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CREATION OF A CORPORATION
Articles
of Incorporation
A corporation comes into existence as a legal entity when the
articles of incorporation are filed with the Secretary of State.
The articles of incorporation designate the name of the corporation,
its purpose, its agent for service of process, its authorized
stock, and any other matters that we considered necessary or
appropriate after discussing your intentions. Each of those items
is important for the following reasons:
1. Name of Corporation. Whenever
you refer to the corporation by name, it must be exactly as it
appears in the articles, including any periods, commas, or other
punctuation marks. You may, however, use the name in all uppercase
letters or in a combination of both uppercase and lowercase letters.
If you ever want to change the corporation's name, the corporation
must amend its articles of incorporation in order to change its
name.
A corporation may conduct business
under a trade name other than its own name, just as an individual
may do. However, the corporation must comply with the same requirements
as an individual. Specifically, the corporation must file a Fictitious
Business Name Statement with the court clerk of the county in
which the corporation does business under the trade name and
must properly publish the trade name in a newspaper of general
circulation in that county. Upon doing so, the name in the articles
of incorporation nevertheless remains the corporation's true
name. The name in the Fictitious Business Name Statement is merely
a trade name under which the corporation does business.
A corporation also can do business
under more than one trade name. Normally, this is done where
the corporation is involved in more than one type of business.
In that case, each business with its own trade name is generally
regarded as a separate "division" of the corporation.
The books and accounting records of each division would be kept
separately, although the corporation would file only one tax
return each year with each tax agency.
If the corporation does business
under a trade name, the failure to comply with the registration
and publication requirements may prevent the corporation from
obtaining a court judgment to collect debts. You can prepare
a Fictitious Business Name Statement yourself. However, most
of our clients do not wish to bother with the nuisance of doing
so and the consequences of making a mistake. Therefore, most
of our clients ask us to prepare such statements. We use a local
company to provide this service at a reasonable cost.
2. Purpose. It is prudent to
arrange for a new corporation to have the broadest possible business
purposes that are permitted under the General Corporation Law
of California. Thus, the corporation may engage in any lawful
activity except the business of banking, a trust company, or
a profession permitted to be incorporated under California law,
such as law or medicine.
3. Agent for Service of Process.
The agent for service of process is the individual identified
in documents filed with the California Secretary of State as
the person who may be served with legal process in order to in
order to commence an action against the corporation. Any officer,
director, or managing agent of the corporation may also be served
to obtain valid service of process upon the corporation. Nevertheless,
we generally recommend that one of the corporation's principals
or our firm be named as the agent for service of process. The
corporation must file an amended Statement By Domestic Stock
Corporation in order to change the agent's name or address. Please
contact us if you need assistance.
4. Authorized Stock. The term
"authorized stock" refers to the classes of shares
and the maximum number of shares that a corporation may issue
to those who own an interest in the corporation, i.e., its shareholders.
Except in special circumstances, a corporation will have only
one class of stock - common stock. The total number of shares
that may be issued and outstanding at any time may not exceed
the maximum number designated in the articles. If you need to
issue more shares than are designated in the articles, please
contact us, so the corporation can amend its articles of incorporation
to increase the authorized number of shares.
5. Indemnification. The articles
of incorporation authorize the corporation to indemnify its officers
and directors to the fullest extent permitted under California
law. To provide for indemnification, the corporation should enter
into an indemnification agreement with its shareholders. Without
an indemnification agreement, the corporation may be prevented
from reimbursing you for expenses you incur on behalf of the
corporation.
6. Other Matters. The articles
can also include other matters permitted under the General Corporation
Law of California such as restrictions on the transfer of shares
or preemptive rights that limit the dilution of shareholder interests.
In most cases, however, including such matters in the articles
increases the delay and expense of making changes because any
change requires an amendment of the articles. Alternatively,
therefore, some of these matters may be included in the corporation's
bylaws, which I will discuss next.
