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BUSINESS PLANNING Long Outline Clutts I. Representing Clients
1. Rep'ing an Entity a. Rules say you are rep'ing the entity, which is separate & distinct fr the officers, directors, & S/Hs. i.
1.13. Organization as Client b. Take-Away for Actual Practice---
i. When you rep a co., be careful how close you get w/officers & directors b/c they aren't your clients.
Know your duty is to the entity, & be prepared to terminate the president if that's what the entity tells you to do. ii. If you know that an officer, director, etc., is engaging in behavior that is likely to result in substantial injury to the org, you MUST report up the ladder!
iii. When dealing w/officers, directors, etc., make sure they understand who you rep. So tell them you don't rep them specifically. iv. Privilege - When officers, directors, etc., are communicating w/you in regards to the org, then that info ISprivileged; however, if they are NOT communicating about the org, then it is not privileged. c. Rule 4.4. Respect for Rights of Third Persons---
i. Shall not use means that have no substantial purpose other than to embarrass, delay, or burden a 3d person, OR use methods of obtaining evidence that violate the legal rights of such person ii. Inadvertently sent docs---lawyer shall promptly notify sender. iii. Overall Take-Away: Be careful when sending emails (double check text & senders) & be courteous as an atty if you receive an inadvertent email. Representing a Closely Held Business - Issues To Think About:
1. Form of business entity to use (part of which is tax planning) a. SP b. GP c. LP d. Corp e. LLC f. Etc.
2. Attorney-Client Agreement (Engagement Letter) a. Very helpful & important b. Who signs?
c. Terms/Provisions: i. Who you are representing (ENTITY, not officers, directors, EEs, S/Hs) ii. Scope of Repn iii. Fees (a) Retainers - there are differing views. iv. How to contact you/your office v. How you will communicate w/client vi. What the client's responsibilities are: (a) To pay (b) To provide info to you (your repn is limited by the scope of the info that they provide to you) Client Objectives
1. Private Business Classifications a. The Soloist i. One owner - no partners, no co-S/Hs ii. Can take many forms: (a) Corp (b) LLC (c) SP iii. No need for buy-sell agreements, control strategies, or IRC provisions on p'ships iv. Still concerned w: (a) Entity forms & structures (b) Motivation & retaining key EEs (c) Funding & growing the enterprise
BUSINESS PLANNING Long Outline Clutts (d) Developing exit strategies (e) Controlling & managing risks (f) Taxes b. Toilers i. Business owned by individuals who work full-time for the bus. ii. Care about: (a) Stability (b) Independence of working for themselves (c) Cash flow to owners (d) "Democratic" control, w/minority rights being protected only on the most sensitive issues (e) Careful control of admitting new owners (f) Exiting & survival after departing partner c. Golfers i. Org owned by investors who do not work for the bus, but often heavily involved in the highest-level
mgmt decisions but not the day-to-day operations ii. Care about quick returns on investment iii. Don't care as much about risks or ownership changes Hybrid i. Org has BOTH toilers & golfers as owners ii. Usually most difficult org to plan (a) Toilers care about risks & stability (b) Golfers care about money, want flexibility to exit & cash out whenever they want Big Fish i. Org has one big majority owner & a few small minority owners (a) Dominant owner (big fish) cd be toiler or golfer (1) Usually wants & expects special treatment (2) Exclusive control rights that can be passed on to chosen successors (3) Special buy-out rights & liquidity protections to ensure his/her position can always be preserved (b) Minority owners usually toilers (1) Usually maintain their equity interests at will of big fish Family Affair i. Org owned & controlled by a single family ii. Planning issues: (a) Estate planning challenges (b) Dynamics among family members (c) Liquidity issues (d) Control issues iii. Planners' family objectives typically take priority over business issues, & children will have special agendas Personal Service Org i. Org that generates income by its owners providing services in fields (a) Typical Fields (1) Healthcare (2) Law (3) Engineering (4) Accounting (5) Actuarial science (6) Performing arts (7) Consulting (b) Typically toiler orgs ii. Distinct bc: (a) Owners are the instruments of production of the business
(1) are well educated, independent & have flexibility to make a move at any time - (2) big egos; makes these orgs fragile (3) Creates transitioning in & out problematic (b) Have own tax provisions (usually not friendly) (1) All income taxed at max corp 45% rate II. Liability A. GR: No Individual Liability
1. Generally, officers of a corporation are not liable to third persons for corporate acts where they do not purport to bind themselves.
