Choice of Entity 2012

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A soup to "nuts" Case Study apprach to choosing the right type of business entity.

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Choice of Entity 2012

  1. 1. CHOICE OF ENTITY – SOUP TO Brian T. Whitlock, CPA, JD, LLM“NUTS” Tax Partner 1
  2. 2. Topics  Revisit basic issues with Choice of Entity  Case Studies  Unusual Issues impacting Choice of Entity Capital Requirements IRC Sec 1202 and IRC Sec 1045 ESOP and IRC Sec 1042  Alternate Entities Captive Insurance Companies IC-DISCs Cooperatives 2
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  6. 6. Case Study #2Don has an opportunity to open an new McDonald’s Franchise ina rapidly growing area of DuPage County.McDonald’s does not offer any tax advice to its franchisees.McDonald’s tells him that they see franchisees operate in lots ofvarious forms, including Sole Proprietorships, Partnerships, LLCs,C Corporations and S Corporation. It recommends that he consultwith his tax advisor, so he calls you.Where do you start? 6
  7. 7. Choice of Entity Comparison 7
  8. 8. Case Study #3 – Real Estate Developer Johnson (80 years of age) personally owns 40 acres of land the near Western Suburbs (Cook/DuPage County). He wants to develop the site with retail shopping, commercial office, townhomes & condominiums. He and his adult children have experience with building condominiums, townhomes, and single family homes in the past. In 2004 they sold their former company for an amount in excess of $200 million to a public company. He mothballed the plans 5 years ago, but feels that the time is rapidly approaching to re-launch this development. 8
  9. 9. Working Within the Entity ToolboxLifecycle of a Family Business Enterprise Sole ProprietorshipStage One (Ground Floor)Inception 9
  10. 10. Lifecycle of a Family Business Enterprise Sole Proprietorship Stage One (Ground Floor) Inception General Partnership Limited Partnership Stage Two (addition owner added) (Passive Investor Added) Adding otherpeople and/orRaising Capital Limited Partnership / LLC S Corporation C Corporation (Debt or Private (Debt or Private (Debt or Private Placement, Placement Capital) Placement Capital) and Venture Capital) 10
  11. 11. Lifecycle of a Family Business Enterprise Sole Proprietorship Stage One (Ground Floor) Inception General Partnership Limited Partnership Stage Two (addition owner added) (Passive Investor Added) Adding otherpeople and/orRaising Capital Limited Partnership / LLC S Corporation C Corporation (Debt or Private (Debt or Private (Debt or Private Placement, Placement Capital) Placement Capital) and Venture Capital) Stage Three LLC or General Partnership C Corporation S Corporation Mature (Joint Venture) (Venture Capital or IPO) (Lower Income Tax Business Access Cash Flow) 11
  12. 12. Lifecycle of a Family Business Enterprise Sole Proprietorship Stage One (Ground Floor) Inception General Partnership Limited Partnership Stage Two (addition owner added) (Passive Investor Added) Adding otherpeople and/orRaising Capital Limited Partnership / LLC S Corporation C Corporation (Debt or Private (Debt or Private (Debt or Private Placement, Placement Capital) Placement Capital) and Venture Capital) Stage Three LLC or General Partnership C Corporation S Corporation Mature (Joint Venture) (Venture Capital or IPO) (Lower Income Tax Business Access Cash Flow) Stage Four Limited Partnership Limited Liability Company C and S Corporations, LLCsDiversification/ (Real Estate related to (Non-family management (Multiple locations, products,Adding Entities Family business) participation in real estate) services) 12
  13. 13. Lifecycle of a Family Business Enterprise Stage One Sole Proprietorship Inception (Ground Floor) General Partnership Limited Partnership Stage Two (addition owner added) (Passive Investor Added) Adding otherpeople and/orRaising Capital Limited Partnership / LLC S Corporation C Corporation (Debt or Private (Debt or Private (Debt or Private Placement, Placement Capital) Placement Capital) and Venture Capital) Stage Three S Corporation LLC or General Partnership C Corporation Mature (Joint Venture) (Venture Capital or IPO) (Lower Income Tax Business Access Cash Flow) Stage Four Limited Partnership Limited Liability Company C and S Corporations, LLCsDiversification/ (Real Estate related to (Non-family management (Multiple locations, products,Adding Entities Family business) participation in real estate) services) S Corporation Family Limited Partnership Limited Liability Company Stage Five End Game Avoid Built In Gains Access Cash Flow Access Cash Flow Access Cash Flow Transfer Value/Keep Control Transfer Value/Keep Control 13
