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Business Tax Law

~Mark Twain~ "Whenever you find yourself on the side of the majority, it is time to pause and reflect."

Whether you are starting a business, growing a business, or presently own an established business interest, there are many important legal matters that will affect your business.

The type of business entity or entities you are using can affect future profits, stability, taxation, and other important matters. Business entities available include corporation / incorporation INC., limited liability companies (LLC), limited partnerships (LP, LLP, or LLLP), or a series or combination of one or more of the above. Running a profitable business is not simply a matter of making a profit; it is also important that you protect what you make, and put it to work in a way most profitable for you and for those who may inherit your business.
Taxation of Business Entities-Corporations, LLC's and Partnerships
One of the most misunderstood areas of tax law is business tax law, especially as it applies to small and medium-sized companies. Many small companies start out as a sole proprietorship, and then later choose to convert to a limited liability company, an S or C corporation or other entity. They type of entity you choose determines the tax treatment of the income.

C Corporations
A C corporation is a corporation whose tax treatment is prescribed in 26 U.S. Code Chapter 1, Subchapter C. Put very simply; a C corporation's income is taxed at the corporate level before there are any profit distributions to the shareholders. C corporations file form 1120, and must file it by March 15 if using a calendar tax year.

S Corporations
An S corporation is a corporation whose tax treatment is prescribed in 26 U.S. Code Chapter 1, Subchapter S. When a corporation is formed, by default the IRS will treat the corporation as a C corporation. To be treated as an S corporation the shareholders and officers must make a Subchapter S election by completing form 2553. This form must be filed before the year in which the corporation wishes to enjoy the benefits of a Sub-S election, but no later than 2 1⁄2 months into the tax year in question. S corporations file form 1120S, and must file it by March 15 if using a calendar tax year.

An S corporation does not pay taxes; instead, its owners pay the tax. At the end of the tax year the tax liability for the net profit (or loss) of the S Corp is attributed to its owners. Each owner is given a form K-1 indicating the amount of income (loss) attributed to that owner. That amount is reported on the individual's federal income tax return.

LLC's
The tax implications of a limited liability company are often misunderstood. LLC's are often treated one way for federal income tax purposes, another for state income tax purposes, and yet another for legal purposes. It is not uncommon for the IRS to completely disregard an LLC and treat the income of the LLC as if it were a sole proprietorship; yet, for legal purposes it will be treated as a separate entity-maybe. Finally, the state tax authorities will likely treat it as a separate entity unless there is a tax liability issue or dispute: then the owner may find that they are personally liable to the state and possibly criminally liable-regardless of the existence of the LLC.

When you form a limited liability company, if there is only one owner the IRS will disregard the entity and treat the income as ordinary income to the owner. This income should be reported on Schedule C as if it were a sole proprietorship.

When you form a limited liability company, if there is more than one owner, by default the IRS will disregard the LLC laws and treat the entity as a general partnership whose income is taxed as ordinary income to each of the general partners as individuals. Depending on certain facts, this income would be reported either on Schedule C, Schedule E, on form 1040 and in some cases elsewhere.

When you form an LLC one can avoid the default treatment and elect to have the LLC treated as an S Corp or as a partnership. Which election to make would depend on many factors including the relationship between the owners and the number of owners and type of owners, whether they are individuals or some other legal entity.

The entity choice of LLC is not as simple as many think and there are many instances where an audit of an LLC reveals many bad choices and misunderstandings that are very costly to its owners. Relying on advice of a company that merely forms corporations and other legal entities is not wise; one should seek the advice of an attorney and a tax professional when making these decisions.

International treatment of LLC's is even more complicated. An international investor from one country may have their LLC treated by their home country as if it were an ordinary corporation, possibly creating a substantial tax liability. Another international investor could have an entirely different result.

Real Estate and LLC's
An LLC is often the knee-jerk response of real estate professionals and online corporate formation companies when asked by their clients about how to purchase and hold title to real property.

A great deal of bad advice is given by real estate salespersons, corporate formation companies and other "professionals" regarding this issue. If you need legal and tax advice, look only to experienced legal and tax professionals for advice or you may find yourself in breach of contract (default) with your mortgage lender, if you have one; or, find yourself liable for taxes and fees for which you were not prepared to pay.

