Tax Treatment/Liability Exposure Flashcards
Liability Exposure - aspects
- Extent to which owners of a business operated in a particular legal form face potential personal liability on the business’s obligations (inside liability exposure)
- Extent to which creditors of the owners of a business operated in a particular legal form can recover agains the business’s assets (outside liability exposure)
Best option for Inside Liabilities
Corporations & LLCs
Veil Piercing
Murky area of law with no leading case in which a court disregards liability shield of a corporation, LLC, etc. and holds its owners personally liable for the entity’s obligations.
Greenhunter Energy, Inc. v. Western Ecosystems Technology, Inc. (2014)
Extraordinary equitable remedy. Veil pierced due to specific circumstances of case.
Greenhunter Energy Inc. sole member of LLC GreenHunter Wind Energy, LLC. Western Ecosystems made a case, which dCourt agreed with, that the two were basically the same entity.
Analysis: Previous Wyoming act says “Failure of a limited liability company to adhere to the formalities required of a corporation is not a basis for disregarding the company in an action seeking to pierce its veil”
Veil of LLC may be pierced when:
1) The LLC is not only owned, influenced & governed by its members, but the required separateness has ceased to exist due to misuse of the LLC AND
2) the facts are such that an adherence to the fiction of its separate existence would, under the particular circumstances, lead to injustice, fundamental unfairness, or inequity.
Fraud generally only factor that meets both prongs. Inadequate capitalization may also be considered. Degree to which business/finances of the company and the member are intermingled.
In this case, undercapitalization by choice, intermingling of business & finance. BUT LLC can properly be taxed as a disregarded entity and single-member LLC is allowed.
Direct Liability
A liability shield doesn’t protect a business owner from liability arising from the business owner’s own actions/inactions.
Outside Liability Exposure
Unincorporated entities generally superior to corporations.
Charging Order
Essentially a lien on the judgment debtor’s limited liability company interest.
The entry of a charging order is the exclusive remedy by which a judgment creditor of a member or a member’s assignee may satisfy a judgment out of the judgment debtor’s limited liability company interest and attachment, garnishment, foreclosure or other legal or equitable remedies are not available to the judgment creditor, whether the limited liability company has 1 member or more than 1 member.
In re Albright
Caveat regarding LLC’s outside liability shield. When Trustee became sole member of the Western Blue Sky LLC, it could sell and distribute net proceeds to his own estate.
Reasoning is that the charging order exists to protect other members of an LLC from having involuntarily to share governance responsibilities with someone they did not choose, or from having to accept a creditor of another member as a co-manager. Serves no purpose in a single member LLC bc not other parties’ interests affected.
Reverse Veil Piercing
Where creditors of a business owner may be able to reach the assets of a business.
C.F. Trust, Inc. v. First Flight Limited Partnership
Barrie Peterson, who owns First Flight, individually along with his wife, guaranteed notes that CF Trust & Atlantic Funding hold totaling 7 million dollars.
Piercing the corporate veil is justified when the unity of interest & ownership is such that the separate personalities of the corporation and the imdivl no longer exist and to adhere to that separateness would work an injustice. Shareholder sought to be held personally liable has controlled or used the corporation to evade a personal obligation, to perpetrate fraud or a crime, to commit an injustice, or to gain an unfair advantage.
Minimizing Federal INCOME Tax Liability
Form in which business operated:
- Sub-C
- Sub-K
- Sub-S
Sub-K/S both provide for pass-through taxation, meaning entity calculates its income/loss for the tax yr and then allocates it to each owner.
- For Sub-S entities, allocations have to be based on percentage of ownership
- For Sub-K entities, allocations can be based on something other than percentage ownership.
- Sub-K only available to unincorporated entities w/two or more owners
Sub-S Requirements
- It’s a domestic entity, incorporated or organized in 1 of the 50 states or DC
- 100 or fewer owners
- All owners are indvls, estates, certain types of trusts, or tax-exempt organizations
- None of its owners are nonresident aliens (don’t live in US & not US citizen = most of world)
- Only has 1 class of ownership interests outstanding (disregarding differences in voting rights)
Default Classifications for Business Entities
Single-Member LLC: Disregarded
Corporation: Sub-C
Limited Partnership: Sub-K
Multi-owner unincorporated entity other than a LP (general partnership, LLP, LLC): Sub-K
Multi-owner unincorporated entity (publicly traded)
Taxed under Sub-C unless >= 90% of its gross income consists of “qualifying income,” in which case it can be taxed as Sub-K.
Qualifying income = interest, dividends, real property rents, gain from disposition of real property, income/gain from commodities or commodity futures, etc.
Sub-C
Entity treated as separate taxpayer. If it distributes money to its owner (dividend), owners must include the distribution in their taxable incomes, resulting in “double taxation”
