SOPHISTICATED CHOICE OF ENTITY, PART 1 & PART 2

First Run Broadcast: February 20 & 21, 2018

1PM EDT, 12PM CDT, 11AM MDT, 10AM PDT (60 minutes each day)

Choosing the right entity for a closely-held business is not about a single point in time but

planning for that business over long stretches of time and the likelihood of substantial change.

One of those changes is the change wrought by tax law, specifically the recently enacted tax

reform legislation. The new law substantially alters familiar tax law considerations when

choosing the right entity for client goals, particularly when considering a range of pass-through

entities. These and a multitude of other considerations often involve a sophisticated tradeoff of

benefits and costs. This program will provide you with a practical guide to sophisticated choice

of entity considerations, including detailed consideration of the new tax law.

Day 1: February 20, 2018:

• Advanced choice of entity considerations – management, tax, finance, regulatory,

employee benefit and other considerations

• Impact of industry norms, investor expectations, and regulatory requirements on choice

of entity

• Management and information rights, and the ability to restrict

• Fiduciary duties and liability of owners and managers, and the ability to modify these

duties

• Economic rights – choosing among capital rights, income rights, tracking rights

• Special considerations for service-based businesses

Day 2: February 21, 2018:

• Impact of new 2018 tax law on C Corps, S Corps, and pass-through entities

• Planning for distributions of property

• Anticipating liquidity events – sale of the company, liquidation of the company, new

investors/members

• Employment tax planning disparities among entities

• State and local tax considerations

• Owner and employee fringe benefit considerations

• When the first choice wasn’t correct – considerations when an entity needs to convert

Speaker:

Paul Kaplun is a partner in the Washington, D.C. office of Venable, LLP where he has an

extensive corporate and business planning practice, and provides advisory services to emerging

growth companies and entrepreneurs in a variety of industries. He formerly served as an Adjunct

Professor of Law at Georgetown University Law Center, where he taught business planning.

Before entering private practice, he was a Certified Public Accountant with a national accounting

firm, specializing in corporate and individual income tax planning and compliance. Mr. Kaplun

received his B.S.B.A., magna cum laude, from Georgetown University and J.D. from

Georgetown University Law Center.

Norman Lencz is a partner in the Baltimore, Maryland office of Venable, LLP, where his

practice focuses on a broad range of federal, state, local and international tax matters. He

advises clients on tax issues relating to corporations, partnerships, LLCs, joint ventures and real

estate transactions. He also has extensive experience with compensation planning in closely held

businesses. Mr. Lencz earned his B.S. from the University of Maryland and his J.D. from

Columbia University School of Law.

VT Bar Association Continuing Legal Education Registration Form

Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name ________________________ Middle Initial____ Last Name__________________________

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Sophisticated Choice of Entity, Part 1 Teleseminar

February 20, 2018 1:00PM – 2:00PM

1.0 MCLE GENERAL CREDITS

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VBA Members $75 Non-VBA Members $115

NO REFUNDS AFTER February 13, 2018

VT Bar Association Continuing Legal Education Registration Form

Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name ________________________ Middle Initial____ Last Name__________________________

Firm/Organization _____________________________________________________________________

Address ______________________________________________________________________________

City _________________________________ State ____________ ZIP Code ______________________

Phone # ____________________________Fax # ______________________

E-Mail Address ________________________________________________________________________

Sophisticated Choice of Entity, Part 2 Teleseminar

February 21, 2018 1:00PM – 2:00PM

1.0 MCLE GENERAL CREDITS

PAYMENT METHOD:

Check enclosed (made payable to Vermont Bar Association) Amount: _________ Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # _______________________________________ Exp. Date _______________ Cardholder: __________________________________________________________________

VBA Members $75 Non-VBA Members $115

NO REFUNDS AFTER February 14, 2018

Vermont Bar Association

CERTIFICATE OF ATTENDANCE

Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: February 20, 2018 Seminar Title: Sophisticated Choice of Entity, Part 1 Location: Teleseminar - LIVE Credits: 1.0 MCLE General Credit Program Minutes: 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