(Please Read ALL Sections Below)
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1. Start a Business

 a. Form Your Business Structure
  I. Incorporate Your Business
   1. Types of Entities
    a. Corporations
    b. Non Profit Organizations
    c. 501(c) Applications to IRS
 b. Business Plans
 c. License Your Business
  I. State Business License
  II. Local Business License
  III. Special Licenses
 d. Sales and Use Tax

2. Manage Your Business Entity

 a. Maintain Required Formalities
 b. Reinstatement of Defaulted Corporation, LLC's, etc.

3. Manage Your Business Operations

 a. Contract Formation
  I. Time if of the Essence
  II. Integration Clause
  III. Modification Clause
  IV. Arbitration Clause
  V. Attorney's Fees Clause
 b. Buy-Sell Agreements, Buy-Out Agreements
 c. Mergers, Acquisitions

4. Protect Your Business

 a. Protecting Trade Secrets
 b. Protect Against Litigation
 c. Tax Issues and Problems

5. Dissolve or Close Your Business

  a. Liquidation, Winding Down of Affairs, and Dissolving a Business Entity


1. Start a Business

Our staff consists of individuals who are experienced with successfully starting and managing various types of businesses. Allow us to use our knowledge and experience to help insure your venture is successful.

There are different approaches to starting a business depending on the type and size of business. Even if you are beginning small, there are some issues worth looking into at the onset. Do not become overwhelmed by advice given to you regarding the many issues of starting a business. Do not doubt your ability to succeed-there are down-to-earth and cost-effective ways to get your new business underway.

The larger the business, the more issues you will need to address involving investors, risk of loss, securities laws, and more. Planning now will help insure that your new business will be a success.

 a. Form Your Business Structure, Incorporations, LLC's
The business structure of your business will affect every aspect of your business, from day-to-day operations to profit sharing to federal and state taxes and other liabilities. Do not make the common mistake of failing to form your business correctly. Forming your business one way, then operating as if formed another way is certain to bring great disappointment to you and your partners.

  I. Incorporate Your Business
A person can operate a business as a "sole proprietor", in other words, without forming a special "entity" like a corporation or limited liability company. However, in most cases this exposes you , your partners and company to a greater risk of substantial personal loss. To promote the profitability of business ventures, and to encourage individuals to start businesses, laws have been drafted so that you can create an entity to act as "the company", thereby limiting exposure to liability.

Different entities provide different governing structures with different degrees of protection from losses, and each has different federal tax implications. The type of entity many choose is a Limited Liability Company, or LLC. Despite their popularity, this may not be the correct entity for your company.

After choosing an entity, it is also important to choose your preferred type of "federal tax treatment" or you may be stuck with being treated, for federal tax purposes, in a manner that will increase your federal tax liability.

There are many issues that need to be considered when creating your "corporate structure". With some businesses, a wise plan may involve the creation of more than one business entity, each having a different purpose.

   1. Types of Entities
    a. Corporations
A corporation is useful for many purposes, and until recently, has been the most frequently used entity. If you intend to offer securities to the general public, have several stock holders, or "go public", you may need to form a Corporation.

If you have a smaller company, there are entities available (limited liability companies (LLC), limited partnerships (LP, LLP, or LLLP)) that not only provide some additional protection from liability via state law, but the IRS provides different methods of "federal tax treatment" that can simplify tax filings or even reduce tax liability.

    b. Non Profit Organizations
You may also decide you wish to form a non-profit organization. You can create a non-profit entity at the state level, but you will also need to apply to the IRS to obtain the status of "non-profit", if you wish those who give to your non-profit company to be able to deduct the gift on their tax returns.

    c. 501(c) Applications to IRS
An application for non-profit status must be fully and accurately completed. It is recommended that you use an attorney to prepare the application for you.

 b. Business Plans
Very few businesses are successful without a reasonably prepared business plan. There are programs available to assist you with drafting a business plan. It is highly recommended that you prepare a business plan or have someone prepare one for you.

 c. License Your Business
Another issue that needs to be addressed when starting a business is the various licenses that you may need. At the very least, you will need a State Business License and most likely Local Licenses, and sometimes you may also need a Special License.

  I. State Business License
Usually, you obtain your State Business License at the same time you create your business entity.

