Data can sometimes come too fast to make sense of what’s happening on a daily basis. Every once in a while, it pays to sit back and sort it out. We can help.

EFP Rotenberg professionals talk to hundreds of clients, colleagues and business associates every week—everyone from business owners, not-for-profit executive directors, attorneys, CFOs, inventors, IRS agents, Ponzi scheme investigators, SEC officials. A pretty diverse bunch. It helps us formulate some big-perspective thoughts on what’s going on in the world today, which sometimes informs how we should be preparing for tomorrow. Bookmark this page (or use the RSS feed) to stay up-to-date on our latest ruminations.

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Small Business Jobs and Credit Act of 2010 Provides Amendment to Section 1202 

Code Section 1202 is not a new law; in fact it’s been around in its current state for some time. The original law stated that non corporate investors may exclude up to 50% of gain they realize on the disposition of qualified small business stock issued after August 10, 1993 and held for more than 5 years. In early 2009 to help stimulate the economy, the section 1202 exclusion was raised from 50% to 75% on gains from the sale of certain small business stock issued after February 17, 2009 and before January 1, 2011. Small business stock, as defined in this code section, is any stock in a C corporation which is originally issued after August 10, 1993. The stock must be originally issued to the taxpayer by a corporation that is a “qualified small business” on the date of issuance. A “qualified small business” generally must be a domestic C-corporation and have aggregate gross assets not exceeding $50 million. Also, at least 80% of the value of the corporation’s assets must be used in the active conduct of a qualified trade of business, which does not include professional service organizations.

In September 2010, the Small Business Jobs Act of 2010 increased the exclusion again to 100% of qualifying gain for qualified small business stock purchased between September 27, 2010 and December 31, 2010 and held for more than 5 years. The 100% exclusion of gain will apply the disposition of qualified stock of any single issuer subject to a cumulative limit for any given tax year equal to the greater of: (1) 10 times the taxpayer’s adjusted basis in all qualified stock disposed of during the taxable year (additions to stock basis made after issuance are disregarded); or (2) $10 million ($5 million for married taxpayers filing jointly), reduced by the total amount of eligible gain taken in prior tax years. Ultimately, this amendment to Code Section 1202 provides a federal capital gains tax rate of zero as long as all requirements are met.

Code section 1202 also benefits those taxpayers in Alternative Minimum Tax (AMT). Originally 42% of the excluded gain was an AMT preference item. For stock whose holding period began after December 31, 2000, 28% percent of the excluded income is included in calculating AMT. The 2003 Act reduced the AMT inclusion amount to 7% for dispositions on or after May 6, 2003. The 2010 Act further reduced the 7% AMT amount to 0%; allowing the excluded gain from these investments to be excluded as a preference item for AMT purposes.

The question is a whether a new company that is starting up should form as a C Corporation or a Limited Liability Company (LLC) or S Corporation if they will be taking in investment money before December 31, 2010. The answer is not straightforward and needs to be evaluated on a case by case basis. The main thing to keep in mind is that the purpose of Section 1202 is an incentive for the owners of a business and not necessarily the business itself. The reasoning is that Section 1202 requires that the business be formed as a C Corporation. A C Corporation is taxed at the entity level on its profits. Capital gains are afforded no benefit at the entity level over ordinary income.

While the benefit of paying no or limited tax on the sale of stock by individual investors in the future is appealing the question remains as to whether it is practical for the small business owned by one or a few individual owners. Keep in mind that to take advantage of the exclusion it must entail a sale of stock. More often than not buyer of businesses wants to buy assets rather than stock. Assets are depreciable or amortizable for tax purposes in the hands of a buyer, stock is not. Asset sales in a C Corporation setting create a tax at the corporate level as well as a tax at the individual lever when the company is liquidated. S Corporations and LLCs typically avoid this problem. However C Corporation owners often can persuade a buyer to purchase stock instead of assets if the sellers are willing to lower their price in order to compensate the buyer for lost tax benefits.

