When Doing Nothing Can Cost You Everything: Why You Need a Business Succession Plan

Thursday, February 11, 2016 @ 12:02 PM
Author: Peter Brehm

No business owner would deliberately risk the very enterprise that could help fund his or her retirement and prove to be a lasting legacy. Yet, an owner who has failed to plan for business-succession or exit upon retirement does exactly that. Here’s how to avoid the sometimes substantial cost of doing nothing.

“Albert” is the 63-year old owner of a profitable retail operation that boasts annual sales (revenue) of around $1 million. Since launching the business 20 years ago, Albert runs the day-to-day operations full time, and has been drawing an annual salary of about $60,000 in recent years. He also employs four part-timers to run the cash registers and stock shelves now and then. Currently, the entity holds about $125,000 worth of inventory (based on current purchase price of items) and around $100,000 in equipment. A quick estimation of the business’s value can be gauged by applying the rule-of-thumb similar businesses (ones selling the same product or service) use in his geographical area: calculate 50% of average annual sales over the past three tax-reporting years.

In Albert’s case, that would amount to a business worth roughly $500,000 (business value including equipment, good will, etc.).

The strain of working 12-hour days in retail is starting to take its toll on Albert’s health, however. Albert agrees that he can’t keep up his current pace much longer, but has procrastinated on actually coming up with a business-transition or succession plan, feeling confused and overwhelmed at the thought of it. “I’ll probably just work until I can’t anymore,” he laughs. When his friends ask what he’d actually do if he were unable to work, he scoffs, “That’ll never happen.” A few weeks later, a fall from a ladder puts Albert in the hospital for several weeks. With no one to take his place, Albert thinks it best to consider closing up for a while, if not permanently. “It had a good run,” he says, thinking that this outcome was probably inevitable.

An All-Too Familiar Story Read More

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Minnesota’s B Corporation – The Public Benefit Corporation

Wednesday, November 12, 2014 @ 09:11 AM
Author: Peter Brehm

Many of our clients at Business Law Center are more than great business people, they are great people who do more for their communities than just create wealth.  The problem for some for profit companies is that the primary, if not exclusive purpose for the company is to create profits for the shareholders.  So, if the board of directors approves a program donating 10% of the company’s profits to a charitable organization, or cancels a lucrative contract with a business because it was using child labor, some (or all of the shareholders) could take action against the board for making decisions for reasons other than company profits.

Enter the B Corporation.  Minnesota’s new (effective January 1, 2015) Public Benefit Corporation.  Not to be confused with non-profit corporations, the B Corporation has shareholders, profits, and the board is required to consider, the impact of all actions on the financial interests of the owners.  Also, unlike a non-profit, there is no public agency that will force to the company to pursue its purpose.

However, like a non-profit, the corporation may also require the board to consider factors other than profits, and shields the directors from liability from doing so:

     In discharging the duties of the position of director of a specific benefit corporation, a director:

          (1) shall consider the effects of any proposed, contemplated, or actual conduct on:

                (i) the pecuniary interest of its shareholders; and

                (ii) the specific benefit corporation’s ability to pursue its specific public benefit purpose;

          (2) may consider the interests of the constituencies stated in section 302A.251, subdivision 5; and

          (3) may not give regular, presumptive, or permanent priority to:

               (i) the pecuniary interests of the shareholders; or

              (ii) any other interest or consideration unless the articles identify the interest or consideration as having priority.

There are two types of B Corporations:

General benefit corporations are required to pursue a net material positive impact from its business and operations on society, the environment and the well-being of present and future generations. In addition to this broad obligation, general benefit corporations may also state a specific public benefit, or benefits.

Specific benefit corporations are required to elect only to pursue one or more positive impacts, or reduction of a negative impact, on specified categories of natural persons, entities, communities or interests other than shareholders (in their capacity as shareholders). This narrower obligation allows the specific benefit corporation to focus its mission on one or more explicit benefits without the general societal concerns required of general benefit corporations.

The B Corporation should not be confused with C Corporations or S Corporations, in that it is not a tax designation, it is really just a subset of a typical Minnesota corporation governed by 302A.  Any new or existing corporation may elect to become a B Corporation though it original articles, by amending its articles to comply with the statute, or through a merger.   Any election to do so, however, will permit unhappy shareholders to be bought out.

