All posts in Corporations

08 Apr

Should You Serve as a Nonprofit Director?

In Corporations,Directors by admin / April 8, 2013 / 0 Comments

Estate Planner May-Jun 1999
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Assume that because of affluence, age, influence, friendship or circumstance you are asked to become a director of a private or public charity, or some other nonprofit corporation. Serving as a director may be prestigious and satisfying, but before agreeing, you need to understand the responsibilities and liabilities that go along with the position.

A director must be completely familiar with the type and range of activities the organization may perform under its governing instruments. These parameters can usually be gleaned from the organizational documents governing the charity’s operation, such as articles of incorporation, bylaws and written internal policies and procedures. These documents provide a useful road map to ensure the proper exercise of the director’s decision-making authority.

Basic Responsibilities Of a Director

Generally, a director must act in the best interests of the charity by exercising a level of care similar to that which would be exercised by an ordinary person under similar circumstances. Here is a close look at a few important aspects of these responsibilities:

Business judgment rule. The directors of a nonprofit corporation can usually fall back on a legal doctrine known as the “business judgment rule.” This doctrine states that if the directors have based a decision in good faith on sufficient and reliable information, they will be protected from liability even if the decision has negative consequences. To be protected by this rule, a director must adhere to these principles:

  • Regularly attend board meetings. Some organizations require frequent meetings. Before accepting, assess whether you are able to attend most of the scheduled meetings.
  • Be informed. Decisions must be based on adequate information. At times, you, as director, must take the initiative because board members will not always receive all relevant information from other representatives of the organization, such as major contributors or office staff.
  • Be deliberate when delegating. As director, you can delegate certain responsibilities. Often this is achieved through the creation of committees. But, take care and be responsible in selecting the delegates; you can’t limit your ultimate exposure merely by allocating responsibilities to others.

Investing funds. Directors must exercise care in investing the organization’s funds. Diversification is usually a prudent course to take, as it spreads the risk of loss of the organization’s funds. However, there is no easy mix, because too conservative of an investment may earn too low of a return to be considered prudent.

Loyalty. A director must avoid conflicts of interest and show primary loyalty to the organization. Generally, this means that you must avoid deriving personal benefit from your position at the expense of the organization. In legal terms, you must avoid acts of “self-dealing.” Courts will examine a director’s duty of loyalty stringently when a conflict of interest exists. The business judgment rule does not protect a director who engaged in a conflict of interest. Therefore, always disclose a conflict of interest. In a case where a conflict of interest does exist, a nonprofit corporation usually requires a majority of disinterested directors to approve the transaction.

Liability Imposed on a Director

A director of a private or public charity can become subject to liability in different ways. For example, you may be the subject of a derivative action, in which someone acting on behalf of the charity (often the state’s attorney general) brings suit against you as director for breach of fiduciary duty. This may occur if there has actually been injury to the charity. If you are considering a directorship, examine both state law and the charity’s policy regarding indemnification. Some charities are required by state law to indemnify a director while others have discretion whether to indemnify. Also, seek counsel to ensure that you are not exposed to unnecessary liability.

Stakes Can Be High

Serving as a director for a nonprofit corporation can provide a person with a great sense of contributing to society, and sometimes even financial reward. A well-educated board of directors not only contributes to a worthwhile charity, but also protects the organization and the directors individually from liability. However, the position is more than an honorary title, and there are risks involved. So make your decision with care, and let us know if we might be of assistance in evaluating the organization you are considering.

Beware of Excess Benefits

A director can also be subject to a lawsuit or sanction by governmental authorities. A recent change in the tax law, for example, imposes an excise tax on excess benefits received by directors and officers, as well as certain other individuals, known as “disqualified persons.” This provision allows the Internal Revenue Service (IRS) to impose a tax equal to 25% of an excess benefit received by a disqualified person. An excess benefit exists when the organization provides an economic benefit to the disqualified person that exceeds the value of services the person performed for the organization. In the case of a private foundation, excise taxes may also be imposed when a director engages in certain “prohibited transactions,” such as a loan, lease or sale of property between the director and the foundation.

 

08 Apr

How to Dispose of Your Interest in a Closely Held Business: Alternatives to Buy-Sell Agreements

In Buy-Sell Agreements,Corporations by admin / April 8, 2013 / 0 Comments

Estate Planner Mar-Apr 1999
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Selling stock in your closely held business may be difficult due to a limited market for it. Although buy-sell agreements provide the way your interest will be bought and sold, alternative methods allow you to both address these concerns and receive financial benefits from the company without selling your stock.

A Few Alternatives

With proper planning, your company can provide you with significant financial benefits. Here are some alternatives:

Deferred compensation. Under a deferred compensation agreement, your company can pay you after your retirement or death, either for services rendered or as payment for recognition of past work. You and your company can establish a substantial severance package before you leave its employ. The company can deduct the severance payments, if reasonable, as a business expense.

Covenant not to compete. Payments your company makes pursuant to a covenant not to compete can provide additional funds to you. The company can also deduct these payments as business expenses. But the covenant must be reasonable in light of all surrounding circumstances. If the IRS finds the covenant to be suspect, it can treat the payments as a dividend to you and the company will not get a deduction.
Benefit plans. Certain retirement plans, such as defined benefit plans and target benefit plans, can quickly fund large retirement accounts for older employees. Their structure allows larger payments to older employees because the payments to younger employees are projected to continue for a longer period of time. An employee stock ownership plan (ESOP) acquiring the company’s stock can work similarly. This option may be especially attractive because the gain on the sale of your stock to the ESOP can be deferred and receive a step-up in basis at death.

