Documents for Your Business – David Vines, Heidi E. Royal Law PLLC

David Vines – Documents For Your Business | Charting Opportunities

John Sanders: [00:00:00] Appreciate everyone coming out guys, all guys today. No, no. girls. So, um, two had to be, yeah, yeah. Um, so bring your watch website for Brett. So anyway, super excited about today. Uh, another, uh, event, episode charting opportunities, right? We’re talking to business owners. Covering different topics. Uh, great topic with a great guy today.

I’ve known David for 15 years. Uh, David hails from Louisiana. Uh, he is a CPA, practicing estate planning and business attorney. Uh, super smart guy. And, uh, he’s gonna go over business documents, uh, what you need, what type of business that you’re running, what makes sense. Are you doing everything right?

Everything included in your documents that you need to include. Um, when it’s time to sell, uh, a buyer’s gonna look at the documents and they’re gonna say, Hey, you got everything set up the way that it’s supposed to be, [00:01:00] or your documents including everything. Are you doing things the right way for your business structure?

Um, if you’re not, then it’s kind of a red flag, right? So, David’s gonna walk through some slides. Uh, feel free to ask questions throughout the presentation, uh, afterwards. We’ll, uh, we’ll open it up to, to more questions at the end. So wherever, wherever you’d like to ask a question, please jump in and, and do so.

Um, and I’ll turn it over to, to David.

David Vines: Thank you very much. Thank you. Thanks to, to those of you who already know me. Thank you for coming out. Anyway. I appreciate that. Uh, for everybody else, I look forward to, uh, to meeting you and speaking a little bit with you. Uh, when John and William first asked me to speak, uh, at one of their, of their, uh, uh, events, I was thinking, wow, we could do something really exciting, some really exciting topics because I love doing estate planning for closely held business owners.

And so I agreed to do it. And then they said, well, we’ve already done estate planning for closely of business owners, so we need you to talk about something else. [00:02:00] So I’m not sure this is going to be the most exciting topic. It’s not for me, but, uh, we will, we will try to make it as interesting as we can as we get along.

The other thing, John mentioned, I’m A-A-C-P-A as well as an attorney. I do practice law, um, and. One of the morals of this story is that a lot of people don’t like to go and see their lawyers. Uh, when things are going well, you don’t really need to see your lawyer. It’s only when something goes wrong that people think about, well now I need a lawyer.

And if you’ve been injured, uh, in some way in business or otherwise, you need to go see your lawyer. And it adds insult to injury that you have to pay some damn lawyer to help you get straightened out with what else is going on. Um, and so I appreciate that. Um, but. One of the morals of today, if you take anything away from it, is that you need to go visit your lawyer and you need to get these things straight while things are good.

Don’t wait until something goes wrong and then try to get [00:03:00] all of the documents in place because by then it may be too late because a lot of what I do is estate planning. I like to think of it as the fact that dead people don’t write wills. Living people, right? Wills. If you try to wait until you actually need the will to be active, it’s too late.

So you need to do it while you still can. Um, in terms of how people feel about lawyers, I had a client tell me this story once she said that she and her daughter were walking on a trail down at the Ann Springs Close Greenway. And while they were walking in this remote section of the woods, a frog jumped out of the woods up onto a rock next to it.

And the frog said to my client, Hey lady, there’s a witch in these woods that’s turned me into a frog. Can you please kiss me? So I’ll turn back into a human. And my client was quite freaked out by that, obviously. And so she said, what are you talking about? Just slow down and tell me that again because this is a little bit weird.

[00:04:00] And he said, look, lady, I’m a lawyer. I came out here, there’s a witch in the woods. She turned me into a frog, so please kiss me so I can turn back into a human. So my client said she picked up the frog and put it in her purse and kept walking. And her daughter said, mom, what are you doing? Aren’t you gonna kissing to turn him back into a human?

And she said, honey, everybody knows a talking frog is worth a lot more than another damn lawyer, Charlotte. And so I don’t know whether that story is true or not. Um, it could be, it could be true, but, uh, hopefully you guys, even if you don’t wanna go see your lawyer, you can go see John and William because those guys know all of this stuff.

And one of the roles they play for, for their clients is to help make sure they’ve got things in order. Um, and so this is, this is part of it. One of your questions probably is at the beginning, who actually cares about the [00:05:00] documentation as long as things are going well? Uh, if you’re, like a lot of my clients, you kind of get your business set up and then you go off and you start making money and you’re running your business, and who really cares about the paperwork, the legal stuff that you gotta do?

And. This is, this is just a list, uh, that I came up with off the top of my head. The top part there is the, is the truth. Anyone who’s evaluating your business for whatever reason, may want to see that you’ve got your ducks in room and they’re going to use that analysis to judge you. They’re going to use that analysis of how orderly your books are to determine are you the kind of person who keeps all of your stuff in your.

It. And the first one on that list, as John mentioned, is if you’re looking to sell your business, if you’re looking to sell the whole business or just a part of it, one of the first things they’re going to do is send you a due diligence list where they wanna see all of your [00:06:00] corporate documents and your financial statements and other things, and that’s going to be their first entree sometimes as to what kind of business is it that they’re looking to invest in.

Is it all? Are all the I’s Dotted and t’s crossed? Or is it kind of loosey goosey? Um, because if it’s loosey goosey, they may think, well, what else is loosey goosey? You know, are the financial statements loosey goosey? Uh, are there business arrangements out there that they’re not going to learn about until it’s too late for them to back out of the deal?

