A soup to "nuts" Case Study apprach to choosing the right type of business entity.

1. CHOICE OF ENTITY – SOUP TO Brian T. Whitlock, CPA, JD, LLM
“NUTS” Tax Partner
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2. Topics
 Revisit basic issues with Choice of Entity
 Case Studies
 Unusual Issues impacting Choice of Entity
Capital Requirements
IRC Sec 1202 and IRC Sec 1045
ESOP and IRC Sec 1042
 Alternate Entities
Captive Insurance Companies
IC-DISCs
Cooperatives
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6. Case Study #2
Don has an opportunity to open an new McDonald’s Franchise in
a rapidly growing area of DuPage County.
McDonald’s does not offer any tax advice to its franchisees.
McDonald’s tells him that they see franchisees operate in lots of
various forms, including Sole Proprietorships, Partnerships, LLCs,
C Corporations and S Corporation. It recommends that he consult
with his tax advisor, so he calls you.
Where do you start?
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7. Choice of Entity Comparison
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8. Case Study #3 – Real Estate Developer
Johnson (80 years of age) personally owns 40 acres of land the near
Western Suburbs (Cook/DuPage County). He wants to develop the
site with retail shopping, commercial office, townhomes &
condominiums.
He and his adult children have experience with building
condominiums, townhomes, and single family homes in the past. In
2004 they sold their former company for an amount in excess of
$200 million to a public company.
He mothballed the plans 5 years ago, but feels that the time is
rapidly approaching to re-launch this development.
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9. Working Within the Entity Toolbox
Lifecycle of a Family Business Enterprise
Sole Proprietorship
Stage One
(Ground Floor)
Inception
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10. Lifecycle of a Family Business Enterprise
Sole Proprietorship
Stage One
(Ground Floor)
Inception
General Partnership Limited Partnership
Stage Two
(addition owner added) (Passive Investor Added)
Adding other
people and/or
Raising Capital
Limited Partnership / LLC S Corporation C Corporation
(Debt or Private (Debt or Private (Debt or Private Placement,
Placement Capital) Placement Capital) and Venture Capital)
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11. Lifecycle of a Family Business Enterprise
Sole Proprietorship
Stage One (Ground Floor)
Inception
General Partnership Limited Partnership
Stage Two
(addition owner added) (Passive Investor Added)
Adding other
people and/or
Raising Capital
Limited Partnership / LLC S Corporation C Corporation
(Debt or Private (Debt or Private (Debt or Private Placement,
Placement Capital) Placement Capital) and Venture Capital)
Stage Three LLC or General Partnership C Corporation S Corporation
Mature (Joint Venture) (Venture Capital or IPO) (Lower Income Tax
Business Access Cash Flow)
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12. Lifecycle of a Family Business Enterprise
Sole Proprietorship
Stage One (Ground Floor)
Inception
General Partnership Limited Partnership
Stage Two
(addition owner added) (Passive Investor Added)
Adding other
people and/or
Raising Capital
Limited Partnership / LLC S Corporation C Corporation
(Debt or Private (Debt or Private (Debt or Private Placement,
Placement Capital) Placement Capital) and Venture Capital)
Stage Three LLC or General Partnership C Corporation S Corporation
Mature (Joint Venture) (Venture Capital or IPO) (Lower Income Tax
Business Access Cash Flow)
Stage Four Limited Partnership Limited Liability Company C and S Corporations, LLCs
Diversification/ (Real Estate related to (Non-family management (Multiple locations, products,
Adding Entities Family business) participation in real estate) services)
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13. Lifecycle of a Family Business Enterprise
Stage One Sole Proprietorship
Inception (Ground Floor)
General Partnership Limited Partnership
Stage Two
(addition owner added) (Passive Investor Added)
Adding other
people and/or
Raising Capital
Limited Partnership / LLC S Corporation C Corporation
(Debt or Private (Debt or Private (Debt or Private Placement,
Placement Capital) Placement Capital) and Venture Capital)
Stage Three S Corporation
LLC or General Partnership C Corporation
Mature
(Joint Venture) (Venture Capital or IPO) (Lower Income Tax
Business Access Cash Flow)
Stage Four
Limited Partnership Limited Liability Company C and S Corporations, LLCs
Diversification/
(Real Estate related to (Non-family management (Multiple locations, products,
Adding Entities
Family business) participation in real estate) services)
S Corporation Family Limited Partnership Limited Liability Company
Stage Five
End Game Avoid Built In Gains Access Cash Flow Access Cash Flow
Access Cash Flow Transfer Value/Keep Control Transfer Value/Keep Control
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14. Unusual Financing Considerations
that Drive Choice of Entity
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15. Case Study #4
Beefco, Inc. is a food processor /distributor operating as an S
Corporation. They have revenue of over $500 million per year
in the sale of cut and pre-cook meat products to large fast food
franchise operations such as McDonalds, Subway & Applebys
throughout the Midwest.
