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Rhode Island Legal Blog

Monday, July 6, 2015

C-Corporation Vs. S-Corporation: Which Structure Provides the Best Tax Advantages for Your Business?

The difference between a C-Corporation and an S-Corporation is in the way each is taxed. Under the law, a corporation is considered to be an artificial person. Shareholders who work for the corporation are employees; they are not “self-employed” as far as the tax authorities are concerned.

The C-Corporation

In theory, before a C-corporation distributes profits to shareholders, it must pay tax on the income at the corporate rate. Then, leftover profits are distributed to the shareholders as dividends, which are then treated as investment income and taxed to the shareholder. This is the “double taxation” you may have heard about.

C-Corporations enjoy many tax-related advantages :

  • Income splitting is the division of income between the corporation and its shareholders in a way that lowers overall taxes, and can avoid or significantly reduce the potential impact of “double taxation.” By working with a knowledgeable tax advisor, you can determine exactly how much money the corporation should pay you as an employee to ensure the lowest tax bill at the end of the year.
  • C-Corporations enjoy a wider range of deductible expenses such as those for healthcare and education.  
  • A shareholder can borrow up to $10,000 from a C-Corporation, interest-free. Tax-free loans are not available to sole proprietors, partners, LLC members or S-Corporation shareholders.

S-Corporation
S-Corporations pass income through to their shareholders who pay tax on it according to their individual income tax rates. To qualify for S-Corporation status, the corporation must have less than 100 shareholders; all shareholders must be individual U.S. citizens, resident aliens, other S-Corporations, or an electing small business trust; the corporation may have only one class of stock; and all shareholders must consent in writing to the S-Corporation status.

Depending on your situation, an S-Corporation may be more advantageous:

  • Electing S-Corporation tax treatment eliminates any possibility of the “double taxation” referenced above. S-Corporations pay no federal corporate income tax, but must file annual tax returns. Because losses also flow through, shareholders who are active in the business can take most business operating losses on their individual tax returns.
  • S-Corporations must still file and pay employment taxes on employees, as with a C-Corporation. An S-Corporation may not retain earnings for future growth without the shareholders paying tax on them. The taxable profits of an S-Corporation pass through to the shareholders in the year they are earned.
  • S-Corporations cannot provide the full range of fringe benefits that a C-Corporation can.

Monday, June 29, 2015

For How Long Should a Business Keep Tax Records?

There are many reasons for retaining tax records. They can be a useful guide for business planning, for tracking receipts and expenses, and in cases where the company or shares are being sold to outside parties. 

The IRS expects taxpayers to keep records for as long as they are needed to administer any part of the Internal Revenue Code. In other words, if you fail to keep records, and an item in a past return is questioned, you may not have the documentation you need to defend yourself and avoid taxes and penalties. In addition, insurance companies and creditors may wish to see tax returns even after the IRS no longer does. 

What is the "Period of Limitations" for a Tax Return? 

Generally, you must keep records that support income and deductions for a tax return until the "period of limitations" for that return elapses. This is the period during which you can still amend your return to get a refund or credit and during which the IRS can still assess more tax. It varies depending on the circumstances surrounding each return. 

  • If you owe additional tax, but you haven't seriously underpaid, committed fraud, or failed to file a return, the period is 3 years from the date taxes were filed. 
  • If you failed to report income that you should have reported, in excess of 25% of the gross income that you did report, the period is 6 years. 
  • If you filed a claim for credit or refund after you filed your return, the period is the later of 3 years after the return was filed or 2 years after tax was paid. 
  • If you filed a claim for a loss from worthless securities or a bad debt deduction, the period is 7 years. 
  • If you filed a fraudulent return or failed to file a return, the period is unlimited. 

Note: Returns filed before taxes are due are treated as though they were filed on the due date.

Other Periods of Limitations

Additionally, if you are an employer, you must keep employee tax records for at least 4 years after the later of the date the tax becomes due or the date it is paid.