Uh, so having your corporate information in order while you still can, before those people come and ask to look at, it’s important. I’ve, I’ve included employees on this list because the way that you treat your business may also trickle down to them. If you want them to be careful and dot the i’s and cross the T’s.

If they see that you don’t really give a damn about that, then they may not give a damn about it either. And so if they see that [00:07:00] you do run a tight ship, that’s going to be the leading by example to make them do it as well when they’re doing, when they’re handling your business. Affairs. The other people are courts in the IRS, and this is really where my world comes into play.

Um, most of what I do is estate planning and I consider asset protection planning to be part of, of estate planning. Um, in a, in a nutshell, what wealthy people are trying to do when they’re doing estate planning, at least partially, is move wealth from their generation. Generation one, down to generation two and or generation three, and they want to do the planning in a way so that as much as possible makes it down to their heirs that where they want it to go.

One of the ways we do that is for people who are looking at paying a big estate tax is we like to put wealth [00:08:00] into business entities of one type or another, and we’ll talk about that a little bit when we talk about the structures. But one of the reasons we do it is because when they’re transferring wealth down to the next generation, they’d like to keep control.

They don’t want their kids to actually be running the business. They’d like to transfer the value, but they want to keep control of themselves so we can create a non-voting class of interests to transfer to the kids or to trust for the kids so that they can maintain control as long as possible, but still shift a bunch of wealth downstream.

The other thing that does. When we’re looking at valuing the assets that have been transferred, when you transfer non-voting interest in the business, you can take what we call a valuation discount off of the assets. So if you’re transferring a 60% interest in the business in terms of the underlying assets, you might value it for transfer tax purposes.

The state and gift tax purposes, like it’s only 40% that you’ve transferred, and so that extra 20% [00:09:00] kind of makes its way downstream tax free.

Understandably, the IRS hates that the courts have upheld that those valuation discounts are real, if it’s done correctly. And so what the IRS tries to do when they see a situation where somebody has taken advantage of these valuation discounts is they try to poke holes in the business entity and they’re trying to find a way that they can make a claim that you guys aren’t really.

Treating the business like it’s a true separate business. You’re really just treating it as your other pocket. It’s like an alter ego of yourself. And so if you’re not treating it like it’s really a separate business entity, they’re not going to either. They’re not gonna let you have those valuations.

Same thing with creditors. Creditors are going to look for ways that you guys aren’t following corporate formalities. And they’re going to say, if you weren’t treating this like it’s a legitimate [00:10:00] other entity, then they don’t have to either. And they can pierce the corporate veil, so to speak, which, which we’ll talk about a little bit here and go after your other assets.

And so those are the kind of constituents that I think about as to who cares. And from my perspective, I tend to think of it as creditor protection. You need to have all your ducks in the road to protect your assets from creditors and from the IRS depending on what else you’ve got going. So what are we talking about?

Uh, the, the different types of documentation that different businesses need are very dependent on the type of entity. And types of entities that are available to you to set up your business will depend on where your business is, what state you’re in, what country you’re in, even. Um, and, you know, I’ve worked some with, uh, GBHs out of Germany, which is their version of a limited liability company.

It stands for [00:11:00] company with whatever the German words are for company with limited liability. Uh, I’ve worked with, uh. Star Trusts and Cayman Islands. Again, I don’t, I don’t know enough about those to really try to teach you guys about them. They all exist. Uh, you may say, well, why aren’t you talking about Massachusetts Business Trusts or Illinois Land Trusts?

There’s all kinds of different business entities depending on where you are. They’re just not part of my practice. These are the kinds of entities that you normally are going to see in North Carolina. These are North Carolina approved types of entities. Um, and I’ve, I’ve kind of ranked them from the ones that require the most paperwork, the most formalities at the bottom to those that are the least.

If you guys are running a business and it’s just in your individual name, that’s a sole proprietorship. There’s really nothing you have to do to form that entity. It’s just you, you know, you report your income from that business on the Schedule C, on your personal [00:12:00] income tax return. There’s not a separate business.

If you have a creditor related to that business, that’s your creditor. They’re coming after you. None of the rest of this discussion really applies. There’s no paperwork to do that. General partnerships are kind of the default in North Carolina in most states. If you are co-owners of a business for Profit anywhere and you don’t have some other entity structure, you’re kind of by default, you’re a general partnership.

A lot of people do that. They don’t realize they’ve got a general partnership. They just think we’re kind of running this business together. Well, that makes you business partners. And if you’re not something else, you’re a general partnership. And we’ll talk about why that matters later. The other entities, you have to file something with the Secretary of State in order to create it in the first place.

Uh, I don’t know if you guys, how many people remember the sitcom soap from the seven? Okay, couple people. For those watching at [00:13:00] home, a couple of people raise their hand. There was a, there was a character on soap who was the, like a crazy dad who thought he could make himself invisible. He would just snap his fingers and say, I’m invisible, and he thought no one could see him.

I’ve had clients in the past who thought they could just say, I’m an LLC, and they had an LLC and they had limited liability. That’s not the way it works. You don’t have one of those other entities until you file the correct paperwork with the Secretary of State and it’s created and they acknowledge that it exists in that form.

All right, so let’s talk about

the key distinction from, from my perspective there. There are management differences and there’s paperwork differences, but the big difference in the different choices of entity is really liability for the owners. Alright. If you’re a sole proprietorship or if you’re a general partner in a general partnership, you’re effectively 100% liable for all of the, of the debts [00:14:00] of the business.

