Category: Tax

Strip Rights

Employees/Contractors, Securities, Stock, Tax

In addition to the other ways we’ve discussed here (stock options, phantom stock, stock appreciation rights), another way to compensate individuals working for a startup is to give them a cash payment upon a change in control of the company, called in the industry a “strip right”.

For example if a startup company has four founders each owning 25% of the shares, and they bring on another but don’t grant him or her shares, the initial founders can agree to pay the new individual a percentage of the “net proceeds” received from a “change in control” of the corporation.   “Net proceeds” is usually defined as the gross proceeds received minus transaction costs and brokers commissions as well as some other items.   A “change in control” is defined as it normally is in these agreements, and covers if the company merges with another or sells substantially all of the company’s assets.  In such a case, the shareholders would receive cash (or assets it can sell for cash, like tradeable shares of the acquirer).  The strip right agreement would require the shareholders that granted it to pay to the holder of the strip right, either a percentage or flat fee before they received their cash for the change of control.

In the example, if the four founders grant a 10% strip right, and a couple years down the road the company is sold for one million dollars, with transaction fees of $100,000, the holder of the strip right would receive $90,000 (net proceeds of $900,000 x ten percent).    The shareholders would split the rest of the $810,000 and each receive $202,500.

One of the benefits of the granting of the strip right is that it is not taxable to the recipient.  The downside, at least to the recipient is that they are not a shareholder of the corporation and they may never receive a cent if there is never a change in control.  Due to its tenuous nature, the strip right is usually granted in connection with other compensation awards.

 

S Corporations: Loss of S Election Due to Disparate Distributions

S Corporations, Tax

Another item that could cause an entity taxed as an S corporation to lose the election is disparate distributions.  Like most things, this is simple in theory but more complicated in application.  The theory is that the shareholders of an S corporation are entitled only to the proportion of corporation distributions based on their percentage ownership of the stock.  In other words, if you are a shareholder of an S corporation, you are entitled to the same proportion of distributions as you own shares (if you own 1/3 of the shares, you are entitled to 1/3 of the distributions). Read more

S Corporations: Losing S-Corp Status Due to Passive Income

Choice of Entity, S Corporations, Tax

Owners of corporations elect S corporation taxation status for the pass through and other benefits the election provides. There are various things that can arise that would cause an S corporation to lose its election.  In this and following posts, I’ll walk through some of the most common.  The one I want to discuss now is the S corporation passive income restriction.  Read more

S Corporations: Electing to be taxed as an S Corporation

Business Entity Formation, Choice of Entity, S Corporations, Startup Formation, Tax

I’m going to be posting a number of posts on the ins and outs of electing and operating a corporation which elects to be taxed as a small business corporation (an “S Corp”) with the IRS.  There are many benefits to such an election, but there are also pitfalls that many owners run into that could jeopardize the election.

The first post in this series is simply how to make the election. Read more

Quicker, Shorter IRS Form 1023-EZ for 501(c)(3) Tax-Exempt Status

Tax

On July 1, 2014, the IRS introduced a new application form to allow small charities to apply for tax exempt status under IRC Section 501(c)(3).

Form 1023-EZ is only three pages long, and organizations with gross receipts of $50,000 or less and assets of $250,000 or less are eligible to use it.  Charities filing the 1023-EZ, provided everything is in order, will know of their status within a couple of weeks (that’s right, weeks, not months).

Compare this with the regular Form 1023 which is 26 pages long and asks for a laundry list of information on the charity, the board of directors and officers.  Many applicants using the Form 1023 didn’t hear back from the IRS for many months, sometimes as long as nine, which can seem like an eternity when in fundraising mode.

The new 1023-EZ Form must be filed online, see here.  The instructions include an eligibility checklist.

Use your Retirement Plan to Fund your Startup

Business Entity Formation, Financing Your Business, Startup Formation, Stock, Tax

First of all, I won’t advise anyone to withdraw their 401(k) funds early as the tax hit the IRS enacts is insane.  If you are thinking about doing that, please don’t, or at least don’t do so until you’ve spoken to your accountant.

This post will, however, detail how to use your qualified retirement plan or IRA to start a new, or buy an existing, business.  This name given to the process I’ll discuss is rollovers as business startups (“ROBS”).  The main gist is that an individual’s current retirement plan is rolled over into a newly established 401(k) plan sponsored by a startup company and then used to purchase the startup company’s stock.  The ROBS arrangement allows income taxes and penalties (see IRC Section 72(t))to be avoided because it is a rollover from one qualified plan to another. Read more

New York’s STARTUP-NY Program

Employees/Contractors, Startup Formation, Tax

Starting at the beginning of 2014, New York’s STARTUP-NY Program went live.  Here is the official website for the initiative.  Its goals are laudable but its only available to a small niche of companies.  If your company qualifies, however, the benefits are rather nice.

In summary, the Program provides eligible companies with free office space (at certain locations) for a period of time and the employees of the company pay no state income tax on their income (at least for the first five years, with a small amount possibly paid in years 5 through ten).  The Program is attempting to lure out-of-state companies into New York, while encouraging sprouting of new startups that otherwise may not have started without these benefits.  Overall New York is looking to add more jobs in the state, and the more jobs now (even with tax breaks) the more taxes the state can collect in teh future.  Read more

Domestic International Sales Corporations

Business Entity Formation, Choice of Entity, Startup Formation, Tax

If you export products for sale of any type and don’t know what an IC-DISC (or simply a DISC) is, or think it’s a round piece of plastic you put in your computer’s drive, then keep reading.  Any United States business with qualifying export sales can save a large amount of money with the use of a Interest Charge Domestic International Sales Corporation (referred to hereinafter as a “DISC”). Read more

Tax Treatment of S-Corp Payments to Shareholders

Choice of Entity, Tax

Shareholders who are employed by a corporation which has elected to be taxed as an S-Corp wear two hats.  They are investors in the entity (they contributed capital to get their shares initially) and allowed to get a return on their capital, and they are employees who receive wages.  When an owner/employee of an S-Corp (or an LLC which is taxed as an S-Corp) is on a salary from the S-Corp, the wages payable are subject to employment taxes, and distributions made to the owner of the S-Corp are not subject to employment taxes.  Also if the S-Corp was loaned money by the shareholder, the S-Corp can make payments to repay the loan to the shareholder, and these payments will not be subject to the employment tax.  Misclassifying payments as distributions or loan repayments, when they really should be wages can lead to an audit from the IRS.

In a recent case from the United States Tax Court (Glass Blocks Unlimited, TC Memo, 2013-180), Read more