Who Owns an LLC?

Who are the owners of an LLC?  Although, limited liability companies have become an extremely popular form of business entity, many small business owners or people forming a start-up business are still unfamiliar with ownership and structure issues related to an LLC.  The article below discusses ownership issues of an LLC, which is a typical question for business owners and those starting up a business.  Please remember to consult your business attorney with your specific facts, questions and circumstances.

The varying types of ownership interest in an LLC are very important for a business owner to understand, and can be very useful in the overall structure of business and even the drafting of operational documents such as the operating agreement.  The owners of an can be:

 

  • LLC Members with an economic interest (often called a “membership interest”) in the LLC;
  • Non-economic members; and
  • Assignees

The LLC Act in Colorado does not define “ownership interest” but the act defines “membership interest” as “a member’s share of the profits and losses of a limited liability company and the right to receive distributions of such company’s assets.”  When forming the LLC, the members will contribute cash, property or can provide services or a promissory to the note to the company.  In Colorado, a person can be a member and receive a membership interest without necessarily making a contribution or being obligated to the LLC in another manner.  Under such an arrangement, the member may receive a profits interest in the LLC whereby the member is allocated a share of the profits and losses of the LLC, but does not yet have a capital interest in the LLC.  A capital interest would be more defined as an interest in the value of the LLC.  In both cases, whether contributing capital or receiving an interest for services or an obligation, the member would hold a “membership interest” in the LLC and have the rights afforded in the act and within the operating agreement of the LLC.

The ability to have non-economic members within an LLC can be very advantageous for the LLC and the members.  The LLC Act in Colorado allows a member to be a non-economic member whereby the person is a member of the LLC but does not acquire a membership interest, and may not be obligated to make any contribution to the LLC.  The non-economic member may hold all of the rights of other members such as voting rights, but no right to an economic interest in the LLC.

An assignee may be admitted through the sale or transfer of an interest.  The assignee may not need to be admitted as a member, and thus although the assignee may receive the right to receive profits and losses from the LLC (the economic portion), the assignee may not have the right to participate in the management of the business, and vote.  The operating agreement of the LLC could control many of these issues.  Allowing the assignee the economic benefit of the interest but not the management portion of the interest can be very beneficial in a closely held business whereby the original members may not want the wife or other family member of an original member to have an operational or management power, but the assignee can still receive the economic portion of the original member’s interest.

Denver Business Attorney

 

 

FBAR Penalty Statutes of Limitations

What are the FBAR statute of limitations for penalty assessments?  What other FBAR statutes should I be concerned about?  If you have failed to file your FBAR, also known as FinCEN Form 114, you may be asking yourself these questions.  The article below will examine and discuss a few of the related FBAR statutes of limitations.

31 U.S.C. 5321(b)(1) and 5321(b)(2) provide the FBAR penalty assessment statute expiration date and collection statute expiration date, which is part of the Bank Secrecy Act.  The FBAR assessment statute expiration date is six (6) years from the due date of the FBAR, and this applies whether the failure to file the FBAR was willful or non-willful.  It is very important to note that you can also be assessed a penalty for failing to maintain required records.  The FBAR penalty statute of limitation for failing to maintain required records, whether willful or non-willful is also six years, but this statute only begins to run from the date the Internal Revenue Service first requests the records.

That being said, let’s apply these FBAR statute of limitations to an example.  Let’s assume Joe has foreign bank accounts in calendar year 2014 that exceed $10,000, and that for purposes of the FBAR filing, Joe is a U.S. Person.  Joe would thus have been required to file the FBAR (Report of Foreign Bank and Financial Accounts) on June 30, 2015.  Oooops, Joe was unaware of the FBAR filing requirement and did not file FinCEN Form 114.  The FBAR penalty assessment statute of limitations for failing to file the FBAR would expire June 30, 2021.

Now lets apply the FBAR statute of limitations for failing to maintain required records.  We will assume the same facts as above, but Joe also failed to maintain required records.  On April 1, 2016 and IRS or other examiner requested the applicable records to Joe’s foreign bank accounts.  The FBAR assessment statute of limitations for failing to maintain required records would expire on April 1, 2022.

