Choice of Entity 2012
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Transcript of Choice of Entity 2012
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Brian T. Whitlock, CPA, JD, LLMTax Partner
CHOICE OF ENTITY – SOUP TO “NUTS”
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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
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Case Study #2
Don has an opportunity to open an new McDonald’s Franchise in a 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 of various forms, including Sole Proprietorships, Partnerships, LLCs, C Corporations and S Corporation. It recommends that he consult with his tax advisor, so he calls you.
Where do you start?
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Choice of Entity Comparison
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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.
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Sole Proprietorship(Ground Floor)
Stage OneInception
Working Within the Entity ToolboxLifecycle of a Family Business Enterprise
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Sole Proprietorship(Ground Floor)
Stage OneInception
General Partnership(addition owner added)
Limited Partnership / LLC(Debt or Private
Placement Capital)
S Corporation(Debt or Private
Placement Capital)
C Corporation(Debt or Private Placement,
and Venture Capital)
Limited Partnership(Passive Investor Added)
Stage Two Adding other
people and/or Raising Capital
Lifecycle of a Family Business Enterprise
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Sole Proprietorship(Ground Floor)
General Partnership(addition owner added)
Limited Partnership / LLC(Debt or Private
Placement Capital)
S Corporation(Debt or Private
Placement Capital)
C Corporation(Debt or Private Placement,
and Venture Capital)
Limited Partnership(Passive Investor Added)
Stage Two Adding other
people and/or Raising Capital
Lifecycle of a Family Business Enterprise
Stage OneInception
Stage Three Mature
Business
LLC or General Partnership(Joint Venture)
C Corporation(Venture Capital or IPO)
S Corporation(Lower Income TaxAccess Cash Flow)
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Sole Proprietorship(Ground Floor)
General Partnership(addition owner added)
Limited Partnership / LLC(Debt or Private
Placement Capital)
S Corporation(Debt or Private
Placement Capital)
C Corporation(Debt or Private Placement,
and Venture Capital)
Limited Partnership(Passive Investor Added)
Stage Two Adding other
people and/or Raising Capital
Lifecycle of a Family Business Enterprise
Stage OneInception
Stage Three Mature
Business
LLC or General Partnership(Joint Venture)
C Corporation(Venture Capital or IPO)
S Corporation(Lower Income TaxAccess Cash Flow)
Stage Four Diversification
/ Adding Entities
Limited Partnership(Real Estate related to
Family business)
Limited Liability Company(Non-family management
participation in real estate)
C and S Corporations, LLCs(Multiple locations, products,
services)
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Sole Proprietorship(Ground Floor)
General Partnership(addition owner added)
Limited Partnership / LLC(Debt or Private
Placement Capital)
S Corporation(Debt or Private
Placement Capital)
C Corporation(Debt or Private Placement,
and Venture Capital)
Limited Partnership(Passive Investor Added)
Stage Two Adding other
people and/or Raising Capital
Lifecycle of a Family Business EnterpriseStage OneInception
Stage Three Mature
Business
LLC or General Partnership(Joint Venture)
C Corporation(Venture Capital or IPO)
S Corporation
(Lower Income TaxAccess Cash Flow)
Stage Four Diversification
/ Adding Entities
Limited Partnership(Real Estate related to
Family business)
Limited Liability Company(Non-family management
participation in real estate)
C and S Corporations, LLCs(Multiple locations, products,
services)
Stage Five End Game
S CorporationAvoid Built In GainsAccess Cash Flow
Family Limited PartnershipAccess Cash Flow
Transfer Value/Keep Control
Limited Liability CompanyAccess Cash Flow
Transfer Value/Keep Control
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Unusual Financing Considerations that Drive Choice of Entity
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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?
Case Study #4
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Unusual Tax Considerations that Drive Choice of Entity
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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
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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
Employee Stock Ownership Plans
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Traditional ESOP
Corporation
ESOP TRUST/ Employee Benefit Plan
Contribution in lieu of Cash as pension/profit sharing contribution
Newly Issued stock
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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
Tax Benefits of ESOP
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Illustration of Leveraged ESOP
Lender
CorporationClient
(Grantor)
ESOP TRUST/ Employee Benefit Plan
Stock
Cash
DebtNewly Issued stock
CashDebt
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Export Sales OpportunitiesInterest Charged – Domestic International Sales
Corporation (IC-DISC)
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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
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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.
A Brief History of IC-DISC
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A corporation formed by a U.S. exporter/shareholder and will qualify as 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.
Requirements for an IC-DISC?
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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.
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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).
Requirements for an IC-DISC?
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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%)
What are the Benefits?
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Illustration
Restaurant Supply and Distribution Company
(S Corporation)
IC-DISC(Tax Exempt C Corporation)
100% OwnerCommissionDividend
Export Sales
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Cooperatives & Subchapter T (an alternative to Franchising)
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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
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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.
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Captive Insurance Companies
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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
• Pollution• Regulatory Exposure• Insurance
Deductibles• Exclusions and
Gaps
• Loss of Key customer or supplier
• Loss of Tenant• Loss of Key Employee• Breach of Contract• Natural Disasters, Terrorism
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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!
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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”
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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 insured's are sufficient (even if subsidiaries, so long as they are not disregarded entities)
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Illustration
Family Owed Captive
Restaurant AS Corporation
Irrevocable Trust for benefit of Client’s Family
Client(Grantor)
Captive Insurance CompanyC Corporation
Premiums
100% Owner
100% Owner
Restaurant BS CorporationPremiums