Pitfalls of Giving Up Equity in a Business Venture (Part 1)

Pitfalls of Giving Up Equity in a Business VentureFrom entrepreneurs to trusted advisors, financing a new business venture can be extraordinarily challenging. When you are considering your options, however, be very cautious about giving up ownership. Such a strategy can help get your business started in the short run, but it also can be a complete headache in the long run.

An Ounce Now, A Pound Later…

  • Imagine that you are an entrepreneur with a great idea and superb business model, but no start-up capital, or at least not enough to take flight with your business. You go to your parents, spouse, brothers, sisters, friends, and your spouse’s brothers, sisters, and friends (you get the picture).
  • They spare you some change, and in return, you offer them something as a symbol of your gratitude, something that will pay huge dividends later when your idea takes off and the big-money suitors come knocking: ownership in your business
  • A few years later, guess what? Congratulations! A large publicly traded company wants to acquire your business. Your hard work has paid off. Your potential acquirer wants to write you a check for several million dollars. All you have to do is cross your “t”s and dot your “i”s and the deal is done. In order to do so, however, your attorney tells you to have a meeting, take a vote, and make sure all of the other owners are on board.

Uh-Oh, I Didn’t Forsee This…

From the initial start-up capital to the equity you granted key employees, your business now has 10 other co-owners, all of whom are entitled to vote on the proposal. By the way, as part of the acquisition, the acquirer wants to move your operations to Ohio. Plus, in the years since you started the business, you and your spouse went through a messy divorce, but your ex-father-in-law and ex-brother-in-law are still owners. (Trust us; we’ve seen this and much worse …)

With all of these variables, do you think getting a consensus vote from all the co-owners will be easy? Not a chance! Some people are not so keen on the idea of moving to Ohio. Others (your ex-in-laws) see the dollar signs and know that they can make life very difficult for you if they refuse to go along with the acquisition.

What’s the Solution?

(more…)

Published in: on March 28, 2017 at 9:46 am  Leave a Comment  
Tags: , , , , , , , ,

Business Attorney Los Angeles Video

Protecting a business, property or personal wealth is an important consideration for many people. At Anker, Reed, Hymes, Schreiber and Cohen, A Law Corporation, we pride ourselves on being a different kind of law firm – one that measures success by its value to clients. Since 1974, our firm has provided business law, real estate, estate planning and litigation services to individuals, families and businesses throughout Southern California.

Published in: on August 1, 2011 at 7:05 pm  Leave a Comment  
Tags: , , , , , , , ,

Drawbacks to Incorporating

Shield of the United States Tax Court.

Image via Wikipedia

Before an entertainer decides to incorporate, he/she must first evaluate the application of Internal Revenue Code Section 269A. This section can be debilitating to the tax benefits of incorporating. Section 269A addresses the PSC and the services performed by it.

§ 269A(a): “If (1) substantially all of the services of the personal service corporation are performed for (or on behalf of) 1(sic) other corporation, partnership or other entity, and (2) the principal purpose for forming, or availing of, or such personal service corporation is the avoidance or evasion of Federal income tax by reducing the income of, or securing the benefit of any expense, deduction, credit, exclusion, or other allowance for, any employee-owner which would not otherwise be available, then the Secretary may allocate all income, deductions, credits, exclusions, and other allowances between such personal service corporation and its employee-owners, if such allocation is necessary to prevent avoidance or evasion of Federal income tax or clearly to reflect the income of the personal service corporation or any of its employee-owners.”

These words empower the government to disregard all of the tax planning done by the employee. If the government feels that “substantially all” of the income of the employee is from one source, the tax benefits afforded the loan-out corporation can be set aside. This issue was addressed by the United States Court of Appeals for the 8th Circuit in Sargent v. Commissioner of Internal Revenue. The case involved a hockey player who incorporated in order to place money in a pension plan for himself.

As discussed above, § 401 of the Internal Revenue Code allows for the corporate retirement plan contribution to be deducted by the corporation while not constituting income to the employee until the money is distributed by the plan. The hockey club contracted with Sargent’s PSC for his services and paid the corporation its contractual fee. The IRS issued a tax deficiency notice to Sargent for unpaid taxes, which was appealed to the Tax Court for consideration.