With this in mind there are a number of issues to consider that may favor C Corporation status:

1) If the company is going to be going public and/or the investors will be selling stock after the 5 year holding period. Certainly if at the outset a company has the goal to take the company public it will be a C Corporation. In this case it would always make sense for the company to be a C Corporation and thus take the benefit of Section 1202.

2) Is the company already set up as a C Corporation? If the company is a C Corporation from the beginning it should remain a C Corporation, unless S Corporation makes sense from a long term planning stand point. S Corporation typically makes sense for a company with fewer shareholders that are entirely made up of individuals. However if there are many shareholder, a shareholder that is not an individual or plans to continually bring in new owners, a C Corporation facilitates such activity. Remaining a C Corporation makes sense in such cases. Additionally a company that is already a C Corporation will rarely want to convert to an LLC because such conversion is treated as an asset sale followed by a liquidation. Such a conversion creates a tax at the corporate level and at the shareholder level as if the company was actually sold outright.

3) If the company is going to be selling stock to another company it may make sense to be a C Corporation. As mentioned above an S Corporation cannot have a company as a shareholder. However, an LLC can have a company as an owner. Since this is the case this item in and of itself is not determinative of whether a company should be an LLC or a C Corporation.

4) If the shareholders definitely plan to sell stock to a third party after holding it for the 5 year holding a period a C Corporation may certainly make sense. However, for closely held businesses with few owners this option may be beyond the control of one shareholder. All owners need to be on the same page for this to work. This position favors a C Corporation with many shareholders who are at liberty to sale their stock without restrictions. A company with few shareholders will want to be fairly certain they plan to sell the company and can do so in a stock sale rather than an asset sale after the required holding period is met.

5) Simplicity is another reason that a C Corporation makes more sense than an LLC or even an S Corporation. Since income does not pass through to the owners taxes are taken care of at the corporate level. There is no need to worry about distributing cash to owners for tax purposes, none of the restrictions on fringe benefits that are imposed on LLCs and S Corporations, no issue for phantom income passing through to owners in years where there may be taxable profits but cash flow that is insufficient to meet the demand of the tax burden.

The above items seem to be the most compelling reasons for opting for C Corporation over an LLC or S Corporation. But a further discussion of LLCs and S Corporation is worthwhile. The advantage of either of these entities is primarily the one level of tax. If the business is not going to be involved in any of the items listed above that are favorable to the C Corporation structure and LLC or S Corporation may make more sense, even in light of the exclusion from tax that is available for C Corporations under Section 1202. And the preferable choice is an LLC that is taxed under the partnership tax regime. Such LLCs offer the maximum flexibility of not only having one level of tax, but of moving from the LLC structure to a corporate structure at some future date if desired with the minimum tax of tax consequences. There is flexibility for type of owner as well as the ability to attract investors that are limited partners. An LLC allows for flexibility in allocations of income and losses where a C or S Corporation do no. Most important is the one level of tax on the sale of the company. From a tax standpoint, typically an LLC is the most favorable form of doing business for businesses that are owned by a few number of owner operators and/or outside investors. The LLC is more attractive even given the Section 1202 exclusion if the plans for the business are uncertain and there are not the criteria outlined above that seems to favor a C Corporation.

Certainly the discussion points in this article are not totally comprehensive. Other facts and circumstances will need to be considered on a case by case basis to determine the proper entity selection for any new business. Consultation with competent tax professionals is crucial for each unique situation before the determination of the proper entity can be made.

Trend Noter: Dave Veniskey, Partner, EFP Rotenberg LLP

Don’t miss out - Internal Revenue Code Section 48D provides $1 billion for eligible companies 

On March 23, 2010, President Obama signed the Patient Protection and Affordable Care Act. The act created Internal Revenue Code Section 48D, which provides for a tax credit or grant for qualified investments. This allows qualifying companies to claim a tax credit or receive a grant for a "Qualifying Therapeutic Discovery Project" (QTDP) during tax years 2009 and 2010. $1 Billion has been allocated under the program and the credit is equal to 50% of allowable expenses of the Qualifying Therapeutic Discovery Project. Companies can also apply for a cash grant for the same amount instead of a credit. 

Projects need to be certified by the Treasury Department on a project by project basis. For further information, click here or please contact our emerging credit team via email at EmergingTechnologyTeamEFPRotenberg [dot] com.

