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A Newsletter from the Tax & Corporate Practice Group Winter 2004

Statutory vs. Common Law Trademark Rights

By Dennis J. Helms and Kenneth S. Goodkind

C opying may be a
sincere form of flat-
tery when it comes to
life styles, but it is nothing
identifier for the same goods or services. If a mark is not registered, then
the owner has common law rights, However, these rights only extend to
the geographic areas where the mark has been used and advertised.
Outside of those areas, those who don’t know about the mark can use it
on their goods and services with impunity.
short of theft when it
comes to a company’s Accordingly, the net affect of having a “registered mark” is that it
trademarks. This issue was allows the owner to mount an uncomplicated case against an infringer to
raised in an unusual, unre- stop the wrongful use of the mark. In other words, issues of first use,
ported case involving com- ownership, description of goods and services will all be clearly delineat-
Dennis J. Helms Kenneth S. Goodkind mon law trademark rights. ed in the registration certificate. If the mark is registered, then more
A large real estate develop- often than not, the matter may be resolved well before litigation is nec-
ment company (“Developer”) had built and sold several large real essary — usually after the lawyer representing the owner of the mark
estate developments, each of which carried its trademark, when an sends the infringer a “cease and desist letter” with a copy of the registra-
interloper bought and rehabilitated an apartment building on an tion certificate.
adjoining property and gave it a name which included the Developer’s In contrast, without registration, the case becomes heavily depend-
trademark. ent on the facts and encounters material proof issues. Among other
To the Developer’s chagrin, it had allowed its federal statutory trade- things, the owner will have to prove: the date of first use; that the
mark registration to lapse, and this may have led the interloper to believe usage was continuous; where the mark was used; where it would be
he could use the Developer’s mark. reasonable to expect expanded use of the mark to occur; how promi-
Although it is a common belief that trademarks are protected only if nently the mark was used, and in connection with what types of activi-
they are registered in the U.S. Patent and Trademark Office, protections ties the mark was used. The owner of the mark may also have to
are derived from use and therefore exist at “common law.” While formal demonstrate at least some degree of diligence in policing the relevant
registration provides streamlined and economical protection, the key to market place for infringements against its mark. All of this significantly
the existence of trademark rights is use of the mark, and it is only the increases the expense of litigation and increases the risk that the owner
extent of protection, which depends on the registration of the mark. If of the mark may not be able to obtain the protections that the mark
the mark is registered, no one can use it in the United States as a source should accord on a cost-effective basis.
(continued on page 3)

Editor’s Note…
Our law firm continues to grow in size and geographic pres-
ence, with the addition of James Huggett to our Bankruptcy
In This Issue. . .
Practice Group and as resident in our newly opened Wilmington,
Delaware office. Statutory vs. Common Law
As a sign that the economy has finally turned up, our involve- Trademark Rights ....................1
ment in sales, mergers and acquisition transactions have experi-
enced a material upsurge, with our clients seeking growth and/or Taxation of Litigation
consolidation to address an increasingly competitive marketplace. Legal Costs ..............................2
Richard J. Flaster With the objective of broadening our base of readership, we
may soon turn to e-mail transmission of this newsletter rather than
Restructuring C Corp PCs
mailing hard copies. If you provide us with your e-mail address and the e-mail addresses of as S Corps ................................3
colleagues who would be interested in receiving Tax and Business Law Report, we would be
pleased to include that information in the newsletter’s e-mail distribution list. Please send the
information to me at ◆
Visit our Web site at:
Copyright © 2003 Tax & Business Law Report • Flaster/Greenberg P.C.

