Starting a new business can be a daunting and an expensive process for new entrepreneurs. Quite often, the sole focus of a new business owner is establishing the physical framework of the business, which may include essential building blocks such as finding a space in which to operate, creating a brand presence through a creative name and specialized product/service, and handling necessary employee and tax obligations. Often first-time business owners establish relationships with suppliers, marketing professionals, and accountants out of necessity to assist in the start-up process, but forego contacting a business attorney until after the first few years of their business venture.

 

By contrast, entrepreneurs who have past experience creating and running small businesses will contact an attorney prior to starting a new venture. There are several reasons why the knowledge and expertise of a business attorney will pay significant dividends to the business owner from the outset and will likely save the business significant legal costs in the long run.

 

Defining a Brand through Sale of a Product, Service, or Combination

 

Most new business ventures start due to some form of creative thought on the part of the entrepreneur. The business owner may have an idea for a new product, service, or a way to better provide an existing product or service to its target market. This new idea is at the forefront of business planning and represents the most significant “value add” to the fledgling business. Creating a brand or trade name for the new service or product is one of the most effective ways to garner notoriety for this new venture.

 

One of the most significant pitfalls for the entrepreneur who foregoes consulting a business attorney during this early process is failing to recognize that the legal rights to this branding concept may already belong to an existing business, or legally conflict with the name, slogan, or logo of another business or product line. Such a conflict can result in the new business owner realizing they are legally precluded from using their brand, but only after sinking significant funds in to its development.

 

Contacting an experienced business attorney at the outset of this process allows the business owner to ensure that state and/or federal rights to a trade name, logo, domain name, business name, or other brand identification (intellectual property) are available for the business and aligned with one another.  If the brand name is available for use, it can be adequately protected from use by competitors through state or federal registration.

 

 

 

Creating a Proper Entity

 

Whether it is through an accountant or from doing legal research through the internet, many new business owners properly identify the need to create a formal business entity out of which to run the business. The basic benefit of forming a small business entity such as a limited liability company (LLC) or an S corporation is two-fold. First, the business entity choice should protect the personal assets of the business owner from lawsuits or claims by creditors against the business. Second, the business entity choice should provide some level of tax benefit at an operational level to the business owner.

 

Despite these perceived benefits, if a business owner fails to consult a business attorney during this important step, these benefits may be diminished in value relative to another entity choice, or even fail to be present at all if the business owner fails to set up the entity properly pursuant to Michigan law.

 

First, in order to ensure a business entity will protect the personal assets of the business owner, the business owner must do a few things beyond simply forming the entity by filing the Articles at the state level. This includes creating proper entity documents as required by state law and maintaining proper separation between personal and business activities. If the creation of entity documents is attempted without the assistance of a seasoned business attorney, documents are very frequently drafted incorrectly or incompletely, resulting in additional cost to re-draft these documents properly. Similarly, pre-paid internet legal services that provide these documents often fail to address important state law, tax considerations, or provide documents that truly fit the scope and character of the new business.

 

Second, entity choice can play a significant role in the operational and long-term tax treatment of the business. Limited liability companies (which are taxed as partnerships by default) and S corporations (taxed under Subchapter S of the Federal Tax Code) provide unique business and tax planning opportunities to a business depending on a large number of different factors. These different tax treatments also create significant differences in the long-term tax treatment of the business, affecting choice in succession planning and the manner in which initial owners may form the business without incurring adverse tax consequences. As such, forming the proper entity for the specific product or service being provided at the outset is key in avoiding costly merger or conversion processes that may be utilized to alter initial entity choice after the business has already been formed.

 

Finding a Space

 

Unless a business owner is operating out of their residence, finding a space to purchase or lease is a necessity in starting a new business. Many business owners will choose to purchase or lease a space because of the physical layout or industry specific equipment present in a particular location. In entering into a purchase agreement or commercial lease, new business owners frequently gloss over significant obligations they are taking on in a rush to get their business open.

 

Unfortunately, many commercial leases and purchase agreements take advantage of restrictive and burdensome provisions that are not legally permissible in a purchase agreement or lease for residential property. This frequently includes requiring the new business owner to move in to the space accepting its current condition, without an inspection, no matter what potential structural flaws may exist. In the case of commercial leases, the agreement also often requires the tenant to pay for all necessary future repairs to the interior, and the obligation to replace all major equipment in the building, including any industry specific equipment, heating and cooling units, and utility related fixtures.  They also often state that any fixtures placed on the property become the property of the landlord.  Leases also often seek to take advantage of the excited, eager entrepreneur by asking the entrepreneur to individually sign a personal guaranty under the Lease, leaving their personal assets vulnerable.

