Minimum Gain Chargeback Provisions

If you have reviewed partnership agreements or operating agreements for an LLC you have probably read provisions relating to Minimum Gain Chargeback.  That being said, the Minimum Gain Chargeback provisions may have put you to sleep, and may not even be practical based upon the facts and circumstances of the partnership.  However, Minimum Gain Chargeback provisions are important to understand if in fact they were to apply to your situation and circumstances.  The article below has been prepared by a tax attorney and business attorney from The McGuire Law Firm to provide an explanation of Minimum Gain Chargeback.

Minimum Gain Chargeback provisions deal with non-recourse debt and the allocations of non-recourse debt.  Such provisions are mandatory if the partnership wishes to allocate non-recourse deductions to the partners in any manner other than per the member’s pro-rata portion of capital interest in the partnership.  Therefore, it is important to identify when a Minimum Gain may be realized.  Minimum Gain occurs when deductions are claimed on property that decrease the partnership’s book basis in the property below the actual balance of the non-recourse debt on the property.  A situation whereby you may see Minimum Gain is when property is depreciated.  The depreciation will drive the partnership’s book basis of the property below the amount of the loan on the property.  When a partnership does have Minimum Gain, the Minimum Gain Chargeback is an allocation of the gain to the partners or members who have received the benefit of non-recourse deductions, or who may have received distributions from the partnership that can be attributed to the non-recourse loan.   In short, if a partner has received a benefit from the depreciation of property whereby they did not bear the economic risk of the loan to acquire the property (because the debt was non-recourse and not personally guaranteed), the benefit can be “charged back” to the partner.

So when does the “charge back” occur?  The deductions or distributions taken by the partners are charged back when the property that was subject to the non-recourse debt is sold, transferred or otherwise disposed of, or when there is a change in the character of the non-recourse debt.  A change in the character of the non-recourse debt could be the debt converted to a recourse liability or the debt being forgiven.

Now, the million dollar question: What is the amount of the charge back?  The partnership’s minimum gain is generally going to be the excess of the non-recourse liabilities over the adjusted tax basis of the property subject to or securing the non-recourse debt.  Perhaps an example will help illustrate this.   Assume J&J, LLC had purchased property for $200,000 and took $100,000 in depreciation on such property.  Thereafter, J&J LLC obtain non-recourse financing of $250,000.  The minimum gain would be $150,000, which is the non-recourse debt of $250,000 less the adjusted basis of $100,000.

It is important to remember that a partner is not subject to a charge back for monies they contribute to repay a non-recourse debt, and it is possible for the partnership to request a waiver of the chargeback under certain circumstances.

John McGuire is a tax attorney at The McGuire Law Firm whose practice focuses primarily on tax matters before the IRS, business transactions and tax issues as they apply to his individual and business clients.  In addition to his law degree, John holds an advanced degree in taxation (LL.M.).  Please feel free to contact John with any questions.

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Initial Considerations Regarding a Corporate Acquisition

In any corporate acquisition, there are tax and non-tax issues, multiple business considerations and goals of the parties involved with the transaction.  The tax planning that is involved before, during and after the acquisition process may include many options and alternatives to achieve the tax and non-tax wishes and goals of the parties.  Thus, one of the most important steps in the planning process of a corporate acquisition is to discuss and review the party’s intentions and goals, which may include short term matters and long term matters.

First, we need to identify the parties.  In any corporate acquisition you will have the buyer who is looking to acquire one or more businesses that are operated and owned by another business.  The seller, which may be referred to as the “target” or “target-corporation” may wish to be disposing of the business in exchange for some type or form of consideration, or merge in some way with the buyer.  Broadly stated, the buyer may wish to purchase the stock of the target corporation, or acquire the assets of the corporation.  Thus, in general, you can consider the purchase options to be a stock purchase or asset purchase of the target.  Furthermore, there is the possibility that the acquisition could be a hostile acquisition.  A hostile acquisition involves the acquisition of a publicly held company, like Wal Mart.  The acquisition begins without any agreement between the purchaser and the target corporation.  It is possible that through a hostile acquisition, the target may not even wish to be acquired or purchased by the buyer.