They have been approached by their customers to establish
operations in North Carolina in order to provide product to
franchise operators in that area.
They may need a significant amount of capital and perhaps
some creative financing. How will the potential financing impact
the choice of entity? How might they restructure?
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16. Unusual Tax Considerations
that Drive Choice of Entity
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17. Section 1202
 Revenue Reconciliation Act of 1993
Sec 1045 Rollover of gain in Qualified Small Business Stock
— 60 days reinvestment
50% exclusion for gains of Qualified Small Business Stock
— C Corporation
— Original Issue Stock after date of enactment
Alternative Minimum Tax Implications IRC Sec 57(a)(7)
— 7% included as a preference
— Effective tax rate at 14%
 Creating Small Business Jobs Act of 2010
75% exclusion for stock acquired in 2009 and 2010
100% exclusion for stock acquired in 2011
Section 57(a)(7) would not apply in 2011
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18. Employee Stock Ownership Plans
 May only be established by Corporate Employer
S Corporation - ESOP permitted shareholder (―single‖ shareholder)
PSC ownership restricted to licensed profession = discrimination
 Designed to Invest Primarily in Employer Securities
 Ownership Substantially all Stock can be restricted
to employees and trust
Prevent competitors
 Plan can contain ―Put Option‖ to require redemption
 If Employer has a class of SEC Registered Securities, then the
ESOP must permit total participant voting of shares
Non-SEC voting only required for sale, reorganization, or liquidation,
dissolution or similar event
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19. Traditional ESOP
Corporation
Newly Contribution in lieu of Cash
Issued as pension/profit sharing
stock contribution
ESOP TRUST/ Employee
Benefit Plan
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20. Tax Benefits of ESOP
 Enhanced deduction available
25% DC Limit
Plus interest necessary to service the ESOP debt
 C Corporation may deduct ESOP portion of dividend
 S Corporation ESOP not subject to UBIT on S income
 Tax-deferred Rollover – Section 1042
Seller of C Corp Shares may rollover proceeds into tax-deferred
— Seller must have owned for 3 years
— ESOP must own 30% after transfer
— Proceeds must be invested in qualified securities (publicly traded)
Seller and Family may not be participants in the ESOP
Non-SEC voting only required for sale, reorganization, or liquidation,
dissolution or similar event
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21. Illustration of Leveraged ESOP
Stock Client
Corporation (Grantor)
Cash
Lender Newly
Issued Debt
stock
ESOP TRUST/ Employee
Benefit Plan
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22. Export Sales Opportunities
Interest Charged – Domestic International Sales
Corporation (IC-DISC)
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23. Understanding Domestic International Sales Corps
 Brief history of IC-DISC
 Requirements of an IC-DISC?
 Benefits outside of the 15% dividend?
 Categories of Gross Receipts
 Identifying Qualified Export Receipts
 How to calculate the Commission
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24. A Brief History of IC-DISC
 The IC-DISC first came about in 1984
I.R.C. Section 991 – 997.
 Unlike other exporting incentives the IC-DISC has yet to be
challenged by the World Trade Organization (WTO).
Extraterritorial Income Exclusion repealed American Jobs
Creation Act of 2004
 With the current low dividend rates the IC-DISC is now an
attractive tax saving vehicle.
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25. Requirements for an IC-DISC?
A corporation formed by a U.S. exporter/shareholder and will qualify
as an IC-DISC if:
Organization Test
— Domestic Corporation
— Formed by U.S. exporter/shareholder
— The IC-DISC does not have more than one class of stock, which the
stock must have a par or stated value of at least $2,500 on each day
of its fiscal year.
— All shareholders consent to the election to be treated as an IC-DISC.
(See Form 4876-A)
— Must maintain its own set of books and records.
— Cannot be a member of a controlling group of which a Foreign Sales
Corporation is a member.
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26. Not Required of a IC-DISC
 It is a ―paper‖ entity. It is not required to have:
Office space
Employees, or
Tangible assets
 How it works:
Exporting company forms a US corporation that elects to be an
IC-DISC by filing IRS Form 4876-A.
Exporting company pays commission to IC-DISC and deducts
the commission as an ordinary business deduction.