 

It is also commonplace for the business owner to become aware of these obligations only after purchasing the building or becoming locked in to a lengthy lease. Contacting a business attorney prior to signing the document will allow a business owner to anticipate any potential issues with the space, be aware of their potential obligations for repair and maintenance, and allow the business owner an opportunity to negotiate these terms or simply find a different space if these obligations prove too daunting.

 

Creating Adequate Purchase, Employee, and Customer Agreements

 

The primary reason for delaying or altogether avoiding having a formal contract or agreement drafted by a business attorney is cost. Most frequently, the alternative is for the business owner to utilize a search engine to find a contract that appears to fit their industry. In other situations, business owners will skip the formalities and leave their business dealings to an oral agreement between themselves and the customer.

 

Despite the appearance of initial cost savings by repurposing an agreement from the internet or foregoing one entirely, a customer agreement that is not tailored to the product or service being provided to the public can create a catastrophic financial loss when a misunderstanding occurs with a customer. This can come from legal fees incurred through litigation and/or the judgment entered against the business in a lawsuit brought by a customer, or lost profits associated with a customer failing to pay and a business owner being unable to enforce its legal rights in collection. Frequently, these disputes arise because there is a difference in expectation between the business owner and the customer as to what was to be provided to the customer and when.

 

A well-drafted agreement will lay out all the material terms between the parties, and ideally leave no “grey area” for misunderstanding, or for the parties to dispute. In addition, in the event of a lawsuit against the business, provisions would be included in the agreement to benefit the business owner to the maximum extent possible under state law. In addition, any state or federal laws that enable the business to take industry specific collection efforts against a customer delinquent on payment would be in place to avoid loss of important cash flows.

 

At the end of the day, a well-drafted agreement will grant a business owner the maximum potential to negotiate a resolution without going to court, potentially saving the business thousands of dollars over and above the cost of drafting the agreement in the first place. Similarly, if litigation is inevitable, a well-drafted agreement gives the business solid footing on which to stand, rather than the shaky ground provided by an ambiguous, poorly drafted or incomplete contract. Unfortunately, once a dispute arises, there is no way to turn back the clock and draft an adequate agreement to avoid the dispute or aid in winning the resulting litigation.

 

Contacting an Attorney

 

Family and friends who own a small business, and other business professionals (financial advisors, CPAs, etc.) can be a great place to start for a referral to a local attorney who specializes in assisting start-ups and new business owners. Finding an attorney in this manner can be very valuable, as the referral is coming from someone who can either personally vouch for the expertise of the business attorney, or from another business professional who trusts the knowledge and integrity of the business attorney with their own clients.

When people ask me what type of law I practice, I tell them that we handle mostly business law, estate planning, and probate.  Because “business law” is so broad, I will often extrapolate on that and talk about how we assist entrepreneurs with everything from the start of the business to the end of the business and everything in between.  That includes entity selection and formation, corporate document drafting and review, contracts, intellectual property, and succession planning.  I was at my daughter’s friend’s birthday party and explained this to the hostess.  When I said “succession planning”, she said, “Oh, so you help businesses be successful?”  My initial reaction was to say no, that is not what that means.  But, actually, it kind of does mean that in a way.  It really got me thinking that a lot of people may not know what succession planning means.

 

The ideal time for us to meet entrepreneurs is at the inception of the business.  We can help them determine which entity structure is best for them from an operating, liability and tax perspective, and ensure they have the proper company documents in place, such as Articles, By-Laws or an Operating Agreement, Consent Resolutions, ownership interest certificates, etc.  We will research the proposed name for the business to ensure that it is not infringing on another business’s name or intellectual property.  Oftentimes, I will ask the entrepreneur what their goal is for the business and what will happen to the business if the principal becomes disabled or passes away, or what will happen when it is time for the principal to retire.  People are frequently taken aback by this line of questioning.  Why do we need to talk about the end of the business that is just getting started? 