Nursing homes and long-term care: the next generation

Many nursing home operators might have started out as mom-and-pops, but increasingly there’s no “junior” to take over the business when mom-and-pop want to retire. Some of it is just the changing nature of family business dynamics, but much of it is a result of the increasingly complex, highly regulated business that elder care has become. So it pays to run your organization as one that you plan to sell on the open market, even if that day seems far off. There will be plenty of sellers, but they’ll be looking for operations with strong balance sheets, solid internal controls, and a good strategy for playing the reimbursement game.

Trend Noter: Kathy Angelone, Director, Rotenberg HealthCare Consulting, LLC.

Faster decision-making: what company doesn’t need that?

Twenty-first century competition demands an agility and fluidity that don’t mesh well with the “I’ve got to check with central office” model that the Big Four relies on in its auditing engagements. Increasingly, we’re finding that clients who may have chosen us for our more reasonable fees are now discovering the advantages of having a senior-level person on site at the audit, the better to have questions and issues addressed on the spot. As tempting as it is to staff those audits with entry-level professionals, we recognize that the increased level of service is of particular value to companies.

Trend Noter: William Friedman, Partner, EFP Rotenberg LLP

Increasing pace of change in tax code, accounting standards

What we all used to think of as the normal rate of change in tax and accounting (in the last several decades of the 20^th century) has been completely eclipsed by the last two decades’ breakthrough pace, which will only accelerate. A flatter world means a trend toward international accounting standards. Financial and banking reform regulations will trickle down into auditing requirements. An increasing emphasis on government-fueled projects (from shovel-ready infrastructure to green technology) will create more reporting requirements.

Trend Noter: Michael Doody, Partner, EFP Rotenberg LLP

Health care: overwhelming complexity

Given the unprecedented push to find savings in health care expenses, and the enormous ripple effects of any health care reform, health care providers of all kinds should expect to find the process of navigating regulations and reimbursement to become more, not less, complex. Particularly given that health care changes will be phased in over several years, and affected by state interpretations and case law as well, most health care organizations will find themselves outsourcing at least some of the regulatory administration. Expecting a single person, with multiple responsibilities, to stay on top of the constant shifts would not be realistic.

Trend Noter: Rob Nasso, Partner, EFP Rotenberg LLP

Regional accounting firms offer diversity of experience to new hires

It’s hard enough to decide you want to be an accountant when you’re twenty years old. But two years later, many of the larger accounting firms—particularly the Big Four—expect you to have chosen your specific areas of expertise when they hire you as a “first-year.” Sometimes, it’s too soon to have to make that decision. Regional firms, with fewer silos between departments, will tend to offer entry-level hires more diversity of assignments. At EFP Rotenberg, we’ve taken it even farther: we rotate first-years through department assignments and encourage them to find their place. In our experience, it makes for less turnover (costly), more satisfied employees (good for clients), and better teamwork (good for the bottom line.)

Trend Noter: Nicholas Bottini, Partner, EFP Rotenberg LLP

A recession’s impact on fraud

I have been asked frequently of late if a recession impacts the occurrences of fraud in organizations.  Fraud festers where opportunities present themselves and individuals succumb to pressures they are experiencing.  During recessionary times, more people experience greater pressures.  It’s critical to safeguard your organization.  The old adage “an ounce of prevention is worth a pound of cure” is certainly applicable in these situations.  It’s to your benefit to see us before a problem occurs rather than quantify the effects of a fraud afterward.  

Trend Noter: Jim Marasco, Partner, EFP Rotenberg LLP

A challenging economy

Everyone knows this is a challenging economy, but it is also a unique opportunity to get stronger, get smarter, and take advantage of opportunities. Most people see problems and challenges.  We see opportunities. Get your business and personal house in order.  Revisit your web site and marketing efforts.  Identify and take care of your best customers.  Look at the world as what are today’s opportunities.  It might be acquiring another business, adding a talented  person who has been downsized, forming a new relationship with another firm.

Trend Noter: Jim Leisner, Partner, EFP Rotenberg LLP