For assets, you should keep records until the period of limitations elapses for the year in which you sell the property in a taxable transaction. You will need records to compute depreciation, amortization, or depletion deductions and to add up your basis in the property for purposes of calculating gain or loss. A business law attorney experienced in tax matters can further guide you in relation to your specific situation.


Wednesday, June 17, 2015

Selecting An Executor Post Mortem

The death of a loved one is a difficult experience no matter the circumstances.  It can be especially difficult when a person dies without a will.  If a person dies without a will and there are assets that need to be distributed, the estate will be subject to the process of administration instead of probate proceedings.

In this case, the decedent’s heirs can select someone to manage the estate, called an administrator instead of executor.  State law will provide who has priority to be appointed as the administrator. Most states’ laws provide that a spouse will have priority and in the event that there is no spouse, the adult children are next in line to serve. However, those that have priority can decline to serve, and the heirs can sign appropriate affidavits or other pleadings to be filed with the court that nominate someone else as the administrator. Once the judge appoints the nominated person they will then have the authority to act and begin estate administration.

In certain circumstances, it may be necessary to change the initially appointed administrator during the administration process. Whether this is advisable depends on many factors. First, the initial administrator will have started the process and will be familiar with what remains to be done. The new administrator will likely be behind in many aspects of the case and may have to review what the prior administrator did. This can cause expenses and delays. Also, it is possible that the attorney representing the initial administrator may not be able to ethically represent the new one, again causing increased expenses and delays. However, if the first administrator is not doing his/her job, the heirs can petition to remove the individual and appoint a new one.

If you are currently involved in a situation where an estate needs to be administered, it is recommended that you speak with an estate planning attorney in your state.


Monday, June 8, 2015

Disaster DIY: Business Law Edition

Have you ever watched the TV show Disaster DIY on HGTV? The premise of the show is that many people have no idea what they are doing when it comes to home remodeling, but they try the “do it yourself” (DIY) approach  anyway. The host of the show then comes in to save the day, repairing what the DIYers have messed up, and teaching them how to do perform certain tasks.

This show has many parallels to the world of business law. It is tempting to try and find a DIY solution to legal issues. Budgets are tight, and professional legal advice can seem like a luxury when you are first starting out or struggling to meet quarterly goals, so many businesses adopt a DIY solution when what they really need is a good lawyer.

The Internet also encourages many businesses to DIY their legal issues, whether its access to legal info or various forms. But the problem is that advice on the Internet is not always accurate, particularly since business law is different in every state.

After pursuing the DIY route and disaster ensues,  business owners are forced to call in the professionals to clean up the mess.  Unlike the TV show, where the show’s producers cover the DIYers costs, the costs of fixing a legal DIY disaster rest solely on the business or the business owner. It often costs businesses significantly more to rework a legal framework that wasn’t carefully thought through. There are two reasons for this. First, proactive legal help is always going to be more cost effective than legal triage; it’s infinitely more costly to actively fight a pending lawsuit than it does to carefully draft and implement needed policies. Second, the results that even the best attorney can salvage from an awful situation are not likely to be as as ideal or as cheap as it would have been to avoid the disaster altogether.


Monday, May 25, 2015

Leaving a Timeshare to a Loved One

Many of us have been lucky enough to acquire timeshares for the purposes of vacationing on our time off.  Some of us would like to leave these assets to our loved ones.  If you have a time share, you might be able to leave it to your heirs in a number of different ways. 

One way of leaving your timeshare to a beneficiary after your death is to modify your will or revocable trust.  The modification should include a specific section in the document that describes the time share and makes a specific bequest to the designated heir or heirs. After your death, the executor or trustee will be the one that handles the documents needed to transfer title to your heir. If the time share is outside your state of residence and is an actual real estate interest, meaning that you have a deed giving you title to a certain number of weeks, a probate in the state where the time share is located, called ancillary probate, may be necessary. Whether ancillary probate is needed will depend upon the value of the time share and the state law.

