Key Terms End of Each Chapter Flashcards
LLC (Limited Liability Company) - L1C1
limited liability & pass through tax treatment income & losses to investors
Unlimited # of persons may invest & have limited liability, & company does not need to have any person retain unlimited liability
LLCs now authorized by law in all 50 states and District of Columbia
Closely Held Business - L1C1
owned by limited # of SHs, who are usually also the primary employees
A CHB is incorporated according to state law, but its shares are not traded, & it operates like a partnership in many ways
Limited Partnership - L1C1
composed of active, or general, partners & passive investment, or limited, partners
GPs have personal responsibility for business operations & unlimited legal liability
LPs only at risk for up to the amount of their investments
Even when additional interests are sold to limited partners to raise capital, the control held by the GPs is not diluted
LLP (Limited Liability Partnership) - L1C1
registers w/ the state so all partners protected by limited liability
All partners may be GPs & still have limited liability
LLP differs from a limited partnership because w/ the latter entity, GPs not protected by limited liability & at least one GP is required
Pass-Through Taxation - L1C1
concept in federal income taxation that business entities, except for corporations, do not pay income tax on their income; rather, the income will be reported by the business owners on their individual income tax returns. As a result, the income will avoid double taxation
Medicare Contribution Tax - L1C1
comprised of:
- 0.9% Medicare tax on earned income
- 3.8% tax on net investment income (NII)
Both taxes imposed on modified adjusted gross income (MAGI) over $200K for individuals and over $250K for married filing jointly
The 3.8% tax is imposed on the lesser of (1) the taxpayer’s NII or (2) MAGI in excess of the threshold amount
NII (Net Investment Income) - L1C1
subject to 3.8% Medicare Contribution tax for individuals w/ modified adjusted income over $200K & for married filing jointly over $250K
NII defined to include interest, dividends, payments from NQ annuities, royalties, rents, & capital gains from assets not held in a trade or business
Pass-Through Entity - L1C1
Partnerships & S Corps are said to be pass-through entities
The earnings of these companies are not taxed to the company but to the owners
earnings are passed through to the owners & then taxed @ the owners’ individual tax rates
Termination by Operation of Law - L1C1
occurs in a general partnership upon death of one of the partners
surviving partners forced to liquidate business & distribute the assets according to the relative partnership interests or the surviving partners will sell the assets & distribute the cash
The decedent’s estate must be paid for its ownership interest
Key Employee - L1C1
an employee who possesses unique skills, knowledge, or business contacts, & whose loss would be devastating to the company
The death/disability of a key employee results in loss of income for the corp
the employee’s unique skills, experience, or talent may not be easily replaced @ the same salary level
Another significant contribution which may be from a key employee is a large client following or a large source of capital or credit to the company
Compensation Planning - L1C1
Purpose is to create a compensation package that best meets the needs of the owners & the business
Planning must take into consideration the sources of income for the business, any tax costs, & ways to minimize the costs of the compensation package
Guaranteed Payments - L1C1
When fixed payments are received by a service partner in an organization, the payments are not called a salary, but guaranteed payments
A service partner is one who provides important skills or services to the partnership
Real Property - L1C1
land & anything permanently attached to the land
Personal Property - L1C1
any property that is not attached to land & generally is moveable
Consequential Losses - L1C1
indirect loss, resulting from a direct loss, which decreases the net income of a business
Such a loss would occur if gross receipts were reduced through the curtailment of operations or if operating expenses were increased
Ex. a fire causes a direct loss by destroying a hotel; consequential losses to the hotel follow as a result of losing the revenues from room rentals
Articles of Incorporation - L1C2
Prepared by organizers of a corp, set forth pertinent facts about the corp, including its purpose, capitalization, # of directors, name, & location; the powers of the directors & the manner of their election; & any other information required by the state
Articles of Incorporation are filed w/ the state, along w/ the filing fees & any taxes
If the articles comply w/ the statues, a certificate of incorporation is issued by the state
Bylaws - L1C2
corporate bylaws = state the duties & powers of the corporation’s BOD &SHs
