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1 Minimizing Risk Through Company Restructuring Garth D. Stevens, Snell & Wilmer L.L.P. Joshua P. Hayes, Eide Bailly LLP
2 ©2010 Snell & Wilmer L.L.P. Objectives of Reorganization 1. Protect specific classes of assets (e.g., real estate, IP) 2. Create firewalls between different businesses 3. Insulate higher risk business from lower risk business
3 Limited Liability and Piercing the Corporate Veil
4 ©2010 Snell & Wilmer L.L.P. Limited Liability A fundamental tenet of corporation and LLC formation: Ordinarily, a company’s shareholders will not be liable for the company’s debts or other liabilities beyond the shareholders’ equity investment in the company.
5 ©2010 Snell & Wilmer L.L.P. Piercing the Corporate Veil Potential triggers: ◦ Fraud ◦ Deliberate efforts to hinder creditors ◦ Recklessly undercapitalizing / underinsuring the company. ◦ Failing to observe legal formalities that give the company independent legal status.
6 ©2010 Snell & Wilmer L.L.P. —High risk operations —Low risk operations —IP assets —Owned real estate Shareholders Company Simple Company Structure
7 ©2010 Snell & Wilmer L.L.P. Common Firewall Structure Shareholders HoldCo OpCo. #1OpCo. #2IPCo. Real Estate Co.
8 ©2010 Snell & Wilmer L.L.P. Three-Step Process First – Factual analysis and planning; preliminary steps. Second – Complete the Reorganization (one time event). Third – Observe corporate & business formalities (ongoing).
9 ©2010 Snell & Wilmer L.L.P. Factual Analysis & Planning; Preliminary Steps Determine appropriate tax structure. Identify contractual restrictions (e.g., bank loan documents; shareholder agreements). Identify permit and licensing issues, including transferability. Identify notices/registrations that will need to be made (e.g., IP transfers; notices to customers). Obtain applicable shareholder/director approvals.
10 ©2010 Snell & Wilmer L.L.P. Tax Analysis and Considerations Tax considerations – e.g., preservation of NOLs and tax credits. Valid business purpose. Shareholders receive stock in exchange for stock. Investment position is equivalent after transaction is complete.
11 ©2010 Snell & Wilmer L.L.P. How Do We Get There? 1. Form new HoldCo. 2. Shareholders of current OpCo assign their shares of OpCo to new HoldCo (Code § 351) 3. In exchange, HoldCo issues shares to OpCo shareholders 4. The result – Shareholders now hold the same % ownership of HoldCo and HoldCo owns OpCo Step One – Formation of New Parent Holding Company Shareholders HoldCo OpCo.
12 ©2010 Snell & Wilmer L.L.P. Shareholders How Do We Get There? 1. HoldCo forms new OpCo subsidiaries. 2. Each OpCo subsidiary issues shares to HoldCo 3. S-election for new HoldCo; Q-Sub elections for subsidiaries (watch timing) Step Two – Formation of New Subsidiaries HoldCo. OpCo. IPCo. Real Estate Co.
13 ©2010 Snell & Wilmer L.L.P. Shareholders How Do We Get There? 1. Original OpCo. makes a dividend/distribution of assets to HoldCo. (Code § 368) 2. HoldCo then contributes the assets to another OpCo subsidiary. 3. OpCo’s then enter into cross agreements on arm’s length terms. Step Three – Transfer of Assets HoldCo. OpCo. IPCo. Real Estate Co. ASSETS
14 ©2010 Snell & Wilmer L.L.P. The End Result Shareholders HoldCo OpCo. #1OpCo. #2IPCo. Real Estate Co. Building Lease IP Licenses Admin Services Agreements
15 ©2010 Snell & Wilmer L.L.P. Subsidiaries vs. Sister Companies Parent Co. OpCo. IPCo. Real Estate Co. HoldCo OpCo.IPCo. Real Estate Co.
16 ©2010 Snell & Wilmer L.L.P. Subsidiaries vs. Sister Companies Consolidated tax election? Combined filing? Tax Filing Considerations:
17 ©2010 Snell & Wilmer L.L.P. Preserving Limited Liability TWO KEYS: 1. Maintenance of independent existence and operation. 2. REASONABLE capitalization and/or insurance for each company.
18 ©2010 Snell & Wilmer L.L.P. Independent Existence Think of (and treat) each company as if it was truly independent of each other company. If you don’t treat each company as a separate legal entity, there is a good chance that a court won’t either.
19 ©2010 Snell & Wilmer L.L.P. Maintaining The Firewalls Avoid co-mingling funds; each company with its own bank account. Document inter-company transactions with written agreements on arm’s length terms. Intercompany loans should be under written, interest- bearing notes or loan agreements (not just GL entry). Each company should follow proper corporate formalities. Where appropriate, each company should have its own employees. If possible, avoid cross guaranties and cross-default terms in contracts. If possible, physical segregation of businesses.
20 ©2010 Snell & Wilmer L.L.P. Capitalization and Insurance The best way to avoid a creditor’s attempt to “pierce the veil” is to give the creditor no need to do so. Take a REASONABLE approach to capitalizing and/or insuring each company.
7 Tax Mistakes that will cost you Payroll Taxes ◦ It’s a VERY easy and tempting loan to make ◦ It isn’t the employer’s money, it is trust fund money on behalf of employees. Independent Contractors ◦ Employees are expensive and healthcare reform is complicated. ◦ 20 part test IRS uses to determine status of worker 21 ©2010 Snell & Wilmer L.L.P.
7 Tax Mistakes that will cost you Owner compensation strategies ◦ Reasonable compensation for services ◦ C-corp vs. S-Corp vs. LLC Hire your Children? ◦ Reasonable compensation for services ◦ Must be real work performed or services performed ◦ College planning with low tax cost and potential credits 22 ©2010 Snell & Wilmer L.L.P.
7 Tax Mistakes that will cost you Keeping Receipts ◦ Must keep an accurate diary or business log in addition to receipts ◦ Documentation of Who? Why? When? Where? Purchasing equipment at the end of the year ◦ Mid quarter convention might limit deduction ◦ Uncertainty of bonus depreciation and Sec ©2010 Snell & Wilmer L.L.P.
7 Tax Mistakes that will cost you Embezzlement ◦ Separation of duties - Ordering vs. receiving - Check writing/signing vs. A/P input ◦ Monthly oversight by owner is a must! 24 ©2010 Snell & Wilmer L.L.P.
25 Thank You Garth Stevens Snell & Wilmer Joshua P. Hayes Eide Bailly LLP
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