Author Archives: Batten & Beasley

Forming a Business in Minnesota: Limited Liability Company (LLC)

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A Minnesota business also may organize as a limited liability company. A limited liability company elects to be treated for tax purposes as a sole proprietorship (disregarded entity), partnership, or corporation. A limited liability company may have one or more members. As described further in the section on tax considerations in choosing the form of organization, organizers of Minnesota limited liability companies have some flexibility with respect to the federal income tax treatment of such entities due to the Treasury Regulations on entity classification. These Regulations appear in 26 C.F.R. § 301.7701-1 et. seq. A limited liability company with more than one member may choose to be taxed as a partnership or a corporation. In either event, the limited liability company must obtain both federal and state tax identification numbers, even if it has no employees.

A limited liability company with only one member may be taxed as a corporation or as a sole proprietorship. A limited liability company that chooses to be taxed as a sole proprietorship generally does not obtain a federal or state tax identification number unless it has employees in which case it will obtain tax ID numbers and use them to remit unemployment taxes. Business income and losses of the limited liability company that chooses to taxed as a partnership or as a sole proprietorship may be passed through to the owners of the business. The income of a limited liability company that chooses to taxed as a partnership or as a sole proprietorship is included in the taxable income of the member or members and taxed at the owner’s individual tax rate. Like a corporation, a liability for business debts and obligations generally rests with the entity rather than with the individual owners. A limited liability company is not subject to many of the restrictions that apply to S corporations. All members of a limited liability company may participate in the active management of the company without risking loss of limited personal liability. It is managed by a board of governors and an active manager.

Forming a Business in Minnesota: Corporations

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A corporation is a separate legal entity from its owners, owned by one or more shareholders. The corporation must be established in compliance with the statutory requirements of the state of incorporation. The shareholders elect a board of directors which has responsibility for management and control of the corporation. Because the corporation is a separate legal entity, the corporation is responsible for the debts and obligations of the business. In most cases, shareholders are insulated from claims against the corporation.

It is worth noting here that because a corporation is an entity separate from its owners, if the owner (and/or members of the owner’s family) performs services for the corporation, these persons are considered to be employees of the corporation. Thus, the corporation will be required to comply with most of the laws and regulations and reporting requirements applicable to employers. The corporation may be taxed under Subchapter C of the Internal Revenue Code (a “C corporation”) or be subject to the provisions of Subchapter S of the Code (an “S corporation”). Minnesota tax laws provide for comparable treatment.

A C corporation reports its income and expenses on a corporation income tax return and is taxed on its profits at corporation income tax rates. The Minnesota corporate franchise tax, sometimes called an income tax, is based on the income of a C corporation’s income allocated to Minnesota. Profits are taxed before dividends are paid. The dividends are taxable income to the shareholders. Sometimes this is incorrectly referred to as “double taxation”, when instead it is two separate legal entities being taxed on their separate income.

An S corporation election may be made by the shareholders of the corporation if the corporation meets the statutory requirements for S corporation status. The S corporation is taxed in much the same manner as a partnership, i.e., the S corporation files an information return to report its income and expenses, but it generally is not separately taxed.  Income and expenses of the S corporation “flow through” to the shareholders in proportion to their shareholdings, and profits are allocated and taxed to the shareholders at their individual tax rate. Under the Internal Revenue Code, an S corporation may have only one class of stock, no more than 100 shareholders, and no shareholders that are nonresident aliens or non-individuals (e.g., corporations, partnerships, limited liability companies) except for certain estates, trusts, and certain tax exempt entities. The federal 2004 American Jobs Creation act allows an S corporation to treat shareholders within six generations of one family as one shareholder thus allowing family business S corporations to distribute shares to family members of existing shareholders without those new shareholders being counted as new shareholders against the 100 shareholder limit.

A closely held corporation is any corporation whose shares are held by a relatively small number of shareholders. The Minnesota Business Corporation Act defines a closely held corporation as one which does not have more than 35 shareholders. Most closely held corporations are relatively small business enterprises, in which all shareholders tend to be active in the management of the business. Some states provide a separate, less formal, less restrictive set of laws for closely-held corporations. Minnesota does not. In Minnesota, the business corporation law is geared to small corporations, so a separate law is not necessary, and all corporations operate under one law.

Forming a Business in Minnesota: Sole Proprietor and Partnerships

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Sole Proprietor

In a sole proprietorship, the business is owned controlled by one individual. That person alone receives the profits and bears the losses from the business, and that person alone is responsible for the debts and obligations of the business. Income and expenses of the business are reported on the proprietor’s individual income tax return, and profits are taxed at the proprietor’s individual income tax rate. If a husband and wife wish to own a business together, they must either form a partnership, corporation or limited liability company (in order to have each of them be an owner of the business) or a sale proprietorship (in which case only one of them be an owner of the business). A married couple who jointly operate an unincorporated business and who file a joint federal income tax return may have a qualified joint venture and can elect not to be treated as a partnership for federal tax purposes provided that the husband and wife are the only members of the joint venture and that both husband and wife materially participate in the running of the business. In this case each spouse will report his or her share as a sole proprietorship.

