This document discusses different entity structures for operating a business including C corporations, S corporations, and LLCs. C corporations are subject to double taxation while S corporations allow profits and losses to pass through to shareholders. S corporations have advantages over partnerships for highly profitable businesses since income is not subject to self-employment tax. LLCs are taxed as partnerships, allow flexible membership, and provide liability protection. The document also summarizes tax considerations for stock acquisitions under Sections 338 and 338(h)(10).

1. Choice of Entity and Selected Corporate Tax Matters September 1, 2011

2. With You Today Jon Zefi LL.M., J.D., M.B.A. Tax Partner EisnerAmper LLP 750 Third Avenue New York, New York 10017 (212) 891-4064 [email_address]

3. Today’s Discussion Agenda Overview of Initial Operating Structures Typical Monetization Structures

4. Overview of C Corporations C Corporations subject to corporate income tax at the entity level. Individual shareholders will be subject to a second level of taxation upon a distribution of a dividend from the corporation. No Flow-thru of losses - Capital Losses can only offset capital gains and excess losses have a limited three-year carryback and five year carryover Distribution of appreciated assets is treated as if the corporation had sold the asset immediately prior to the distribution. The shareholder must take the FMV of the asset into account in measuring gain recognition. (The tax liability is mitigated by the 15% individual cap gain and dividend rate)

5. Overview of S Corporations S Corporations not subject to corporate income tax. Items of income, deductions, losses and credits are passed through to shareholders and reported on their respective returns Losses flow through to shareholders for deductibility within their individual tax returns Losses are allowable to the extent of shareholder’s basis in stock and debt If a shareholder does not materially participate, losses may be passive and used by the shareholder to offset other passive income and not to offset active business income such as wages, self-employment income or portfolio income. Capital Losses flow to shareholders who can use the losses to offset up to $3,000 per year of ordinary income, in addition to capital gains. Unused capital losses of an individual have unlimited carry-forward during the life of the taxpayer When an S corporation distributes an appreciated asset the same code sections applied to C corporations and causes gain to be recognized but the gain recognition causes a basis increase as the gain passes through to the shareholder thus effectively negating any double taxation consequences.

6. Overview of S Corporations S corporations have a distinct advantage over highly profitable partnerships since S corporation pass through business income is not subject to self-employment tax (i.e., 2.9% Medicare tax which jumps to 3.8% for wages on a joint return of $250,000; for a married filing separately $125,000 and in the case of other taxpayers is $200,000) Example: Jon has built a business that brokers computer chips yielding net income of $500,000 (not from personal services). If Jon forms an S corporation and receives an annual salary of $110,000 (reasonable compensation) the remaining earnings of $390,000 will not be s.t. the 2.9% Medicare tax. S corporations may not have a nonresident alien as a shareholder, nor may it have a corporation or partnership as a shareholder. Further, it may have no more than 100 shareholders although all members of a family are counted as one shareholder. S corporations may only have a single class of stock. An S corporation may issue both voting and nonvoting shares within a single class.

7. Overview of S Corporations S corporations must generally use a calendar year or make a Sec. 444 elections that allows limited use of a September, October or November fiscal year end. A required payment must be made for S corporations making a Sec. 444 election to avoid deferral. An S corporation shareholder has been entitled to a favorable 15% tax rate for long term capital gains recognized on the sale S corporation stock. As opposed to the sale of an interest in a partnership whereby gain may be taxed as ordinary income to the extent the assets in the business are ordinary income property or are subject to Sec. 1245 depreciation recapture. Difficult to convince a buyer to acquire the stock of an S corporation rather than purchase the assets since the buyer does not achieve a fresh depreciable basis in the assets and the buyer inherits potential legal liabilities.

8. Overview of S Corporations State Tax Nonconformity A C corporations that elects S status may still incur corporate level tax under the following three scenarios: Sec. 1374 built-in-gains tax will apply to any asset based gain recognition that occurs in the first ten years following a conversion; Sec. 1375 excess passive gross receipts tax applies to S corporations with former C corporation earnings and profits and portfolio-type passive gross receipts that exceed 25% of total gross receipts; and A C corporation using LIFO method of inventory valuation must recapture its LIFO reserve and pay corporate level tax upon converting with the tax spread over 4years.