Tax Treatment of Legal Costs Incurred in Tax & Corporate Practice

Taxable Litigation Recoveries Group Services
By Alan H. Taxpayers across the country have chal- Federal and State Taxation
Zuckerman lenged the IRS on this point — arguing that ◆ Tax planning
they should not be required to include in ◆ Corporations, partnerships and LLC’s

T axable litigation
encounter serious
tax problems for
gross income the portion of the award that is
payable to the attorneys. However, taxpayers
have lost more times than they have won.
There is a major split amongst the federal
circuit courts, with six finding in favor of the

Sales, mergers and acquisitions
IRS rulings
Tax litigation
Tax collections/liens
taxpayers in the Third
Circuit (which includes IRS and only three in favor of the taxpayer. Business Corporate Services
Alan H. Zuckerman New Jersey and In the most recent circuit court case, the Sixth ◆ Business formations
Pennsylvania) as a result Circuit held for the taxpayer, ruling that he ◆ Structuring ownership arrangements
of its special treatment of legal fees and costs was required to report in income only the net ◆ Corporate control/management
incurred in the litigation. The problem is partic- amount of litigation recovery (i.e., the recov- contracts
ularly relevant in contingent fee cases. A typical ery net of the attorneys fees). See Banks v. ◆ Shareholder disputes
example is the situation where an individual Commissioner, 6th Cir. (9/30/03). ◆ Contracts
engages an attorney to file suit against a former Unfortunately, the Third Circuit, which is ◆ Sales, commercial mergers and
employer for back pay or improper termination the circuit court that governs tax cases in both acquisitions
or discrimination, and the attorney is paid a per- New Jersey and Pennsylvania, has held for the ◆ Securities and finance
centage of the amount recovered. IRS and requires that the full amount of the ◆ Buy-ins/Buy-outs
The problem exists because the IRS takes award must be included in the individual’s ◆ Employee agreements and
the position that the individual receiving the taxable income. See O’Brien v. Commissioner,
award must report the full amount of the 319 F.2d 532 (3d Cir. 1963) (per curiam),
◆ Trademark and copyright licensing and
award as part of his or her taxable income and aff’g 38 T.C. 707 (1962).
then deduct the legal costs as a miscellaneous Given the split in the circuit courts, this
itemized deduction. As a miscellaneous issue will hopefully be heard by the U.S. Wealth Preservation and Transfer
deduction the legal expenses effectively offset Supreme Court in the not too distant future. ◆ Estate planning
the taxability of the recovery only to the In the interim, taxpayers in the Third Circuit ◆ Drafting wills, trusts and other estate
extent that it exceeds two percent of the are faced with the untenable position that planning documents
taxpayer’s adjusted gross income—and more the amount of legal fees they pay in connec- ◆ Administration of estates and trusts
importantly, are not deductible for alternative tion with litigation recoveries must be ◆ Guardianships and conservatorships
minimum tax purposes. included in their income and then deducted ◆ Litigation involving trusts and estates
Example: Assume that an individual on their tax return. ◆ Asset protection
receives an award of $450,000 and the attor- ◆ Business transfers from one generation
ney is paid a contingent fee of $150,000, and Observations to the next
the individual has a substantial adjusted gross Although the U.S. Supreme Court might
income before the litigation recovery. On an Technology, E-Commerce
normally be expected to consider the issue and and Internet
economic analysis, the individual would resolve the seemingly “inconsistent” holdings
assume that the transaction leaves him or her ◆ Contract agreements
of the various circuit courts, such resolution
with taxable income equal to the $300,000 of ◆ Protecting intellectual property rights
may not be forthcoming, since the U.S.
net proceeds, thus paying tax of approximately ◆ Licensing
Supreme Court previously denied hearing an
$100,000 on the $300,000 net recovery. appeal of the Seventh Circuit decision (holding ◆ Government regulation
However, under the IRS’s view of the transac- that the gross amount is taxable)—presumably ◆ Venture capital
tion, the individual must report the entire on the rationale that the split among the cir- Employee Benefits
$450,000 in gross income, and while the cuits is based on the different state attorney ◆ Design and implementation of
$150,000 attorney fee would be partially lien laws (although recent decisions have not
deductible for regular tax purposes (viz, the qualified retirement plans
turned on the relevance of the state’s attorney ◆ Employee Stock Ownership Plans
excess over the two percent AGI threshold), lien law).
it would not be deductible for alternative (ESOPs)
minimum tax purposes. This could cause the Query: Would or should the case hold- ◆ Stock options, phantom stock and
taxpayer to pay approximately $30,000 more ings differ depending on whether the plaintiff SARs
in taxes. has a separate right to claim to have his or her ◆ Plan qualification, IRS audits and
legal fees paid by the defendant? ◆ compliance issues
◆ Cafeteria plans and other welfare
benefit programs
This report is for general use and information, and the content should not be ◆ Employee benefit trusts
interpreted as rendering legal advice on any matter. Specific situations may raise ◆ Deferred compensation
additional or different issues and such information should be coordinated with arrangements
professional legal advice.

