A PRIMER ON DIRECTORS AND OFFICERS INSURANCE FOR PRIVATE ENTITIES

by Fredric L. Shenkman, Esq., LL.M.

This primer is intended to outline the fundamentals of directors and officers insurance (“D&O”) for non-publicly traded entities.

Historically, corporations could not indemnify their officials against personal losses arising out of their duties as directors or officers. A precipitous increase in litigation against officers and directors, who often serve gratis, was the genesis for widespread  D&O coverage.

D&O insurance is a form of professional liability insurance. It protects corporate officials from personal losses arising out of the fulfillment of corporate duties and responsibilities.

There are no standardized policies for D&O insurance. The reasons for this lack of standardization include: the differing  requirements of public versus private entities, particularly with regard to exposure for securities law violations; varying size of the entities; and varying types of exposures, depending upon the entity’s involvement in a particular industry or undertaking.

INSUREDS.

Typically, a D&O policy will define “directors and officers” as past, present or future duly elected or appointed directors or officers. Coverage is normally afforded only when the officer or director is acting in discharge of his or her corporate responsibilities. Coverage may extend to “mixed” acts, where the acts on behalf of the corporation are inextricably linked with non-covered acts.

TYPES OF COVERAGE.

D&O insurance, traditionally, has three possible facets of coverage. The first protects individual directors by paying defense costs and settlements arising out of a lawsuit. This facet is colloquially known as “Side A” coverage. This type of coverage applies when the entity is unable or not allowed to provide indemnity for its officers and directors.

The second type of coverage provides indemnity for the entity to the extent it has paid for the defense and indemnity of its directors and officers. This is known as “Side B” coverage.

The third type of coverage provides indemnity for the entity itself; this is “Side C” coverage.

Recently, claims related to sexual harassment have come to the forefront. A director or officer can face liability for engaging in such conduct or permitting and/or fostering a corporate culture that is conducive to such conduct. These types of claims are typically covered under employment practices liability insurance (“EPLI”). EPLI coverage can be provided separately or as part of D&O coverage. The coverages should dovetail. For example, a D&O policy may exclude coverage for wrongful termination while an EPLI policy insures same based on the conduct being “employment related.”

Cyber liability may also implicate D&O coverage. The coverage comes into play  when officers and directors are alleged to have failed to take reasonable steps to protect  an individual’s privacy. If a data breach occurs and the entity is sued, typically same is a “wrongful act” covered by the D&O policy. There have been attempts to implicate D&O coverage for direct losses for data breach independent of any suit. Although these claims are the subject of coverage pursuant to a cyber liability policy, policy-holders attempt to obtain coverage for these issues from the D&O policy when the cyber liability policy is inadequate or there is no cyber liability policy.

EXCLUSIONS TO COVERAGE.

Exclusions of D&O policies are of two broad categories: claims related to corporate governance and claims related to matters covered by other types of insurance.

The exclusion related to corporate governance includes directors’ and officers’ dishonest acts.  Corporate governance exclusions include  “wrongful acts” such as an officer engaged in discriminatory acts. Suits by and between officers and directors are typically not covered.

Exclusions based on the availability of other coverage include claims for  bodily injury and property damage.

More specific exclusions include: fraud; willful conduct for personal profit or advantage; pending litigation; breach of contract; and circumstances noticed to the prior carrier. See “Reporting Period.”

REPORTING PERIOD.

D&O policies are almost all “claims-made.” Such policies cover claims that are made during the reporting period, not when the alleged wrongdoing occurred. The insurer’s purposes in writing claims-made policies are to reasonably estimate losses likely to be paid and to prevent the coverage of claims made years after the policy expired.

The reporting period for a claims made policy is governed contractually. Some policies require notice “as soon as practical.” Other policies specify a number of days in which notice must be given after the policy period ends. Some policies require notice as soon as practical and within the policy period; this has the practical impact of denying coverage for claims made late in the policy period.

If a D&O policy is claims made, and the coverage lapses, there would be no coverage for conduct that occurred during the insured period because the claim would not be noticed until the reporting period has ended. This situation is normally dealt with by the D&O policy including “prior acts.” In the absence of the availability of coverage for prior acts, an extended reporting endorsement can be available as part of the lapsing policy.