Okay? If William and John and I form a general partnership and John goes out and runs over a a, a herd of Carolina Panthers, no, that’s not dangerous enough. He runs over Taylor Swift. Um. That liability if he’s on an errand for the business, when he does that, William and I are gonna be fully liable for that debt to the Taylor’s estate because John was negligent driving our car on a, on a business trip.

So be careful. Um, if we’re a corporation and John goes out and he, he runs over Taylor Swift, John’s still gonna be liable ’cause he’s a crappy driver. But William and I are not going to be liable for that unless we somehow were negligent letting John Drive because we knew he was a bad five. Then we might also somehow be personally liable, but just because we’re shareholders of the corporation, [00:15:00] those Taylor’s estate’s not gonna be able to come after our separate assets.

Okay. Same thing with a limited liability company. Same thing with if we have a limited partnership and the three of us are limited partners. Then none of us are necessarily going to be liable for that liability, but with a limited partnership, there always has to be at least one general partner. That general partner is going to be liable for that debt.

Even if the general partner was William John goes out on an errand and runs over Taylor Swift. William is liable for that debt. Probably again, if, if. If anyone watching from home is a, uh, a litigation lawyer, this is all high level. Don’t call me, put any comments. Alright. Um, I’m not really gonna talk too much about limited liability.

Uh, registered limited liability partnerships or registered limited liability limited partnerships. [00:16:00] What, what happened Back in the old days, there were just corporations at one end of the spectrum. There were partnerships at the other end, and someone came up with the idea of limited liability. Companies that are kind of in the middle.

They give you all, all the owners get limited liability protection, but you can run it kind of loosey goosey like a partnership. And so it’s kind of the best of both worlds. And my impression is a lot of people who had limited partnerships or general partnerships said, well, that’s kind of unfair to us.

That you’re letting these limited, these owners of this limited liability company run their companies and have limited liability anyway. We ought to have limited liability. So they came up with these other entities, which are basically a general partnership that registers with the Secretary of State, so the general partners have some degree of limited liability.

If, if we were a registered limited liability partnership, John runs over somebody, William and I wouldn’t be liable for John’s debt. But all three of us would be liable for the [00:17:00] general debts of the partnership. Same concept with a limited liability, limited partnership where there’s a general partner who could be shielded from liability to some extent in the real world.

I have never encountered either of those types of entities in the wild. I’ve never formed one, never run across one. I don’t know any. Have any of you guys run across? So. My impression is that they were created for specific people who felt like they had a, they had somebody who was a general partner who didn’t like the idea that they were liable, so they made this up.

But for my money, if you’re looking for that kind of structure, just do an LLC because you can do everything you can do with those other entities through an LLC and have better liability protection. So I think in pictures and. This is, this is kind of the, the what we’re, what we’re talking about. If you’ve [00:18:00] got a, a business creditor who’s doing business with the company, the business, whatever form it’s in, what you would like to have, if you want liability and protection for the owner to protect the owner’s other assets, you’d like to have it so that the only assets the creditor can get access to are the business assets.

Okay. If you have a general partnership or there’s a general partner who is an owner of the business, you’ve got this separate liability where the creditor can go after the general partners of their assets. Depending on what the liability is, the risk is because a general partnership is the default business entity.

If you have one of the other types of entities, but you screw it up for some reason, if you think you’ve got limited liability. But you do something wrong so that your entity fails because you haven’t done the right paperwork. You by default become a general [00:19:00] partnership, your state law. And so that gives an excuse to creditors to come through and pierce through to go back.

If you thought you had, if you thought you had limited liability, but it fails, now you’ve got full liability. And I showed John earlier, I can. Toggle that. So it’s a flash red light. That’s what we’re trying to, so you’re welcome. That’s free gimmicky technology. Alright, is it, so there are I, I did say anybody could ask questions.

Any questions on just that concept so far? We’re about to dive into specific entities, so I’m sorry that the beer’s all the way across the street, but hopefully everybody needs one’s. Got one. Alright, so just real, real quick, the different types of entities. Uh, partnerships, the owners are called partners.

All of the general partners manage it, that that’s the case. If it’s a general partnership or if it’s a limited partnership, uh, you have flexibility [00:20:00] to allocate income. That’s one of the reasons people a lot of times, like partnerships, you can enter into whatever kind of agreement you want to about how the income’s gonna be split up when you’ve got a corporation.

It’s you, you’re limited by the share, the how you’ve defined share classes as to how the economics are going to work. And so a partnership is a lot more flexible than the corporation. And the big reason a lot of people like it, you get flow through taxation. The partnership itself doesn’t pay income tax.

All of the partners separately pay their, uh, the, the tax on the, their share of the income flows through on a K one partnership doesn’t pay, it’s on taxes. Now some of you guys may be aware that when they passed the salt, the state and local tax limitation, uh, in Congress back in 2017 and limited how much individuals could deduct for state and local income taxes.

North Carolina did come up with some sort of special version [00:21:00] of pass through taxation where they said you can have your flow through entity pay taxes. At the entity level so that you can get the full deduction for all of your state and local taxes and then flow through the rest. Um, I played around with that with one client.

I’ve not actually done that. Uh, I don’t know if any of you guys have toyed with that. Uh, how, how many, how many people in the audience have flowed through entities as opposed to like a C corporation for your business? So, alright. So it’s a mix. Alright, so I don’t know if anybody played that game with the, uh, special purpose entities buts, uh, the, the key documents you form the, the limited partnership by filing a certificate, limited partnership with the Secretary of State.

Um, but most of the meat of how the partnership is gonna work is in a partnership agreement. Okay. So when we talk about minding the paperwork, the partnership agreement is. Is where the action is, uh, that has all the terms about how the entity’s gonna be [00:22:00] managed, how you’re gonna split up income and cash flow, whether or not there are restrictions on transferring interests, uh, what kinds of provisions, what kind of things might trigger the right of one partner to buy out the other.

If John and William and I have a partnership. And John, for whatever reason, because he ran over Taylor Swift, his wife decides she wants to divorce him, and as part of the divorce, she’s making a claim to his share of the partnership interest. William and I didn’t really ever wanna be partners with his wife.

I mean, she’s very nice, but William and I would rather have the right to buy that interest out rather than have to deal with. Uh, with Ruthie as our partner in the partnership. So there, there can be all kinds of triggers to what would give somebody the right to buy out the other partners or buy out just one of the other partners.

But that’s all embodied in the limited partnership agreement, uh, succession. What happens. Sure. So if you buy his car, [00:23:00] are you buying that problem as well? That is our problem that. It. Well, in my hypothetical about running over Taylor Swift. Yes. I mean, he’s still dealing with that, his work with that. When you buy that part, you find the issue as well.

That’s, that’s, that’s his problem. If it’s, if it’s a general partnership and he becomes bankrupt or something like that, there’s probably a pro. We would like to have a provision in there that says, that gives us the right to buy him out rather than have a bankrupt department. It might say that his interest converts from being a general partner to being a limited partner, so he no longer has any control over the assets.

There could be a lot of different ways to deal with that, but normally speaking, once we buy him out, we’re done with the Taylor Swift business. That’s, that’s, that was his problem to begin with. I mean, if it’s the assets of the business, if he was on this, this is getting a little bit deep on, on, on debtor creditor issues, so thank you.

Um. [00:24:00] If, uh, if he was on a, an errand for the business, it may be that our entire business is about to go away. You know, if that was a business debt, Taylor Swift’s estate, it’s probably gonna come and take the entire business. And so none of this is going to matter, but they can’t come after William and my personal assets.

So if we buy John’s interest out to keep Ruthie from being our partner, that’s not going to save the business from Taylor Swift Estate. But it’s also not gonna cause William and me to become liable because of our status as owners. John’s liability for that was because John was the guy who drove the car.

So does that, if that makes any sense. All right. Um, the other thing I want to mention with respect to partnership agreements. If, depending on how old y’all’s partnership agreements are, there’s probably a provision in there, and this is true with operating agreements as well. When we talk about LLCs, there [00:25:00] used to be a concept of something called a tax matters partner, and that’s because the IRS wants to only deal with one person at the entity instead of having to deal separately with all the partners and then having to fight with each partner separately.

So there was a, a provision in the tax code that allowed you to designate someone to be the Tax matters partner who could deal with the IRS. That concept was repealed. That’s no longer in the Internal Revenue code. Now they’ve replaced it with something called a partnership representative. And that partnership representative has a lot more authority under the code to bind all of the partners in making their deals with the IRS about something.

And so if you’ve got one of those older agreements that talks about a tax matters partner, you probably ought to revisit that and update it so that you can spell out who is your partnership representative and what, what are their powers, what is their authority to bind the partnership and what are the other partner’s obligations to work with them to get, get that done.

We should then switch. So if my [00:26:00] partnership agreement is before or when, then do have need to update it. Uh, that’s a very nice question. Approximately, I would say. I would say maybe five or 10 years. Um, but if you, it’s very easy to spot because a lot of partnership agreements and operating agreements have a, an article or a clause that says Tax Matters partner.

If it says that instead of partnership representatives. If You’all to update that Doug, as the state attorney do all the time. So you update their state documents every three to five years, or least review their state documents every three to five years. Um, as you talk about partnership, grievance and operating with grievance, how will, should those documents being reviewed?

I would, I would do it same. Oh, sure. The, the, the question for those playing at home. Is how often if, if you have to review your estate planning documents every three to five years, which you don’t actually have to do, but we certainly recommend that [00:27:00] you ought to do the same thing with partnership agreements, operating agreements, just to make sure nothing has changed, uh, to to see if there are any provisions that no longer make sense.

One of the other things that, uh, we’ll we’ll talk about, but. It’s good to do that, partially because you wanna make sure your ownership schedule is correct, and part of what a partnership agreement does in an operating agreement, it will generally list here are the people who are the members or the partners of the entity, and here’s how much their share is.

A lot of people don’t go back and update that when there’s an ownership change, and so that’s another reason to periodically check it, just to make sure. Does that does what you’re. Agreement among the owners say, does that match what you’re reporting on the tax returns? Does that match how you’re actually operating?

Because that’s where you get into problems is when what the paper says you’re doing is not what you’re doing in reality, that’s a red flag. [00:28:00] That’s what the IRS will latch onto. That’s what creditors will latch onto, is if you’re not doing things the way your great paper says that you’re doing things. So there’s no, there’s no magic timeframe.