B. Exceptions:Piercing the Corp Veil
1. Dram Shop Cases a. In the cases in class, pertinent ones involved P being injured in car wreck by driver who left tavern. The injured P sued the S/Hs/owners of the bar, trying to pierce the veil.
b. Take-Away:that you can't escape your own wrongdoing---the court was really imposing tortious liability in the case that the P prevailed
c. Pennmark Resources, 2000 OK Civ. App 63 i. Rule: Corporate distinctions may be disregarded and two separate entities may be treated as one if
one corporation is but an instrumentality or an agent of another. (a) Factors: (1) The parent corp. owns all or more of the subsidiary's stock; (2) The corporations have common directors & officers; (3) The parent provides financing to its subsidiary; (4) The dominant corporation subscribes to all the other's stock; (5) The subordinate corporation is grossly undercapitalized; (6) The parent pays the salaries, expenses, or losses of the subsidiary; (7) Almost all of the subsidiary's business is with the parent or the assets of the former were conveyed from the latter; (8) The parent refers to the subsidiary as a division or department; (9) The subsidiary's officers or directors follow directions from the parent corporation; and (10) Legal formalities for keeping the entities separate and independent are observed; (11) Commonality of purpose King v. Modern Music Co, 2001 OK Civ. App 126 i. Rule for Piercing the Veil:Both law and equity disregard the distinct existence of the corp & the persons composing it & treat them as identical when necessary to circumvent fraud, protect the rights of third persons, and accomplish justice. (a) In order to disregard the corporate entity, must show either (1) That the separate corporate existence is a design or scheme to perpetrate fraud, or (2) That one corporation is so organized & controlled and its affairs so conducted that it is merely an instrumentality or adjunct of another corporation. In other words, it must appear that one corporation is merely a dummy or a sham. ii. OKLAHOMA permits the court to disregard the corporate entity if used (a) To defeat public convenience, (b) Justify wrong, (c) Perpetrate fraud whether actual or implied, or (d) To defend crime. iii. The GOAL in piercing the corporate veil is to impute liability for the acts of the corporation to the responsible persons. (a) The corporate shield may be disregarded when it is essential in the interest of justice to do so, OR (b) Where the corporate shield is used to defeat an overriding public policy. Smith v. Teel, 2008 OK Civ. App 7 i. Rule for Piercing the Veil:The rule in OK (Brigance) is that "one who sells intoxicating beverages for on the premises consumption has a duty to exercise reasonable care not to sell liquor to a noticeably intoxicated person." Thomas v. Vertigo, Inc., 1995 OK Civ. App 45
BUSINESS PLANNING Long Outline Clutts i. Facts: This case dealt with a company that didn't have statutorily required workman's comp insurance and had an employee injured. Because he couldn't collect on workman's comp Held:the shareholders had to be held personally liable. Rule for Piercing the Veil for Public Policy:If it is shown that S/Hs used the corporate entity for the purpose of defeating or evading important legislative policy, in order to perpetrate a fraud or wrong on another, equity will permit the corporate form to be disregarded and will hold the S/Hs personally liable for the corporation's improper actions. g. Pate v. Alian, 2002 OK Civ. App 68 i. Rule for Piercing the Veil: (a) Plaintiff has the right to recover against an individual if he can establish that the individual neglected to perform his official corporate duties. (b) The corporate shield may be disregarded where it is used to justify wrong, defend crime or defeat an overriding public policy. Over-Issuance of Stock a. 18 Okla. Stat. SS1006: Cert. of Incorporation i. b. Agosta v. SW Breeders, Inc., 1991 OK Civ. App. 12 - Fraudulent Issue of Stock i. Summary: SW Breeders sold more shares than were allowed through its articles of incorporation, and Agosta bought stock from SW Breeders and then brought suit. ii. Held: The sale of stock to Agosta to be void iii. Rule for Certificate of Incorporation:A corporation whose capital is limited by its charter either in amt. or in the number of shares cannot issue valid certificates in excess of the limit prescribed. Certificates of stock issued in violation of statute are wholly valueless and void without regard to the intent of the parties to the over-issue. iv. Rule for Piercing the Veil: Officers and agents of the corporation may be held personally liable by the purchaser for a fraudulent issue of stock or stock issued in violation of the law. Certificate a. 18 Okla. Stat. SS 1006(b)(6) i.
