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345829246_a7434a76dc_z.jpgElecting "subchapter S" status has many benefits for a corporation and its shareholders, although it is subject to certain limitations on the number and type of shareholders. If a corporation's S status is revoked, it may be able to make the election again at a later date, but that raises the question of whether tax benefits available to shareholders during the original subchapter S election are still available. The Office of Chief Counsel for the Internal Revenue Service (IRS) recently issued a memorandum on this question with regard to corporate earnings for which shareholders paid income tax, but that they did not receive as dividends. IRS regulations assign a special account for these funds and allow shareholders to withdraw them tax-free in later tax years. The account does not, however, survive the revocation of subchapter S status, meaning that shareholders lose tax-free access to those funds.

Shareholders of S corporations pay taxes on corporate income, similar to partnership taxation. They are responsible for paying income tax on their pro rata share of corporate income even if they do not receive dividends during that tax year. The IRS allows S corporation shareholders to withdraw dividends for previous tax years without incurring additional tax liability, since that money was already taxed. IRS regulations define an "accumulated adjustments account" (AAA) as containing the amount of corporate earnings taxed to shareholders but not yet paid out to them. 26 U.S.C. §§ 1366(a)(1), 1368(e)(1); 26 C.F.R. § 1.1368-2. The account is not apportioned among the shareholders.

The question presented to the IRS was whether an S corporation's AAA survived "beyond the post-termination transition period into a subsequent S period." In Memorandum No. 201446021 (PDF file) ("IRS Memo"), issued on November 14, 2014, the IRS concluded that the AAA does not survive this transition.

Continue reading "Converting an S Corporation to a C Corporation Eliminates Certain Tax Benefits, According to the IRS, Even If the Corporation Converts Back to S Status" »

Analyzing_Financial_Data_(5099605109).jpgFund transfers between business subsidiaries could be considered interest-generating loans under New Jersey tax law, according to a series of court cases culminating in a decision by the New Jersey Supreme Court. The shipping company United Parcel Service (UPS) appealed the assessment of late fees and penalties against five of its subsidiaries by the New Jersey Division of Taxation (NJDOT). The New Jersey Tax Court affirmed the NJDOT's findings regarding imputation of interest income, but it held that the late fees and penalties were in error. UPS v. Dir., Div. of Taxation ("UPS I"), 25 N.J. Tax 1 (2009). The Superior Court, Appellate Division and the Supreme Court of New Jersey affirmed the Tax Court's ruling. UPS v. Dir., Div. of Taxation ("UPS II"), 61 A.3d 160 (N.J. App. Div. 2013); UPS v. Dir., Div. of Taxation ("UPS III"), No. A-16/17, Sep. Term 2013 072421, opinion (N.J., Dec. 4, 2014).

The plaintiffs belonged to two groups of UPS subsidiaries: a group consisting of "internal service companies" that support other subsidiaries, and a group of companies "that transported packages and documents." UPS I, 25 N.J. Tax at 11. The UPS parent company maintained a "cash management system" for its subsidiaries that involved transferring all cash received by the subsidiaries into a bank account maintained by the parent company on a daily basis. Id. at 14-15.

The NJDOT treated these transfers as loans from the subsidiaries to the parent company and imputed interest income to the subsidiaries that was not reported. It assessed late payment penalties and five-percent amnesty penalties, N.J. Rev. Stat. §§ 54:53-17, 54:53-18, against the subsidiaries. UPS appealed these actions.

Continue reading "Transfers of Funds Between Businesses with Common Ownership May Be Deemed Loans under New Jersey Tax Law" »

Dr_Martens,_black,_old.jpgNew York and New Jersey laws provide a wide range of options regarding the organization and structure of businesses, with recognition that the needs of a small, one- or two-person operation are likely to be substantially different from those of a much larger business. Businesses with no formalized legal structure are known as sole proprietorships if they have only one owner, and general partnerships if they have two or more. An informal business structure works for many business owners, but the business entities defined by state law have certain benefits that everyone should consider. Converting a business from a sole proprietorship to a limited liability company (LLC) can be an effective way for a business owner to protect both the business and themselves.