If an insured learns of wrongful acts or circumstances which could give rise to a future claim,  most D&O polices allow the insured to give notice of the potential claim during the policy period. If the actual claim is made after the policy period, it will be treated as having been noticed during the policy period. Essentially, by notifying the carrier of potential claims, coverage is extended beyond the term of the policy. However, same comes at the cost of an impact on premiums and a heightened scrutiny as to whether coverage will be renewed.

RETENTION.

Unlike D&O policies for public entities, certain policies for private entities provide that defense costs do not deplete a policy’s liability limit. The usual policy does not have a retention as to Side A coverage; there is usually a retention as to Sides B & C coverage.

CONCLUSION.

D&O coverage is, effectively, a form of malpractice insurance. The scope of coverage can include the individual director or officer, the entity to the extent it expends money for defense and indemnity of an director and officer, and the entity itself. Coverage is claims made. Coverage may not extend to employment issues or cyber security issues.

Ric Shenkman To Speak: Top 8 LLC Mistakes to Avoid in Everyday Business Practices, Mon. Dec. 17

(Atlantic City) – Fredric L. Shenkman, Esq. of Cooper Levenson will present at “Top 8 LLC Mistakes to Avoid in Everyday Business Practices,” a seminar on Mon. Dec. 17, 2018 at the Sheraton Atlantic City Convention Center Hotel, 2 Convention Blvd., Atlantic City, N.J.

The seminar is intended for attorneys, accountants, CPAs, commercial bankers/loan officers, and paralegals. The presenters will share how to spot potential pitfalls, and also how to design an LLC to better meet specific needs. Topics to be covered include:

  • Determining when and how to use the LLC, as opposed to the S Corp;
  • Uncovering all the uses (and liabilities) of using LLCs in connection with tax planning;
  • Better understanding how to overcome issues when dividing and issuing ownership interests and transferring assets;
  • Reviewing real-world operating agreement provisions gone wrong, including distribution, allocation, capital call and voting;
  • Identifying the charging order landmines that must be avoided; and
  • Tackling tax mistakes made during LLC formation, change of tax status, conversion and reorganization.

The seminar runs from 8:30 a.m. to 4:40 p.m. Shenkman will present on the “Top Single Member LLC Mistakes to Avoid,” from 10:45 a.m. to 11:45 a.m., and on “LLC Ethical Traps,” from 3:40 p.m. to 4:40 p.m.

A partner in Cooper Levenson’s Atlantic City office, Shenkman has decades of experience in both transactional work and commercial litigation. His transactional work includes the drafting of asset sales; cross-purchase and redemption agreements; asset based financing agreements; post-employment restrictive covenants; business separation agreements; PILOT Agreements (payment in lieu of taxes agreements) and work-outs. He has lectured extensively on general equity and attorney ethics to various bar associations and Inns of Court. He also served as chairperson and as secretary of District 1 of the New Jersey District Ethics Committee.

The seminar is coordinated by the National Business Institute. Participants receive Continuing Legal Education Credit Hours: CLE 8.00 –  NJ, CLE 8.00 –  NY, and CLE 6.50 –  PA. Accountants receive 8.00 CPE Hours of specialty credits from the National Association of State Boards of Accountancy. The cost is $359. For more information or to register, visit https://www.nbi-sems.com/ProductDetails/Top-8-LLC-Mistakes-to-Avoid-in-Everyday-Business-Practices/Seminar/81093ER?N=0&searchTerm=shenkman.

Insurance Coverage for Business Owners… What Coverage is Best?

By: Louis Niedelman, Esq.

Published in “The Chronicle”, a Southern New Jersey Development Council Publication

Business owners and operators know that they must protect themselves from various risks and perils that are acts of nature or human behavior. The best protection is comprehensive insurance coverage that maximizes benefits and minimizes losses…….

Click here to read the complete article.

When the FBI shows up at your door

The scenario is unfathomable to an operating business, whether large or small: two federal agents show up at an employee’s house, at night or in the early morning, asking about individuals or specific incidents in the company. The agents can be from the IRS, FBI, Homeland Security or from an agency Inspector General’s Office. The instinctual reaction is to talk to the agents to show that there is nothing to hide and that nobody has done anything wrong. Unfortunately, that is precisely what the agents are seeking: for somebody to talk. After nearly 25 years working in and around federal law enforcement, I have learned that these types of visits rarely end well for the target of the investigation. There is nothing wrong with assisting law enforcement. Indeed, it is quite often our civic duty to assist our Government in the investigation and enforcement of our State and Federal laws. The goal for the business-owner and employee alike, however, is to ensure that the accurate information is conveyed to law enforcement in a manner that cannot be viewed as incriminating to the individual or the business.

