prohibited under dilution law.
CO MMON L AW T RAD E M A R K S
Trademarks need not be registered with the U.S.
government in order to be protected. Common law
trademark rights are acquired simply by using a given
trademark (or “mark”) in connection with a good
or service in commerce. Common law trademark
protection is limited only to those areas in which the
mark is actually used. The first individual or business
to use a mark in a geographic area has priority and
can prevent others from using the same or confusingly
similar mark on similar goods or services.
F E D E RAL LY RE GIST E RE D TR A D EM A R K S
Trademarks may also be registered with the Patent
and Trademark Office. Federally registered trademarks
(denoted by “®”) are generally protected throughout
the United States, not just the geographic areas in
which the goods and services are available. Once
a trademark has been registered, it is evidence of
the trademark owner’s exclusive right to use the
mark in commerce, and it allows the company to
direct the U.S. Customs Service to prevent the
importation of infringing goods into the United States.
Registration also serves as notice to other individuals
and companies running trademark searches. A U.S.
trademark registration can provide the basis for a
foreign trademark registration.
To obtain a federally registered trademark, a company
must file an application with the PTO:
• Designating the trademark,
• Naming the classes of goods and/or services the
trademark is associated with,
• Providing “specimens” of the mark as actually used,
and
• Stating the extent of the actual use of the trademark
in commerce or a statement that the applicant
intends to use the trademark in commerce within a
certain period of time. (If an application is based on
“intent to use,” the applicant must file an “Allegation
of Use” with the PTO within six months — or 36
months if the applicant has filed Extension Requests
— of the allowance of the trademark.)
The PTO will examine the trademark application to
determine that the trademark is not confusingly similar
to an existing mark, generic or merely descriptive,
misdescriptive of the goods and services, deceptive,
immoral or scandalous, or otherwise unable to be
federally registered. Federal trademark protection
lasts for as long as the trademark is used and the
trademark owner does not take any action which would
cause him to lose his trademark rights. Additionally, a
trademark owner must file a Declaration six years after
the registration issues and renew the registration every
10 years.
In addition to federal trademark registration, a
trademark owner can seek a state trademark
registration. However, while relatively easy and
inexpensive, state trademark protection is not as
strong as federal trademark protection.
IN FR IN G EM EN T
An individual’s trademark is infringed if someone
else uses an identical or confusingly similar term or
mark on related goods or services or in an area that
is reasonably similar to the trademark owner’s type of
business. For a common law trademark, this use must
be in the same geographical area as the trademark
owner’s prior use of the mark. Federally registered
trademarks provide for protection throughout the
United States. Trademark infringement can result in
large civil penalties, loss of profits, an injunction against
use of the infringing mark, destruction of infringing
goods, and additional fines and fees.
CO PYRIGHT S
Copyrights offer protection to the authors of
“original works of authorship.” Copyright protection
is available whether or not the work is published.
Copyright protection grants the copyright owner
the exclusive right to:
standard of originality to be copyrightable; copyright
protection is not available for a work that consists only
of information that is common knowledge and contains
no original authorship (like a calendar or a phonebook).
• Reproduce the work in copies or photocopies;
C O P Y R IG H T O WN ER S H IP
• Prepare derivative works (a derivative work is a
work that is based on the existing work);
• Distribute copies or phonorecords of the work to
the public by sale, rental, lease, lending, or other
form of transfer;
• Perform the work publicly, in the case of literary,
musical, dramatic, and choreographic works,
pantomimes, motion pictures, and other
audiovisual works;
• Display the work publicly, in the case of literary,
musical, dramatic, and choreographic works,
pantomimes, and pictorial, graphic, or sculptural
works; and
• Perform the work publicly via a digital audio
transmission, in the case of sound recordings.
In addition to the above rights, certain visual art works
enjoy rights of attribution and integrity. The right of
attribution ensures that an artist is properly identified
with his work of art and that he is not improperly
identified with a work he did not create. The right
of integrity also protects artists and their works by
permitting artists to prevent the modification or
destruction of their art that might be harmful to the
their reputations.
