How Tax Reform Could Incentivize the Creation of Pass-Through Entities

San Diego corporate attorneys provide assistance in structuring companies using the appropriate type of business entity to secure protection from liability and to reduce tax burdens by the corporation and by shareholders.

Tax reform proposals put forth by the U.S. House of Representatives and by the U.S. Senate both propose modifications to the corporate tax rate which might necessitate a change to your business structure. Gehres Law Group can provide assistance in understanding the implication of tax reform on the decisions your company must make about whether to operate as a C-corporation, an S-corporation, or another type of business entity. 

How Tax Reform Could Incentivize the Creation of Pass-Through Entities

When a company is organized as a C-corporation, the company pays taxes on profits. Shareholders also pay taxes when profits are distributed, which means some corporate income is double-taxed.  Pass through entities work differently. When a pass through entity like an S-corporation is formed, the S-corp does not pay taxes on income the company earns. Instead, profits and losses “pass through” to owners and shareholders declare profits and losses on personal tax returns.  S-corp income is thus taxed at the tax rate of the shareholder who declares that income on his tax return.

As part of initial tax reform proposals, President Trump indicated he wanted to lower the corporate tax rate applicable to C-corporations. However, the president also wanted pass-through income from S-corps and other pass through entities to be taxed at the lower rate as well.

President Trump indicated he wanted to lower the corporate tax rate to 15%, including for S-corporations. Because many S-corp owners have a significantly higher personal tax rate than 15%, this would amount to a substantial tax cut for any shareholders with a higher tax rate. This proposal from President Trump was viewed as a loose framework for House and Senate republicans to put forth their own tax reform plans, but each plan was expected to include changes to how pass-through income is taxed along, with other modifications to the corporate tax code.

Bloomberg reported, before the tax reform proposals were formally released, that proposals to modify the pass-through rate would create a “pass-through boondoggle,” by changing the current system and introducing added complexity through offering a different lower-tax rate for pass-through owners. A strong incentive would be created for anyone with a tax rate above the new lower rate to form S-corps and earn as much income as possible through these organizations to be taxed at the lower rate. According to Bloomberg, “to keep other people who make lots of money from shifting their income into these vehicles to take advantage of the 25 percent rate, Congress will have to “adopt measures,” whatever those might be.”

The tax reform proposals have been released now, and both do include important changes to how pass-through income is taxed.  According to the Washington Post, the House plan contains a complicated rule permitting 30% of pass through income to be taxed at the 25% rate that the House proposed for the new corporate tax rate. The remaining percentage of the business income would continue to be taxed at ordinary income tax rates by shareholders.  The Senate plan, on the other hand, allows pass through entities to reduce income by 17.4 percent. However, law, engineering, medicine, and financial service companies with higher incomes would not be permitted to take this deduction.

It remains to be seen which plan is adopted or if either initial proposal for changing pass-through income ultimately makes it into law. However, it is clear that with proposed changes to the tax code that could have such a profound impact on how businesses are taxed, many companies will likely benefit from working with our San Diego corporate attorneys.

How San Diego Corporate Attorneys Can Help

San Diego corporate attorneys at Gehres Law Group can provide invaluable assistance with determining how best to structure your business to reduce your tax obligations within the current legal framework. To find out more about how our firm can help you, give us a call today.

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How Does the Business Judgment Rule Protect Corporate Executives?

Corporate attorneys at Gehres Law Group, P.C. provide representation to companies and executives when these parties are at risk of being sued.  Executives have some protection from personal liability for decisions made in the course of doing business, and should consult with an experienced attorney to understand when and how the business judgement rule can provide protection. 

How Does the Business Judgement Rule Protect Corporate Executives?

In California, there are two parts to the business judgement rule. The first part of this rule provides protection for corporate directors so they are not held personally liable for business decisions if they comply with the standards found within the relevant statutes. For nonprofits, the standards are found in California’s Corporation Code section 7231 and for for-profit corporations, the standards are established in California’s Corporations Code section 309.

There is also a common law aspect of California’s business judgement rule which protects against court intervention in management decisions made by directors acting with a good faith belief regarding the best interests of the corporation. Click here for more information on the common law aspect of this rule.

In order for a director to be protected from liability by the statutory protections in the Corporation Code, the requirements that must be fulfilled include:

• The director acted in good faith.
• The director acted in what he or she believes to be the corporation’s best interests and the best interests of the company’s shareholders.
• The director acted with such care that an ordinarily prudent person in the same position would exercise. This can include making reasonable inquiries. Directors are allowed to rely on information, statements and opinions provided by other reliable and competent officers or corporate employees; information from independent accountants or counsel; and board committees that the director has confidence in.  If the director relies upon information from committees, the director must act in good faith and must make reasonable inquiries if necessary.
• The director must not have any knowledge about the information or individuals upon which the director relies that would cause the reliance to be unwarranted. 

Provided that a director has complied with these specific requirements in making decisions, the director cannot be held accountable for the consequences of decisions that he or she made in accordance with these provisions when acting within the scope of his or her official duties.

The second part of the business judgment rule also insulates a board of directors and corporate executives from court interference in business decisions. The common law business judgement rule requires that courts defer to the judgements made by corporate directors as long as there is no conflict of interest, breach of trust, or fraud. Provided the decision by executives or board members was made in good faith, courts will not typically substitute their own judgement for the judgement of those individuals in charge of business operations. 