9. Overview of LLCs LLCs are taxed as partnerships and allow each member to take part in management decisions without losing personal liability protection. There is no limitation on the number and type of LLC members (e.g., corporations, partnerships, estates, trusts, nonresident aliens, corporations and other LLCs can be members) Check-the-box regulations: Default Pass through Status An eligible entity (i.e., an entity not automatically classified as a corporation) with at least two members is able to choose to be treated as either a partnership or an association taxable as a corporation. An entity with only a single member can choose to be classified as an association or to be disregarded as an entity separate from its owner. Form 8832, Entity Classification Election filed by eligible entities that do not want default classification. After making such an election, the entity cannot change classification again for 60 months unless there is a greater than 50% ownership change. The electing entity can specify an effective date on Form 8832 that is no more than 75 days before or 12 months after the election filing date. If no date is specified the election is effective on the date filed. The Exception: Formless Conversion Under State Law

10. Taxable Stock Acquisitions Sec. 338 To be eligible to make a 338 election purchasing corporation must make a qualified stock purchase (i.e., 80% of the total voting power and value of the stock) of the Target corporation’s stock during a twelve month acquisition period. The twelve month period begins to run on the date of the first purchase of stock included in a qualified stock purchase. Under 338(g), Purchaser must make the election no later than the 15 th day of the 9 th month beginning after the month which includes the acquisition date. If Purchaser makes the election, the original target corporation (old T) is deemed to sell its assets to a new corporation (new T) at FMV. The deemed sale is treated as occurring at the close of the acquisition date. New T takes a basis in the assets of old T determined by reference to the purchase price of old T’s stock, adjusted for liabilities and other items.

11. Taxable Stock Acquisitions Sec. 338 S Corporations – Because of the S eligibility rules, a qualifying stock purchase by a C corporation terminates the Target’s status as an S corporation. Since the Target is now treated as a C corporation, any net built-in-gain inherent in its assets will potentially be subject to corporate level tax. If a Sec. 338 election is made, the Purchaser will bear the economic burden of the corporate level tax resulting from the deemed asset sale unless the purchase price of the S corporation stock is discounted to reflect the tax.

12. Taxable Stock Acquisitions Sec. 338 Example: T owns a single asset with a basis of $500 and a fmv of $1,000 and T’s only liability is a potential tax of $75 that would be imposed on a sale of its asset. P buys all of T’s stock for $925. If P makes a Section 338 election, T will be treated as selling its asset to new T for $1,000, triggering $500 of gain. New T will receive an asset with a basis of $1,000 ($925 stock purchase price plus $75 tax liability on deemed sale of the asset). The entire $1,000 is allocated to the basis of the asset. The tax consequences would be identical if T actually sold its asset to P for $1,000 and paid the $75 tax on the asset sale and distributed the $925 to T’s former shareholders in complete liquidation

13. Taxable Stock Acquisitions Sec. 338(h)(10) If an acquiring corporation (P) purchases stock of T from T’s Parent a Sec. 338(h)(10) may be beneficial. If an election is made, T’s Parent will not recognize gain or loss on the sale of T’s stock and T will recognize gain or loss as if it sold its assets. The treatment of Parent’s stock sale as an asset sale allows Parent to dispose of its subsidiary with only one tax at the corporate level even though the purchaser obtains a stepped up basis in the assets. The election is beneficial if the unrealized appreciation in the subsidiary’s assets is less than the unrealized appreciation in the Parent’s stock. Moreover, a Sec. 338(h)(10) election will be more desirable if the purchase price is allocable to depreciable assets or amortizable Sec. 197 intangibles. A Sec. 338(h)(10) election is available if the target is a member of a selling consolidated group. Any gain or loss on the deemed sale of T’s assets must be included in the selling group’s consolidated return.

14. Taxable Stock Acquisitions Sec. 338(h)(10) Unique S Corporation Matters To Think About and Why To avoid double level tax, an (h)(10) election may be made jointly by the Purchasing corporation and the S corporation shareholders. Any gain or loss recognized by the target while still an S corporation on the deemed sale of its assets passes through to its shareholders and increases the basis of their stock. The S corporation is deemed to distribute the Sale proceeds to its shareholders in complete liquidation pursuant to Sec. 331. To the extent that their stock basis has already been increased to reflect previously taxed gain attributable to the deemed asset sale, the liquidation should generally be tax free to the S shareholders. If the purchaser is another S corporation and acquires 100% of the Target’s stock, the parent S corporation may elect to treat the acquired S subsidiary as a Qualified Subchapter S Subsidiary. A joint election under Sec. 338(h)(10) can be made allowing the basis of the S Target’s assets to be stepped up with a single layer of tax.

15. EisnerAmper LLP is an independent member firm of PKF International Limited