Now that we have determined Joe’s FBAR statute of limitations for assessing a FBAR penalty, does the government have a statute of limitations to file suit?  Yes, there is a two (2) year statute for the government to file a civil action against Joe to recover an FBAR penalty.  However, there is no statute of limitations for the time period in which the government can receive payment from Joe by offsetting certain payments.

The above article has been prepared to provide information relating to FBAR statutes of limitation, but please remember to always discuss your specific facts and circumstances directly with your tax attorney or other counsel.  If you wish to speak with a tax attorney at The McGuire Law Firm, please feel free to contact us at any time.

Denver Tax Lawyer

Limited Liability Companies in Colorado

A limited liability company (LLC) is a popular choice of entity for many business owners in Colorado.  Further, many business owners in Colorado will form other forms of partnerships whether they actually mean to or not.  When forming the actual entity though many business owners are unaware of the statutory requirements to form the business in Colorado.  The article below has been prepared by a business attorney to provide information regarding the necessary requirements, but please remember to always consult directly with your business attorney.

In Colorado, a limited liability company is formed by filing articles of organization with the Colorado Secretary of State.  The articles of organization must provide the following:

  • The LLCs name and principal office address:
  • The name and address of the registered agent;
  • The true name and mailing address of the persons that are forming the LLC;
  • Whether the LLC is a member managed or member managed LLC; and,
  • That there is at least one (1) member of the LLC.

 

Section 7-80-204(1)(h) of the Colorado Revised Statutes also permit but does not require the article to disclose any other matter related to the LLC or the articles of organization that the persons forming the business determine to include in the articles.

Other Partnerships

A simple handshake can for a general partnership in Colorado, and no filing with the Colorado Secretary of State is necessary.  Section 7-64-202(1) of the Colorado Revised Statutes states, “the association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership.  Thus, you can form a partnership and expose yourself to liability without even intending to do so!

Limited partnerships, however, require the filing of a certificate with the Colorado Secretary of State.  All of the general partners must approve the filing of certificate of limited partnership.  A limited partnership will be governed by CULPA or CUPL, but limited partnerships formed on or before August 10, 2016 that does not elect to be governed by CUPA will be governed by CUPL for issues not covered by CULPA.  The information required on the limited partnership certificate is:

  • The name of the limited partnership, and the initial and principal address of the limited partnership;
  • Name and address of the registered agent;
  • The name and mailing address of each general partner LLC; and,
  • That there are at least two partners in the partnership, and at least one of them is a general partner.

One should also note that a general partnership may become a limited liability partnership (LLP) and limited partnerships may become a limited liability limited partnership (LLLP), by filing a registration statement with the Colorado secretary of state.

The above article was prepared by John McGuire, a business attorney at The McGuire Law Firm.  Please consult directly with your business attorney or other advisors regarding your specific issues.

Distributions of Stock and Stock Options

Many corporations may provide or distribute stock or stock rights to employees. When a corporation distributes it’s own stock, this would be referred to as a stock dividend and when a corporation grants stock rights, these are typically referred to as stock options. When individuals receive stock dividends and stock options, they generally will ask or inquire as to whether or not these dividends or stock options are taxable. Generally, the answer is no, stock dividends and stock options are not taxable, and thus not reported on an income tax return. However, under certain circumstances, the stock dividends or stock options can be taxable. These circumstances are discussed below, and please remember to always consult directly with your tax advisors regarding your specific circumstances.

A distribution of stock dividends and stock rights or stock options are taxable if any of the following apply:

1) The corporation distributes cash or other property to certain shareholders of the corporation and provides other shareholders with an increase in their percentage of interest in the assets and earnings and profits of the corporation.
2) The distribution can be converted by the shareholder into preferred shares.
3) Any shareholder has the ability to choose cash or other property be received as opposed to the stock or stock rights.
4) The distribution is a distribution of preferred stock. It should be noted, however, that such a distribution would not be taxable if it is solely an increase in a conversion ratio of convertible preferred stock, which has been made solely due to a stock dividend, stock splitting or similar action that would result in reducing the overall conversion rate.
5) The distribution allows for preferred stock to be issued to some common stock shareholders and common stock of the corporation to be issued to other shareholders.