Vermont Bar Association

CERTIFICATE OF ATTENDANCE

Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: February 21, 2018 Seminar Title: Sophisticated Choice of Entity, Part 2 Location: Teleseminar - LIVE Credits: 1.0 MCLE General Credit Program Minutes: 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

© 2018 Venable LLP

Paul Kaplun, Partner

Corporate, Securities, and Business Transactions Practice Group

202-344-8535

ptkaplun@venable.com

Chris Davidson, Counsel

Tax and Wealth Planning Practice Group

410-244-7780

csdavidson@venable.com

Sophisticated Choice of Entity After the Tax Cuts and Jobs Act

© 2018 Venable LLP

• The recent enactment of the Tax Cut and Jobs Act has dramatically changed the tax landscape for all taxpayers, but the legislation has a particularly significant impact on choice of entity consideration. While the typical non-tax considerations continue to play an important role, the tax changes may cause some taxpayers to re-evaluate their previous choice of entity decisions.

• While the new rules certainly create many opportunities for tax savings, careful planning is necessary to ensure that pass-through entities and their owners take maximum advantage of these new opportunities.

• Given the speed with which the legislation was passed, there are many unanswered questions as to how the new rules will apply.

• This presentation will assist practitioners in understanding how to best navigate some of these new rules, as well as an in-depth analysis of the impact of the new rules on the “choice-of-entity” decision.

2

Introduction

© 2018 Venable LLP

Sole Proprietorship C Corporation S Corporation

Limited Liability

Company (taxed as a

Partnership) Limited Partnership

Ownership; Liability of

Owners

- One owner; unlimited

personal liability

- Unlimited number of

shareholders without

restrictions as to types of

owners

- Shareholder liability

limited to the amount of

capital contribution

- Up to 100 shareholders

- Generally, only US

citizens or residents can be

shareholders

- Certain trusts and tax-

exempt organizations are

eligible shareholders

- Shareholder liability

limited to the amount of

capital contribution

- Unlimited number of

members without

restriction as to types of

owners (this chart assumes

at least two members)

- Member liability limited

to the amount of capital

contribution

- Unlimited number (but at

least two, one of whom is

a general partner) of

partners without restriction

as to types of ownership

- Unlimited personal

liability of general partner

- Limited partner liability

limited to the amount of

capital contribution

3

Choice of Entity Comparison Chart

© 2018 Venable LLP

Sole Proprietorship C Corporation S Corporation

Limited Liability

Company (taxed as a

Partnership) Limited Partnership

Formation/

Organizational Documents

- Trade Name Certificate

or equivalent, if

desired/necessary

- Articles/

Certificate of

Incorporation

- Bylaws

- Shareholders’ Agreement

- Articles/

Certificate of

Incorporation

- Bylaws

- Shareholders’ Agreement

- Form 2553 (Election of S

Corporation status); may

need to file state elections

as well

- Certificate of Formation/

Articles of Organization

- Limited

Liability/Operating

Agreement

- Certificate of Limited

Partnership

- Limited Partnership

Agreement

4

Choice of Entity Comparison Chart (continued)

© 2018 Venable LLP

Sole Proprietorship C Corporation S Corporation

Limited Liability

Company (taxed as a

Partnership) Limited Partnership

Management/

Governance

- Rests with sole

proprietor

- Board of Directors

responsible for overall

management

- Officers responsible for

day-to-day management;

serve at the pleasure of the

Board

- Shareholders may vote to

approve certain major

matters/

Transactions

- Some state statutes

permit elimination of

Board of Directors

- Board of Directors

responsible for overall

management

- Officers responsible for

day-to-day management;

serve at the pleasure of the

Board

- Shareholders may vote to

approve certain major

matters/

Transactions

- Some state statutes

permit elimination of

Board of Directors

- Flexibility in allocating

management

responsibilities between

members and managers,

including, if desired, the

adoption of a corporate

governance structure

- Interplay of governing

state statute and Limited

Liability/Operating

Agreement

- General partner

responsible for overall

management; limitations

can be imposed and

certain matters can be

subject to vote of the

limited partners

5

Choice of Entity Comparison Chart (continued)

