FINAL REVIEW Flashcards
Reasonable Salary & Bonuses
deductible to corp, taxable to employee
Paying unusually large salaries to business owners is NOT considered an appropriate adjustment to earnings (disguised dividends which would NOT be deductible)
Owner/Executive/Key Person Additional Compensation Plans
Cash bonus plans are not subject to nondiscrimination rules generally applicable to other benefits
Equity split dollar life insurance plans generally pay a DB to the ER equal to the lesser of the ER’s premium contributions or the policy’s cash value
Reasonable Accumulated Earnings
Earnings in a corp can be accumulated at reasonable levels for business purposes, meaning taxation to the owners can be deferred
The accumulated earnings tax (beyond minimum credit) does not automatically subject a business to excess earnings if they can prove a valid and acceptable business reason
LLCs Operating Agreement
LLCs (limited liability companies) organized under state law and must have an operating agreement in writing
Avoiding Estate Tax on Section 162 Plan
Estate tax inclusion of an ER provided life insurance sec. 162 plan can be avoided if an irrevocable trust is the applicant, owner, and beneficiary of the policy
Math: Sec. 162 Double Bonus or Zero Tax Calculation
Taxable bonus divided by 1 minus EE tax rate
Partnership Liquidation with NO Buy/Sell Agreement
a deceased partner’s heirs can force the partnership to liquidate
Surviving partner(s) becomes liquidating trustee(s); they may not seek new business from existing customers; MUST account for all partnership profits
Two Partner General Partnership
an equally owned two-partnership GP does not mean that all partnership assets are owned 50% each; but it does mean that at the death of a partner, the other partner becomes a liquidating trustee
Value of Deceased Partner’s Interest for Estate Tax
in establishing the value of a deceased partner’s interest for federal estate tax purposes under a buy/sell agreement w/ unrelated partners, the agreement should contain a first offer option during lifetime to prevent a lifetime sale above the buy/sell price at death
Stock Attribution Rules
Shares of stock in a partnership are considered as being owned proportionately by the owners
Shares of stock owned by an estate are considered being owned by a beneficiary w/ a 100% direct present interest in the estate
S Corporation (Miscellaneous)
S corp shares may be transferred to family members who are not actively involved in the business
A voting trust can be an S corp shareholder
Premiums for life insurance funding in an S corp stock redemption plan are paid out of the taxable income of the S corp
T or F: The estate and the beneficiaries can take advantage of a Sec. 303 stock redemption
True
Section 303 Stock Redemption
Allows corp to purchase stock w/out any adverse income tax effect to cover federal estate taxes, state estate or inheritance taxes, and funeral costs
Does NOT allow stock sales to corp to pay taxes due on the final income tax return of the deceased business owner; and the stock does NOT have to be redeemed before the estate tax return is filed
Family attribution rules do NOT apply to a Sec. 303 redemption
Book Value/Intangible Assets/Goodwill
Book value of a business entity is the excess of business’s total assets over total liabilities
Intangible assets that tend to increase value of a business above its book value include the reputation of the business, quality of the management, and the ownership of a brand name
Goodwill = a business’s earnings in excess of a fair ROR
Selling a Business
When business is sold, selling price need not be a predetermined exact or fixed amount, and the payment for the business need not be in cash
When a business liquidates, accounts receivables are not included at 100% and goodwill is not typically included as a significant part of the business’s value
Selling a Business: Capitalization of Earnings Method
Capitalization of earnings method uses weighted avg of last 5 years business earnings divided by an appropriate ROR
Business Interruption Insurance
Can replace business earnings lost d/t peril involving machinery and equipment; NOT losses d/t adverse business conditions
Miscellaneous
Corporations can and often do have only 1 shareholder
Corporations do not have to be incorporated in every state where they conduct business
Limited Partnerships must have general partners and limited partners
A Sole Proprietor files just one tax return for both business and personal income
T or F: Tax free stock recapitalization of a corp can provide preferred stockholders w/ a steady dividend income
True
Preferred Stock
does not usually share in the growth of the business
Right to income = YES
Priority @ liquidation = YES
Restrictions that affect value = YES
Share in growth = NO
Uses of Preferred Stock
Uses of preferred stock issued as a dividend or issued in a recapitalization:
a. The preferred stock can be used in a Sec. 303 stock redemption
b. The preferred stock can be gifted w/out diluting control of the corp
Issuing Nonvoting Common Stock (NVCS) in a Recapitalization
NVCS is received by existing shareholders w/out current income tax
NVCS can be redeemed by corp via Sec. 303 w/out affecting voting control
Transfers of NVCS can be made to a shareholder’s children w/out reducing the parent’s control of the family corp
NVCS gifted to successors will benefit from future appreciation equally with the voting stock
The voting common stock retained by the parent after a gift of the NVCS will give the parent control
Nonvoting stock is typically discounted as a minority interest
Insured Disability Buy/Sell Agreement
In an insured corporate or partnership disability buy/sell agreement, definition of disability should match definition in the insurance policy and a mandatory period of time of disability should be stated for the sale
Premiums are NOT deductible
If there is a lump sum paid to a disabled shareholder/partner, does NOT qualify for step up basis
Primary Purpose of Closely Held Corporation Buy/Sell