SS1006(b)(6) - MAY have a provision which imposes personal liability for the debts of the corp upon S/Hs Suspension of Corp Charter for Failure to Pay Franchise Taxes : SS1212(c) a. OKLAHOMA!!!!! BAT Tax: Business Activity Tax i. Right now the law in OK is that there are NO franchise taxes ; they've been temporarily suspended for 2010-2012; however, they could return in 2012 because this is only a temporary suspension. ii. In their place is the BAT Tax: (a) Whereas franchise taxes applied to corporations but not to LLCs (hence, a built-in favoritism to LLCs), the BAT tax applies to both the corps and LLCs, and all limited partnerships. (b) The BAT tax is a set fee ($25, or if a corporation, then what they would have paid if there were a franchise tax). (c) We won't know until 2011-2012 whether the BAT tax works and whether the franchise taxes will ever be returned...maybe so, maybe not. b. Franchise Taxes i. Has nothing to do w/a franchise. ii. "Franchise" means the right to do business as a corporation in OK. iii. The rate is $1.25 for every $1,000 of capital that the corp used or invested in business in OK; so every corp had to pay this franchise tax every yr. It's a relatively insignificant tax, but the failure to pay it has dire consequences for the corporation. c. Oklahoma Statutes i. 18 Okla. Stat. SS1002(B): Provides that if there is a conflict between a corporate act provision and the taxing Code, the provisions of the taxing code prevail - including any statute that deals w/the personal liabilities of any officers or directors. ii. 18 Okla. Stat. SS1120(E): (a) Get reinstated by paying your back franchise taxes (b) Provides that after reinstatement that validates everything that the corp died while suspended; thus, the take-away is basically that the effect of suspension is nothing. iii. BUT: 68 Okla. Stat. SS1212(C): Tax Code prevails over SS1120!!
4. BUSINESS PLANNING Long Outline Clutts (a) SS1212(C): Provides that any act that occurs between the period of suspension and the period of
reinstatement, the officers/directors can be held personally liable, regardless of their awareness of the suspension---what's important is their knowledge of the corporation incurring debts. (b) EX: 5/23/08 Form Corp 7/23/09 Suspended 8/5/09 Incurred Debt*
7/1/10 Reinstated 3/2/11 Become D on the 8/5/09 K*
(c) There is a GAP - (1) If you fail to pay franchise taxes, then your license to do business in OK is suspended when the OK Tax Commission tells the Secretary of State, who then suspends your license. (2) OFFICERS/DIRECTORS CAN BE HELD PERSONALLY LIABLE FOR DEBTS INCURRED BY THE CORP BETWEEN THE PERIOD OF SUSPENSION AND REINSTATEMENT. (3) Take-Away:the debts incurred during the period of suspension and reinstatement should probably be paid before any debts incurred after reinstatement because the officers and directors are only liable for the debts incurred between the period of suspension and reinstatement, and not for those debts incurred when the corp is reinstated. State Ins. Fund v. AAA Engineering & Drafting, Inc., 1993 OK 142 i. Rule for Piercing the Veil:Corporate officers of a foreign corporation can be held personally liable for the premiums on a workers' comp. policy which became due while the corp. was suspended from doing business in OK when the suit was not filed until after the corporation's reinstatement. ii.
SS1120(E) of title 18Interpretation---Provides that the reinstatement of a cert of incorporation after suspension validates the acts of the officers and bridges the suspension to the effect that acts which occurred within the period of suspension are treated as acts of the corporation. iii.
SS1212(c) of title 68Interpretation---Provides that officers of a corp. w/a right to do business in OK are liable to the same extent as if the officers were partners in the business, and thus it is not necessary to have a judgment against a partnership before including the individual partners as defendants. KJ McNitt Construction, Inc. v. Economopoulos, 2001 OK Civ. App. 45 i. 68 O.S.1991 SS1212(c): When a corporation's charter is suspended for failure to pay its franchise tax, its officers are liable as though they were partners for any corporate debts "created or incurred" during suspension, w/the officer's "knowledge, approval, or consent." (a) Legislative Intent: The Court concluded it's to prevent a suspended corp. from performing any act (b) Rule for Piercing the Veil - 68 O.S.1991 SS1212(c): Because the corporation has ceased to have the capacity to do business in the State of Oklahoma, corporate officers only have the power to create personal liability and cannot legally act for the corporation. Williams v. Smith & Nephew, Inc., 2009 OK 36 (a) Language at Issue:"...as to any suit against the corporation on a CoA that arose before forfeiture, no affirmative relief shall be granted to the corporation UNLESS it is reinstated." ii. Held:that SS1212(C) denies the corporation a right to sue and the right to defend in the courts of this state while suspended. Thus, a corporation, after reinstatement, can sue no a claim that arose while it was suspended, and this denial of the use of or access to the courts of the state is limited to while it is suspended; it does not deny the claim itself. iii. Rule for Interpreting Tax Statutes - 68 O.S.1991 SS1212(c):SS1212(c) is penal in nature and is to be strictly construed in favor of those sought to be charged. Court's conclusion: Reinstatement to good standing restores the corporation's ability to sue and to defend in courts of this state, and the corporation may proceed in any viable claims that it has. LLCs i. 18 Okla. Stat SS 2055.2 - LLC Certificates & LLC Tax (a) (H) makes it clear that the failure of an LLC to pay its fee under its section doesn't impair the validity of any K; and (b) (I) provides that the member or mgr. of an LLC will not have liability for that debt simply because they didn't pay this fee. ii. Take-Away: LLCs didn't have the same problem. This was a big reason why many businesses chose to be LLCs instead of corporations
BUSINESS PLANNING Long Outline Clutts
5. Upon Dissolution of the Entity a. Law in OK is that when a corp dissolves and the assets are distributed to the S/Hs, and there has not been
III. adequate provision for the creditors, the money going out to the S/Hs can be accessed (thus, the S/Hs are only liable for the amt that they received in distributions - not joint & several) to pay the creditors. b. The question is whether there is an adequate provision to pay the creditors. c. Policy behind this is that the first to get paid upon corp dissolution should be the creditors, THEN the equity holders.
6. Failure to Remit Trust Fund Taxes a. Trust fund taxes are taxes that corporations (or any other entity) collectson behalf of somebody else. b. There are two main examples: i. EmploymentTaxes&
(a) When you get a paycheck and the ER has withheld taxes, the ER is supposed to put those taxes in a trust and then send to the IRS ii. SalesTaxes (a) Money is held in trust for the OK Tax Commission. c. Officers & directors are held personally liable for failure to pay trust fund taxes . d. This usually happens when businesses are short on cash and really need quick financing to pay other bills - but don't do it!!!
7. Security Law Violations
8. Future Legislative Action a. From time to time, somebody in the OK legislature will propose legislation that imposes liability on officers and directors for certain things...so watch legislation obviously. C. Remember that creditors can circumvent around the GR of no liability if they get a personal guaranty from the officers/directors!!!