Bylaws
The bylaws of the corporation are the administrative rules by
which your corporation must operate. Among other things, the
bylaws describe all of the corporation's rules relating to shareholders,
directors, and officers, including annual and special meetings
of the shareholders and the directors. You should review and
familiarize yourself with the bylaws, because you may be held
personally liable if you do not comply with them. If there is
anything in the bylaws that you do not understand, please call
us.
CORPORATE
ACTION
The corporation acts only through individuals. Depending on the
circumstances, a corporation primarily acts through its directors,
officers, and/or managing agents.
Although the shareholders own
the corporation, their actions generally do not constitute acts
of the corporation. Rather, the shareholders elect the individuals
who establish policies for the corporation and who make certain
key management decisions. Those individuals are the directors.
The directors, in turn, elect the corporate officers who carry
out the day-to-day operations of the business.
In a small, closely held corporation,
the same individuals generally occupy all those positions. In
a one-shareholder corporation, one individual may occupy all
of the positions simultaneously.
California law requires that
some of the actions of the directors and officers be authorized
in writing. This is done by written resolutions adopted in written
actions or at meetings. The resolutions and written record of
the actions or meetings are called minutes. The minutes are kept
in a minute book along with a certified copy of the articles
of incorporation and the bylaws
1. Actions of Shareholders.
Every year the shareholders must elect directors for the ensuing
year. This may be done by a written action or at a regular annual
meeting of the shareholders recorded in the minutes. If it is
done by a written action, all of the shareholders must sign,
and an annual meeting is not required. If it is done at an annual
meeting, then minutes of the meeting must be prepared properly
and kept in the minute book. The required date for the annual
meeting and the number of directors to be elected is set forth
in the bylaws. A one-shareholder corporation may opt to have
only one director. The shareholders do not have to elect directors
to fill all of the seats, but they must elect enough directors
so that at least a majority of seats are filled. Otherwise, the
board of directors will not be able to meet the quorum requirements
in the bylaws to hold a valid meeting and adopt valid resolutions.
2. Organizational Actions of
Directors. Every year the directors must elect the corporate
officers for the ensuing year. At a minimum, this must include
a president, secretary, and chief financial officer. The same
individual may hold all three offices if the directors so decide.
The directors may also elect additional officers such as a chairman
of the board, vice presidents, or an assistant secretary, as
necessary or appropriate for the management of the corporation.
The election of officers may be by a written action or at a regular
annual meeting of the directors recorded in the minutes. If it
is done by a written action, all of the directors must sign,
and an annual meeting is not required. If it is done at an annual
meeting, then minutes of the meeting must be prepared properly
and kept in the minute book. The required date for the annual
meeting is set forth in the bylaws.
3. Fiscal Year-End Actions
of Directors. Although not required, the directors should take
certain actions at the end of every fiscal year of the corporation,
such as: (a) establishing the salaries, changes in salaries,
bonuses, or other compensation paid to officers, (b) determining
the amount of any corporate contributions to retirement plans,
(c) ratifying any major asset acquisitions of that fiscal year,
and (d) declaring any dividends to be distributed to the shareholders.
This may be done by a written action or at a special meeting
of the directors recorded in the minutes. If it is done by a
written action, all of the directors must sign, and a meeting
is not required. If it is done at a meeting, then minutes of
the meeting must be prepared properly and kept in the minute
book.
4. Special Actions of Directors.
Generally, whenever the corporation does something other than
in the ordinary course of business, the directors should authorize
the act in writing. In particular, the directors should approve
of actions that may provide a benefit to individual officers,
directors or shareholders, such as loans to or from officers,
directors or shareholders. The directors must also approve of
transactions with banks or other lending institutions in which
the corporation represents that the directors have adopted a
resolution authorizing the transaction, or any other transaction
in which the corporation represents that the directors have adopted
a resolution author-izing the transaction. This may be done by
a written action or at a special meeting of the directors recorded
in the minutes. If it is done by a written action, all of the
directors must sign, and a meeting is not required. If it is
done at a meeting, then minutes of the meeting must be prepared
properly and kept in the minute book.