bylaws provide rules for director & SH meetings & for other matters pertaining to corporate operations
bylaws are adopted either by the directors or the incorporators, depending on state practice
Quorum - L1C2
minimum # of directors (typically a majority) which must be present for the BOD to take any action
Business-Judgement Rule - L1C2
Corporate officers & directors must meet their fiduciary obligations to the corp, which is measured by a standard known as the business-judgement rule
This rule holds that if officers and directors use honest, acceptable business judgment, they will avoid liability for corporate losses
Cumulative Voting - L1C2
voting method designed to insure representation of minority stockholders on BOD
some states require cumulative voting, while other states permit it if authorized by the corporate charter
each share of stock receives one vote for each of the directors to be elected at a meeting
The SHs may accumulate votes and allocate all votes for one candidate or spread the votes among the condidates
Formula to determine the # of votes necessary to elect a given # of directors:
S = ((TxN) / (-D+1)) + 1
S = # of shares needed to elect N directors T = Total # of shares voted N = # of directors the SH hopes to elect D = Total # of director positions to be filled
Voting Trust - L1C2
Arrangement whereby SHs transfer shares in a corp to a trust
the trustee then can exercise voting rights represented by the shares allowing stockholders to combine their votes to realize common objectives, as long as those objectives are proper
The stockholders receive trust certificates for their shares & retain their beneficial interest in the stock such as receipt of dividends
Professional Corporation - L1C2
corp whose owners must be licensed members of the profession
Owned by SHs who perform professional services & who operate their corporation according to state laws, just as any other corp
Proprietorship - L1C2
business enterprise owned by one person
the owner usually manages the business but may hire employees & agents to assist in the operations
Partnership - L1C2
Unincorporated association of two or more persons carrying on as voluntary co-owners in a business for profit
General Partnership - L1C2
business entity composed only of GPs, each of whom is a general agent for the firm & is fully liable for the debts & other obligations of the firm
Tenants in Partnership - L1C2
refers to the legal relationship of general partners to the partnership’s property
The partners own partnership property as tenants in partnership
Each partner has equal right to possession of partnership property (but they may exercise that right only for partnership purposes)
Partnership Interest - L1C2
Each general partner owns a partnership interest composed of their share of the firm’s profits & surplus
surplus = total value of firm’s assets minus liabilities
partnership interest is intangible personal property & will be so treated for state inheritance tax purposes
Assignee in Interest - L1C2
party that receives an interest in a partnership but does not become a partner
ex a third party buyer, the estate of a deceased partner, or someone who gets a partnership interest as a gift
Dissolution - L1C2
the result of any change in the relationship among partners that results from any partner ceasing to be associated in the carrying on of the firm’s business
Members - L1C2
A member of a limited-liability company is an owner
No limit on the # of members in an LLC, but there must be at least two
Operating Agreement - L1C2
An operating agreement for a limited-liability company states the rules under which the organization will conduct it’s business
The agreement specifies how the company will be managed, how profits will be divided, & how the members will conduct business
QBI (Qualified Business Income) - L2C3 ** PULLED FROM INVESTOPEDIA
net business income, not including capital gains & losses, certain dividends, or interest income
eligible for 20% tax deduction for QBI, business must be pass through entity (SP, partnerships, S Corps, trusts and estates
C corps income is subject to corporate tax rates
20% deduction reduces federal & state income taxes but not social security or medicare taxes, which means it also doesn’t reduce self employment taxes
Accumulated Taxable Income - L2C3
Accumulated-earnings tax is a penalty tax designed to prevent the avoidance of taxes by accumulating of earnings w/in a corp beyond the expected needs of the business
Accumulated taxable income is defined as the taxable income of the corp less:
(a) corporate taxes paid on income
(b) dividends paid
(c) amounts accumulated as retained earnings for reasonable business needs or, if greater the remaining minimum accumulated earnings credit
PSC (Personal Service Corporation) - L2C3
Engaged substantially in performing services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting, & substantially all stock is held by employees performing the services, by retired employees, or by their estates