Sole Proprietorship vs. LLC

Operating a business as a sole proprietorship may offer some advantages:

- Simplicity: There is no need to file any specific paperwork with the state to maintain the business, aside from an assumed business name, also known as a "DBA."

- Only one tax return: A sole proprietorship, unlike a corporation, does not file its own tax return. The business owner includes business income and expenses in a schedule attached to his or her personal return.

These possible advantages, however, come with some distinct disadvantages:

- The owner of a sole proprietorship is personally liable for any and all business debts.

- Similarly, business assets are susceptible to claims against the owner as an individual.

- A sole proprietor must keep meticulous records distinguishing personal and business assets, debts, and expenses.

Continue reading "Converting a New York or New Jersey Sole Proprietorship to an LLC" »

295128_6656.jpgA business may decide to sell all or a substantial amount of its business assets to another individual or company for a variety of reasons. These types of transactions are known as "bulk sales" if they are not part of ordinary business activities. Both New York and New Jersey require businesses that collect sales tax to disclose a planned bulk sale to state tax authorities. This disclosure is the purchaser's obligation, since the purpose is to allow the state to determine the seller's tax liability. If the purchaser does not make the required disclosures, it could become liable for the seller's outstanding tax debt to the state. The disclosure process is not terribly complicated, but it appears to be one that many businesses forget in the course of purchasing another business' assets.

What Is a "Bulk Sale"?

Any sale of business assets that is not part of the normal course of business could qualify as a bulk sale under state law. A bulk sale may occur if a company is going out of business, upgrading its equipment, or making significant changes in its business activities. Bulk sales may also occur in mergers or acquisitions, or if a business is converting from a sole proprietorship to a corporation or other business entity.

"Business assets" include any assets used in the course of business, including:
- Personal property, such as computers, office furniture, and inventory;
- Intellectual property, including patents, trademarks, and trade secrets;
- Certain types of real property; and
- Intangible assets, like business goodwill.

Continue reading "New Jersey and New York Require Notice Before Bulk Sales of Business Assets" »

BurgerKingFood.jpg"Corporate inversion," the process by which a corporation merges with a foreign corporation and relocates its headquarters to the foreign company's home country, has received a considerable amount of attention in recent months. It is often expressly intended to reduce a corporation's tax burden by moving the company to a country with lower corporate taxes, while still maintaining physical operations in the U.S. The White House and others have criticized the practice, and corporations are lobbying against laws that would restrict it. The Internal Revenue Code (IRC) already contains "anti-inversion" provisions, and a recent notice from the Department of the Treasury (DOT) states that new Internal Revenue Service (IRS) regulations will enhance the scrutiny of foreign mergers.

Section 7874 of the IRC, 26 U.S.C. § 7874, seeks to regulate corporate inversions. It applies to any U.S. corporation that transfers its headquarters and other assets overseas through a merger with a foreign corporation after March 4, 2003. The merged foreign corporation is subject to the same tax treatment as a domestic corporation if 80 percent of its stock is held by the U.S. company's former shareholders, and it does not have "substantial business activities" in its home country. Id. at §§ 7874(a)(2), (b). If the merged foreign corporation has 60 percent of its shareholders in common with its domestic predecessor, the IRS designates it as a "surrogate foreign corporation" and applies U.S. tax rates to the amount of its inversion gain. Id. at §§ 7874(a)(1)-(2).

Several U.S. corporations have announced inversion plans in 2014. While some of them decided not to follow through after public opinion turned against them, other deals are still in the works. The U.S. pharmaceutical company Pfizer abandoned a bid to acquire the British company AstraZeneca, and the pharmacy chain Walgreens decided not to reorganize in Switzerland after merging with that country's Alliance Boots. The fast-food chain Burger King, however, is reportedly still in the process of acquiring Tim Hortons and reorganizing in Canada.

