Blog — Beyond the Virtual Law Firm
Category: Tax Law and International Tax
“Employees” v. “Independent Contractors”: A Benefits Perspective
The Internal Revenue Code provides significant tax benefits to employers that sponsor tax-favored retirement and health and welfare plans. For example, in calculating an employer's income tax, the current cost of providing benefit coverage may be deducted from taxable income, although plan participants are not currently taxed on the benefits at that time. However, these tax benefits are available only if the employer sponsoring the plan does not discriminate against its rank and file employees. Determining who are in the group of covered employees for discrimination testing is critical to the analysis.
House Passes Changes to Carried Interest Taxation
On May 28th, the House passed H.R. 4213, the "American Jobs and Closing Tax Loopholes Act." The Act addresses an array of issues, but has particular signficance for certain partnership and LLC "carried interests" for investment fund managers. If it goes through, the Act would prevent investment fund managers of venture capital, private equity, hedge and real estate funds from paying taxes at capital gain rates on investment management services income received as carried interest in an investment fund.
Under the proposed changes, return on invested capital in the form of carried interest would continue to be taxed at capital gain tax rates. But to the extent that carried interest does not reflect a return on invested capital, investment fund managers would eventually be required to treat seventy-five percent of the remaining carried interest as ordinary income.
The proposed changes would not take effect until 2011. However, for the bill to become effective it must also be passed by the Senate, an outcome which is not certain to occur.
An LLC Can be Treated as an S-Corporation for Tax Purposes
An LLC can be treated as an S-Corporation for tax purposes if it makes an S-Corporation election as long as the entity meets the IRS criteria to be taxed as an S-Corp, files an S-Corp election and gets approved by the IRS to be taxed as an S-Corporation. Without an S-Corporation election, single member LLCs default to be taxed as sole proprietors and a multi-member LLCs defaults to be taxes as partnership since they are considered “disregarded entities”. However, if a single or multiple member LLC agreement meets the IRS criteria to be classified as a small business corporation, the S-corporation election is filed and gets approved by the IRS, then for tax purposes, not legal purposes the entity is an S Corp not a LLC.
The Criteria for Being Classified as an S-Corporation
In order to be classified as an S-Corporation, a company must: be domestic, have no more than 100 shareholders, have one class of stock, all shareholders must be individuals, decedents’ estates, bankruptcy estates, trusts or tax-exempt charitable organizations, or wholly owned by another S corporation, and all shareholders must be residents of the United States (as defined by the tax code not immigration laws). Shareholders of an S-Corporation can not be financial institutions that use a reserve method of accounting for bad debts, companies taxable as insurance companies, taxable mortgage pools, or domestic international sales corporations. So, if a business entity meets these criteria it can be considered an S corporation by the IRS and taxed as an S corporation as long as the S corporation election forms are properly filled-out and approved by the IRS. Many states including California automatically give business entities an S-corporations tax status if it was approved by the IRS.
The tax benefits of making an S-Corporation Election?
Many small business owners incorporate their businesses not only for legal protection, but also to reduce owners’ payroll taxes through S-Corp tax election with the IRS. One advantage of an S-Corp is that it gives business owners the ability to reduce their self employment taxes. Any small business owner who has not made an S-Corp election and uses Schedule C for their personal tax return for 2010 is subject to both employer and employee FICA and Medicare payroll taxes at 15.3% up to $106,800, 2.9% Medicare for Schedule C net income greater than $106,800, and California SDI for 1.1% up to 93,316. If a business owner pays himself/herself a “reasonable salary”, the rest of the net income is not subject to these payroll taxes.
UK Reporting of Undiscosed Foreign Accounts
On September 1, 2009, the Government of the United Kingdom implemented the New Offshore Disclosure Opportunity (“NDO”).
The NDO allows those individuals with unpaid UK taxes relating to previously undisclosed income and/or capital gains linked to offshore accounts and/or assets to settle related tax liabilities at a favorable 10% penalty rate. Ordinarily, penalties are charged at up to 100% of the tax due.
The NDO provisions apply to all UK residents and certain non-UK domiciled individuals (who themselves may be or once were subject to tax in the UK) who have an interest in any Offshore Accounts, Trusts or Corporate entities that would otherwise be subject to UK tax.
Under the NDO, formal notification of the intention to disclose must be given to Her Majesty’s Revenue & Customs (“HMRC”) in the UK by November 30, 2009 at the latest. The actual disclosure must be submitted to HMRC together with payment of related taxes and penalty charges by March 12, 2010 if the disclosure is done online or by January 31, 2010 if the disclosure is done on paper.
Care needs to be taken when making this disclosure since, by submitting a request under the NDO, an individual does not automatically receive immunity from criminal prosecution.
The amnesty will apply if any income, capital gains and inheritance tax outstanding is paid in full together with (in most cases) an additional minimum of 10% penalty charge if any tax due is above £1,000 and any interest due on the unpaid tax .