To protect shareholders from an unwanted sale to outside interests if a shareholder wants to sell their stock
Installment Payment Interest Rate
IRS will NOT accept whatever interest rate is chosen to be used in the installment contract on which the seller and buyer agree
There is imputed interest and rates published by the Treasury; the AFR (applicable fed rate) a low rate, may be used depending on the terms of the agreement
Tax-Free Asset vs. Tax-Free Stock
A buyer will prefer a tax-free asset purchase over a tax-free stock purchase because the asset purchase would receive a higher potential basis
Math: Capitalization of Earnings Method for Value of a Key Employee
Determine amount of excess earnings by dividing the tangible assets by expected ROR
Excess earnings divided by expected ROR equals the value of key employee
Key Person Life Insurance
The DB should be selected to reflect the key person’s value to the business
Corp must provide notice to key person and obtain the key person’s consent
Policy can be used to fund a NQ deferred comp plan w/ retirement benefits if the key person lives to retirement
Corp owns the policy, pays the premiums and is the beneficiary
Premiums NOT deductible to corp as a reasonable business expense
Key person’s value to the business cannot be forecasted indefinitely
Documents of Organization and Tax Filing Status
Ccorps/Scorps/LPs required to file documents of organization; GPs are not required to do so
Ccorps/Scorps/partnerships have either a separate tax status or file an informal tax return; SPs do NOT
Corporate Form of Business
Provides continuity of the business, limited liabilities to shareholders, transferability of ownership interests and lower marginal tax rates
NOTE: at complete corporate liquidation, a corporate distribution of property to shareholders generally recognize gain in the property for which they pay income tax
Corporate Directors
Assume no contractual liability for legal contracts formed by corp
Generally not liable to shareholders for errors in judgement even if they used reasonably prudent standards
Qualified Business Income Deduction
Subject to limitations, pass-through entities (SPs/partnerships/Scorps) can take a 20% tax deduction for qualified business income (QBI), this deduction may be positively impacted for high income owners if there are significant W-2 wages or investments in qualified property
Sole Proprietor (SP)
Can create retirement plan for themselves similar to corporate retirement plan
Can deduct losses incurred in business from their AGI from other sources
May not deduct premiums for group term life insurance on their own life
Partnership Dissolution and Termination
Property rights in a partnership property continue after partnership is dissolved
Termination of a partnership is not the same as dissolution in legal terminology
Professional Corporations
Stock Redemption Buy/Sell: Professional corps typically redeem the stock of a deceased SH
Liquidation: at the liquidation of a professional service corp, if the IRS imputes a goodwill value, it will be added to the capital gain to be recognized by SHs
Math: Capitalization of Earnings Method
Average earnings divided by expected ROR
T or F: A corp may acquire its own stock if it serves a business purpose and there will be no financial injury to the corp’s creditors
True
Corporations and Unincorporated Entities Taxed as Corporations
Business organized as corporations under state law will be taxed as corporations; so will “unincorporated” entities such as banks, insurance companies, state and foreign owned entities
Closely-Held Business Owner Income
Income to the owners of a closely-held business can be in the form of compensation for services provided as a director or EE, as well as income in return for capital invested in the business
Executor Liability IF Business Continues
If the executor of a deceased SP gets the consent from all heirs and creditors to continue the business, the executor is liable for acting in a negligent manner and incurring business losses
IRC 6166
Provides for the payment of estate taxes in 10 installments; 1st installment of principal MUST be paid 5 years after the date the federal estate tax return is due; w/ payments being made over the next 9 years and estate kept open until installments are paid
***Section 6166 would not be used if an insured buy/sell agreement is in place
Specific Performance as a Judicial Remedy
“Specific Performance” serves as an effective judicial remedy for surviving partners if there has been a breach of the buy/sell w/ the deceased partner’s estate
Estate as Beneficiary in Cross-Purchase Buy/Sell
The estate of the insured should not be listed as the beneficiary because the estate would hold both the deceased’s business interest and the life insurance policy proceeds,
ALSO,
The deceased’s shareholder’s business interest and the life insurance policy proceeds might be subject to claims against the estate
Family Attribution
Family attribution rules provide a tax burden for a senior family member who wants to transfer their business interest to heirs
Family attribution rules: a SH whose stock has been redeemed by the corp will have stock attributed to them if owned by their spouse, child or grandchild, NOT BY A GRANDPARENT
Family attribution rules can be waived so long as the individual whose stock is redeemed agrees to the following over the 10 year period following redemption:
a. Not serve as an officer of the corp
b. To acquire NO stock in the corp unless inheritance or bequest
c. Notify IRS if a prohibited interest in the corp happens
d. NOTE: the former stockholder may become a creditor to the corp
Grantor Related Annuity Trust (GRAT)
Stock transferred into a GRAT:
Ex. 5 yr trust, annuity payments for 5 yrs
At end of 5 yrs, grantor’s son receives the stock
The transfer IS subject to gift taxation
If grantor dies before trust pays out and is terminated, the principal of the trust is included in the grantor’s estate
Stock Redemption? Cross Purchase?