Continue reading "Treasury Department Issues New Guidance for Corporations that Transfer Operations Abroad to Reduce Tax Liability" »

US_Corporateation_Income_Tax_Return_2011_form_1120.jpgThe minority shareholder of an S corporation appealed a ruling of the Internal Revenue Service (IRS), which held him liable for tax on his pro rata share of the corporation's income, to the U.S. Tax Court. He argued that he was not the "beneficial owner" of the shares and therefore should not be liable for the tax because he had been shut out of management and received no distributions from the corporation. Kumar v. Commissioner of Internal Revenue, T.C. Memo 2013-184 (2013). The Tax Court rejected his argument, finding that the liability of an S corporation shareholder for federal income tax on the corporation's earnings is not dependent on factors like management authority or actual receipt of distributions or other income. This should serve as a reminder for all S corporations to maintain shareholder agreements that provide for distribution of income in minimum amounts sufficient to cover taxes.

A subchapter S corporation avoids the "double taxation" found in corporations covered by subchapter C of the Internal Revenue Code, in which the corporation first pays tax on its income, and the shareholders then pay tax on dividends they receive. S corporations do not pay federal income tax. 26 U.S.C. § 1363(a). Instead, income and losses "pass through" directly to the shareholders, who pay taxes on income and deduct losses in proportion to their number of shares on their personal tax returns.

The petitioner in Kumar owned 40 percent of Port St. Lucie Ventures, Inc. (PSLV), a Florida medical practice organized as an S corporation. A dispute arose between him and his business partners in 2004. Around the same time, the majority shareholder of PSLV allegedly shut the petitioner out of the management of the company. The petitioner did not receive any wages or distributions from PSLV for 2005 or any subsequent year. He did, however, receive a Schedule K-1 from the corporation for the 2005 tax year, which reported his share of the corporation's taxable income as $215,920 and his share of interest income as $2,344.

Continue reading "S Corporation Shareholder Excluded from Management and Salary Still Faces Tax Liability" »

1QPS.pngLawmakers often use state and federal tax laws to encourage certain types of business activity, or to discourage activities in lieu of banning them. Tax breaks often serve as incentives to investors and entrepreneurs to focus on a particular industry or market. Bills pending in the U.S. Congress and the New Jersey Legislature propose various tax incentives for businesses, including technology investments, infrastructure development, and hurricane relief. Supporters of these bills hope to promote job creation by spurring business activity. Critics contend, however, that similar New Jersey incentives have not had the desired impact on job creation in the past. New Jersey and New York businesses should be aware of pending legislation in order to take advantage of any tax breaks or tax incentives that might benefit them.

On April 9, 2013, a Democratic lawmaker from Maryland introduced H.R. 1415, the Innovative Technologies Investment Incentive Act of 2013 (ITIIA), in the U.S. House of Representatives. The bill would allow a tax credit for qualified investments in "high technology and biotechnology business concerns," H.R. 1415 § 2 (113th Cong.), equal to twenty-five percent of the investment amount. This would be a direct credit against the amount of tax owed by the investor, as opposed to a deduction from the investor's total taxable income. The total amount of the credit would be subject to a nationwide limit of $500 million per year, and the Small Business Administration (SBA) would be responsible for allocating credits among qualified investors. To qualify for the credit, the investment must be a stock purchase or other capital investment in a high-tech or biotechnology business with less than five hundred employees. Investors must hold onto their investments for at least three years. The purpose of the bill is to encourage investment in technology and biotechnology companies, which in turn will hopefully promote innovation and job creation.

Continue reading "Proposed State and Federal Legislation Offers Tax Incentives for Technology Investment, Job Creation, and More" »

file0001476330609.jpgJust as new businesses start every day, some businesses must cease activities, wind up their affairs, and dissolve. This can occur for any number of reasons, including bankruptcy or the decision of the owners to stop doing business. Any New Jersey business that must wind up and dissolve must follow procedures established by state law, which include notification of creditors, payment of debts, and disposition of other assets.

Reasons for Winding Up a New Jersey Business

Businesses may wind up voluntarily or involuntarily. An involuntary dissolution usually results from bankruptcy or a court order in some other legal matter. A court-appointed trustee may handle the dissolution of a business in a Chapter 7 or Chapter 11 bankruptcy case, but in other situations, the management of a business must handle the winding up process itself. Court-ordered dissolutions in non-bankruptcy cases are rare, but might occur in a dispute between partners in a joint venture or some other single- or limited-purpose business entity.