The Tax Court agreed with the IRS that the corporation set up by Sargent was merely a form of assigning income to the corporation and that Sargent was still liable for the taxes. The issue in the Tax Court was whether Sargent was an employee of the hockey team or his PSC. If he was an employee of the PSC, then the deductions taken for pension plan contributions were allowable. If he was an employee of the hockey club, then his pension plan contributions were not deductible, and the income from the hockey club would be attributed to Sargent as an individual and not to his PSC.

* For specific inquiries regarding a business legal matter that you may have, you are contact our Tax Attorney in Los Angeles.

Enhanced by Zemanta
Published in: on January 27, 2011 at 11:30 pm  Leave a Comment  
Tags: , , , , , , , ,

Alternative Minimum Tax: The Effect on Itemized Deductions

 

The western front of the United States Capitol...
Image via Wikipedia

 

This is also part of third section of  Anker Reed HSC’s blog series entitled “To Incorporate or Not to Incorporate? That is the Question” regarding the alternative minimum tax and its effect on medical and miscellaneous itemized deductions.

An additional issue with regard to the deductibility of both medical and miscellaneous itemized deductions is the imposition of the Alternative Minimum Tax. “Congress enacted the alternative minimum tax (AMT) in 1969 to make wealthy taxpayers pay their fair share instead of using tax shelters and other means to reduce, or even eliminate, their federal tax liability.” (Kern, 1999). “The alternative minimum tax generally can be described as a flat tax rate which is imposed on a broader income base than the taxable income yardstick used for the regular corporate tax.” (Lind, supra note 11 at 15).  “The tax is designed to ensure that all taxpayers pay at least a minimum amount of taxes.” (Blacks Law Dictionary, 1990). “Without the alternative minimum tax, some of these taxpayers might be able to escape income taxation entirely. In essence, the AMT functions as a recapture mechanism, reclaiming some of the tax breaks primarily available to high-income taxpayers, and represents an attempt to maintain tax equity.” (Commerce Clearing House, 1999).

The AMT is paid in addition to any other income tax imposed and calculated as the excess of the tentative minimum tax for the taxable year over the regular tax for the taxable year. The definition for tentative minimum tax, though, depends on the status of the taxpayer, whether noncorporate or corporate. The tentative minimum tax for the noncorporate taxpayer is the sum of 26% of so much of the taxable excess as does not exceed $175,000 plus 28% of so much of the taxable excess as exceeds $175,000. The Internal Revenue Code also provides for tax exemption status, evidencing the congressional intent of taxing the high-income taxpayers. If the taxpayer’s taxable income does not exceed $45,000 for taxpayers filing a joint return, $33,750 for the individual taxpayer, or $22,500 for the married taxpayer filing separately, the taxpayer is exempt from alternative minimum tax treatment. This means that, depending on the individual taxpayer, there could be an exemption from AMT for the lower income brackets. After the $33,750 exemption, the next $175,000 will be taxed at a rate of 26%. Taxable income exceeding this will be taxed at 28%. At the corporate level, the first $40,000 of taxable income is exempt from AMT treatment.

As previously discussed, the PSC will have little or no taxable income as a result of “zeroing-out.” Therefore, no discussion of corporate AMT is necessary.

When analyzing the application of AMT to the noncorporate taxpayer, the focus of the discussion turns to the medical and miscellaneous itemized deductions. For Regular Income Tax (“RIT”) purposes, medical expenses are deductible when they exceed 7.5% of adjusted gross income (“AGI“). For AMT purposes, medical expenses are deductible only when they exceed 10% of AGI. With regard to miscellaneous deductions, the difference between RIT and AMT is even more conspicuous. For RIT purposes, miscellaneous itemized deductions (specifically unreimbursed employee business expenses) are deductible to the extent they exceed 2% of AGI. Under AMT, however, miscellaneous itemized deductions are not allowed. This is significant since an employee working in a noncorporate structure will be considered an employee for whom she provides services.

Therefore, any business expenses she incurs will be considered unreimbursed employee business expenses, shown as miscellaneous itemized deductions subject to the 2% of AGI limitation and rendered non-deductible for AMT purposes. Under the PSC, these business expenses escape both the RIT limitation and the AMT exclusion.

* For specific inquiries regarding a business legal matter that you may have, you are welcome to visit our Tax Attorney in Los Angeles.