Finally, one of the significant drawbacks of the B Corporation, is the requirements of transparency.  Every year, the company must file an annual report with the Secretary of State.  That report is public, and must detail how the company sought to fulfill its public purpose.  If the company is a general benefit corporation,  report must be based upon an independent third party standard for similar companies.

Peter C. Brehm

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New Minnesota Estate and Gift Tax Laws

Thursday, June 6, 2013 @ 10:06 AM
Author: Steven Ness

At the end of May the Minnesota Governor signed a bill into law that will impact people who reside in Minnesota and those who claim their residence in another state but own property in Minnesota.  Minnesota is now the second state (after Connecticut) to impose a gift tax. The new law also imposes a Minnesota estate tax for all property located in Minnesota held in pass-through entities (an LLC, Sub S Corp or partnership). Some key provisions provide:

  1. A Minnesota gift tax of 10 percent will be imposed on certain taxable gifts made by Minnesota residents and non-residents owning property located in Minnesota.

·         Beginning on June 30, 2013, Minnesota residents and non-residents will be subject to Minnesota gift tax on all transfers of real property located within Minnesota and transfers of tangible personal property that is customarily kept in Minnesota at the time the gift is executed. In addition, Minnesota residents will also be subject to Minnesota gift tax on transfers of intangible assets (e.g., cash, securities, business interests).

 ·         Each person has a lifetime exemption of $1,000,000 from the Minnesota gift tax. The Minnesota gift tax only applies to transfers that are treated as taxable gifts for federal gift tax purposes. As a result, certain gifts that are not subject to the federal gift tax – including transfers falling under the annual exclusion cap ($14,000 in 2013), gifts to spouses, charitable gifts and certain transfers for educational or medical purposes – will not be subject to the Minnesota gift tax.

 ·         This may be particularly important for people who have not yet taken advantage of their $5,000,000 federal gift, estate and generation-skipping transfer tax exemptions (indexed for inflation to $5,250,000 in 2013)

 

  1. Unlike many other states, Minnesota still has an estate tax on taxable estates that exceed $1,000,000 (with a top tax rate of 16%). Beginning in 2013, individuals who die resident in Minnesota or those who own property located in Minnesota will be required to include in their Minnesota taxable estate taxable gifts made within 3 years of death.

 

  1. For people dying after December 31, 2012, who own a pass-through entity (such as an LLC, S Corp or partnership) the location of real or tangible personal property held in the entity will be determined as though the entity does not exist. This means that property located in Minnesota held in pass-through entities will be subject to estate tax.

 ·      Under prior law, a non-resident owner of an interest in a pass-through entity that owned real estate, inventory or equipment in Minnesota was not subject to Minnesota estate tax on that property. The new law will subject such property to Minnesota estate tax, even if the business owner or investor has no other connection to Minnesota and even if the business entity is organized and operated in another state.

·         Non-Minnesota residents who may have previously transferred Minnesota situated property to a pass-through entity, in order to avoid the Minnesota estate tax, should to review these transfers. This is no longer an effective way to reduce or avoid Minnesota estate taxes.

·         Since the new law does not apply to Minnesota-situated property owned by C Corporations people owning pass through entities will want to consider whether a conversion to a C Corporation is appropriate.

At this point in time, the new law does not include a similar provision for Minnesota gift tax. After June 30, non-residents may be able to continue making gifts of interests in pass-through entities owning Minnesota property, without triggering a Minnesota gift tax. It must be remembered that any such gifts made within 3 years of death will be included in the gifting individual’s Minnesota taxable estate. People who desire to complete gifts of Minnesota situated assets should consider doing so as soon as possible.  It is anticipated by many that the Minnesota gift tax provisions will be modified to align with the new Minnesota estate tax provisions in one of the next legislative sessions.

 

 

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It May Be Time to Review Your Estate Plan

Wednesday, March 6, 2013 @ 09:03 AM
Author: Steven Ness

For more than a decade the estate planning landscape has been foggy at best.  During that entire period, existing laws created “automatic” changes that many tax and legal professionals found difficult to predict.  The passing of the American Taxpayer Relief Act of 2012 (the “2012 Act”) at the close of 2012, finally makes the estate and gift tax laws “permanent,” meaning that they are not scheduled to expire, be repealed or rolled back. This is a significant change because since 2001 taxpayers and their advisers have had to plan based on an uncertain statutory framework.

The 2012 Act sets the estate tax exemption amount at $5 million. This is the amount of money that can pass estate tax free to any individual without triggering federal estate tax.  Since this exemption amount will be adjusted for inflation, the exemption amount in 2012 was actually $5.12 million and it is predicted to rise to $5.25 million this year.

The 2012 Act unifies the estate tax with the gift tax, making the lifetime gift tax exemption amount also equal to $5 million (adjusted for inflation). The generation-skipping tax (“GST”) exemption amount is also set at $5 million (adjusted for inflation). As a result, a person can gift over $5 million during life ($10 million between spouses) and not trigger any transfer tax.

The maximum estate and gift tax rate was increased from 35% to 40%.

The “portability” of exemptions between spouses has been permanently extended so that a surviving spouse will be able to utilize his or her last deceased spouse’s unused exemption amount. This does require the filing of a federal estate tax return, but with proper elections built into a carefully prepared estate plan, a surviving spouse can protect up to $10 million (adjusted for inflation) if his or her deceased spouse did not utilize any of his or her exclusion amounts.

While the exemption amounts are high and portability enables a surviving spouse to use both spouses’ exemptions, there are still many reasons why planning during life is very important, including:

  1. All appreciation on gifted assets escapes federal and state estate taxes. For this reason, it still may make sense to make lifetime gifts if you anticipate that assets may appreciate and/or grow to a level that exceeds the exemption amounts.
  2. While the federal exemption amount is $5 million, the Minnesota estate tax exemption amount is still $1 million. A $10 million estate may not be subject to federal estate tax but will be subject to approximately $1 million in Minnesota estate tax.  Proper planning can reduce or eliminate this $1 million state estate tax exposure.
  3. While the estate tax exemption is portable, the state level estate tax exemption and the federal GST exemption are not portable. If not properly planned for, these valuable exemptions can be wasted, costing significant tax dollars.

Steven E. Ness is an estate planning attorney for Business Law Center, PLC in Bloomington, Minnesota.

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Tax Savings for Companies Selling in Foreign Countries

Friday, February 1, 2013 @ 01:02 PM
Author: Steven Ness

An Interest Charge Domestic International Sales Corporation (commonly called an “IC-DISC”) is a unique tax savings entity, available to U.S. companies that have substantial sales to foreign countries, which includes sales to Canada and Mexico. An IC-DISC reduces tax liability by converting a portion of export income, which is taxable at ordinary income rates as high as 35% into qualified dividends generally taxed at 15%.

In short, an IC-DISC is a tax-exempt, domestic “paper” C corporation set up to receive commissions on the company’s export sales. The IC-DISC must have its own bank account, keep separate accounting records and file U.S. tax returns. But this separate entity need not have an office, employees or tangible assets nor is it required to perform any services.

To qualify as and IC-DISC a U.S. corporation must:

1. Be incorporated in one of the 50 states or District of Columbia;
2. File an election with the IRS to be treated as an IC-DISC for federal tax purposes (the application can be found at http://www.irs.gov/pub/irs-pdf/i1120icd.pdf);
3. Maintain a minimum capitalization of $2,500;
4. Have a single class of stock;
5. Meet a qualified export receipts test and a qualified export assets test;

Meeting a qualified export receipts test and a qualified export assets test indicates that at least 95% of an IC-DISC’s gross receipts and assets must be related to the export of property whose value is at least 50% attributable to U.S. produced content. Some services, such as engineering and architectural services related to construction projects outside the U.S. may also generate qualified export receipts.

The internal processes followed by an IC-DISC can be summarized as follows:

1. An owner-managed exporting company organizes a new C corporation and applies for qualification as a tax-exempt IC-DISC;
2. The exporting company pays IC-DISC a commission;
3. The exporting company deducts commission from ordinary income taxed at 35%;
4. The IC-DISC pays no tax on the commission;
5. The shareholders of the IC-DISC must pay income tax on dividends at a qualified rate of 15%;
6. The result is 20 percent tax savings on commissions.