 

It’s a fair question.  This discussion is important for several reasons.  Bad things happen and when a business relies solely on one person, the business can be destroyed quickly if something happens to that one person.  Is there someone that can step in and run the business?  The answer to this question is extremely important to the business owner(s), the business owner’s family members, employees, and perhaps most pressing, to the customers or clients of the business.  Additionally, we see too often a business owner in their seventies that is ready to retire but has no qualified retirement plan in place.  Most of the time, when this situation occurs, the business owner views their business as their retirement plan, but has no way to cash out of the business to sustain their lifestyle.  This can be catastrophic.  The business could be worth very little to an outside purchaser, or, even worse, there may be no one that wants to purchase the business.  As such, it is imperative that the business owner have a plan in place well before he or she is ready to retire.  This includes setting aside money for retirement and also having a business succession plan in place.

 

So, what is a succession plan?  A succession plan is just that – a plan for the future of the business beyond the career of the initial owner(s).  That means, it takes time to develop it and it needs to be in place prior to when it is needed.  It is a plan to address what will happen in the case of certain events.  If the principal becomes disabled or dies, there needs to be a plan in place for what will happen to the business.  There either needs to be someone who can run the business indefinitely unless and until the principal can return (in the case of disability), or there needs to be a plan to either sell the business or wind up the business and close down.  A succession plan needs to be developed to ensure continuity of the business if the principal is no longer in the picture due to disability, death, or retirement.  It is important to plan ahead so that the transition can be as seamless as possible.  Often, the plan includes family members who are involved in the business or trusted key employees that are well-versed in running the business.  This will make everything easier on the business owner, their family, the employees, and the customers or clients of the business.

 

Another key step in creating the succession plan is ensuring that the initial owner(s) can be sufficiently compensated for their ownership interest when the plan is put in to action. In the case of a sale to other existing owner(s) or to key employees of the business, if the sale is pre-planned, significant cost and tax savings can also be achieved. To accomplish this requires weighing and considering complex legal, financial, and tax factors surrounding the plan. Creating a team consisting of an experienced business attorney and business financial planner is the best way to ensure that all of these factors are accounted for so that the proper framework is put in to motion in enough time before the plan must be executed.

 

The hostess at the child’s birthday party wasn’t wrong.  Succession planning is helping to make a business successful - whether that be the retirement of the principal, a partial change in ownership, winding up the affairs of the business and closing down, passing the business to family members and/or key employees, or selling the business to a third party.  It is never too early to have a plan in place.

One common mistake made by business owners in either new or well-established businesses is that their company is set up as a limited liability company (LLC) with the State of Michigan and elects to be treated as an S corporation for Federal Income Tax purposes.  The result of this structure, or, for all intents and purposes, lack of structure, is that the entity is an LLC for state law purposes and a corporation in the eyes of the IRS.  We typically do not recommend this set up as there are pros and cons to each type of entity and it is important to maintain entity consistency on the Michigan and Federal Level.

In most situations, we do not favor LLCs for active, operating businesses. We do, however, recommend LLCs for rental and commercial real estate, and ownership and operation of capital equipment.

Why does State and Federal consistency matter?

The main purpose and benefit of setting up a business entity is to separate the liabilities of a business from the business owner’s personal assets.  In order for a business entity to properly protect the owner’s assets from liabilities of the business, the entity must be set up and operate as a valid business entity both on a State and Federal level.  The entity must also hold itself out to be a separate, valid, and lawful entity to customers and the public at large.  If a Michigan LLC is created but the company elects to be treated as an S Corporation with the IRS, an inherent disconnect between the operation, the tax filings, and the State corporate filings occurs.  If the business were to be sued, a plaintiff’s attorney may attempt to reach through the entity and assign liability to the business owner personally. This is particularly true for single-member LLCs, as historically they were not treated with the same liability protection as multi-member LLCs in some other states. Furthermore, the annual business activity of a single-member LLC is reported on the member’s personal tax return as a sole proprietorship. This is not a position that the business owner would ever want to be in when faced with a potential lawsuit.

In addition, there are certain tax-favored benefits afforded to the business owner in the operation, sale and merger of an S corporation that are not afforded to LLCs.  For example, if all of the shares of an S corporation are sold back to the company when a new owner buys in, the S corporation owner is afforded substantial tax benefits in the transaction.  These tax benefits do not exist for LLCs because the Federal Tax Code treats LLCs like partnerships. Rather than leaving the tax treatment of a sale or redemption of shares to be determined by the IRS on audit, it is far better to structure the entity as an S Corporation both on a State and Federal level from the inception, or at the very least, prior to the sale of the company. 

We also do not recommend that an LLC owning rental or commercial real estate or capital equipment elect to be taxed as an S corporation, as this election removes the tax benefits afforded to these types of LLCs under partnership taxation rules at the Federal level.