IC-DISC pays no tax on commission if two operational test met.
Shareholders are not taxed until earnings are distributed as
dividends.
— Deferred dividends reported on IRS Form 8404 and interest is paid.
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27. Requirements for an IC-DISC?
Operational Tests
— 95% of its gross receipts are qualified exports receipts
– I.R.C. Sec. 993(a)(1).
— 95% of the adjusted basis of its assets on the last day of its taxable
year is qualified export assets (i.e., accounts receivable, temporary
investments, export property, and loans to producers).
– I.R.C. Sec. 993(b).
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28. What are the Benefits?
 Commissions paid by export Corporation to IC-DISC
Fully deductible at regular tax rate
Not treated as taxable income by IC-DISC
Taxable to Shareholders as a dividend when paid
— Plus low rate of interest
Deduct at 35% taxed at 15% (20% Savings)
 Flexible ownership
Minors (dependents)
Parents (dependants)
Trusts, partnerships, corporation and foreign persons.
Roth IRA? (Deduct at 35% taxed at 0%)
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29. Illustration
Restaurant Supply and
Distribution Company
(S Corporation)
100% Owner
Dividend Commission
IC-DISC
(Tax Exempt C Corporation)
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30. Cooperatives & Subchapter T
(an alternative to Franchising)
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31. Cooperatives
 Two Types
Exempt cooperatives under IRC§ 501:
— § 501(c)(12) Cooperatives and Homeowners Associations
— § 501(c)(16) Cooperative Organizations to Finance Farms
— § 501(e) Cooperative Hospital Service Organizations
— § 501(f) Cooperative Service Organizations of Operating
Educational Organizations
— § 521 Farmers' Cooperative Associations
– Land O’ Lakes
Non-Exempt Cooperatives - Subchapter T of the IRC
— True Value Hardware
— Ace Hardware
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32. Non-Exempt Cooperatives
 A cooperative is a purchasing, marketing, or service enterprise
owned by and operated for the benefit of its patrons.
 Co-ops are ―Hybrid‖ tax structures
Modified Conduit entities
Operate partially like C Corporations and partial like a trust
 The taxable income of a cooperative is computed like a
corporation, except
Allowed to deduct amounts paid within eight and one-half months
after the end of the taxable year as patronage dividends
 Patronage dividends
Paid in cash or in kind (―by certificate‖)
Dividends are included in the gross income in the year of receipt.
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33. Captive Insurance Companies
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34. Captive Insurance Company
 A captive insurance company ("Captive") is an insurance
company formed by a business owner to insure the risks of
related or affiliated businesses.
 Business owner creates a Licensed Insurance Company
which offers to cover traditional risks
Property Insurance
Casualty Insurance
 Captive can also cover non-traditional risks
• Business Interruption • Loss of Key customer or supplier
• Pollution • Loss of Tenant
• Regulatory Exposure • Loss of Key Employee
• Insurance Deductibles • Breach of Contract
• Exclusions and Gaps • Natural Disasters, Terrorism
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35. Captive Insurance Company
 Business Reasons for creating a captive
Lower insurance costs
— Share in benefit of low claims
— Charge a premium that reflects loss experience
Cash Flow
— Invest premium dollars and use investment income to reduce
costs
Risk Retention
— Managing risk results in greater profit to owned captive
Access Reinsurance market
— Reinsurance is international wholesale market
— Lower cost structure = lower cost
Tax Minimization and deferral
— Self Insurance is not deductible – premiums paid to a captive are!
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36. Tax Benefits of Captive Insurance Companies
 Subchapter L requires Insurance Companies to be C
Corporations
 Section 831(b) exempts first $1.2 million of premium from
income tax
 Premiums in excess of $1.2 million can be sheltered by loss
reserves
Insurance companies operate as C Corporations
Insurance companies can deduct ―reserves‖
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37. IRS Required Elements for Insurance Companies
 A Captive must provide
Risk Shifting and
Risk Distribution
 “Risk Shifting” is the actual transfer of Risk from the insured
to the Captive Insurance Company
 “Risk Distribution” is the Captives exposure to adequate third-
party risk to obtain the risk-pooling effect had by traditional
insurance companies.
Reduce the possibility that a single claim will exceed premiums
received.
Generally, 12 insured's are sufficient (even if subsidiaries, so
long as they are not disregarded entities)
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38. Illustration
Family Owed Captive
Client
(Grantor)
Irrevocable Trust for benefit
of Client’s Family
100% Owner
Restaurant A
100% Owner S Corporation
Captive Insurance Company
C Corporation Restaurant B
S Corporation
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