When a taxpayer does receive a taxable stock dividend or stock rights, the taxpayer would include the fair market value at the time of the distribution in their income. It is also important for shareholders to be aware of constructive distributions. A shareholder may have to treat certain transactions that increase their proportionate share or interest in the earnings and profits or assets of the corporation as if stock or stock options were distributed if the result is the same as items 1, 2, 4 or 5 above. This treatment would apply to a change in a shareholder’s conversion ratio or redemption price, a difference between the stock’s redemption price and issue price, a redemption that is not treated as the sale or exchange of the applicable stock and other transactions whereby the similar effect is realized on the shareholder’s interest in the corporation. An example of a taxable distribution would be the receipt of preferred stock that holds a redemption price higher than the price the stock was issued for. This difference is considered the redemption premium, and generally the redemption premium would be considered a constructive distribution and taxable.

The above article has been prepared by John McGuire of the McGuire Law Firm for informational purposes and should not be considered tax or legal advice. John is a tax attorney and business attorney in Denver, Colorado and Golden, Colorado serving clients in Colorado and nationwide on certain tax matters.
Denver Tax Lawyer

Gain, Loss & Realization Events in Property Transactions

When must I realize gain?  For the most part, it is easy to recognize when gain or loss has been realized, but at other times it may be hard to ascertain.  The article below has been prepared by a tax attorney to discuss gain or loss on certain property transaction and certain realization events.  Please remember this article is for informational purposes and specific facts and circumstances should be discussed specifically with your tax attorney and other tax advisors.

When an asset is sold, disposed of or transferred it may go without saying that a realization event has occurred.  Gain on the sale or disposition of the asset will be the amount received (realized) in excess of the adjusted basis of the property.  Loss, on the other hand would be the amount the adjusted basis exceeded the amount realized.  It is important to remember that not all transactions would require one to recognize the gain or loss in their income at the time of the transaction.  The word recognize in the previous sentence would mean to include the gain or loss in your current income.  A requirement to include gain or loss in your income is the occurrence of some realization event.  Once a realization event has occurred, then you must ascertain and determine the proper tax treatment of the transaction such as:

 

  • The adjusted basis in the property that was sold, transferred or disposed of;
  • The amount realized from the transaction as a whole;
  • Was gain or loss recognized from the transaction;
  • The character of the gain. For example, was the gain short term capital gain or long term capital gain.  Or perhaps, is the gain subject to recapture rules.
  • If there was a loss, is the loss allowed in whole or in part.

In regards to a realization event, generally speaking, a transaction with property will be considered a realization event if the taxpayer’s relationship, or control of the property is terminated, or the interest is significantly or materially reduced.  The lack of any transaction would tend to show a lack of a realization event.  Further, it should be noted that the mere increase or decrease in the fair market value of property does not, by its self, create a realization event.  For example, you may purchase Microsoft stock.  As the stock increase, you do not recognize gain, but rather, when you sell the stock, if the sale price of the stock is in excess of your adjusted basis, gain would likely be realized, and need to be recognized by reporting the gain on your income tax return.  Furthermore, transferring or disposing of property through a gift is generally not a realization event.  While the gift may have many tax implications, the gift alone may not be enough for a realization event whereby income or loss would be recognized on an income tax return.

There are multiple issues to consider relating to realizing gain and loss, and recognizing gain and loss.  Further, there are many situations whereby a loss may be disallowed in whole or part, or the loss can only be recognized in certain amounts or over certain times.

This article has been prepared by John McGuire at The McGuire Law Firm.  John is a tax attorney and business attorney working with individuals and businesses before the IRS and assisting clients with other tax and business matters.  John can be reached at 720-833-7705.