MINUTE
BOOK
The corporation's minute book stores the written records of all
of the corporation's formal actions. This is crucial for several
reasons:
1. Protecting Against Personal
Liability. One of the principal reasons to form a corporation
is to protect the owners of the business from personal liability.
In California, as in most states, a legal doctrine exists which
can pierce the corporate "veil" of protection and hold
the shareholders personally liable for the corporation's actions.
That legal doctrine is often referred to as the "alter-ego"
doctrine. It derives that name from the concept that where the
shareholders of a corporation do not treat the corporation as
a legal entity separate and distinct from themselves, then the
law permits the corporation's creditors to regard the corporation
as the mere the alter-ego of its shareholders and hold them personally
liable for the corporation's obligations.
The law considers several factors
to determine whether a corporation is the mere alter-ego of its
shareholders. Examples include whether the corporation is adequately
capitalized, whether the shareholders commingle their personal
funds with those of the corporation, whether the shareholders
use the corporation's funds to pay personal debts, and whether
the corporation complies with its corporate formalities. The
corporate formalities include keeping proper records of corporate
action as discussed above. Thus, the minute book is an important
record to help establish that the corporation complies with corporate
formalities and, therefore, that the shareholders should not
be held personally liable for the corporation's debts.
2. Tax Audits. When the Internal
Revenue Service or Franchise Tax Board audits a corporation,
the auditor generally asks to inspect the corporation's minute
book. The failure to keep a proper record of certain financial
transactions could result in the auditor reclassifying those
transactions as non-deductible dividends. This would result in
a double tax at both the corporate and the shareholder levels.
3. Administrative Agencies.
If a federal or state agency challenges a corporation on whether
it has complied with the agency's regulation, the agency may
ask to inspect the corporation's minute book. The failure to
properly document the basis for a decision of the corporation's
directors concerning that regulation could result in fines or
penalties against the corporation or its directors.
4. Good Housekeeping. Finally,
as with any financial or business matter, it just makes good
sense to keep complete records of the major actions and decisions.
If later you decide to sell the company, the buyer and the buyer's
attorney will want to examine the corporation's minute book to
determine that the company was properly incorporated, capitalized,
and managed throughout its corporate existence. The failure to
keep adequate records could cause such a potential buyer to view
the corporation as a "shoot from the hip" operation
with potentially large contingent liabilities looming on the
horizon. That could adversely affect the sale price.
Thus, when this law firm represents
a corporation, we normally retain the corporation's minute book
(along with its stock register) in a safe place in our offices
and prepare the corporation's annual minutes and/or written actions
as discussed above. Doing so provides several benefits to our
clients:
First, it ensures that the
minutes and written actions will actually be prepared without
being overlooked and that the corporation has complied with its
corporate formalities, thus, reducing any exposure to the alter-ego
doctrine discussed above.
Second, it safeguards the official
records of the corporation's actions.
Third, it allows you to do
what you do best, which is to run the company with optimum effectiveness
without being mired in legal details that could consume your
time and detract your attention from the operations of the business.
In providing this service,
we do not charge a storage fee for warehousing your minute book,
as do many law firms. We calendar the annual dates for your corporate
actions and prepare the minutes and/or written actions in a timely
manner. Our staff performs most of the routine work to keep your
expense to a minimum.
The way we implement this service
is as follows: We send you the drafts of the annual shareholder
and director actions to either sign "as is" or to revise.
After you sign the documents, we file them in your minute book.
As to the fiscal year-end actions of the directors, we can provide
you or your accountant a questionnaire to complete and send to
us. Alternatively, your accountant may have a form familiar to
the accountant that he or she can send us. Finally, we ask you
to provide us with any information that may be necessary to properly
document any corporate actions that arise other than at the times
of the regular annual actions. We will proceed with this plan
unless you instruct us to do otherwise.
STATEMENT
BY DOMESTIC STOCK CORPORATION
Each even or odd year, the Secretary of State requires this corporation
to file a Statement By Domestic Stock Corporation. The statement
requests such information as the corporation's principal place
of business, its officers, its directors, and its agent for service
of process.