Shareholder or partnership agreements may include provisions for mandatory dissolution if certain events occur. Voluntary dissolution usually results from a decision by the business' owners, made according to the procedures established in a shareholder agreement, partnership agreement, or other management agreement.

Continue reading "Winding Up and Dissolving a New Jersey Business" »

800px-New_York_Harbor.jpgThe New Jersey Legislature passed sweeping reforms of the laws governing limited liability companies (LLC) in September 2012. The changes to the Limited Liability Company Act will take effect in March 2013, affecting newly-formed companies immediately. LLCs already in existence will continue to be governed by current LLC law until March 2014, when the new law becomes applicable to all LLCs in the state. The new law represents a major departure from current law, which is based on Delaware's LLC laws. The Revised Uniform Limited Liability Company Act (RULLCA) forms the basis for the new law.

The new law began in the Assembly as AB 1542, where the RULLCA was introduced in January 2012. The Assembly passed it on May 24, 2012 by a vote of 77 to 1. The Senate passed a counterpart, SB 742, on June 21, 38 to 0. The Governor signed it into law as P.L. 2012 on September 19.

The RULLCA is the work of the National Conference of Commissioners on Uniform State Laws, commonly known as the Uniform Law Commission (ULC). The ULC prepares model statutes for a variety of purposes and proposes them to state legislatures in an effort to develop a standardized set of laws. It first developed the RULLCA in 1996, when LLCs were still a relatively new idea, and modified it in 2006. The New Jersey law is largely based on the 2006 version.

Continue reading "New Limited Liability Company Act to Take Effect in New Jersey in 2013" »

1277560_99475835.jpgA New Jersey organization representing more than one thousand small business owners rallied outside the Statehouse in Trenton recently to advocate for a state health insurance exchange (HIX). The Legislature passed a bill that would have created a New Jersey HIX in early 2012. Governor Chris Christie vetoed the bill in May, citing the pending decision from the U.S. Supreme Court regarding the constitutionality of the Affordable Care Act (ACA), commonly known as "Obamacare." Governor Christie stated that, until the Supreme Court ruled on the ACA, the New Jersey law's constitutionality was similarly up in the air. Since the Supreme Court upheld most of the ACA in June, many small business leaders want him to approve a HIX for the state.

The ACA requires states to create HIXs in order to assist people in obtaining health insurance coverage for the themselves or their families. States have until November 16, 2012 to enact their own state-run HIXs. After that date, the federal government will operate the HIX for the state. So far, eleven state legislatures have created HIXs, and three governors have created them by executive order.

Consumers and small businesses can use HIXs to compare and contrast private health insurance plans, and to learn about tax credits and other benefits. The federal government has made grants available to the states to facilitate the establishment of HIXs. According to the U.S. Department of Health and Human Services (HHS), New Jersey has received two grants: a $1 million "State Planning Grant" in 2010 and a $7.6 million "Level One Grant" in 2011. State HIXs are expected to go online, sometimes literally, in 2014, when many of the provisions of the ACA take effect.

Continue reading "New Jersey Small Business Owners Urge State to Pass Health Insurance Exchange Law" »

369109_6448.jpgA decision from the New York Tax Appeals Tribunal illustrates the importance of clearly and carefully documenting business transactions, even when those transactions are between family members. The case, Matter of Ultimat Security, Inc., involved an attempt by the New York Division of Taxation (DOT) to hold a company liable for sales tax owed by the company whose assets it acquired. The original business and its successor were owned by a son and his mother, respectively, and they contended that the asset transfer was not a "bulk sale" subject to tax liability. The courts disagreed and held the successor business liable for the full tax bill.

From November 2000 to May 2007, Tim Butler owned and operated Ultimate Security, Inc., a Hempstead-based provider of residential and commercial security guard services. The company employed Butler's mother, Vera Drayton, as an office administrator. Drayton reportedly wanted to start her own business, and Butler approached her about taking over his company. Drayton created a new business entity, Ultimat Security, Inc. During May 2007, Ultimate Security transferred its business assets, which consisted of a customer list, office equipment, equipment for security guards, and other personal property, to Ultimat Security. Neither the two companies nor Butler and Drayton signed a sales contract, nor did any consideration change hands.

