Death Hollow and Doing Difficult Things

Posted by McCullough

My dad has been a scoutmaster all his adult life. He has done 7 or 8 camping trips every year for over thirty years. I asked him once, “What is the most memorable scout trip you ever did?” He said the most memorable trip was Death Hollow because it was the most difficult. He said that those who went will never forget it as long as they live.

And so it was, in June of 2007, that I took 22 boys and 9 men to a place called Death Hollow. This is a deep, beautiful canyon, 33 miles long, and filled with obstacles of every kind. Can you imagine hiking through thick forest with no trail, sandy riverbeds, endless cactus fields, deep narrows full of choke stones, beaver dams, swimming holes, waterslides, and lots of poison ivy, all in one trip?

The canyon changes every year depending on the water flows. We took plenty of water for the first 11 miles, expecting to refill at a well marked spring. But in June of 2007, the canyon was burning hot, and the spring was dry. We all suffered from severe dehydration, but most of the boys made it to flowing water at the 13 mile mark. I was with a small group that collapsed from dehydration. We found a small pool of dirty water with a dead bird in it. We filtered the water many times and attempted to drink. But my body was so dehydrated I threw it up. Six times I tried to drink and threw it up. I knew I desperately needed water, but my body wouldn’t take it. I thought I was going to die. I prayed with a desperation and sincerity I never felt before in my life. It was a long night, but I did finally keep the water down and recover my strength.

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In the morning we joyfully reunited with our friends and continued on our way. The rest of the trip was challenging, adventurous, and thoroughly enjoyable. We cherish the memories of Death Hollow the same way my dad’s troop did. In fact, we came up with a new motto for our troop, “We do difficult things.”

It is no coincidence that the most difficult things in life are often the most rewarding. The best business advice I ever heard is to find the thing that is so difficult that no one else wants to do it, and master that thing, and this will make you valuable.

My accounting professors at college said that the most complicated parts of the Internal Revenue Code are partnership special allocations and the generation-skipping transfer tax. I made a special effort to learn these provisions and I found that this made me valuable at work because I knew things that were useful, but very few were willing to learn.

If I stay in my comfort zone, I am no more valuable to others tomorrow than I am today. But if I take on the difficult process of continual education and improvement, I increase my ability to help myself and others. I believe this applies in many fields of endeavor. I suggest that you adopt our troop motto, “We do difficult things.” Look around for difficult challenges that will stretch your capacity, and then do it and see what it does for you. If you are unable to find a difficult challenge, we are planning another trip to Death Hollow this year, and you are welcome to come along!

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How to Avoid a Piercing of Your Corporate Veil

Posted by McCullough

If you have one or more corporations or LLCs, this subject should be of importance to you. The general rule in every state is that a creditor of a corporation or LLC cannot reach the assets of the owners unless the owners have signed a personal guarantee, or unless the creditor can pierce the corporate veil.

Courts in every state generally uphold the liability protection offered by a corporation or LLC, and they rarely are willing to pierce the corporate veil. A two-part test has been developed by the Utah Supreme Court to assist in determining when to disregard a corporation or LLC.　”[I]n order to disregard the corporate entity, there must be a concurrence of two circumstances: (1) there must be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist, viz., the corporation is, in fact, the alter ego of one or a few individuals; and (2) the observance of the corporate form would sanction a fraud, promote injustice, or an inequitable result would follow.” (Envirotech Corp. v. Callahan, 872 P.2d 487, 499 (Utah App. 1994)).

There are slight differences from state to state, but courts will typically look at the following factors to determine if a corporate veil can be pierced: (1) is there commingling of funds between the entities, (2) is the management the same, (3) is the ownership the same, (4) do the entities have separate bank accounts and accounting records, (5) do the entities have their own operating agreements, (6) is their a unity of purposes, assets, or operations, (7) does one entity exert dominion over the other, (8) is the entity undercapitalized for its operating needs, (9) is there a failure to fulfill corporate formalities, etc.

