Technology Companies Practice Tax Practice Goodwin Procter LLP Goodwin Procter LLP

Technology Companies Practice Tax Practice

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©2010. Goodwin Procter ^LLP

Yes Yes Yes Limited Liability

Filings/Fees On-going Yes

1+ Limited Liability Company

Filings/Fees On-going Yes

1+ S-Corporation

Filings/Fees On-going Yes

1+ C-Corporation

Formation/ Existence Formalities Separate

Entity? Number of

People Entity Type

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Liability Taxation

Management and Control Continuation of Business

Formal Requirements and Fees

Tax issues

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Will the business generate taxable income and, if so, how much?

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Will the business generate tax losses?

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The number of owners and who they are

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How the owners intend to share profits

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What is the exit strategy?

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Double Taxation (C-Corporation)

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The corporation is taxed as it generates taxable income

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The shareholders are taxed on those same dollars when they receive cash dividends (i.e., distribution of the profits)

Pass-through Taxation (S-Corporation and LLC)

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The entity does not pay tax on the income it generates; tax liability is passed through to the owners of the entity (i.e., is reflected on their individual income tax returns)

Example: ABC earns $100 before taxes in 2009. Assuming that the federal corporate tax rate is 35%, the federal ordinary income tax rate for individuals is 35% and the corporate dividend rate for individuals is 15%, how much will the individual owners realize in 2009?

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Example (Cont’d):

C-Corporation: $100 corporate income is taxed at 35%, leaving

$65 of net income. Assuming all earnings are distributed to the shareholders, the individual shareholders will pay $9.75 of

federal income tax ($65 x 15%) and have $55.25 of cash.

Example (Cont’d):

S-Corporation: $100 corporate income. Since there is no entity level income tax, the stockholders take into account their share of the $100 income and receive $100 in distributions. After

payment of federal income tax at a rate of 35%, the stockholders have $65 of cash (compared with $55.25 for individual

stockholders of a C-Corporation).

Limited Liability Company: Same as the S-Corporation

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Capital structure

Equity compensation

Efficient/familiar to all parties

Stock sale/merger may be done tax free

Limited liability

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Stockholder Liability

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Liability is generally limited to the consideration paid for the stockholder’s stock provided that the shares are fully paid for and the corporation is adequately capitalized

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If a corporation is under-capitalized or neglects corporate formalities (e.g., holding meetings, maintaining minutes, etc.), its stockholders may lose their limited liability in litigation

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Hold regularly scheduled meetings

Hold special meetings or obtain written consents

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Entering into a new lease

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Entering into a substantial funding commitment

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Entering into any other significant contractual agreement

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Changing an officer’s salary

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Issuing new equity interests

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Corporate formalities Taxed at entity level

Asset sale subject to double tax

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Pass-through taxation

Limited liability as a corporation Familiarity

Maximum flexibility upon liquidity event (asset or stock sale) Employee compensation and benefits

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Limits to ownership

• 100 shareholders or less

• Must be U.S. citizen or resident, exempt organization and certain trust

Capital structure

• Only one class of stock

• No preferred (non-voting common okay)

Big-S tax in Massachusetts at state level; other states may have similar issues

Conversion to LLC

• Distributions of appreciated property generally not tax-free-- conversion to LLC often results in tax

Corporate formalities

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Must file Form 2553 to elect S-Corporation status

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If filing invalid or if terminated, corporation will be taxed as C-Corporation

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Filings must be made within two months and 15 days after incorporation to apply to initial tax year

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All shareholders must sign the election form

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Flexibility

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Statute defers to the LLC agreement

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Control/governance Multiple classes of equity

A single-member LLC is disregarded as an entity separate from its sole owner for U.S. federal income tax purposes

unless it elects to be taxed as a corporation. It, therefore, has the same U.S. federal tax treatment of a sole proprietorship,

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Accommodates any type of investors, although certain

investors may have tax reasons why they prefer not to invest through LLCs, such as:

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Foreign investors

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^Tax-exempt

Sale of assets has tax benefits to both seller and buyer

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Flexibility can cause complexity Expensive

Employees/Benefits

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Self-employment tax

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Benefit plan restrictions

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Can’t deduct fringe benefit contributions

Traditionally, investors generally don’t like/aren’t familiar with

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A member has no liability beyond their initial investment, even if they actively participate in or control the LLC’s management To put it another way, only the assets of the LLC are at risk (not the member’s personal assets)

Members (and managers) may be indemnified by the LLC