  14. 14. Unusual Financing Considerations that Drive Choice of Entity 14
  15. 15. Case Study #4 Beefco, Inc. is a food processor /distributor operating as an S Corporation. They have revenue of over $500 million per year in the sale of cut and pre-cook meat products to large fast food franchise operations such as McDonalds, Subway & Applebys throughout the Midwest. They have been approached by their customers to establish operations in North Carolina in order to provide product to franchise operators in that area. They may need a significant amount of capital and perhaps some creative financing. How will the potential financing impact the choice of entity? How might they restructure? 15
  16. 16. Unusual Tax Considerations that Drive Choice of Entity 16
  17. 17. Section 1202  Revenue Reconciliation Act of 1993 Sec 1045 Rollover of gain in Qualified Small Business Stock — 60 days reinvestment 50% exclusion for gains of Qualified Small Business Stock — C Corporation — Original Issue Stock after date of enactment Alternative Minimum Tax Implications IRC Sec 57(a)(7) — 7% included as a preference — Effective tax rate at 14%  Creating Small Business Jobs Act of 2010 75% exclusion for stock acquired in 2009 and 2010 100% exclusion for stock acquired in 2011 Section 57(a)(7) would not apply in 2011 17
  18. 18. Employee Stock Ownership Plans  May only be established by Corporate Employer S Corporation - ESOP permitted shareholder (―single‖ shareholder) PSC ownership restricted to licensed profession = discrimination  Designed to Invest Primarily in Employer Securities  Ownership Substantially all Stock can be restricted to employees and trust Prevent competitors  Plan can contain ―Put Option‖ to require redemption  If Employer has a class of SEC Registered Securities, then the ESOP must permit total participant voting of shares Non-SEC voting only required for sale, reorganization, or liquidation, dissolution or similar event 18
  19. 19. Traditional ESOP Corporation Newly Contribution in lieu of Cash Issued as pension/profit sharing stock contribution ESOP TRUST/ Employee Benefit Plan 19
  20. 20. Tax Benefits of ESOP  Enhanced deduction available 25% DC Limit Plus interest necessary to service the ESOP debt  C Corporation may deduct ESOP portion of dividend  S Corporation ESOP not subject to UBIT on S income  Tax-deferred Rollover – Section 1042 Seller of C Corp Shares may rollover proceeds into tax-deferred — Seller must have owned for 3 years — ESOP must own 30% after transfer — Proceeds must be invested in qualified securities (publicly traded) Seller and Family may not be participants in the ESOP Non-SEC voting only required for sale, reorganization, or liquidation, dissolution or similar event 20
  21. 21. Illustration of Leveraged ESOP Stock Client Corporation (Grantor) CashLender Newly Issued Debt stock ESOP TRUST/ Employee Benefit Plan 21
  22. 22. Export Sales OpportunitiesInterest Charged – Domestic International Sales Corporation (IC-DISC) 22
  23. 23. Understanding Domestic International Sales Corps  Brief history of IC-DISC  Requirements of an IC-DISC?  Benefits outside of the 15% dividend?  Categories of Gross Receipts  Identifying Qualified Export Receipts  How to calculate the Commission 23
  24. 24. A Brief History of IC-DISC  The IC-DISC first came about in 1984 I.R.C. Section 991 – 997.  Unlike other exporting incentives the IC-DISC has yet to be challenged by the World Trade Organization (WTO). Extraterritorial Income Exclusion repealed American Jobs Creation Act of 2004  With the current low dividend rates the IC-DISC is now an attractive tax saving vehicle. 24
  25. 25. Requirements for an IC-DISC?A corporation formed by a U.S. exporter/shareholder and will qualifyas an IC-DISC if: Organization Test — Domestic Corporation — Formed by U.S. exporter/shareholder — The IC-DISC does not have more than one class of stock, which the stock must have a par or stated value of at least $2,500 on each day of its fiscal year. — All shareholders consent to the election to be treated as an IC-DISC. (See Form 4876-A) — Must maintain its own set of books and records. — Cannot be a member of a controlling group of which a Foreign Sales Corporation is a member. 25
  26. 26. Not Required of a IC-DISC  It is a ―paper‖ entity. It is not required to have: Office space Employees, or Tangible assets  How it works: Exporting company forms a US corporation that elects to be an IC-DISC by filing IRS Form 4876-A. Exporting company pays commission to IC-DISC and deducts the commission as an ordinary business deduction. IC-DISC pays no tax on commission if two operational test met. Shareholders are not taxed until earnings are distributed as dividends. — Deferred dividends reported on IRS Form 8404 and interest is paid. 26