We prepare the first statement
for you, have you sign it, and file it with the Secretary of
State. In future years, the Secretary of State will send the
statement to the corporation directly. When you receive it, you
have two choices: you can complete it yourself and file it with
the Secretary of State, or you can send it to us to complete
for your signature and filing.
If there has been no change
in the information since the previous year's statement, you can
simply mark a box on the form indicating that the information
has not changed, and then sign the form in the proper place and
mail it to the Secretary of State. However, if there has been
any change, each change must agree with the corporation's minute
book. For this reason, we recommend that you sign and forward
the statement to us to complete on your behalf so we can ensure
that it agrees with the minute book. Failure to file the statement
on time can result in the assessment of a penalty and the corporation
can lose its right to do business in California, including the
right to appear in court to collect debts or to defend itself.
CALENDAR
OR FISCAL YEAR-END ACCOUNTING
One of the first things you must consider is the corporation's
year-end. You must decide whether the corporation will keep its
accounting and file its tax returns on a calendar or a fiscal
year-end. If you decide on a fiscal year-end, you must decide
which month of the year will be the corporation's year-end. This
decision will affect the deadlines to file the corporation's
first tax returns and may allow you to defer taxable income or
to obtain other benefits. You should make this decision with
either our input or the assistance of an accountant or competent
bookkeeper.
TAX
IDENTIFICATION NUMBERS
The corporation must file a Form SS-4 with the Internal Revenue
Service to obtain a tax identification number. If the corporation
will have payroll taxes, it must file Form DE-1 with the California
Franchise Tax Board to obtain a payroll tax number. You also
should contact the California Employment Development Department
to see whether the corporation needs a State Unemployment Insurance
Fund number. Finally, if the corporation will make sales subject
to sales tax, it should file for a sales tax resale number with
the California Board of Equalization. Some clients prefer to
have their accountants prepare and file those forms. We will
not prepare and file those forms unless you have instructed us
to do so.
TAX
RETURNS AND ACCOUNTING
The corporation must make estimated tax payments prior to certain
deadlines throughout its tax year. Also, the corporation's first
federal and state income tax returns are due no later than the
15th day of the third month after the corporation's fiscal year-end,
unless certain exceptions apply or the corporation obtains an
extension. The California return must be prepared whether or
not the corporation experiences a net profit because the corporation
must pay a minimum franchise tax to the State of California regardless
of its profits. The corporation must also file payroll tax returns
for any compensation it pays its employees, and it must file
information returns for payments to others. Depending on the
corporation's business, there may be other filing requirements,
too, such as sales tax returns.
The payment of year-end bonuses may be critical in saving taxes,
unless the corporation has filed an "S" corporation
election. If the corporation pays a year-end bonus to any person
who directly or indirectly owns over 50% of the corporation's
shares, the payment is not deductible on the corporation's tax
return unless it is paid before the corporation's year-end. For
purposes of this rule, a shareholder is deemed to indirectly
own any shares attributed to the shareholder under the complicated
attribution rules of the Internal Revenue Code. For example,
under the attribution rules, a shareholder is deemed to own any
shares that both the shareholder and the shareholder's children
own directly. Thus, if a shareholder and the shareholder's children
each directly own less than 50% of the corporation's shares,
but the total shares that they own together exceeds 50%, the
shareholder is deemed to own over 50% of the corporation's shares
for purposes of determining the deductibility of bonuses.
As you can see, the preparation
of a corporation's tax returns, as well as the maintenance of
its books and records, are more complex than that of a sole proprietorship
or partnership. You should immediately consider retaining an
accountant. If you do not already have someone in whom you are
confident, we can refer you to someone reasonably convenient
to meet your needs.
CORPORATE
SEAL
Occasionally you may find that you are asked or required to use
the corporate seal on a document to signify that a corporate
officer's signature on behalf of the corporation is "official."
