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Business Law & Order - January 20, 2014 - Tax Planning


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Business Law & Order - January 20, 2014 - Tax Planning

  1. 1. Business Law & Order: Tax Planning January 20, 2014
  2. 2. Business Law & Order – Tax Planning January 20, 2014 Presenters: Cory J. Thompson, CFA Managing Director Investment Banking Valuation & Financial Opinions Dispute Advisory & Forensic Services
  3. 3. Disclaimer This presentation is intended for general information purposes only and is not intended to provide, and should not be used in lieu of, financial, accounting, legal, or other professional advice. Stout Risius Ross, Inc. assumes no liability for the use of the information herein and the audience is encouraged to seek professional assistance with regard to specific matters. The opinions expressed during this presentation are solely those of the presenter and do not necessarily reflect the views of Stout Risius Ross, Inc. 3
  4. 4. Equity Incentive Strategies What are Share-Based Payment Awards  Equity shares  Share options  Share appreciation rights  Restricted stock  Other equity instruments (e.g., performance units)  Granted in exchange for services 4
  5. 5. Equity Incentive Strategies What are Share-Based Payment Awards  Who receives them and why? – Executives and other company employees are granted share-based awards as a component of a total compensation package  Received as one-time grants or annual grants  Can be structured to vest upon certain timing, performance, or market conditions  This form of variable compensation may fit most strategically with the interests of a company’s shareholders (i.e., pay can be tied to performance) 5
  6. 6. Equity Incentive Strategies Valuation Implications  Tax reporting: IRC 409A (Fair Market Value)  Financial reporting: FASB ASC 718 (Fair Value)  Other Considerations: – Dilutive impact to remaining stakeholders – Change of control issues pertaining to NOLs (more of an issue for new capital raises) 6
  7. 7. Valuation Methodologies Enterprise Value Model Selection Considerations  Income Approach  Market Approach  Asset Approach 7
  8. 8. Valuation Methodologies Equity Value Allocation Model Selection Considerations  Current Value Method – Company sold on valuation date – Proceeds distributed according to investors’ liquidation rights and preferences  Probability Weighted Expected Return Method (“PWERM”) – Probability weighted of future likely outcomes – IPO, sale, status quo, liquidation  Option Pricing Method (“OPM”) – Treats securities as call options on the company’s equity value  Hybrid Method – Combination of the above approaches 8
  9. 9. Early Stage Company Valuation Challenges  Must consider the impact of negative cash flows that may occur in the early years – Value dependent on accuracy of prospective financial information  High chance of failure of early stage, high growth companies – Discount rate selection is key  Analysis of prior capital raises is critical – “Backsolve Method” – employ prior capital raises to solve for indication total equity value  Difficult to find comparable companies  Valuing a company for what it wants to be – not what it is today 9
  10. 10. Net Investment Income Tax Additional Medicare Tax Annette Tenerelli-Lemke, CPA, MST Partner Plante Moran, PLLC 10
  11. 11. Pat i ent Pr ot ect i on & A f or dabl e C e A f ar ct • Items to cover: I. Additional Medicare Tax II. Net Investment Income Tax (NII) III. How much NII gets surtaxed? IV. Examples V. Planning ideas - Individuals 11
  12. 12. C par e 2012 t o 2013 om 2012 Tax Brackets by “Taxable” Income 2013 Tax Brackets by “Taxable” Income Rate MFJ Single Rate MFJ Single 10% 0-17,400 0-8,700 10% 0-17,850 0-8,925 15% 17,400-70,700 8,700-35,350 15% 17,850-72,500 8,925-36,250 25% 70,700-142,700 35,350-85,650 25% 72,500-146,400 36,250-87,850 28% 142,700-217,450 85,650-178,650 28% 146,400-223,050 87,850-183,250 33% 217,450-388,350 178,650-388,350 33% 223,050-398,350 183,250-398,350 35% Over 388,350 Over 388,350 35% 398,350-450,000 398,350-400,000 39.6% Over 450,000 Over 400,000 12
  13. 13. A t i onal M car e Tax ddi edi • 0.9% HI (Hospital Insurance)Tax on earned income • total wages and other self employment income of taxpayer and spouse in excess of: – $250,000 MFJ/ $125,000 MFS • – $200,000 Single and HOH • Employee contribution 2.35% • Employer matching 1.45% 13
  14. 14. A t i onal M car e Tax ddi edi • Employer responsible to withhold/pay on wages in excess of $200,000/250,000 • Additional tax is not deductible 14
  15. 15. N I nvest m et ent I ncom Tax e ( 1411) • Enacted as part of the Health Care and Education Reconciliation Act of 2010 • Intended to help fund health care reform • Effective 1/1/13 • 3.8% tax on certain “net investment income” • This new tax will apply to individuals, estates and trusts 15
