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2.
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Tax factors in choice of business form.
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2.1 |
Tax factors in choice of business form. Checklist. In deciding whether to incorporate or to do business in a noncorporate form, a number of tax factors should be considered. The most important is being the impact of the income tax laws on the different types of business.
Checklist of tax factors to be considered:
The following is a broad outline of various tax considerations which must be considered.
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1. |
Federal income tax:
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a. |
Loss treatment.
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b. |
Disposition of potential taxable income.
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c. |
Double taxation.
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d. |
Death benefits.
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e. |
Retirement plans.
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2. |
Group term life insurance.
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3. |
Disability payments and medical benefits.
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4. |
Death benefits.
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5. |
Retirement plans.
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6. |
Tax affect of incorporation itself.
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7. |
Possibility of IRS challenge.
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See, S-corporations Yes or No.
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2.2 |
Non tax factors in choice of business form generally. There are many non-tax consideration to be considered in deciding which forms of business
enterprise is the best for the particular client. The non-tax issues may outweigh the
disadvantages. This does suggest that the choice is not obvious and should be given serious consideration.
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2.2.1 |
Liability of owners, is the
primary non-tax consideration in deciding whether to incorporate. See, Corporate existence and liabilities. While the achievement of limited liabilities through the corporate form is a definite advantage for established corporations, the achievement of limited liability for the owners if a closely held or new corporation can be negated for the major corporate obligations, such as bank loans lease obligations and key suppliers, because such creditors may require the shareholders to personally guarantee the credit extended to thir formed or weak corporation. See Corporation credit. Moreover, a corporation does not limit the liability of a stockholder for his own wrongful acts or omissions. Furthermore, liability may be imposed for an item such as payment of corporate taxes to include penalties, for issuance of watered stock, and when the corporate veil is pierced, as when the corporation is undercapitalized. See Piercing the corporate veil.
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2.2.2 |
Structure and control of management. While the centralization management can be created in a partnership, corporate statues themselves foster a centralized approach (See Planning control of the corporation), under state statues, shareholders periodically elect directors (See Election of Directors), who are charged with the management of corporation (See Directors, and source of power), and the Board of Directors, in turn, elects officers to carry out management policies on a day-to-day basis (See Appointment or selection of agents or officers). Corporations are generally required to have a president, secretary and treasurer, and they may have such other officers as the Board of Directors deems necessary. The respective rights and the duties of the shareholders, directors, and officers and then further defined by the corporate by-law (See Bylaws). A corporate form of organization may allow fewer than all of the owners to have more control over management by dividing the Board of Directors into classes and by creating and using an executive committee of directors. Moreover, the corporation also lends itself conveniently to a structure where management may be centralized in just a few stockholders, or even a group or individuals who owns no stock at all.
In contrast to this well-organized corporate management structure a partnership generally vests equal and indistinguishable management responsibility in all of its partners (See Partnerships), state statue
governing partnerships are far shorter and less detailed than state corporate acts, and have no equivalent provisions for a clear
separation between management and investment statues. Thus the internal management structure of a partnership must usually be
effectuated by the individual agreement of its partners, which may not lend itself to either uniformity or easy understandability. While separation between managers and investors under some state limited partnership acts, the use of such act may be less
advantageous than the corporation form in the absence of special tax or other factors.
The management advantage of corporation, may be lost in a one corporation and or when there are several owner-employees where each owner may want an equal voice in management, by agreeing to corporate organization might assist these owners to consider agreements
of need of centralized management and its benefits.
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2.3 |
Transferability of ownership, checklist. Owners have several methods of transferring the business ownership of the corporation including a sale of shares, merger or consolidation, or a sale of assets, some of which may not otherwise be available to owners of a noncorporate organization (See Transfer of stocks). Because a corporation is legally separate and distinct from its owners, and also because a corporation has a
perpetual existence, the ownership interest in a corporation, represented by stock certificates, may easily and conveniently be transferred, simply by transferring such shares, transfer of stock, shares of a corporation are freely transferable, unless otherwise agreed, without obtaining the prior consent of the remaining
owners, and upon transfer of shares, the liabilities and assets of the corporation remain with the corporation. Restrictive buy/sell agreements on stock can effectively control the
transferability of interest in a business when desired.
Checklist of free
transferability shares, are as follows:
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1. |
Equity financing is facilitated because investors understand what is it that they are purchasing.
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2. |
Easy transferability facilitates the acquisition of competent management.
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| 3. |
Gift giving and selling fractional interest is easier to deal in concept of stock rather than
percentages of interest.
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4. |
Estate planning
interest are served because shares of stock, as personal property, may usually be disposed of conveniently as part of an overall estate plan.
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5. |
The concept of freely
transferable stock allows considerable flexibility in financing a corporation with such possibilities as common stock, preferred stock, convertible shares, and stock options. These classes of stock, can be created to represent investors different expectations, and debt and stock interest can be combined in an infinite number of mixes. As a result, the corporation can accommodate owner with vastly different number of mixes. As a result, the corporation accommodate owners with vastly different objectives.
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A noncorporate interest, such as a partnership, on the other hand, is rarely represented by a certificate of ownership and is not freely
transferable. In the event of noncorporate setting it is frequently difficult to transfer ownership interest without affecting assets and liabilities (See Partnerships). Also,
transfer of ownership by fewer than all of the owners of a noncorporate form of organization often requires the consent of the remaining owners. Partnership interests are less attractive to outside
investor and give the partnership interests are less attractive to outside investors.
In a one-person of ownership by several owner employees, ease in transferring ownership may not be desired, the owners may wish to restrict the transfer of shares to keep ownership in the hands of those acceptable to the present shareholders.
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2.4 |
Continuity of enterprise. A corporation has perpetual existence, which contributes to its stability over long periods of time and is viewed as an
advantage. By contrast, the partnership usually disappears with the death or retirement of the proprietor, though the transfer of the tangible assets may be transfer. The death of a stockholder does not legally affect the continuity of the corporation. The stock simply passes to the stockholder heirs or legal representatives.
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2.5 |
Anonymity of owners. Corporations are not generally required to report the names of their owners. Where partners are required both in state filling and in court actions.
However, corporations are required to provide a name of a person of corporation for tax identification purposes and for certain personal property tax and other properties held by state residents.
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2.6 |
Organization and administrative costs. Forming a corporation is generally more expensive than forming a partnership. A partnership can legally exist and function without any documentation, though this obviously not recommended, see Partnership. A corporation does not legally exist until it is properly formed under the relevant state business corporate laws. Incorporation usually requires the expenditure of funds for legal and
filing fees that will typically exceed the cost of preparing a simple partnership agreement.
Corporations also require larger legal and accounting fees and administrative costs, as opposed to a noncorporate form. This is particularly true of the very small business. The differences are less dramatic in a large
enterprise, particularly a partnership, where additional tax return must be
prepared and file separate income returns, and must prepare and file with the state as required. Furthermore, additional legal and account ing expense must typically be incurred to
substantiate corporate accounts, and maintain corporate characteristics for federal income tax purposes.
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2.7 |
Formality of operation, is a factor connected to the cost of administration. In order to be treated as a separate entity, it must act like a separate entity. Courts have "pierced the corporate veil" to impose tax and personal liability on shareholders when the affairs of a corporation have been so intermingled with those of its shareholders that the two deemed legally indistinguishable, see Piercing the corporate veil.
One advantage, however, of the corporate form is the availability of statutory law and generally more developed judicial law to determine the authority of a corporation and the rights and obligations of its shareholders, directors and officers. Because of this there is more certainty and great
predictability as to any person's rights and obligations with respect to a corporation than with respect to a noncorporate form of organization.
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2.8 |
Doing business across state lines. Partnerships have unrestricted right to do business in other states pursuant to the
privileges and immunities of Article IV, Section 2, of the U.S. Constitution. Corporations have no such protection, however, and must formally qualify to do business in each state in which they are engaged in anything beyond what is considered pure interstate commerce, see Qualifications in a foreign state and Checklist of factors. The
failure to qualify as a foreign corporation will result in unlicensed foreign corporation being denied affirmative access to that state courts, plus being subjected to statutory penalties. This denial to access to the court of the forum state can adhere to the view that contracts made in the state before qualification may not be enforced by a foreign corporation even after subsequent
compliance with the statutory requirements.
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| 2.9 |
Terminating and changing form of organization. Dissolution is a statue process, see corporate dissolution. Some state statues may require the corporation to obtain formal certificates indicating that taxes have been paid or to give written notice of disolution confronting to specifies requirements.
Noncorporate organizations, require taxes to be paid, but dissolutions is generally not a statutory process, and no formal requirements such as certificates or notice are necessary.
Changing from a noncorporate form of organization to a corporation is generally easier and less expensive than changing from a corporate organization to a noncorporate form of organization. Changing from corporate to noncorporate not only requires dissolution of the corporate entity, but also is a taxable transaction to the shareholders, see federal taxation. Changing from noncorporate to corporate does not generally require dissolution of the noncorporate organization and may be accomplished tax-free to owners if there is no resulting change in control, see federal taxation.
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3. |
Planning Control of the Corporation. When it has been decided to incorporate, a clear understanding of the intentions of the corporation's founders as to who is to have control. Certain control devices are often necessary to ensure that all interests are protected.
Incorporator's often find these control issue to be one of the most difficult areas in planning with the founders. In a close corporation, for example, it is often assumed that majority stock holder has complete control. However, recently courts have held that majority stockholders have
fiduciary duties to minority stockholders even in closely held corporation as if they were
partners.
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3.1 |
Methods of allowing control. As mentioned
there are various devices which may be used to ensure allocation of control per the wishes of the founder(s). The more commonly used are:
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3.1.1 |
Capital structure, can provide a convenient and self-executive device for allocating positions o the board of directors or for controlling various types of corporate activity. Even in an all-common stock structure different classes of stack might be created with specified voting rights. For example, one class of stock might be guaranteed the right to elect a certain number of directors, or one class might have veto power over certain corporate events such as a merger, sale of assets, etc. See Capital stock. The same can also be done with preferred stock, with certain rights.
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3.1.2 |
Shareholder agreements, can also be used as devices to assure certain controls, see shareholder agreements. The founders of a new corporation may find it useful to have a written understand during the preliminary stages of incorporation as to such matter as capital contribution obligations, election of directors and officers and compensation for stockholder-employees. Ultimately such concerns should be addresses in carefully drafted by-laws, corporate cote authorization and employment agreements. Employment agreements with stockholder and non-stockholder should
address issues as duties, compensation, non-competition, protection of trade secrets and fringe benefits. Shareholders agreements should address such items as corporate deadlock and conditions when a
closely held corporation may be transferred.
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3.1.3 |
Voting, trusts and agreements, are useful if the founders want to provide contractually for their continued representation on the board of directors or for the continuation
so some fundamental business or corporate policy, see voting agreements of director, officers or employees, see voting trusts. In a voting trust, voting rights and other attributes of ownership are separated from each other. Hence they are often used when stockholders are not active in the business. A voting trust might also be useful when certain estate or tax planning concepts are required especially for older generations to transfer value but not control. This act is very complex and too much control there could be a view of retention values. A voting trust may also be used when a protective device is needed during an installment stock buyout.
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3.1.4 |
Bylaws provision, can be added to the bylaws or articles of incorporation to assure a certain pattern of control, such as preemptive rights to one or more classes of stock to maintain equity position, see bylaws. The articles may provide for special voting and quorum requirements for directors actions. Such as, bylaws which allow for the directors election of officers. Bur bylaws could provide for election of certain principle officers by the stockholders or by one class of stockholders.
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3.1.5 |
Stock transfer and buyout agreements. Often, shareholders agreements are used to restrict the transfer of shares and provide for the purchase of shares when a stockholder dies, ceases to be actively involved in corporate affairs, or otherwise to terminate stockholder status. While transfer of stock cannot be absolutely barred, restrictions can be imposed which make transfers very difficult or economically
disadvantageous to the selling stockholder. For example, the corporation could have an option to purchase the shares at a stated price which is low. Usually, however, the stockholder want an agreement that provides fair
compensation for the stock of a departing stockholder. A variety of valuation approaches can be used, alone or in combination, such as book value, capitalization of earnings and third-party
appraisal. Some agreements require for an annual revaluation, others provide for purchase at a negotiated price. Further, life insurance can be used to fund a buyout of stockholder upon his death. Finally, the parties must decide whether the stock of a departing stockholder is to be acquired by the corporation, the remaining stockholders or by some combination of the two approaches, see agreements restricting transfers.
