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.

The White House first released its proposed Tax Reform Plan in April, 2017. The initial release was one page and short on details. Following that, the Secretary of the Treasury released more details on the proposed “Trump Tax Plan.”
 
The Trump Tax Plan would have the most dramatic changes for wealthy individuals, as well as for corporations, both large and small. Individual tax rates for the super wealthy and high income families would drop dramatically. Corporate income tax rates would decrease by 57%.
 
The following highlights will allow you to roughly estimate the impact of the specific proposals on your personal tax situation if the proposed plan becomes law.
 
INCOME TAX
The Trump Tax Plan would replace the current seven personal income tax brackets with three tax rates – 12%, 25% and 33%. The 33% tax rate is lower than the highest marginal rate today – 39.6%. In addition, the 3.8% Affordable Care Act Investment Tax and the Pease 1.3% unlimited Medicare Tax on compensation would be repealed.
 
Income up to $24,000 would not be taxed. As such, the present standard deduction of $12,000 would double to $24,000. All itemized deductions would be eliminated except for mortgage interest, the charitable deduction, and child care expenses. This will negatively impact taxpayers who have higher itemized deductions in relation to their adjusted gross income.
 
Several credible organizations have modeled the income tax impact of the Trump Tax Plan at various income levels for married persons filing jointly. It is concluded that,  for the majority of the middle class, taxpayers would experience only a slight increase in net Federal Income Tax or no change at all.
 
Under present law, capital gains are most commonly taxed at 15%. Certain high income taxpayers pay these at a 20% tax rate. Capital gain taxes would be restructured and essentially return to the law as it was prior to Congress implementing a flat rate capital gain tax structure. The capital gain tax would be structured such that one-half of a capital gain would be taxable at the taxpayer’s regular tax rate. So, with the highest personal income tax rate at 33%, the highest capital gains tax rate would be 16.5%. The capital gain tax rate would apply to capital gains, interest and dividends.
 
The Alternative Minimum Tax would be repealed in its entirety. This is a tax that applies to individuals whose calculated income tax is considered to be below a theoretical “acceptable” composite income tax rate. This normally results from having a disproportionately high percentage of income coming from “passive sources” or from very high itemized deductions.
 
BUSINESS TAXES
The Trump Tax Plan would reduce the corporate income tax from 35% to 15% on C corporations. C corporation taxation status is typically chosen by companies that are larger, and thus can handle the income tax burden. These companies pay tax at the company level on their net taxable income in addition to their shareholders paying tax on dividend distributions. It is believed that this change will make America more competitive with respect to attracting and retaining corporations in relation to other western economies.
 
The Trump Tax Plan calls for S corporations, limited liability companies and partnerships to be taxed at a rate of 15% on flow through income to the shareholders, members or partners. This rate would be payable by the shareholders, members or partners, as opposed to the current rule which taxes S corporation, LLC, or partnership income at the individual taxpayer’s income tax rate. The new structure would create a strong bias towards not paying compensation to the shareholders, members or partners which would be taxed at one of the three new tax rates. If the net S corporation, LLC or partnership income is allowed to “flow through” to the individual shareholder’s Form 1040, as opposed to reporting it as compensation, it will be taxed at a flat 15% rate, as opposed to 12%, 25%, or 33%.  In addition, such a payment structure would avoid Social Security Tax of 15.3% to the extent it is not paid as wages.
 
With the restructuring of the C corporation and S corporation tax structure, there would be a strong incentive for C corporations to elect S corporation status to take advantage of the single 15% tax on net corporate income. Under present law, in order for a C corporation to elect to be treated as an S corporation for tax purposes, one of the key requirements is that the corporation can have no more than 100 shareholders. Thus, that avenue would not be open to large, publicly traded companies.
 
ESTATE TAX
The estate tax proposal is radical. First, the Trump Tax Plan would eliminate the estate tax. This is a tax imposed on individuals with over $5,490,000 in total assets (adjusted annually), or $10,980,000 for a married couple. Assets over this amount are taxed at 40%.
 
The Trump Tax Plan would replace the estate tax with a deemed capital gain tax.
 
Under current law, upon death, any assets owned by the deceased taxpayer are marked up to their fair market value on the date of death. Thus, death transfers do not incur any capital gain taxes if the appreciated asset is sold immediately following death. The Trump Tax Plan would tax the capital gain that is deemed to occur at death whether or not the deceased taxpayer’s beneficiaries have sold the assets. The decedent’s tax basis would be deducted from the fair market value of the appreciated asset, and the capital gain tax immediately payable on the difference.
 