A business receiving most of its income in commissions is NOT a PSC
Grantor Trust - L2C3
Under the income tax laws, a grantor trust = a trust over which the grantor has retained certain powers/benefits, so the income is taxed to the grantor rather than to beneficiaries or to the trust
Typically, the grantor trust is a revocable trust, & the grantor places assets in the trust w/ the aim of having them avoid probate
QSST (Qualified Subchapter S Trust) - L2C3
Law allows formation of a qualified Subchapter S trust (QSST) to hold S Corp stock
Useful planning device for splitting S Corp income among family members, w/out relinquishing complete control of the stock
The tax burden is thereby shifted to the trust beneficiary, but the trustee votes the stock until the designated trust termination date
ESBT (Family Partnership electing small business trust - L2C3
Family Partnership = partnership consisting of family members who are treated as partners, regardless of whether they are actively involved in the partnership or have made any contribution to it
ESBT = special trust eligible to hold S Corp stock, may have more than 1 SH, but the trust may only receive the S Corp stock by gift or bequest
Estates & individuals may be beneficiaries, & qualified charities may be contingent beneficiaries
While the EBST has the advantage of allowing more than one current beneficiary, it has the disadvantage that income is taxed to the trust at the highest individual income tax rates, currently 35% & capital gain at the rates for individuals
QSSS (Qualified Subchapter S Subsidiary) - L2C3
Wholly owned subsidiary of a Subchapter S Corp
If a QSSS election is made, all income, deductions, & credits are treated as belonging to the S Corp which is the parent company
Self Employed Business Owner - L3C4
for federal income tax purposes include SP, partners, & owners of S Corps (more than 2% owners)
Cannot participate in favorable tax treatment of employer-provided health & accident plans
Self employed persons are able to obtain retirement plan benefits similar to what is provided by corporate retirement plans
Reasonable Compensation - L3C4
Under Sec 162, only reasonable compensation qualifies as a business deduction
Purpose is to distinguish b/t bona fide compensation pmts & disguised dividend distributions
Reasonable compensation taxed only once to employee
Excessive compensation pmts deemed to be distributions, thus taxed twice, once at corporate level & once to employee-SH
Reasonableness standard is imprecise, IRS can attack pmts of closely held corps
Lack of precision means an opportunity for planning & tax strategy
Important Point: compensation will have to be defended, the best defense is properly documented authorization of compensation that is related to the employee’s contribution to the business
Zero Tax Bonus Plan - L3C4
bonus amount paid to employee after deduction of income taxes
Since bonuses are taxable, employees are liable for additional income taxes
In order to offset the additional taxes it is possible to determine the required bonus that will deliver the desired net bonus to the employee:
Formula:
Required Bonus = TB / (1 - t)
TB = after tax bonus to be paid t = employee's tax bracket
Salary Reduction Plans - L3C4
Permit executives to postpone to future years current earnings as long as the constructive receipt & economic benefit tax doctrines are not violated
Plan should exist prior to earning of the compensation (constructive receipt) & the property cannot be protected from the creditors of the business (economic benefit)
SERP (Supplemental Executive Retirement Plan) - L3C4
NQ plans (deferred) that provide for supplementary, compensatory pmts @ retirement or death benefits
Must not violate the constructive receipt & economic benefit rules
Only difference b/t SERPs & excess-benefit plans is the latter are used solely for executives whose qualified deferrals equal the statutory limits
DBO (Death Benefit Only) Plan - L3C4
NQ plans that provide death benefits for the executives’ beneficiaries
Pmts may be in installments or lump sum & are taxable to the beneficiaries when received
NQ plan - must not violate constructive receipt & economic benefit rules
To avoid inclusion in decedent’s estate, all incidents of ownership (such as right to change beneficiaries) MUST be relinquished & decedent must not have been a participant in any other NQ plan providing living benefits
Constructive Receipt - L3C4
concept in tax law which requires the recognition of income when it becomes available to the taxpayer, w/out any significant restrictions or limitations
Income is taxed regardless of whether or not the taxpayer actually receives it
Taxation of income may not be deferred with the following exceptions:
- When an agreement b/t the employer & employee regarding the income deferral is established prior to the compensation being earned
- When the deferred income is a contribution to a qualified profit sharing retirement plan
Economic Benefit - L3C4