Related articles

Enhanced by Zemanta
Published in: on January 14, 2011 at 2:11 am  Comments (2)  
Tags: , , , , , , , , , , , , , , ,

The Medical Reimbursement Plan with Regards to Deduction Limitations

This is part of the third section of Anker Reed HSC’s blog series entitled “To Incorporate or Not to Incorporate? That is the Question” regarding the medical reimbursement plan and deduction limitations of the corporation and individual.

The corporation may establish a medical reimbursement plan as a benefit to its employees, which eliminates the medical expense deduction limitation. In a medical reimbursement plan the corporation will reimburse the entertainer/employee/shareholder for expenses incurred in securing medical treatment. When the corporation reimburses the employee for the medical expenses incurred, the employee avoids the limitation on the deductibility of medical expenses.

Furthermore, the employee avoids taxation on the reimbursed amount under Internal Revenue Code § 105 which provides that “gross income does not include amounts paid, directly or indirectly, to the taxpayer to reimburse the taxpayer for expenses incurred by him for the medical care … of the taxpayer, his spouse, and his dependents.” The effect on the corporation is equally beneficial to the corporate taxpayer in that “payments pursuant to a medical reimbursement plan by the employer corporation are deductible as a business expense.” (Berwind, 1985)

Using the previous example, all $25,000 in medical expenses would be specifically excluded from the gross income of the employee and would be deductible to the corporation; this saves approximately $12,500 in tax to the employee as an individual taxpayer.

Therefore, there is a definite tax benefit to the incorporated employee in the form of increased deductibility of expenses-deductions which may be limited to the individual taxpayer.

* For specific inquiries regarding a business legal matter that you may have, you are welcome to visit our Los Angeles Business Lawyer services page.

Published in: on January 6, 2011 at 9:20 pm  Comments (1)  
Tags: , , , , , , , , , ,

Deduction Limitations of the Corporation and Individual

Painted by Toulouse-Lautrec in the year of his...
Image via Wikipedia

This is the third section of Anker Reed HSC’s blog series entitled “To Incorporate or Not to Incorporate? That is the Question” regarding deduction limitations of the corporation and individual.

The corporation, on the other hand, is not affected by the § 67 limitation. A corporation will be allowed a one hundred percent deduction on itemized deductions. Therefore, in the foregoing example, the corporate taxpayer will be able to deduct the full amount of $50,000 without limitation. The corporation has effectively just saved the individual taxpayer approximately $4,000 in federal taxes and $1,000 in state taxes.

The subject of deduction limitations becomes more significant when addressing the issue of deductions allowed for medical expenses. An individual taxpayer can deduct the expenses for medical care of the taxpayer, his spouse, or a dependent to the extent that the expenses exceed 7.5% of the adjusted gross income. Using the previous example, if the individual had medical expenses of $25,000, they are not deductible because only those expenses that exceed 7.5% of the adjusted gross income are deductible. With an adjusted gross income of $500,000, the individual would need to have medical expenses of at least $37,500 before any deductions may be taken. In applying the applicable federal and state tax rates, the individual with $25,000 of medical expenses would pay a tax of approximately $12,500 ($10,000 to the federal government and $2,500 to the state government).

* For specific inquiries regarding a tax planning legal matter that you may have, you are welcome to visit our Los Angeles Business Attorney services page.

Enhanced by Zemanta
Published in: on December 17, 2010 at 9:35 pm  Comments (1)  
Tags: , , , , , , , , , , , , ,

To Incorporate or Not to Incorporate? THAT is the Question (Part 6)

This is part 6 of Anker Reed HSC’s blog series entitled “To Incorporate or Not to Incorporate? That is the Question”.

The tax implications for an LLC (limited liability corporation) are identical to that of a partnership. ” For federal income tax purposes, the LLC is not a separate taxpaying entity and is not subject to tax at the entity level. Instead, the LLC’s members report their respective distributive shares of LLC income, gain, loss, and deduction and credit on their individual federal income tax returns.” (Continuing Education of the Bar of California, 1999)

The tax treatment of an LLC by the state of California may also be problematic to the entertainer. Whereas the LLC and partnership will pay the same annual franchise tax that a corporation pays ($800), an LLC will be charged, pursuant to California Revenue & Taxation Code § 17942(a)-(b), an additional fee if there is net income exceeding $250,000. The additional fee is specified in the California Revenue and Tax Code and provides for the fee to be graduated at specified levels of income. Taking our earlier example of the partnership that has $1,000,000o taxable income, should this partnership be an LLC, there would be an additional fee of $5,190 assessed.