Original Issue Discount and Debt Instruments

What is original issue discount?  Original issue discount (OID) is a form of interest that you may not realize you have earned, received or need to report.  The article below has been prepared by a tax attorney to provide information regarding (OID), but please consult directly with your tax advisors regarding your specific facts and circumstances.

Generally, you should (or will) report OID as income as it accrues over the term of any debt instruments even if you do not received any payment(s) of the actual interest from the party paying the debt and/or interest.  A debt instrument could be a promissory note, bond, debenture or any other evidence of indebtedness based upon the facts and circumstances.  You may typically see a debt instrument have OID when the debt instrument was issued for less than the stated redemption price.  A debt instrument that pays no interest before the instrument matures would likely be considered issued at a discount.  The following are examples of discounted debt instruments.

 

  • Municipal Bonds (interest may not be taxable)
  • Notes between individuals or private parties
  • United States Treasury Bonds
  • Stripped Bonds
  • Certificates of Deposit (CODs)

An example may help illustrate the discount and interest amount.  If a bank issues a bond with a maturity price of $1,000 for $900, the original issue discount is $100, and the discount would be included in income as it accrues over the term of the bond.  Please note, if the discount is less than one-quarter of an interest percentage (.0025) the discount may be considered de minimis discount and treated as zero.

 

All of the above being said, many people will ask if there are any exceptions to reporting OID income. The OID may not apply to the debt instruments below, but please always check current law and regulations with your tax attorney or tax advisors.

 

  • United Savings Bond
  • Tax Exempt Obligations
  • Debt instruments with a fixed maturity date less than one-year from the date of issuance (short-term debt instruments)
  • Obligations issued by an individual prior to March 2, 1984
  • A loan between individuals if the loan and any other prior loans between the same individuals is less than $10,000 (USD), the individual lending the money is not in the business or regularly lending money; and, a primary purpose of the loan is not to avoid federal income tax.

Is a 1099 issued?  If the total of the OID is $10 or greater, the party issuing the debt instrument should issue a 1099-OID.

You can speak with a tax attorney or business attorney with questions related to interest and OID by contacting The McGuire Law Firm.   Call 720-833-7705 to discuss your matters with a tax attorney.

Tax Attorney

Denver Tax Attorney

 

 

What is my Cost Basis?

What is my cost basis in certain property and why do I care?  Many people and businesses are not fully aware of their basis in property, do not properly track the basis and may be unaware as to the importance of their basis in property.  The article below has been prepared by a tax attorney to provide information regarding basis.  Please remember, this is not legal advice and it is recommended you consult directly with your tax attorney regarding your specific issues and questions.

You could look at your cost basis as your initial threshold for gain or loss when an asset or property is sold.  Although, not discussed in this article, under certain circumstances you may not be able to recognize a loss, and you may not have recognize gain.  Further, your basis may be adjusted because of certain issues.  Regardless, to calculate basis, you would start with your cost basis.  Generally, the basis of your property is the cost.  You would likely determine cost by the amount of cash paid, debt obligations (loan or promissory note) and other property transferred.  However, it is very important to remember that your cost basis may also include:

  • Freight/shipping
  • Installation and testing
  • Sales Tax
  • Legal and accounting fees
  • Excise Taxes
  • Recording Fees
  • Real estate taxes

For example, say you decide to purchase a piece of equipment for $100,000.  The shipping fee was $2,500 and you paid an attorney $1,000 to draft the bill of sale and related purchase documents.  Your cost basis would thus be $103,500.  Thus, if you sold the equipment immediately thereafter, your threshold for any gain would be $103,500.  If you held the equipment for business use, and depreciated the equipment, this depreciation would lower the cost basis and you would track the adjusted basis of the property.