Taxable benefit an employee receives from a NQ deferred compensation plan, whether or not the employee is in constructive receipt of the benefit
An economic benefit is a cash equivalency which has been set aside for the employee & is not accessible to the employer’s creditors, such as an employer’s vested contributions to the plan
Sec 79 Plan - L3C4
the cost of group term life insurance up to $50K is excludible from the taxable income of the employee & deductible by the employer as long as all employees are covered (or eligibility is determined by age, marital status, or factors related to employment)
Special eligibility rules for companies w/ fewer than 10 employees
Cost of coverage in excess of $50K is taxable to the employee, based on factors provided by the IRS
Sec 162 Plan - L3C4
Plans that satisfy the reasonableness requirement of the Internal Revenue Code may provide various forms of compensation, including executive bonuses in the form of life insurance
Premiums are deductible by business & must be included in the income of the executive
Advantages of bonuses to fund life insurance:
- Administration is simplified
- Discrimination in favor of key employees is permitted
- These plans can be used to supplement Sec. 79 plans (known as carve-out plans)
- The pmt is tax deductible; this is especially important for the personal-services corp since insurance premiums are not deductible
Split Dollar Plan - L3C4
splitting the benefits of life insurance into its savings & pure insurance & allocating the costs b/t the company & the executive
The executive’s taxable income includes the economic benefit (the pure insurance portion in the traditional plan minus any amount paid by the executive
Premium pmts by the employer are not deductible
DB subject to estate taxation – if includible in executive’s estate, if there were any incidents of ownership w/in 3 years of death, or if the executive was a majority SH and the corp possessed incidents of ownership
Generally exempt from ERISA vesting, funding, participation, claims procedures, & fiduciary appointment requirements
Traditional Form: requires the executive to pay the excess of premium over the increase in cash surrender value; death benefit also split w/ corp receiving the cash surrender value; employee does not possess any living benefits
Endorsement Method - L3C4
Split dollar life insurance plan
employer owns life policy insuring the employee
employee designates the beneficiary
Endorsement to the policy filed w/ insurer prohibiting a change to the beneficiary designation w/out the insured’s consent
employee & employer split the pmt of the premium
@ time of employee’s death, employer & designated beneficiary will split the policy proceeds
Collateral Assignment Method - L3C4
Split dollar arrangement
life insurance policy owned by insured-employee who is responsible for premiums
employer lends employee its share of the annual premium amt
employer’s contributions are secured by the assignment of the portion of the policy benefit it is to be paid
employee names a beneficiary who will receive their share of the benefits
Equity Split Dollar Plan - L3C4
equity plan transfers ownership in the cash surrender value to the employee, but w/out terminating the split dollar plan
employee normally pays the PS 58 or Table 2001 cost, & since that amount usually exceeds the pure insurance portion of the premium, the excess is the employee’s equity interest in the cash surrender value
Split Dollar Rollout - L3C4
transfer ownership of cash surrender value from employer to provide living benefits & increased death benefits for the employee
Planning problems are when to transfer (terminate plan) & how to pay for the transfer
Pmt options include bonuses (taxable to executive) or outright purchases by the executive (including use of bona fide loans)
Timing will depend on how the transfer is to be paid; if executive is to buy out the corp’s interest, early termination is probably preferred
Reverse Split Dollar Plan (RSD) - L3C4
interests of the employer & the employee reversed when compared to traditional plan
employee effectively owns the living benefits & business owns the death benefits
Allocating the premium pmts b/t the employee & the business has tax implications for the employee if the employee pays less than the increase in cash surrender value
Interest Free Loan - L3C4
According to IRS regulations, equity collateral-assignment split dollar plans will be taxed as interest free loans from the corp to the employee
Corp’s contribution of the premium is considered a loan in the amount of forgone interest, which is considered income to the employee
Executor Administrator - L4C5
The Executor of a deceased’s estate is the fiduciary appointed by the proper court to settle the estate of the deceased in accordance w/ the terms of the deceased’s will
Frequently, the will of the deceased designates the one whom the testator suggests (or nominates) to be the executor or personal representative