Um. After you listen to some jerk lawyer talking about it is a perfect time to do it

or a great lawyer. So, uh, so corporations, again, uh, they can be very complicated. They can be as complicated as you want ’em to be. Um, most of the, the, the big picture terms about. What kind of classes of stock are authorized? That kind of stuff is in the articles of incorporation. So if you’re curious about somebody’s corporation and you wanna see what does their capital structure look like, you can go on the Secretary of State’s website and look at their articles of incorporation to kind of see they got voting stock, they have non-voting stock, they have 20 different classes of stock.

Um, it’s managed. [00:29:00] Generally speaking, this is one of the reasons corporations are a little bit more complicated than others, shareholders. Their only responsibility for managing the corporation is to elect directors. The board of directors actually manages the company, and the board of directors can either do that directly or usually they hire officers.

And so this is where, because there’s this process where the shareholders elect directors and directors elect the officers, one of the things that’s very important to do is actually jump through the hoops to do that every year. Um, and we’ll, we’ll talk on the last page about one of the things you need is record keeping that shows your minutes of your meetings.

If you have a corporation and you go look at the bylaws, I would bet you money. It says the shareholders are going to meet on the first Tuesday of June every year. And when you first set up your corporation, you probably paid no attention to that provision and you’ve probably never had a meeting on the second.[00:30:00]

First Tuesday of June and any year, and in fact, you may never have had shareholder meetings, you may never have had director’s meetings, but you need to have, because your bylaws say you’re supposed to have, and so I would encourage you in the, in the context of reviewing your corporate documents, if you don’t see those in your, in your corporate kit, you need to find them.

And it may be that John and William can help you find them. It can be something very simple that says. You know, the below shareholders as of the effective date of whatever date it was. Elect the following people as directors of the company for the upcoming year, and we approve of all the things the directors did, signed off by all the shareholders.

It might be that that document looks exactly the same every year after year after year, but it’d be nice if that were in new corporate records to show that. Um, LLCs and partnerships, one of the reasons I like them is it’s not quite that formal. You [00:31:00] can build into the operating agreement of an LLC that you want to have meetings periodically, that there’ll be meetings of the board of managers or something like that, but you don’t have to.

And I discourage clients from doing that because in my experience, the more things you say I’m going to do, it’s the more places you can screw it up by not doing it. And so the less you have to do, the less likely you have to screw it up and get predators. Some sort of something they can hang their hat.

Um, taxation, C corp, S corp, uh, C corp is basically the default. It results in double taxation, which you guys have probably all heard. The corporation is not only is it a separate person for state law purposes, it’s a separate tax taxpayer for income tax bills. And so whatever the corporation’s income is, it pays that tax.

Then when it makes a distribution to the shareholders, they pay income tax on the dividends they receive, just depending on the [00:32:00] circumstances. And so there’s two layers of tax, which is one reason a lot of people don’t set up CQL operations anymore. You have to have some real specific reason that you’re trying to do a corp.

It may be that you’re planning to sell your business to some. Multinational company and they’re going to want you to be a C Corp. Um, but in my 30 year career, I don’t think I have ever set up a corporation that I intended to be a C Corp. Going forward, I’ve set up a number of S corporations. An S corporation is basically just like a, for state law purposes, it’s just like any other corporation, but it makes a special election to be taxed as a small business corporation, uh, under subchapter s of code, and it gets.

Flow through taxation almost as good, almost as pure flow through as you get with a partnership. There are some more restrictions. I don’t usually recommend putting real estate in there. Question, is there any point that you can no longer be at escort at some, uh, net or [00:33:00] that revenue level that you have?

Uh, not based, not based on revenue. The, the question is, is there a, is there a point where you’re too big? Basically, is there a point where you’re too big to be an scorp? Yeah, not usually based on revenues, but based on the number of shareholders. You can only have a certain number of shareholders, and the bigger problem with scorp, they, all of the shareholders have to be eligible shareholders, so there are some types of people you might want to transfer your shares to who are ineligible Shareholders, like most trusts and partnerships can’t be an SCORP shareholder, so it’s very easy to accidentally screw up your S election.

By transferring your, your stock to somebody who is not an eligible shareholder or a a, a non-US person is an ineligible shareholder. The the whole idea is the government feels like they’re gonna pick up their income tax from the shareholders. If you’ve got somebody where that’s not necessarily the case, they make you an an eligible share.[00:34:00]

But the, the type of revenue, there’s no, there’s no maximum for that. Is is that tipping point the number of shareholders? I I think they raised it to a hundred a few years ago. It was 75 wrong and I now it’s a hundred. So it’s a lot. Yeah. Um, but again, if you’re, if you’re looking for flow through taxation, in my mind the LLC is the, is so flexible.

If there’s almost nothing you can’t do with an LLC, well let’s talk about it. We talked about meetings. How am I looking on time? Good, good. Um, so one of the things that’s important with the corporation, you know, we talked about a partnership agreement, and it’s gonna be the same with LLCs with an operating agreement.

It’s kinda like a partnership agreement with a corporation. You normally have bylaws that really only cover the internal governance of the organization. Are you gonna issue, what are you gonna look like in terms [00:35:00] of stock certificates, when a meeting’s going to be, how do you handle voting? Uh, those kinds of administrative things are what usually is in bylaws.

Anything that’s more, um, dealing with how the owners relate to each other. You know, when is it okay to transfer your stock to somebody else? You know, what are the buy sell types of provisions? Those are usually handled in a separate agreement called the shareholders agreement. Those are not usually accompanied in the bylaws.