 

Often when a business is purchased, you purchase all assets and the assets differ.  Thus, how do you report or track the cost basis in the purchase of a business?  When you purchase business assets, you can report the amount paid for each class of assets on Form 8594.  The IRS allocates purchase price in an asset sale between seven classes of assets, which are outlined on the Form 8594 and defined in the instructions and elsewhere.  The business selling the assets would report the sale of the assets on Form 4797 (Sales of Business Property).  Generally, the seller and buyer involved in the asset purchase will agree to the allocation of the purchase price and Form 8594 will be agreed upon and completed prior to closing, perhaps even as an exhibit to the asset purchase agreement.

 

If you have questions relating to your basis in property and tax treatment through the sale or purchase of property, you may want to speak with a tax attorney and/or business attorney.  You can contact The McGuire Law Firm at 720-833-7705 with any questions.

Denver Tax Lawyer

Operating Agreement Invalidating S Corporation Election

Limited Liability Companies (LLC) are a very popular entity choice and structure for new businesses and closely held entities.  An LLC can be formed quickly and has a lot of flexibility regarding members, operations and taxation structure.  It is not rare for an LLC to eventually consider and perhaps decide to be taxed as an S corporation.  Although, an LLC converting to a Subchapter S corporation has benefits, such as potentially reducing self-employment taxes, these benefits may be mistakenly lost if the Subchapter S corporation status is invalidated.  A means by which to invalidate the S corporation status, which is many business owners may not consider is the LLC operating agreement.  Abiding by the LLC operating agreement may cause the entity to operate in a manner than invalidates the S corporation election.  The article below has been prepared by a tax attorney and business attorney to further discuss the risk of losing S corporation status by abiding by an operating agreement.  Please remember this article is for information purposes only, and is not intended to be legal or tax advice.

To properly evaluate how an S corporation could lose or invalidate the S corporation election, it is important to remember how a business qualifies and the requirements for an S corporation.  The qualify as an S corporation, the corporation must:

 

  • Have only allowable shareholders (no partnership, corporate or non-resident alien shareholders)
  • Have only 100 shareholders or less
  • Have only one class of stock
  • Be a domestic corporation
  • Not be an ineligible corporation (insurance companies and other disallowed companies)

Our focus will be on the one class of stock requirement.  The one class of stock requirement requires that all shareholders receive distributions and liquidation preferences pro-rata per their stock ownership.  An S corporation can have a different class of stock for voting rights, but the economic benefits and distributions to the shareholders must follow the ownership percentage, which is directly related to the number of shares each shareholder owns.  Many LLC operating agreements will contain clauses and language that actually require unequal or disproportionate distributions to the LLC members.  Thus, if the distributions are in accordance with the operating agreement, the issuance of disproportionate distributions could lead to the IRS claiming the corporation has multiple classes of stock, and therefore, the S corporation election is invalid.  Treasury Regulation Section 301.7701-(3)(c)(1)(v)(c) states that the S corporation election is valid only if ALL requirements are met.  Thus, an LLC electing be to be taxed as an S corporation should consider removal of certain clauses within the operating agreement relating to substantial economic effect, IRC Section 704 and any other clause that could create disproportionate distributions.  If the S corporation election was lost, the owners may be subject to additional self-employment tax, or the business, if taxed as a C corporation would be subject to tax at the corporate level, and the shareholder level, thus double taxation.

If you have questions related to your choice of entity, taxation matters and internal business documents, it is recommended you speak with a tax attorney and/or business attorney to review the documents, taxation matters and intended tax treatment.

Denver Tax Attorney Denver Tax Lawyer IRS Tax Attorney

 

Denver Business Attorney

The Cohan Rule

Individuals or business who have been audited by the Internal Revenue Service may be familiar with the Cohan rule.  The Cohan rule is based upon a court case that may allow a taxpayer an allowance for certain business deductions even if the taxpayer is unable to verify or substantiate certain expenses.  This article has been prepared by a tax attorney at the The McGuire Law Firm to provide additional information related to the Cohan Rule and IRS tax audits.  It is recommended you use this article for informational purposes only and discuss your facts and circumstances specifically with your tax attorney and other advisors.