When it comes to the point that a law enforcement agency decides to visit witnesses or targets for interviews, the law enforcement agents already possess some information that they believe may relate to the violation of a criminal law. Often the agents will not tell you precisely what they are investigating or why. The focus of their investigation could be the business, it could be an individual in the business, or it could be someone or something completely outside the business. Even if the agents do explain what they are looking for, they often will leave critical facts out as to the precise nature of their investigation. They do not have to tell you what they are investigating or why, and they can even lie to you. The purpose of withholding critical information – and even providing misleading information – is to elicit statements and evidence that they believe may constitute admissions or otherwise provide useful information that will further their investigation. How can you be sure that the federal agents are telling the truth or that you are not a target of their investigation? You can’t. Ever.

It is for this reason that businesses and business owners should institute policies relating to interactions with law enforcement and effectively communicate them to all employees. Some of the most effective policies advise employees that they are never required to speak with law enforcement and guarantee that the business will provide representation to employees for communications with law enforcement in investigations relating to the company. Understandably, any business owner might bristle at the thought of guaranteeing such a debt without knowing ahead of time how much it will cost. On the other hand, providing legal counsel to employees for law enforcement interviews relating to the business can, in many circumstances, ensure that accurate information about the company and its activities is conveyed properly to law enforcement. If there is a problem for the business because of some inappropriate conduct by an employee, independent employee legal counsel can often assist the business in identifying the problem and resolving the issue before there is significant financial and reputational damage to the business.

No one ever thinks that they or their business will be involved in a criminal investigation, until they are. A minimal amount of preparation, along with effective communication, can save time, money, heartache and a good reputation.

Veterinary Offices Vulnerable to Cyber Attacks

Although the Health Insurance Portability and Accountability Act (HIPAA) may not apply to animals, it does not mean that a veterinary practice should ignore cyber security best practices. Many veterinary owners believe that their practices will never be subject to the cyber security threats that we so often hear about in the news. However, many veterinary clinics and hospitals are precisely the type of companies that are the most targeted and vulnerable. Hackers and other cyber criminals may believe that most small businesses do not have proper security measures in place, which makes them easy targets. Unfortunately, the hackers are often correct. Veterinary clinics and hospitals often maintain credit card information and background information about pet owners that can be very enticing to cyber criminals.

As more aspects of operating and managing a business move online, cyber security is becoming increasingly more important. There are no federal laws that specifically govern veterinary practices. Instead, each state is governed by its own board of veterinary medicine. However, the American Veterinary Medical Association provides educational resources and guides for promulgating state rules, including the Model Veterinary Practice Act (MVPA). The MVPA serves as a guideline for those in the veterinary field and many states use the MVPA as a guide in enacting laws governing veterinarians and clinics.

The majority of states have not enacted laws regarding a cyber-security breach in a veterinary practice. However, most states have enacted laws with respect to maintaining confidentiality of animal records. For example, in New Jersey, a licensed veterinarian is required to keep patient records confidential unless one of four specific exceptions applies. These exceptions include: 1) being required by law to release the records, 2) the New Jersey Board of Veterinary Medical Examiners (Board) requests the records, 3) the client authorizes a veterinarian to release the records (the authorization must be at the time that the services were rendered), or 4) necessity to protect the health of the animal in question, a person, or another animal. Florida similarly has a statute governing confidentiality of veterinary records. Patient records and the medical condition of an animal may not be discussed with or released to anyone other than the client, the client’s lawyer, or another veterinarian involved in the care or treatment of the patient. Again, several exceptions exist if: 1) the client provides written authorization, 2) a subpoena has been issued in any civil or criminal action, 3) the data is needed for statistical and scientific research (as long as the identity of the patient and client are protected), or 4) a medical negligence action or administrative proceeding has been filed against a veterinarian.