The sole proprietorship is the simplest form of organization, and the least expensive to establish. There are no statutory requirements unique to this form of organization. From a regulatory standpoint, the business owner only needs to obtain the necessary business licenses and tax identification numbers, register the business name, and begin operations.

Partnership

A general partnership is a business owned by two or more persons who associate to carry on the business as a partnership. Partnerships have specific attributes, which are defined by statute. All partners in a general partnership share equally in the right, and responsibility, to manage the business, and each partner is responsible for all the debts and obligations of the business. Distribution of profits and losses, allocation of management responsibilities, and other issues affecting the partnership usually are defined in a written partnership agreement. Income and expenses of the partnership are reported on federal and state “information” tax returns, which are filed by the partnership. The partners are taxed on their respective share of the partnership’s profits at their individual income tax rates.

Minnesota partnerships are formed and governed only by the Revised Uniform Partnership Act (RUPA), Minn. Stat. § 323A. Partnerships formed under former partnership law are now subject to this chapter. If you were formed under former laws and have not yet consulted with an attorney about the changes in partnership law, you are encouraged to do so immediately.

Innocent Spouse Relief Under the Internal Revenue Code

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Newlyweds are typically the recipients of well wishes and presents from friends and family alike.  Although Congress is neither friend nor family, it also leaves its imprint on the occasion by bestowing important tax benefits upon married couples.  For the typical taxpayer, the impact of this favorable treatment is most visible through the joint taxation of the marital unit.  Joint returns are subject to tax rates which are lower their individual counterparts.  In addition, the benefits of this arrangement are compounded by the ability of a married couple to jointly file regardless of their respective incomes.  As such, joint returns represent a permissible method of income shifting.  Although Minnesotans often benefit by filing a joint return, such an arrangement can also produce inequitable results.

In addition to the above-listed benefits, taxpayers who file as a couple are also subject to joint and several liability for the payment of tax, including interest and penalties.  Joint and several liability can create an injustice where only one of the spouses is liable for the underlying tax deficiency.  One common situation involves a wife who the IRS claims is liable for additional tax on a joint return due to the illegal activities of her husband.  Prior to 1971, the wife in this example would be held liable for the tax, interest, and resulting penalties even though she had no knowledge of her husband’s illegal activities.

In recognition of this problem, Congress passed Interal Revenue Code Section 6015.  This provision, also known as “innocent spouse” relief, grants a limited release from joint liability under certain circumstances.  Originally narrow in scope, Section 6015 was extensively revised in 1998 to extend protection to a greater number of people.  Under Section 6015(b), relief will be granted if the affected spouse can establish that she did not know of the liability attributable to an erroneous item of her husband.  Equally important, the petitioner for relief must establish that it would be inequitable to be held liable for the deficiency in tax.  In order to apply for innocent spouse relief, the petitioner must elect to apply this provision within two years after the date on which the IRS has instituted collection activities.

Although it may seem like a simple procedure, the above-described provision entails an inquiry which is highly fact specific.  If the IRS is attempting to collect a debt attributed to the illegal acts of your spouse (or former spouse), do not hesitate to contact a tax attorney.

Starting a Small Business – How to Limit your Liability

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Previously in the Starting a Small Business Series we discussed the importance of limiting your liability as a Minnesota small business owner. In this post we will discuss how small business owners can best limit their liability. The first step to limiting your personal liability is to create a limited liability entity. A local twin cities attorney can help you with that.

Once your company exists, the second step is to create its structure. The most important reason to do this is to avoid personal liability for company debts, also known as “piercing the corporate veil.” In Minnesota, the courts may apply one of three different “tests” to determine whether or not to pierce the veil in any given circumstance.

The Agency Test: under this test a Plaintiff must show that the owner of the business exercised a significant degree of control over the company’s decision making;

The Alter Ego Test: here the court will pierce the veil to prevent fraud, illegality, or injustice, or when not doing so would defeat public policy or shield someone from liability from a crime;

The Instrumentality Test: a Plaintiff must show that the parent company exercises extensive control over the acts of a subsidiary, giving rise to the claim of wrongdoing.

Unfortunately, the courts have done very little to explain these tests. However, the Minnesota Supreme Court did provide a list of factors that they consider when determining whether to look through the limited liability entity. Those factors include: insufficient capitalization for purposes of the corporate undertaking, failure to observe corporate formalities, nonpayment of dividends, insolvency of the debtor corporation at the time of the transaction in question, siphoning of funds by the dominant shareholder, nonfunctioning of other corporate officers and directors, absence of corporate records, and existence of the corporation as merely a façade for individual dealings. To complicate matters further, the Court has said that in addition to a number of the previously mentions factors being present, there also must be an “element of injustice or fundamental unfairness.”

