• Photocopying & Copyright Law
• Real Estate: Private Mortgage Insurance 
• Estate Planning: Tax Basis of Inherited and Gifted  Property
• Taxes on Tips
• Credit reports: Improper Use
• Noncompetition Agreements: Employer/Employee
• Fall 1998 Topics:  Employment: Sexual Harrassment; Real Estate: Lead Paint Hazards; Estate Planning & Life Insurance; IRS Reforms; Credit Unions
• Summer 1998 Topics: Limited Liability Companies, Elder care, Commercial Leases, Real Estate, Estate Planning
• Spring  1998 Topics: Employment Law; Technology; Health Care; Drug Testing in Schools; Legal Protection for Volunteers; Credit Card Fraud
• Wills & Trusts Seminars
• Legal News

Fair Use

In deciding whether copying without permission is legal under the fair-use doctrine, courts look at four factors. First, if the purpose and the character of the copying relate to endeavors such as criticism, comment, news reporting, teaching, scholarship, and research, fair use is more likely to be found. Second, the nature of the material to be copied is significant. For example, material meant to be consumed when used, such as workbooks or test answer forms, is less likely to fall under fair-use copying than a page from a newspaper or magazine article. The third factor is the amount and substantiality of the portion of the work that is copied. The sheer volume of copying is not the only consideration, as a single page from a newsletter can be as "substantial" as a whole chapter from a large book. In general, the more importance the copied portion has to the content of the whole document the less likely it is that fair use applies. 

The final, and often decisive, factor is the effect of the photocopying on the potential value of the copyrighted work. This relates in part to a dollars and cents consideration of whether the market for the material is adversely affected. 

For example, copying and distributing a publication to employees in a company to save the cost of multiple subscriptions may seem harmless, but each saved subscription deprives the copyright owner of income as surely as selling photocopies of the publication on a street corner. The unauthorized use of material can also damage its value in a manner that is harder to quantify, such as copying portions of a book without attribution, which deprives the copyright owner of the credit and publicity he or she otherwise would receive. 

Damages

The Copyright Act allows a copyright owner to sue for actual damages caused by an infringement and for any profits that are attributable to the infringement. Since it can be difficult to calculate actual damages, Congress provided an alternative--the recovery of statutory damages in an amount determined by a court within a range set forth in the Act. Because the statutory damages are imposed for each work infringed, substantial damages awards are possible. The owner also can recover for the costs of bringing suit and for attorney's fees. 

It may be too much to expect that a person poised at the copying machine will run through the four-part, fair-use test before pushing the "copy" button. If the material to be copied has the copyright symbol on it, however, would-be copiers should at least consider whether they would object to the photocopying if they had written or drawn the material. If the answer is "yes," the copying is almost certain to be a copyright infringement. Even if the answer is "no," the person could still be committing copyright infringement. 

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A range of benefit programs under the broad umbrella of the Social Security Act is financed largely from taxes paid by employers and employees under the provisions of the Federal Insurance Contribution Act (FICA). The Internal Revenue Code requires every employee to pay a FICA tax, calculated as a percentage of his or her wages. The employer must deduct FICA taxes from wages as they are paid. Independent of the employee's obligation is the employer's duty to pay FICA taxes, which are computed as a percentage of the wages paid by the employer. 

With some exceptions, tips received by employees are treated as wages for both the employee's and the employer's share of FICA taxes. On a monthly basis, employees are required to report to their employers in writing all tips received. As far as cash tips are concerned, employees are effectively operating under an honor system, since only they and the customers know the exact amount of the tips. 

For the employee's portion of the FICA tax, federal law requires that the employer take into account only those tips that are included in the written report from the employee. However, there is no such statute for the employer's portion. Since the employer's tax must take into consideration tip income not included in the reports from its employees, the question arises as to how the employer must make this calculation. Competing methods advocated by businesses and the IRS have led to litigation in various federal courts, with conflicting results. 

Aggregate Method

Most recently, a federal appeals court upheld the IRS in its claim against a restaurant for over $30,000 in back FICA taxes due to the underreporting of tip income received by its employees. The court approved of the IRS's use of the "aggregate method" for calculating the yearly tip income for each employee, including tips not on a written report. 

The aggregate method applies an indirect formula that is indirect in the sense that it does not involve an examination of each employee's tax records to determine whether, and to what extent, tip income may not have been fully reported. Instead, the employer calculates the yearly sales attributable to each employee and then multiplies that figure by an average tip rate to arrive at the yearly tip income for each employee. This method advocated by the IRS was approved by the court of appeals in part because a contrary ruling could give an employer an incentive to discourage accurate reporting or simply to ignore inaccurate reporting by employees so that the employer could reduce its FICA taxes. 

