Part 3 - Transfer Restrictions - Buy-Sell Agreements
Typical for any S-corporation, C-corporation, limited liability company, or partnership, owned by more than one person, are certain provisions that govern who can be an owner and under what circumstances. For example, although your partner and you chose to work together, in the event of the death of one of the other owners, many business owners would not chose to work with the decedent-owner's inheritors. For this reason, legal restrictions called buy-sell provisions are typical in owner agreements. Partnership agreements are the easiest example, since there is broad discretion to restrict transfers, either voluntary or involuntary.
The shares of a corporation may be restricted for any reasonable purpose as long as it is not unconscionable. However, the type of restrictions are limited in their remedies to (1) obligate the shareholder first to offer the shares to the corporation or other persons; (2) obligate the corporation or other persons to acquire the shares; (3) require consent to the assignment if not manifestly unreasonable; (4) prohibit transfer to designated persons or classes of persons, if not manifestly unreasonable; or (5) contain any other provision reasonably related to an authorized purpose. In contrast, a LLC membership interest is freely assignable except as provided in the articles of organization or a written operating agreement. The assignee only becomes a member of the LLC if the other members unanimously agree or if the articles of organization or operating agreement otherwise provide.
A buy-sell agreement or provisions, whether it is contained in a shareholders agreement or operating agreement, provides transfer restrictions if a triggering event occurs. These triggering events typically include the death of an owner, the firing of an employee-owner, the retirement or disability of an owner, or the attempted sale or transfer by an owner. These buy-sell provisions often require the triggering event owner to sell to the remaining owners or the company itself at a set price or a price deduced by an accountant or using a formula. Typical valuation formulas for small or large companies include (1) books value, (2) some factor or multiple of gross or net revenue, or (3) liquidation values.
Visit our law firm website at: http://www.walkerlambe.com/
Showing posts with label S-Corporation. Show all posts
Showing posts with label S-Corporation. Show all posts
Monday, May 9, 2011
Tuesday, January 11, 2011
S-Corporations: What are they and why care? - Part 2
Part 2: Saving on Employment Taxes? How?
1. Introduction.
As described in the previous post, an "S-Corporation" is a unique tax designation created by the IRS that is neither a corporate tax status, nor a partnership tax designation. It is designated as a "Small Business Election" by the IRS. Under the IRS's check the box regulations, any qualified business entity can be designated as an S-Corporation by the IRS, be it a partnership, corporation, LLC, or sole proprietor. To form an S-Corporation, the business entity, files a form 2553 with the IRS asking for the designation and will receive a reply letter acknowledging its acceptance. Not every business entity may become an S-Corporation. All members of the business entity must be U.S. residents or citizens, natural persons, and there can be no more than one hundred (100) owners of one class of stock. Below, I will further describe some of the advantages and restrictions on S-Corporations.
2. Saving Money on Payroll Taxes: Dividends are Not Payroll.
Closely held C-corporations often distribute substantial salaries to the owners, and avoid double taxation on corporate earnings by insuring that salary deductions match remaining unspent income to the corporation. In constrast S-corporations shareholders may be paid salaries but any remaining amounts of S-corporation income are taxed to them at ordinary individual rates without any payroll taxes deducted.
In order to appreciate the significance of this tax savings, it is important to understand how much payroll taxes cost the owner of a business on his own salaried income. Under the IRS Code, Social Security and Medicare (FICA) taxes are assessed on both the employer and the employee at the rate of 7.65% of wages paid to the employee during the year (15.3% total). The FICA tax consists of Social Security tax at the rate of 12.4% on the first $XX of wages paid (increase each year) with 6.2% paid by the employer and 6.2% paid by the employee. Also, the hospital insurance (Medicare) tax is assessed at the rate of 2.9% on all wages paid to the employee during the year, with 1.45% paid by the employer and 1.45% paid by the employee. There is no wage base cap on the Medicare portion of the FICA tax. By example, on $100,000.00 of income, the typical owner-employee would pay $15,300.00 in payroll taxes, both employer and employee shares. The S-corporation employee-owner avoids this by paying only "reasonable compensation" as salary and the remainder as dividends.
