Running the Family-Owned Business

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Family-owned businesses offer certain advantages not always available in larger publicly-held businesses. These advantages generally include close contact with upper management, less bureaucracy, built-in trust among officers, board members and shareholders, and the opportunity for hands-on training, mentoring and early exposure of the younger generation to the business.

Family-owned businesses also present certain unique challenges. In particular, family-owned businesses often have problems with succession. These succession problems can often be tied to inadequate training of the younger generation, family rivalries and jealousies, inadequate communication between family members and lack of planning. These succession problems can also occur when the senior generation does not allow the younger generation the opportunity to grow (and make mistakes), develop, and at some point assume a leadership role in the business.

Most successful family-owned businesses have clearly defined roles and responsibilities for family-members. Most successful family-owned businesses also do a thorough job training and preparing the younger generation to assume leadership positions. This can include job shadowing where the younger generation hears, sees, and absorbs the actions of a mentor in the actual business environment. Many family-owned businesses span multiple generations.

These family-owned businesses can be quite complicated to run smoothly as multiple generations interact in running the business. These family-owned businesses can be even more complicated to run when in-laws are involved. Planning is critical for any business. But careful planning is even more crucial to the family-owned business because many families have all or most of their assets tied up in the business. Personal estate and family planning therefore gets intertwined and inter-woven with succession and business planning.

Owners of family-owned businesses need to carefully plan to move assets where they are needed for family reasons, while minimizing transfer taxes and preserving necessary resources within the business. Business, estate and succession planning can be overseen by the company’s Board of Directors, an advisory panel, or other professional advisors. It is important for owners of a family-owned business to ask and answer the hard questions. Who should be in charge 5, 10, or 20 years from now? Does my son or daughter have what it takes to run this business successfully? Are there employees in the business who could help lead the business profitably? Do we have the time to train and develop the next generation? Are there vendors or customers who would be interested in buying part or all of the business?

If you would like to meet with one of our business and tax attorneys to discuss succession planning or any other aspect of your family-owned business, please contact me at 937-223-1130 or Jsenney@pselaw.com.


AND ONE MORE THING. The Ohio legislature released a proposed resolution of the tax differences in House Bill 59. Under this proposed resolution, most Ohioans would pay less income tax, while paying more property and sales taxes. More on this as it develops. Call or email me at 937-223-1130 or Jsenney@pselaw.com with any questions about state or federal tax issues.

Passive or Active? It Makes a Difference

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Under IRC section 469(c)(1), the losses from a passive activity can generally be deducted only against passive income.  So the characterization of an activity as active or passive controls whether a taxpayer can deduct the losses of such activity against other active income.  An activity is not characterized as an active trade or business with respect to the taxpayer unless the taxpayer materially participates in the activity. A taxpayer is treated as materially participating in an activity by meeting at least one of the seven tests in Treas. Reg. section 1.469-5T.  As an example, a taxpayer is considered to materially participate if: (1) the taxpayer participates in the activity for more than 500 hours during the year (first test); or (2) on the basis of all of the facts and circumstances, the taxpayer's participation was regular, continuous, and substantial during the year (seventh test).  In determining whether any of the tests are satisfied, the participation of the taxpayer's spouse is considered.

A taxpayer can demonstrate his or her participation in an activity by any reasonable means.  Contemporaneous daily time logs, calendars, appointment books, reports, or similar documents aren't required. Reasonable means includes identification of services performed over a period of time and the approximate number of hours spent performing the services during the period, based on appointment books, calendars, or narrative summaries.

If you have any questions about how to properly characterize an activity as active or passive, or how to best structure your business and investment activities, contact one of our tax and business attorneys at 937-223-1130 or Jsenney@pselaw.com.

AND ONE MORE THING.  An S corporation shareholder may deduct his or her pro-rata share of any loss sustained by the corporation.  However, the shareholder's deduction of such loss is limited to the sum of the shareholder’s basis in his or her stock and the amount of any debt owed to him or her by the corporation.  For this purpose, a shareholder's guarantee of a loan made by a third person to the S corporation is not treated as a debt from the S corporation to the shareholder.   In a recent tax court case, the Court looked at whether the guarantee of a corporate note to a bank would give a shareholder basis in his or her stock or debt at the time the corporation defaulted and the Bank looked to the shareholder-guarantor for payment.  The Court found that the mere fact that the corporation defaulted and thereby rendered the shareholder-guarantor liable was not sufficient.  The Court found that, the shareholder-guarantor had not changed his position to that of the primary obligor prior to the default.  If you have questions about deductibility of losses contact 937-223-1130 or Jsenney@pselaw.com.

Treating a Stock Purchase Like an Asset Purchase

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Potential buyers of a corporate business generally want to buy the assets of the corporation and not the stock.  Sellers generally want to sell the stock and not the assets.