© 2018 Venable LLP

Sole Proprietorship C Corporation S Corporation

Limited Liability

Company (taxed as a

Partnership) Limited Partnership

Equity/Capital

contributions

- Governed by owner’s

contribution to the

business

- Common and preferred

stock

- Multiple classes; series

within a class; differences

in rights and preferences

- Distributions

proportionate to stock

ownership within a class

where class preferences

exist

- One class of stock;

differences in voting rights

permitted

- Avoidance of second

class of stock through debt

and equity equivalent

issuances

- Distributions

proportionate to stock

ownership

- Membership interests

can be held in proportion

to ownership and can be

classified into multiple

classes with differences in

rights and preferences

similar to common and

preferred stock

- Distributions may be

disproportionate to

ownership

- Distribution between

general and limited partner

classes

- Distributions may be

disproportionate to

ownership

6

Choice of Entity Comparison Chart (continued)

© 2018 Venable LLP

Sole Proprietorship C Corporation S Corporation

Limited Liability

Company (taxed as a

Partnership) Limited Partnership

Employee Equity

Incentives

- Not applicable - Stock options

(nonqualified/

qualified – typically

incentive stock options

(ISOs))

- Restricted Stock

- Stock appreciation

rights/phantom stock

- Stock options

(nonqualified/

qualified – typically

incentive stock options

(ISOs))

- Restricted Stock

- Stock appreciation

rights/phantom stock

- Equity incentives need to

be structured to comply

with single class of stock

requirement

- Profits interests

- Options and equity

equivalent awards are

possible but not common

- Profits interests

- Options and equity

equivalent awards are

possible but not common

7

Choice of Entity Comparison Chart (continued)

© 2018 Venable LLP

Sole Proprietorship C Corporation S Corporation

Limited Liability

Company (taxed as a

Partnership) Limited Partnership

Tax Considerations

1. General - One level of tax to

owner; state law may

impose tax at business

level

- Potential for two levels

of tax

- Potential of two levels of

tax if S corporation was

formerly a C corporation

- One level of tax to

members; state law may

impose tax at entity level;

new audit rules may

impose entity level tax

- One level of tax to

partners; state law may

impose tax at entity level;

new audit rules may

impose entity level tax

2. Current Distributions - Not taxable - Generally taxable - Generally not taxable

unless amount exceeds

stock basis or if S

corporation was formerly

a C corporation with

earnings and profits

- Generally not taxable

unless amount exceeds

basis

- Generally not taxable

unless amount exceeds

basis

3. Self-employment tax - Applicable to owners - Not applicable - Not applicable but

subject to reasonableness

of wages

- May/may not be

applicable

- Applicable to general

partners

4. Sale of Ownership

Interest

- Gain/loss may be capital

and/or ordinary

- Gain/loss generally

capital

- Gain/loss generally

capital

- Gain/loss generally

capital

- Gain/loss generally

capital

8

Choice of Entity Comparison Chart (continued)

© 2018 Venable LLP

Sole Proprietorship C Corporation S Corporation

Limited Liability

Company (taxed as a

Partnership) Limited Partnership

Tax Considerations

5. Sale of Assets - One level of tax to owner - Potential for two levels

of tax

- Potential two levels of

tax if S corporation was

formerly a C corporation

- One level of tax to

members

- One level of tax to

partners

6. Liquidating

Distributions

- No tax - Generally taxable - Generally not taxable

unless amount exceeds

stock basis or if S

corporation was formerly

a C corporation with

earnings and profits

- Not taxable unless

amount exceeds basis

- Not taxable unless

amount exceeds basis

7. Potential for tax-free

organization

No Yes Yes No No

9

Choice of Entity Comparison Chart (continued)

© 2018 Venable LLP

• Corporate income tax rate is permanently lowered to 21%

beginning in 2018

• Corporate AMT permanently repealed

• Dividends received deduction reduced

10

C Corporation Changes

© 2018 Venable LLP

• New “below the line” deduction for “qualified business income” from pass-through entities and sole proprietorships

