TAX AND

BUSINESS
LAW REPORT
A Newsletter from the Tax & Corporate Practice Group

www.flastergreenberg.com 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 Rick.Flaster@Flastergreenberg.com. ◆
Visit our Web site at:
www.flastergreenberg.com
Copyright © 2003 Tax & Business Law Report • Flaster/Greenberg P.C.

Tax Treatment of Legal Costs Incurred in
Taxable Litigation Recoveries
By Alan H.
Zuckerman
T axable litigation
recoveries
encounter serious
tax problems for
taxpayers in the Third
Circuit (which includes
Alan H. Zuckerman New Jersey and
Pennsylvania) as a result
of its special treatment of legal fees and costs
incurred in the litigation. The problem is partic-
ularly relevant in contingent fee cases. A typical
example is the situation where an individual
engages an attorney to file suit against a former
employer for back pay or improper termination
or discrimination, and the attorney is paid a per-
centage of the amount recovered.
The problem exists because the IRS takes
the position that the individual receiving the
award must report the full amount of the
award as part of his or her taxable income and
then deduct the legal costs as a miscellaneous
itemized deduction. As a miscellaneous
deduction the legal expenses effectively offset
the taxability of the recovery only to the
extent that it exceeds two percent of the
taxpayer’s adjusted gross income—and more
importantly, are not deductible for alternative
minimum tax purposes.
Example: Assume that an individual
receives an award of $450,000 and the attor-
ney is paid a contingent fee of $150,000, and
the individual has a substantial adjusted gross
income before the litigation recovery. On an
economic analysis, the individual would
assume that the transaction leaves him or her
with taxable income equal to the $300,000 of
net proceeds, thus paying tax of approximately
$100,000 on the $300,000 net recovery.
However, under the IRS’s view of the transac-
tion, the individual must report the entire
$450,000 in gross income, and while the
$150,000 attorney fee would be partially
deductible for regular tax purposes (viz, the
excess over the two percent AGI threshold),
it would not be deductible for alternative
minimum tax purposes. This could cause the
taxpayer to pay approximately $30,000 more
in taxes.
This report is for general use and information, and the content should not be
interpreted as rendering legal advice on any matter. Specific situations may raise
additional or different issues and such information should be coordinated with
professional legal advice.
Tax & Business Law Report • Flaster/Greenberg P.C.
2
Tax & Corporate Practice
Group Services
Taxpayers across the country have chal- Federal and State Taxation
lenged the IRS on this point — arguing that ◆ Tax planning
they should not be required to include in ◆ Corporations, partnerships and LLC’s
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
IRS and only three in favor of the taxpayer. Business Corporate Services
In the most recent circuit court case, the Sixth ◆ Business formations
Circuit held for the taxpayer, ruling that he ◆ Structuring ownership arrangements
was required to report in income only the net ◆ Corporate control/management
amount of litigation recovery (i.e., the recov- contracts
ery net of the attorneys fees). See Banks v. ◆ Shareholder disputes
Commissioner, 6th Cir. (9/30/03). ◆ Contracts
Unfortunately, the Third Circuit, which is ◆ Sales, commercial mergers and
the circuit court that governs tax cases in both acquisitions
New Jersey and Pennsylvania, has held for the ◆ Securities and finance
IRS and requires that the full amount of the ◆ Buy-ins/Buy-outs
award must be included in the individual’s ◆ Employee agreements and
taxable income. See O’Brien v. Commissioner,
terminations
319 F.2d 532 (3d Cir. 1963) (per curiam),
◆ Trademark and copyright licensing and
aff’g 38 T.C. 707 (1962).
protection
Given the split in the circuit courts, this
issue will hopefully be heard by the U.S. Wealth Preservation and Transfer
Supreme Court in the not too distant future. ◆ Estate planning
In the interim, taxpayers in the Third Circuit ◆ Drafting wills, trusts and other estate
are faced with the untenable position that planning documents
the amount of legal fees they pay in connec- ◆ Administration of estates and trusts
tion with litigation recoveries must be ◆ Guardianships and conservatorships
included in their income and then deducted ◆ Litigation involving trusts and estates
on their tax return. ◆ Asset protection
◆ Business transfers from one generation
Observations to the next
Although the U.S. Supreme Court might
Technology, E-Commerce
normally be expected to consider the issue and and Internet
resolve the seemingly “inconsistent” holdings
◆ Contract agreements
of the various circuit courts, such resolution
◆ Protecting intellectual property rights
may not be forthcoming, since the U.S.
◆ Licensing
Supreme Court previously denied hearing an
appeal of the Seventh Circuit decision (holding ◆ Government regulation
that the gross amount is taxable)—presumably ◆ Venture capital
on the rationale that the split among the cir- Employee Benefits
cuits is based on the different state attorney ◆ Design and implementation of
lien laws (although recent decisions have not
qualified retirement plans
turned on the relevance of the state’s attorney ◆ Employee Stock Ownership Plans
lien law).
(ESOPs)
Query: Would or should the case hold- ◆ Stock options, phantom stock and
ings differ depending on whether the plaintiff SARs
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
◆ Employee benefit trusts
◆ Deferred compensation
arrangements
 3
Advisability of Switching PCs to S Corporation Status
By Laura B. Wallenstein
A
lthough permitted to operate as limited
liability companies or S corporations, most
professional corporations operate as “C”
corporations, which means that to the extent that
“profits” remain in the corporation, there is a
double level of tax — once at the corporate level
and then again when the corporate after-tax profit
is ultimately distributed to the shareholders by
dividends or in liquidation.
Laura B. Wallenstein
Converting from a “C” corporation to an “S”
corporation has always been an option for professional corporations.
Historically, however, there has been no compelling reason to convert,
since professional corporations typically have been able to channel most of