It is likely that the single most important factor in an acquisition will be the consideration to be paid or consideration received by target (property, stock and other items could be used as consideration).  Thereafter, an important issue to consider and understand is whether the shareholders of the target corporation plan to or wish to have an equity ownership in the combined entity after the acquisition is completed, or if such shareholders wish to sell their entire ownership interest in exchange for a cash payment or other financial benefit.  This issue will likely dictate the overall consideration involved and will, in many respects, control the overall structure of the transaction as well as the characterization of the transaction for tax purposes (taxable versus tax free).  For example, if the parties wished to have a tax free reorganization, a common theme in a tax free reorganization is continuing ownership interest in the combined business by the previous shareholders of the target business.  The transaction may only be able to qualify as a tax-free reorganization if a substantial portion of the consideration paid is the stock of acquiring corporation, or perhaps the stock of the acquiring corporation’s parent.  Thus, consider whether or not the target shareholders receiving shares of the acquiring corporation would be practical if in fact the some or all of the target shareholders wished to receive cash consideration for their ownership interests.  This example illustrates how the goals and wishes of the parties involved can dictate the transaction structure and thus the tax implications to the parties.

The above article has been prepared by John McGuire of The McGuire Law Firm.  As a tax and business attorney, Mr. McGuire’s practice is focused on tax planning, tax matters before the IRS and business transactions from business start-ups & formation, to business contracts & acquisitions.  You can schedule a free consultation with a business attorney at The McGuire Law Firm by calling 720-833-7705.

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Employee Stock Options

Successful businesses will have successful, driven and strong employees.  Often businesses are faced with questions and issues regarding maintaining employees, hiring the right employees and incentivizing employees.  Incentive compensation arrangements are often used by large and small businesses as a means by which to reward employees, as well as a benefit to individuals the business is hoping to hire and maintain.  An incentive compensation plan can have a number of benefits over cash compensation and qualified plans such as:

  • They can be easy to adopt, with low upkeep and administrative costs
  • Employees can defer taxation
  • The plan can allow a key employee to participate and share in corporate growth through direct equity ownership, or grant equity flavored compensation such as phantom stock
  • Incentive compensation plans do not need to meet discrimination requirements, whereas qualified plans may need to meet such requirements

A small business such as an S corporation can use an incentive plan just like a C corporation, but one must be mindful of the S corporation eligibility rules.  The eligibility rules for an S corporation create matters and issues that must be considered when an S corporation implements an incentive compensation plan.  This article has been prepared by a business attorney and tax attorney to provide information regarding stock options available to small businesses when implementing an incentive compensation plan.

Stock Options

Stock options can be used by corporations to compensate certain key employees.  There are two forms of these stock options: 1) Nonqualified Stock Options (NQSOs) and 2) Incentive Stock Options (ISOs).

A Nonqualified Stock Option is an option granted by the corporation to an employee.  The option provides the employee with the right to purchase corporate stock at a specific and designated price through some date established in the future.  Generally, the option will grant an executive or key employee the ability to purchase stock at a price that is below fair market value.  For example, John, a highly trained & key employee of Do It Right, Inc. may receive an option to buy shares at $15/share, when the fair market value of the share is $30/share through a certain date in the future.   After a specific holding period, the option can be exercised, or it may vest in steps or stages in the future.

Options are not taxed at the date they are granted under Section 83 of the Internal Revenue Code, unless there is a readily ascertainable fair market value.  Generally, the treasury regulations would hold that an option not actively traded on a market does not have an ascertainable fair market value unless the value can be determined with reasonable certainty.  Therefore, generally the regulations presume an untraded option would not have a readily ascertainable fair market value.  It also can be relatively safe to assume that S corporation options would rarely have an ascertainable fair market value and therefore, the option would not be taxed until exercised.  When exercised, the difference between the stock’s fair market value and the amount paid by the employee in exercising the option are taxed to the employee as compensation, and the employer is permitted a deduction for compensation.

 

Incentive Stock Options

An incentive stock option plan is similar to a nonqualified stock option in that it is an option purchase stock in the corporation at a future date.  The difference is, the holder of an incentive stock option can receive preferential tax treatment upon exercising the option that is not available to the holder of a nonqualified stock option.  The incentive stock option plan must meet very specific standards.  Under IRC Section 422(b), the option must: 1) be granted to an employee via a plan approved by the shareholders; 2) have an exercise price not less than the stock’s fair market value as of the date of grant; 3) no longer than a 10 year exercise period, and be granted within 10 years; 4) restrictions on transferability; 5) the holder of the option, at the time the option is granted cannot own more than 10% of the combined total voting power of all corporate stock.  The last issue #5, does not apply if the option price is at least 110% of the fair market value of the applicable stock when granted.  When the requirements are met, the holder of the option can exercise the option free of tax!  Yes, the holder postpones the taxable event until the stock received via the option is disposed, sold or exchanged.