3. Asset Protection Issues.
Asset protection is important to professionals and high-wealth individuals as well as ordinary individual business owners with good credit and a desire to avoid debt collectors. Often the regular business owner is asked to guaranty a loan or other form of indebtedness. If the purpose for the loan or the overall business enterprise is unsuccessful, the individual owner may become liable to the maker of the promisssory note. Under these circumstances, the business owner looks to his business attorney to best advise him on these issues and which business entity best protects him and his business. If the business owner has personally guaranteed a debt, his personal assets are at risk. With regard to his ownership in the business enterprise itself, the business owners' assets are best protected by the LLC, rather than a corporation, partnership or sole proprietorship. This is because his debtors cannot attach or have ownership in the LLC, but instead may obtain only a charging order instead. The creditor cannot obtain distributions from the LLC and the debt will likely remain unpaid. In contrast, the debtor can obtain the stock of the debtor's ownership in any corporations, and can force dividends to be paid to shareholders. This is also true of sole proprietorships.
Visit our law firm website: http://www.walkerlambe.com/
1. Introduction.
As described in the previous post, an "S-Corporation" is a unique tax designation created by the IRS that is neither a corporate tax status, nor a partnership tax designation. It is designated as a "Small Business Election" by the IRS. Under the IRS's check the box regulations, any qualified business entity can be designated as an S-Corporation by the IRS, be it a partnership, corporation, LLC, or sole proprietor. To form an S-Corporation, the business entity, files a form 2553 with the IRS asking for the designation and will receive a reply letter acknowledging its acceptance. Not every business entity may become an S-Corporation. All members of the business entity must be U.S. residents or citizens, natural persons, and there can be no more than one hundred (100) owners of one class of stock. Below, I will further describe some of the advantages and restrictions on S-Corporations.
2. Saving Money on Payroll Taxes: Dividends are Not Payroll.
Closely held C-corporations often distribute substantial salaries to the owners, and avoid double taxation on corporate earnings by insuring that salary deductions match remaining unspent income to the corporation. In constrast S-corporations shareholders may be paid salaries but any remaining amounts of S-corporation income are taxed to them at ordinary individual rates without any payroll taxes deducted.
In order to appreciate the significance of this tax savings, it is important to understand how much payroll taxes cost the owner of a business on his own salaried income. Under the IRS Code, Social Security and Medicare (FICA) taxes are assessed on both the employer and the employee at the rate of 7.65% of wages paid to the employee during the year (15.3% total). The FICA tax consists of Social Security tax at the rate of 12.4% on the first $XX of wages paid (increase each year) with 6.2% paid by the employer and 6.2% paid by the employee. Also, the hospital insurance (Medicare) tax is assessed at the rate of 2.9% on all wages paid to the employee during the year, with 1.45% paid by the employer and 1.45% paid by the employee. There is no wage base cap on the Medicare portion of the FICA tax. By example, on $100,000.00 of income, the typical owner-employee would pay $15,300.00 in payroll taxes, both employer and employee shares. The S-corporation employee-owner avoids this by paying only "reasonable compensation" as salary and the remainder as dividends.
3. Asset Protection Issues.
Asset protection is important to professionals and high-wealth individuals as well as ordinary individual business owners with good credit and a desire to avoid debt collectors. Often the regular business owner is asked to guaranty a loan or other form of indebtedness. If the purpose for the loan or the overall business enterprise is unsuccessful, the individual owner may become liable to the maker of the promisssory note. Under these circumstances, the business owner looks to his business attorney to best advise him on these issues and which business entity best protects him and his business. If the business owner has personally guaranteed a debt, his personal assets are at risk. With regard to his ownership in the business enterprise itself, the business owners' assets are best protected by the LLC, rather than a corporation, partnership or sole proprietorship. This is because his debtors cannot attach or have ownership in the LLC, but instead may obtain only a charging order instead. The creditor cannot obtain distributions from the LLC and the debt will likely remain unpaid. In contrast, the debtor can obtain the stock of the debtor's ownership in any corporations, and can force dividends to be paid to shareholders. This is also true of sole proprietorships.