If the laws governing confidentiality are violated, a veterinarian or other employee will very likely be subject to discipline. Cyber-security breaches are a relatively new issue and the issue has not frequently arisen in the veterinary field so penalties and other consequences have not been clearly outlined. Most state laws leave the question of penalties and discipline to the discretion of the state board that oversees veterinary medicine. In New Jersey, for example, the Board has a wide range of options in imposing discipline stemming from violations of confidentiality within a veterinary practice. These options include, but are not limited to, civil penalties, a letter of warning, revocation or suspension of a license, or taking corrective actions. Similarly, in Florida, the consequences include revocation or suspension of a license, a fine up to $5,000 for each violation, a reprimand, or imposing new education requirements. Although this is an emerging field of law within the veterinary field, cyber security has already had a major impact on many other industries. We will likely receive more guidance through case law and new legislation in the near future. While there may not be a developed body of cases on the issue, this does not mean that veterinary clinics and hospitals have not experienced cyber security breaches. Many of the breaches experienced by veterinary hospitals and clinics likely go unreported or do not result in published news articles or cases.

It is imperative that all veterinary clinics and hospitals take basic measures to proactively protect data and implement a plan of action in the event of a security breach. Simple measures such as strong passwords, implementing firewalls and encrypting sensitive data will go a long way toward maintaining strong cybersecurity.

Michael Salad is an attorney in Cooper Levenson’s Business & Tax and Cyber Risk Management practice groups. He concentrates his practice on estate planning, business transactions, mergers and acquisitions, tax matters and cyber risk management. Michael holds an LL.M. in Estate Planning and Elder Law. Michael is licensed to practice law in New Jersey, Florida and the District of Columbia. Michael represents several veterinary hospitals and clinics and regularly advises clients about cyber-security. Michael may be reached at 609.572.7616 or via e-mail at msalad@cooperlevenson.com.

Re-inventing Atlantic City

In Louis Malle’s classic 1980 film, Atlantic City, Burt Lancaster’s character stares wistfully out from the Boardwalk. “You should have seen the Atlantic Ocean in those days.” The response he gets is a quizzical look. After all, the ocean is always the ocean. Right?

Maybe, but Atlantic City is not always Atlantic City. It changes -as most cities do – from periods of growth and prosperity to periods of despair and problems. As Michael Pollock, author of “Hostage to Fortune: Atlantic City and Casino Gambling, often notes: “With Atlantic City, the lurches from euphoria to despair simply occur more frequently, and the best metaphor for Atlantic City is that of a Boardwalk roller coaster. How the city looks depends on when you open your eyes during that ride.”

That 1980 Louis Malle snapshot was taken just after the grand urban “experiment” with casinos had begun, and Atlantic City was a different type of metaphor. It was a place for reinvention. We all know how the story of Atlantic City evolved from there: Prosperity in the early 1980s, followed by despair in the late 1980s, followed by prosperity in the mid-1990s, followed by . you get the picture.

As this column is being written, the sun is shining, the sky is blue, and the Boardwalk is filled with visitors who have both time and money to spend. Atlantic City appears to be emerging from a period of deep despair, as the remaining casinos are showing growth, and a number of non-gaming investments are being opened, planned or considered. Such projects range from capital investment in Boardwalk Hall to a proposed waterpark complex at the shuttered Atlantic Club to the newly opened, still-expanding Playground (formerly The Pier at Caesars) and other attractions.

This is clearly a period of optimism, but does that mean the Atlantic City pendulum is swinging back toward a period of euphoria? In part, yes, because Atlantic City is slowly but surely leveraging its natural attractions – the beach, Boardwalk and tourism infrastructure – and growing less dependent on its core industry: casino gambling, which is by definition a risky foundation since it is so easy for other markets to emulate.

Those of us who live and work in this important market recognize that prosperity cannot be built on a foundation of a legal monopoly, with hopes that are pinned on maintaining that monopoly. Atlantic City’s old business model of being the most convenient place to gamble is a mode that is metaphorically (and somewhat literally) built on sand.

Atlantic City’s future is as an entertainment center, and if that sounds suspiciously like its past, so be it. The city needs more capital investment, but it needs something else as well: longer season.