Choice of Entity (Us. Like GP, Inc. - 1% S/H) (Us. LPS 99% S/Hs) GP LPs LP
S-Corp vs. C-Corp = tax distinction only
C Corp SP
Corp S Corp LLC
A. Check-The-Box Game - Election of Tax Status
1. In 1997, the IRS abandoned the corporate resemblance tests used for classifying unincorporated businesses and, in
its place, adopted a "check-the-box" system, providing certainty and default provisions that greatly reduce the likelihood of the uninformed being punished. The regulations apply to any business entity that is separate from its owner and that is not a trust---briefly, descriptions of the key provisions of the "check-the-box" system: a. Corps - Any entity organized under fed/state statute that uses the words "incorporated," "corp," "body corp," or "body politic" is taxed as a corp b. Unincorporated Entity - i. 2+ owners (a) (i.e., p'ship, LP, LLC) (b) Taxed as p'ship under subchapter K (c) UNLESS the entity elects to be treated as a corp for tax purposes ii. Only 1 owner (a) (e.g., SP, single-member LLC) (b) Treated as a disregarded entity - a nullity (c) UNLESS a corp status election is made (d) Default is taxation as a SP (e) Single-entity owner will NEVER be subject to p'ship provisions Once a classification election is made it CANNOT BE CHANGED FOR 60 MOS., UNLESS: a. IRS authorizes new election OR
BUSINESS PLANNING Long Outline Clutts b. More than 50% of the ownership interests are acquired by persons who did not own any interest in the co.
time election was made
4. It's easier to go from a flow-through entity to a C Corp than it is to go from a C Corp to an S Corp, LLC, or LLP.
5. Election Tax Consequences: a. Entity Taxed as P'Ship Elects to Be Taxed as Corp - Deemed: i. To have contributed ALL its assets & liabilities to the corp in return for stock & then ii. To have distributed the stock to the partners in liquidation of their p'ship interests b. Unincorporated Entity Taxed as Corp Elects to Be Taxed as P'Ship - Deemed: i. To have distributed its assets & liabilities to the S/Hs ii. S/Hs will be deemed to have contributed the assets & liabilities to a newly formed p'ship c. Similar rules apply to a single-owner entity that elects corp. status or that, having elected & maintained corp. status for at least 60 mos., elects sole proprietorship.
B. Important Factors:
1. Taxation Structure a. Double Tax i. C Corp ii. Top Tax (Most Common) = 34% (Under Bush Tax Cuts) iii. S/H can get money in 2 ways: (a) Dividends - 15% (Bush Tax Cuts - goes back to 33% in 2012) (b) Salary (Bonus) - 36-39% tax rate iv. Ex: TI = $1000 - pays 34% ($340), $660 left in C Corp Tax 1 (Entity) Tax 2 (S/H)
v. 2. 3.
One way to avoid this is to zero it out so that you have no TI. b. Flow-Through i. S Corps, LLCs, LLPs, LPs, GPs, etc. ii. Only taxed at the S/H/owner level, not at the entity level Tax Deferrals a. Deals w/the advantage of deferring the payment of taxes by using a fiscal year b. Usually ONLY possible w/C Corp that is not a personal service corp - may select any fiscal year for tax reporting purposes. c. P'Ships, LLCs, S Corps, & SPs generally are required to use a calendar year unless they can prove a business purpose for using a fiscal year, which is a tough burden, OR make a tax deposit (eliminates any deferral advantage) d. Personal Service C Corps MY adopt a FY w/deferral period of no more than 3 mos. - but still not as good. Alternative Minimum Tax (AMT) a. Applies ONLY TO C CORPS that have annual gross receipts >$7.5M ($5M during 1st 3 yrs) b. Imposed only to the extent that the GI exceeds that limit c. For life ins. policies - can avoid the AMT threat by having the S/Hs cross-own the life ins. policies, rather than having life ins. policies owned by the corp (bc AMT triggered on receipt of life ins. proceeds upon the death of a key EE or S/H) Passive Activity Rules a. Rule is that if you have passive losses, you can only use those losses to offset passive income. Thus, you cannot deduct passive losses against active income (e.g., salary, wages, when you do something to earn the income). b. A passive loss is a loss from an entity that you don't participate in. c. Pass-Through Entities: i. Material Participant Standard - must be resolved for each individual owner ii. Better for non-participating owners d. C Corps not great b/c there's no way for the income of the business to be sheltered by operating passive losses that the OWNERS generate from other activities
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