Simplified Employee Pension (SEP)

Denver Business AttorneysSimplified Employee Pension (SEP)

Certain individual retirement accounts or individual retirement annuities may qualify as a simplified employee pension (SEP).  Under a SEP each employee’s contributed funds are placed in an individual retirement account (IRA) that the employee controls as an investment and the distributions.  Our tax attorneys in Denver have helped many individuals understand the tax implications of a SEP and other retirement vehicles.  The article below should act as a general guide to understanding a SEP.  If you have questions, please contact a Denver tax attorney at The McGuire Law Firm.

Under IRC Section 408(k), SEP individual retirement accounts have five characteristics: Contributions may not discriminate in favor of highly compensated employees; the SEP must be an individual retirement account or individual retirement annuity; the employer must make contributions to the SEPs of all employees; employees must be allowed to withdrawal portions without penalty imposed by the employer; and, the employer contributions must be allocated to the SEPs of the employees per a written formula specifying how the contribution is to be divided and how much each of the contribution an employee may expect to receive.

If the SEP is established using an IRS form or certain information is provided to eligible employees, the employer may qualify for relief from reporting and disclosure requirements otherwise required by ERISA.  Generally, this relief would come in the form of not being required to file Form 5500 as well preparing and distributing a plan description and summary to employees.

A SEP may only be established by an employee.  Thus, an individual must first be an employee and under a SEP arrangement or plan before an IRA can be used as a SEP.  A sole proprietor may establish a SEP because they are treated as their own employer.  Further, a partnership can establish a SEP as the partners are considered employees of the partnership under IRC Section 408.

A SEP requires a written document executed by the employer, which must be in place by the latest date allowed by law for employer deductible contribution.  This is an advantage to other qualified plans under IRC Section 401.  For example, Joe could create a SEP arrangement and contribute to the SEP on or before April 15, 2009 for the 2008 tax year.  However, an IRC Section 401 qualified plan would need to be executed by December 31, 2008.

The written SEP arrangement must include four elements: the name of the employer, the requirements for an employee to receive an allocation or share of the employer’s contribution; the equation for allocating the employer’s portion amongst those employees that are eligible; and, a responsible officer must sign the written document.  The written instrument requirement can be satisfied by the employer filing Form 5305-SEP.

An employer considering the creation of a SEP should obtain information from their tax attorney, business attorney and/or financial advisor regarding the requirements and tax implications to their business.  A Denver tax attorney at The McGuire Law Firm would be happy to assist you with any questions you may have.

 

Contact The McGuire Law Firm to schedule your free consultation with a Denver tax attorney.

Corporate Earnings & Profits

Corporate Earnings & Profits Denver Tax Attorney

A tax attorney at The McGuire Law Firm can assist your corporation regarding corporate issues such as earnings & profits, and what this term means to their business.  A tax attorney can help individual business owners regarding certain transactions of which the corporate earnings & profits will play a role.  Below is an article related to corporate earnings & profits that we hope you find useful.

From a tax perspective a corporation’s earnings & profits (E&P) do not impact the corporation’s tax liability.  Thus, why is the E&P of a corporation important, and what impact does such amount of figure have on the corporation?  The reason corporate E&P is so important is because a corporation’s E&P is used to calculate how distributions to shareholders of the corporation are taxed.  Corporate distributions are included in a shareholder’s gross income for individual income tax purposes to the extent the distribution constitutes a dividend under IRC Section 301.  Internal Revenue Code (IRC) Section 316 defines a dividend as any distribution of property from a corporation to the corporation’s shareholders out of E&P.

Corporate distributions are first treated as a dividend to the extent of the corporation’s E&P.  Thereafter, the distributions are treated as a return of capital to the shareholder(s), and thereafter capital gain to the shareholders.  Thus, a corporation’s E&P really appears to be a measure of the corporation’s ability to make distributions to the corporate shareholders without returning the shareholder’s capital contribution or other investor investments. This means a corporation’s E&P is a measure that represents a corporation’s ability to make distributions to shareholder’s without disrupting the shareholder(s) basis in their capital investment.