The NDO will not affect as many people living outside the United Kingdom as the US Voluntary Disclosure Program did for those Americans living abroad, since many of them are no longer considered to be UK tax resident. However, historic tax liabilities are under review by HMRC and recent immigrants from the UK in particular will need to consider their position in more depth.
In addition, those who are considered to be UK tax resident, for example under a relevant Tax treaty or under general UK law, but who are neither ordinarily resident nor domiciled in the UK (for tax), may be able to use the remittance basis to argue that the offshore income and gains were not taxable in the UK. In many of those cases, tax would only be due on income or gains that were brought into the United Kingdom.
For additional information about the New Disclosure Opportunity please contact Dave Wolf, Esq. by email at .(JavaScript must be enabled to view this email address).
Start-up package
Check out our start-up package: Rimon Law Startup Package.
It gives an entrepreneur a big picture view of legal issues they should consider when they start/grow their company
Important Tax Issues for Companies with U.S. and Israeli Operations
If you are a company with operations in both the United States and Israel, you should be aware of several very important U.S. and Israeli Tax issues when you engage in cross border operations. I have set forth below several of the main issues. This list is not exhaustive and only reflects briefly the main tax issues. Other issues such as employment, banking, intellectual property rights, custom duties etc. will be addressed in other communications.
U.S. Reporting of Undisclosed Foreign Accounts
The IRS has now implemented a special approved penalty framework for resolving the civil side of offshore voluntary disclosures and this approved penalty framework is effective till September 23, 2009 at which time the IRS intends to re-evaluate the approved penalty framework. Under the approved penalty framework, the taxpayer has to file correct or amended tax returns for tax years 2008 back to 2003.
A Primer on Stock Option Agreements and Restricted Stock Agreements
Why have a stock option plan?
Startups often prefer to compensate using stock options because it does not require a cash outlay. In addition, employees may prefer the favorable tax treatment associated with stock options. Stock options also often give employees a stake in the long-term success of the company that salaries or bonuses often do not.
What is a stock option?
A stock option is the right to acquire a certain number of shares of stock for a specific price (“exercise price”). Usually, the employer does not permit an employee to exercise the right to purchase immediately on the date the stock option is issued. Rather, the right to purchase stock typically “vests” or accrues over a period of time or upon meeting certain company performance goals. This encourages employees to remain with the company for the rest of the vesting period or helps the company meet its goals.
Tax consequences of Incentive Stock Options and Nonstatutory Stock Options
There are two forms of stock options: incentive stock options (“ISO”) and nonstatutory stock options (“NSO”). ISOs are different from NSOs in that ISOs receive favorable federal tax treatment if the option meets certain requirements of the Internal Revenue Code.
When granted, both ISOs and NSOs should have an exercise price that is not less than 100 percent of the fair market value of the underlying stock. Neither ISOs nor NSOs are taxable upon grant to the employee or when the option vests. The difference between them lies in the tax consequences when the option is exercised. When an NSO is exercised, the employee recognizes compensation (ordinary) income in an amount equal to the spread at exercise. An employee does not recognize taxable income on exercise of an ISO. However, the spread at exercise is includible in the employee’s federal alternative minimum taxable (“AMT”) income and may give rise to AMT tax liability.
If stock acquired upon exercise of an NSO is held for more than one year, any gain realized on the disposition of the stock is taxed at favorable long-term capital gain rates. ISOs must be held for at least two years from the date of grant and at least one year from the date of exercise to qualify for favorable capital gain tax rates. Otherwise, the employee recognizes compensation income that is taxed at ordinary income tax rates.
The other difference between ISOs and NSOs is in the benefit to the employer: for NSOs, the employer can take a deduction equal to the amount recognized by the employee upon exercise of the NSO. For ISOs, there is no deduction.
The different aspects of ISOs and NSOs provide flexibility in tailoring an equity compensation plan to fit a company’s needs.
What is restricted stock?
Instead of issuing stock options, some companies issue “restricted stock.” Restricted stock refers to stock that is transferred to an employee as compensation for services, subject to a vesting schedule. The employee usually is not required to pay for the stock. If the employee does not remain with the employer until the end of the vesting period, the stock must be returned to the employer. If the employee has paid any amount for the restricted stock but then fails to become vested, the employer usually refunds the purchase price to the employee. A discussion of the tax consequences of restricted stock is beyond the scope of this primer and requires a detailed conversation with a tax attorney.
Given the complex legal, accounting and tax issues, a company should seek advice before implementing an equity compensation plan.
Rimon offers the following flat-fee packages:
1. Basic non-qualified stock option plan without revisions drafted by a corporate attorney for $300. A review by a tax attorney for an additional $400: The client receives a basic no-frills non-qualified stock option plan. This package is appropriate if the value of the stock at the date of issuance is easily determinable and the client accepts the plan without discussing the alternatives.
2. A more extensive analysis by a corporate attorney and tax attorney: $400 for drafting by a corporate attorney and $700 for tax review: This includes a consultation as to whether to choose (a) qualified or (b) non-qualified stock option plan, or (c) restricted stock. This package is appropriate if the value of the stock at the date of issuance is easily determinable.