What do I do if my business is an LLC that elected to be treated as an S Corporation?

As indicated, this is a fairly common circumstance in the State of Michigan.  If a business has elected to be treated as an S corporation but is registered with the State of Michigan as an LLC, it signals to us that the entity is likely not set up properly with all of the required documents in place and therefore is not a valid LLC in Michigan.  Furthermore, even if it is a valid LLC, we highly recommend conversion to a corporation on the State level. 

If you have questions regarding the process for converting an LLC into an S corporation in the State of Michigan, please give us a call so that we can explain and assist with the process.

Most people will die with at least some debt to their name. The average total balance of debt for U.S. consumers in what is considered to be the “middle to upper middle class” is $290,000.

 

What happens to these debts when you die?

 

In short, when you die, debt incurred by you during life belongs to your estate and sometimes, your trust. When you die with enough assets to cover your taxes and debts, your taxes will be paid first. After your taxes are paid, your debts are paid. Your beneficiaries or heirs will receive what is left after those payments.

 

If there isnt enough to cover your debts, taxing authorities will get paid first. Creditors may then get some – but not all – of what they're owed. Michigan law provides an “order of priority” to determine which debts should be paid and the order in which debts are to be paid, if there are not enough assets to pay all of the debts.

 

In Michigan, family members generally don't become legally responsible for a deceased relative’s debts, but many worry they might. Regardless of this fact, creditors and debt collection agencies often contact family members to attempt to collect the debts of the deceased.  It is very important to discuss any of these collection attempts with an attorney before paying them on behalf of a deceased family member.

 

In Michigan, if you leave behind personal or business debts, when your estate is opened in Probate Court, your creditors have the right to file their claims against it. If a Probate Court case is not opened for you within a specific period of time, the creditors actually have the right to go into Probate Court and open your estate and file their claims against the estate. If you have a will and a living trust, this is much less likely to happen because there is not a clear target to bring claims against.

 

If there aren’t enough assets in your estate, under Michigan law, your trust may have to transfer funds to your estate to pay off debts and taxes. This is what is known as the “permeable membrane” between estates and related trusts.

 

Complicating Factors

 

There can be complex factors, though, depending on the type of debt and the value of your estate and trust.

 

  • If credit cards are held jointly, then the survivor on the account continues to be fully responsible for the debt.

 

  • Federal student loan debt is eligible for cancellation upon death, but private student loans typically don't offer cancellation. These lenders may collect from your estate and trust.

 

  • If other people live in your house, the house may be used to satisfy your debts — whether it's the mortgage or line of credit debt. The people who live there may have to qualify for a new mortgage or sell the home to pay off your creditors.

 

  • Debts incurred by you as co-signer or co-applicant can result in a claim against your estate. 

 

  • If you die with a financed or lease vehicle in your name, the financing company or leasing company may file a claim for the difference between what your vehicle brings at auction and the total remaining payments owed under the finance/lease agreement.

 

Protecting Beneficiaries

 

It is critically important to remember that estate planning is not just about you or what you want to have happen when you die. Its also about protecting those you leave behind, including protection from creditors and collection agencies.

 

There are ways to protect beneficiaries from certain debts and to plan for handling known debts that will remain payable upon death. Your estate planning attorney can help you with this planning and ensure these matters are handled properly.

 

On Saturday, December 2, 2017, the Senate garnered 51 votes to pass its proposed Tax Reform Bill. It now goes to the Joint Committee on Taxation, a joint creature of the Senate and the House, for reconciliation to try to work out the differences in the two proposed versions of the Tax Bills.
 
The Senate Bill contains both tax and non-tax legislation. The following explains the basics of the tax and non-tax provisions of the Senate’s Bill. The House is also working on its own version of the Bill. The specifics of the House legislation are not settled at this time and could impact the way these provisions are worded in the final version of the legislation.
 
TAX PROVISIONS
 
Business Taxation
 
The most significant proposed tax change is the tax rate for large corporations, which would fall from 35 percent to 20 percent starting in 2019. This would presumably place the US on an equal footing with other western nations in terms of their business income tax structure.
 
The second most significant change is that the Bill would transform the tax system on business income from a worldwide approach to a territorial system. Currently, U.S. companies are taxed on all income earned throughout the world. The territorial system would change this, focusing taxation of businesses primarily on their earnings in the U.S., a change corporations have advocated for many years. Historically, the U.S. was the only nation to utilize the worldwide taxation approach to companies and individuals.
 
