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Blogging from Heckerling 2018: Post One

Jan 24, 2018

Starting off on the right foot while avoiding foot faults -- Issues at the formation of a closely-held business

Several EisnerAmper professionals are attending the 52nd annual Heckerling Institute on Estate Planning in Orlando, Florida this week. The Institute is the leading educational program in estate planning in the country, with record breaking attendance. 

The Institute is focusing on the 2017 Tax Cuts and Jobs Act and how it will impact estate planning, income tax planning, retirement planning, charitable giving, and business succession planning. Our EisnerAmper professionals are blogging in real time on topics of interest discussed at this year’s proceedings; here’s the first of our posts.

As we determine the correct entity to use based on the individual circumstances of the business, this discussion addressed entity issues other than tax consequences for use as we determine the correct entity to use based on the individual circumstances of the business. (The Tax Cuts and Jobs Act will cause a lot of the conversation related to the following to be reconsidered within the next few months.)

The speakers (Sam Donaldson of the Georgia State University College of Law, Stephanie Loomis-Price of Winstead P.C., and Ivan Taback of Skadden, Arps, Slate, Meagher & Flom LLP) stated that the number one concern of clients coming in looking to set up a new business is personal liability.   While the simplest entity type to set up is the sole proprietorship (no registration or documentation needed), it provides the lowest level of personal protection.  The owner has personal liability for the debt of the business and creditors can easily come after the owner’s personal assets if the business cannot pay its debts. 

It has always been assumed that a C corporation provides the greatest personal liability protection. However, the mere fact that an entity is a C corporation does not guarantee protection. The C corporation needs to have by-laws, shareholder agreements, recorded minutes to meetings, etc. -- and these rules must be followed.  There must be clear lines of delineation between the shareholder and the C corporation.  Should there be a lawsuit down the road, and it can be determined you really did not follow these by-laws and did not act as a corporation, shareholders can have personal liability, as the courts will say the entity did not act as a C corporation.

C corporations have the added benefit of allowing two or more classes of stock, something that is not allowed in an S Corporation. If the shareholders need common and preferred stock, the entity needs to be a C corporation.  In addition, IRC Sec. 1202 (Small Business Stock) applies only to C Corp stock.  The gain exclusion allowed under IRC Sec. 1202 is certainly a better way to attract new investors for a company meeting the 1202 requirements.  (As a planning note – like-kind exchanges of Section 1202 stock did survive tax reform; however, IRC Sec. 1031 exchanges are only allowed for real estate post-2017.)

Partnerships come in a few shapes and sizes.  General partnerships (“GPs”) are automatically created when two or more individuals have an idea and go into business.  These partners have personal liability for the partnership, so their personal assets are at risk.  Because of this, a GP is really not a good idea unless there is very little risk of liability and the partners do not want the expense or complications of other entity types.  Limited partnerships will have one partner with unlimited liability but the other limited partners’ risk will be limited to their contribution to the partnership.  However, again: Partners need to be sure they clearly delineate between their personal and partnership activities and do not allow limited partners to participate in management.  Failure to do so could expose personal assets if there is a lawsuit, because the rules of the limited liability partnership had not been adhered to.

Limited liability companies (“LLCs”) are the most prevalent new entity type at this time.  It provides a strong level of protection for personal assets. A single member LLC would not require a separate filing but would be included on the taxpayer’s schedule C of form 1040.  Again the owner needs to adhere to the by-laws of the LLC.  Failure to do so will pierce the corporate veil and expose personal asset to risk. 

Tax reform will be adding a new wrinkle into the mix.  The reduced corporate rates need to be compare to the new IRC Sec. 199A deduction of a partnership or S corporation to determine the best tax result.  Regardless of what you call the entity, the corporate or partnership rules need to be followed to protect the personal assets of the investors.

 Blogging from Heckerling 2018

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Barbara Taibi

Barbara Taibi is a Partner in the Private Client Services Group with years of public accounting and income tax planning and tax return preparation experience. Barbara focuses on helping clients plan for and meet their financial and tax goals.

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