ADVISING STARTUPS AND - … • Starting a new business venture Choosing the business form Basic compliance and governance Financing a new business • …

ADVISING STARTUPS AND

ENTREPRENEURS

Sponsored by T. Joshua Wu

www.jwlawdc.com

ADVISING STARTUPS AND

ENTREPRENEURS

T. Joshua Wu

www.jwlawdc.com

2

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 entrepreneurs

3

POLL QUESTION #1

• How often to you advise clients with respect to

starting a new business?

4

BASIC ENTITY CHART

Sole

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.

5

BASIC ENTITY CHART

Sole

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

6

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

7

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

8

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

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

10

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 Crowdfunding

13

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

15

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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DEALING WITH COMMON TAX ISSUES

• Recordkeeping

• Start-up expenditures

• Expanding existing business

• Travel and Entertainment Expenses

• Car and Truck Expenses

• Advertising Expenses

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• Payroll time management, Billing

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• Simple clock in/out functionality

• Full job tracking, dept., location,

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• GPS capabilities

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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 20

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

21

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

22

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 expenditures23

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

• Employment taxes

24

POLL QUESTION #3

• When a business closes any unpaid employment

taxes that the business cannot pay are

discharged (True or False)?

25

UNIQUE ETHICAL ISSUES

• 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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Poll Question #5

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•I need more information

•I already am a TSheetsPRO

31

QUESTIONS?

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The information contained in this presentation provides background information about certain legal issues and

should not be regarded as rendering legal advice to any person or entity. As such, the information is not

privileged and does not create an attorney-client relationship with JW Law PLLC, or any of the firm’s lawyers.

This presentation does not constitute an offer to represent you, and you should not act, or refrain from acting,

based upon any information so provided. In addition, the information contained in this presentation is not specific

to any particular case or situation and may not reflect the most current legal developments, verdicts, or

settlements. In the event that you have questions about and are seeking legal advice concerning your particular

situation in light of the matters discussed in the presentation, please contact us so that we can take the necessary

steps to form an attorney-client relationship if that is warranted.

Copyright

© 2017 JW Law PLLC

All Rights Reserved.

SPEAKERS

33

T. Joshua Wu

(571) 294-3850

[email protected]

LinkedIn

@jwlawdc