Make your own business succession decisions

Do you want to be in business with the spouse or children of your business partner?  Do you want to be forced to sell your business to fund estate taxes?

Every business eventually needs a succession plan to address:

• Transferring wealth to subsequent generations or worthy causes
• How a key employee or management team will take over operations
• Sale of the company to a third party

Document and fund your succession plan

Once you have a plan, it needs to be documented and funded. This often requires a team of experts and we often find ourselves captain of this team.

When asked about their closely-held business, a survey of business owners showed:

• An average of half of their personal net worth is the family business
• 88% said they strongly believe their business will still be controlled by the family in five years
• 26% said they have spent little or no time on succession planning

While 88% of business owners want their business kept in family hands only 26% have started the succession planning process. 

During the early part of 2012, take the first step toward fulfilling your own goals for your business by scheduling a conference.

As I have said before, once business owners get started, the succession planning issues are not as daunting as they had believed. Most clients experience a sense of relief to begin chipping away at something they feel has been hanging over their heads for some time.

Piercing the “Corporate Veil”

One of the reasons owners establish businesses entities is to protect themselves from personal liability. However, if a business doesn’t properly document its decisions, file annual reports or conduct annual meetings, for example, creditors and plaintiffs in lawsuits can successfully argue that owners aren’t truly operating in a businesslike manner. This means the corporate “veil” can be “pierced” and if the veil is successfully pierced, shareholders will become personally liable for business debts and for legal matters before the courts.

Your Corporate Minutes

What must be documented in the corporate minutes?

• A list of shareholders
• Board committee structure
• A list of board directors and their terms
• Executive salaries and board member compensation
• Employee benefit plans
• Mergers and acquisitions

We are happy to answer your questions about whether certain decisions must be memorialized as Corporate Resolutions.

Annual meetings

Closely-held companies generally utilize a “Consent in Lieu of an Annual Meeting.” If you have not conducted an annual meeting or signed a signed Consent in Lieu, we can help you get your documentation in order.

Remember, if your firm ever becomes party to a lawsuit, one of the first things an opposing attorney will ask to see is your company’s minutes, hoping to pierce the corporate veil (see above). In this era of frivolous lawsuits you never know when one is coming your way. Keep your documentation current.

We are often asked whether annual consents must be filed with the Secretary of State, and the answer is generally “no.” However, if your company amends its articles of incorporation, authorizes additional shares, authorizes a different class of shares or makes any other “material” decisions, then there may be forms to file with the State. We will gladly answer your questions in this area.

Going paperless

Many companies maintain a paper-bound minute book, but with the trend toward paperless documentation, rest assured a virtual minute book is legitimate. Simply sign and scan your documents. There are specific exceptions, however, where original documents may be required, so consult with us before shredding any originals.

Several so-called “cloud computing” companies and computer security firms have developed services for managing these documents, but if you would like for Stewart Law to manage your paper- or virtual-minute book we will do so. 

1. For a 338 election, the buyer has to be a corporation, but there are strategies to help get there, including mergers.
2. The manner in which purchase price is allocated to assets is important, but it is not essential for the buyer and seller to agree.
3. If closely-held business owners are separating, watch the related party rules carefully as these can cause losses to be disallowed.
4. When you are selling a partnership interest, you generally get capital gain treatment, but there are a lot of exceptions to consider.
5. In the service firm setting, choosing the “C corporation” income tax classification still looks like an unlikely bet right now.  With dividend income tax rates set to jump to 39.6% in 2013, the C corporation “double tax” could be around 60%.

While this is not an exhaustive analysis or set of recommendations, it is a starting point for a legal consultation. 

What is a Section 338 Election?

A corporate buyer of C corporation stock may, if it meets certain requirements, make a Sec. 338 election. If made, the company being acquired is treated as having sold all of its assets on the acquisition date for fair market value (FMV) to a new corporation, and thereafter immediately liquidated (Sec. 338(a)(1)).

The acquired company recognizes gain or loss on the “deemed sale” just as if  it had sold its assets.

The deemed sale is treated as occurring after the acquired company’s stock has been sold, and is included in a one-day deemed-sale return that the purchaser must file as owner of new entity; see Sec. 338(h)(9) and Temp. Regs. Sec. 1.338-10T.

The new entity’s Federal income tax liability (which would normally be paid by the acquired company in an actual asset sale) shifts to the purchaser.

The complexities of the Federal income tax code are a specialty of our firm. Please call for a consultation of how this information applies to your situation.

We recently attended a professional development conference at the Southern Federal Tax Institute and this article represents state-of-the-art thinking on choosing the corporate structure that best meets its owners’ needs.

Making the final choice with regard to business entity usually involves weighing the answers to the following questions:

• Which kind of entity allows me to operate most efficiently?
• What entity choice will provide me maximum protection from the liabilities I’m worried about?
• Which choice is the smartest from a tax perspective?

We welcome the opportunity to discuss your particular situation.

Today, there are many more options available to business owners, including the limited liability company (LLC). In addition to the numerous income taxation options (discussed to the right of this article), the LLC can be very flexible in its management and entity governance provisions which allow its owners and managers to escape the rigidity of the corporation.

The good news is that the LLC is not just for new businesses.  Under North Carolina law, a corporation (of any age) can be converted to an LLC in a relatively straight-forward and painless process.

If you think a conversion might be right for your business, please contact us to discuss your options.