Copyright protection is available to:
• Literary works, including books, poems, scripts,
articles, and computer programs;
A copyright belongs to the author of the work.
Generally, the individual or individuals who wrote,
composed, or developed the work will be considered
the “authors” of the work. However, some works,
particularly those created in an employment
relationship or business context, are “works made for
hire.” With a “work made for hire,” the author and the
original copyright owner of the work is the employer,
not the employee. A work has been made for hire if (1)
an employee prepares the work within the scope of his
or her employment, or (2) the work was commissioned
and there is a written agreement signed by the parties
indicating the work has been made for hire.
Joint authors of a work are co-owners of the copyright,
unless they agree otherwise in writing. For works that
are compilations of works of separate authorship,
the copyright in each individual work is separate
from the copyright in the collective work. Copyright
ownership may be transferred. If the author wishes
to transfer any exclusive rights, the transfer must
be by written agreement signed by the copyright
owner or his authorized agent. Such transfers may
be recorded with the Copyright Office, but it is not
necessary. Furthermore, a copyright may be conveyed
by operation of law, such as through a will. The
current copyright law allows an author (or his specified
beneficiaries, if he is dead) to terminate a copyright
transfer under certain conditions if he provides written
notice to the transferee in the specified time period.
• Musical works, including any accompanying words;
• Dramatic works, including any accompanying music;
• Visual works, including paintings, sculptures, and
photographs;
• Pantomimes and choreographic works;
• Sound recordings, including phonorecords;
• Audiovisual works, including television programs
and motion pictures; and
• Architectural works.
Copyright protection is not available to works that
have not been fixed in a tangible form of expression,
nor is it available to lists of ingredients, titles, slogans,
names, and short phrases. Furthermore, copyright
protects expression only, not ideas, methods, systems,
processes, principles, or discoveries, although the
original description, explanation, or illustration may
be protectable. Finally, a work must meet a very low
C O P Y R IG H T R EG IS TR ATIO N
A work is under copyright protection from the moment
that the work is created in a fixed form. Publication,
registration, and copyright notice (the “©”) are not
requirements for copyright protection.
However, for businesses, formal registration of a
copyright is recommended. Copyrights are registered
with the Copyright Office, which is a part of the Library
of Congress. Copyright registration provides the
following benefits:
• Establishes a public record of the copyright, putting
others on notice of the copyright;
• Allows the copyright owner to file a copyright
infringement suit (a copyright must be registered
before a suit is filed);
• Allows the copyright owner to record the copyright
registration with the U.S. Customs Service to prevent
the importation of infringing works;
• Serves as prima facie evidence in court of the
copyright’s validity and the truth of the information in
the copyright registration documents (this is available
only if the copyright is registered before or within five
years of the work’s publication);
• Allows the copyright owner to receive statutory
damages and attorneys’ fees, as opposed to only
actual damages and the defendant’s profits, in
an infringement suit (this is available only if the
copyright registration is made within three
months of the work’s publication or prior to
any copyright infringement).
Additionally, while not required for copyright
protection, affixing copyright notice is recommended.
Copyright notice serves as actual notice of copyright.
Without notice, an innocent infringer will not be liable
for actual or statutory damages until he receives actual
notice of the copyright. Copyright notice consists of
(1)“©”, “Copyright,” or “Copr.,” (2) the year of first
publication, and (3) the name, abbreviation, or other
recognizable designation of the copyright owner.
The copyright notice should be affixed to the
copyrighted work in such a way as to provide
reasonable notice of the copyright.
RE G IST RAT ION PROCE DU R E
The Copyright Office has different registration forms
for different types of works. The author, a copyright
claimant, an owner of an exclusive right or rights in
the work, or an authorized agent thereof submits
the appropriate application form, the filing fee,
and a deposit copy of the work in one package to
the Copyright Office. There are different deposit
requirements for different types of works.
A copyright registration is effective as of the date that
the Copyright Office receives all of the necessary
application materials in the appropriate form. However,
as a certificate of registration requires additional
processing, the Copyright Office generally sends out
the Certificate of Registration within a few months.