(For that reason, we suggest that the corporation keep the corporate
seal rather than us.) However, a seal is not required in California
as long as an officer's signature on behalf of the corporation
is done properly. The proper way to sign on behalf of the corporation
is to always reflect the exact name of the corporation as the
name appears in the articles of incorporation. We also recommend
that immediately below or after the corporate name you include
the words, "A California corporation." Finally, either
immediately below or after the officer's signature, you should
include the word, "By" followed by the signing officer's
printed name and corporate office. If the corporation does business
under a trade name other than its own name, you should also include
the trade name. The following are examples:
| Without a Trade
Name |
|
| |
XYZ, INC.
A California corporation
______________________________
By: John Doe, President |
| With a Trade Name |
|
| |
ABC COMPANY
A Division of XYZ, INC.
A California corporation
______________________________
By: John Doe, President |
The manner in which a corporate
officer signs on behalf of the corporation is extremely important.
Any creditors with whom an officer deals on behalf of the corporation
must understand that the officer represents the corporation and
is not acting individually. Failure to follow the proper format
can result in the officer becoming personally liable for the
corporation's debt. This legal doctrine in California law is
know as the "agent of an undisclosed principal." This
adverse liability can arise in several seemingly innocent ways.
The following are examples:
1. Failing to reflect the corporation's
correct name on business cards, stationery, and/or invoices.
2. Failing to identify that
the business is a corporation on its business cards, stationery,
and/or invoices.
3. Signing contracts, purchase
order, and other documents without designating the corporate
office of the signer or the corporation's name.
The exposure to personal liability as agent of an undisclosed
principal can be easily avoided by following the simple signature
procedures outlined above.
REPAYMENT
OF INCORPORATION EXPENSES OR OTHER LOANS
In forming the corporation, the principals may have advanced
funds, such as legal expenses, on behalf of the corporation.
One of the resolutions in the first corporate action of the directors
provides for the reimbursement of those expenses. Normally, you
should capitalize the corporation in an amount that is sufficient
to reimburse those expenses. Later, when you deem it convenient
(after opening the corporation's bank accounts), you may disburse
sufficient funds from the corporation's account to reimburse
those expenses. The repayment of the incorporation expenses constitutes
the repayment of an advance (i.e., a loan). Thus, whenever the
corporation repays such expenses, the corporation should not
withhold any payroll taxes from the payments. Also, the corporation
may amortize the repayment of the incorporation expenses over
an appropriate period of time. You should consult the corporation's
accountant on that subject when the corporation's first-year
tax returns are prepared.
The principals also may loan
money to the corporation from time to time for the corporation
to use as working capital. As I mentioned above, any such loan
should be properly approved by minutes or written actions of
the directors. Furthermore, any such loan should be properly
documented by a promissory note from the corporation to the principal
bearing appropriate terms of repayment. Please do not hesitate
to contact us to draft such documents. When the corporation's
profits are sufficient, the corporation can then repay the loans,
together with any interest. The repayment of loan principal is
not tax deductible, but the payment of interest generally is.
Similarly, the receipt of the loan principal is not taxable income
on the individuals' returns, but the receipt of interest is.
DIRECTORS'
FEES
When directors hold meetings to consider corporate actions, the
corporation is permitted to pay them directors' fees. Under current
tax law, directors' fees are not subject to withholding taxes
for FICA (Social Security) or SDI (State Disability Insurance).
Therefore, this can be a method of taking money out of the corporation
with a lesser tax burden, provided the amount of the directors'
fees is reasonable.
REAL
ESTATE, MAJOR EQUIPMENT, AND/OR OTHER LEASES
Another way to take money out of the corporation with a lesser
tax burden is through leases. If the corporation must use real
estate or major equipment in its operations, it can be owned
by and leased from one or more of the corporation's principals.
This affords several benefits: First, the lease payments are
not subject to withholding for payroll taxes. Second, the payments
constitute income, but not earned income, so you will avoid self-employment
taxes on the payments. Third, the income may be offset by depreciation
deductions which are more valuable to individual shareholders.
Fourth, if the corporation is ever dissolved after a sale of
its assets, any gain on the real estate or equipment will not
be subject to double taxation at both the corporate and shareholder
levels. Finally, if the corporation is adequately capitalized,
the assets may escape creditors' claims against the corporation.