I suggest you heed the words of Steve Norton, a venerable observer of gaming who played an instrumental role in building Atlantic City when he served as Executive Vice President of Resorts International, back in the 1970s. He recently wrote: “These new additions are great for Atlantic City, but they will still attract most customers during the summer months and on Fall and Spring weekends. Vegas has changed from 70 to 80% dependence on casino win, to a very balanced revenue mix, where casino win only represents 35% to 40% of most resort casino revenue.”

Norton suggests – and I wholeheartedly endorse – a further emphasis in Atlantic City on conventions and meetings, further emulating the Las Vegas model.

Norton further writes: “That market is even more perfect for Atlantic City, because the meetings market primarily plan their events during the Fall, Winter and Spring, and almost exclusively mid-week. And since the attendees are attending a work event, they are getting paid, and their travel, accommodation and meals paid for by their employers. We have the first class hotels, a variety of quality dining and entertainment venues; but Atlantic City lacks first class transportation. And taking a bus from Philadelphia International is not an acceptable solution, especially when we have a first-class airport 9 miles away. Air service is the major missing ingredient, to create a smaller version of Las Vegas right here in South Jersey.”

Las Vegas in South Jersey. Does that sound familiar? It should. That is what New Jersey tried to do when it legalized casinos in Atlantic City, but here is the real lesson from Las Vegas: When times get tough, reinvent yourself.

Louis Malle got it right. The Susan Sarandon character in his movie tries to reinvent herself, and indeed the entire film is a metaphor for reinvention and starting anew. Bruce Springsteen also got it right, with these lyrics:

“Everything dies baby that’s a fact. But maybe everything that dies someday comes back. Put your makeup on fix your hair up pretty and meet me tonight in Atlantic City.”

You don’t need to recite lyrics or see movies to know that Atlantic City is all about reinventing itself, and coming back.

Lloyd D. Levenson is Chief Executive Officer of the Atlantic City-based law firm Cooper Levenson and Chairman of the firm’s Casino Law Practice Groups in Atlantic City, Las Vegas and Harrisburg, Pennsylvania (www.cooperlevenson.com). Mr. Levenson can be reached at (609)344-3161 or by e-mail at ldlevenson@cooperlevenson.com.

Taxation of Cancelled Debt arising from Foreclosure of Real Property

Thumbnail image for Foreclosure.jpgWhile the United States economy slowly improves, foreclosure rates continue to remain high. According to RealtyTrac, there were nearly 127,000 foreclosures filed in May 2015 and New Jersey had one of the highest rate of foreclosures in the nation. In fact, one in every 483 housing units is being foreclosed. New Jersey experienced a 197 percent year-over-year increase in bank repossessed properties, which was the highest increase in the nation. Additionally, Atlantic City, New Jersey had the highest foreclosure rate among metro areas in the country, with one in every 230 housing units experiencing a foreclosure filing.

However, many of our clients are pleasantly surprised to learn that cancelled debt on a taxpayer’s qualified principal residence and business may not be income subject to tax. The Mortgage Forgiveness Debt Relief Act of 2007 (the “Act”) allows taxpayers to exclude the discharge of debt from a principal residence and real property business indebtedness if two criteria are met:

(1) The discharge cannot occur pursuant to a title 11 (bankruptcy) case; and

(2) With regard to amounts excluded due to insolvency (“Insolvency Exclusion”):

(i) The Insolvency Exclusion takes precedence over any claim under the business property exclusion; and (ii) The taxpayer expressly elects to apply the Insolvency Exclusion in lieu of the principal residence exclusion.
Under the Act, the Insolvency Exclusion permits a taxpayer to exclude any amount by which a taxpayer is insolvent. Insolvency is defined as “the excess of liabilities over the fair market value of assets. With respect to any discharge, whether or not the taxpayer is insolvent, and the amount by which the taxpayer is insolvent, shall be determined on the basis of the taxpayer’s assets and liabilities immediately before the discharge.”

For example: A taxpayer accrues credit card debt in the amount of $5,000 and a credit card company forgives the entire amount of debt. Prior to cancellation, the taxpayer incurs $15,000 in liabilities and $9,000 in assets, resulting in insolvency in the amount of $6,000. As such, the taxpayer may exclude the $5,000 debt forgiven by the credit card company under the Insolvency Exclusion because $6,000 is greater than $5,000.