However, only the court can make the appointment; the executor takes legal title to the property of the estate
Executors can make valid transfers of title to the estate properties under their own signatures
Trade Creditors - L4C5
creditors of the continued business, as distinguished from estate creditors
Those trade creditors who deal with a SP business firm after the death of the owner have no claim against the general estate assets
In seeking pmt for goods or services provided the business (after the owner’s death), the trade creditors’ claims must be limited to the specific assets of the continued business or of the one who is operating the business
Liquidating Trustees - L4C5
@ death of one of the partners in a general partnership, the surviving partners become liquidating trustees
surviving partners have the legal responsibility for winding up affairs of the partnership and terminating it
liquidating trustees hold the partnership assets as fiduciaries, acting in the best interest of the heirs of the deceased partner
obligated to dispose of the partnership assets & transfer decedent’s share to his or her executor for ultimate distribution to heirs of the deceased
surviving partners have no authority to continue the business beyond the time necessary to wind up its affairs & terminate the partnership
Liquidation - L4C5
means disposing of the partnership assets for cash or items that can be converted into cash
First-Offer Restriction - L4C5
provision, usually included in both cross purchase & entity type buy/sell agreements, commits the owners to offering their interests to the other contracting parties during their lifetimes, before an owner is permitted to make any other disposition of their interest; this is a one way commitment
the other party or parties are not required to buy the interest
Option Agreement - L4C5
grants a party the right for a limited time to purchase stock at a specified price (or in accordance w/ a formula)
Stockholders of a closely held corp may enter into such an agreement, giving the survivors the right to purchase the deceased’s shares
Surviving stockholders thus have a right but not the obligation to purchase
Therefore, the option agreement provides no security for the heirs of the deceased stockholder
Special-Use Valuation - L4C5
permitted for farmland & other closely held business property for federal estate tax purposes
Use-value for such property often is much less than FMV of the property if the property were made available for its highest & best use
Specific Performance - L5C6
mandated by courts in situations where money damages are difficult to determine or are not an adequate remedy for the aggrieved party
courts generally mandate specific performance of buy/sell agreements because “money damages constitute an inadequate remedy”
significant in the context of the buy sell agreement because neither the buyer nor the seller usually has an alternative market in which to buy or sell the business interest
IRD (Income in Respect of a Decedent) - L5C6
income attributed to the efforts of (or otherwise credited to) the deceased for the tax year in which death occurred
such income is reportable on the estate’s federal income tax return for the year of the deceased’s death
Cross-Purchase Agreement - L5C6
type of buy sell agreement among the owners of a business, including the partners in a partnership, the stockholders of a corp, & the members or owners of a limited liability company
Terms of the agreement are that @ death of an owner, the surviving owners will buy the deceased owner’s share & the deceased owner’s estate will sell their ownership interest to the surviving owners
Entity Agreement - L5C6
an entity agreement (partnership) is a buy sell b/t the partnership (acting as a separate business entity) & the individual partners, in which the partnership entity agrees to buy the partnership interest from the estates of the partners upon their death
The individual partners commit their respective estates to selling their partnership interests to the partnership
The agreement usually sets forth the purchase price for the respective partnership interests or specifies a formula to be used to determine the value of the interests
Agreement usually contains a first offer commitment
Hot Assets - L5C6
Any unrealized receivables & any substantially appreciated inventory items owned by a partnership @ the time of a partner’s death
These assets do not get a “stepped-up-basis” at the partner’s death; rather the amount received by the estate for these items is considered “income in respect of a decedent” & is taxed as ordinary income
Section 754 Election - L5C6
permits the surviving partners to adjust the basis for partnership assets purchased from the deceased partner’s estate; prevents double taxation
Savings Fund - L5C6
bank account designed to increase in amount to provide the dollars for the purchasing party in a buy/sell agreement
The uncertainty of the fund’s growth & the uncertainty of the timing of death of the selling party make the device impractical