What all of this amounts to for the Minnesota small business owner is that they must not only create their business, but they must observe the organizational formalities imposed by state law. They must do things such as elect directors, adopt bylaws, elect officers, adopt banking resolutions etc. While it may seem silly for a single member business to hold a meeting as the sole member of the board, and then another as sole shareholder (or sole Member if an LLC), this is what is required under Minnesota law for a small business owner to protect themselves from personal liability.

Any twin cites attorney can help the small business navigate these confusing waters, and it is highly recommended that you consult one before moving forward with your business transactions.

Chapter 7 Bankruptcy Process in Minnesota

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This article will provide a brief overview of the process to file a chapter seven bankruptcy in Minnesota. Assuming that you have already selected your bankruptcy attorney, the first step will be to provide the attorney with all pertinent information as found in the article “What Information You Need to File for Bankruptcy.” While the bankruptcy attorney is preparing the debtors Minnesota bankruptcy petition and schedules, the documents to be filed with the court, the debtor will need to take a court approved instructional course concerning personal financial management. This mandatory course must be completed to avoid automatic dismissal upon the filing of the bankruptcy petition and schedules. Upon the completion of both the course and paperwork, the bankruptcy attorney will electronically file the bankruptcy case with the court.

In the District of Minnesota the court will schedule the 341 Meeting of Creditors within one to two days after the petition and schedules are filed. The 341 Meeting of Creditors will usually take place between twenty and thirty days from the date of filing. The 341 Meeting of Creditors is for most debtors the only appearance before a court. At the meeting the debtor will appear before a bankruptcy trustee who will question the debtor concerning the petition and schedules. The debtor’s creditors have the opportunity to come to the meeting and question the debtor, but the likelihood of a creditor making an appearance is quite rare. If the trustee is satisfied with the answers of the debtor, the trustee will close the 341 Meeting of Creditors within a few days.

Once the 341 Meeting of Creditors is closed the debtor enters the final stage of a chapter seven bankruptcy. During the next sixty days the debtor will have to complete a second counseling course. This course will take a minimum of two hours. The debtor must complete this course to receive a discharge. During this time-frame the debtor will also execute any reaffirmation agreements. A reaffirmation agreement is an agreement between the debtor and a creditor where the debtor reassumes a debt that would otherwise be discharged. The most common occurrences where a reaffirmation agreement is used would be with a secured debt such as a vehicle or house. After the sixty day period, the debtor will receive a discharge from most types of debt. Each bankruptcy case filed in Minnesota may deviate from the process listed above to some extent. It is recommend that a debtor contact a Minnesota bankruptcy attorney to assist with this process.

Why Small Businesses Need Legal Counsel

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There are many old adages that apply to why a small business needs to consult with and use the services of an attorney. My favorite is “You don’t know what you don’t know!” It is your job as an entrepreneur to focus on what you do best, which would be to run your business. It is the job of the attorney to understand and provide proper guidance regarding the legal hurdles and pitfalls that are waiting for small businesses. Four legal hurdles that small businesses are likely to encounter include the need for contracts, which choice of entity to select, real estate and need for an exit strategy.

At various times, every small business will need to have a contract drafted. An attorney will be able to help the business determine the exact language that should be included in the contract. The types of contracts that may need to be drafted include contracts for customers, clients, suppliers and even co-owners. Continue reading →

What Information You Need To File For Bankruptcy

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Bankruptcy is personal.  Whether you file under Chapter 7 or Chapter 13 depends on your income and expenses, your assets and liabilities, and your personal circumstances.  To complete your Chapter 7 non-business bankruptcy petition, you will need to draw from many different documents and sources.  This article addresses the most common of those.

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Differences Between an S-Corporation and Limited Liability Company

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There are three main differences between an S-Corporation “S-Corp.” and a Limited Liability Company “LLC”. These differences are (1) ownership restrictions, (2) the treatment of self-employment tax and (3) the distribution of profits and losses.

The ownership restrictions for an S-Corp. are much more substantial than those of an LLC.  Pursuant to IRS code section 1362, an S-Corp. cannot have more than 100 shareholders. While this provision is very limiting, it does allow for a family to count as one shareholder. S-Corps. also have a limitation on who can be a shareholder. A shareholder must be either US citizens or resident aliens. What this means is that no corporations or LLCs may be a shareholder of an S-Corp. Finally, an S-Corp. may only have one class of stock.  However, the S-Corp. can differentiate whether the shareholders are able to have voting rights in that one class of stock.

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The Need for Member Control Agreements for LLCs

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Often, new business owners question whether they need a member control agreement. They commonly don’t know of the possible pitfalls of operating without one. In this article we will address why a member control agreement for an LLC is a necessary component for the business. A member control agreement should address four primary issues.

Determine Ownership
Operational Control
Succession Planning
Protecting Limited Liability of Single Member LLCs

While they can, and usually do address more, these four will be covered below, as they are necessary components to most LLCs.

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