Other popular business entities include sole proprietorships, general partnerships, limited partnerships, and limited liability partnerships. It is not important that we analyze each of these entities with regard to the tax effects. What is important, though, is that we note that over time these entities have been regarded as being inappropriate for application to the entertainer. For example, the sole proprietorship provides no tax benefit insofar as taxes are assessed on the sole proprietor at the individual rate.

Furthermore, the purpose of this blog series is to assess the benefits and detriments of incorporation to the entertainer. An examination of all of the business entities and their utility to the entertainer would be of no use, for attorneys and accountants have long-held that an entertainer’s decision is solely whether to incorporate or remain a non-taxpayer. Therefore, the main consideration will be whether incorporation is beneficial to the entertainer as taxpayer.

* For specific inquiries regarding a business legal matter that you may have, you are welcome to visit our Los Angeles Business Attorney services page.

Enhanced by Zemanta
Published in: on November 4, 2010 at 8:33 pm  Leave a Comment  
Tags: , , , , , , , , , , , , , , ,

To Incorporate or Not to Incorporate? THAT is the Question (Part 4)

DETROIT - JANUARY 13: Sergio Marcionne (L) C...
Image by Getty Images

This is part 4 of Anker Reed HSC’s blog series entitled “To Incorporate or Not to Incorporate? That is the Question”.

“The desire to avoid employee classification, and to obtain the benefits of the corporate form and independent contractor status, often motivates workers to create an employee loan-out corporation.” (La France, 1995)

Primarily, though, an entertainer will be considering the formation of a business entity for the purpose of creating a more beneficial tax structure. By filtering income through a business entity and with proper Tax Planning advice, different tax advantages arise. Yet, the structures of a limited liability company (“LLC“) and a partnership will not provide the desired tax benefit to an entertainer.

A partnership includes a syndicate, group, pool, joint venture, or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this title, a corporation or a trust or estate.

* For specific inquiries regarding a business legal matter that you may have, you are welcome to visit our Business Organization and Business Formation legal services page.

Enhanced by Zemanta
Published in: on October 20, 2010 at 12:20 am  Leave a Comment  
Tags: , , , , , , , , , , , , , , , , , , , ,

To Incorporate or not to Incorporate? THAT is the Question (Part 3)

LAS VEGAS - MAY 21: Entertainer Donny Osmond ...
Image by Getty Images

This is part 3 of Anker Reed HSC’s blog series entitled “To Incorporate or Not to Incorporate? That is the Question”.

Which Business Entity Should the Entertainer Choose?

The analysis of which business entity will be most advantageous for an entertainer is no different from the analysis done with regard to which business entity will be optimal in any other industry. An analysis of the benefits and detriments with regard to liability, tax consequences, and control issues all factor in the decision of which business entity to employ. Over time, though, this analysis has been refined in that attorneys and accountants have recognized that certain business entities are more favorable in certain industries while other business entities more appropriately pertain to other industries.

The general analysis of the benefits and detriments of the various business entities have led attorneys and accountants to conclude that incorporating is more advantageous to an entertainer than forming a limited liability company, partnership, or other business entity. This is because the purposes for the formation of a business entity by an entertainer will not be served by any of the alternative business entities. The other attributes of incorporation, namely liability protection and control issues, become irrelevant.  Usually a corporation’s directors and shareholders will be shielded from liability in that a corporation and its owners are separate entities. This is untrue, though, when the shareholders have personally guaranteed the liability. This was a major teaching of the Basinger case, in that had Ms. Basinger signed the contract on her own behalf, this effectively would have been a personal guarantee of the contract. Additionally, the control issues are not important to analyze in that an entertainer is usually the sole shareholder of the loanout corporation.

* For specific inquiries regarding a business legal matter that you may have, you are welcome to visit our Business Organization Formation legal services page.

Enhanced by Zemanta
Published in: on October 13, 2010 at 1:07 am  Comments (1)  
Tags: , , , , , , , , , , , , , , , , ,
« Older Entries
%d bloggers like this: