Monthly Archives:' March 2015

S Elections for Limited Liability Companies

The limited liability company (LLC) is a popular entity choice for many new businesses because it limits the liability of its members (like a corporation) and provides a great deal of flexibility for its members to determine the business arrangement (like a partnership). This flexibility extends to the preferred tax treatment of the LLC. By default a single-member LLC (SMLLC) will be treated as a disregarded entity and an LLC with multiple members will be treated as a partnership for federal income tax purposes. Under the check-the-box rules, however, an LLC can also elect to be classified as a corporation for federal income tax purposes. Those same rules also allow LLC’s to elect to be taxed under the S corporation rules. While both partnership and S corporation tax treatment provide that LLC income is passed through to its members, differing treatment with respect to employment taxes may lead some LLC’s to make the S election and forego partnership treatment.

Employment Tax Benefit

Each member of an LLC taxed as a partnership is subject to self-employment taxes on his or her distributive share of partnership net income. For 2015, self-employment taxes (equivalent to social security and medicare payroll taxes) are imposed at a combined rate of 15.3% of the first $118,500 of a member’s net income and an additional 2.9% on any amount over $118,500. Additionally, a medicare tax of 0.9% is imposed separately on the amount of net income over a certain threshold ($200,000 for single taxpayers and $250,000 for married filing jointly taxpayers). For an LLC with a substantial amount of income, these self-employment taxes can add up.

Shareholders of an S corporation, on the other hand, are not subject to self-employment taxes on the income distributed from the S corporation. Rather, an S corporation is subject to the typical payroll taxes on its employee wages. Employee-shareholders such as company officers, however, are required to receive “reasonable compensation” for their services to prevent such individuals from accepting payment via distributions and avoiding this employment tax liability. Employee-shareholders are subject to employment tax only on their wages, not on their share of the company’s income.

In the context of an LLC that has the option to be taxed as a partnership or make an S election, members could realize some tax benefit if they make the S election and draw a salary from the LLC that is less than their share of net income from the LLC. The amount of this tax savings will vary depending on the LLC’s income and the compensation to the member. As mentioned, the salary paid to an employee-member of the LLC is required to be reasonable. This “reasonable compensation” is determined based on a number of factors including:

  • Employee qualifications
  • Nature, extent, and scope of the work
  • Size and complexity of business
  • Prevailing economic conditions
  • Employees compensation as a percentage of both gross and net
  • Employee-member’s compensation compared with member distributions
  • Employee-member’s compensation compared with non-member employee compensation
  • Salaries for comparable positions with the market or industry

In the case of a professional services firm where income is heavily based on services provided by the owners, one would expect reasonable compensation to represent a higher proportion of the overall income of the company. Alternatively, if the business activities are highly dependent upon deployment of capital or equipment, reasonable compensation may be lower in proportion to net income generated by the business.

When assessing the benefit of potentially reduced employment taxes, LLC members must also be aware of the withholding and reporting requirements that will apply if an S election is made. In the case of an LLC with no current employees (and no current payroll system), withholding and reporting compliance may reduce or eliminate any employment tax savings associated with making the S election.

Sacrificing Flexibility

The S election will also subject the LLC to the comparatively complex, rigid rules governing S corporations. Importantly, S corporations are limited in the type and number of shareholders allowed. An LLC that makes an S election cannot have corporations, partnerships, or non-resident alien individuals as shareholders. Another important limitation is the single class of stock rule. S corporations are prohibited from issuing multiple classes of stock that confer different liquidation or distribution rights to holders. Different voting rights, however, are permissible.

Conformity with this rule can potentially limit one of the major benefits of the LLC – flexibility in structuring the business arrangement between the members. LLC operating agreements commonly contain special allocations of income or loss, and distribution or liquidation provisions that treat members differently. This flexibility to define the business arrangement between the parties often reflects varying amounts of capital, services, or other contributions each member has or is willing to make to the venture. An LLC that makes an S election cannot include any special allocation, distribution, or liquidation provisions that treat members differently. Each member will be required to receive allocations of income, loss and other tax items, as well as distributions and liquidations, in accordance with their respective interests in the LLC (capital account balances).