So if you’ve got a company and you think you’ve got all of your bases covered, but you don’t have a separate shareholders agreement, you probably don’t have all the documents you need to have. And that’s especially true if you’ve got an S corporation because you can accidentally ruin your S election and become a C corporation with double taxation.

Uh, you, like, you, you should have a shareholder’s agreement that prohibits all of the shareholders from transferring their shares to an ineligible shareholder so that you can [00:36:00] prevent people from screwing up your SLH. I have seen situations where certain shareholders, where there was no prohibition on them transferring their shares to whomever they want to transfer them to.

Using that as leverage to negotiate with the other shareholders by saying either you do what I want you to do, or I’m gonna transfer my shares to this trust over here. That’s ineligible to be an S scared shareholder and it’s gonna screw up the S selection for everybody. So you don’t want somebody to be able to hold you hostage.

That way have a shareholder’s agreement that prohibits them from doing that so that they can’t come back later and, and hold that over your head. Um, annual reports are the other thing that partnerships in North Carolina don’t have to file an annual report with the Secretary of State corporations and LLCs do.

Um, that can be a big problem because if you fail to file your annual [00:37:00] report and you do it long enough. And when the Secretary of State sends you a notice that says, Hey, you haven’t done this yet, and they send you another notice that says, Hey, you still haven’t done this yet, we’re gonna dissolve you. If you still fail to do it, they can administratively dissolve your corporation.

Same thing with an LLC. If they administratively dissolve your entity, you’re no longer authorized to transact business in the name of the company. Uh, you may, if you’re, especially if you’re an LLC, you may effectively, for state law purposes, become a general partnership, which means all the members are suddenly subject to all the liability of the entity.

Because people failed to file that annual report. And so that’s something I normally recommend that people have their CPAs every year when they’re filing an income tax return to file the annual report as part of that process, uh, just so that somebody’s doing it. Um, I had a [00:38:00] client who actually had a certificate of authority.

They were an out-of-state corporation, had a certificate of authority to transact business in North Carolina, the registered agent. That the Secretary of State was sending the notifications to had moved his office. And so nobody was getting the notifications that, Hey, you haven’t filed your annual report.

I came along because this is what I do. Uh, like after they’d been dissolved for about five years, they had a significant amount of business in North Carolina. They had done that. Arguably was all illeg legitimate. If any of those people they were doing business with had wanted to renounce any of their contracts, arguably they could have done so.

Arguably those people were exposed to unlimited liability. The shareholders of that company arguably were exposed to unlimited liability. They had no idea. The Department of Revenue also [00:39:00] would love to come back and. They, they were facing a mini multitudes of thousands of dollars fine from the Department of Revenue for transacting business in the state without a license.

Um, they loved the fact that I pointed this out to them and they told me, we’ll handle that. Don’t you worry about it. Uh, they’re no longer my clients, but something as simple as filing the annual reports can be a huge problem. All right. I told you guys, LLCs are kind of the cross between corporations and uh, uh, partnerships.

I probably talk about all of this as we’ve gone, again, articles of organization, big picture, things like indemnification of the members, things like that will be in the articles of InCorp, articles of organization. Everything else is gonna be in an operating agreement, okay? And the operating agreement can be amended from time to time.

The operating agreement is [00:40:00] not public information, so whatever you guys have agreed to in an operating agreement or a partnership agreement that’s not filed with the Secretary of State. So it can say whatever you want it to say. If you want to be supportive of the Communist Party, that can be in the operating agreement.

Nobody has to. Um, alright, let’s talk about, about common documents for all of the companies. Um, we talked a little bit about ownership records. Anytime there’s a change of ownership, uh, I’ve dealt with, I’ve dealt with a, a number of clients recently where they initialed, they issued stock when they first set up their corporation, but then they had all kinds of, have deemed changes of ownership over the years.

Uh, at one point they were a minority owned business, so the wife was treated as the owner. At another time, the husband was, was reporting himself as the owner. They never did anything [00:41:00] in their corporate records to show that they had changed any of the ownership. So we had to go back and decipher when were the stock transfers happening based on public filings.

We could see about who was claiming to be the owner, who was claiming to be the president of the company. Um, that’s something that should not be overlooked. If you’re about to sell your company, that’s one of the things they’re going to want to know, right? Who owns the business that they’re gonna be buying this from?

You don’t want to have to scramble and not know the answer to that question. That’s a huge red flag. Um, same thing with partnership interests and LLC membership interests. It’s just something your CPA. A lot of times I go to the CPA because the CPA has to report all of that every year, and I make sure that the.

Paperwork matches the tax returns. ’cause I trust, generally trust the tax returns more than the paperwork. Financial statements, um, is probably, probably obvious to you [00:42:00] guys. That’s probably the one thing that you guys pay attention to because that’s the thing that tells you how your business is doing.

The one thing I would like to point out about financial statements. Is a lot of times the way it it works with a close business owner is they send their QuickBooks reports or something to their accountant and their accountant goes through that to prepare the tax return. And the thing that I see frequently, uh, that jumps out at me is there’ll be some big line item called do from shareholder or do from partners, or do to partners or do to shareholders.

And so I asked the question, what is that? And a lot of times it turns out the accountant just saw some money going out or coming in and didn’t know what else it was. So they put a line item on the books. They called it a loan. If you’re going to say that you’ve got a loan, you need to have a promissory note to document that loan.

When is it gonna be paid back? Is their interest being. Okay. All of [00:43:00] those things show that you are treating the entity like it’s a legitimate separate entity, and it’s not just your other pocketbook so that you can take money out and put money back in whenever you want to and nobody cares. That’s a huge red flag.