Stock Redemption Arrangement - L5C7
purchases of SH stock by the corp
such purchases may take place any time by mutual agreement, but our discussion involves redemptions provided for by a stock redemption buy/sell agreement
the provisions of such an agreement are binding on the parties
Sale-or-Exchange Treatment - L5C7
shares of stock are given capital gains treatment for federal income tax purposes
As a result, no tax is paid on the amount of the owner’s basis for the shares
The only taxable gain is the amount in excess of the taxpayer’s basis
Wait-and-See - L5C7
buy/sell agreement w/ no predetermined purchaser for the deceased owner’s stock, corporation itself is given the first option
If the corporate BOD votes not to exercise its option, the surviving stockholders are given the right to buy their pro rata share of the stock
corp is required to buy any shares not purchased by the stockholders individually
Buy-Sell - L5C7
provides for the sale of a business interest @ the death, disability, or retirement of the owner
agreement assures a sale of the business interest @ the specified time & continuation of the business by the purchaser(s)
The purchaser(s) may be other owners, employees, family members, or third parties
the agreement will typically provide a formula or other means to determine the price that will be paid for the business interest & requires the owner or the owner’s estate to sell to the new owner
Insurable Interest - L5C7
For life insurance purposes, an entity has an insurable interest in an insured’s life when it has an expectation of financial benefit from the continued life of the insured or will suffer a financial loss if the insured dies
The law requires a person to have an insurable interest in the life of another if the first person wishes to purchase a policy insuring the life of the second person
Partners usually (but not always) have an insurable interest in the lives of the other partners
E & P (Earnings and Profits) - L5C7
both income; when corporate earnings & profits are not paid out as dividends, they become “retained earnings”
There may be an additional tax on “unreasonably accumulated earnings”
Not Essentially Equivalent to a Dividend - L6C8
In order to allow a case by case consideration of the tax implications of a corporate redemption, IRC Sec 302(b)(1) allows a partial redemption to be treated as a sale of stock, as long as the redemption is not essentially equivalent to a dividend, even though it does not meet the strict mathematical tests of other Code provisions
Substantially Disproportionate Redemption - L6C8
corporate stock redemption that must meet the following two tests:
1. after the redemption, the SH must own less than 50% of the total combined voting power of the corporation
AND
2. the percentage of the voting stock owned by the SH after the redemption must be less than 80% of the amount of voting stock the SH owned before the redemption
Complete Redemption - L6C8
redemption of all of a SH’s stock interest in the corp, which is treated as a capital transaction
Partial Liquidation - L6C8
distribution of corporate property to someone who is not a stockholder, & the distribution qualifies for capital gain treatment rather than the more burdensome tax rules for dividends
Such a distribution must not be essentially equivalent to a dividend (from the POV of the corp rather than the SH) & must occur w/in the taxable year in which a plan of liquidation is adopted or w/in the succeeding taxable year
Attribution - L6C8
stock which is owned by one person or entity is treated as if owned by another party for the purpose of determining the tax treatment in a given transaction
There are attribution rules of stock ownership which apply to certain types of corporate redemptions
Attribution of ownership (also called constructive receipt) applies to any redemption of the stock of a corp owned by related parties because a SH could have control of the company, b/t their shares & those owned by close relatives
To determine how the redemption will be taxed, the stock of a SH’s spouse, parents, children, & grandchildren will be attributed to the SH
Waiver of Family Attribution - L6C8
In certain complete redemptions, the waiver of family attribution rules can be used so that the SH redeeming the stock is not considered to own the stock owned by certain related family members
Attribution rules do not apply under the following three conditions:
1. The redeemed SH must terminate all interest in the corp, including any interest as an officer, director, or employee; the SH however may continue to be a creditor
- The redeemed SH must not require any interest in the corp w/in 10 years from the date of the redemption, except for stock acquired by bequest or inheritance
- The redeemed SH must file an agreement to notify the IRS of any acquisition of any interest in the corp w/in the 10 year period & must retain appropriate records
Sec 303 Redemption - L6C8