Recommendation

In analyzing whether an S election should be made, LLCs should be cognizant of the benefits and burdens association with taxation under Subchapter S of the Internal Revenue Code. First, a reasonable estimate of the potential employment tax savings should be made. This will depend upon the anticipated net income of the LLC, and the reasonable compensation paid to members that perform services for the LLC. Note that this tax benefit may be reduced by the added complexity of payroll tax withholding and reporting requirements. If a reasonable benefit or tax savings warrants further consideration, the LLC’s members should determine whether the LLC currently has or anticipates any activities or events that may disqualify it from making an S election. This includes ineligible members (e.g. corporations and partnership) or special allocations or differing distribution and liquidation rights among the members. Overall, an LLC S election may be an effective way to produce significant tax savings, but is only suited to certain businesses and ownership groups that fully appreciate the increase in complexity and rigidity associated with the election.

If you would like assistance in assessing or executing an S election for your LLC, please contact us at (210) 228-9500.

Target Settles Data Breach, are Banks Next?

On March 19, Target agreed to pay $10 million to settle a class action lawsuit brought by consumers harmed by its 2013 data breach. “The settlement strengthens the case of the banking industry which is asking Target and other retailers to cover the hundreds of millions of dollars incurred protecting their customers from losses,” said American Bankers Association President and CEO Frank Keating. “After covering consumers’ losses from its data breach, “Target should step up and cover [the banking industry’s] costs too,” he said, in a press release. “This settlement does little to address the real problem – stopping a breach before it happens. Target − and the many other retailers who have suffered recent breaches due to holes in their internal computer defenses − should be forced to do more.”

According to documents filed to the United States District Court in Minnesota this month, shoppers who were affected by the breach are eligible for damages up to $10,000 each. To claim damages, victims must prove, among other things, that unauthorized charges were made to their credit cards. They must also show that they invested time in addressing the fraudulent charges and incurred costs from correcting their credit report because of higher interest rates or fees, from replacing driver’s licenses or other forms of identification, or from hiring identity protection companies or lawyers.

Reporting for Legal Entity Identifiers

On March 16, the Federal Reserve Board (FRB) issued a proposal seeking public comment within 60 days that would require all banking organizations with existing Legal Entity Identifiers (LEIs) to report their respective LEIs on regulatory reporting forms beginning June 30, 2015.  Specifically the report ask for comments on: (a.) Whether the proposed collection of information is necessary for the proper performance of the Federal Reserve’s functions; including whether the information has practical utility; (b.) The accuracy of the Federal Reserve’s estimate of the burden of the proposed information collection, including the validity of the methodology and assumptions used; (c.) Ways to enhance the quality, utility, and clarity of the information to be collected; (d.) Ways to minimize the burden of information collection on respondents, including through the use of automated collection techniques or other forms of information technology; and (e.) Estimates of capital or start up costs and costs of operation, maintenance, and purchase of services to provide information.

Several years ago, the Financial Stability Board began implementing a global identifier system that would uniquely identify parties to financial transactions, and in January 2013, the LEI Regulatory Oversight Committee was established to oversee the Global Legal Entity Identifier System. As the usage of LEI becomes more prominent, it should enable examiners, economists, and financial analysts to perform improved analyses, particularly during stressed market conditions, and would assist the regulatory community and the financial services industry at large. In addition, it is expected that the use of the LEI among the regulators will expand to facilitate better information sharing and coordination regarding financial policy, rulemaking, examinations, reporting requirements, and enforcement actions.

Credit Union Files Class Action Suit for Data Breach

On March 13, a federal credit union filed a lawsuit against a national retailer and parent company, alleging their actions during a September 2014 data breach injured credit unions, banks, and other financial institutions. Greater Chautauqua FCU v. Kmart Corp and Sears Holdings Corp., No. 15-cv-2228, (N.D.Ill. Mar.13,2015) claimed that due to the data breach the credit union had to: (a.) cancel or reissue any credit and debit cards affected by the breach; b. close any deposit, transaction, checking, or other accounts affected by the  breach; (c.) open or reopen any deposit, transaction, checking, or other accounts affected by the breach; (d.) refund or credit any cardholder to cover the cost of any unauthorized transaction relating to the breach; (e.) respond to a higher volume of cardholder complaints, confusion, and concern; (f.) increase fraud monitoring efforts; and (g.) lose revenue as a result of a decrease in card usage after breach was disclosed. The suit claims that the credit union believes that “failure to adequately secure their data was inexcusable.” In addition, the retailer failed to detect or notify customers for a period of at least five weeks.

The lawsuit alleges damages in excess of $5,000,000 for violations of the Illinois Personal Information Protection Act, the Illinois Consumer Fraud and Deceptive Business Act, and New York General Business Law, as well as negligence, and negligent misrepresentation and/or omission.