Tax & Business Law Report • Flaster/Greenberg P.C.


Advisability of Switching PCs to S Corporation Status

By Laura B. Wallenstein

Compensation Arrangements: The IRS concluded that the com-

lthough permitted to operate as limited
liability companies or S corporations, most pensation arrangements did not create an additional class of stock based
professional corporations operate as “C” on the fact that the arrangements were not intended as such. Although
corporations, which means that to the extent that all shareholders could receive different compensation under the formula,
“profits” remain in the corporation, there is a each shareholder was subject to the same compensation formula, which
double level of tax — once at the corporate level had been in place for 10 years. The IRS relied on Treas. Reg. §1.1361-
and then again when the corporate after-tax profit 1(b)(4) (entitled “Treatment of Deferred Compensation Plans”) which
is ultimately distributed to the shareholders by provides that an arrangement is not deemed to be outstanding stock if it
dividends or in liquidation. (a) does not convey the right to vote; (b) is an unfunded and unsecured
Laura B. Wallenstein promise to pay money in the future; (c) is issued to an employee for
Converting from a “C” corporation to an “S”
performance of services; and (d) is issued pursuant to a plan under
corporation has always been an option for professional corporations.
which the employee is not currently taxed on income. Treas. Reg.
Historically, however, there has been no compelling reason to convert,
§1.1361-1(b)(4) would seem to run afoul of the fourth criterion (since
since professional corporations typically have been able to channel most of
the shareholders would be taxed currently on the income). The IRS,
their “profits” to their shareholder/employees as deductible compensation.
however, presumably looked to the additional language of the regula-
Moreover, there were some negative consequences associated with being
tion, which provides that a deferred compensation plan that has a cur-
an S corporation (viz, the inability to deduct certain employee benefits
rent compensation feature is not for that reason precluded from being
such as health and disability insurance, and self-insured medical expense
reimbursement plans).
Buy-Sell Arrangements: Citing Treas. Reg. §1.1361-1 (1)(2)(iii)(A),
Recent developments, however, have changed the equation.
the IRS held that the differing buy-sell arrangements would not violate
• As of 2004, certain non-deductible shareholder expenses (such as the single class of stock rule as (a) a principal purpose of the arrange-
health insurance) will be fully deductible ment was not designed to circumvent the single class of stock rule, and
• The IRS has been attacking compensation deductions for professional (b) the purchase price established under the agreement reflected the
service shareholders, successfully arguing that a portion of such com- approximate current fair market value of the stock at the date of execu-
pensation was a non-deductible dividend distribution of “profits” tion of the arrangements.
where the services that engendered such profits were “attributable”
Observation: The IRS stated that a good faith determination of fair
to services of non-shareholder employees.
market value will be respected unless it can be demonstrated that (a) the
Changing the form of a professional corporation to an LLC could value was substantially in error and (b) the determination was not per-
result in a significant tax consequence by virtue of the immediate taxa- formed with reasonable diligence. Since there is no indication that the
tion of the corporation’s appreciated and untaxed assets (such as IRS investigated the actual value of the stock and compared it with the
accounts receivable). As a result, electing to be an S corporation has buy-sell formula (presumably because the arrangements were in place
become a more appealing option. prior to the election and would have been negotiated at arms length), it
Practitioners have expressed concern, however, that the IRS could appears that the IRS simply accepted the representation that the second
invalidate the election based on internal compensation and buy-out requirement was met. ◆
arrangements typical of professional corporations. In particular, the
concern has been that these arrangements could be asserted to violate
the requirement that an S corporation have only “one class of stock.” Statutory vs. Common Law Trademark Rights
A corporation can be considered to have more than one class of stock (continued from page 1)
(even though not so denominated), if stock held by different share-
holders has different attributes. Since shareholders of professional cor- In the case of the infringed Developer, the interloper tried to take
porations are often employees of those corporations, the concern has advantage of the goodwill associated with the Developer’s now unregis-
been that differing compensation and buy-sell arrangements among tered mark and create the appearance of an association with the
employee/shareholders could also be deemed to create more than one Developer’s property. Initially, the interloper refused to cease and
class of stock. desist, claiming that since the Developer’s registration had lapsed, it
had no protected rights in the mark. The interloper’s obstinacy contin-
A recent IRS Private Letter Ruling has given practitioners some com-
ued until the Court issued an emergency restraining order, requiring
fort. PLR 200329011. In this ruling, the professional corporation’s
the interloper to either cease use of the Developer’s mark, or use a
shareholders had (a) current compensation for all shareholders based on
prominent and detailed disclaimer to indicate that infringer had no
an internal formula that tied their contribution to profitability, and (b)
affiliation with the Developer. When the defendant failed to comply
stock purchase agreements pursuant to which the two senior shareholders
with the court’s order, a second court order was issued — prohibiting
had different arrangements than other shareholders. As to the second
the defendant from using the mark and awarding counsel fees and
situation, the two senior shareholders were required to sell their shares at
other relief for its contempt of the first court order.
“book value” and receive certain deferred compensation upon retirement
whereas the other shareholders were required to sell their shares based Planning Note: If you have established a brand name for your
on a complex formula value that was designed to retain those sharehold- name products and services, make sure you consult with experienced
ers as employees. counsel to obtain maximum protections for your mark. You must be
vigilant in uncovering infringers and be ready to litigate, if necessary, to
The IRS ruled that neither the compensation nor buy-out arrange-
protect your rights, since you can lose those rights if you do not.
ments violated the single class of stock requirements.
However, registration will help ensure that if litigation is ever necessary,
it will be cost effective as well as successful. ◆
Bellmawr, NJ
Permit No. 58