 

There is no black and white rule, method, statute or law for a corporation to follow when calculating E&P.  Due to the important role E&P plays in characterizing corporate distributions as dividends, the allocation of E&P in tax free corporate distributions such as reorganizations are important considerations when corporations consider such transactions and reorganizations.  IRC Section 381 deals with the carryover of corporate E&P.  For example, what occurs when one corporation with an E&P deficit is acquired by a corporation with accumulated E&P?  The IRS has issued regulations section 1.312-10 to address these issues, which will not be discussed in this article.

 

Under IRC Section 302 certain corporate distributions may not be treated as dividends and thus be given sale or exchange treatment to the taxpayer.  These transactions are primarily based on the overall impact to the shareholder’s ownership in the corporation after the transaction has been completed.  If a shareholder’s corporate ownership has been reduced or diminished enough, the distribution to the shareholder can be afforded sale or exchange treatment.  If the shareholder, after the transaction no longer holds any stock and has completely liquidated their interest, the transaction may be afforded sale or exchange treatment.  Certain transactions may also be considered partial liquidations and thus receive sale or exchange treatment.

Corporations with questions regarding their E&P, or considering distributions of property should consult with their CPA and/or their tax attorney and business attorney to discuss the tax implications to the corporation and shareholder. A Denver tax attorney at The McGuire Law Firm would welcome the opportunity to discuss such tax matters and issues with any business owner.

You can schedule free consultation with a Denver tax attorney by contacting The McGuire Law Firm.  720-833-7705 or John@jmtaxlaw.com

Offices in Denver, Colorado and Golden, Colorado.

C Corporation Considerations When Selling Your Business

C Corporation Considerations When Selling Your Business Denver Business Attorneys

As a business and tax attorney, John McGuire at The McGuire Law Firm is commonly asked, “how should I sell my business, and what are the tax implications?”  This question brings about many issues; way too many to be discussed in a short article, but the owners of a C corporation should understand the basics behind a stock sale versus and asset sale and the advantages and disadvantages to each.

When the business owner is considering the sale of their business they must determine whether they wish to sell the stock or the assets of the business.  A shareholder or seller would usually prefer a stock sale and a buyer would usually prefer an asset sale.  When the stock of a C corporation is sold sale or exchange treatment is given to the transaction and therefore the shareholder will receive capital gain treatment on the amount received above the basis in their stock.  The buyer prefers an asset sale because the purchase of the assets allows for a step up in basis, and the buyer does not carryover the seller’s depreciation schedule.  This generally will afford the buyer greater deductions and less tax.  Furthermore, when the stock of a corporation is purchased, the seller is relieved of liabilities and liabilities or exposures to such are transferred to the buyer.

The above issues show why the sale of C corporation assets is not favorable due to the fact there are not capital gains rates for corporations.  A C corporation selling appreciated assets will pay corporate level tax even if a capital gain is generated.  If cash is distributed to the shareholders after the sale of corporate assets, this is also a taxable event likely to be treated as a dividend or receive capital gains treatment.  Regardless, double taxation has occurred.

A C corporation may be able to mitigate some or all of the double taxation based upon the current tax attributes of the corporations.  For example, the corporation may have a net operating loss or certain credits that carry forward.

Any business considering liquidating or the sale of stock or assets should contact their business attorney and/or their tax attorney to discuss the full implications of the transfer.  A Denver tax attorney or business attorney at The McGuire Law Firm can assist you with your tax or business questions or issues.

Contact The McGuire Law Firm to schedule a free consultation with a tax attorney or business attorney.

Partnership Special Tax Allocations

Special Tax Allocations Denver Business Attorney

The special tax provisions included in the majority of partnership agreements such as limited partnership and limited liability company (LLC) operating agreements, exist to satisfy requirements regarding the regulation of partnerships as established within the Internal Revenue Code.  These special allocation provisions can alter the bargained for agreement and understanding of the partners thus, creating disruption between the partners during the operation of the partnership.  A Denver tax lawyer at The McGuire Law Firm can assist partners and partnerships in understanding the impact of special tax allocations.