Visit our law firm website: http://www.walkerlambe.com/
Friday, June 18, 2010
S-Corporations: What are they and why care?
Overview of S-Corporations and C-Corporations
There are two types of corporations for purposes of federal taxation. C-Corporations and S-Corporations. C-Corporations are your grandfather's traditional corporation. C-Corporations, like Intel, Dupont or Exxon, pay tax at the entity level with graduated tax rates up to 35%. Then, in addition, any employees of the C-Corporation pay taxes on their wages and shareholders pay taxes on their dividends. S-Corporations are different. S-Corporations are pass-through tax entities like partnerships. What is pass-through taxation? The S-Corporation pays no tax at the entity level. Rather, the S-Corporation shareholder pays taxes on their share of the income as reported on their K-1s. The S-Corporation shareholder/employee also pays income taxes and employment taxes on wages received. Finally, the S-Corporation shareholder pays taxes on any dividends. Thus, S-Corporations are said to avoid the double taxation of C-Corporations, although the matter is more complex than that.
Benefits and Limitations of S-Corporations vs. C-Corporations
1. Double Taxation.
One of the big benefits of S-Corporations is the avoidance of double taxation of the C-Corporation shareholder/employee. As referenced above, the C-Corporation pays taxes, then the shareholder/employee pays their income taxes and employment taxes on payroll received. In contrast, the S-Corporation shareholder pays their share of the S-Corporation's taxable income, but deducts any salary or dividends paid to the shareholder, thus avoiding double taxation. Although this is generally true, S-Corporation shareholders who own 2% or more of the corporation's stock will be taxed on some of the benefits received, which would normally be non-taxable to C-Corporation shareholders, thus incurring a double taxation to the extent of these benefits. These benefits taxed to the S-corporation shareholder include:
Next article, the Triangle Business Matters Blog will address additional S-Corporation limitations and benefits, including the exclusion from employment taxes of dividends paid to S-Corporation shareholder/employees.
Visit our law firm website at: http://www.walkerlambe.com/
There are two types of corporations for purposes of federal taxation. C-Corporations and S-Corporations. C-Corporations are your grandfather's traditional corporation. C-Corporations, like Intel, Dupont or Exxon, pay tax at the entity level with graduated tax rates up to 35%. Then, in addition, any employees of the C-Corporation pay taxes on their wages and shareholders pay taxes on their dividends. S-Corporations are different. S-Corporations are pass-through tax entities like partnerships. What is pass-through taxation? The S-Corporation pays no tax at the entity level. Rather, the S-Corporation shareholder pays taxes on their share of the income as reported on their K-1s. The S-Corporation shareholder/employee also pays income taxes and employment taxes on wages received. Finally, the S-Corporation shareholder pays taxes on any dividends. Thus, S-Corporations are said to avoid the double taxation of C-Corporations, although the matter is more complex than that.
Benefits and Limitations of S-Corporations vs. C-Corporations
1. Double Taxation.
One of the big benefits of S-Corporations is the avoidance of double taxation of the C-Corporation shareholder/employee. As referenced above, the C-Corporation pays taxes, then the shareholder/employee pays their income taxes and employment taxes on payroll received. In contrast, the S-Corporation shareholder pays their share of the S-Corporation's taxable income, but deducts any salary or dividends paid to the shareholder, thus avoiding double taxation. Although this is generally true, S-Corporation shareholders who own 2% or more of the corporation's stock will be taxed on some of the benefits received, which would normally be non-taxable to C-Corporation shareholders, thus incurring a double taxation to the extent of these benefits. These benefits taxed to the S-corporation shareholder include:
- (a) Group term life insurance;
- (b) Accident and health insurance plans;
- (c) Meals and lodging;
- (d) Employee death benefits;
Next article, the Triangle Business Matters Blog will address additional S-Corporation limitations and benefits, including the exclusion from employment taxes of dividends paid to S-Corporation shareholder/employees.
Visit our law firm website at: http://www.walkerlambe.com/
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