New York state law requires the purchaser in a "bulk sale" of assets to file a notification with the DOT, which Ultimat did not do. The DOT requested information about the bulk sale from Ultimat in December 2007, and received a reply denying that the transfer of asset constituted a bulk sale. In January 2008, the DOT notified Ultimat of a possible claim for sales taxes owed by Ultimate. The DOT concluded that the transfer was a bulk sale because of, among other factors, the relationship between Butler and Drayton, the commonality of the companies' customer and employee lists, the similarity of the company names, and the lack of documentation filed by Ultimat upon the commencement of its business operations. The agency issued a Notice of Determination that February holding Ultimat liable for tax assessments against Ultimate, totaling almost $350,000.

Continue reading "New York Tax Court Rules that Business is Liable for Full Sales Tax Bill after Transfer of Business Assets" »

1375057_40170684.jpgStartup businesses in New York and New Jersey always begin with enthusiasm and excitement. A new business is an opportunity to create and explore, but also requires careful planning and attention. Certain risks, if not managed effectively, can sink a new business before it has a chance to succeed. Here are five errors that new businesses often make, and tips on how to avoid them.

1. The Wrong Business Entity. Identifying the right type of business organization is critical to a company's success. Owners must consider how they want business income to be taxed, and how they want to handle the liabilities of the business. Corporations, limited liability companies (LLCs), and partnerships each offer unique advantages. "C" corporations and "S" corporations offer similar liability protections, but different tax advantages. Partnerships offer tax benefits in some circumstances, as well as flexibility in the company's governance. LLCs offer a great deal of flexibility, but may not be right for fast-growing companies.

2. Insufficient Planning and Agreement Among Owners. Business owners must consider not only how to start their business, but also how they plan to either end or exit it. They must plan for contingencies, like the early departure or death of an owner, with regard to how the company will handle that owner's equity share. Any promises or contingent offers regarding additional stock or equity should be in writing. Agreement among owners at the start of the business is no guarantee of continued harmony.

Continue reading "Five Common Mistakes New York and New Jersey Startup Businesses Make" »

1109016_48841117_03012012.jpgA proposal from the Obama administration to reduce the federal corporate tax rate has not generated as much enthusiasm among small business owners as might be expected. Small business advocates claim that the proposed reduction, while seemingly beneficial at first glance, would actually only help a small percentage of companies. The proposed reduction would lower the top corporate tax rate from thirty-five to twenty-eight percent. For manufacturers, the rate would top out at twenty-five percent. The problem is that the proposed reduction only applies to C corporations, the corporate structure used by most large businesses and very few small ones.

According to the Associated Press, only twenty-five percent of small businesses use the C corporation structure. Other small businesses are organized as S corporations, limited liability companies (LLC's), partnerships, or sole proprietorships. The primary difference between a C corporation and a S corporation is the way in which they pay taxes. C corporations pay federal income taxes on net revenues, and shareholders pay taxes on dividends received from the corporation. This is sometimes known as "double taxation," since the corporation and the shareholders both pay income tax on what is essentially the same money. In a S corporation, income "passes through" to the shareholders, who pay the income tax. Tax laws set specific restrictions on who can be a shareholder in a S corporation, and the total number of shareholders is capped.

Other types of businesses, like LLC's and partnerships, also usually do "pass-through" taxation, although they may sometimes opt to pay tax like a C Corporation. Sole proprietorships are typically just a legal alter ego for the business owner, so taxes are paid through the individual's tax return. According to the National Small Business Association, up to eighty-three percent of small businesses pay taxes at the level of the owner's personal income.

While larger corporations may see a reduction in their taxes, small businesses may not see any change, or may even see an increase in some circumstances. The Wall Street Journal reports that people with total income of more than $250,000 per year will see an increase in their personal tax rates if the Bush tax cuts expire on schedule at the end of 2012. This would have the effect of raising the tax rate on small businesses whose taxes are tied to their owners. Several small business advocates quoted by the Wall Street Journal promote reducing the personal income tax rate along with the corporate rate in order to more effectively help small businesses and the self-employed.