Steven E. Ness is a busienss attorney with Business Law Center in Minneapolis Minnesota

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Starting a Business Seminar for Veterans

Tuesday, October 16, 2012 @ 10:10 AM
Author: BLCADMIN

On October 20, 2012, Peter will be a presenter at a seminar provided by SCORE and the VA to help veterans and their family members start a  business.   The seminar will be held 9 a.m.-3 p.m. in the auditorium of the Minneapolis VA Medical Center, One Veterans Drive, Minneapolis, and the cost of the seminar is covered by the VA, so if you (or someone you know) in interested in starting a business you can register here.

 

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Tax Plans Must Have A Business Purpose, and Sometimes Even Tax Attorneys End Up in Jail

Friday, September 14, 2012 @ 10:09 AM
Author: Peter Brehm

When I was in the mire of my tax education I was presented with this seemingly contradictory reality:

1. Congress creates rules in the tax code (including deductions and credits) to encourage businesses to engage in specific types of conduct (buy certain products, hire certain types of employees, or provide specific benefits); and

2. Congress (and the IRS) also creates rule prohibiting businesses from claiming those tax benefits unless there is a substantial business purpose for the transaction other than tax savings.

One of the frustrating parts of tax planning is coming to grips with the idea that Congress wants to control your behavior with rewards, but then denies you the reward if they find out that you only did it for the money. Its a bit like offering someone $1,000 to be your friend, and then refusing to pay them when you find out that they only liked you for your money. So the game becomes convincing the IRS that you love their sense of humor and just as much as (if not more than) their deductions.

Successful business owners are like gold to tax planning consultants because they have the two things that all tax planners need: taxable income and a desire to send less of that income to the government. As a result, the more successful you are, the greater the chance that you will find yourself in contact with an army of tax planners and consultants. Tax planners (and tax attorneys) range from conservative (declare all income at the highest possible tax rate), moderately creative (use the plain language of the tax code to reduce taxes within the letter of the law), aggressively creative (expand the possible meaning of the code, and fill in gaps of the code to aggressively reduce taxes), to criminally creative (knowingly engaging in planning and conduct that is contrary to the law to avoid taxes at all costs).

Its not always easy to tell which kind of adviser you are dealing with, but the line you should never cross (and a clear indication that you are entering the world of the criminal planner) is a fairly bright one: would I do this transaction if I wouldn’t save taxes? If the answer is yes, then you are probably fine. If the answer is a resounding NO, there is a good chance that something is amiss, and that you should speak with a lawyer (unrelated to the people selling you their plan) about the transaction. For example, would you take all of your liquid assets, transfer them into a trust controlled by someone you don’t know in another country, who then deposits the funds in a third world bank? If you can think of a good reason for your business to do that, and you were going to do that anyway, any tax benefits will probably be appropriate. If the primary, if not exclusive, reason was to save taxes then tough times may be ahead.

Often times these people will have already anticipated your objections, and may present you with a letter from a reputable lawyer or accounting firm to alleviate your fears. Rather than calm you, let me suggest that this is exactly the time to reach out to a qualified tax lawyer who has no stake in the proposed transaction. Why? Because some lawyers (and I am going to shock some of you here) are not particularly ethical.

Yesterday a lawyer out of Chicago pled guilty to conspiracy and tax evasion (in a scheme in which she made $1.6 Millon). Her crime? Knowingly writing false tax opinion letters. In those letters, the attorney opined that transactions without any purpose other than tax avoidance had “a substantial business purpose”. The client needed the letter to justify a transaction that was solely for tax avoidance and the lawyer was willing to write the letter for money. Now, they are all going to prison. Here is a copy of the plea agreement if you have ever wanted to see one.

There are a LOT of very good and ethical tax planners in this country, with a LOT of very good and creative tax planning ideas and opportunities. And to be very clear, the tax code is almost beyond common sense comprehension, and some of the best legal and tax minds will disagree among themselves about what the code does and should say. So nearly all tax planning, even good faith conservative planning, has some level of risk associate with it. But there are three things I want people to understand: 1. whatever planning you do should generally be tied to a purpose beyond tax savings; 2. there are professionals who will advise you to take a tax benefit you are not entitled to so that they can make money off of your money; and 3. when you enter into those kind of transactions, no matter how many letters you have saying it was OK, everyone can end up in jail.

Peter Brehm is a tax attorney practicing with the Business Law Center in Minneapolis, Minnesota and Scottsdale, Arizona.

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Don’t Hire an Unregistered Subcontractor After 9-15-2012!

