Rimon Law Blog

An LLC can be treated as an S-Corporation for tax purposes if it makes an S-Corporation election as long as the entity meets the IRS criteria to be taxed as an S-Corp, files an S-Corp election and gets approved by the IRS to be taxed as an S-Corporation. Without an S-Corporation election, single member LLCs default to be taxed as sole proprietors and a multi-member LLCs defaults to be taxes as partnership since they are considered “disregarded entities”. However, if a single or multiple member LLC agreement meets the IRS criteria to be classified as a small business corporation, the S-corporation election is filed and gets approved by the IRS, then for tax purposes, not legal purposes the entity is an S Corp not a LLC.

In order to be classified as an S-Corporation, a company must: be domestic, have no more than 100 shareholders, have one class of stock, all shareholders must be individuals, decedents’ estates, bankruptcy estates, trusts or tax-exempt charitable organizations, or wholly owned by another S corporation, and all shareholders must be residents of the United States (as defined by the tax code not immigration laws). Shareholders of an S-Corporation can not be financial institutions that use a reserve method of accounting for bad debts, companies taxable as insurance companies, taxable mortgage pools, or domestic international sales corporations. So, if a business entity meets these criteria it can be considered an S corporation by the IRS and taxed as an S corporation as long as the S corporation election forms are properly filled-out and approved by the IRS. Many states including California automatically give business entities an S-corporations tax status if it was approved by the IRS.

Many small business owners incorporate their businesses not only for legal protection, but also to reduce owners’ payroll taxes through S-Corp tax election with the IRS. One advantage of an S-Corp is that it gives business owners the ability to reduce their self employment taxes. Any small business owner who has not made an S-Corp election and uses Schedule C for their personal tax return for 2010 is subject to both employer and employee FICA and Medicare payroll taxes at 15.3% up to $106,800, 2.9% Medicare for Schedule C net income greater than $106,800, and California SDI for 1.1% up to 93,316. If a business owner pays himself/herself a “reasonable salary”, the rest of the net income is not subject to these payroll taxes.

On September 1, 2009, the Government of the United Kingdom implemented the New Offshore Disclosure Opportunity (“NDO”).

 The NDO allows those individuals with unpaid UK taxes relating to previously undisclosed income and/or capital gains linked to offshore accounts and/or assets to settle related tax liabilities at a favorable 10% penalty rate.  Ordinarily, penalties are charged at up to 100% of the tax due.

The NDO provisions apply to all UK residents and certain non-UK domiciled individuals (who themselves may be or once were subject to tax in the UK) who have an interest in any Offshore Accounts, Trusts or Corporate entities that would otherwise be subject to UK tax. 

Under the NDO, formal notification of the intention to disclose must be given to Her Majesty’s Revenue & Customs (“HMRC”) in the UK by November 30, 2009 at the latest.  The actual disclosure must be submitted to HMRC together with payment of related taxes and penalty charges by March 12, 2010 if the disclosure is done online or by January 31, 2010 if the disclosure is done on paper. 

Care needs to be taken when making this disclosure since, by submitting a request under the NDO, an individual does not automatically receive immunity from criminal prosecution.

The amnesty will apply if any income, capital gains and inheritance tax outstanding is paid in full together with (in most cases) an additional minimum of 10% penalty charge if any tax due is above £1,000 and any interest due on the unpaid tax .

The NDO will not affect as many people living outside the United Kingdom as the US Voluntary Disclosure Program did for those Americans living abroad, since many of them are no longer considered to be UK tax resident.  However, historic tax liabilities are under review by HMRC and recent immigrants from the UK in particular will need to consider their position in more depth.

In addition, those who are considered to be UK tax resident, for example under a relevant Tax treaty or under general UK law, but who are neither ordinarily resident nor domiciled in the UK (for tax), may be able to use the remittance basis to argue that the offshore income and gains were not taxable in the UK.  In many of those cases, tax would only be due on income or gains that were brought into the United Kingdom.

For additional information about the New Disclosure Opportunity please contact Dave Wolf, Esq. by email at dave.wolf@rimonlaw.com.