Another way you could accomplish this goal is to execute what is called a "transfer on death" deed. However, not all states have legislation that permits this so it is imperative that you check state law or consult with an attorney in the state where the time share is located. A transfer on death deed is basically like a beneficiary designation for a piece of real estate. Your beneficiary would submit a survivorship affidavit after your death to prove that you have died. Once this document is recorded the beneficiary would become the title owner.

It is also important to investigate what documents the time share company requires in order to leave your interest to a third party. They may require that additional forms be completed so that they can bill the beneficiary for the annual maintenance fees or other charges once you have died.

If you want to do your best to ensure that your loved ones inherit your time share, you should consult with an experienced estate planning attorney today. 

 


Monday, May 18, 2015

Are Non-Compete Agreements Appropriate For My Business?

The aim of non-compete agreements is to bar departing employees from working for your business competitors or from starting a competing business. These agreements used to be reserved for high-level employees or people working in certain fields who had access to sensitive information. While non-compete agreements are becoming more common, they are only enforceable to a limited degree and in some states not enforceable at all.

In considering whether a non-compete agreement can be enforced, courts generally examine whether there is a legitimate business interest at stake and whether the agreement is narrowly crafted to protect that interest. Courts tend to disfavor restrictive covenants such as non-compete agreements because it limits commerce and can prevent an individual from earning a livelihood. Here are a few factors to consider when looking to implement a non-compete:

  • What is unique about my business? If there is something about your business that sets it apart from its competitors - a product, a process, a method of doing business - a non-compete agreement could protect your advantage. It might also be wise to consider other protections such as patents.

  • Over what area would I need a non-compete to apply? Would employees be barred from working at a competing business across the street? In the same city? Within 50 miles? Within the same state? The larger the radius, the less likely a court is to enforce it.

  • To which companies would a non-compete need to apply? Are your employees going to be able to get jobs in your field if they leave your company, or would your agreement make them essentially unemployable? Courts typically frown on agreements that leave people completely out of work.

  • How long would a non-compete need to last? The shorter the time an employee is restricted by the agreement, the more likely the court is to find the restriction reasonable.

  • Under what circumstances would the non-compete kick in? If an employee is fired, are they going to face the same restrictions as an employee voluntarily leaving your employ?

When considering any agreement with your employees, including restrictive covenants such as non-compete agreements, it is important to consult an experienced business law or employment law attorney who can properly advise you and help you craft an agreement that is likely to be enforceable.


Monday, May 11, 2015

Selecting An Executor Post Mortem

The death of a loved one is a difficult experience no matter the circumstances.  It can be especially difficult when a person dies without a will.  If a person dies without a will and there are assets that need to be distributed, the estate will be subject to the process of administration instead of probate proceedings.

In this case, the decedent’s heirs can select someone to manage the estate, called an administrator instead of executor.  State law will provide who has priority to be appointed as the administrator. Most states’ laws provide that a spouse will have priority and in the event that there is no spouse, the adult children are next in line to serve. However, those that have priority can decline to serve, and the heirs can sign appropriate affidavits or other pleadings to be filed with the court that nominate someone else as the administrator. Once the judge appoints the nominated person they will then have the authority to act and begin estate administration.

In certain circumstances, it may be necessary to change the initially appointed administrator during the administration process. Whether this is advisable depends on many factors. First, the initial administrator will have started the process and will be familiar with what remains to be done. The new administrator will likely be behind in many aspects of the case and may have to review what the prior administrator did. This can cause expenses and delays. Also, it is possible that the attorney representing the initial administrator may not be able to ethically represent the new one, again causing increased expenses and delays. However, if the first administrator is not doing his/her job, the heirs can petition to remove the individual and appoint a new one.

If you are currently involved in a situation where an estate needs to be administered, it is recommended that you speak with an estate planning attorney in your state.


Monday, April 27, 2015

Is a copy of a will sufficient?