When a seller sells stock of a corporation, the seller pays tax at capital gain rates on the gain recognized on the sale of the stock.  On the other hand, if the seller had caused his or her corporation to sell its assets, then the corporation generally would have had to pay tax at ordinary income tax rates on the depreciation recapture amount and tax at capital gains rates on the balance of the recognized gain.  And this is in addition to any tax the sellers pay upon distribution of the sales proceeds by the corporation to themselves.  So sellers generally prefer doing a stock sale because they pay less tax when the deal is structured as a stock sale.

On the other hand, a buyer wants to do a deal as an asset sale because the buyer avoids becoming liable for seller’s known and unknown liabilities, and because buyer will get an automatic step-up basis in the corporation’s assets.  As a result, the buyer will  get larger depreciation deductions and will pay less tax in the future.  For these reason, buyers generally insist on doing the deal as an asset sale.

Assuming taxes and existing liabilities are not a major concern, there are some situations where both buyer and seller would prefer to do a deal as a stock sale.  Doing a stock sale can eliminate the need to transfer or obtain new licenses, permits and certifications.  Doing a stock sale is somewhat less cumbersome since only title to the stock gets transferred and not all of the individual assets.

When buyer and seller negotiate the structure of the deal as an asset sale or a stock sale, they need to factor in the tax consequences when setting the agreed purchase price.  A higher purchase price will generally be paid by the buyer in an asset sale.  A lower purchase price will generally be paid by a buyer in a stock sale.

But if a deal must be structured as a stock sale, is it possible for a buyer to do the stock sale and still get the tax effect of doing an asset deal?  It is.  IRC section 338(h)(10) permits a buyer and seller to jointly make an election to treat the stock sale as an asset sale for tax purposes.  If this election is made, only corporate-level gain on the deemed asset sale is recognized.  No shareholder-level gain is recognized on the actual stock sale.  Second, the deemed asset sale is treated as occurring while the target corporation is still a member of the selling group.  As a result, it is often possible for the seller to shelter the gain on the deemed sale of assets with operating losses or other tax benefits within the selling group.  As a result, an IRC section 338(h)(10) election may be agreeable to both parties when negotiating the structure of a deal if the value of the future tax benefits to the buyer (stepped up basis) exceeds the current tax cost to the seller.  To the extent the buyer gains significant basis step-up as a result of the election, buyer might increase the stock purchase price somewhat to account for the increased taxes paid by the seller.

If you have questions about making a 338(h)(10) election, call one of our business and tax attorneys at 937-223-1130 or jsenney@pselaw.com.


AND ONE MORE THING.  Don’t forget that making a 338(h)(10) election for an “S” corporation could cause the built-in-gains tax to apply.  BIG tax applies when an “S” corporation that was formerly a “C” corporation sells appreciated assets at any time during the recognition period.  If you have any questions about BIG tax please call one our tax and business attorneys at 937-223-1130 or Jsenney@pselaw.com.

Why Do I Need to Comply with the Required Corporate Formalities?

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Met a former business owner and his spouse at a networking event recently. The husband used to own a corporation. Funds were tight and he missed some payroll tax deposits. Then he missed a few sales tax deposits. Next thing you know the IRS and State of Ohio filed liens and levies to collect the unpaid tax.

The corporation went out of business and liquidated. The delinquent federal and Ohio taxes were not paid. The IRS and Ohio went after both the owner and his spouse for payment of the "trust fund" portion of the taxes arguing that each was a responsible person. Generally a responsible person is an officer, director, shareholder of a corporation who has the power and authority to make payment decisions. The owner now says that his spouse is not a responsible person since at the time the tax liabilities arose only he was a shareholder, director and officer of the corporation.

I suggested he could easily prove to the tax authorities that his spouse was not a responsible person by showing them copies of the corporation's stock certificates, stock ledgers, corporate resolutions and other documents that listed only the owner as a shareholder, director and officer at the relevant times. He was a bit embarrassed to admit he never kept a corporate record book or did annual minutes, and he really had no documents to show the tax authorities to disprove their assumption that both the owner and his spouse were responsible persons.

To add insult to injury, the failure to maintain the corporate record book gave the tax authorities support for their argument that they should be permitted to "pierce the corporate veil" and go after both the owner and his spouse for all the corporate taxes (not just the trust fund portion) as partners.

At times it can seem a bit troublesome to prepare annual minutes for a small corporation. But the annual cost to maintain a corporate record book is low when you compare it against the problems that can arise from failure to comply with the required corporate formalities.

AND ONE MORE THING.  Shahrzad Allen of Pickrel, Schaeffer & Ebeling and others will be presenters at the Immigration Reform Leadership forum sponsored by the Dayton Hispanic Chamber on June 19^th from 7:30 to 9 am.  The event will be held at the Hilton Garden Inn in Beavercreek.  The cost is $20 for non-members and $15 for non-profit organizations.  Continental breakfast will be served.  For more information, visit DHC’s website at  www.daytonhispanicchamber.com.  Or contact Jeff Senney jsenney@pselaw.com or Jan Burden jburden@pselaw.com.