ADVISING STARTUPS AND ENTREPRENEURS€¦ · •Starting a new business venture Choosing the business form Basic compliance and governance Financing a new business • Dealing with

ADVISING STARTUPS ANDENTREPRENEURS

Travis Austin GreavesT. Joshua Wu

Greaves | Wu LLP1

OVERVIEW

• Starting a new business venture● Choosing the business form● Basic compliance and governance● Financing a new business

• Dealing with common tax issues• Hiring and compensating employees• Identifying tax issues during an investment,

acquisition, merger, or wind down• Unique ethical issues for representing startups

and entrepreneurs2

POLL QUESTION #1

• How often to you advise clients with respect to starting a new business?

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BASIC ENTITY CHARTSole Proprietor

C Corp S Corp Partnership LLC

Ownership Individuals 1+ shareholders

Limit of 100 shareholders

2+ partners 1+ members (2+ for partnership tax)

Control Proprietor Board of Directors

Board of Directors

Per partnership agreement

Per LLC agreement

Allocation of Income

100% to proprietor

100% to C Corp entity

Pro-rata based on shares

Agreement controls if has economic reality

Depends on tax election

Liability No limit Limited to capital invested

Limited to capital invested

No limit for GPs. Limited for LPs.

Limited to capital investment

Ease of Funding

Difficult. Based on owner’s credit.

Easy. Can sell interests.

Easy. Can sell interests.

Moderate. Can sell partnership interests.

Moderate. Can sell membership interests.

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BASIC ENTITY CHARTSole Proprietor

C Corp S Corp Partnership LLC

Losses Normal individual rules

At corporate level

Passed to shareholders

Passed to partners

Depends on tax election

SE Tax Yes No, wages. No, wages. Yes if GP Depends on tax election

Double tax No Yes No No Depends on tax election

Income Character

Depends on income

Dividend to shareholder

Passed to shareholders

Passed to shareholders

Depends on tax election

Admin. Obligations

Low High Moderate Moderate Moderate

Tax Compliance Burden

Low Moderate High High Depends on tax election

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THE SOLE PROPRIETORSHIP

• Most basic business form• Owned and operated by one individual• Control rests with owner• No legal entity required • Not recognized as a taxable entity• May need state and local licenses and permits• Self-employment taxes • No limited liability for owner• Difficult to raise funding

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THE PARTNERSHIP

• Default when two or more persons go into business for profit, as co-owners, sharing profits and losses

• Written agreement normally not required, but highly recommended

• Third parties may generally rely on authority of any partner to bind partnership

• General partners have no limited liability• Partnership must file annual return

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C CORPORATION

• Created under state law• Controlled by stockholders, board of directors,

and officers• No liability for shareholders unless “pierce the

corporate veil” (e.g., thin cap or alter ago)• Double tax

● Corporate tax ● Dividend tax

• But, no “phantom income”• More conducive to equity funding

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C CORPORATION TAX EXAMPLE

• Penny owns a restaurant that serves cheesecake. She owns 100 shares and her co-investor, Sheldon, owns 100 shares.

• In 2015 the cheesecake restaurant made a profit of $100,000.

• The corporation would pay tax of ($13,750 + 34% of amount over $75,000) or $22,250.

• Assume the corporation then pays the $100,000 out to Penny and Sheldon.● Penny pays 15% tax on dividend or $7,500● Sheldon pays 15% tax on dividend or $7,500

• Total taxes paid are $37,250. 9

S CORPORATION

• Variation of C Corporation ● Still must observe corporate formalities

• Ownership● No more than 100 shareholders● All must be U.S. citizens or permanent residents

(with small exception for certain trusts)● All shareholders must have same class of stock (can

be voting and non-voting)• Potential employment tax savings

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THE LIMITED LIABILITY COMPANY

• All states have LLC laws● Must file with Secretary of State and pay fees● Should adopt operating agreement

• Owned by members who may run business or appoint managers.

• Ownership ● Individuals or other entities

• Fewer corporate formalities than C Corporation• Flexible profit/loss allocations• Profits taxed once• Self-employment taxes 11

GOVERNANCE AND CONTROL ISSUES

• Control● Voting● Share classes

• Transferability of interests● Restricted shares● Re-purchase rights

• Anti-Dilution protections• Tag Along or Drag Along rights• Confidentiality agreements• Noncompete• Assignment of Invention• Governing law 12

FINANCING A NEW BUSINESS

• Debt or Equity• Founder’s contributions• Friends and family offerings• Preferred Equity

● Voting or nonvoting● Dividend participation● Liquidation preference

• Convertible Securities● Conversion ratio

• Equity Crowdfunding13

DEALING WITH COMMON TAX ISSUES

• Start-up expenditures• Expanding existing business• Recordkeeping• Travel and Entertainment Expenses• Car and Truck Expenses• Advertising Expenses

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POLL QUESTION #2

• What is the most flexible legal business entity?