The capital gains tax would be payable even though the individual has no cash proceeds to pay the capital gain tax. This suggests that if this part of the Trump Tax Plan is enacted, it would make sense for individuals to purchase life insurance on the decedent’s life to pay the tax associated with the deemed capital gain tax. Otherwise, the requirement to pay the deemed capital gain tax would necessitate selling the appreciated asset to pay the tax. This would be particularly harmful if the asset is in a “value through”, such as stocks and securities were in 2007 - 2011.
 
SUMMARY
 
 
Congress and the Trump Administration have set December 31, 2017 as the deadline for enacting tax legislation. Please review your specific situation and let us know if there is any aspect you wish to address.

On January 31, 2017, the Michigan Court of Appeals issued an opinion in Allard v. Allard (Allard III) that seemed to have a dramatic impact on the status of prenuptial and postnuptial agreements under Michigan law. Despite the initial outcry, the actual impact of this decision on such agreements is fairly negligible, with prenuptial agreements remaining an important tool for couples contemplating marriage.
 
Above all, Michigan contract law protects the principle of freedom to contract by recognizing all contracts entered into upon the mutual agreement of the parties. As such, many legal provisions that provide specific rules or expectations can be modified, waived, or supplanted by contractual agreements. That being said, it is also well recognized that freedom of contract does not permit contracting parties to impose obligations or waive the rights of third parties without their permission to do so.
 
In its most simple form, Allard affirmed the power of a divorce court to invade the separate property of one spouse if the martial estate is insufficient to provide for the suitable support and maintenance of the spouse seeking additional support.  This accounts for the needs of any children in their care despite the presence of a contractual agreement to the contrary. In exercising this equitable power, the court is also limited, as it may only be exercised over property for which the spouse seeking additional support contributed to the acquisition, improvement or accumulation. Necessarily, this would likely include all property accumulated during the course of the marriage.
 
As such, where prenuptial agreements are concerned, this does not change the effectiveness of these agreements where property accumulated prior to marriage is concerned, nor does it affect provisions controlling any inheritance by a spouse. In addition, unless there is an equitable reason for the court to invade the individual property of a spouse, the terms of a prenuptial agreement will remain binding.
 
As the Court of Appeals stated in Allard III, however, a divorce proceeding is an equitable one that allows the court the freedom to afford whatever relief is necessary to accomplish its own directives. In the decision, the Court emphasized these equitable principles and pointed out that the couple’s children are third parties whose rights are impacted without their consent via a prenuptial agreement.
 
The broad impact of the decision is that the bounds of contractual freedom for creating a prenuptial agreement have been diminished, at least to the extent to which these agreements may be utilized to maintain economic inequity between spouses upon divorce. Practically speaking, most couples signing prenuptial agreements are doing so to protect property accumulated prior to marriage, and inherited during marriage, not to ensure that they will retain a disproportionate portion of property accumulated during the marriage.
 
In summary, here are the key highlights:
 
  • Prenuptial agreements continue to be critical to protect the separate property of each spouse accumulated prior to marriage, as well as any property or assets inherited during marriage by a spouse.
  •  A divorce court will only employ equitable principles to redistribute property – despite such property having been deemed as separate by a prenuptial agreement – when necessary to resolve an inequity of property between the spouses that makes support of one of the spouses impossible without such redistribution.
  • Continued and future support of minor children is an extremely important factor in the court’s decision to judicially redistribute separate marital property.

 

If you are looking to have a prenuptial agreement drafted, please contact your attorney to address your individual concerns.

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The Firm, deeply rooted in Livingston County, has its origins in 1994 when it was founded by Tim Williams.  After having practiced predominantly in tax law for many years with larger firms, Tim decided to start a new firm that centered around working with people rather than with only highly complex tax issues. The Firm is centered in working with entrepreneurs and individuals with a personal touch.  The goal of the Firm has always been to create a relationship-driven rapport with its clients to establish long-lasting, personal relationships.  From the time it was founded, the Firm has specialized in business law and estate planning and probate practice.  Many of the Firm’s clients rely upon its attorneys for business guidance as well as legal counselling. The Firm has always made it a priority to devote time to giving back to the Livingston County community and its residents by working with and giving to charitable and service organizations.  The firm plans to continue to grow its client base in Livingston County and the surrounding areas.

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