And so promissory notes and financial statements, that’s my big, my soapbox about those. Um, we talked about records of important decisions. Again, I typically set up LLCs. And partnerships where you don’t have to have meetings. But if there’s some big decision that the entity has made, I like to see a resolution that the owners or the managers sign off on so that you at least have a paper trail so that somebody can’t come along later and say, you didn’t do this right.

Uh, or why did you do this? Um, but with a corporation that’s critically important that you have all of those major decisions documented, uh, with minutes as we talked about employment agreements. Okay. Um, you don’t want [00:44:00] to get into a fight with an employee somewhere down the road where they say, you promised me you were going to pay me a certain amount of comp if we hit certain benchmarks or something like that.

It’s always a good idea. Anytime you’ve got more than just a handshake at will employment that you document, what is the deal. Uh, so that you don’t have to get in court and say it’s a, he said, she said kind of situation about what was the arrangement document that, um, same thing with vendor customer agreements.

I don’t know how many of you guys work with, with, uh, customers or vendors where they want to see, you know, they want proof of who’s, who’s authorized to sign on behalf of the company. They did you, did they ask you for a certificate of incumbency or something like that? Um, but if you’ve got agreements with them about what kind of benchmarks are gonna require different types of payments, always good, uh, to have those in writing for the extent possible.

Asset title, uh, and leases to me [00:45:00] kind of go hand in hand. Um, I’m working with a client right now, so I’ve got probably most of my horror stories are actually around asset title. I’ve got a client right now who, uh, he and his brother owned a couple of partnerships, um, and the partnerships owned the real estate that the family business was operating on.

Dad had set all this up years ago when dad died. Some of the property went into these partnerships with the brothers co-owned. They got to the point they were ready to sell the property to the company so that they can go their separate ways. And it turns out when they did their deeds to put the property into the, uh, the partnership, they didn’t put all the parcels on there.

So there were some parcels that still showed up in the tax records as being owned by their dad who had died 20 years. Guy. And when dad died, his will said, I want all of [00:46:00] this, you know, any, anything that I still own in my individual name goes to a trust for my wife. So legally, under North Carolina law, those parcels that never got transferred into the partnership were owned by this trust.

Well, mom had died 10 years ago, and so the trust hadn’t existed for years. And so before they could sell this property. They had to pay some jackass lawyer, thousands and thousands of dollars to straighten out the title. We had to go track down the trustees of that trust that hasn’t existed for years just to get the title straightened out.

Um, they have finally closed that deal. Uh, so, but much pain in many, many fees to jackass lawyers later. Um, for not just my firm but other firms. Um. Another, another former story, and this is one of my favorite ones because Yeah, put time for this. [00:47:00] Uh, they, we’d have to make something, huh? We’d have to do, uh, yeah.

That’s a, that’s a long story, Jill. That’s fortunately, fortunately the succession of trustees included my client and his sister, who was very cooperative, so. She was surprised that we asked her to do this, but she was very cooperative. I don’t know what he had to promise her to get her to sign up. Um, but the, the important thing is the title company bought it.

So, uh, so if anyone’s watching this from a title company on the video replay, this was not your deal. Um, but the, because a lot of what I do is, is. Is oftentimes work is the hired gun to do sophisticated estate planning techniques. A lot of times in my career I’ve worked with local, you know, kind of the local attorney who’s maybe sometimes a general practitioner.

There’ve been a couple of cases [00:48:00] that I worked on where local attorney, local financial advisor hired my firm to come in and do some sophisticated transactional planning that involved gifting or selling. Membership interest in LLCs or family limited partnerships down to some trusts so they could shift to a significant amount of wealth over time in order to save on legal fees for my big ivory tower firm.

They tried to minimize what we did as much as possible, so they let the local attorneys do as much of the work as they could to get it all ready for us to do the transaction. And this is true in both of these matters that I’m about to describe to you. In one case, um, in both of these cases, both of these clients owned a lot of parcels of real estate.

Like some of it was Timberland in one case, and some of it was a bunch of residential real estate. Uh, just a ton of parcels. So they provided us the list of the [00:49:00] parcels, the descriptions we handled, getting valuations done, getting the entity values, setting up the. Setting up all of the transaction, getting it closed out, got appraisals all done.

It was a beautiful, beautiful thing for the, the residential clients filed a gift tax return the next year, reported $20 million worth of of gifts. Um, and then the following year the local advisor called up and said, we got a question about one of these parcels of real estate because. The it’s in the client’s name and we thought it was in the LLC, and so we went back and discovered none of the real estate had ever been transferred to the LLC that we were doing as part of our transaction.

The transaction that we reported to the IRS. Sorry if anyone’s watching from the IRS, this was a long time ago. Don’t bother looking at it. But we reported a big $20 million [00:50:00] transaction and the LLC was actually worth zero because it had no assets. We relied on someone to tell us the real estate has been transferred into the LLC.

Uh, that’s a huge problem. Um, I left that firm that I was at before they resolved it. I think they went back, did it all over again. Paid us again, filed another gift extern and said, ignore that other gift extern, and it was wrong, and then paid double the legal fees to get all of that done because they didn’t have the deeds done correctly.

The other thing with my client who just completed the sale, there was, by the way, one of the, the parcels of real estate they were trying to sell back to the business they had leased to this old dude who was living in a house on this property and the lease that they pulled up. My client found after a lot of searching, he found a lease.