Many people keep their important documents at home where they are easily accessible. It’s not at all uncommon to find people with a filing cabinet or even a shoe box containing passports, account statements, deeds, tax returns, birth certificates and social security cards. Wills are often added to these files once the estate planning process is completed. In choosing to store your important estate planning documents at home, however, you risk having the originals lost or destroyed in the case of fire, flooding or theft. So what happens if the original version of your will is lost or ruined?

Generally when a person dies, state law determines what must happen in the state probate proceeding. In most cases, the "original" of the will must be submitted to the probate court in the county where the person resided. If the original of the will cannot be located and provided to the court, there likely is a provision in your state's probate code that would permit the submission of a photocopy of that signed will.

In many cases, the attorney who prepared the will maintains a copy of the estate planning documents. Assuming, that the copy your attorney has could be submitted to the probate court, additional steps may need to be taken, and additional pleadings prepared in order to submit a copy.

Should you lose the original copy of your will, the best practice would be for you to execute a new will which would make things easier for your family and loved ones upon your death. In that case there would be better assurances that your wishes were followed and carried out. Preparing a new will should not take much time for your attorney. He or she likely still has the word processing file on his or her computer, and could easily modify it for you to execute again. If for some reason this is not done, you may wish to execute a document stating the original was destroyed in a flood or fire but that you did not intend to revoke it. However, it’s important to note that this may not be effective in every instance as many states have very strict requirements in terms of requiring originals and execution formalities.

To keep the originals of your estate planning documents safe, even in the face of disaster, you might consider purchasing a fireproof/waterproof safe for your home or rent a safe deposit box with a local bank where you can still easily access your documents but keep them secure off-site.


Monday, April 20, 2015

The Risks of Tenant-in-Common Investments

Historically, tenant in common (TIC) projects were owned by a relatively small group of investors who knew each other, such as long-time friends, business partners or family members. Strategies to maximize tax savings and preserve equity typically guided investors to this type of structure, rather than creating a limited liability company or partnership to own the property.

In the late 1990s, real estate sales in the form of tax-deferred 1031 exchanges created a new industry. Promoters began soliciting and pooling funds from investors to purchase real estate. Participation in the pool helped investors find replacement property to guarantee their capital gains tax deferment continued.

In 2002, the IRS clarified when this type of pooling is considered a partnership interest as opposed to a TIC interest, a critical distinction for investors using funds from a 1031 exchange transaction. Following that, investments in TIC interests grew considerably due to the numerous advantages. For those who needed a place to invest their 1031 exchange funds quickly, TIC interests provide a relatively simple way to ensure the funds are spent within 180 days of the sale of the previous property, without the hassle of researching, investigating, negotiating and financing a property in less than six months. TIC investors do not have to burden themselves with the day-to-day management of their investment property. Finally, TIC investors can pool their resources to purchase fractional shares of investment-grade property which would otherwise be out of reach.

With all of its advantages, the TIC interest also carries its share of risks. For example, many TIC promoters charged fees that were excessive, or sold the property to the investors for more than it was worth. If property values decline or purchase loans mature, it may be difficult to refinance, forcing the property into foreclosure and taking the entire investment with it.

Other promoters failed to maintain reserve funds separate for each property. If a promoter filed for bankruptcy and did not properly use the reserve funds, TIC investors were left with no recourse and were forced to cover the reserves out of their own pockets or risk losing their investment.

Further risks are caused by the investors themselves and the nature of their relationship to one another – or lack thereof. Owners of TIC typically do not know each other. Decisions regarding TIC governance often require unanimous agreement by all owners, and just one objection can grind the action to a halt. When owners don’t know each other, or are spread across many states, it can be difficult to communicate and obtain a unanimous agreement.

Despite the risks, TIC interests can still be a good place to park your money – but you must be a cautious, diligent purchaser. Visit the property, seek information from sources other than the promoter, and carefully review the past and projected financial data.
 


Tuesday, April 14, 2015

Financing and Growing Your Small Business Through Crowdfunding

What is crowdfunding? Part social networking and part capital accumulation, crowdfunding is simply the collective cooperation, attention and trust by people who network and pool their financial resources together to support efforts initiated by others.