With regard to the principal residence exclusion under Section 108 of the Internal Revenue Code (“IRC”), gross income does not include any amount which would be includible in gross income by reason of discharge (in whole or in part) of indebtedness by the taxpayer if the indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2014. The principal residence exclusion may only be used toward debt that was discharged between the years 2007 through 2014. Taxpayers who file a joint or individual tax return are eligible for the Principal Residence Exclusion, up to $2,000,000. Married taxpayers who file a separate tax return are eligible for the Principal Residence Exclusion up to $1,000,000.

QualificationSection 108 of the IRC provides that the Principal Residence Exclusion cannot be applied to the discharge of a loan if the discharge is on account of services performed for the lender, or “any other factor not directly related to a decline in the value of the residence or to the financial condition of the taxpayer.”

Additionally, if a loan is discharged, in whole or in part, and only a portion of the loan is qualified principal residence indebtedness, the Principal Residence Exclusion “shall apply only to so much of the amount discharged that exceeds the amount of the loan (as determined immediately before such discharge) which is not qualified principal residence indebtedness.”

Eric Browndorf, Esq. is a partner and Chairman of Cooper Levenson’s Bankruptcy & Financial Restructuring practice group. Eric has practiced exclusively in banking, creditor’s rights, bankruptcy and commercial litigation since 1984. Eric may be reached at 609.572.7538 or via e-mail at ebrowndorf@cooperlevenson.com. Eric is licensed to practice law in New Jersey, Pennsylvania and Kentucky.

Michael Salad, Esq., LL.M. is an associate in Cooper Levenson’s Business & Tax and Cyber Risk Management practice groups. He concentrates his practice on estate planning, business transactions, mergers and acquisitions, tax matters and cyber risk management. Michael holds an LL.M. in Estate Planning and Elder Law. Michael is licensed to practice law in New Jersey, Florida and the District of Columbia. Michael may be reached at 609.572.7616 or via e-mail at msalad@cooperlevenson.com.

Changes in Nevada Corporate Tax Practices

Nevada Tax changes 200by200.jpg

Tax Alert – On May 31, 2015, the Nevada Legislature (i) approved a “Commerce Tax” on all business transacted in Nevada and (ii) increased the rate and expanded the number of businesses required to pay the Modified Business Tax (“MBT”).

The Commerce Tax is imposed annually on all businesses with Nevada-sourced gross revenue in excess of $4,000,000 per year. Companies responsible for remitting Nevada Commerce Tax must file a Commerce Tax return with the Nevada Department of Taxation (the “Department”) within forty-five (45) days of the fiscal year ending on June 30. The Commerce Tax rates vary based on a company’s North American Industry Classification System (“NAICS”)…

The MBT is a quarterly payroll tax imposed on all Nevada businesses. On July 1, 2015, the MBT rate increased from 1.17% to 1.475% and the MBT quarterly exemption decreased from $85,000 to $50,000.

Nevada businesses that incur Commerce Tax and the MBT may be eligible for limited tax relief. A business that files a Nevada Commerce Tax return may apply for a credit of up to 50% of that year’s Commerce Tax on a dollar-for-dollar basis, which is assessed against the immediately following year’s MBT quarterly returns. The Commerce Tax credit may be applied to any or all of the immediately following year’s MBT quarterly returns until exhausted, but may never exceed the quarterly MBT amount due. For example, in fiscal year 2015 – 2016, if a business pays Commerce Tax in the amount of $10,000, the business will be assessed the following quarterly MBT by the Department for the 2016 – 2017 fiscal year:

The business may apply a $3,000 tax credit in quarter one and a $2,000 credit in quarter two or evenly distribute the credit amongst all four tax quarters. Alternatively, a business may devise another form of distribution as long as it does not result in the credit exceeding the relevant quarterly MBT due.

Due to the relative complexities of the interaction between the Commerce Tax and MBT, companies conducting business in Nevada should seek appropriate tax counsel before filing a Commerce Tax or MBT return. With effective tax planning, companies may be able to mitigate the significant costs imposed by Nevada’s new tax laws.

Should my company be an LLC or an S Corp?

With the increase in popularity of shows such as Shark Tank and The Profit, there has been a significant increase in entrepreneurs starting new businesses. There are numerous reasons why owners should form business entities. One of the most common questions that we receive is about the type of business entity that a business owner should form. Many business owners wish to form a limited liability company (“LLC”). However, subchapter S corporation (“S Corp”) provides several tax advantages that are unavailable to LLCs.