Read the Class Action Suit.

Overdrive Lenders Resource Conference

Join Kennedy Sutherland for the Overdrive Lenders Resource Conference on March 27th at the newly renovated St. Anthony hotel in San Antonio, Texas.

Who Should Attend?
SBA & commercial
lenders and assistants, processors
who use or wish to utilize the
SBA tools to support their customer base

Schedule                                                                                                                             7:30-8:00 Registration & Breakfast
8:00-8:30 Welcome/Opening Remarks
8:30-10:00 SBA Eligibility Issues & Best Practices
10:15-11:45 7a Closing Guidance & Best Practices
12:00-1:00 Keynote Address & Lunch
1:15-2:30 Business Acquisitions, Partner Buy-Outs and Business Valuations
2:45-4:00 504 Closing Guidance & Best Practices
4:00-5:30 Appraisal and Environmental Issues, Updates & Best Practices
5:30-7:00 Cocktail Reception & Networking

Speakers                                                                                                                            Rod Starkweather Attorney, Starkweather Law Office, P.C.
William (Dub) Sutherland Partner, Kennedy Sutherland, LLP
Neal Patel Principal, Reliant Business Valuation
Melanie Edmundson Principal, Phase Engineering
Kevin Bowie Attorney, Bowie Law Office
Kelly Isley COO, bancserv Partners
Charles (Chuck) Bunch Director of Military Relations &
Business Development, Red McCombs Toyota
Helena Hauk President/CEO, 5th Gear Consulting

Register Now

Learn How New Markets Tax Credits Stimulate Growth

Nationwide, more than $38 billion of New Markets Tax Credit capital has been invested into thousands of businesses and real estate developments since 2002. Please join Baker Tilly, Chase Community Development Banking, Community Hospitality Healthcare Services, Raza Development Fund, Texas Mezzanine Fund, and TransPecos Development Corporation to learn how to access New Markets Tax Credits for your qualified business or real estate development. These unique tax credits have helped developers and business owners gain access to a low-cost source of capital to solve a portion of their capital needs while creating significant community and economic impact in distressed areas. Join them on Wednesday, March 25th from 8:30 to 10:30 am to learn more about the New Markets Tax Credit program and find out if your project or business qualifies.

To register, please contact Wendy Jones atwendy.j.jones@chase.com. There is no charge to attend.

Join Kennedy Sutherland at New Market Tax Credits Event

Nationwide, more than $38 billion of New Markets Tax Credit capital has been invested into thousands of businesses and real estate developments since 2002. Please join Baker Tilly, Chase Community Development Banking, Community Hospitality Healthcare Services, Raza Development Fund, Texas Mezzanine Fund, TransPecos Development Corporation, and Kennedy Sutherland LLP to learn how to access New Markets Tax Credits for your qualified business or real estate development. These unique tax credits have helped developers and business owners gain access to a low-cost source of capital to solve a portion of their capital needs while creating significant community and economic impact in distressed areas. Please join us to learn more about the New Markets Tax Credit program and find out if your project or business qualifies.

UPCOMING SESSION
Wednesday, March 25th
8:30 A.M. – 10:30 A.M.
Plaza Club
100 W. Houston, #2100
San Antonio, TX 78205

To register, contact Wendy Jones at: wendy.j.jones@chase.com

.Bank Domain: What you Need to Know

In 2008, the Internet Corporation for Assigned Names and Numbers (ICANN), which manages the registration of internet domain names, approved a program to open up the Internet to thousands of additional top level domains in addition to existing generic domains such as .com, .gov, .edu, .net, and .org, to name a few. Due to cyber security concerns and the overcrowded internet arena, the American Banking Association joined forces with Financial Services Roundtable and other industry members in 2011 to form fTLD Registry Services, LLC (“FRS”) and apply for the authority to operate and govern the .bank and .insurance domain names. On September 25, 2014, ICANN granted the application of FRS to operate .bank along with .insurance. The .bank domain name will only be available for registration to verified members of the banking community. This process will include charter verification through each applicant’s state or national regulatory agency on a first come, first serve basis. The .bank domain combined with verification and other security requirements put in place by FRS will provide a new marketing and branding tool for financial institutions with enhanced security controls that current, generic domain names cannot provide.

