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Funding a Buy Sell Agreement

When business partners enter into a buy sell agreement, one of the pertinent issues or items for the partners to discuss is how the buy-out will be funded. The purchasing business entity or purchasing party can obtain the funds to purchase business interests from a variety of sources, which are discussed below.

The purchaser always has the ability of self-funding the purchase.  If the purchaser does not have the required cash to purchase the interest, issues may arise whereby the seller will request some type of security interest.  Furthermore, if the purchaser lacks the cash to purchase the interest in full and equity in assets to fully secure the seller, a seller may request the buyer obtain a life insurance policy whereby the seller or the seller’s designee is the beneficiary of the policy until the purchase terms have been complied with.

Apart from a self-funded purchase, the most common source of funds for a buy-sell agreement is insurance.  Multiple types of insurance such as life insurance or disability insurance could be used to fund the buyout of the seller’s interest.  Where the triggering event for the purchase of the applicable interest is death, life insurance on the individual can be a very clean means by which to fund the purchase.  However, what if a disability or the retirement of an individual leads to the need to purchase such individual’s ownership interest?  Under these circumstances, life insurance may not be very useful as a source for funds.  To be useful as a source of funds for a buyout, a life insurance policy may need a significant cash value.

When the buy-sell agreement is between the owners of the business, it will likely be necessary for each owner to carry insurance on the life of each of the fellow business owners.  Therefore, multiple policies may be needed if each owner is separately insured.  Further, consider how many policies may be needed if there were say 8 different partners or business owners? If a redemption agreement is used, the owners do not insure the lives of the other owners, but rather, the business must purchase a joint-life policy or separately insure the life of each owner who the business has the obligation to redeem.

The types of life insurance policies could include term life insurance, cash value life insurance, whole life insurance, universal life insurance and survivor joint life insurance.  In regards to the need to purchase an owners interest because of a disability, the owners should consider disability insurance.  In many respects, it may be more likely for a business owner to be disabled than pass away during a time in their life when they still own the business interests and thus a purchase would be necessary.  Therefore, business owners should consider the need for disability insurance to fund a buyout, in addition to having life insurance available.

This article was written by John McGuire, a business attorney and tax attorney at The McGuire Law Firm in Denver, Colorado. Please remember this article was prepared for informational purposes and you should always speak with a business attorney or other counsel to discuss your specific issues & circumstances.

Denver Business Attorney

 

 

Deducting Business Expenses

Can I deduct my meals as a business expense?  Can I deduct this flight as a business expense?  Can I deduct the cost of my clothes or uniform as a business expense?  As a tax attorney, these are common questions I am asked, and rightfully so as everyone wants to take advantage of all potential deductions allowed by the Internal Revenue Code.  Not only is the deductibility of certain business expenses a hot topic with business owners, it is a hot topic and highly litigated topic with the Internal Revenue Service.  In fact, I recall reading a recent annual report to Congress by the Taxpayer Advocate Service whereby the deductibility of trade or business expenses he been one of the top ten most litigates issues for a very long time.  Furthermore, the same report stated that the courts affirmed the position taken by the Internal Revenue Service (the dissallowance 0f the deduction) in the vast majority of cases and that the taxpayer only prevailed (in full) about two-percent (2%) of the time.  The article below is not intended to be legal advice, but rather to provide general information regarding this issue.

First and foremost, we should start with the current law regarding deductions for business expenses.  Internal Revenue Code (the “Code”) Section 162 allows deductions for ordinary and necessary expenses incurred in a business or trade.  What actually constitutes ordinary and necessary may better be understood through an analysis of the case law, which is significant, surrounding the question.  Generally, the determination is made based upon a court’s full review of all facts and circumstances.

Based upon the black and white law under the Code, what constitutes a trade or business for purposes of Section 162.  Perhaps it is ironic that the term “trade or business” is so widely used in the Code, but yet, neither the Code nor the Treasury Regulations provide a definition for Trade or Business.  Personally, I think it would be quite hard to provide a definition for trade or business, especially under the auspices of income tax.  The concept of trade or business has been refined and defined by the courts more so than the Code.  The United States Supreme Court has held and stated that a trade or business is an activity conducted with continuity and regularity, and with the primary purpose of earning a profit.  Albeit broad, I would agree this definition would be sufficient for the majority of businesses I work and assist.

Now that we have an idea of what may constitute a trade or business, what is “ordinary and necessary?”  Again, the Supreme Court has helped provide definitions for these broad, but important terms.  Ordinary has been defined as customary or usual and of common or frequent occurrence in the trade or business.  Necessary has been defined as an expenses that is appropriate and helpful for the development of the business.  Further, it should be noted that some courts have also applied a level of reasonableness to each expense.