• Maximum deduction is 20% of “qualified business income” (QBI)

• Maximum 20% deduction is also available for qualified REIT Dividends and qualified cooperative dividends

• Non-corporate taxpayers (including estates and trusts) are eligible to claim the deduction

• Effectively reduces the rate on pass-through income to eligible taxpayers to 29.6%

• Sunsets in 2026

11

Pass-Through Deduction – In General

© 2018 Venable LLP

• Generally, the ordinary income, gain, deduction, and loss of a qualified trade or business

– What is a “qualified trade or business”? • Generally, any business other than a specified service business or the trade or business of performing

services as an employee

• Specified service business - a trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or where the principal asset of the business is the reputation or skill of one or more of its employees, or which involves the performance of services that consist of investing and investment management, trading or dealing in securities, partnership interests or commodities.

• Excluded items: the taxpayer’s wages (or reasonable compensation), guaranteed payments, and investment-type income (capital gains, interest, dividends)

12

Pass-Through Deduction - Qualified Business Income

© 2018 Venable LLP

Subject to certain limits and thresholds, the deduction generally is the sum of:

• The lesser of:

– 20% of the taxpayer’s qualified business income; or

– The greater of:

• 50% of the W-2 wages with respect to the business, or

• 25% of the W-2 wages with respect to the business plus 2.5% of the unadjusted basis of all qualified property

• Plus 20% of qualified REIT dividends and distributions from publicly traded partnerships

• Plus 20% of qualified cooperative dividends

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Pass-Through Deduction - Calculation

© 2018 Venable LLP

Availability and/or calculation of the deduction is subject to limits

based on the taxpayer’s income and the type of business

conducted:

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Pass-Through Deduction – Limits

Total Taxable Income Not Exceeding Threshold

(Single - $157,500 /

Joint - $315,000)

Threshold Plus Phase In Over Threshold

(Single - $207, 501 / Joint

- $415, 001)

Specified Service Full 20% deduction, no

W2/basis limit

20% deduction subject to

phase-out, W2/basis limit

phased in

No deduction permitted

Non-Specified Service Full 20% deduction, no

W2/basis limit

20% deduction subject to

phase-in of W2/basis limit

20% deduction permitted

but fully subject to

W2/basis limit

© 2018 Venable LLP

• Example 1: A wholly-owned business purchases an office

building for $6M ($3M building, $3M land). The building

generates annual rental income of $500,000. The maximum

potential allowable pass-through deduction would be $100,000

(20% of $500,000). If the business paid no wages, the business

would qualify for a deduction of only $75,000 (2.5% x $3M =

$75,000).

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Pass Through Deduction - Example

© 2018 Venable LLP

• Example 2: Same facts as Example 1, but assume $4M is

allocated to the building. The deduction would not be limited

and thus the full $100,000 (2.5% x $4M = $100,000) would be

deductible.

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Pass Through Deduction - Example

© 2018 Venable LLP

• Example 3: Same facts as Example 1, but assume the business

pays $100,000 of W-2 wages. The full $100,000 pass-through

deduction would now be available, calculated as follows:

– 25% x $100,000 of W-2 wages = $25,000

– 2.5% x $3M unadjusted basis = $75,000

– $25,000 + $75,000 = $100,000

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Pass Through Deduction - Example

© 2018 Venable LLP

• Deduction is limited to 20% of the excess of taxable income over net capital gain

• Example: $100,000 of QBI, $200,000 of long-term capital gain and $50,000 of itemized deductions, resulting in taxable income of $250,000.

• Before application of this limit, deduction is equal to 20% of QBI of $100,000, or $20,000

• Taxable income less net capital gain is $50,000 ($250,000-$200,000 = $50,000).

• So the deduction will be reduced under this limit from $20,000 to 20% of $50,000, or $10,000

• Note that dividends are not subtracted, even though taxed at capital gain rate

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Pass Through Deduction – Taxable Income Limit

© 2018 Venable LLP

• Is rental real estate a “qualified trade or business”?