Stock redemption. If your company cannot purchase your interest for cash on your death or retirement, it can redeem your stock in exchange for company assets through a taxable transaction. Then you can either sell the assets or lease them back to the company. Or, the company can create a market for your stock by paying reasonable bonuses to your children or other younger employees that they can use to purchase your stock.

Sale of the company. If the company doesn’t have enough cash to buy you out, the other owners can sell it while remaining involved through employment and consulting agreements. Or, you could wind down the business while your children begin a new, similar business. You receive the accounts receivable of your closed company. In effect, its goodwill will inure to the benefit of your children’s company without there having been an actual transfer.

Charitable remainder trust. If you are charitably inclined, you can use your stock in the company to fund a charitable remainder trust that provides you income and allows you to receive an income tax deduction for the remainder passing to charity when the trust terminates. Your children can have a right of first refusal to repurchase the stock, which may be useful if the charity has no interest in owning the stock. If income is not your goal, then you can make an outright gift of stock to the charity and avoid any gain on the stock gifted while receiving an income tax deduction.

Gifting to children. If you have sufficient other resources, your stock may be an appropriate asset to establish a gifting program to your children.
Spin-offs. If you and other owners are concerned about conflicts, then you may want to consider dividing the company through either a tax free spin-off, split-off or split-up that allows each owner to receive a separate part of the business.

 

 

Consider Your Goals

Careful consideration of your goals can help determine how you should dispose of your closely held business interest. Remember, though, that any arrangement must reflect a bargained-for agreement between you and the other parties — a court will look for this if a dispute arises later. If you are interested in learning more about how alternatives to a buy-sell agreement may work for you, please call us. We would be happy to discuss your situation and help you determine how to best dispose of your interest in a closely held business.

08 Apr

Breaking Up Is Hard To Do: How to Split Closely Held Corporation Stock in a Divorce Settlement

In Corporations,Divorce by admin / April 8, 2013 / 0 Comments

Estate Planner Mar-Apr 1998
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Jeff and Jessica are divorcing and negotiating an equal property settlement. The marital estate includes a home valued at $350,000, two cars worth $16,000 each, and other miscellaneous assets with a total value of $100,000. The two also jointly own all stock of a computer business, Computers ‘R’ Us. The business is operated through a closely held corporation and has been appraised at $800,000.

One recurring issue in divorce is how to divide the marital estate when the couple owns all of the stock of a closely held corporation. This can be a daunting task, especially when the value of the business exceeds half of the value of all marital assets. Although the spouses can continue the business through joint ownership after the divorce, this often proves difficult.

Spouses (and former spouses if the transfer is made pursuant to divorce) can transfer property to each other without income or gift tax, so the easiest way to divide a marital estate is simply to split it between the spouses. This will not work, however, if the value of the business dominates the value of the entire estate. Thus, Jeff and Jessica must look at other options.

Redeem the Stock of One Spouse

If only one spouse wishes to continue the business, the best alternative may be for the corporation to redeem the stock of the other spouse. For example, if Jeff wanted to continue the business and Jessica wanted to liquidate her interest, the corporation could redeem her stock at its fair market value. Jessica would walk away with cash of $400,000.

From a tax perspective, the goal is to have the transaction treated as an exchange to take advantage of capital gains tax rates, which are lower than ordinary income tax rates. The tax consequences of a stock redemption in this context, however, are unclear. Interpreting the interplay of several tax provisions, a court might classify the redemption of Jessica’s stock as a dividend to Jeff. As a dividend, it would be taxed at the higher, ordinary income rates.

Transfer Stock and Pay Alimony

To avoid the tax uncertainty of a redemption yet still equalize division of the assets, one spouse could transfer all of his or her stock to the other spouse, who then would pay alimony to the transferring spouse. Properly structured, a divorce-related transfer of property would not result in taxable gain or a taxable gift.

To take advantage of this planning opportunity, Jessica would transfer her stock to Jeff pursuant to a written agreement. Jeff would then pay alimony to Jessica, which would include an amount equal to the value of the stock. He would make payments over a number of years until the full amount was paid. Jeff would also be able to deduct the payments. Payment for Jessica’s stock as alimony would result in ordinary taxable income to her, but it could be structured so that the parties would share this additional tax liability.

Split the Business

If the corporation consists of two separate and distinct lines of business or specialties, the couple might wish to divide the company into two businesses. The corporation could transfer the assets and liabilities of one of the businesses into a new corporation.
For example, if Computers ‘R’ Us consisted of a consulting division and a repair division, and Jeff wished to retain one side and Jessica the other, they could transfer the assets and liabilities of one division into a newly created subsidiary corporation. The corporation could then distribute the stock of the subsidiary solely to Jessica in exchange for her stock in Computers ‘R’ Us. With proper planning, they could execute this strategy tax-free, and Jeff and Jessica would each control his or her own business.

Consider All the Opportunities

The estate and gift tax aspects of divorce normally involve a number of complex issues. When a closely held business is part of the mix, however, the complications increase exponentially due to the many planning opportunities available. Careful planning is required to avoid potential adverse tax consequences that may accompany the use of some of these strategies. We would be pleased to help you structure a property settlement to minimize the tax consequences and meet both spouses’ needs.

 

Why Not Liquidate?

The easiest alternative may be to liquidate the corporation. The proceeds then can simply be distributed between the spouses. There is a major potential obstacle to this solution, however: Both spouses may not want to sell. And, even if both are willing, this method is often still undesirable, because the business will usually be worth more as a going concern (especially if it’s a service business) and finding a buyer may be difficult.