The Internal Revenue Code allows a partnership to have flexibility regarding the partner’s pass through of income and loss.  However, Internal Revenue Service will not respect allocations that do not have substantial economic effect.  In short, substantial economic effect means that partnership allocations need to be passed through to the partners who receive or enjoy the benefit of the income or hold the economic burden associated with the partnership losses.  The IRS can reallocate income or losses if the IRS determines an allocation or allocations do not have substantial economic effect.

The impact on the substantial economic effect regulations may be most apparent when looking at the limited partners in a limited partnership (or limited liability company).  The benefit of limited liability can result in certain allocations lacking substantial economic effect in the eyes of the Internal Revenue Service.  When considering the special allocations within a partnership agreement, one should note that a safe harbor is provided and can be satisfied in the partnership agreement with the inclusion of certain provisions as outlined below.

Non-Recourse Debt Allocations: Such provisions require that the allocation of losses and deductions to partners associated with non-recourse debt-financed property have substantial economic effect.

Partner Minimum Gain Chargeback: Such provisions apply when there are non-recourse liabilities that a partner bears the risk of economic loss.  The minimum gain related to these liabilities need to be allocated to partners that previously received allocations of losses and deductions related to the applicable liabilities.

Distribution Triggered Special Allocations: Such provisions allocate gain and income to a partner that offset “excess” distributions received by the partner that would be in excess of the partner’s interest.

It is recommended that the partners or partnership consult with a business attorney or tax attorney to discuss the impact of special allocations and to draft the operating agreement of the partnership.  The reallocation of income, loss, gain or deductions by the IRS can create negative individual income tax consequences to the individual partners.  Our tax attorneys and business attorneys are available to consult you regarding these issues.

Contact The McGuire Law Firm to speak with a Denver tax attorney or business attorney.  Free consultation!

The Corporate Capital Structure

The Corporate Capital StructureDenver Business Attorneys

At The McGuire Law Firm, a Denver business attorney or tax attorney can assist you with the capital structure of your corporation and other business entities.  The article below is a general outline of some issues to consider when looking at your corporate capital structure.  Please feel free to contact a Denver tax attorney and business attorney at The McGuire Law Firm.

When forming a corporation, the capital structure should be designed in a manner that effectively allocates the various interests in the corporation amongst the owners and investors.  The pertinent interests will be: interests in current income, interests in control and, interests in accumulated income and capital.  When organizing the corporation, there is significant flexibility to design the capital structure and thus accomplish the preferred allocation.

The capital structure of a corporation will consist of securities issued by the corporation in exchange for cash, property or services contributed to the corporation.  Stock issued by the corporation represents ownership in the corporation or an equity interest in the corporation.  Debt of the corporation is a creditor interest.  Although the difference between an equity interest and a debt interest would appear clear, the difference between an equity interest and debt can often be very unclear.

Stock, Debt, Options & Hybrid Securities

Common Stock: Every corporation has at least one class of common stock outstanding.  The common stock holders are entitled to the corporation’s profit, increase in value and the right to vote on corporate matters.  Common stock however, would be considered more of a “junior” security due to because common stock holders are entitled to their rights only when required allocations have been made to other “senior” security holders.

Preferred Stock: A corporation can issue one or more classes of stock, and often a corporation will issue “senior” securities known as preferred stock.  A preferred stock holder’s right to current income and/or accumulated capital is limited.  Each share of preferred stock usually holds a stated liquidation preference, which is the amount to be paid on the retirement of the preferred stock and the amount paid to the corporation to acquire the preferred stock.  The limitation on current income of a preferred stock holder is usually limited to a percentage rate of the liquidation preference.  Thus, preferred stock can appear to be quite similar to a loan.  Generally, for tax purposes, preferred stock has been treated as “stock” and similar to common stock.