However, the same argument carried little weight for a federal district court which only a month earlier rejected the aggregate method espoused by the IRS and the resulting IRS claim for $23,000 in back taxes. In that court's view, the federal tax statutes require that the IRS review each employee's tax records and determine that they are inadequate before using an aggregate method to estimate the amount of tips received by the employee.

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Most first-time home buyers purchase their homes using mortgages with relatively small down payments. To protect themselves from losses in the event a borrower with such a mortgage defaults early in the life of the loan, lenders typically require borrowers to pay for private mortgage insurance (PMI). 

In theory, but not always in practice, the insurance is dropped once the borrower builds up enough equity in the home to give the lender sufficient security to remove any risks of loss to the lender. Testimony before a congressional committee indicated that payment for unnecessary PMI is widespread and sometimes continues over the entire life of a 30-year loan. One analysis of a portfolio of 20,000 loans showed that one in five homeowners was paying PMI unnecessarily. 

A new federal law will make it easier to cancel PMI, which could mean substantial savings for a typical homeowner. The Homeowners Protection Act of 1998 will apply to new residential mortgages and refinancings entered into after July 28, 1999. Most such mortgages will be covered, but some government mortgage guarantee programs and high-risk mortgages are exempt. 

As a general rule, the Act will require automatic termination of PMI when the borrower's equity in the home reaches 22% of its original value and the borrower is current on mortgage payments. When the amount of equity equals 20%, a borrower with a good payment history may request cancellation of PMI. The Act also requires lenders to notify borrowers at closing, and annually thereafter, of their cancellation and termination rights under the Act. 

The primary enforcement mechanism for the Act is private litigation. Borrowing from other consumer credit laws, Congress made lenders who violate provisions of the Act liable to borrowers for actual damages with interest and statutory damages up to $2,000, plus the costs of bringing the action and attorney's fees.

The Fair Credit Reporting Act (FCRA) limits access to credit reports to parties having a legitimate interest in obtaining the information. If a credit reporting agency provides a "consumer report" to someone for a purpose other than those set forth in the Act, the agency and the recipient are subject to a suit for damages and attorney's fees.

A recent federal case illustrates how the Act may be applied. James was involved in a car accident and submitted claims of bodily injury and property damage to the other driver's insurance company. Suspecting the claims to be fraudulent, an investigator for the insurer obtained from a credit agency a computer-generated "Inquiry Activity Report" (IAR) on James. 

An IAR contains a list of all entities, such as lending institutions or collection agencies, that have inquired about a subject's credit history for the previous two years. Although an IAR does not give the purpose of each inquiry, evidence in the lawsuit brought by James indicated that having numerous inquiries on an individual's report is a negative factor in evaluating credit risk. 

A federal district court dismissed James's claim under the FCRA on the ground that the IAR was not a consumer report covered by the Act. The appeals court disagreed. Among the necessary elements for a consumer report is the requirement that its initial compilation, its expected use, or its ultimate use be for one of the permissible purposes listed under the FCRA. The IAR in James's file was a consumer report despite the fact that its ultimate use by the insurance company--to evaluate an insurance claim--was not a permissible purpose under the statute. The document constituted a consumer report because the credit agency initially compiled and expected the IAR to be used for credit-related transactions. Both the credit agency and the insurer were exposed to liability under the FCRA for misuse of a credit report.

A very common but often overlooked aspect of income taxation concerns the tax consequences of an individual's sale of an asset received either by inheritance or as a gift. When such property is sold, the question arises as to whether the seller has realized a taxable gain. The determination of gain depends on a key factor known as "basis," which is essentially the figure against which the selling price is measured to show whether there was a gain or loss. 

Where an individual sells an asset that he purchased, his basis for determining gain or loss on his subsequent sale of the asset is normally his cost. Where the property was received by inheritance or as a gift, there is, of course, no cost to the recipient. Federal tax law provides a series of rules for establishing basis in such situations. 

Calculating the Basis of Inherited Property

The general rule, which is usually favorable to taxpayers, is that the recipient's basis for inherited property is stepped up (or stepped down) from the decedent's cost to the asset's fair market value at the decedent's date of death. The advantage of a step-up in basis is demonstrated by the example of a decedent who bought shares of stock for $500 and held onto the investment until his death, at which time the stock had appreciated to a value of $1 million. The person who receives the stock upon the decedent's death will take a stepped-up basis of $1 million, the stock's fair market value at the decedent's death. Therefore, upon the recipient's subsequent sale of the stock, the appreciation in value between $500 and $1 million will not be recognized for income tax purposes, and the recipient of the stock will be taxed only on the gain represented by any appreciation of the stock beyond $1 million. 