  II. Local Business License
Local Business Licenses are usually required. Depending on where your business is operated, you will either need a Business License from the City or County.

  III. Special Licenses
Special Licenses are those required by professionals, Realtors®, or by those engaging in the sale or distribution of controlled items such as alcohol, etc.

 d. Sales and Use Tax
County and City government offices are very helpful in assisting you with all that you need to insure you are properly collecting sales tax.



2. Manage Your Business Entity

 a. Maintain Required Formalities
Many make the mistake of thinking that there is nothing more to forming a Corporation or LLC than simply filling out forms with the Secretary of State and paying a few hundred dollars in fees. The fact is, if you do not follow the formalities of your Corporation, Limited Liability Company, or other entity, state and federal courts could totally disregard your entity and subject you to liability and many other potential problems.

If you are truly concerned about your business and about protecting you, your family and business from potential losses, you probably should hire an experienced corporate attorney.

 b. Reinstatement of Defaulted Corporation, LLC's, etc.
Many who fail to pay the corporate yearly fees and properly maintain certain corporate formalities call our offices, desperately looking for a way to remedy the problems that have arisen. If you have not paid the yearly fees and properly maintained the required corporate formalities, one step that often needs to be taken is the "Reinstatement" of the Corporation or LLC. In order for this to be successful, among other legal requirements, the Secretary of State will require that all back fees, plus penalties, be paid.



3. Manage Your Business Operations

 a. Contract Formation
Regardless of who you are working with, you should reduce every agreement into writing. When it is in writing, and well written, there are fewer misunderstandings. Honest parties to a verbal agreement will almost always have some kind of misunderstanding regarding the terms of the agreement (contract), which could have been avoided had the agreement been in writing, reviewed by all parties, and signed.

Depending on the type of agreement, it may not always have to be complicated; but, there are a few things that you AND your attorney should consider when drafting almost every agreement.

  I. Time is of the Essence
This clause often simply states that time is of the essence. This simply means that deadline dates and times must be strictly adhered to. In other words, if one party is required to deliver a certain product by April 1st, but is unable to (for any reason) to deliver the product until April 2nd, this would be considered a material breach of the terms of the agreement. (A material breach is one that affects the "essence" of the agreement, and such a breach usually gives the Non-breaching party the right to terminate the entire contract).

You may think this term would be in your best interest, but there are many times when this seemingly innocuous term unfairly harms one of the parties to an agreement. There are times when this clause can be helpful and other times you should make sure this clause is NOT part of the agreement.

  II. Integration Clause
This clause refers to communications and agreements made that are not contained in the written contract. In most cases, an integration clause should be inserted in a written agreement to make sure there are no misunderstandings regarding agreements or other terms that were discussed before the final contract was written and executed (signed).

However, it is very important to note that if all terms and all aspects of your agreement are not placed in that particular document, they are no longer part of the final agreement.

  III. Modification Clause
This clause refers to the terms under which the agreement can be changed. By default, generally, an agreement cannot be modified unless the modification is agreed to by both parties. However, there are exceptions, and to avoid any confusion, this issue should be agreed upon and inserted into the written contract.

  IV. Arbitration Clause
This clause refers to whether or not the parties to the agreement have the right to a jury trial if there are any controversies that arise under the contract. The parties to a contract can agree that they must use an arbitrator to settle claims that arise under the contract. This can save time and money, but there are many instances where this approach is most inappropriate for one or both of the parties. One should seek legal counsel regarding this issue.

  V. Attorney's Fees Clause
This clause can often prevent frivolous, or baseless, lawsuits by one party against the other. The clause deals with the issue of who pays attorney's fees if there is a claim that arises under the contract. If it is stated that the losing party to a lawsuit must pay the legal fees and costs of both parties, this can help reduce the risk of a lawsuit brought against you for no reason.

 b. Buy-Sell Agreements, Buy-Out Agreements
This agreement controls what happens if certain "trigger events" occur. If a triggering event occurs, the provisions of the Buy-Sell Agreement would be "activated". Triggering events include such events as death, disability, retirement, or an owner leaving the company or declaring bankruptcy or getting a divorce.