John R. McGuire is a tax attorney and business attorney at The McGuire Law Firm.  In addition to his J.D. Mr. McGuire holds an LL.M. in taxation.  Mr. McGuire advises his clients on matters before the IRS, tax planning & issues and business transactions from formation & sale to contractual issues.

Contact The McGuire Law Firm to schedule a free consultation with a business attorney regarding your business matters and issues.

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Direct Stock Acquisition and Reverse Triangular Merger

There are multiple options to implement the acquisition of a business.  The purchaser or acquirer could purchase the stock of the target corporation, or the assets of the target corporation.  If the stock of the target corporation is to be purchased there are multiple options and variations by which the stock can be acquired.  The article below will discuss some of the common stock acquisitions that are available for a corporation to acquire another.

The Direct Stock Purchase

The direct purchase of stock from the target shareholders may be the simplest structure and means by which to implement a stock acquisition.  Through a direct stock purchase, the acquirer will purchase stock of the target from the shareholders of the target for an agreed upon purchase price or consideration.  When the target is a closely held corporation, the acquirer can work out and negotiate the deal directly with the shareholders of the target corporation.  When the target corporation is a publicly held corporation, the acquirer could purchase stock via the open market, or produce a cash tender offer (or exchange offer) for the purchase of the target corporation’s stock.  A tender offer would be an offer to purchase shares of the corporation for cash, in comparison to an exchange offer, which is an offer to exchange stock, securities or other consideration.  Certain (and different) securities laws must be considered when weighing tender offers versus exchange offers.

Often one or both parties will wish for the transaction to be a tax-free exchange under the Internal Revenue Code.  It is important to note that for the exchange to be considered under Internal Revenue Code Section 368, a tax free exchange of stock would require the consideration paid to the target shareholders consist solely of the voting stock the acquiring corporation, or the parent of the acquiring corporation.  See IRC section 368(a)(1)(B) and related treasury regulations for more information regarding a tax-free exchange.

Reverse Triangular Merger (Indirect Stock Purchase)

 A direct stock purchase may not always be feasible to consummate an acquisition, especially if the target corporation is publicly held.  When publicly held, each shareholder must decide whether to sell their shares via the public market or via the tender or exchange offer.  The odds may be stacked such that one or a few number of shareholders do not wish to sell, or perhaps are even unaware of the offer to dispose of their shares. There is an approach that can legally require the shareholders to sell known as the reverse triangular merger.  The benefit of the reverse triangular merger is that conversion of the shares occurs via operation of law, and is binding on the target corporation’s shareholders.  Thus, the purchaser or acquirer can legally force and guarantee the acquisition of the shares.

The reverse triangular merger would work as follows: Purchasing, Inc. wants to acquire all of the shares of Targeted, Inc., which is publicly held.  Purchasing Inc. and Targeted, Inc. have agreed upon the consideration to be paid and the other terms and conditions.  Purchasing, Inc. would form Subsidiary, Inc. and Subsidiary, Inc. would be merged with Targeted, Inc., with Targeted, Inc. as the survivor.  Via operation of law, the stock of Subsidiary, Inc. is converted to stock of Targeted, Inc. and Purchasing, Inc. as the sole shareholder of Subsidiary, Inc. would receive all of the stock of Targeted, Inc.  The former shareholders of Targeted, Inc. would receive the agreed upon consideration.  Further, Purchasing, Inc. is now the sole shareholder of Targeted, Inc.

The above article has been prepared by John McGuire of The McGuire Law Firm.  John is a tax attorney and business attorney in Denver, Colorado and can be contacted at John@jmtaxlaw.com

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Constructive Ownership Within Foreign Corporations

Under the context of controlled foreign corporations, a U.S. shareholder is defined as a U.S. Person who owns or is considered as owning 10% or more of the total combined voting power of all classes of stock entitled to vote of a foreign corporation.  Does this language mean that constructive ownership is considered when determining whether the applicable person is a 10% owner and thus a U.S. shareholder?  The answer is yes!  Stock that is held directly, indirectly and constructively with the meaning of Internal Revenue Code Section 958 is taken into account when determining ownership.

