Chris Stevenson, Esq. November 5, 2015

Transcription

1 Chris Stevenson, Esq. November 5,

2 C Corps Pros: a) Venture Capital: Venture funds are usually partnerships i. Can t invest in S Corps (s/h restrictions on pship or foreign investors s/h; no pref d stock) ii. Investing in pships can create tax filing obligations for foreign investors in venture fund, UBTI for nonprofit investors in venture fund. b) Qual. Stock Options: C Corps (and S Corp) can issue. LLCs cannot (but can issue profits interest). c) Tax When Cash (Dividend) is Received:

3 C Corps Cons: a) Double Taxation a) Losses: No flow through treatment

4 S Corps Pros: a) Avoid FICA: only on reasonable wages, not distributions b) Simpler: bylaws, Form 1120-S. c) Possible Tax-Free Exit: S and C Corp owners may be able to avoid paying taxes on exit if the business is acquired in a 368 tax-free re-organization S Corps Cons: Many (losses, taxable property distributions, etc)

5 LLC Pros: a) Flexibility: non pro-rata allocations b) Easier to Deduct Losses: basis credit c) Tax-Free Distributions of Appreciate Property: both inservice and liquidating distributions. LLC Cons: a) FICA: participating owners owe FICA on all earnings b) Expensive to Do It Right: Operating agreement; Form 1065

6 FICA Tax Rates: >Soc. Sec. 12.4% of first $118,500; >Medicare: 2.9% of all; plus 0.9% ($200K single, $250K joint) Rule: Participating LLC owners subject to FICA on all earnings; S Corp owner subject to FICA solely on reasonable wages. Example: Chris owns clothing store that has $100K of profit after paying all expenses except for Chris s time/effort. Chris determines $70K of wages is reasonable. He avoids approximately $4,590 of FICA on $30K of excess distributions ($30k x 15.3%). Roth IRA to supplement lower Soc. Sec wage base?

7 Issue: Can I contribute property or services in exchange for S Corp shares or LLC equity tax-free? Svcs for Vested Equity/Shares: always taxable to service provider Property for Equity/Shares: Can be done tax-free but easier with an LLC (no 80% control requirement). Example: Chris and Jill form C&J. Chris contributes building with $1K basis, $10K FMV. Jill agrees to serve as chef. Both receive 50%...

8 Jill s Shares/Equity: Taxable compensation (LLC or S Corp). Chris s Interest: LLC: Tax-free. 721 no control requirement. S Corp: Taxable to Chris. 351 requires transferors of property to control (80%) the corp immediately after. >Cure: Have Jill transfer property of relatively small value (10%) with her service. Rev. Proc

9 Other Formation Notes: Chris s Basis: Transferred basis for tax-free contributions. Chris s cost basis in the LLC would be $1K (same as basis of building). Tax-Free Exception for Excess Liabilities: If the building was subject to $2K liability assumed by entity, Chris subject to tax on $1K excess and his basis in the LLC/S corp interest would be $0. Tax-Free Exception for Boot: Taxable to the extent of FMV of any boot Chris receives (cash, other property). LLC Contribution-Distribution Rule: If LLC distributed building to Jill within 7 years, Chris may be taxed on appreciation

10 Profits: Advantage LLC Profits taxed even if cash is not distributed (LLC or S) S Corp Pro-Rata Limitation: 50% owner must be allocated 50% of all profits, losses, deductions, credits, etc LLC Allows Special Allocations: Example: Chris and Jill form C&J LLC. Chris contributes $1K; Jill contributes know-how. Both receive 50% equity but LLC OA provides Chris is allocated first $1,000 of income ; thereafter all profits are split 50:50.

11 Losses: HUGE Advantage LLC** >Basis is very important for both S Corp and LLC Owners: Limits ability to receive tax-free distributions of cash Limits ability to deduct losses (ordinary or capital) on owners personal tax returns. >Basis consists of: 1. Financial investment in LLC/S Corp (e.g. $10K Cash) 2. Owner loans directly to LLC/S Corp 3. Owner s share of LLC s Debts to 3 rd P: LLC Only*****

12 Losses: HUGE Advantage LLC** Example: Chris and Jill form C&J LLC, each contributing $50. C&J acquires a building for $100 down payment and C&J takes out a $900 mortgage. As and LLC, Chris and Jill each have $500 of basis. If the LLC has losses, Chris and Jill will be able to deduct up to $500 each on personal income tax returns assuming passive activity and at risk rules (see qualified non-recourse financing) are met. If the business was formed as an S Corp, each would have $50 of basis, limiting the ability to deduct losses. Any un-allowed losses would be held in suspense until sufficient basis (e.g. the building is sold). Any un-allowed losses in suspense when Chris or Jill sells S Corp shares are lost.

13 Distributions: HUGE Advantage LLC** Rule: Never put appreciating property in an LLC** LLC s allow for tax-free distributions of appreciated property to owners (in-service; at liquidation). Example: Chris and Jill form C&J LLC, each contributing $50. C&J acquires a building for $100, plus a $900 mortgage. Each have a $500 basis. The building increases in value to $1,500. Chris and Jill want to own the building as individuals. C&J distributes the building tax-free to Chris and Jill. Chris and Jill inherit C&J s cost basis in the building of $1,000. The basis in the LLC interests are reduced from $500 to $0.

14 Distributions: HUGE Advantage LLC** S Corp Example: Same facts but C&J is an S Corp. Chris and Jill would have only $50 of basis. The distribution of the building is treated as a deemed sale and C&J incurs $500 of gain ($1,500 - $1,000) allocated to Chris and Jill.

15 C Corp: Capital Gain 1202 QSBS Gain Exclusion: between 50% and 100% of gain, depending upon acquisition date. Remaining gain taxed at 28%. S Corp: Capital Gain LLC: Capital gain except portion of the gain attributable to hot assets (inventory, A/R) taxed at ordinary rates and depreciation recapture on building taxed at 25%.

16 C Corp Converts to S Corp: (possible tax) Generally tax-free except: 1. LIFO Recapture: 1363(d) 2. Built-In Gain if Assets sold w/in 10 years: Example: C&J has building worth $10K with a $1K cost basis. C&J converts to an S Corp. If C&J sells the building during next 10 years, the S Corp pays a tax on up to $9K of gain and S Corp shareholders pay tax on next gain ($9K tax paid by S Corp).

17 C Corp Converts to LLC: (double tax unless no appreciation) Corp pays tax on appreciate assets Shareholders pay tax on deemed liquidation. Example: Chris and Jill convert Restaurant C Corp into Restaurant LLC. They did not invest any of their money. Business paid $100K for assets now worth $1.1M. At conversion, business pays 35% tax rate on $1M appreciation ($350K), there is a deemed taxable distribution of $750K ($1.1M - $350K taxes) to Chris and Jill. Chris and Jill owe capital gains on the $750K distribution.

18 Health Insurance by LLC/Corp to 2% Owner-EE: LLC: 1) Taxable income to owner but owner gets an above the line deduction on his/her personal income tax return if not eligible for coverage through spouse. 162(l)(2)(B). 2) Subject to self-employment tax. 162(l)(4). S Corp Owner (2%): 1) W-2 taxable income with corresponding above the line deduction. 162(l)(2)(B). 2)**Not subject to FICA. SMLLC: Disregarded Entity QSSS: Disregarded Entity; S Corp owned 100% by an S Copr.

19 C Corps: Venture Capital S Corps: Avoid FICA LLCs: Non pro-rata allocations Easier to deduct losses* Tax-free distributions of appreciated property* *Always put appreciating property in an LLC

20 Questions? Chris Stevenson, Esq 20