If you are a company with operations in both the United States and Israel, you should be aware of several very important U.S. and Israeli Tax issues when you engage in cross border operations. I have set forth below several of the main issues. This list is not exhaustive and only reflects briefly the main tax issues. Other issues such as employment, banking, intellectual property rights, custom duties etc. will be addressed in other communications.

A. U.S. TAX ISSUES

1. U.S. Distributor

The use of a distributor or agent should not subject the Israeli company to U.S. tax unless such business is conducted through a so-called permanent establishment.

Whether a distributor is deemed to be a permanent establishment for the Israeli company in the United States should be examined under domestic U.S law and under the U.S./Israel Income Tax Treaty.

In general, a U.S. distributor can be deemed to be a permanent establishment of a foreign entity if it is not independent of the foreign entity and/or can sign contracts on behalf of the foreign entity.

2. Sales and Use Tax

A U.S. entity of an Israeli company may have to charge sales tax to its customers if it has nexus where it is located. Nexus can be created if a business maintains a presence of people or property in a given jurisdiction. Sales tax rates and exemptions differ per state.

3. Tax Administration
A U.S entity will be subject to filing different tax returns such as federal tax returns (Form 1120: U.S. corporate income tax return) and state tax returns (e.g., Form 100: California Corporation Franchise or Income Tax Return). If doing business in several states, the U.S. entity might have to file in different jurisdictions.

4. Foreign Tax Credits
If a U.S. company earns income in Israel, that income is taxable in the United States and may be taxable in Israel as well. Therefore the United States allows the U.S. company to offset taxes due in the United States with the income taxes paid in Israel. However, since the United States only provides a foreign tax credit for foreign income taxes imposed on what the United States considers to be foreign source income, the U.S. sourcing rules are very important and require the U.S. company to maximize the foreign source income to allow a maximum foreign tax credit
5. Foreign Currency Transactions
The U.S. Tax code has several sets of rules for the treatment of gains and losses arising out of currency transactions, which can arise (e.g., as a result of the acquisition and disposition of foreign currency, lending and borrowing of foreign currency and foreign transactions).

B. ISRAELI TAX ISSUES

1. Grants, Tax and R&D Incentives

The Law for Encouragement of Capital Investment features two types of benefits. The first is a package of grants and tax reductions, administered by the Investment Center at the Ministry of Industry, Trade and Employment. The second is the Automatic Tax Benefits Program administered by the Tax Authority.

There are several conditions in order to qualify for the grants and tax reductions. The scale of benefits depends on the location and size of the investment.

The Office of the Chief Scientist (OCS) is responsible for promoting industrial research and development. There are various incentive schemes available through the OCS.

2. Corporate Taxation

A corporation will be deemed to be resident in Israel if its activities are managed and controlled from Israel or if it is organized under the laws of the State of Israel. The basic rate of company tax is 26% in 2009, to be reduced to 25% as from 2010 and onwards. A recent proposal under the 2009-2020 Israeli Budget even calls for reducing the company tax rate to 18% by 2016.

Business losses may be offset against income from any source in the same year. Losses may be carried forward indefinitely from one income year to another but may not be carried back.

3. Value added tax (VAT)

VAT applies to most goods and services, including imported goods and services and is levied at the rate of 16.5% Certain items are zero-rated, including exported goods and the provision of certain services to nonresidents.

C. MUTUAL TAX ISSUES

1. Withholding Taxes

When an Israeli company remits dividend, royalty or interest payments to a U.S. party (or vice versa), these payments are subject to a withholding tax as set forth in the U.S./Israel Income Tax Treaty (the “Treaty”). Under the Treaty, the maximum withholding tax on these payments is 25% for dividends, 15% for royalties and 17.5% for interest payments.

2. Intercompany Transactions

The IRS scrutinizes intercompany or related parties transactions (e.g., transactions between U.S. headquarters and Israeli subsidiary) to ensure that the parties conducted the transaction at arm’s length and that the related parties did not set prices at artificial levels in order to avoid the tax that would have been due had unrelated parties negotiated the price.

The IRS has published guidelines for evaluating whether or not a transaction between related parties was conducted at arm’s length. These guidelines provide a number of methods depending on the type of business and products sold.