  16. 16. N I nvest m et ent Tax 3.8% tax imposed on lesser of: 1) Net Investment Income (NII); or 2) Excess of AGI over $250,000/$200,000 Net Investment Income: Category 1: Interest, Dividends, Annuities, Royalties and Rents Category 2: Passive income from Trades or Businesses Category 3: Net gain (but not loss) from Dispositions of other than Active Trade or Business Property 16
  17. 17. N I nvest m et ent Tax cont .: Certain types of income are excluded from NII 1. Earned income including wages and SE income 2. Active trade or business income 3. Distributions from qualified retirement plans and IRAs 4. Interest on municipal bonds 5. Excludable portion of gain on primary residence sale 6. Gain on sale of partnership or S corporation interests • Note that while earned income, active trade or business income, retirement and IRA distributions and active gains are excluded from NII, they are INCLUDED in AGI and thus increase the likelihood that the tax will apply. 17
  18. 18. Examples • Example 1: X and Y, married filing jointly, together have income of $500,000, all of which is salary. The surtax will not apply because they have no net investment income. • Example 2: X and Y, married filing jointly, have $500,000 of salary and $50,000 of net investment income. The surtax applies to the $50,000 of net investment income because it is less than the excess of MAGI over the threshold (i.e., $550,000 – $250,000 = $300,000). 18
  19. 19. Examples • Example 3: X, a single filer, has $275,000 of net investment income and no other income. The surtax applies only to the $75,000 that exceeds the $200,000 threshold for single filers. • Example 4: X and Y, married filing jointly, have $225,000 of salary income and $125,000 of net investment income. The surtax applies to $100,000, the difference between their threshold ($250,000) and MAGI ($350,000), which is less than their net investment income of $125,000. • Example 5: X, a single filer, has $500,000 of interest and a $500,000 net capital loss. The surtax applies to $297,000, $500,000 less $200,000 threshold and the $3,000 maximum capital loss that may offset ordinary income 19
  20. 20. N I – C egor y 2 I ncom I at e Category 2 – Gross income from passive activities and from trade or business of trading financial instruments • Example: a pass-thru entity in which you do not materially participate 20
  21. 21. Passive Activity Importance of Passive Activity Rules - Material Participation Generally The taxpayer works 500 hours or more during the year in the activity; • The taxpayer does substantially all the work in the activity; • The taxpayer works more than 100 hours during the year in the activity and no one else works more than the taxpayer; 21
  22. 22. • The activity is a significant participation activity (a “Significant Participation Activity”) because the taxpayer works more than 100 hours in the activity, and the sum of the taxpayer’s time spent on Significant Participation Activities exceeds 500 hours that year; • The taxpayer materially participated in the activity in any 5 of the prior 10 years; • The activity is a personal service activity and the taxpayer materially participated in that activity in any 3 prior years; or • Based on all of the facts and circumstances, the taxpayer participates in the activity on a regular, continuous, and substantial basis during such year. However, this test only applies if the taxpayer works at least 100 hours in the activity, no one else works more hours than the taxpayer in the activity, and no one else receives compensation for managing the activity. 22
  23. 23. Exam e: pl Joint w/AGI Over Threshold and Passive K-1 Passthrough $ $ $ $ $ 240,000 25,000 2,500,000 2,765,000 -250,000 2,515,000 2,525,000 2,515,000 x 3.8% 95,570 IRA distribution Interest and dividends (NII) K-1 passive activity Modified AGI Joint Threshold MAGI less threshold NII Lesser of NII or MAGI – threshold Medicare Investment Tax HI tax increase 23
  24. 24. Joint w/AGI Over Threshold and Active K-1 Passthrough $ $ $ $ $ 240,000 25,000 2,500,000 2,765,000 -250,000 2,515,000 25,000 25,000 x 3.8% 950 IRA distribution Interest and dividends (NII) K-1 Active trade or business Modified AGI Joint Threshold MAGI less threshold NII Lesser of NII or MAGI – threshold Medicare Investment Tax HI tax increase 24
  25. 25. D educt i ons agai nst N I I • Deductions are allowed against Net Investment Income to the extent they are allowed for income tax purposes. • – 2% misc itemized deductions • Investment interest expense • Investment advisory & brokerage fees • Tax prep fees, fiduciary expenses • State and local income taxes 25