• Aggregation/grouping issues – multiple projects under common ownership

– Real estate management company model – do management company wages count?

– Two buildings, one fully-depreciated, with high income, the other brand new, with no or little income.

– If treated as separate businesses, no 20% deduction available

– If they can be aggregated, full 20% deduction available

• When is a principal asset of the business “the reputation or skill of one or more of its employees”?

• Will “reasonable comp” principles apply to partnerships?

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Pass-Through Deduction - Open Issues

© 2018 Venable LLP

• Switch from W-2 employee to 1099 independent contractor (IC)

– Loss of employee benefits (e.g., health insurance, 401K, etc.)

– IC must pay all self-employment taxes

– Employer may prefer paying W-2 employees in order to “max out” on its pass-

through deduction

– Need to revisit employee vs. IC classification criteria

• Can a “specified service business” “spin off” qualifying portions of its

business (e.g., HR, IT, IP)?

• Separate books and records for two lines of business, one a “specified

service business” and the other a “qualified trade or business”?

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Pass-Through Deduction – Planning Opportunities

© 2018 Venable LLP

• “Multiply” $157,500 per person threshold through children and trusts

• Switch from guaranteed payments (which don’t qualify) to preferred returns (which do qualify)

• S corp vs. LLC

– Wages paid to S corp owners “count” towards W-2 limit, guaranteed payments to LLC don’t because of K-1 rule

– Possible solution – use tiered structure, employed at lower-tier, own equity through upper-tier

– “reasonable comp” requirement for S corps

• Switch from 1099 (IC) to W-2 employee to increase W-2 limit

21

Pass-Through Deduction – Planning Opportunities

© 2018 Venable LLP

As a result of the new lower corporate rate, should taxpayers

reconsider their choice of entity?

*Assumes no 3.8% tax applicable and full use of 20% pass-through deduction

22

Choice of Entity – Effective Rates

C Corporation Pass-Through

Income Tax Rate 21% 29.6% (effective)*

Dividend/Exit Tax Rate 20% + 3.8% = 23.8% 0%

Aggregate Tax Rate 39.8% 29.6%

State/Local Tax Deduction

100%

Property taxes deductible, SALT

income taxes not deductible

© 2018 Venable LLP

• Potential for future changes

• Many disadvantages to C corp status

• Easy to move into C corp status, but difficult to move out

– Triggering of Section 311(b) gain on conversion/liquidation

– But S corp election possible after potential 5-year wait

• Limits on ability to defer C corp distributions

– Cash needs of shareholders

– Accumulated earnings tax

– Personal holding company rules

23

Choice of Entity – Other Considerations

© 2018 Venable LLP

• If a business is being conducted in corporate form, it may be

possible to work around some of the disadvantages of corporate

form through an F reorganization

• This can be helpful in the context of sales, employee

compensation, removing assets from corporate solution

24

Restructuring – F Reorganization

© 2018 Venable LLP

Step 1: A, B and C form Newco and contribute their S Corporation stock to Newco in

exchange for Newco stock. Newco makes an S corporation election and S Corporation makes a

QSub election. As a result, S Corporation becomes a disregarded entity for tax purposes.

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S Corporation

A B C

A B C

Newco

S Corporation (QSub)

© 2018 Venable LLP

Step 2: S Corporation, now a QSub, converts to a LLC under a state law conversion statute

or by merger. As a result, the LLC continues to be a disregarded entity for tax purposes.

26

S Corporation (QSub)

Newco

LLC converts

Newco

LLC

A B C A B C

© 2018 Venable LLP

• REITs do especially well:

– Only one level of tax

– Shareholders entitled to a 20% qualified business income deduction for

ordinary distributions – with no W2/basis limits

• But REIT compliance and maintenance rules are onerous

27

Choice of Entity - REITs

© 2018 Venable LLP

Paul Kaplun Chris Davidson

Venable LLP Venable LLP

Baltimore, MD Baltimore, MD

202-344-8535 410-244-7780

ptkaplun@venable.com csdavidson@venable.com

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