Debt: The debt of a corporation may come in many forms.  Extensions of credit (debt) could be a short term loan needed to purchase goods and inventory, or could be a long term investment in the corporation.  Further, a bank may loan money to the corporation.  Each form or type of debt is likely to have different terms and maybe secured by different means, or even unsecured.  In most circumstances and absent an agreement to the contrary, debt is senior to all stock.  Thus, interest on the debt is paid before dividends are paid to shareholders, and upon dissolution of the corporation, the debt is priority and will be satisfied first and foremost.

Options: An option is the right to purchase stock of the corporation, at a fixed price in the future.  Thus, the investor may be able to benefit in the later appreciation of the stock for a smaller current investment.

Hybrid Securities:  A single security may hold the attributes of multiple types of securities.  For example, a convertible security is a hybrid.  The terms of a debt instrument may allow the holder (creditor) to exchange the note or instrument for a specific number of shares of stock.  These forms of securities create difficulties in defining and labeling the security as either equity or debt.

Investing in a Corporation

An investor is free to make multiple types of investments in a corporation, and some investors prefer this balance and strategy.  The pertinent question for the investor is how to balance the additional security of debt against the stock’s potential for appreciation.

Debt or Equity Financing, or both?

Structuring the correct balance between debt and equity financing is not easy, and often, only time allows the investor or corporation to reflect upon the decisions made- hindsight is always 20/20!  However, the structuring can be vital to the success of the corporation and thus an investor’s rate of return on their investment.  There are tax and non-tax issues to consider, and often the answers to these issues create more questions and are in conflict with one another.  Some favor debt due to the fact that a C Corporations profits distributed on stock are subject to double taxation and the payment of interest on debt is deductible.  Investors may prefer debt due to the greater security and generally steady and consistent annual return on investment that is not always found with dividend payments.  Some favor stock because stock, unlike debt can be received in a tax free transaction.  Further, too much debt can impact the corporation’s credit, and the payment of debt interest can create cash flow issues for businesses, especially newer businesses.

We recommend that the business owners contact their business attorney or tax attorney when considering the formation and structure of their business.

Contact The McGuire Law Firm to schedule a free consultation with a Denver business attorney.

5 Reasons to Hire a Denver Business Attorney

Denver Business Attorney Denver Small Business AttorneyAt The McGuire Law Firm,  a Denver business attorney can assist you on a number of issues and on an ongoing basis as your business grows.  Below are situations in which you may wish to consult with a Denver business attorney at The McGuire Law Firm.

  1. A business attorney can help you form the proper entity or entity structure based upon the needs of your business. Further, through this process, your business attorney can explain to you the different liability protections afforded different entities and the different tax implications to the business and business owners based upon the choice of the business entity.  For example a C Corporation, S Corporation and Limited Liability Company (LLC) are all treated differently for tax purposes, and a fundamental understanding of the taxation of your business entity is a must to properly run and operate your business.  Further, your business attorney can explain the individual income tax issues that you as the business owner will need to consider.
  2. How should your business be financed?  Do you want more debt or equity interests in your business?  A Denver business attorney at our office can help you understand what constitutes debt and equity, and the good & bad behind both debt and equity financing.
  3. Did you read and understand your lease agreement?  A business should always hire a business attorney to review and negotiate their lease agreement.  The vast majority of lease agreements are very “one-sided” in favor of the landlord and a business attorney may be able to help you negotiate more reasonable terms, as well as explain the terms of the lease agreement and your personal exposure to the lease agreement as an owner and likely guarantor of the lease agreement.
  4. You’ve heard the saying that death and taxes are the only 2 certainties in life.  While this may be true, if you own a business, there is also the certainty that as at some point during your life or at your death, you will need to sell, dispose of or otherwise transfer your business interests.  A business attorney can help you establish a plan regarding the transfer or sale of your business or business interests in a manner that is most beneficial to you regarding your exposure to liability and in regards to the taxation of the transfer or disposition.  Your business attorney can also help in regards to the drafting of the purchase agreements and the necessary negotiations with the parties involved.
  5. As a business owner, you may want to establish retirement accounts for yourself and your employees.  A business attorney can assist you regarding the different options and tax benefits, as well as the reporting requirements for such compensation plans.

Contact The McGuire Law Firm to schedule your free consultation with a Denver business attorney.