First, formation of an S Corp allows shareholders to reduce their self-employment tax liability. Self-employment taxes are based upon an individual’s self-employment income for the year. Self-employment tax consists of old-age, survivors, and disability insurance (“OASDI”) and hospital insurance. OASDI is taxed at a rate of 12.4% of an individual’s self-employment income. There is a cap on the amount of self-employment income that is subject to the OASDI component of the tax. This cap, commonly referred to as the social security taxable wage base, is $127,200 in 2017 and is indexed for inflation (resulting in a maximum tax of $15,772.80). Conversely, the health insurance component of self-employment tax is computed at a rate of 2.9% of all of an individual’s self-employment income. However, the .90% tax on compensation in excess of $250,000 is not applicable to the distributive share of income in an S corp.

S Corp shareholders do not pay self-employment taxes on income that is allocated to them. If an S Corp shareholder performs services for a corporation as an employee, the corporation must pay the shareholder reasonable compensation. The compensation of an S Corp shareholder is subject to a tax under the Federal Insurance Contributions Act (“FICA”), which is computed similarly to the self-employment tax as well as the Federal Unemployment Tax Act (“FUTA”). There is no self-employment tax liability or FICA or FUTA tax liability to the extent that an S Corp shareholder’s pro rata share of a corporation’s income exceeds reasonable compensation paid in consideration of the shareholder’s services. A member of an LLC must include all net earnings from that member’s distributive share of the LLC’s business income for self-employment tax purposes.

An S Corp may offer deferred compensation benefits to employees that are not available to employees of an LLC. An employee stock ownership plan (“ESOP”) may own stock in an S Corp. An S Corp ESOP may also offer additional opportunities for income tax deferral because the income of an S Corp that is allocated to an ESOP is not taxed as unrelated business taxable income. Accordingly, no tax is imposed on an ESOP’s pro rata share of income from an S Corp until that income is distributed to the employees.

Finally, an S Corp may participate in tax-free reorganizations with other corporations while LLCs generally may not, which affords S Corps an advantage in mergers and consolidations. Under certain circumstances, however, an LLC may be preferable to an S Corp if the entity to be combined with the LLC is a partnership, a limited partnership, a limited liability partnership or another LLC. A merger or consolidation between an LLC and a corporation is generally a taxable event but an LLC and another entity that is classified as a partnership may generally merge or consolidate on a tax free basis.

Click Here for a PDF Version

 

Michael Salad is an attorney in Cooper Levenson’s Business & Tax and Cyber Risk Management practice groups. He concentrates his practice on estate planning, business transactions, mergers and acquisitions, tax matters and cyber risk management. Michael holds an LL.M. in Estate Planning and Elder Law. Michael is licensed to practice law in New Jersey, Florida and the District of Columbia. Michael may be reached at 609.572.7616, 954.889.1850 or via e-mail at msalad@cooperlevenson.com.

Peter Fu is an attorney in Cooper Levenson’s Business & Tax and Cyber Risk Management practice groups. He concentrates his practice on sales and use tax, enterprise risk management, and commercial transactions. Peter is licensed to practice law in New Jersey and Florida. Peter may be reached at 609.572.7556 or via e-mail at pfu@cooperlevenson.com.

The Affordable Care Act Health Insurance Responsibilities of Large, Midsize & Small Employers

Date: 11/19/2014
Publication: Website
CooperLevenson Publication: Website
Summary: Introduction: An Employer’s responsibility to offer health insurance under the Affordable Care Act depends on the number of full time equivalent people employed. A business with fewer than 50 full time equivalent employees is not required to offer health insurance; beginning in 2016, a business with 50-99 employees is, and in 2015, a business with more than 100 employees must offer insurance to 70% of its employees which increases to 95% beginning in 2016. The uninsured can buy insurance in the Individual Health Insurance Marketplace; financial assistance may be available. Small business owners may buy health insurance for their employees through the Small Business Health Options Program (“SHOP”), for which they may receive a tax credit.
Article: The Affordable Care Act Health Insurance Responsibilities of Large, Midsize & Small Employers.pdf .pdf