Closely-held family business, is a stock redemption agreement preferable to a cross purchase agreement? Not necessarily
INC wants to hold purchase price down in their buy/sell and wonders if the life insurance funding will inflate the value of the stock: is a stock redemption agreement preferable to cross purchase agreement? Not necessarily
Option to Purchase Shares in the Event of SH Death
If a SH in a close corp enters into a contract that allows the corp an option to buy their shares in the event of their death:
a. Option is not enforceable
b. Option agreement can provide a price or a price formula
Installments in a Disability Buyout
Installments instead of a lump sum payment/purchase is an advantage because the IRS allows capital gains treatment on the sale as installments are paid
Interest on installment payments is not considered tax-free to the seller
Risk Management
Loss Prevention = risk management technique to reduce the chance of loss
Insurance and risk management is NOT concerned w/ “speculative risk”
Insurable Risk = a risk where losses are definite in regards to amount and time
T or F: Common methods for a business interest to transfer risk include the purchase of insurance and using hold-harmless agreements
True
Tax Treatment of Salary Continuation Plan
For an ER to receive favorable tax treatment for contributions to a salary continuation (disability income) plan, the plan does not need to be funded by DI insurance and the plan does not need to cover all employees
Payments from plan are taxable for EE
ER receives a tax deduction for benefit payments from a plan
Installment Sale of Stock
An installment sale may be designed to remove stock from the seller’s estate but unpaid installment payments before the seller’s death are included in the estate
The IRS will NOT accept just any interest rate used in the installment contract on which the seller and buyer agree
Irrevocable Life Insurance Trust (ILIT)
Very useful estate planning tool for a business owner and it can accomplish a lot of things, but providing retirement income for the owner is NOT one of them
Life Insurance to Fund a NQ Deferred Compensation Plan
No deduction for premiums paid by ER
Benefits are taxed to EE
Miscellaneous 2
Transfer restrictions will decrease the value of preferred stock
Fringe benefits to EEs do not result in a tax credit
IRS does NOT provide a mathematical formula for determining maximum reasonable compensation
Minority Shareholders
The value of a minority stock interest in a closely-held business can be discounted, but this is not the case in a publicly-traded corporation
Cumulative voting may enable minority shareholders to get representation on the corp’s BOD
Economic Effects of Partnership Liquidation
Economic effects of the liquidation of a partnership following the death of a partner:
interfering w/ the surviving partner’s careers
a shrinkage of partnership assets
a delay in the settlement of a deceased partner’s estate
T or F: Business overhead insurance benefits typically include reimbursement for the disabled individual’s lost income or earnings
False
Anti-Estate Freeze Statutes
A business owner may experience difficulty in planning to transfer their ownership to family successors d/t anti-estate freeze statutes that have added uncertainty and transfer tax costs to many traditional transfer techniques
Section 302 Stock Redemption
To be treated as a capital transaction, a Section 302 stock redemption can be substantially disproportionate w/ respect to the shareholder whose stock is redeemed and it can be a complete redemption of all stock the corp owned
To qualify as substantially disproportionate, a redemption must reduce the SH to below both (1) 50% of ownership and (2) 80% of their prior holdings
Deceased Shareholders (Miscellaneous)
If no stock redemption agreement exists, the executor or administrator has the right to vote for then deceased SH
If there is no buy/sell agreement in a close corp, it may be difficult for the heirs of a minority SH to sell the corporate stock following their death
Surviving SHs are favored over a deceased SH’s heirs if an option agreement is in place that sets out a predetermined price
Sole Proprietor Death
If no buy/sell, their personal representative has a duty to complete unfinished obligations that do not require the sole proprietor’s personal performance
SP buy/sell w/ a key employee funded w/ life insurance: key employee should be the life insurance policyowner AND beneficiary
If key employee cannot afford premiums, options can be bonus the amount or set up a split-dollar insurance arrangement
Trustee Used in Insured Buy/Sell
the trustee does not necessarily have to pay the premiums on the policies
T or F: All state require ERs to purchase insurance coverage for workers compensation
False