The Bill would also allow companies to bring back any money they have stored overseas at a tax rate of 14.5 percent.
 
Additionally, in an attempt to spur new investment by American businesses, companies would also be able to write off most of their cost for new buildings and other investments for the next five years. The usual method for companies to recover the cost of buildings and other investments is through a deduction for depreciation over many years.  This makes this particular change significant, especially for large corporations seeking to expand their operations.
 
The Bill also would lower the tax on non-professional service companies that are structured as pass-through entities. This includes S corporations, limited liability companies, and partnerships. The Bill allows owners of such entities to deduct 23 percent of their pass-through earnings. There is an exception for owners of professional service businesses. Owners of professional corporations would only be allowed to take the 23 percent deduction if their income is less than $500,000. If left unprotected, the Bill would create a very strong incentive for owners of pass-through entities to not pay themselves a salary because the salary would be taxable at one of the new tax bracket rates.  By not taking a salary, the business owner would utilize the overall lower effective rate on all income generated by the entity resulting from the 23% deduction of all pass through earnings. In addition, the incentive that exists today, which is to avoid the 15.3% Social Security Tax on Self-Employment income, would continue under the new law. The Bill does have some measures built into it to prevent this from happening.
 
Individual Income Taxation
 
The top tax rate for higher income taxpayers would fall under this plan from 39.6 percent to 38.5 percent. The other tax brackets would also be slightly lower than under current law. However, some of the deductions which save taxpayers taxes – particularly in the Midwest – would be limited, which would result in net higher taxes for some starting in 2018, rather than lower taxes.
 
At the moment, Americans are able to deduct $4,050 as a “personal exemption” for themselves, their spouse and each dependent. The Senate Bill eliminates the personal exemption entirely. Instead, the Bill expands the standard deduction so the first $24,000 of income for a married couple ($12,000 for an individual) would not be taxed. The Bill also would bump up the child tax credit from the current $1,000 to $2,000. The overall effect here is that most people are better off, but not everyone.
 
Taxpayers would still be able deduct their contributions to charity under the Bill. In addition, the deduction for mortgage interest would still be available. The deduction for state and local property taxes would be capped at $10,000.
 
The threshold for deducting medical expenses would be reduced from medical expenses exceeding 10 percent of adjusted gross income down to 7.5 percent.
 
Under the current law, if a taxpayer owns and has lived in their home for two out the past five years and they sell the home, they can exclude up to $500,000 of capital gain. Under the proposed Bill, a taxpayer would have to own and live in the home for five out of the last eight years. This change will discourage “house flippers” and home builders who typically build or rehab, live in the home for two years, and then sell it off at capital gains tax rates, repeating this process every two years. With respect to Michigan construction law in particular, this change may serve to further discourage the abuse of builders failing to obtain a residential builder’s license by “flipping” the house as an unlicensed Michigan builder.  Currently, the tax code is more favorable to unlicensed builders who may utilize the exemption to build houses under the veil of their own personal use and then sell them to unsuspecting buyers after living in the home for a short period.
 
The House Bill, unlike the Senate Bill, would eliminate the tax deduction for ex-spouses that pay alimony for divorces occurring on and after January 1, 2018.
The deductions for moving expenses, casualty losses, biking to work and tax preparation have all been eliminated in the proposed Bill.
 
Estate Taxation
 
Under present law, up to $5,490,000 can be excluded from the Estate Tax per individual. This number would be doubled under the Bill, but not eliminated as rumored.  
 
NON-TAX CHANGES
 
The Bill would eliminate the individual mandate under the Affordable Care Act. The Congressional Budget Office estimates this will result in 13,000,000 Americans losing health insurance.
 
The Bill would also allow for oil drilling in the Alaskan Arctic Wildlife Refuge.
 
ACTION STEP
 
We urge business and individual clients alike to review their own situation in light of the Senate Tax Bill, and to begin to consider what changes in their future plans may be necessary to take advantage of the positives in the Bill and avoid the negatives. For example, if you are thinking about constructing a building or making long-term capital expenditures, doing so in the next five years makes sense. Additionally, if you live in a home that has greatly increased in value, and you are thinking of selling, beware of the five of eight year “live-in” requirement for exclusion of capital gain that would be imposed by the Bill.
 
Please contact us if you have questions about the likely impact of the tax legislation on your business or personal situation.