  27. 27. Requirements for an IC-DISC? Operational Tests — 95% of its gross receipts are qualified exports receipts – I.R.C. Sec. 993(a)(1). — 95% of the adjusted basis of its assets on the last day of its taxable year is qualified export assets (i.e., accounts receivable, temporary investments, export property, and loans to producers). – I.R.C. Sec. 993(b). 27
  28. 28. What are the Benefits?  Commissions paid by export Corporation to IC-DISC Fully deductible at regular tax rate Not treated as taxable income by IC-DISC Taxable to Shareholders as a dividend when paid — Plus low rate of interest Deduct at 35% taxed at 15% (20% Savings)  Flexible ownership Minors (dependents) Parents (dependants) Trusts, partnerships, corporation and foreign persons. Roth IRA? (Deduct at 35% taxed at 0%) 28
  29. 29. Illustration Restaurant Supply and Distribution Company (S Corporation) 100% Owner Dividend Commission IC-DISC (Tax Exempt C Corporation) 29
  30. 30. Cooperatives & Subchapter T (an alternative to Franchising) 30
  31. 31. Cooperatives  Two Types Exempt cooperatives under IRC§ 501: — § 501(c)(12) Cooperatives and Homeowners Associations — § 501(c)(16) Cooperative Organizations to Finance Farms — § 501(e) Cooperative Hospital Service Organizations — § 501(f) Cooperative Service Organizations of Operating Educational Organizations — § 521 Farmers Cooperative Associations – Land O’ Lakes Non-Exempt Cooperatives - Subchapter T of the IRC — True Value Hardware — Ace Hardware 31
  32. 32. Non-Exempt Cooperatives  A cooperative is a purchasing, marketing, or service enterprise owned by and operated for the benefit of its patrons.  Co-ops are ―Hybrid‖ tax structures Modified Conduit entities Operate partially like C Corporations and partial like a trust  The taxable income of a cooperative is computed like a corporation, except Allowed to deduct amounts paid within eight and one-half months after the end of the taxable year as patronage dividends  Patronage dividends Paid in cash or in kind (―by certificate‖) Dividends are included in the gross income in the year of receipt. 32
  33. 33. Captive Insurance Companies 33
  34. 34. Captive Insurance Company  A captive insurance company ("Captive") is an insurance company formed by a business owner to insure the risks of related or affiliated businesses.  Business owner creates a Licensed Insurance Company which offers to cover traditional risks Property Insurance Casualty Insurance  Captive can also cover non-traditional risks • Business Interruption • Loss of Key customer or supplier • Pollution • Loss of Tenant • Regulatory Exposure • Loss of Key Employee • Insurance Deductibles • Breach of Contract • Exclusions and Gaps • Natural Disasters, Terrorism 34
  35. 35. Captive Insurance Company  Business Reasons for creating a captive Lower insurance costs — Share in benefit of low claims — Charge a premium that reflects loss experience Cash Flow — Invest premium dollars and use investment income to reduce costs Risk Retention — Managing risk results in greater profit to owned captive Access Reinsurance market — Reinsurance is international wholesale market — Lower cost structure = lower cost Tax Minimization and deferral — Self Insurance is not deductible – premiums paid to a captive are! 35
  36. 36. Tax Benefits of Captive Insurance Companies  Subchapter L requires Insurance Companies to be C Corporations  Section 831(b) exempts first $1.2 million of premium from income tax  Premiums in excess of $1.2 million can be sheltered by loss reserves Insurance companies operate as C Corporations Insurance companies can deduct ―reserves‖ 36
  37. 37. IRS Required Elements for Insurance Companies  A Captive must provide Risk Shifting and Risk Distribution  “Risk Shifting” is the actual transfer of Risk from the insured to the Captive Insurance Company  “Risk Distribution” is the Captives exposure to adequate third- party risk to obtain the risk-pooling effect had by traditional insurance companies. Reduce the possibility that a single claim will exceed premiums received. Generally, 12 insureds are sufficient (even if subsidiaries, so long as they are not disregarded entities) 37
  38. 38. Illustration Family Owed Captive Client (Grantor) Irrevocable Trust for benefit of Client’s Family 100% Owner Restaurant A 100% Owner S Corporation Captive Insurance Company C Corporation Restaurant B S Corporation 38
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