  26. 26. Pl anni ng – m ni m zi ng “N i i et I nvest m ent I ncom e” Tax Exempt Bonds That will depend on a comparison of the after-tax yields of both. The after-tax yields of taxable bonds will now be affected by this additional 3.8% tax. Minimize dividends Dividends will now be taxed more heavily. This could encourage a preference for investments that generate capital appreciation. This could include non-dividend, or low dividend, paying stocks and non-principal protected structured notes. 26
  27. 27. Pl anni ng – M ni m zi ng N I i i I Increase participation to make passive income non-passive. Gross income from a passive activity will be subject to the 3.8% tax. If your level of activity could be increased so that the business income becomes not passive, that would avoid the tax. Review how your passive activities are aggregated. In determining whether you are active or passive in an “activity,” there are rules governing what constitutes an “activity” and how different activities might be combined and considered one single “activity.” 27
  28. 28. Pl anni ng – M ni m zi ng N I i i I • Consider a charitable remainder trust (CRT) • Maximize deductible contributions to qualified retirement plans (e.g. traditional IRA’s and 401(k)s) • Convert LLC to S corp (careful planning required) 28
  29. 29. Thank-you! Annette Tenerelli-Lemke Partner 1000 Oakbrook Dr. Suite 400 Ann Arbor, MI 48104 Direct Dial: 734-302-6407 Mobile: 248-420-3310 Fax: 248-233-8687 Plante & Moran | Twitter | Facebook | LinkedIn Celebrating 16 years as one of FORTUNE magazine's “100 Best Companies to Work For” 29
  30. 30. Tax Efficient Exits: Two Opportunities for C Corporation Sellers Ann Arbor SPARK January 20, 2014 Marko J. Belej 30
  31. 31. Generally, C corporations are undesirable in an exit Tax consequences with a C corporation seller/target • Stock sale: - Shareholders only subject to tax on gain from sale of stock - But purchaser does not get stepped up tax basis • Asset sale: - Purchaser does get stepped up tax basis. - But double tax- C corporation taxed on sales gain and shareholders taxed on distribution of proceeds Contrast with an LLC or S corporation: • Members/shareholders only subject to tax on gain • And purchaser gets stepped up tax basis 31
  32. 32. Opportunity #1: Code Section 1202 Under Code Section 1202, a seller of C corporation stock may exclude a portion of the gain What portion? > Depends on when the stock was acquired •100%, if acquired after Sept 27, 2010 and before Jan 1, 2014 •75%, if acquired after Feb 17, 2009 and before Sept 28, 2010 •50%, if acquired before Feb 18, 2009, or after Dec 31, 2013 Limitation: Generally, shareholder can’t exclude more than $10 million from the sale of stock of any issuer Also, the exclusion is an AMT preference amount 32
  33. 33. Opportunity #1: Code Section 1202 (cont.) Requirements for Code Section 1202 exclusion •Shareholder has held stock for more than 5 years •Stock is “qualified small business stock” - - Stock of a C corporation Shareholder acquires stock at original issue in exchange for money or property or as compensation for services Corporation meets active business requirement- generally that 80% (by value) of assets used in a “qualified trade or business” (certain service and financial businesses, among others, are excluded) during holding period Corporation is qualified small business – amount of cash and tax basis of assets held by corporation not more than $50 million at stock’s issuance; certain reporting required •Additional rules for stock held through pass-through entities and for certain tax-free and other transfers of stock 33
  34. 34. Opportunity #2: Personal Goodwill Theory: One or more shareholders personally own goodwill or similar asset used in business Structure 1 (Seller favorable): Purchaser acquires personal goodwill and corporation stock from shareholder • Only shareholder recognizes gain from sale • Purchaser obtains stepped up basis in personal goodwill Structure 2 (Purchaser favorable): Purchaser acquires personal goodwill from shareholder and assets from corporation • Shareholder recognizes gain from goodwill sale • Corporation recognizes (minimized) gain from sale of assets • Purchaser obtains stepped up basis in all assets 34
  35. 35. Opportunity #2: Personal Goodwill (cont.) Limitations: • Will not work if shareholder/employee has previously executed an employment/noncompete agreement with corporation • May be difficult to get purchase consideration to shareholders who are not active in business • Identifying and transferring personal goodwill must be done carefully • Valuation 35
  36. 36. Next Business Law & Order Program: Monday, March 17th Basics of Formation Office hours included