1810 Chapel Avenue West

Cherry Hill, NJ 08002-4609

Flaster Greenberg Tax & Corporate Practice Group Office Locations

Richard J. Flaster Elaine J. Petruzziello
Harvard Law School, J.D. 1966 Willamette University, J.D., MBA 1985 Commerce Center
Stephen M. Greenberg University of Denver, L.L.M. 1986 1810 Chapel Avenue West
Yale Law School, J.D. 1976 Elliot D. Raff Cherry Hill, NJ 08002-4609
Laura B. Wallenstein University of Wisconsin Law School, J.D. 1990 (856) 661-1900
Rutgers Law School, J.D. 1977 Jeffrey A. Cohen
New York University Law School, L.L.M. 1981 University of Pittsburgh School of Law, J.D. 1993 1835 Market Street, Suite 1215
Allen P. Fineberg Matthew Azoulay Philadelphia, PA 19103
Columbia Law School, J.D. 1979 Widner University School of Law, J.D. 1997 (215) 569-1022
Markley S. Roderick Aaron C. Buser
University of Virginia Law School, J.D. 1982 Rutgers Law School, J.D. 2001 190 S. Main Road
Peter R. Spirgel Mitchell R. Cohen (Of Counsel)
Vineland, NJ 08360
Georgetown Law School, J.D. 1985 Temple University Law School, J.D. 1979 (856) 691-6200
Temple Law School, L.L.M. 1988 Marc Garber (Of Counsel) 216 North Avenue
Alan H. Zuckerman Duquesne University School of Law, J.D. 1981
CPA 1982; Temple Law School, J.D. 1985 Cranford, NJ 07016
Dennis J. Helms (908) 245-8021
William S. Skinner University of Virginia Law School, LL.B 1967
University of Pennsylvania Law School, J.D. 1986
2900 Fire Road, Suite 102A
Egg Harbor Township, NJ 08234
(609) 645-1881
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