C O P Y R IG H T D U R ATIO N
For works created on or after January 1, 1978,
the copyright term is the life of the author plus 70
years. If a work has multiple authors, the copyright
term lasts for 70 years after the last author’s death.
For anonymous (works without an author) and
pseudonymous works (works authored under a
fictitious name) and “works for hire,” the copyright term
is the shorter of 95 years from publication or 120 years
from creation.
C O P Y R IG H T IS S U ES
An individual infringes a copyright if he uses or copies
a copyrighted work without authorization. Copyright
infringement can result in large civil penalties, criminal
penalties, and the seizure or forfeiture of infringing
materials. However, as copyrights do not protect ideas
alone, it is not infringement to use the underlying idea
of a work without copying the “expression” of the
work. Furthermore, there are several exceptions to
copyright infringement. Among the most important is
the concept of “fair use.” Fair use allows others to use
a copyrighted work for criticism, education, research,
news reporting, satire, and other limited purposes.
U.S. copyright protection is available for all
unpublished works, regardless of the nationality or
domicile of the author. Published works may receive
U.S. copyright protection if they are Berne Convention
works or if, as of the date of first publication, any of
the authors are nationals or domiciliaries of the United
States or a country that is party to a copyright treaty
with the United States.
T RAD E SE CRE T S
Some companies choose not to patent their
technology and know-how. Instead, they opt to
protect this information by keeping it secret, and,
thus, this information is known as “trade secret.”
Because the information is not available to others and
especially a company’s competitors, trade secrets are
valuable. Trade secrets may include such information
as formulae, design specifications, computer
programs, pricing information, and customer lists.
There is some legal protection available from state
law for trade secrets. Additional protection may
be provided in written agreements with company
employees and business partners. The terms of
such agreements should include confidentiality and
nondisclosure provisions, prohibiting the parties to
the agreement from revealing any confidential or
proprietary information regarding the business and
technology of the company. Moreover, successful
protection of trade secrets requires that the company
take reasonable precautions to keep the information
from being disclosed to the public.
Protecting technology by trade secret can be risky.
When employees leave the company, they possess
valuable information about the company and its
technology. Even with an agreement prohibiting
disclosure of trade secrets, the information may be
leaked to the public and the competition. Furthermore,
some technology may be “reverse engineered”
by competitors, even without a disclosure of the
secret information. Unlike patents, once the trade
secret information gets into the public, the company
cannot prevent others from using it. Therefore, it is
recommended that a company should secure stronger
forms of intellectual property protection if available.
labor & employment
IN T R
RODUCT
ODUCT IO N
The employment relationship in the U.S. is subject to a wide array of federal, state, and local
regulations. Foreign employers may also face additional challenges in navigating these requirements.
E MPLOYME NT D ISCRIM IN ATIO N
Many U.S. laws prohibit discrimination against
individuals in both the hiring process and during
the term of employment. Discrimination is defined
broadly in this sense – regulations exist to prohibit
discrimination based on factors such as age, race,
color, sex, national origin, religion, disability, and other
protected characteristics. Discriminatory practices
include bias in hiring, promotion, termination and
various types of workplace harassment, in addition
to retaliation against employees and applicants who
exercise their rights under these laws.
Many, but not all, of the discrimination laws depend
on the number of employees. However, in most cases
the threshold number of employees is low enough
that most employers will be subject to the regulations
and should be mindful of them. Therefore, no matter
the number of individuals employed, an employer is
encouraged to familiarize itself with the discrimination
laws and to work to follow them as closely as possible.
F E D E RAL E MPLOYME NT D IS C R IMIN ATIO N LAWS
The following are the most notable of the
many federal employment discrimination laws:
1 Title VII of the Civil Rights Act (“Title VII”)
Title VII prohibits discrimination in hiring, employment,
and termination on the basis of race, color, national
origin, religion, sex, and pregnancy. In addition, sexual,
racial, religious, and ethnic harassment by supervisors,
coworkers, or third parties is also prohibited.