Buy-Sell agreements are very important and often overlooked. These agreements prepare you and your company for events most people do not expect, but unfortunately often occur. A company that heavily relies on its owners can be devastated by such events. Overnight, such events can change ownership and control of a company-perhaps to someone that is not capable of properly managing the company, or someone with whom the other partners are unable to peacefully work or "get along".

It is always good to plan ahead, even for events that seem unlikely or unpleasant.

 c. Mergers, Acquisitions
When merging two companies or when purchasing another company, there are possible latent issues that may not arise until it is too late. You need a professional to help insure that you do not purchase a company that has latent or hidden liabilities for which you did not account and cannot afford. Part of the plan for avoiding such a catastrophe is to have the transfer governed by a properly drafted agreement and by obtaining legal counsel throughout the process.



4. Protect Your Business

 a. Protecting Trade Secrets
Do not underestimate the risk of having another group take your ideas and implement them and make a fortune without your authorization or involvement. This happens often. Be sure to take full advantage of Patent, Trademark, and Copyright laws; and, take advantage of other strategies that can reduce this risk.

 b. Protect Against Litigation
We live in a litigious society. There are many methods whereby a company or person can limit your exposure to a law suit, such as, privacy strategies, choice of entity decisions, and other planning. Different business operations create different degrees of risk; e.g., a building contractor has a higher risk than a bookkeeping business. Both have risk, but the chance and degree of risk is much higher for the contractor. A contractor should implement more involved strategies to avoid litigation than a bookkeeping company.

 c. Tax Issues and Problems
With the proper pre-planning and consultation, you can avoid many tax problems that would otherwise arise. Early in the process of beginning a new business, it is important to determine what is the best choice of federal tax treatment and what is the best choice of entity (Corporation, LLC, etc.). If you do not plan ahead, the IRS will choose a "default federal tax treatment" (without your input) for your company, which is usually the type of tax treatment most dis-advantageous to you.

If your business is already established and you are having problems with the IRS, promptly obtaining counsel and direction, along with prompt action, is the most profitable way to handle such issues. Procrastinating or putting a tax problem off until later is done all too often, and once the time comes that it must be dealt with, the problem is so enormous it seems impossible to handle.

Do not be intimidated by federal tax problems. Do not feel the problems are so large that there is no way to solve them. Contact us and we can assist you and help calm the storm.



5. Dissolve or Close Your Business

  a. Liquidation, Winding Down of Affairs, and Dissolving a Business Entity
There are many laws regarding liquidating or winding down the affairs of a company. Statues usually require a certain number of the owners of the company to authorize the liquidation. The laws are designed to protect creditors and other partners from harm caused by selling all of the assets of the company.

If possible, liquidation should be done with legal counsel present during the process in order to protect you from future liability.

California Tax Law Help

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    Please Be Aware: Individuals who deliberately fail to comply with federal or state tax laws may be subject to a criminal investigation, which could result in prosecution, fines, and imprisonment. Do not deliberately ignore your problems with the IRS or FTB; instead, contact a professional as soon as possible and settle any issues you may have.


“Thank you for getting me on the right track with using a LLC and not the Inc. that I had thought, I needed...”
Jon M.

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As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code. Furthermore, the contents of this website are neither intended to be, nor should be, construed as either legal OR tax advice. Each individual's circumstances are unique. This site contains general and overall discussions, and as such, the content of this site is not intended as definitive legal or tax advice that would apply to any particular person. Those who view this web site should seek advice from an independent tax advisor with respect to their particular transaction or matters that is based on the reader's particular circumstances. You must have your particular financial and tax situation personally reviewed by a tax professional or attorney in order to obtain tax or legal advice upon which you can rely.

David DL Horton, Esq., EA
**Licensed in California**
**Practice in Nevada limited to federal tax law & legal work performed under continuous direction and approval of Jacqueline Mary McQuigg, Esq.**


In NEVADA, services provided are strictly limited to those authorized by the IRS under Treasury Department Circular No. 230. 31 U.S.C. §330. Should a client need legal services related to Nevada-law matters such as probating an estate, real estate law, filing a petition for bankruptcy, or any other Nevada-law matter, the client must enter into a separate agreement with, and directly engage the services of, Jacqueline Mary McQuigg & Associates, or another Nevada-licensed attorney.

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