Vajtay and Broderick Business Planning Spring 2014
· Choice of Entity
o When person says they wanna form biz, need to ask what kind (sole proprietier, llc, corp)
o Once you’ve chosen one form, very difficult to chose another form. If try to form new one, gov takes a lot of taxes out
· Form
o One of most common is general partnership
§ Governing law- Revised Uniform Partnership Act, which is state law
§ How formed- can be formed by default. Formed by action of parties. Or by entering into a written agreement. This is unique, cuz there is no public filing necessary
§ Ownership Interests- partnership interest
§ Governance- by agreement. Basically can agree to any type of governance that you want. Can also be governed pursuant to default rules of RUPA
§ Liability of Owners- unlimited. Not limited to what was invested. Joint and several. Ex: if company sued for 1mil, and you are 50% owner, if ur partner cant pay, you are liable for entire 1mil. Also have subrogation rights against non-contributing partners (sue for the other partners contribution)
§ Tax Treatment- pass through
· Notes:
o Partnerships have a lot of defeacts, such as liability, no public filings
o Not used often. Ex of when could be formed- if IBM and Google work together. Both companies form a subsidiary, that subsidiary is an LLC. Then those subsidiaries enter into a general partnership. By using subsidiaries, you get around the issue of liability. A lot of time these are called joint ventures
o Limited Partnership (hedge funds use these)
§ Governing law- RULPA (Revised Uniform Limited Partnership Act), with individual state variations. DE has favorable law
§ How formed- need to file with state a certificate of limited partnership, which must be filed with state. If don’t make this filing, you don’t have an LP. Now you only need minimal information, such as name and address of partners, where to serve service of process. Once u create legal entity in particular state, so if u do business in NY, u need to file to qualify to do business in that state.
· Also need a limited Partnership Agreement- this contains business terms you have with other partners, capital contributions, buy outs, ect. You want these to be private. Where as the certificate is more barebones, kept private.
§ Ownership Interest- One is limited partner, other is general partner. Each different partner has different liability
§ Liability of owners- general partner has unlimited liability. Same as other partnership. If a limited partner, limited to their interest in the LP. One exception is “fraudulent transfer”- when company was solvent, and transfers to partners, in detriment of creditors. Ct can order the partners to put that money back into partnership. Other exception is capital contribution commitment- the investors sign a legally binding doc that says when find investment, you agree to stand by and write a check. Usually seen when have investment fund, and limited partners only pay small amount upfront, and then over time pay more money to fund for investment in future.
· Most sophisticated LP’s will have these types of exceptions
· General Partner- general partner may be a corporation or LLC that is insulated from liability. GP doesn’t need to be a real person. ALWAYS an entity with limited liability
o Usually see a general partner contributing a small amount of value (capital entity contributed)- want fewest amount of assets available n the GP. There’s some tax reasons GP needs to put money in.
· No natural person has unlimited liability, but need to form 2 entities instead of one.
· Creditors have no protection.
§ Governance- governance must be by the general partner. The LPs participate in management, they are considered GP’s with unlimited liability
· LPs can vote on anything
o Corporation
§ Governing law- state corporation law. Each state has indiv nuances. Law of corporations varies a lot from different states, not like the uniform law
· Model business associations act- this is more academic
§ How formed- file a certificate of incorporation. File petition with the state. Nj is only state you don’t file with secretary of state, you file with dept of treasury.