The Internal Revenue Code requires that a taxpayer maintain certain records for the IRS to allow an expense or deductions.  When a taxpayer is being audited by the IRS, generally the taxpayer must show a receipt, invoice, cancelled check or like item for the IRS to allow the expense that is under audit.  If the taxpayer is unable to provide the necessary documentation, the IRS may disallow the expense or item.  Under the Cohn rule, the IRS or a court may allow a taxpayer reasonable amount of the deductions.  The key issue is, what is reasonable?

The Cohan rule was established through a Court of Appeals case in the Second Circuit in 1930.  Although, the court stated the taxpayer did not have adequate substantiation to verify expenses, the court held the board (IRS) should make an approximation.  In short, the court felt that it was reasonable for the taxpayer to have some reasonable business expenses, and should not be disallowed all deductions due to lack of records.  Thus, under the Cohan rule, a taxpayer can make an argument for an expense deduction to be allowed without proper documentation.

It is important to remember that the Cohan rule does not apply to all expenses.  For example, the Cohan rule does not apply to items whereby Internal Revenue Code Section 274(d) applies.  IRC 274(d) applies to travel expenses, entertainment expenses, gifts and other listed property, and taxpayer must comply with very strict verification rules for the IRS to allow a deduction.

One question that is often asked is, who has the burden of proof in a tax audit?  Generally, the taxpayer will have the burden of proof that they are entitled to the deduction and the additional tax proposed by the IRS is incorrect.  However, under Internal Revenue Code Section 7491(a), the burden of proof can switch to the IRS when the taxpayer produces credible evidence relating to factual issues, complies with requirements and verifies deductions, cooperates with reasonable requests by the IRS relating information, documents, interviews, meetings and maintains records under the Internal Revenue Code.

If you are being audited by the IRS, you may consider representation by a tax attorney.  You can speak with a tax attorney by contacting The McGuire Law Firm.

Deductible or a Capital Expense?

Is an amount paid by a business an expense that is currently deductible, or is it a capital expenditure that should be depreciated,, amortized or depleted?  This issue is one of the most common issues in a tax audit with the Internal Revenue Service, as well as one of the most litigated issues in United States Tax Court.  The article below has been prepared by a tax attorney to provide additional information related to this common issue.  Please remember that this article is for informational purposes, and you should consult directly with your tax attorney and advisors related to your specific issues.

A currently deductible expense is an ordinary and necessary expense that is paid or incurred by the business during the taxable year in the ordinary course of operating the trade or business.  Please reference Internal Revenue Code Section 162.  In comparison, a capital expenditure would be the cost to acquire, improve or restore an asset that is expected to last more than one year.  These capital expenditures are not allowed a deduction, but rather are subject to amortization, depreciation or depletion over the useful life of the property. See Internal Revenue Code Section 263.

That being said, how does one determine whether an expenditure is an expense to be deducted or a capital expenditure?  The answer is, it is a question of fact.  The Courts have applied the principles of deductibility versus capitalization on a case by case basis, and the facts and circumstances of each case will likely determine the outcome.

An example may help illustrate the difference between an expense that would be deductible versus one that would be capitalized.  If a business owner bought certain office supplies such as pens and paper, they would be deductible.  If the same business owner, purchased a building to operate the business, the building would be capitalized.  Let’s look at a different example that might not be as obvious.  Assume a business owns and rents property.  In one property a hole was placed in the wall when a tenant moved.  In another property, the owner decided to replace the walls with new drywall and paint.  It is likely the fixing of the hole in the wall would be deductible as a repair or maintenance, whereas the cost to replace the walls would be capitalized by the business.

One further issue to consider beyond the matters discussed above is that the Internal Revenue Code requires books and records to be maintained to verify and substantiate the expense whether it be a deduction or capital expense.  If the item or amount of the expense cannot be verified and substantiated by the taxpayer, the IRS may disallow the deduction or the capital expense.

If you have questions related to a deduction or capital expense, you can speak with a tax attorney by contacting The McGuire Law Firm.   The McGuire Law Firm offers a free consultation with a tax attorney to discuss your questions and issues.

Denver Tax Attorney