Because of this rule and the application of attribution rules, a U.S. shareholder of shareholders are unable to avoid U.S. shareholder status by distributing stock of a foreign corporation to related parties.  For example, if Corporation 1 spread ownership equally amongst 20 other U.S. affiliates within an affiliated group, and thus each corporation would own 5% of the stock of Corporation 1, U.S. shareholder status could not be avoided for each shareholder because of the attribution rules, and each corporation would be treated as constructively owning the shares.  It can also be important to remember that the attribution rules, attribute the stock on the value of the shares owned and the not the voting power.  For example, assume stock was held by John in a corporation and the stock held was 10% of the votes but 25% of the value.  The value would be considered as owning 25% of the stock held.

What about ownership in a foreign partnership, foreign trust or even a foreign estate?  Do the controlled foreign corporation rules in Subpart F apply to these foreign “entities?”  The answer would be no because a foreign entity must be a corporation to fall within the definition of a controlled foreign corporation, and therefore, Subpart F would not apply as a result of ownership by a United State person.  Thus, we must ask the question, for purposes of a controlled foreign corporation, how is a corporation defined?  One should reference Internal Revenue Code Section 7701(a)(3) per the regulations when determining whether or not a foreign business or entity is in fact a corporation within the definition of the code.  Prior to 1997 a facts and circumstances test applied reviewing continuity of life, centralized management, limited liability and free transferability of assets whereby now, under 7701(a)(3) regulations, there are elective rules for classifying most foreign entities.  These classification matters could be akin to certain options, often referred to as “check the box” regulations.  For more information regarding check the box regulations, see 910 T.M.

You can contact a tax attorney and business attorney at The McGuire Law Firm to discuss your tax & business related matters.  The McGuire Law Firm has offices in Denver, Colorado and Golden, Colorado for your convenience and offers a free consultation to all potential clients.

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Who Enforces FBAR?

If you have foreign bank accounts or interests in foreign assets, you may be required to file the FBAR, which is the reporting of foreign bank and financial accounts.  That being said, who enforces the FBAR regulations, and collects on penalties that have been assessed?  FinCEN has directed that the enforcement of the FBAR be handled by the Internal Revenue Service.  Thus, if you were assessed a penalty for failing to file the FBAR, the IRS would collect on the penalty.

The video below has been prepared to provide additional information regarding enforcement of the FBAR.

John McGuire is a tax attorney in Denver, Colorado at The McGuire Law Firm.  John’s practice in taxation involves matters before the Internal Revenue Service such as tax audits, FBAR & OVDP matters, tax debts, issues before United States Tax Court and individual & business taxation.  You can speak with a Denver tax attorney at The McGuire Law Firm by calling 720-833-7705 and scheduling a free consultation.

What is FinCEN

FinCEN is the Financial Crimes Enforcement Network.  The goal and objective of FinCEN is to monitor financial institutions through regulations that require certain record keeping, record maintenance and reporting.  Because many crimes such as illegal drug trafficking, terrorism and others involve large sums of money and the use of financial institution, FinCEN and other law enforcement agencies feel the record keeping and reporting is invaluable in fighting crime.  John McGuire is a tax attorney with The McGuire Law Firm and has prepared the video below to provide additional information regarding FinCEN.  You can contact The McGuire Law Firm to speak with a tax attorney in Denver, Colorado or Golden, Colorado.

Introduction to the BSA

What is the Bank Secrecy Act?  The Financial Recordkeeping and Reporting of Currency and Foreign Financial Transactions Act of 1970, is generally referred to the Bank Secrecy Act (BSA).  The act can be found at 31 U.S.C. 5311.  The purpose of the act is relatively simple, that being to require financial institutions in the United States to maintain a certain level of records and recordkeeping, and require the filing of certain reports regarding currency transactions relationships with certain customers of the financial institution.

Generally a bank or financial institution complies with the BSA through the filing of Currency Transaction Reports, also referred to as CTRs and Suspicious Activity Reports, also referred to as SARs.  In addition to certain record keeping requirements, the Bank Secrecy Act also requires, in general, a financial institutions records be sufficient enough to allow for the reconstruction of a customer’s account if such reconstruction is necessary.  Therefore, an audit trail or paper trail can be constructed if needed, which as reported by certain federal agencies, has been very useful information and vital in criminal investigations as well as other tax and regulatory investigations and cases. 