partial redemption of shares included in the decedent’s estate as a result of the SH’s death
amt of stock redeemable cannot exceed the amt of death taxes, funeral expenses, & administrative expenses; such a partial redemption is considered the sale of stock & not a dividend
The purpose of this code provision is to avoid the need to liquidate small family-owned businesses & to prevent the concentration of business control in large public corporations
Corporate Liquidation - L6C9
In the liquidation of a corp, the following occur:
- the corporate-owned properties are distributed to the SHs
- the corp’s stock is canceled
Stock Sale - L6C9
the disposition of the SH’s corporate stock interest, which is taxable to the extent that the sale price exceeds the selling stockholder’s basis
Asset Sale - L6C9
the corporate sale of assets prior to liquidation, which generally results in federal income tax for the corp on any gain
Installment Sale - L6C9
payment by a note due over a period of time
this can allow the seller to spread a taxable gain over a period of years & allow a cash-shy buyer to spread payments over a period of years
Imputed Interest - L6C9
minimum rate of interest set by the IRS under Code Sec 483 for installment obligations
I.I. is either 9% or the applicable federal rate published monthly
IRS controls the use of interest in an installment transaction under the I.I. rules, so a buyer & seller cannot avoid tax by reporting only artificially low rates of interest
The substantial difference b/t the tax rates on capital gains & ordinary income makes this concept significant
Tax Free Reorganization - L6C9
Normally, business dispositions are taxable events, whether the stock sale or asset sale method is used
However, a tax free reorganization makes possible a tax-free disposition of a business interest & can be carried out either as a sale of assets or a sale of stock
Ex: when the Browns sell their stock in Ajax Corp to Zenith Corp, in exchange for Zenith Corp stock
Estate Freeze - L7C10
transfer of a business interest which has potential for substantial appreciation
owner retains an interest w/ a fixed value that will usually provide substantial income until the owner’s death
The value of the estate & of the assets held by the owner are frozen because any appreciation will accrue to the benefit of the new owners
Qualified Payments - L7C10
a dividend payable on cumulative preferred stock or a comparable payment @ a fixed rate w/ respect to a partnership interest
A payment has a fixed rate if it is determined by reference to a specified market rate of interest
Grantor-Retained Annuity Trust (GRAT) - L7C10
transfer in trust w/ a retained right to receive fixed amounts from the trust, paid at least annually
A GRAT is a qualified interest & will be valued for Sec. 2702 purposes at its full value
Grantor-Retained Unitrust (GRUT) - L7C10
transfer in trust w/ a retained right to receive a fixed % of the trust’s assets paid at least annually
A GRUT is a qualified interest & will be valued for Sec. 2702 purposes at its full value
Liquidation Rights - L8C11
refer to the legal interests the owners of a partnership or corp have against the business property if the business is dissolved & the assets liquidated
FMV (Fair Market Value) - L8C11
price @ which the property would change hands b/t a willing buyer & willing seller
neither being under any compulsion to buy/sell
both having reasonable knowledge of relevant facts
Book Value - L8C11
the excess value of the assets over the liabilities on a business’ books
It does NOT reflect the FMV of the business
Intangible Assets - L8C11
The intangible assets of a business are assets such as business know-how, business location, customer relations etc, that are not included in valuing tangible property, but which have value to a purchaser of the business
These assets, generally called goodwill, should be valued & should be included in the FMV of a business
Adjusted Book Value - L8C11
The adjusted book value of a business is the same as book value except the assets & liabilities are both revalued to reflect the current FMV of the assets/liabilities
Goodwill - L8C11
the name given to those intangible assets that should be taken into consideration to arrive @ adjusted book value that approximates FMV of a business
Goodwill should not be included in the balance sheet unless it has been bought & paid for (as when a business w/ goodwill is purchased by another business)
The new purchaser can show the goodwill as paid for
Capitalization of Earnings - L8C11
method of valuing a closely held business, based on the premise that a business should be valued according to the value of its income stream
Weighted Average Earnings - L8C11
In determining the weighted avg earnings of a business, an average of earnings is used, but each year’s earnings are weighted to reflect the trend in earnings
Thus, the most recent year in the average is given the greatest weight, & the preceding years are given progressively less weight
Capitalization Factor - L8C11
