Business

Constructive Transfers

It is axiomatic that the tax treatment of interactions between a closely held business and its owners will generally be subject to heightened scrutiny by the IRS, and that the labels attached to such interactions by the parties will have limited significance unless they are supported by objective evidence.

Benefit to the Shareholder

Thus, arrangements that purport to provide for the payment of compensation, rent, interest, royalties, etc., by a corporation to a shareholder – and which generally would be deductible by the corporation – may be examined by the IRS and possibly re-characterized to comport with their true nature.

Similarly with respect to a corporation’s satisfaction of an expense or other obligation that, on its face, is owing from a shareholder to a third party but for which the corporation claims a tax deduction by characterizing the amount as an expense incurred by or on behalf of the business.
Continue Reading Business Expenses Paid by Shareholder, But Whose Deduction Is It?

Sibling Rivalry

You have probably encountered family-owned corporations in which the founder’s offspring are involved in the business to varying degrees. They may even own some equity, typically having received such equity as gifts from their parents.[i] These situations often evolve in a way that they present challenging succession planning issues for the family and its business.

Let’s assume that two siblings are active participants in the family-owned business. Each aspires to lead the corporation after their parents have retired. At some point, their competing goals, divergent management styles, or different personalities may generate enough friction between the siblings, and within the corporation, so as to jeopardize the continued well-being of the business.[ii]Continue Reading Dividing the Multi-Family Corporation

Tax Alchemy?

How many of you remember Section 138509 of the Ways and Means Committee’s markup last September of what would have been the Build Back Better Act? (A moment of silence, please.)  Allow me to jog your memory. Its heading read as follows: “TEMPORARY RULE TO ALLOW CERTAIN S CORPORATIONS TO REORGANIZE AS PARTNERSHIPS WITHOUT TAX.”[i]

“Oh, that Section 138509. Of course.”

Yep. Under the proposal, any corporation that was an S corporation on May 13, 1996[ii] could have been reorganized as a partnership without triggering a tax liability,[iii] provided the corporation transferred substantially all of its assets and liabilities to a domestic partnership during the two-year period beginning on December 31, 2021.
Continue Reading S Corps with Real Property: Separating Shareholders & Partnership Envy

A More Cautious Approach

Compared to the torrid pace of M&A transactions last year,[i] the current year seems rather pedestrian. That is not to say businesses are not being sold; they are. The purchase and sale of a business is one of the natural alternative paths in the evolution of the business.[ii]

However, the environment in which buyers and sellers are now considering their options and the manner in which they are approaching one another seem to have changed; one might say they are generally being more cautious, notwithstanding that the economy apparently remains strong by many measures.
Continue Reading The Earnout: Contingent Purchase Price or Compensation?

Don’t Do It

There are certain generally accepted “dos and don’ts” of which almost every investor is certainly aware. For example, do not put all your eggs in one basket; if an investment seems too good to be true, stay away from it; take a long-term approach; etc. These guidelines are so obvious, they have become cliché.

However, based upon my recent experience, it seems too many investors in real property have yet to understand that, in the overwhelming majority of cases, they should not acquire real property in a corporation, even one that has elected to be treated as an S corporation. These investors and their successors will often pay the consequences of this misstep for many years.
Continue Reading An S Corporation’s Sale of Real Property Following the Death of Its Shareholder

Sale of the Business

Imagine Client has just received an attractive, all cash offer[i] for the sale of their business; there is no financing contingency.[ii] The buyer has proposed a cash-free and debt-free deal.[iii] The only post-closing adjustment to the purchase price will be for net working capital;[iv] for example, there is no earnout based upon the post-closing performance of the business. Subject to further diligence, the buyer expects that a portion of the purchase price will be held in escrow by a bank for a stated period[v] to secure the client’s general indemnity obligations with respect to its representations and warranties in the purchase and sale agreement.[vi] Other than the net working capital adjustment and the escrowed amount, the entire purchase price will be payable at closing.

Before accepting the offer, Client – to its credit (and to your relief) – asks that you explain the tax consequences of the proposed transaction; specifically, how much will Client net from the sale on an after-tax basis?[vii]Continue Reading Selling Your Business? Take the Money But Defer the Tax?

An often-explored theme of this blog is the frequency with which similarly situated owners of similarly situated closely held business, facing a similar set of economic circumstances, and presented with a similar set of choices, will repeat the mistakes made by countless taxpayers before them.[i]

Rational behavior? Does the answer depend upon the taxpayer’s appetite for risk-taking? Being an entrepreneur necessarily involves some exposure to risk. However, there is a difference between the calculated risk that an intelligent business owner knowingly takes, on the one hand, and the risk that comes with negligently disregarding well-established tax principles, on the other.
Continue Reading Unreasonable Compensation As Constructive Dividend, Redux

Withdrawing Value

In general, the owners of a closely held business have several options by which they may withdraw money from the business without selling their interest in the business.[i] For example, an owner may:

  • Receive compensation for services rendered to the business (an employee-employer, or other service-provider/service-recipient, relationship);
  • Receive rent or royalty for allowing the business to use the owner’s property (a lessor-lessee/licensor-licensee relationship);
  • Sell property to the business (a seller-buyer relationship); and
  • Borrow money from the business (a debtor-creditor relationship).

Continue Reading Current Partnership Distributions: When Do You Figure Your Basis?

Withdrawing Value

Any tax adviser who has represented closely held businesses and their owners long enough realizes there are certain recurring themes that transcend the otherwise unique characteristics of the industry of which the business is a part, the market or geographic region in which the business operates, the overall economic climate, and even the personal traits of its owners.

Last week we explored a variation on one of these themes – the withdrawal of value from a closely held business on a tax-efficient basis – when we reviewed several of the factors that the owners of a closely held business (organized as a C corporation[i]) should take into account in setting the amount of compensation the business should pay the owners in exchange for their services while preserving the corporation’s ability to deduct such payments in determining its taxable income.[ii]Continue Reading Constructive Dividends and The Closely Held C Corporation

Double Tax

The shareholders of C corporations have long sought legitimate operational and transactional structures by which they may reduce the double tax hit that is realized when such a corporation distributes its after-tax operating profits or its after-tax sale proceeds to its shareholders.[i]
Continue Reading Reasonable Compensation Meets The Principal Shareholder of a C Corp