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| 3.1.6 |
Stockholders of particular types of corporation. In carrying on the intentions of the founders, the planner should determine what type of corporation is desired. From the stand point of corporate control, there are four basic types of
corporations: the one-stockholder corporation, the public corporation, the close corporation where each stockholder has a veto over corporate action and policy, and the close corporation when one
stockholders or a group of stockholders will control corporate action and policy. There may be variations on these basic types. For example, in a close corporation, certain kinds of corporate action might regular unanimous consent while other kinds might only require majority approval.
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A. |
One stockholder controls, is easily provided for, since one person owns all of the stock. However, potential problem might arise, such as state law requirements that a corporation may be managed directly by its board of directors, or the possibility of loss of some of the stock if the stockholder is divorced, particularly in a state that calls for an "equitable division" of a couple's property on divorce.
Checklist of provisions as to control of One-stock corporation:
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| 1. |
Provide for management by the stockholder instead directors if state status allow.
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2. |
Provide for only one director, if allowed by state.
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3. |
Provide for removal of directors at any time without cause.
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4. |
If none of these are available in the state where business is to be done, incorporate in another state.
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5. |
If the sole stockholder is married, consider agreements to insure such continued control in the event of a divorce, such as allocating stock to the stockholder, such as allocating stock to the stockholder in the event of division of property in a divorce, having articles that allow for a majority of stock to control any corporate action.
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B. |
Public corporation controls, a public corporation is one whose shares are owned by more than a "few" people. There is no clear dividing between that constitutes a close corporation and a public corporation, but for the purposes of this discussion a public corporation will be treated as any corporation where the ownership if stock by the founder and their associates is insufficient in and of itself to insure their control of the corporation.
Presumably, the founders of a corporation will wish to retain control even if it is necessary to sell stock to the public to raise needed capital. If, after the sale of stocks to the public, the founders still own more than half the
out standing shares, retention of control should be no problem as long as founders continue to work together. If the founders are minority, it will, of course be more difficult to maintain effective control. This is especially true if they own a small
percentage such as 20% or less of the outstanding shares. Nevertheless, it is still possible for the owners of a small
percentage, especially if the remaining shares are owned by a large number of stockholders and there is no single owner has a large block of shares. This is even easier if the founders have the initial power to organize the corporation. There are various provisions which must be places in the articles, bylaws, or separate agreements to enable the founders to maintain control, such as:
Checklist to control a public corporation:
The following are suggestions as to what can be done to help founder retain control of a public corporation:
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1. |
Maximize power of board of directors including the following:
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a. |
Give board power to adopt, amend, and revoke by.
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b. |
Where possible put
rules for regulation of corporation's affairs in bylaws.
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c. |
Give board power to determine consideration to be received for shares and value of property given for shares.
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d. |
Allow a class of shares to be issued in series with board to determine rights, preferences, and limitations of series.
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e. |
Allow remaining directors to fill
vacancies of board.
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f. |
Provide that stockholders may remove director only for cause.
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2. |
Provisions with respect to stock.
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a. |
Use non-voting stock where feasible.
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b. |
Raise capital by borrowing instead of issuing stock.
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c. |
No preemptive rights.
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3. |
Provisions with respect to voting.
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a. |
No cumulative rights.
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Low quorum for stockholders meetings.
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c. |
Majority vote enough for stockholders' actions.
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d. |
Elect directors by classes.
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e. |
Majority vote and minimum quorum or director actions.
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4. |
Maintaining founders' unity.
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a. |
Voting trusts.
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b. |
Voting agreements.
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5. |
Allow dissolution only by majority vote of outstanding shares
eligible to vote.
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6. |
Incorporate in state where right of
appraisal of descending stockholders is limited.
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7. |
Incorporate in state which requires disclosure of tender offers.
