In a blow to the city of Los Angeles, Legal-Zoom.com Inc. is about to leave Hollywood after a long-running dispute over its business tax rate.

The booming online legal documents company led the fight for an Internet business tax bracket, which was adopted by the City Council last month. But LegalZoom won’t qualify for the full discount provided by the lower rate.

LegalZoom, which employs almost 400 people, has notified its landlord that the firm will move from its 50,000-square-foot offices at 7083 Hollywood Blvd. when its lease expires in June. A for-lease sign has already gone up on the building. The company may move to a neighboring city, possibly West Hollywood, Burbank or Glendale where tax rates are lower.

“With this business tax, the economic costs don’t justify staying here,” said Fred Krupica, LegalZoom’s chief financial officer. “Physical location is not important to us as an Internet business.”

It is possible the city could come back to LegalZoom with a compromise proposal. However, the city has indicated it is reluctant to open up a loophole for LegalZoom that would allow other companies to reduce their taxes.

Another aspect that has rankled the local business community is the lost opportunity from LegalZoom’s expansion. It is opening a regional office in Austin, Texas, using $1.2 million in incentives from that state and Austin. The company will hire 60 people in Austin, but that number could grow to 600 in four years. That means Los Angeles could lose as many as 1,000 jobs.

“Those jobs could have been anywhere, including right here in Hollywood,” said Leron Gubler, chief executive of the Hollywood Chamber of Commerce. “Instead, because of the high cost of doing business here, they are going to Texas.”

Krupica said there were several reasons for expanding in Texas instead of California – including access to a high-tech work force, along with lower labor and lease costs.

Critics of the city’s tax policy note that Los Angeles will not only lose the company’s expansion, but also will lose all the tax revenue it receives from LegalZoom because the company didn’t get the break it wanted.

LegalZoom was founded by prominent L.A. attorney Robert Shapiro; two other lawyers, Brian Lee and Brian Liu; and former technology company executive Eddie Hartman. In addition to providing documents, it offers initial contacts with attorneys online. The company has grown tenfold in seven years.

The driving force behind the decision to move was LegalZoom’s lengthy battle with the city over a big increase in business taxes.

The company initially paid the lowest rate, which was designed to lure so-called multimedia companies. But two years ago, the city reclassified many such online companies, including LegalZoom, into the highest bracket, reserved for law firms and other professional service companies. The reclassification quintupled LegalZoom’s city tax bill.

Under the multimedia category, businesses pay $1.01 for each $1,000 in gross receipts. But under the professional services category, they pay $5.07. That means a reclassified business with $100 million in revenue that would be exposed to the tax saw its annual bill soar from $101,000 to $507,000.

Although LegalZoom’s revenues aren’t known, sizable companies like it could see increases in their yearly tax bills of $1 million or more.

Multimedia businesses caught in tax hikes revolted, and the City Council last month approved a new category for Internet businesses at $1.01 per $1,000 in revenues, the same as the old lowest rate.

So far, at least two companies eligible for the lower tax rate have committed to staying in the city as a result: Shopzilla Inc. and MyLife.com Inc.

However, the city concluded that since LegalZoom is not purely an Internet company but one that also provides professional services, it would not see all its revenues taxed at the lower rate.

City officials would not comment on LegalZoom’s case. However, speaking generally, they said companies that provided a mix of Internet and non-Internet services would be taxed proportionally. That implies LegalZoom effectively would pay a blend between the high and low rates.

Gubler said that the city’s Office of Finance has given LegalZoom an indication of what proportion of its revenue will be subject to the Internet classification discount, and that the company isn’t satisfied.

LegalZoom had already extended its lease on Hollywood Boulevard for a year pending the tax dispute. The extension ends in June.

“There are many alternate locations that would take us outside the borders but would still be in close proximity,” Krupica said. “Some of those are only a mile or two away from where we are now.”

The company has looked at sites in West Hollywood, Burbank, Glendale and other cities in the area.

West Hollywood taxes businesses on their gross receipts, but at generally lower levels than Los Angeles. The highest rate in West Hollywood is $1.44 per $1,000 in revenues versus the $5.07 per $1,000 in revenues in Los Angeles.

Burbank taxes businesses on the number of full-time employees in the city. For a company like LegalZoom, an employee-based business tax would likely result in a much smaller total bill than one based on revenue. Glendale has no business tax, just a nominal zoning fee for businesses.

Blow to Hollywood

News of LegalZoom’s pending departure from Hollywood has hit the business community hard.

Last month, LegalZoom Chief Executive John Suh addressed the Hollywood Chamber of Commerce. Gubler said that Suh announced the company was leaving Hollywood because of the city’s stance on the business tax issue.

“They are the largest employer on the west end of Hollywood Boulevard,” Gubler said. “Their leaving will have a huge impact on employees going out to lunch, patronizing local businesses for office supplies and the like.”

Although it is tempting to say new tenants ultimately will replace LegalZoom, other Hollywood business leaders said that would minimize the loss but miss the point.

“This is exactly the kind of employer we want to see here in Hollywood,” said Kerry Morrison, executive director of the Hollywood Entertainment District, a business improvement district for central Hollywood. “Not only are they a fast-growing technology-based company with a nationally known brand, but upwards of half of their employees either walk or take public transit to work.”

Gubler and Morrison criticized L.A. city officials, especially those in the Office of Finance, for not doing enough to address LegalZoom’s concerns about the business tax.

As it led the effort to create the lower-rate Internet business tax category, LegalZoom had expected that all its revenues would be included in the new bracket.

But city officials contend that LegalZoom is not a pure Internet company; it also has a customer service component that is not limited to online applications. They did not want to create a loophole that other brick-and-mortar companies could exploit.

Antoinette Christovale, the city’s finance director, said that the Internet business tax category was meant to include companies with business models “unique to the Internet, versus business models that … could be facilitated by a bricks-and-mortar business.”

In other words, the city wants to make sure that a big, long-established company that launches a service over the Internet cannot claim that they should be classified for the lower tax rate. So under the new category, only the portion of revenue directly attributable to the Internet should be considered for the Internet category.

No guarantee

Council President Eric Garcetti, who authored the Internet business tax ordinance and who represents the Hollywood area where LegalZoom is now headquartered, confirmed this position in a statement his office provided to the Business Journal.

“We believe this tax reform for Internet-based businesses will help us retain businesses and also attract businesses to Los Angeles,” Garcetti said in the statement. “We also know that some businesses may not qualify to have the rate applied to 100 percent of their gross receipts and that no policy is a 100 percent guarantee that every business will stay.”

One business that will only see a portion of its revenues applied to the low Internet business tax category is West L.A.-based Fandango.com, a unit of Comcast Interactive Media that sells movie tickets online. Fandango executives have accepted that not all their revenue will be taxed at the lower rate.

“We were aware when the city passed the new Internet business tax that we might not qualify for it with respect to our core business,” Stacey Olliff, senior vice president of legal and business affairs, said in a statement to the Business Journal. “But we wanted to support the other companies that deserved a return to their prior tax rate as a matter of fairness.”

He said the company has no plans to move.

Two off-the-record sources told the Business Journal that LegalZoom’s departure wasn’t solely related to the business tax dispute. The company was hoping for a reduction in its lease from CIM Group, owner of the building, the sources said, because the lease was signed several years ago near the top of the market.

But Krupica of LegalZoom and a spokeswoman for CIM Group both said that leasing issues had nothing to do with the move. If this was merely a leasing dispute, LegalZoom would be looking at other sites within the city of Los Angeles.

“We want to see a definitive answer that we’re in the Internet category,” Krupica said. “This is a very important issue for us.”

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