Employers may not engage in discrimination, whether
or not it is intended, by use of requirements that have
an adverse effect on protected groups. In order to
justify the exclusion of disproportionate numbers
of a protected group, the employer must prove that
the requirements are job-related and required by
business necessity.
Title VII is enforced by the Equal Employment
Opportunity Commission (“EEOC”). The EEOC also
requires each employer to display a poster explaining
the employees’ rights under Title VII.
2 The Age Discrimination in Employment Act
of 1967 (“ADEA”)
The ADEA prohibits discrimination in hiring,
employment, and termination against individuals aged
40 or older. In addition, the law prohibits mandatory
retirement and certain other practices. The ADEA is
enforced by the EEOC.
3 The Americans With Disabilities Act of 1990 (“ADA”)
The ADA protects individuals with disabilities or
with a history of a serious condition. As long as
the individual is able to carry out the essential
functions of a given job and without unreasonable
special accommodations, the individual cannot be
discriminated against based on his disability. Whether
or not an accommodation is “reasonable” takes
into account the company’s size, the nature of the
employment position, the cost of the accommodations,
and the effect of the accommodations on the business.
Based on these terms, the ADA requires a case-bycase analysis to determine whether the employee can
perform the job and whether the employer is obligated
to make special accommodations.
In addition, the ADA prohibits discrimination against
individuals because of their relationship with a person
who has a disability, such as a parent of a disabled
child. It also bars pre-offer inquiries about medical
history or existence of disabilities. Physical exams,
however, are permitted if needed to determine the
applicant’s ability to do the job.
The ADA is enforced by the EEOC.
4 The Civil Rights Act of 1866, U. S. Code
Title 42, Section 1981 (“Section 1981”)
Section 1981 states that all individuals, regardless
of race, are entitled to equal treatment with respect
to making contracts, enforcing contracts, and
enjoying the rights, privileges, and terms of contracts.
Additionally, all individuals shall receive equal treatment
under the laws of all states. According to the U.S.
Supreme Court, Section 1981 applies to employment
discrimination against minority group members and
members of various ethnic groups, but does not apply
to women as a separate class.
5 The Family and Medical Leave Act of 1993
(“FMLA”)
The FMLA protects employees who take leave when
they or their family members have a serious health
condition requiring medical care for which a doctor
determines that leave is necessary. The period of
leave available depends on the health condition, but
is limited to 12 weeks of unpaid leave. In addition, the
FMLA may cover employees who request leave due
to the birth or adoption of a child. Employers may not
discriminate against employees who request leave in
these circumstances and must continue the employee’s
health insurance coverage in these situations.
The FMLA is administered by the U.S. Department
of Labor (“DOL”). The DOL also requires that each
employer display a poster explaining the employees’
rights under the FMLA.
6 The Equal Pay Act of 1963 (“EPA”)
The EPA prohibits sex-based discrimination in the
payment of wages. Under this statute, employers must
provide equal pay for equal work to employees whose
jobs require equal skill, effort and responsibility, and
which are performed under similar working conditions.
The burden of proof rests on the employer to prove
that a difference in pay between a man and a woman is
due to a seniority system, merit system, or some factor
other than sex. The EPA does not allow employers to
justify lower pay to a female employee who is doing
work identical to that of a male employee on the
grounds that she did not bargain as well in her initial
employment agreement.
The EPA covers all employers who are covered by the
Fair Labor Standards Act (discussed below). Thus,
most employers are required to abide by the EPA.
E MPLOYME NT D ISCRIM IN ATIO N G EN ER A LLY
Most U.S. states, and some localities, have similar
laws; some of these laws may go beyond the
protections of the federal discrimination laws.
Discrimination violations can result in substantial
penalties, as most statutes are tailored to allow
lawsuits against the employer. Remedies available may
include compensatory and punitive damages, back
pay, front pay, reinstatement, injunctions, awards of
attorney’s fees and costs, and liquidated or “double”
damages. These statutes generally also provide for jury
trials, and juries might harbor a “pro-employee” bias.