the inverse of the selected ROR for the capitalization procedure
DFE (Discounted Future Earnings) - L8C11
method of valuation is a sophisticated variation of the capitalization-of-earnings method, based upon the present value of future income
Minority Discount - L8C11
The sale of a minority interest of stock would be worth less per share than a majority interest because it does not represent control
Therefore, there would be a discount for a minority interest
Marketability Discount - L8C11
recognized by the IRS in valuing a business interest which must be sold in a short period of time
The discount is attributed to the limited market for a closely held business
The discount typically ranges from 10% to 35%, but may sometimes be greater
Blockage Discount - L8C11
permitted by the IRS when a large block of publicly traded stock is valued for estate tax purposes
The discount helps align the price w/ the depressed market price that would occur if a large block of corporate stock were offered in a short period of time
Dividend Coverage - L8C11
ratio obtained by dividing pretax earnings by the sum of interest payable on debt, plus the corp’s earnings needed to pay the preferred dividend
Elimination Period - L9C12
time that must pass b/t the start of a disability & the trigger date on which the buy/sell agreement takes effect
Designed to eliminate a too-hasty action in the case of temporary incapacity
Trigger Date - L9C12
date on which a disability buy/sell agreement becomes operative
In disability, this is usually delayed until the end of an elimination period to allow for possible recovery
Presumptive Disability Provision - L9C12
in a disability insurance policy automatically provides benefits when the insured sustains impairments such as loss of sight in both eyes or the loss of two limbs
Salary Continuation Plan - L9C12
Arrangement whereby compensation is paid to an employee who is absent from work d/t injury/sickness
It is often used w/ a disability buyout plan for a period until the buyout is effected
Residual Disability Benefit - L9C12
Designed to provide reduced benefits to an injured insured who is able to return to work but is unable to attain his or her pre-injury level of income upon returning
Noncancelable - L9C12
term used to describe a disability insurance policy which guarantees that the insurer can neither cancel the contract nor change the premium rate prior to age 65
Business Overhead Expense Disability Insurance - L9C12
reimburses the insured for eligible expenses incurred in the ordinary operations of the business
Benefits are paid during the owner’s disability, usually for b/t 12 to 24 months, up to a maximum amount per month
Expenses that are commonly covered include the business mortgage/rent, utilities, employee salaries & benefits, property taxes, insurance premiums, cleaning & maintenance, interest on equipment purchases and legal and accounting fees
Pure Risk - L9C13
prevents only two possible outcomes: loss or no loss; whereas, speculative risk may result in loss, no loss, or gain
Maximum Probable Loss - L9C13
the largest loss that is likely to occur
For example, the maximum probable loss from fire for a company w/ buildings in two different parts of the country is the value of the most expensive of the two buildings, not the value of both buildings
A fire loss at one building is not likely to result in a fire loss @ the other building @ the same time
Risk Avoidance - L9C13
can be accomplished by either avoiding the risk or by abandoning a risk
Loss Prevention - L9C13
the effort to reduce the chance of loss from risks that cannot be or are not being avoided
Loss Reduction - L9C13
the control of the magnitude or severity of losses that occur despite efforts to avoid risk or prevent loss
Fire extinguishers & sprinkler systems are examples of loss reduction techniques
Hold-Harmless Agreement - L9C13
contractual arrangement whereby one party assumes another’s liability for losses, in exchange for some other contractual consideration (i.e. a lease)
Workers’ Compensation - L9C13
benefit provided to injured/ill employees under the laws of all 50 states
If an employee is injured/ill in the course of their employment, they are eligible for benefits under the program, regardless of employer negligence
Key Employees - L9C13
an employee who possesses unique skills, knowledge, or business contacts, & whose loss would be devastating to the company
The death/disability of a key employee results in loss of income for the corp
the employee’s unique skills, experience, or talent may not be easily replaced @ the same salary level
Another significant contribution which may be from a key employee is a large client following or a large source of capital or credit to the company
Income Taxation of Installment Sales, Capital Gain Amt = ? Formula - L6C9
Capital Gain = Pmt Amt x (Gross Profit / Total Contract Price)
Capitalization of Earnings Method of Valuation Formula - L8C11
Value of Business = Avg Earnings / Expected ROR