Inspired by crowdsourcing, this innovative approach to raising capital has long been used to solicit donations or support political causes. This method has also been successfully implemented to raise capital for many different types of projects, including art, fashion, music and film.

Entrepreneurs can also tap the internet as a way to raise financing from a broad base of investors without turning to venture capitalists. With crowdfunding, you can raise small amounts of capital from many different sources, while retaining control over your business venture. Crowdfunding for business ventures, however, is not without its risks, and likely requires advice of an attorney.

In the traditional crowdfunding model, donations are pledged over the internet to fund a particular project or cause. The contributors are supporting the project, but receive no ownership interest in return for their monetary donation. This type of arrangement can exist with non-profit ventures and political campaigns, as well as start-up businesses. The person or entity soliciting the funding utilizes existing social networks to leverage the crowd and raise contributions in exchange for a reward, which is typically directly related to the project being funded, such as a credit at the end of a movie. With this type of arrangement, the contributor does not receive any ownership interest in the venture in exchange for the donation.

However, when for-profit companies solicit funds from a large number of individuals to raise capital in exchange for shares of ownership in the company, care must be taken to ensure the arrangement does not run afoul of federal and state securities laws.

Various companies and websites have popped up to assist entrepreneurs in raising capital through crowdfunding. Some operate on a flat fee, others charge a percentage of funds raised.  Keep in mind that any securities in a company sold to the public at large must be registered with regulatory authorities, unless they qualify for a specific exemption from the registration requirement. Selling shares of ownership to low-net-worth individuals (“unaccredited investors”) can trigger numerous registration and disclosure obligations. Additionally, state laws may also affect the transaction. As the number of investors and states involved increases, so do the cost and complexity of obtaining this type of capital financing. The various rules can be difficult to navigate, and missteps can result in significant penalties.
 


Monday, March 23, 2015

Overview: Buy-Sell Agreements and Your Small Business

If you co-own a business, you need a buy-sell agreement. Also called a buyout agreement, this document is essentially the business world’s equivalent of a prenup. An effective buy-sell agreement helps prevent conflict between the company’s owners, while also preserving the company’s closely held status. Any business with more than one owner should address this issue upfront, before problems arise.

With a proper buy-sell agreement, all business owners are protected in the event one of the owners wishes to leave the company. The buy-sell agreement establishes clear procedures that must be followed if an owner retires, sells his or her shares, divorces his or her spouse, becomes disabled, or dies. The agreement will establish the price and terms of a buyout, ensuring the company continues in the absence of the departing owner.

A properly drafted buy-sell agreement takes into consideration exactly what the owners wish to happen if one owner departs, whether voluntarily or involuntarily.  Do the owners want to permit a new, unknown partner, should the departing owner wish to sell to an uninvolved third party? What happens if an owner’s spouse is involved in the business and that owner gets a divorce or passes away? How are interests valued when a triggering event occurs?

In crafting your buy-sell agreement, consider the following issues:

  • Triggering Events - What events trigger the provisions of the agreement?  These normally include death, disability, bankruptcy, divorce and retirement.
     
  • Business Valuation - How will the value of shares being transferred be determined? Owners may determine the value of shares annually, by agreement, appraisal or formula.  The agreement may require that the appraisal be performed by a business valuation expert at the time of the triggering event.  Some agreements may also include a “shotgun provision” in which one party proposes a price, giving the other party the obligation to accept or counter with a new offer.
     
  • Funding - How will the departing owner be paid?  Many business owners will obtain insurance coverage, including life, disability, or business continuation insurance on the life or disability of the other owners.  With respect to life insurance, the agreement may provide that the company redeem the departing owner’s shares (“redemption”).  Alternatively, each of the owners may purchase life insurance on the lives of the other owners to provide the liquidity needed to purchase the departing owner’s shares (“cross purchase agreement”).   The agreement may also authorize the company to use it’s cash reserves to buy-out the departing owners.  
     

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