Calculating the Basis of Gifted Property

The rules as to basis in the case of a gift do not allow for a stepped-up calculation and they depend upon whether the basis is being calculated for purposes of gain or loss. For determining gain, the basis is the same as it would have been in the hands of the donor and is called a "carryover" basis. In the above example, if the individual who had acquired the shares of stock for $500 chooses to give them to the recipient as a gift and does not hold them until his death, the recipient takes the same $500 basis as the donor. Therefore, if the recipient sells the shares when they reach $1 million in value, the tax liability would be based on the gain of $999,500. The choice between transferring an appreciating asset by gift and holding it until death can be crucial for purposes of the recipient's income tax liability on a later sale. 

Where an asset transferred by gift depreciates to a value below the donor's original cost, the recipient's basis is the fair market value of the asset at the time of the gift. Thus, in the stock example, if the shares that had cost the donor $500 were worth $250 at the time of the gift and had depreciated in value to $150 at the time of the recipient's subsequent sale, the recipient's basis for measuring his loss would be $250, and his loss would be $100. If, however, the stock had been worth $600 at the time of the gift but had declined to $300 by the time of the recipient's subsequent sale, the basis for loss would be the donor's basis of $500 (because that figure is lower than the $600 at the value date of the gift), and the recipient's loss would be $500 less $300. 

Neither Gain Nor Loss

In the unusual situation where the recipient's selling price is higher than the asset's value on the date of the gift but lower than the donor's cost basis, the recipient will have neither a gain nor a loss. For instance, once again using the stock example and the donor's $500 cost basis, if the value of the shares at the time of the gift was $300 and the recipient sells the shares for $400, (1) there would be no gain because, for purposes of gain, the recipient would have a $500 carryover basis, which would be greater than the selling price, and (2) there would be no loss because the $400 selling price would be measured against a basis of $300, the lower of the asset's value at the time of the gift or the donor's cost basis. 

The gift recipient's carryover basis can be increased where the donor has paid a federal gift tax on the transfer. The amount of the gift tax that is attributable to the appreciation in value of the asset as of the date of the gift can be added by the recipient to his carryover basis. For instance, if the donor's cost basis in an asset is $50,000, he transfers the asset as a gift when it is worth $100,000, and he pays a gift tax of $20,000, the appreciation in value ($50,000) accounts for one-half of the asset's value at the time of the gift. Therefore, the recipient is entitled to add one-half of the gift tax liability ($10,000) to his carryover basis, resulting in a carryover basis of $60,000. 

Even with such breaks, from the standpoint of the recipient's income tax liability on later sale the disadvantages of making lifetime gifts are clear. Of course, there are situations where the immediate transfer of property is so strongly desired and the consideration of the recipient's later income tax liability is not a priority. Tax savings should not be allowed to overwhelm the basic reasons for the transfer itself. 

This article introduces the tax consequences of selling an asset that is inherited or received as a gift. Estate planning and tax laws are complex. You should always consult with a qualified professional to assist you in such matters. 

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The desire of employers to keep their employees from competing with them has been a source of much litigation. In a typical arrangement, the employer requires the employee to sign an agreement that prevents the employee from engaging in specified forms of competition with the employer for a certain time period and in a specific geographic area. Courts usually will enforce the noncompetition agreement if it strikes a reasonable balance between protecting the interests of the employer and allowing the employee enough leeway to earn a living. 

Validity and Enforcement

A challenge to the validity and enforcement of an agreement often focuses on the reasonableness of the geographic scope and the duration of the restrictions. Another factor considered is the nature of the former employee's duties and whether those duties increase or diminish the possibility of competitive harm to the employer. An extensively trained employee who has access to trade secrets or who has developed substantial contacts with customers poses a greater competitive threat than a worker who has few connections to the company's place in competitive markets. 

Blue Pencil Rule

If it is determined that a noncompetition agreement is too restrictive, some courts may take a flexible approach. Under the "blue pencil" rule, a court can preserve acceptable parts of the agreement and enforce offending provisions with appropriate modifications. For example, a five-year ban on competition may be enforced for only three years. Or, a five-state, no-competition area may be reduced to the state where the employee worked. 

At-Will Employees 

Sometimes the legality of a noncompetition agreement is before a court not because the employer is enforcing it but because it fired an employee who refused to sign the agreement. In that setting, the law generally favors the employer's right to discharge an "at-will" employee for any reason or for no reason at all. An at-will employee is one hired for an indefinite term and not protected by contractual or statutory provisions requiring that there be a good reason for termination. An employee who balks at signing a noncompetition agreement may argue that termination for that reason goes against a public policy that prohibits unreasonable restraints on trade. On a case-by-case basis, many states have carved out specific public policy exceptions to the at-will rule, but the exceptions tend to be created in piecemeal fashion and based on policies derived from state law. 

Be sure to seek the advice of legal counsel whenever drafting or signing a noncompetition agreement. 

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