Getting Help from Corporate Attorneys

Corporate executives who are facing legal action because of their role in decision-making for their organization should consult with the corporate attorneys at Gehres Law Group, P.C. Our experienced legal team provides representation in mediation, informal disputes, arbitration, and court proceedings, and can help business executives take advantage of the protections that the business judgement rule provides to them. Call or contact us online today for your complimentary consultation.

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California Businesses are Banned from Asking Applicants Their Prior Salary

Business lawyers at Gehres Law Group provide assistance to California organizations in complying with labor and employment regulations, including new laws that are passed in California. Keeping abreast of legal changes is important as new regulations are passed frequently that employers are expected to comply with. For example, AB 168 was signed into law by Governor Jerry Brown on October 12, 2017 imposing a ban on California employers inquiring about salary history from job applicants. 

California Employers May No Longer Ask Applicants About Their Salary Histories

California law currently prohibits discrimination in pay on the basis of a worker’s gender. The Fair Pay Act and other equal rights legislation exists in an attempt to close the continuing wage disparity between men and women. However, while the California Fair Pay Act prohibits prior salary from being used to justify a pay differential between a male and female employee doing substantially similar work, the Fair Pay Act does not prohibit an employer from asking about salary history when hiring or promoting workers.

The state legislature has now recognized that inquiries into salary history often perpetuates this wage gap which results in female workers being paid significantly less, on average, than male workers. Numerous locations throughout the United States, including in Oregon, New York, Delaware, Massachusetts, and Puerto Rico, already prohibit employers from making inquiries into salary history. Some California cities, including San Francisco, also have existing rules that prevent employers from asking about wage history.  Now, with the signing of AB 168, a new provision — Section 432.3 — is being added to California’s Labor Code to prevent employers statewide from seeking salary history information.

Employers are not only prohibited from asking applicant’s about their past salary but they are also prohibited from finding out about a candidate’s salary history through an agent. However, there is an exception if salary history is publicly disclosable as a result of the Freedom of Information Act or as a result of the Public Records Act in California.

Employees and candidates are not prohibited by law from voluntarily making the choice to share salary history with a current or potential employer; however, if applicants choose to share this information on their pay, employers may not use the employee’s past salary to justify paying the worker any less than a worker of the opposite gender would be paid for doing the same work. Employers also cannot prompt employees to provide this salary history information and, according to the new law, employers must be willing to provide staff members with information about the company’s pay scale upon request.

Business Lawyers Can Help Companies Comply with Rules and Regulations

The new rule is one of many modifications to California’s labor and employment laws that have occurred in recent years. The trusted and knowledgeable attorneys at Gehres Law Group represent companies who want to ensure they are not inadvertently violating any anti-discrimination rules, wage and hour rules, or other labor laws.  To find out more about how business lawyers at our firm can provide assistance to your company in complying with California’s complex framework of labor laws, give us a call at 858-964-2314 or contact us online today.

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California Law Entitles Shareholders to Annual Reports: What Your Business Needs to Know

Business lawyers at Gehres Law Group, P.C. can provide assistance to business organizations in understanding and complying with their obligations under state law. One such obligation for companies with shareholders is a requirement to produce an annual report. Your organization needs to understand when an annual report must be made and the requirements associated with the report. . 

What Your Business Needs to Know About Annual Reports to Shareholders

According to California Corporations Code section 1501(a), the board of directors of a corporation is required to send an annual report to shareholders no later than 120 days after the fiscal year closes. This requirement is in place except when a corporation has less than 100 shareholders of record and the requirement is expressly waived in the corporate bylaws.

Unless otherwise specified in the articles of incorporation or the corporate bylaws, the report can be sent by electronic transmission. The report must contain a balance sheet at the close of the fiscal year. The report also must contain an income statement for the fiscal year and a statement of annual cash flows for the fiscal year.  The report either must be accompanied by a report created by independent accountants or must contain a certificate from an authorized corporate officer indicating that the financial statements were prepared without an audit from the corporate books and corporate records.

The report must also provide notice of certain specific transactions, such as when advances or indemnification of more than $10,000 was paid during the fiscal year to directors or officers of the corporation.

California courts have broadly interpreted section 1501(a) because an annual shareholder report is vital to investors being able to understand the operations of business entities in which they are invested. As a result, court opinions have held that even former shareholders may be entitled to receive an annual report from the organization under certain circumstances.

If a report is not sent in a timely manner, shareholders can make a request for the report. California Corporation Code section 1601 establishes the rule that there is no requirement for shareholders to specify a separate reasonable purpose for obtaining the reports to which they are entitled under section 1501(a). Instead, they are entitled to such reporting as a matter of law.  California law also imposes a statutory fine if a corporation neglects to send, fails to send, or refuses to send an annual report.

If the corporation produces a false, misleading, or an improperly prepared report, the corporation is in breach of its fiduciary duty and can be held legally liable for losses. Shareholders may pursue a damage claim to recover compensation for losses caused by the corporation’s misconduct in connection with the annual report, including in situations where negligence was the cause of the losses.  See Small v. Fritz Companies, Inc.

Getting Help From Business Lawyers

If your organization requires assistance in understanding your obligations or complying with the laws regarding annual reports to shareholders, give us a call today. If you are a shareholder who has not been furnished with a required annual report, you can also reach out to our legal team for assistance. Just give us a call at 858-964-2314 or contact us online to find out how our business lawyers can help you.

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