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C. |
Unanimous consent close corporation. From viewpoint of control, the close corporation where each stockholder which take active interest in the business and no important corporate policy will be adopted unless all stockholders consent. This type of corporation will be referred to as a "unanimous consent close corporation". In this simplest form, each stockholder, regardless of the amount of stock he owns, can veto action or
policy desired by the other stockholder.
Each stockholder would, in this case be taking active interest and would consent to managerial decisions that the board usually responsible for, but it does not mean that they would have to agree on decisions normally made in the day-to-day operations of the corporation. Corporate office or employee would still have authority to make such decisions. The following provisions would be used in attaining the purposes of a unanimous consent corporation as referred to above. Some of these provisions would be necessary only if a particular state's law didn't allow other provisions to be adopted, for example, provisions concerning the directors wouldn't be needed if a state allowed a corporation to be managed directly by the stockholders.
Checklist, Unanimous consent of close corporation:
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1. |
Provide for management directly by stockholders with unanimous consent of all stockholders required to adopt corporate policies and approve important actions.
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Provide that all stockholders shall be directors by using one or more of the following:
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a. |
Cumulative voting.
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b. |
Classes of stock.
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c. |
Voting agreements.
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3. |
Provide that all directors must be present to constitute a quorum for meetings, and that all directors must consent to adopt corporate policies and approve important actions.
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d. |
Allow stockholders preemptive rights.
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e. |
Restrict right to transfer without cause.
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f. |
Allow directors to be removed without cause.
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g. |
Employment agreements between the corporation and stockholder employees should allow discharge only for a cause.
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h. |
Permit any stockholder to dissolve corporation.
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i. |
Consider, providing, in articles, a formula for determining the amount of dividends the corporation is required to pay.
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j. |
Allow stockholders and / or directors to take action without meeting.
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D. |
Close corporation stockholder(s) control, is a corporation whose founders are willing to delegate control of the
corporation to one stockholder or group of stockholders, even though such stockholders of group does not own a majority of the outstanding shares. There will usually be some things that control stockholder(s) can't do without consent of the others. For example , the control stockholder(s) close corporation will probably allow stockholders preemptive rights, not as a means of insuring control and keeping outsiders out, but in order to prevent dilution of a stockholder's interest. The exact dimensions of the control to be given to the
stockholder(s) will vary from corporation to corporation. Generally, the control stockholder(s) will have full run of the day-to-day operations, to determine new lines of business, whether to open new business and whether to seek additional financing. On the other hand, their power over structural
ones, such as mergers of dissolutions may be limited by providing for consent by all the stockholders. The following matters should be considered by the founders and planners of a control stockholder(s) close corporation.
Checklist, Control stockholder(s) close corporation:
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1. |
Consider incorporating in a state that allows a corporation to managed by one
to more general manager's instead of by a board of director's if a provision to that affect is contained in the articles.
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2. |
If having a general manager isn't feasible, limited number of directors to number of stockholders and prove that only control stockholder(s) be directors. Consider using one of the following to make such provision:
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a. |
Voting and non-voting common shares.
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b. |
Voting trusts.
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c. |
Voting agreements.
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3. |
Consider incorporating in a state that allows a corporation to managed by one
to more general manager's instead of by a board of director's if a provision to that affect is contained in the articles.
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4. |
Unanimity needed.
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5. |
Majority enough.
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6. |
Percentage greater than majority but less than.
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7. |
Consider what corporate actions should be approved the vote of the stockholders generally either because required by state law or because the founders want certain matters reserved to the stockholders generally and decide what
percentage of the voting stock will be needed for approval of such matters.
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8. |
Consider whether corporate purposes should be limited so as to limit control stockholder(s). Discretion as to business corporation will be able to engage in.
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9. |
Consider provisions as to who may dissolve the corporation.
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a. |
The control stockholder(s), and if more than one,
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i. |
Any control stockholder.
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ii. |
Majority of control stockholders.
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iii. |
Percentage of control stockholders greater than majority but less than all.
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iv. |
100% of control stockholders.
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b. |
Holders of a stated
percentage of outstanding shares, such as ¼ or 1/3 less than majority, but one of whom must also be a control stockholder.
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c. |
Holders of majority of outstanding stock.
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