After reviewing applicable case law, the following are my tips to avoiding a piercing of your corporate veil:

Each entity should have its own bank account, keep its own accounting records, collect its own income, and pay its own bills. It is possible to have another entity provide management services (such as collecting income and paying bills) if a written management agreement is in place and if proper allocations and reimbursements are made.
Corporations should have an updated corporate book with bylaws, organizational meeting minutes, a stock ledger, updated stock certificates, and minutes of annual meetings of shareholders and directors. LLCs should have an operating agreement and they may strengthen their position by having resolutions or minutes of manager meetings although these are not required. Entities must be operated in accordance with the rules set forth in the bylaws or operating agreement.
Related party transactions should be documented with written leases, promissory notes, purchase agreements, etc, and the terms should be typical of an arms-length transaction.
Different entities should have differences in the identify of their officers, directors or managers. In a family setting, you could have one spouse manage one entity and another spouse manage another entity. After all, who could argue that a husband and wife have such a unity of interest that the separate personalities no longer exist and one is the alter ego of the other?
Any use of assets, employers or resources of one entity by another entity should be compensated or reimbursed.
Each entity should have sufficient capital to meet its operating needs.
Each entity should have its own assets and resources which are allocated to its independent purposes.
Most entities should have an annual meeting with an outside CPA and attorney to discuss tax and business planning issues, update corporate documents, review buy sell agreements and leases, check on asset titles and corporate renewals, and review the factors necessary to avoid a piercing of the corporate veil.

How to Protect Your Home

Posted by McCullough

For most of us, protecting our home is paramount. We do this through the acquisition of homeowners insurance, fire insurance, flood insurance, personal liability insurance, burglar alarms, fire alarms, frightening dogs, and an assortment of high powered weapons. In addition to all the above, you should consider legal asset protection planning for your home.

I have a client who works in a high risk occupation. My client has a recurring nightmare that he will incur serious personal liability and have a sheriff come to his house with a judgment in hand, kick his family out, and attempt to take furnishings or other personal items from the house to satisfy the judgment. He wants to be sure that his wife and children don’t experience this kind of invasion of their peace, privacy and personal belongings, but what are his options?

These are a few of the common strategies for protecting a home:

Using Mortgages and Liens

Some people keep enough debt on the home so there isn’t much equity for a creditor to attack. A lack of equity may deter a creditor, but it results in a significant interest expense Others sign up for a home equity loan that results in a lien for the full amount of the credit line even if they don’t borrow any money. This gives the appearance of low equity, but it is only a smokescreen It may deter a lazy creditor, but it also may fail if a creditor discovers that no funds have been borrowed and there is equity in the home.

Separate Property Ownership for a Safer Spouse

If a couple has a safer spouse who is not likely to be sued, it is possible for the couple to sign a legal agreement whereby they agree to own property separately. If the couple has signed a prenuptial agreement, or a post-marital separate property agreement, the creditors of one spouse should not be able to reach the separate property of the other spouse (see Lakeside Lumber Products vs. Evans under “Important Articles, Cases and Rulings” on my website). This can be a safe and convenient strategy, and it allows a couple to retain all the tax advantages of home ownership. The only disadvantages are the risk of a suit against the safer spouse, and the risk in some states that you could be left at a disadvantage in the event of a divorce.

Using an Irrevocable Trust

The advantages of transferring a home to an irrevocable trust are: (1) the assets can be protected from the creditors of both spouses, (2) the couple can retain the tax advantages of home ownership, (3) the trust can serve other important purposes such as avoiding probate, avoiding estate taxes, and transferring assets to heirs according to your wishes. The disadvantages of an irrevocable trust include: (1) cost and complexity, (2) possible difficulty in later refinancing the home, and (3) the transfer must occur far before trouble occurs so it is not deemed to be a fraudulent transfer.

Renting from a Safer Entity

If you don’t own something, your creditors can’t take it away from you. I have some clients who rent their furnished house from a friendly landlord to ensure that the assets are protected from creditors. The obvious risk is that the landlord could kick you out, or he could jeopardize the home due to his own liabilities. It is best to structure a protected entity to own the home and collect rent from you for your future benefit. By paying full rental value for your home and personal property, you can transfer additional funds into a protected entity This option requires some cost, complexity, and tax planning, but if properly designed and managed, it can provide phenomenal peace of mind.