It was like a one page thing somebody had written that was between their dad and this guy from 20 years ago, and with one thing about leases, you guys [00:51:00] need to know, usually they have an end date. If you’ve got a lease, it’s got an end date. And most people think it’s set it and forget it. They don’t realize they may be operating with, there’s no valid lease in place, or at least it’s not valid under the terms that it says it’s valid under.

So we had to go to this old dude and get him again. I think he was very cooperative. Um, the other, the other thing I’ll say about the deeds, the other client where we did a whole big transaction with his family limited partnership. Where they had told us all the assets that were in there and got it all appraised, did a big transaction.

The uh, advisor called up and said, do we need to have a lease on the client’s house? Because it’s in that partnership that he just sold. And for those of you who get involved in estate planning is the huge bugaboo for the IRS. If you’ve put a personal [00:52:00] use asset into this entity that you’re claiming is a business entity.

And you’re still living in it rent free. That is a a a guarantee. The IRS is gonna say, you get no discount on the interests that you just said. You transfer these limited partnership interests. That’s a huge screw up. Creditors will do the same thing if you’ve accidentally put personal use assets in there and you’re continuing to use those assets without paying.

For them, some fair market arm length value. The courts are going to agree. That’s just your alter ego. We’re gonna ignore the existence of that entity. Come after

that was very sly. Um, actually, you know, the rest of that’s kind of lame. Anyway, so I’ll, I’ll open up for questions. Anybody have any questions about that stuff, Gerald? I was gonna ask about the charging orders. Charging orders, so, yeah. How, how that works. What [00:53:00] advantage of that? It, it depends. It depends on what state you’re in.

So Gerald’s question is about charging orders, and this comes back to debtor creditor relations, which is not necessarily my what I’m, what I’m, you know, I’m gonna tell you about charging orders, but take it with a grain salt. The idea is if John’s wife were to take over his interest in the LLC that he and William and I have together.

She wouldn’t necessarily be automatically entitled to become a full blown member of the LLC. It may be, and this is the case under North Carolina. Theoretically, she’s only entitled to a charging mortar, which means she’s only entitled to step into his shoes for the economics. If William and John and I were planning to make a distribution from the LLC, it would instead go to his wife.

Who took over his interest, but she wouldn’t get to sit at the table to make decisions about whether or not to make that distribution. So that’s the theory. I was wondering if that would be [00:54:00] the advantage in Taylor Swift, uh, example, and that she wouldn’t get distributions. Well, theoretically she would get distributions if there would, right.

My, my preferred approach is to buy that interest out so we don’t have to deal with Taylor Swift’s estate ever again. But if we don’t have that kind of buy, sell provision, it might be that we could rely on at least that level of protection. And, and it varies from state to state. You know, different states have different rules about what creditors are entitled to, and there’s some ambiguity if it were a single member, LLC.

Some people have even taken the, the approach that. Uh, with a single member, LLC, the only thing a creditor could get access to would be a charging order. I think that’s, personally, I think that’s kind of bogus. If I’m a hundred percent owner of my LLC and I run over Taylor Swift. I can’t imagine her estate’s not going to take my [00:55:00] 100% membership interest and then change whatever the rules are and basically take over the business.

That makes logical sense to me. Apparently there are some cases around the country where people have taken the opposite tact, which is, even though it’s a single member LLC, the only thing Taylor’s estate is entitled to is a charging order. I can still run my company however I wanna run it. She gets any distributions I make.

That’s, doesn’t make a lot of sense to me, but there is an argument to be had if you were, if you were in a single member LLCI. I’ll hold this chart back up just to, just to say I’ve been focusing on what I think of as cred of, of assets up protection. That’s like the, the liability we’re dealing with is radioactive in the business assets.

You know that there’s a business deal that made it radioactive and so you’re trying to shelter the owner from the liabilities of the business. It actually can work the other way too. And that’s kind of Gerald’s Gerald’s point. If the [00:56:00] liability comes from outside, it may be that the business shields the business assets and the other owners from John’s liability.

It can be a two-way liability sheet. But that’s, that’s where the charging work. Good question. Anybody else can, can you speak to the ELL provisions similar to a safe planning documents that probably have standard language, but it’s in there? Do I need a separate ELL agreement or the provisions that are probably in, uh, operating shareholder agreement, courtship agreement?

Are they sufficient or what’s your gut there? Um. I, I would say you need to review them and make sure they do what you want them to do because there, there’s an infinite variety of buy sell provisions. There can be, uh, you know, it can be very just straightforward that says if you try to transfer your interest and we didn’t approve it, we get to buy you back.

It might [00:57:00] be covers if you become bankrupt. There usually are a, a lot of provisions about how does the buyout actually work. You know, how do we determine what’s the purchase price? How do we, how are we gonna pay it? Are we gonna pay it in some in cash, some in a promissory note? There’s a lot of different ways to, to deal with that.

Um, and so I, I don’t know that I could say there’s some boilerplate that she should be looking for, like the Tax Matters partner. That one’s easy. But buy, sell provisions are usually unique. I mean, if you’re, if you’re trying to sell the company, two things to be looking for are drag along rights and tag along rights so that if you’ve got a majority owner who wants to sell.

Their interests and the buyer wants all the interests. You can have something called drag along rights, which means they can force the minority shareholders to tag along rights. Go the other. Is that That’s what you Yeah. No, thank you everybody. [00:58:00] Yeah.