Continue reading "Proposed Reduction in Corporate Tax Rate May Not Benefit Many New York Small Businesses" »

701013_11155185_02172012.jpgThe Wage Theft Prevention Act (WTPA), which passed the New York Legislature in 2010 and took effect in April 2011, requires New York employers to provide annual notices to their employees detailing their total wages and providing the identifying information of the employer. The WTPA is intended to help workers assert their rights by ensuring they have all the information they would need to make a wage claim if they believe their employer has violated New York labor laws. It applies to all private sector employers, regardless of size. The WTPA has generated controversy among business owners, and has even led some of its original sponsors to say it should be modified.

The law requires extensive reporting of wage amounts, withholding of income and payroll taxes, and other benefits for every employee. For many small businesses, this can be quite an onerous task. Some business leaders quoted by Buffalo's WGRZ News describe the law as "government overstepping its bounds and being a problem for the private sector." Some state legislators already have plans to try to repeal all or part of the law. One state senator noted that the information required by the law is available to the Department of Labor on demand already if they initiate an investigation of an employer.

The WTPA requires employers to keep reports on file for six years. It also requires employers to provide notices to employees in the employee's "primary language." The Department of Labor has produced template forms in Chinese, Creole, English, Korean, Polish, Russian, and Spanish. Penalties for failing to provide notices in a timely manner can be as high as $50 to $100 per employee per week.

A Democratic state senator who sponsored the bill in 2010 has stated that she believes the law should be "tweaked." For example, she says that employers who provide weekly or bi-weekly pay stubs, which generally contain income and withholding information, should not be required to file annual notices as well. The purpose of the law, she told WGRZ, was to help the Department of Labor investigate and penalize employers who bilk employees out of wages or skip out on payroll taxes. Put another way, the WTPA was intended to catch "bad employers," not add burdens to good employers.

Continue reading "New York Employers Must Verify Their Employees' Salaries Under 2010 Law" »

534981_64316266_02042012.jpgTechnology has given businesses many different ways to collect payments from their customers, to the point that cash makes up only a portion of revenue for some businesses, and others do not receive cash at all. Credit card payments form a large part of how businesses collect payments, both through merchant accounts and services like PayPal. The fees associated with such payment methods are often more than worth the convenience they offer. Small businesses accepting credit cards through merchant accounts, in which a financial institution pays the business the amount of a transaction minus a small percentage, should know of recent legislation that may impose some reporting requirements on them come tax time.

The Housing Assistance Tax Act of 2008 became law in June 2008, primarily as a means of addressing the subprime mortgage crisis that had begun the previous year. The law mainly affects banks and other financial institutions that engage in mortgage lending, authorizing the Federal Housing Administration to guarantee certain fixed-rate mortgages and allowing states to refinance subprime mortgage loans. The financial crisis of late 2008 had a significant impact on Fannie Mae and Freddie Mac, two intended beneficiaries of the law, but certain provisions of the law have an impact even outside of the real estate sphere.

According to regulations from the Internal Revenue Service (IRS) that took effect in 2011, "payment settlement entities" must report payments made to merchants for credit card and other third-party credit transactions. "Payment settlement entities" are defined as banks and other financial companies that receive and process credit card, debit card, and other credit-based transactions for businesses (or "merchants.") This does not impose any additional tax liability, but rather requires reporting by these payment settlement entities of the amounts they pay to merchants, which could be companies of any size or even individuals who accept credit cards as part of their business activities. These reports are included in a Form 1099-K issued by payment settlement entities at the end of each calendar (or fiscal) year.

The important consideration for companies that accept credit card payments is this: reports by payment settlement entities do not include any credits, offsets, discounts, refunds, or other modifications made by the merchant for the customer. This means that the amount stated by the payment settlement entity on the 1099-K might not match the amount of income reported by the merchant to the IRS. The merchant then has the responsibility of accounting for the difference in the corporate or partnership tax returns or Schedule C of a personal 1040 form.

Continue reading "Federal Tax Law May Impose New Reporting Requirements on Any Business Accepting Credit Cards" »