John McGuire is a tax attorney and business attorney at The McGuire Law Firm focusing his practice on issues before the IRS, tax planning & analysis and business transactions from formation to sale.

Denver Tax Attorney

Attempting to Avoid Shareholder Loan Reclassification

Many corporate shareholders may have taken a loan from their corporation.  In a prior article we discussed issues related to corporate loans and issues considered regarding the reclassification of a loan.  The article below discusses issues and actions a shareholder may consider taking to prevent the reclassification of a loan.  Please remember that this article is for informational purposes and it is recommended that you discuss any corporate loan issue directly with your tax attorney, business attorney or other advisors.

Proper recordkeeping and maintaining current promissory notes are of extreme importance regarding this issue.  The promissory notes must be kept current and reflect the payments that have actually been made by the shareholder to the corporation, the accrual of interest and other related issues in the previously executed notes.  Moreover, the approval of the loans should follow the proper approval and acceptance by the corporation’s board of directors and memorialized via the corporate minutes and other corporate memorandums.  The shareholder should also be able to verify that the interest has been paid on the note, the interest should be paid at regular intervals, and at least on an annual basis.  Contemporaneous evidence is always important when verifying loan payment and loan treatment to the Internal Revenue Service. From a tax return perspective, the corporate tax return should accurately reflect the loan on the balance sheet.

Because payment of the loan is such a vital factor, I often find it can be helpful to have multiple options or strategies for repayment.  Of course, the shareholder can make regular payments on a monthly, quarterly or yearly basis, but there are also other options for repayment.  If the corporation has strong earnings and profit, the shareholder could also use a distribution to pay make payment on the loan, perhaps even a lump sum payment to expedite payment on the note.  The shareholder may also be able to provide additional services to the corporation and receive bonuses for their work.  These bonuses could be paid to the shareholder and then paid to the corporation, or at least taxed to the shareholder as compensation and then reduce the amount of the note.

In short, generally the most important issues will be recordkeeping from corporate documents such as minutes, agreements and returns to the actual promissory note and making sure the shareholder is making payments with interest on the loan.

John McGuire is a tax attorney and business attorney at The McGuire Law Firm.  John assists clients with matters before the IRS, tax planning and advice, and business matters from contracts to the sale of business assets and interests.

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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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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.

Bank Secrecy Act

FinCEN Examining Virtual Currency Businesses

FinCEN (Financial Crimes Enforcement Network) has recently been investigating and examining businesses involved with virtual currencies such as Bitcoin.  In fact, on May 5, 2015, FinCEN announced the first civil enforcement action stemming from a virtual currency provider.  FinCEN and the United States Attorney General Office for the Northern District of California assessed a $700,000 civil penalty against Ripple Labs, LLC and a subsidiary for violation of the Bank Secrecy Act (BSA).  The applicable businesses apparently did not comply with requirements regarding an anti-money laundering policy as required under the Bank Secrecy Act.  Furthermore, penalties were assessed for failing to report suspicious activities (Suspicious Activity Reporting) in regards to certain transactions. 

FinCEN’s position is that virtual currency businesses and virtual currency providers as well as exchangers must comply with the Bank Secrecy Act.  FinCEN Director Jennifer Calvery stated, “Virtual currency exchangers must bring products to market that comply with our anti-money laundering laws.  Innovation is laudable but only as long as it does not unreasonably expose our financial system to tech-smart criminals eager to abuse the latest and most complex products.” 

Compliance with the BSA helps safe guard financial institutions and thus the American people from illegal motives, which is why certain institutions must have anti money laundering policies and other compliance and reporting requirements.  The failure of an institution or business to comply with the BSA can lead to civil penalties and possible criminal charges.  When civil penalties are assessed, the Internal Revenue Service has been delegated the authority and responsibility to collect the amounts that have been assessed.  In regards to the benefits of the applicable regulations, it is believed that certain reporting requirements have helped prevent and detect criminal activity related to illegal drug trafficking, terrorism and other illegal activities. 

If you are involved with or are considering involvement with a virtual currency business, it is recommended you become aware of the record keeping, reporting and other compliance measures required by the Bank Secrecy Act and other acts implemented for similar purposes. Such compliance issues may include an Anti-Money Laundering Policy (AML), Suspicious Activity Reporting (SAR), Know Your Customer and other programs and procedures.