Therefore, unless there are more important non-tax considerations,
you generally should hold title to real estate, major equipment,
and other items of substantial value outside of the corporation
and lease those items to the corporation.
DIVIDENDS
Generally, there is little advantage for a corporation to pay
dividends to its shareholders. This is primarily because a dividend
creates a so-called "double tax." The payment of dividends
is not a deductible expense on the corporation's tax return,
but it constitutes taxable income to the shareholders. Thus,
the "double tax" arises because the corporation cannot
reduce its taxable income with the non-deductible payments, and
the shareholders pay tax upon the receipt of the same payments.
The double tax can be avoided
by making an S-corporation election, which I will discuss below,
or by simply not paying dividends. However, an S-corporation
election may have undesirable disadvantages and, under certain
circumstances, the decision to not pay dividends may have adverse
consequences. For example, If the corporation has a profit, it
will accumulate earnings that will be taxable when a distribu-tion
to shareholders is made in later years, unless the corporation
has losses that exceed the earnings accumulated in prior years.
Some corporations avoid profits by increasing the compensation
of shareholder-employees. However, if a corporation has a shareholder
that is not active in the business, increasing the compensation
of shareholder-employees may be improper without paying a dividend
to the inactive shareholders. The inactive shareholders might
sue the majority shareholders for damages under the California
legal doctrine that imposes a fiduciary duty upon shareholders.
A payment of unreasonable compensation may also be nondeductible,
which defeats the purpose of the payment.
In a nutshell, if you find
yourself in a situation where you foresee substantial surplus
profits by the 10th or 11th month of the corporation's tax year,
you should consider discussing the circumstances with us so we
can assist you in both your business and tax planning.
S-CORPORATION
ELECTION
You may already have considered whether to file an S-corporation
election, as defined in the Internal Revenue Code. What that
means is after filing an S-corporation election, the corporation
does not pay any taxes. Instead, the corporation's net profit
or loss is deemed received by the shareholders in proportion
to their stock ownership, whether or not they receive a distribution
from the corporation. If the corporation will incur a loss in
the first year, an S-election will allow you to claim the loss
as a deduction on your individual income tax returns. However,
there are also drawbacks to making an election. For example,
the corporation must use a calendar year for tax purposes, so
it will be unable to defer income using a non-calendar tax year.
The corporation also may be unable to use some employee benefit
plans.
There are advantages and disadvantages to an S-corporation election.
If we have not already discussed those advantages and disadvantages,
and you are interested in considering such an election, please
contact me. The important point to remember is that the deadline
to make the election so that it is retroactive to the date of
incorporation is the 15th day of the third month after we filed
the articles of incorporation with the Secretary of State. Therefore,
in order to make the election, you would have to instruct us
to do so well in advance of that deadline so that we can prepare
the required documentation for both the federal and state elections.
LICENSING
AND REGISTRATION
Most corporations must have a local business license. Some corporations
also are required to file a special registration or obtain a
special license because a state or federal agency regulates the
business. Also, some business operations require the corporation
to have an officer or employee who holds a special license, referred
to as a responsible managing officer ("RMO") or responsible
managing employee ("RME"), respectively. In most instances,
the corporation's failure to comply with these licensing requirements
exposes the corporation to fines or other liabilities or prohibits
the corporation from protecting its rights in court. We can assist
you in obtaining licenses. Unless you contact us, we will assume
that you will obtain all necessary licenses without our assistance.
INSURANCE
Nearly every business requires insurance coverage. This may include
insurance on automobiles that the corporation owns or leases,
public liability insurance, group medical and life insurance
for employees, and workers' compensation insurance, among other
forms of coverage. There can be many issues involved in selecting
insurance and tailoring it to your needs. For example, the corporation
is not required to pay for workers' compensation insurance for
its officers who are employees if all of the officers agree to
waive such coverage. The same rule, however, does not apply to
non-officer employees the corporation is required to provide
them workers' compensation insurance under any circumstances.