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HIRING AND COMPENSATING EMPLOYEES

• Stock (equity) as compensation ● Ordinary income● Deductions

• Stock in C corporations• Stock in S corporations• Equity in partnerships• Section 83(b) election• Section 409A• Executive compensation

● Bonuses● Deferred compensation● Stock options

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HIRING AND COMPENSATING EMPLOYEES

• Reasonable compensation (C Corps & S Corps)● If compensation unreasonable might be reclassified

as a dividend● IRS scrutinizes owner compensation in small

businesses● In S Corp context IRS may try to recharacterize

distributions as compensation• Employee versus Independent Contractor

● Right to control and direct as to result and means● Statutory employees and statutory non-employees● IRS 20-factor test

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TAX ISSUES IN TRANSACTIONS

• Due Diligence• Stock Acquisitions• Asset Acquisitions• Deductible Expenses• Winding Down a Business

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DUE DILIGENCE• Legal entity chart

● Identify jurisdiction of tax residency for all entities• Review previously-filed returns (state and

federal)● Filed timely?● Items accurately reported?● Elections? ● Disclosures?● Information reporting?

• Written analysis/documentation of positions and completed transactions

• Information pertaining to audits or agreements with various tax authorities

• Compensation agreements and qualified plans 19

STOCK ACQUISITION• Target corporation

● Shareholders have capital gain or loss on the sale (long-term if held for more than 1 year)

● Not subject to tax • Acquiring corporation

● Obtain a cost basis in the stock● Tax basis in Target’s assets will remain unchanged

(unfavorable if value in excess of their tax basis)• 338(h)(10) election

● T is either S corporation or has 80% U.S. corporate shareholders

● Parties elect to treat stock acquisition as an asset sale for tax purposes

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ASSET ACQUISITION• Target corporation

● Recognizes gain or loss on the sale of its assets at the corporate tax rate

● If it liquidates, shareholders recognize gain• Acquiring corporation

● Tax basis in Target’s assets equal to the purchase price including assumed liabilities

● Step-up in basis allows Acquirer to obtain greater depreciation and amortization deductions

• Report on Form 8594

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DEDUCTIBLE AND CAPITALIZED EXPENSES• Cost related to an acquisition or restructuring

must be capitalized if the costs “facilitated” the transaction

• “Bright-line date”: earlier of● date parties execute letter of intent, exclusivity

agreement, or similar written communication (other than a confidentiality agreement) ; or

● date on which the material terms of the transaction are authorized or approved by the taxpayer’s board of directors

• Capitalized costs• Success-based transaction fees• Start-up expenditures

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WINDING DOWN A BUSINESS

• Dissolving the company under state law• S corporation

●Recognize gain/loss at FMV (exceptions)•C corporation

●Two separate levels of tax●Liquidation of subsidiaries

• Partnerships/LLCs

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WINDING DOWN A BUSINESS

• Filing final tax return●S corp●C corp●Partnership/LLC

• Tax liabilities●Employment tax●IRS tax liens

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WINDING DOWN A BUSINESS

• Shareholder/partner loans●S corporation●C corporation●Partnership/LLC

•Cancellation of indebtedness income●Generally treated as income if debt is forgiven●No income if incurred in connection with

bankruptcy, insolvency, qualified farm indebtedness or qualified real property indebtedness.

●Determined at corporate level for S and C corps25

POLL QUESTION #3

• When a business closes any unpaid employment taxes that the business cannot pay are discharged (True or False)?

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UNIQUE ETHICAL ISSUES

• Legal fees paid as equity● Circular 230, Section 10.27

• Practitioner may not charge an unconscionable fee. • Practitioner may not charge a contingent fee for services in connection with any matter before the IRS.

• Relationships with funding sources• Circular 230, Section 10.29

● A conflict of interest exists if there is a significant risk that the representation of a client will be materially limited by the practitioner’s personal interests.

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UNIQUE ETHICAL ISSUES

• Tax/legal advice versus business advice ● IRC 7525 – With respect to “tax advice,” the same

common law protections of the attorney-client privilege apply to taxpayer and federally authorized tax practitioner.

• Who is the client? ● Entity versus founder● Founder conflicts

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POLL QUESTION #4

• What was the most important thing you learned on today’s webinar?

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QUESTIONS?

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SPEAKERS

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Travis Austin Greaves(202) 412-0019LinkedIn@GreavesWu greaveswu.com

T. Joshua Wu(571) 294-3850LinkedIn@GreavesWu greaveswu.com