This attitude may be even more likely in cases involving
foreign employers. In many instances, juries have
awarded large monetary verdicts to employees.
Employment discrimination lawsuits are often costly.
The suits involve factual disputes, making them
difficult to dismiss before trial. Thus, it can be costly
for employers to defend against even frivolous claims.
Familiarity with the current employment laws may help
to minimize the number of lawsuits filed, thus saving
the employer money.
E MPLOYME NT D ISCRIM IN ATIO N
AN D F O RE IGN E MPLOYER S
Foreign companies in the U.S. are often targets
of employment discrimination claims brought by
American employees. Most of these lawsuits are based
on claims of preferential treatment of staff from the
foreign employer’s home country. Many claims are
based on the company’s treatment of “rotating” or
“expatriate” staff. The expatriate staff members are
typically nationals of the foreign employer’s country
who are employed in the parent company’s offices
overseas but are assigned to work in the U.S. office for
a certain amount of time. American employees have
challenged: the “reservation” of high-level positions at
the U.S. office for rotating expatriate staff members;
the lack of opportunities for the promotion for American
employees; alleged pay differences or other instances
of disparate treatment of American and expatriate staff;
and sex, race, and national origin-based discrimination.
However, foreign employers do enjoy some special
defenses not available to all U.S. companies. For
example, certain types of treaties (particularly
Friendship, Commerce and Navigation Treaties, or
“FCN treaties”) between the U.S. and foreign nations
may be raised as a possible defense. Some U.S. courts
have begun to take a broad view of the extent to which
FCN treaties may allow a foreign company to treat
expatriate staff preferentially. However, the law in this
area is still developing, and this view of FCN treaties is
far from universal.
In addition to these claims based on preferential
treatment of expatriate staff, American employees may
also make other claims against foreign employers.
Some American employees have claimed that foreign
employers engage in discriminatory practices by failing
to include American staff in informal gatherings of
expatriate staff. Therefore, it is essential for the foreign
employer to be aware of behaviors and activities that
may make American staff may feel as if they are being
treated differently from employees from the employer’s
home country.
Other issues arise in connection with the role of women
and minorities in the workplace. Conduct that would
be acceptable in other countries may lead to claims of
discrimination or harassment in the U.S.
EM PL OYME NT COMPE NSAT IO N A N D B EN EFITS
Various state, federal and local laws set out
requirements for employee compensation and
benefits. Several of these laws are discussed below.
Wage and Hour Laws
The federal Fair Labor Standards Act (“FLSA”)
contains detailed requirements regarding employee
compensation. The four main components of the
FLSA are as follows:
1 Minimum Wage Requirements. The FLSA requires
employers to pay employees the “minimum wage.”
The current minimum wage is $5.15 per hour in
most industries.
2 Overtime Requirements. Employers must pay
overtime to employees who work over 40 hours
per week, with certain exceptions for professional
and managerial work. The FLSA generally requires
overtime pay at 1.5 times the normal hourly rate of the
employee. However, some industries have successfully
lobbied for exceptions to this requirement.
3 Child Labor. Youths under 18 years of age are
generally not permitted to work more than 20 hours
per week when school is in session. In addition,
youths are restricted from working with certain types
of dangerous equipment and machinery. The FLSA
also prohibits labor by children under age 16, with
certain limited exceptions.
4 Equal Pay. The Equal Protection Act (“EPA”)
constitutes the fourth component of the FLSA.
The requirements of this act have already been
discussed above.
The FLSA is enforced by the U.S. Department of
Labor (“DOL”). The DOL requires each employer to
display a poster explaining the employees’ rights
under the FLSA. The FLSA provides for civil and
criminal penalties for FLSA violators. There may be
similar state laws in effect as well.
Fringe Benefits
In addition to wages, most private employers in
the U.S. provide their employees with some sort of
benefits package, although the law does not require
the provision of these “fringe benefits.” These fringe
benefits generally include health insurance, life
insurance, pension or 401(k) plans, sick pay, paid
vacations, and paid holidays. There are several laws in
place to govern the administration of these benefits.