Usually a qualified insurance broker can help you make these
decisions and can arrange to transfer any existing policies to
the corporation or issue new policies as the case may be. Sometimes
clients feel they should divide this type of professional responsibility
among more than one insurance broker or agency. If you do not
already have someone in whom you are confident, please contact
me and I can refer you to someone reasonably convenient to meet
your needs.
INVOICES
If the corporation collects its payments by sending invoices
to its customers, you should consider printing certain terms
and conditions on the corporation's invoices. Among these terms
and conditions are clauses for attorneys' fees and interest.
1. Attorneys' Fees. If the
corporation finds itself in a position of having to sue a customer
to collect payment, California law does not permit the prevailing
party to recover its attorneys' fees in the judgment unless there
is a provision in the agreement permitting attorneys' fees. Therefore,
we generally recommend that our clients include such a provision
in their invoices.
2. Interest. If a customer
becomes delinquent in paying an invoice to the corporation, the
corporation is not permitted to charge the customer any interest
for the delay in payment unless the customer has so agreed. One
way to ensure this is to include a provision in the invoice for
a rate of interest on past-due amounts. We generally recommend
that our clients do this.
SALE,
ISSUANCE, OR OTHER TRANSFER OF SHARES
Both state and federal law govern the sale, issuance, or other
transfer of shares of a corporation. We have arranged for your
corporation to issue its shares of stock under applicable exemptions
provided for in the law. For the issuance of the shares of stock
to be valid and legal, the corporation and its shareholders were
required to meet certain requirements. These requirements change
from time to time. The failure to comply with those requirements
constitutes a securities violation. Also, a sale, issuance, or
transfer can have dramatic tax consequences depending on how
it is structured. Therefore, if you decide in the future to sell,
issue, or transfer any of the corporation's shares, please consult
us first.
SALE
AND/OR DISSOLUTION OF THE CORPORATION
There are several ways to structure the sale of a corporation.
One way is to sell its shares of stock. There are securities
and tax issues that must be considered in the sale of stock.
Liability issues may also affect the sale price. Since a buyer
of the corporation's stock becomes the owner of the corporation,
which includes not only its assets but also its liabilities,
the buyer may not be willing to pay as high of a purchase price
as it would if the liabilities could be avoided.
Thus, another way to sell a corporation is to sell its assets.
By selling the assets, the transaction may be eligible for a
"bulk sale" under the Uniform Commercial Code of California.
A bulk sale is a sale in which the buyer acquires the assets
without inheriting the seller's liabilities. Since the buyer
avoids the seller's existing liabilities, the buyer may be willing
to pay a higher purchase price for the business or agree to terms
and conditions more favorable to the seller than in a sale of
the corporation's shares of stock.
Despite these factors, a sale
of assets is not necessarily the most favorable alternative for
both parties. From the seller's viewpoint, a sale of assets can
result in a "double tax." One tax at the corporate
level which usually results in a mixture of ordinary income and
capital gains and a second tax to the shareholders at capital
gains rates when the corporation dissolves and distributes its
net, after-tax profit to the shareholders in exchange for their
shares. This will generally result in less net profit to the
shareholders than a direct sale of stock to the buyer at capital
gains rates for the same purchase price.
This should illustrate that
there are several factors that must be considered in the sale
of a business, even before negotiations begin. The considerations
are further complicated by the fact that the tax laws change
continually. Therefore, it is important that you consult us at
such time that you decide to consider a sale of the corporation.
BUY-SELL
AGREEMENTS
A specialized form of a "sale" of the corporation occurs
when the shareholders decide that, upon the death, disability,
or retirement of one of the shareholders, the remaining shareholders
do not want to end up in business with anyone other than themselves.
Conflicts can be avoided by using a buy-sell agreement. A properly
drafted buy-sell agreement protects the remaining shareholders
from ending up in business with others and ensures a fair price
and reasonable liquidity to the heirs of the departed shareholder.
Such an agreement can be appropriate whether the shareholders
are family members or strangers. We can assist you in preparing
a buy-sell agreements to meet these objectives.
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