The proper income tax classification for your business

We find that entrepreneurs see room for improvement when companies were poorly formed, the documents were not well thought out, or when circumstances change after a few years in operation. For example, the company may now have more or fewer owners than expected on formation; it may be making more or less money; or perhaps an owner is working more or less than anticipated.

Generally, domestic entities can choose from the following income tax classifications:

• C-Corporation
• S-Corporation
• Partnership
• Disregarded Entity

Change to or from Partnership

While the general partnership as an entity-type is seldom used, the Partnership tax classification is alive and vibrant.  Because it allows flexibility to allocate income and expenses among owners creatively, we often consider it for owners involved in real estate activities and investment entities.

On the other hand, we see that this classification is too often mis-used for active businesses and it can result in unnecessary taxes.

Time to explore the possibilities

If you believe there may be room to improve your results with a different  income tax classification, we need to begin exploring your options early in the first quarter.  IRS form 8832  (and/or other tax forms, depending on the circumstances) must be completed to change company entity classification. It walks the owner through qualification questions and addresses the issue of timing the change.

Generally, an election specifying an eligible entity’s classification cannot take effect more than 75 days prior to the date the election is filed, nor can it take effect later than 12 months after the date the election is filed. An entity may be eligible for late election relief in certain circumstances.

Contact us for an appointment to explore the options and possibilities for your businesses.

Family Wealth Over the Long Term

It is a good time to look at long-term (“dynasty”) trusts.  The $5 Million GST exemption means that you can pass a lot of money to future generations (beyond your children) without taxation.  On top of that, it now seems clear that North Carolina’s new statute allows for very long-term trusts.

Protecting Assets with the Help of Your Spouse

A trust that you establish for your spouse can be used to take advantage of the large exemption amount (i.e., $5 Million) that applies for 2011 and 2012 and can be used to protect the assets from creditors.

Because of a new North Carolina law, many such trusts will be given even stronger creditor protection if you are a beneficiary of the trust following the death of your spouse.  Thus, you might have indirect access to the trust assets you place in the trust during your lifetime (through your spouse) and direct access after your spouse’s death.  All of these assets could be considered protected from your creditors for claims that arise after you set up the trust.

Saving for College

In North Carolina, 529 income limits will not be imposed.  Therefore, a couple can still deduct up to $5,000 per year for contributions to NC 529 Plans.

Family Limited Partnerships and LLCs.

Family limited partnerships and Family LLCs continue to be used to great effect in estate plans.  So long as you are establishing one of these entities for the many non-tax benefits they offer, there is a good chance you will find there are tax advantages too.

New Estate Tax Law, New Opportunities and Challenges

Drafting for the new estate tax law (that is set to expire at the end of next year) means we need to consider some new concepts.

In addition to the much larger exemption amount ($5 Million), the new law allows the surviving spouse to take advantage of the unused exemption amount of the first spouse to die (this is referred to as “portability”).

Some situations where portability requires special consideration in an estate plan include (1) remarriage of the surviving spouse and (2) plans where amounts will (or may) pass to grandchildren or more remote descendants.  This latter circumstance presents an issue due to the fact that the amount transferred to the surviving spouse (using the portability feature) is not exempt from special taxes that apply in the case of property left to descendants in a generation below your children.

Clients often ask whether they should incorporate or form their new LLC in Delaware. In some cases they should avail themselves of Delaware law, but without special circumstances, most business owners will eventually opt for North Carolina as the controlling law.

LLCs: creatures of contract

Because LLC Operating Agreements are creatures of contract, the parties are generally free to establish the terms of their agreements.  The material statutory and common law provisions that override these Operating Agreement terms are relatively few and often not worth the extra burdens of maintaining a Delaware LLC.

Bottom line: A Delaware LLC may be right for your business, but before you ship the controlling law provisions of your new LLC to Delaware, talk with us and we will help you weigh the benefits and burdens of such a decision.

For those interested in further reading, the Business Law Section of the NC Bar Association has published a comparison of NC and DE law.

• Ask yourself these questions:Do you have a succession plan in place?
• Are there mechanisms in effect to incent the right persons to manage your business if you are unable to do so, temporarily or permanently?
• How much would your family receive for your stock if you died?
• Will this amount be paid in cash or deferred?

We have a process by which we help business owners think through these important issues.

Please contact us for a personalized review.

A common situation involves a new investor that wants to invest in Target Company (“T”) with borrowed capital and wants T to be responsible for the debt.  There are three ways to inject senior debt into T:

Recapitalization structure

T enters into loan agreements sometime before the closing.  At the closing, T incurs the debt.  The new investor purchases T shares from T.  T redeems a portion of T shares from old T shareholders using borrowing and sale of shares to new investor.  Shareholders who will remain shareholders going forward (“rollover shareholders”) retain T stock.

Reverse merger structure

New investor forms a merger subsidiary.  The merger subsidiary (Sub) enters into loan agreements sometime before the closing.  The new investor contributes cash to Sub at closing.  At the closing, Sub incurs the debt.  Sub merges into T. T stock (other than rollover shares) converted into right to receive cash.  Rollover shareholders retain T stock.

Purchase Structure

T does not enter into loan agreements before the closing.  New investor purchases all T shares (other than rollover shares) from T shareholders using cash from new investor and “60-second” note.  T incurs senior debt immediately after the closing.  T assumes and repays the 60-second note using senior borrowing proceeds.  Rollover shareholders retain T stock.

Please contact our offices to explore the best solution for your transaction.