Some of the most notable are discussed below.
The Health Maintenance Organization Act (“the HMO
act”) requires certain employers who are already
offering health insurance benefits to offer an alternative
HMO option to employees if a qualified HMO exists. In
addition, the HMO act requires employers to allow their
employees to make contributions to their share of the
cost through payroll deductions.
Many retired employees continue to receive payments
from their employers in the form of a pension. The
Employee Retirement Income Security Act of 1974
(“ERISA”) governs the administration of designated
pension plans and certain other benefit plans. ERISA
requires the sponsors and administrators of these
benefit plans to protect the assets available to plan
participants and to advise employees of their rights
under the plans. In addition, ERISA regulates the
minimum requirements for benefit plans and prohibits
retaliation against employees who assert their rights
under ERISA. Tax benefits are often available to
employers who follow the ERISA guidelines.
In situations where employees would otherwise lose
coverage under company medical insurance plans,
the Consolidated Omnibus Budget Reconciliation Act
(“COBRA”) allows employees of qualified employers to
continue their existing insurance coverage by payment
of the company’s cost of such insurance. For example,
termination, layoff, or death may trigger COBRA.
Under COBRA, eligible employees and dependents
can generally extend their health insurance for up to 18
months.
The Health Insurance Portability Act (“HIPAA”) prohibits
companies from adopting eligibility rules for group
health insurance plans based upon health-related
factors. Under HIPAA, employers also cannot drop an
individual from a health insurance plan based upon
poor health or charge higher premiums due to health
problems. HIPAA also details certain situations in which
exclusion of employees due to pre-existing conditions
is acceptable or unacceptable.
Unemployment Insurance, Workers’ Compensation,
Short-Term Disability Insurance, and Social Security
Most states require employers to provide
unemployment insurance, short-term disability
benefits, and workers’ compensation.
benefits are available to individuals when they retire or
when they are so disabled that they cannot continue to
earn a living. An individual’s Social Security benefits are
payable to his survivors upon his death.
Issues for Foreign Employers
Unemployment insurance allows individuals to
receive temporary compensation when they lose
their job through no fault of their own. This temporary
compensation lasts for a relatively limited period,
unless the individual finds a new job. Both state and
federal laws regulate the system of unemployment
insurance, and state and federal taxes are imposed on
employers to fund the unemployment compensation
system. Additionally, some states also provide
additional benefits to workers who are disabled and
unable to work.
Foreign employers are often found to be in violation of
these laws due to a lack of familiarity with the details.
For example, many foreign companies run afoul of the
employment regulations for “temporary” employees
and treat them in ways that cause them to become
regular employees with different benefit, compensation,
tax, and wage-hour requirements. Other issues often
arise related to the FLSA, described above, including
requiring “full-time” work from “part-time” employees,
failing to pay overtime where earned, and failing to
maintain the required employment records.
Workers’ Compensation laws protect employees who
are injured or disabled on the job. Instead of suing
employers for injuries sustained on the job, employees
receive fixed workers’ compensation payments.
In addition, workers’ compensation provides benefits
for the families of workers’ who are killed due to
work-related accidents or injuries. Workers
compensation laws also help employers by limiting
the amount an injured employee can recover from
his employer. Generally, state laws set the standards
for workers’ compensation.
Similar problems may arise in the classification of
“independent contractors.” Foreign employers may
treat workers as independent contractors, even
though they are legally classified as employees of the
company. To complicate the matter, an individual may
be considered an “employee” under some laws, but
an “independent contractor” under others. Therefore,
legal advice should be sought prior to hiring
independent contractors.
The federal Social Security program is financed by
taxes levied on employers and employees (generally
through payroll tax withholding). Social Security
O CCUPAT IONAL SAF E T Y A N D H EA LTH LAWS
The federal Occupational Safety and Health Act of
1970 (“OSHA”) sets forth the minimum requirements for
occupational health and safety. These regulations are
aimed at eliminating workplace injuries and illnesses.
Many states have their own occupational health and
safety laws as well.