The Israeli transfer pricing rules are based on the OECD guidelines. Several pricing methodologies apply, with preference given to transaction-based methods over profit-based methods.

OUR SERVICES
Rimon Law Group is well positioned to assist you and your clients with cross border tax issues, especially between the U.S. and Israel as a result. Our attorneys have extensive experience and expertise in international tax and cross-border transactions. Every attorney in our Israel Practice Group is licensed to practice in both the United States and in Israel, is fluent in both Hebrew and English, and has at least ten years of experience at top U.S. and Israeli law firms and companies.
If you have any questions about international tax issues you can contact Dave Wolf, Esq. at Dave.Wolf@rimonlaw.com. To discuss Rimon’s Israel practice group, you can contact Michael Moradzadeh, Esq. at Michael@rimonlaw.com.

Circular 230 Disclaimer: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or tax-related matter(s) addressed herein.

INTRODUCTION

As most of you know by now, there may be more than 50,000 U.S. taxpayers who have held accounts at UBS in Switzerland that were undisclosed to the IRS. They could face criminal prosecution and significant penalties.

VOLUNTARY DISCLOSURE PRACTICE

The IRS has had a voluntary disclosure practice in its Criminal Manual for many years.

The IRS has now implemented a special approved penalty framework for resolving the civil side of offshore voluntary disclosures and this approved penalty framework is effective till September 23, 2009 at which time the IRS intends to re-evaluate the approved penalty framework. Under the approved penalty framework, the taxpayer has to file correct or amended tax returns for tax years 2008 back to 2003.

Taxpayers with undisclosed foreign accounts or entities should make a voluntary disclosure because it enables them to become compliant, avoid substantial civil penalties and generally eliminate the risk of criminal prosecution. When a taxpayer truthfully, timely, and completely complies with all provisions of the voluntary disclosure practice, the IRS will not recommend criminal prosecution to the Department of Justice.

Making a voluntary disclosure also provides the opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues. Taxpayers who do not submit a voluntary disclosure run the risk of detection by the IRS and the imposition of substantial penalties, including forfeiture of the money in the foreign accounts, the fraud penalty and foreign information return penalties, and an increased risk of criminal prosecution.

REPORT OF FOREIGN BANK AND FINANCIAL ACCOUNTS

The purpose for the voluntary disclosure practice is to provide a way for taxpayers who did not report taxable income in the past to voluntarily come forward and resolve their tax matters. Thus, if a taxpayer reported and paid tax on all taxable income but did not file a Report of Foreign Bank and Financial Accounts (FBAR), the taxpayer should not use the voluntary disclosure process but should file the delinquent FBAR.

An FBAR gets reported by filing Form TD F 90-22.1 with the Department of the Treasury (not the IRS) on or before June 30, of the succeeding year.

An FBAR is required to be filed for all accounts where a U.S. person or entity has a financial interest or signature authority in foreign financial accounts if the aggregate value of these accounts exceeds $10,000 at any time during the calendar year.

In the case of a corporate officer, for securities that are listed on a national exchange over which there is no direct financial interest on the part of the officer, there is not an individual filing requirement. This exception is only if the organization has filed the Form and notified the officer in writing that they are not required to file.

CRIMINAL CHARGES AND CIVIL PENALTIES

A person convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000.

Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.

OUR SERVICES

Rimon Law Group is well positioned to assist you and your clients with foreign
disclosure matters as a result of our attorneys’ extensive experience working with high-net-worth individuals and companies and their expertise in international tax.

We have made extra efforts for the next three weeks for our attorneys to be available to speak with you in more detail about how we might work with you to ensure that you or your clients take the smartest steps and make the best decisions when it comes to foreign bank account disclosure and the IRS voluntary compliance program.

FOR FURTHER INFORMATION
Additional information about the foreign bank account disclosure or the IRS voluntary disclosure practice can be found on the IRS website or by contacting Dave Wolf, Esq. at dave@rimonlaw.com

Circular 230 Disclaimer: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or tax-related matter(s) addressed herein.

Why have a stock option plan?

