The document provides an overview and summary of a presentation on tax planning related to equity incentive strategies, valuation methodologies, challenges in valuing early stage companies, and the net investment income tax. It discusses share-based payment awards, considerations in selecting valuation models, difficulties in valuing startups, and details of the additional 3.8% tax on net investment income over certain thresholds. Examples are also given to illustrate how the net investment income tax applies in different scenarios.

1. Business Law & Order:
Tax Planning
January 20, 2014

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. 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. 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. 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. 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. Valuation Methodologies
Enterprise Value Model Selection Considerations
 Income Approach
 Market Approach
 Asset Approach
7

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. 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. Net Investment Income Tax
Additional Medicare Tax
Annette Tenerelli-Lemke, CPA, MST
Partner
Plante Moran, PLLC
10

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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. • 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. 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. 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. 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. 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. 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. 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. 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. Tax Efficient Exits:
Two Opportunities
for C Corporation Sellers
Ann Arbor SPARK
January 20, 2014
Marko J. Belej
mbelej@jaffelaw.com
30

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. 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. 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. 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. 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. Next Business Law & Order Program:
Monday, March 17th
Basics of Formation
Office hours included