Tuesday, August 14, 2012 @ 03:08 PM
Author: Peter Brehm

As of 9-15-2012, subcontractors in the State of Minnesota may have to register with the state, or they will deemed to be employees. The law replaces the old exemption certificate process with a (purportedly) simplified online registration. Hiring an unregistered contractor to perform subcontracted work will reclassify the worker as an employee of the party hiring them. That means increased workers compensation, unemployment compensation, state and federal withholding, FICA, penalties and interest on these and general liability premium increases. Further, there is a $2,000 penalty for violating the registration law. This reclassification is a bright-line test to state and federal authorities, and will increase the likelihood of a successful audit because proof requires only the absence of registration.

The following people and entities must register:

1. Individuals or business entities;
2. That performs commercial or residential building construction or improvement services;
3. Do not have a current license, certificate or registration issued by DLI;
4. Do not have a current independent contractor exemption certificate;
5. Do not have an employee of a business performing construction services; and
6. Are not exempt from licensing under Minnesota Statutes 326B.805, subd. 6 (5) or excluded from registration requirements under Minnesota Statutes 181.723, subd. 4a.

If you are a subcontractor, and you don’t know if you have to register, the DOLI has a site that can help you, you can read the Summer 2012 CCLD Review, or you can call our offices. To register, you can go the DOLI’s web site here.

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Gifting Stock: Use a Formula, Not a Savings Clause

Thursday, August 9, 2012 @ 02:08 PM
Author: Peter Brehm

Small business owners often struggle finding ways to transfer the value of what they have built to their children and grandchildren.  The current tax law permits a parent to gift $13,000 to each child without paying gift tax.  So, for example, a husband and wife with 4 children could gift $26,000 in stock every year to each child ($104,000 per year) without paying tax.   As most small business owners know, however, establishing the value of small business stock is not easy to do, and if the IRS decides that the amount of stock you gave exceeds the annual exclusion amount, there is the potential for a rather punitive gift tax.

Many practitioners have tried to remedy this situation by adding a ‘savings clause’ to the gift that says: we are gifting X number of shares to each child with the expectation that the value of the shares does not exceed the gift tax exclusion amount, and if the IRS finds that  X number of shares exceeds the gift tax exclusion amount, we take back enough of the gift so that no tax is owed.  The IRS, and most court have rejected this approach.

However, the Tax Court has held that a gift of stock based upon a formula, where the gift is for a set dollar amount (not a specific number of shares) the taxpayer can effectively create a gift that will never exceed the exclusion amount.  In Wandry v. Commissioner, the court held that “[a] savings clause is void because it creates a donor that tries ‘to take property back’.  On the other hand, a ‘formula clause’ is valid because it merely transfers a ‘fixed set of rights with uncertain value’.  The difference depends on an understanding of just what the donor is trying to give away.”

For the small business owner the solution is clear: when planning around the gift tax exclusion, you should use a formula based gift, not a savings clause.

Peter Brehm is a small business and estate lawyer practicing in Minneapolis, Minnesota and Scottsdale, Arizona.

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Will Minnesota Tax Your Estate?

Tuesday, July 10, 2012 @ 08:07 AM
Author: Steven Ness

The State of Minnesota imposes a tax on the estates of individuals who are residents of the state when they die or who own tangible property in MN when they die. The taxable estate is generally the fair market value of the estate on the day the decedent died, less deductions (e.g., transfers to a surviving spouse and charitable bequests) and an exemption mount, which is $1 million for unmarried individuals. The tax is imposed under a graduated rate schedule on the taxable estate.  The tax rates range from 0.8% to 16%. For the 16 years ending December 31, 2001, the MN estate tax was directly linked to the federal tax as a “pickup” or “soak-up” tax equal to the credit allowed under federal estate tax for state death taxes. As a pickup tax, the MN tax imposed no additional tax burden on estates. For each dollar of state tax paid, federal tax was reduced by an equal amount.

However, U.S. Congress repealed this credit in 2001, the MN legislature chose to continue imposing the estate tax under the rules in effect before Congress repealed the credit. As a result, the MN estate tax now is a stand-alone tax.  Many people, including some estate planning practitioners, drafted their estate plan around the federal estate tax and ignored the impact of Minnesota’s estate tax rules.  All estate plans, especially estate plans created prior to 2002, should be reviewed, and may need to be modified to recognize Minnesota’s lower taxable estate threshold.

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