· Substantive document
· Need to put in form what kind of stock you are authorized to issue, and also how much (authorized stock)
· Need a definite number of shares
· File what the rights of classes and series are
· All the information is public, which could be a disadvantage
§ Ownership interest- capital stock (shares)
· Classes of stock
o Common
o Preferred
§ Series A
§ Governed
· Stock holders vote, elect board; then,
o Usually founders of company, investors
· Board of directors; then,
· Officers- CEO
o In US, these usually work bottom up- someone becomes CEO, they have big role in picking people to be nominated for board of directors
§ Liability of Owner
· Liability of share holder is limited, limited to invested capital
o No additional contribution obligation
§ Governing documents
· Certificate of incorporation (COI)
· Bylaws- typically covers how board is nominate and elected, notice for meetings, routine things. Usually routine, but necessary
o Unless it’s a public company, this document is private
· Shareholders agreement- every small company should have shareholders agreement
o These are private agreements, between shareholder and company. They look a lot like partnership agreements
§ Tax Treatment
· Taxpayer itself. Pay income taxes. Different from every other company we’ll study. These are subchapter C corporations
· Other type of corp can be pass through- subchapter S
o How you are taxed, in termed of meeting C or S is entirely a federal law issue, not a state law. State law looks at just forming a corp, then the C and S part is fed law for tax purposes.
o Limited Liability Company (LLC)
§ Governing law- state LLC Act, most are uniform
· NJ adopted new Act in 2013, its modern and up to date.
§ How formed
· File certificate of formation with secretary of state
o This is a simple, one page doc
§ Ownership interest
· Membership interest
o Can have different classes
o Different series
o They look like the rights that stock holders have in a corporation
o Almost complete freedom to define the interest
o Membership interest are usually called units or shares
§ Governance
· Different alternatives:
o Member managed
o Appoint a managing member (a person who is better equipped to manage, more like a general partner)
o Board of managers
§ Liability of owners
· Limited to invested capital
· May have additional contribution obligation
o Ex is there is litigation with the company, members may ha
he asset
o (this has important business planning consequences)
· basis can go down if depreciate the asset
o depreciate is designed to allow the entrepreneur to recover the cost of asset over what is deemed to be their useful lives.
o Dep example: If something was bought in 1944, and has a 10 yr useful life, you could record an expense of 100K if it was worth 1M
§ Tax shelter ex:
· Back in 80s people trying to get deductions to not pay as much tax
· Tax L’s recommend setting up Limited Partnership, 4 people put in $25
· This caused banks to fail
Class 5
· Only worry about 2 types of tax payers cuz the entities we worry about in this class are pass through entities, meaning the entity doesn’t pay tax, the entity allocates the tax and the indiv pays.
o We worry about C corp and indiv for tax purposes
· Capital asset- any asst of a business. Look at the basis, and any increase or loss is the capital gain/loss. The debt is included in the basis when u purchase the asset (ex: if buy house, basis includes the mortgage)
· Basis is so important because of depreciation
· When set up corp, 3 indiv put capital into it, and each take 10 shares of stock, the shares are considered capital assets
· Ordinary income
o All other income not capital gain
o Examples of business ordinary income:
§ Inventory; money recognized by sale of inventory (real estate, equipment)
§ Interest income
§ Cancellation of indebtedness
§ Compensation
§ Royalties- money paid to use or access intellectual property
§ Dividend* (generally are ordinary income)
· Federal Income tax purposes
o Individual Tax Rate
§ Ordinary Income- 39.6%
· State is 8.9%
§ Short Term Capital Gains- 39.6%
· State is 8.9%
§ Long Term Capital Gain- 20% (used to be 15%)
· State is 8.9
· 90% of tax planning is the for indiv to pay the 20% long term cap gain instead of the 40% ordinary income
o C Corporation Tax Rate
§ Ordinary Income- 35%
· State is 9%
§ Short Term Capital Gain- 35%
· State is 9%
§ Long Term Capital Gain- 35%
· State is 9%
· There’s a big difference in how indiv and c corps are treated in the gain of a long term capital asset
· No difference in how long a corp holds a cap gain
· There is a difference in the diff of ord tax rate of indiv and corp. when planning, this may tell you why you would want to hold onto money.
o Ex; one biz is an LLC with 3 owners (own 33% partnership int), one is a C Corp with 3 owners (own 10 shares of common stock). Each entity has 100 dollars of taxable income. The owners of LLC, will be taxed at 39.6 percent. The C corp will pay tax of 35% or $35.