Startups often prefer to compensate using stock options because it does not require a cash outlay. In addition, employees may prefer the favorable tax treatment associated with stock options. Stock options also often give employees a stake in the long-term success of the company that salaries or bonuses often do not.

What is a stock option?

A stock option is the right to acquire a certain number of shares of stock for a specific price (“exercise price”). Usually, the employer does not permit an employee to exercise the right to purchase immediately on the date the stock option is issued. Rather, the right to purchase stock typically “vests” or accrues over a period of time or upon meeting certain company performance goals. This encourages employees to remain with the company for the rest of the vesting period or helps the company meet its goals.

Tax consequences of Incentive Stock Options and Nonstatutory Stock Options
There are two forms of stock options: incentive stock options (“ISO”) and nonstatutory stock options (“NSO”). ISOs are different from NSOs in that ISOs receive favorable federal tax treatment if the option meets certain requirements of the Internal Revenue Code.

When granted, both ISOs and NSOs should have an exercise price that is not less than 100 percent of the fair market value of the underlying stock. Neither ISOs nor NSOs are taxable upon grant to the employee or when the option vests. The difference between them lies in the tax consequences when the option is exercised. When an NSO is exercised, the employee recognizes compensation (ordinary) income in an amount equal to the spread at exercise. An employee does not recognize taxable income on exercise of an ISO. However, the spread at exercise is includible in the employee’s federal alternative minimum taxable (“AMT”) income and may give rise to AMT tax liability.

If stock acquired upon exercise of an NSO is held for more than one year, any gain realized on the disposition of the stock is taxed at favorable long-term capital gain rates. ISOs must be held for at least two years from the date of grant and at least one year from the date of exercise to qualify for favorable capital gain tax rates. Otherwise, the employee recognizes compensation income that is taxed at ordinary income tax rates.

The other difference between ISOs and NSOs is in the benefit to the employer: for NSOs, the employer can take a deduction equal to the amount recognized by the employee upon exercise of the NSO. For ISOs, there is no deduction.

The different aspects of ISOs and NSOs provide flexibility in tailoring an equity compensation plan to fit a company’s needs.

What is restricted stock?

Instead of issuing stock options, some companies issue “restricted stock.” Restricted stock refers to stock that is transferred to an employee as compensation for services, subject to a vesting schedule. The employee usually is not required to pay for the stock. If the employee does not remain with the employer until the end of the vesting period, the stock must be returned to the employer. If the employee has paid any amount for the restricted stock but then fails to become vested, the employer usually refunds the purchase price to the employee. A discussion of the tax consequences of restricted stock is beyond the scope of this primer and requires a detailed conversation with a tax attorney.

Given the complex legal, accounting and tax issues, a company should seek advice before implementing an equity compensation plan.

Rimon offers the following flat-fee packages:

1. Basic non-qualified stock option plan without revisions drafted by a corporate attorney for $300. A review by a tax attorney for an additional $400: The client receives a basic no-frills non-qualified stock option plan. This package is appropriate if the value of the stock at the date of issuance is easily determinable and the client accepts the plan without discussing the alternatives.

2. A more extensive analysis by a corporate attorney and tax attorney: $400 for drafting by a corporate attorney and $700 for tax review: This includes a consultation as to whether to choose (a) qualified or (b) non-qualified stock option plan, or (c) restricted stock. This package is appropriate if the value of the stock at the date of issuance is easily determinable.

In a pass-through (or flow-through) entity, the entity’s income and expenses “pass through” the entity and are treated as the income and expenses of its owners. LLCs and S-Corporations are pass-through entities. This differs from a C-Corpoartion (which is the default form of corporation) which is taxed a corporate income tax at the end of the fiscal year in addition to the personal income taxes and dividend taxes that its owners and employees pay. Federal corporate income tax is about 15% to 35% of profits, and most states also have corporate income tax. This means after a C-Corporation has paid its expenses for the year, it will be taxed at least 15%-35% of whatever is left above the amount the company started with that year. If the company is an LLC or an S-Corporation, there is no corporate tax, and indeed the owners can even apply losses of the company against their personal income.