their “profits” to their shareholder/employees as deductible compensation.
Moreover, there were some negative consequences associated with being
an S corporation (viz, the inability to deduct certain employee benefits
such as health and disability insurance, and self-insured medical expense
reimbursement plans).
Recent developments, however, have changed the equation.
• As of 2004, certain non-deductible shareholder expenses (such as
health insurance) will be fully deductible
• The IRS has been attacking compensation deductions for professional
service shareholders, successfully arguing that a portion of such com-
pensation was a non-deductible dividend distribution of “profits”
where the services that engendered such profits were “attributable”
to services of non-shareholder employees.
Changing the form of a professional corporation to an LLC could
result in a significant tax consequence by virtue of the immediate taxa-
tion of the corporation’s appreciated and untaxed assets (such as
accounts receivable). As a result, electing to be an S corporation has
become a more appealing option.
Practitioners have expressed concern, however, that the IRS could
invalidate the election based on internal compensation and buy-out
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.”
A corporation can be considered to have more than one class of stock
(even though not so denominated), if stock held by different share-
holders has different attributes. Since shareholders of professional cor-
porations are often employees of those corporations, the concern has
been that differing compensation and buy-sell arrangements among
employee/shareholders could also be deemed to create more than one
class of stock.
A recent IRS Private Letter Ruling has given practitioners some com-
fort. PLR 200329011. In this ruling, the professional corporation’s
shareholders had (a) current compensation for all shareholders based on
an internal formula that tied their contribution to profitability, and (b)
stock purchase agreements pursuant to which the two senior shareholders
had different arrangements than other shareholders. As to the second
situation, the two senior shareholders were required to sell their shares at
“book value” and receive certain deferred compensation upon retirement
whereas the other shareholders were required to sell their shares based
on a complex formula value that was designed to retain those sharehold-
ers as employees.
The IRS ruled that neither the compensation nor buy-out arrange-
ments violated the single class of stock requirements.
Compensation Arrangements: The IRS concluded that the com-
pensation arrangements did not create an additional class of stock based
on the fact that the arrangements were not intended as such. Although
all shareholders could receive different compensation under the formula,
each shareholder was subject to the same compensation formula, which
had been in place for 10 years. The IRS relied on Treas. Reg. §1.1361-
1(b)(4) (entitled “Treatment of Deferred Compensation Plans”) which
provides that an arrangement is not deemed to be outstanding stock if it
(a) does not convey the right to vote; (b) is an unfunded and unsecured
promise to pay money in the future; (c) is issued to an employee for
performance of services; and (d) is issued pursuant to a plan under
which the employee is not currently taxed on income. Treas. Reg.
§1.1361-1(b)(4) would seem to run afoul of the fourth criterion (since
the shareholders would be taxed currently on the income). The IRS,
however, presumably looked to the additional language of the regula-
tion, which provides that a deferred compensation plan that has a cur-
rent compensation feature is not for that reason precluded from being
compliant.
Buy-Sell Arrangements: Citing Treas. Reg. §1.1361-1 (1)(2)(iii)(A),
the IRS held that the differing buy-sell arrangements would not violate
the single class of stock rule as (a) a principal purpose of the arrange-
ment was not designed to circumvent the single class of stock rule, and
(b) the purchase price established under the agreement reflected the
approximate current fair market value of the stock at the date of execu-
tion of the arrangements.
Observation: The IRS stated that a good faith determination of fair
market value will be respected unless it can be demonstrated that (a) the
value was substantially in error and (b) the determination was not per-
formed with reasonable diligence. Since there is no indication that the
IRS investigated the actual value of the stock and compared it with the
buy-sell formula (presumably because the arrangements were in place
prior to the election and would have been negotiated at arms length), it
appears that the IRS simply accepted the representation that the second
requirement was met. ◆
Statutory vs. Common Law Trademark Rights
(continued from page 1)
In the case of the infringed Developer, the interloper tried to take
advantage of the goodwill associated with the Developer’s now unregis-
tered mark and create the appearance of an association with the
Developer’s property. Initially, the interloper refused to cease and
desist, claiming that since the Developer’s registration had lapsed, it
had no protected rights in the mark. The interloper’s obstinacy contin-
ued until the Court issued an emergency restraining order, requiring
the interloper to either cease use of the Developer’s mark, or use a
prominent and detailed disclaimer to indicate that infringer had no
affiliation with the Developer. When the defendant failed to comply
with the court’s order, a second court order was issued — prohibiting
the defendant from using the mark and awarding counsel fees and
other relief for its contempt of the first court order.
Planning Note: If you have established a brand name for your
name products and services, make sure you consult with experienced
counsel to obtain maximum protections for your mark. You must be
vigilant in uncovering infringers and be ready to litigate, if necessary, to
protect your rights, since you can lose those rights if you do not.
However, registration will help ensure that if litigation is ever necessary,
it will be cost effective as well as successful. ◆
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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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