OSHA is administered by the Occupational Safety
and Health Administration (under the Department
of Labor). OSHA gives this agency the authority to
conduct workplace inspections and investigations, and
to impose citations, fines, and penalties for violations
of the OSHA standards. Where workplace conditions
are especially bad, the agency may seek injunctions to
remedy conditions or practices that pose an immediate
threat to employees. OSHA requires each employer to
display a poster explaining the act.
T E RMIN AT ION OF E MPLOYMEN T
The federal Worker Adjustment and Retraining Act
(“WARN”) requires those employers with 100 or more
full-time employees to give 60 days advance notice to
affected employees before a “plant closure” or “mass
layoff” (as defined by WARN). In these situations, the
employer must notify the employees or their union
representative, as well as certain state and local
government offices. Failure to provide proper notice
may result in civil penalties.
Aside from WARN, federal law does not detail
specific procedures that private sector employers
must follow in cases of employee termination. Most
employees in the U.S. have not entered into an
individual employment contract. Rather, most American
employees are covered by the “employment-at-will”
doctrine. This doctrine holds that as long as no other
laws are violated (such as the discrimination laws
discussed above), any employee without a formal
written employment contract can be discharged at any
time, for any or no reason, with or without cause or
notice.
However, in recent years some courts have begun to
reject parts of this doctrine, and now the treatment
of employment-at-will varies from state to state.
For example, various states have recognized
exceptions to the employment-at-will rule, making
the legal implications of this doctrine somewhat
unclear. Challenges to the employment-at-will rule
have occasionally resulted in large jury verdicts in
favor of employees. These suits, like employment
discrimination suits, may be costly and difficult to
defend. Familiarity with the applicable laws may help to
prevent these types of suits.
LABO R L AW AN D UNIONIZ ATIO N
Labor laws generally aim to equalize the bargaining
power between employers and employees. Employers
operating in interstate commerce (most employers in
the U.S.) are subject to the National Labor Relations
Act of 1935 (“NLRA”). The NLRA prohibits employers
from discriminating against employees who choose
to engage in (or decline to engage in) any unionrelated activities.
The NLRA protects the right of employees to form,
join or assist labor organizations or unions. In addition,
employees have the right to bargain collectively
with the employer through their chosen union
representatives. This collective bargaining consists
of negotiations between an employer and a group of
employees to determine the conditions of employment.
The NLRA also governs numerous aspects of the
employer-union relationship, including collective
bargaining and arbitration. Rather than lawsuits,
disputes between the union and employer are generally
solved by arbitration. In effect, the NLRA establishes
guidelines for good faith bargaining and relations
between the parties.
The NLRA is administered by the National Labor
Relations Board (“NLRB”). If an employer is found to be
in violation of the NLRA, the NLRB has the authority to
determine the appropriate remedy.
There are several labor law issues that are of particular
note to foreign employers doing business in the U.S.
In recent years, unions have stepped up their efforts to
organize the employees of foreign-owned companies.
In addition, some union representatives may try to take
advantage of foreign employers’ relative unfamiliarity
with the NLRA.
O T H E R CO N SIDE RAT IONS
Many of the laws surrounding the American workplace are enforced by federal, state, or local agencies.
In many cases, these agencies have broad investigative and enforcement powers. Thus, employers must
always be aware of the limits of these powers, as in some cases agency personnel may attempt to exceed
or abuse their powers. In addition, employers must be careful to avoid violations of these laws. Due to
the complexity of workplace regulations, most employers should undertake a periodic review to ensure
their compliance with the applicable laws.
Some of the considerations employers should take
into account are listed below.
1
Posting Requirements
Federal law requires posting of several notices in
the workplace. Employees must be advised of the
federal laws prohibiting job discrimination. There
must be notices explaining minimum wage and
overtime requirements under the FLSA, as well
as safety requirements under OSHA. In addition,
employers must post a notice explaining the Employee
Polygraph Protection Act, which prohibits employers
from administering polygraph (lie-detector) tests to
employees except in very limited circumstances.