There are two parts to the BSA those being: 1: Financial Recordkeeping and 2: Reports of currency and Foreign Transactions.  Financial Recordkeeping authorizes the Secretary of The Treasury to issue regulations that will require the maintenance of certain records by insured financial institutions.  Thus, think about the FDIC notices when you walk in your bank.  These types of financial institutions that are insured are required to maintain a certain level of records.  Reports of Currency and Foreign Transactions allows the Department of Treasury to regulate and thus require the reporting of certain transactions.  You may have heard that banks are required to report transactions in excess of $10,000 and in many cases this is correct and what Part 2 of the BSA in terms of currency transaction reporting is associated with. 

The purpose of the BSA is thus to require maintenance of records and reporting of transactions that enable and aid investigations and examinations of a wide variety of criminal activity from tax evasion to money laundering that may associated with illegal drug trafficking and/or terrorism.  The idea is that if certain records are maintained, and certain transactions reported, these records can be used to investigate and examine certain individuals and track certain criminal activity.  This makes a lot of sense.  The paper trail left by money can often lead to the individuals responsible for crime.  The majority of criminal activities can create and lead to large sums of money, and generally require a certain amount of money.  Thus, finding the source of this money can assist law enforcement. 

Other acts and regulations have expanded and thus strengthened the scope of the Bank Secrecy Act.  For example, please see the Money Laundering Control Act of 1986, the Annuzio-Wylie Anti-Money Laundering Act of 1992 or the Money Laundering and Financial Crimes Strategy Act of 1998.

This article has been drafted by John McGuire, a tax attorney in Denver, Colorado at The McGuire Law Firm.  Mr. McGuire’s practice focuses on taxation matters with individuals and businesses, and tax representation before the Internal Revenue Service and other taxing authorities.  Mr. McGuire also works with businesses regarding their transactional matters.

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Denver Sales Tax Questions and Issues

Many businesses in Denver are required to collect and pay sales tax, but many business owners have questions regarding sales tax matters.  The article below has been prepared to provide additional information regarding sales tax matters in Denver County.

First and foremost, when is sales tax imposed in Denver?  In Denver, sales tax will be imposed on the purchase price for retail sales, leases and rentals of certain tangible personal property.  Further, some services can be taxable that are purchased or performed in Denver or if delivered, used or stored in the county.  Thus, it begs the next question, what services are taxable?  The following services could be taxable, but please note, the list below is not all inclusive of the services that could be taxable.

  • Software charges
  • Entertainment Services
  • Informational Services
  • Fees such an entrance fees or a cover charge or mandatory tips/gratuity

What if a business is not located in Denver but receives business from Denver?  Does a business outside of Denver need to collect and pay the Denver Sales Tax?  If a business is licensed outside of Denver, the business may be required to collect and remit the Denver Retailer’s Use Tax on sales in Denver that would be taxable Denver retail sales.  These applicable activities could include performing an activity in Denver in connection with the sale or lease of tangible personal property. 

What sales tax is charged if delivering items outside of Denver County?  You should generally charge the applicable tax for the location you are delivering the item.  You should also check to see if any type of license is required for the location, or any other fee required.

What food is taxed and what food is exempt from sales tax?  When you purchase food in Denver County that is prepared such as in a restaurant, or when food is ready to eat, sales tax will apply to the purchase.  Food that is purchased for domestic consumption in your home can be exempt from sales tax. 

Does sales tax apply to the sale of alcoholic beverages such as beer and wine?  Yes, sales tax always applies to the sale of alcoholic beverages.

What is a home rule city?  A home rule city, which is what Denver is, elects to collect and administer their own sales tax, as opposed from another taxing authority such as the state department of revenue.

John McGuire, a local tax attorney in Denver and Golden Colorado prepared the above article.  You can contact John by contacting The McGuire Law Firm.  A free consultation with a tax attorney is provided to all potential clients.

IRS Form 872

If you are being audited by the IRS, the IRS may request that you sign Form 872, which extends the amount of time the IRS has to assess you additional tax.  In essence, you are agreeing to extend the statute of limitations the IRS has to assess you additional tax.  Whether or not you agree to extend the statute may depend upon the facts and circumstances of the audit and tax period at audit.  If you are being audited by the IRS, it may be best to contact a tax attorney or tax professional to discuss the matter.  You can speak with a tax attorney in Denver, Colorado by contacting The McGuire Law Firm.  The video below has been prepared by a tax attorney to provide additional information regarding Form 872.

Schedule a free consultation with a Denver tax attorney- 720-833-7705 or http://jmtaxlaw.com/contact-us/

The McGuire Law Firm has successfully resolved IRS audits for many individual and business clients.