Tax Planning for Business Opportunities

Posted by McCullough

I am an amateur outdoor photographer. To me, photography is all about capturing the opportunities when they come and before they leave To get the perfect photo, you simply have to be in the right place at the right time Consider the following photos:

I have been to these places many times when the colors weren’t as brilliant, or the water wasn’t flowing, or the light wasn’t just right These photos are as good as they are because I was lucky to be in the right place at the right time.

Business opportunity planning is similar, in that you try to transfer a business to a Dynasty Trust or a Roth IRA at just the right time.

Consider these examples:

1. A young software developer established and funded a Self-Directed Roth IRA when his income was low enough for him to qualify, and at a time when he had an opportunity to purchase stock in his company for a very low price The Roth IRA bought the stock, the value grew exponentially, the company was sold, and the young guy walked away with $700,000 in a Roth IRA, never to be subject to income tax! That is what we call business opportunity planning.
2. One of my clients owned a huge commercial real estate center At a perfect time when values and interest rates were low, he sold the real estate to a Dynasty Trust Now he is 85 years old and he has $200,000,000 in a Dynasty Trust that can pass to future generations without estate tax.

Neither of these examples required a bending of the rules Both were made possible by a convergence of good timing, good thinking, and a quick and decisive response Both are very applicable to current conditions Right now we have historically low market values, historically low interest rates, and the opportunity for people of any income level to convert to a Roth IRA Now all you need is a legitimate and reliable once-in-a-lifetime business opportunity!

Advance Planning for the Sale of a Business

Posted by McCullough

The best way to prepare for the sale of your business is to sell your stock to a grantor trust (often called a Dynasty Trust) In addition to other benefits, this will protect the appreciation of your stock from estate taxes as well as other potential creditors

If you want to provide incentive to key employees by promising them a portion of the proceeds from a sale of the business, a “profits interest” may be the most tax efficient way to do it A “profits interest” is simply an interest in the future profits of a partnership without any current equity or liquidation rights A profits interest can be granted without any income tax affect and it can allow an employee to receive long-term capital gains from the proceeds of a sale A profits interest can be designed with any kind of limits, restrictions, adjustments, vesting schedules or other specific features.

If you give an employee a bonus plan, this will result in ordinary income and employment taxes to the employee If you give an employee stock, this is ordinary income to the employee when it is received If you give an employee stock options, this will create ordinary income to the employee when the options are granted, or when they vest Incentive stock options result in AMT income instead of ordinary income, but the end result is almost equally negative Also, most of these options can’t be undone if the employee is terminated.

Consider this example of a profits interest Assume that you give your key employee a profits interest defined as 10% of the proceeds from the sale of the business, but only to the extent the proceeds exceed the current business value of $10,000,000, and only if the employee is not terminated for cause before the sale If the business sells for $15,000,000, the employee will receive $500,000 as a long term capital gain and pay $75,000 in taxes (using the current 15% federal rate) If the employee had received the same $500,000 as ordinary income, the employee would have paid $175,000 in taxes (assuming a 35% federal rate).

On the other hand, a sale to a grantor trust for an employee can accomplish the same result as a profits interest, with even greater control and flexibility And a sale to a grantor trust works just as well with a corporation as it does with a partnership or LLC If you are starting to get the impression that I attempt to solve all of life’s problems with a grantor trust, you may be on to something I haven’t found too many problems that can’t be solved with fresh air, duct tape, or a grantor trust!

Tax Planning for Loans to Children

Posted by McCullough

Many of my clients make occasional loans to their children. A few of these loans have actually been repaid, or at least partially repaid.

The problem is that if you make a loan to your child for his new business, and the child’s new business experiences temporary or permanent financial losses, the child can’t take a deduction for the loss because the child has no basis and no income, and you only get a capital loss that can only be offset against capital gains.

A better approach may be to establish a partnership with your child and file it as an LLC. Then you contribute cash to the LLC instead of loaning the money to your child. If you include special allocations language in the LLC providing that all losses are allocated to the partners according to their tax basis, then you get to take 100% of the losses as a business loss which you can offset against ordinary income (subject to passive activity limitations).

If you loan $200,000 to your child and suffer a total loss, the difference between a capital gain and ordinary income could be 20%, or $40,000.

So before you plow ahead with a loan to your child, you should consult with your tax advisors and see if a better structure will give you additional tax benefits. Who knows, maybe you will be lucky and your tax advisor will talk you out of making the loan altogether!