Individual posters may be obtained from each
government agency, or posters combining all of these
notices into one document are available from private
sources. Each state has its own posting requirements
as well.
2
age, race, sex, national origin, ancestry, citizenship,
religion or disability. Several other topics may be off
limits as well, depending on any state laws regarding
discrimination.
Job Applications and Interviews
In order to obtain all of the information from job
applicants that may be necessary for the employer
to make informed employment decisions, employers
should consider developing their own employment
application forms. These application forms should
contain (1) a statement of the equal employment
opportunity policy, (2) a statement that the employment
will be at-will, and (3) a release for claims associate
with a check of the applicant’s references or
background.
Employers must remember that on an employment
application or in an interview, it is illegal to ask
questions relating to information about an applicant’s
3 Processing New Hires
Employers are not allowed to hire or employ individuals
who do not possess authorization to work in the
United States. In order to prove compliance with this
requirement, employers and new hires must fill out
the “Employee Information and Verification Form”
(“Form I-9”). A sample Form I-9 is included after
this discussion. In addition, new hires must provide
documents demonstrating that they are legally
authorized to work in the United States.
4
Personnel Files
Employers should generally maintain personnel files
for all employees. These files should contain (1) the
employee’s job application, (2) the new hire form,
(3) any performance evaluations, (4) any disciplinary
information, and (5) any other documents related to the
individual’s employment. The personnel files should
not contain medical information, employee benefits or
Form I-9. Those documents should be kept in separate
confidential files. Personnel files are considered to be
the employer’s property, and therefore access to these
files should be granted only to those individuals who
need to review the files. Depending on the applicable
state law, some employers may be required to grant
employees access to their personnel files.
5 Employee Policies and Handbooks
Employers should develop written policies for a variety
of workplace issues, including but not limited to at-will
employment, harassment, jury duty, vacation/personal
time, work hours, overtime, sick leave, discipline,
solicitation, disability leave, resignation, termination,
equal employment opportunity, holidays, and smoking.
These policies can be compiled into an employee
handbook that is given to each employee.
6 OSHA Hazard Communication
All employers must establish a written Hazard
Communication Program, aimed at training employees
to identify workplace hazards. In addition, employers
must educate employees with regard to maintaining
labels and material safety data sheets for all hazardous
substances before employees handle them.
7 Smoking
Depending on the applicable state and local laws,
some employers may be required to establish
smoking policies. In general, these policies must
provide, among other things, a smoke-free work
area for non-smoking employees.
8 Record-Keeping
There are various federal, state and local laws requiring
employers to retain certain documents for possible
inspection by government agencies. Federal law
contains three major record-keeping requirements:
• Under the Immigration Reform and Control Act,
employers must keep an employee’s Form I-9 for
three years after the employee’s hire date or one
year after the employee’s termination date,
whichever is later.
• Federal employment discrimination laws require
employers to retain documents relating to any
personnel or employment records, payroll records
and benefit plans for specified periods of time.
• The Fair Labor Standards Act requires employers to
keep payroll records, individual contracts or collective
bargaining agreements, wage-hour notices, and sales
and purchase records for three years.
The individual states may have additional
record-keeping requirements.
If any government agency investigates an employer’s
policy or practice, any documents relating to said
policy or practice should be retained until the
investigation is complete.
9 State Employee Benefit and Insurance
Requirements
Though these requirements vary depending on
the state, state employee benefit and insurance
requirements generally include provisions for
disability benefits, unemployment benefits, and
workers’ compensation.
10 Employee Conduct and Progressive Discipline
Though the law does not require it, many
employers choose to design and publish written
policies advising employees of workplace rules and
of what constitutes inappropriate conduct in the
workplace. Many employers publish these policies to
ensure that employees are advised of the employer’s
expectations and of the consequences of failing to
behave appropriately.
It may be in the employer’s best interest to develop
corrective action and progressive discipline policies for
correction and punishment of inappropriate behavior.
Uniformity and consistency of these disciplinary
procedures may minimize employment discrimination
or wrongful discharge claims against the employer.
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