Increased Security

The primary benefit of having a .bank domain name is the added security measures that are not included in other generic top level domains (gTLDs) such as .com or .net. With the new domain name several increased security measures have been implemented:

  • The use of the .bank domain by verified banks and other financial institutions should reduce spoofing and other malicious email or internet-based scams that prey on bank customers. Because each bank applying for the domain will be verified and authenticated as a bank or financial institution, bank customers will be able to quickly distinguish authentic emails from their financial institution from potentially malicious attempts to obtain personal identifying information (“PII”) or banking information.
  • Unlike existing gTLDs, the .bank domain will include an increased level of encryption (NIST Level 3 Encryption), which should decrease the risk of criminals redirecting customers to nonbanking websites, or stealing their PII or banking information.
  • Lastly, the .bank domain will have increased abuse monitoring and compliance enforcement to help ensure that only verified financial institutions will be able to use the domain. An individual from each financial institution must be established as the point of contact to help verify their business status as a member of the banking community and to ensure compliance with the new domain requirements.

Registrants who apply for the .bank domain will also be asked to agree to terms and conditions under the Acceptable Use Policy (AUP) and will be responsible for the usage of its domain at all times.

.Bank Availability & Timeline

The .bank domain is estimated to be available to the general public on June 24, 2015. Domains will be assigned on a first come, first serve basis. The multiplicity of banks across the country that share identical or similar names is likely to create a race to register once this open registration period begins. In addition to this general availability date there are two potential dates during which certain parties may complete early registration.

Banks that own a federally registered trademark on their name can take advantage of a 30-day “Sunrise Period” beginning on approximately May 18, 2015. During this Sunrise Period, a bank may record their trademarks via ICANN’s Trademark Clearinghouse and register for their respective .bank domain name early. The cost of registration is $150 per trademark, per year for most banks and will allow banks to obtain .bank domain names only if such names are identical to the trademark owned. Should a bank wish to register a name that deviates from their registered trademark, it must wait until the later general availability period. Immediately after the Sunrise Period, there will also be a brief period during which the founding members of FRS will have early access to register domains (approximately June 17th – June 23rd). All other verified members of the global banking community may register domains beginning on approximately June 24, 2015.

Banks desiring to register domains will do so through various registrars that have been approved by and contract with FRS. The growing list of approved registrars is currently available of the FRS website at https://www.ftld.com/approved-registrars. These registrars, however, cannot process requests for domain names until the opening of the registration periods set forth above. The cost on a .bank domain registration will vary based on the registrar providing the service. Each registrar determines its own pricing and is responsible for paying a set fee to FRS. It is anticipated that the .bank domain registration fees will be higher than gTLD domain names to fund the enhanced security measures associated with the .bank domain.

Timeline Summary:

  • Sunrise Period ( registered trademark owners): Estimated May 18 – June 16
  • Founders (founding members of FRS): Estimated June 17 – June 23
  • General Availability (eligible members of banking community): Estimated June 24 – Ongoing

Recommendations

Over the next few months, we recommend that banks desiring to register a .bank domain develop a strategy for registration that best suits its eligibility and needs. For example, banks should review their federal trademark portfolios to determine eligibility to register a domain early during the Sunrise Period. Note that early registration requires the domain to match the trademark exactly (e.g. a trademark for “ABC BANK” can only be registered as ABCBANK.bank during the Sunrise Period). Due to the proximity of the general availability date, it is unlikely that a new trademark registration can be completed in such a short time.

Banks that have common names should establish several potential options for domain name registration in case the first, second, or third option is already taken. Additionally, community banks that are specific to a geographic region or have a specific customer profile may wish to register a domain geared towards that customer or geographic region. Such a strategy can provide additional visibility for the bank in addition to a traditional domain associated with the bank’s name.

Finally, banks that have not registered names or marks for federal trademark protection should consider doing so. The trademark registration process is relatively simple two-step process. First, a search of the trademark database is conducted for similar marks to ensure the likelihood that an application will be approved by the U.S. Patent and Trademark Office. Provided no registrations exist that may create a likelihood of confusion with applicant’s mark, a short application describing the mark, owner, and a description of services covered is submitted to the U.S. Patent and Trademark Office. Once submitted, an application will be assigned to an examining attorney within three months and a review of the application should be completed with 6-12 months of initial submission of the application.

If you would like assistance in either securing a domain name with .bank or learning more about trademark registration and protection, please contact us as we would be happy to discuss potential strategy and tactical registration tailored to your financial institution. 

Annual Report on Incentives for Rehabilitating Historic Buildings Released

The National Park Service (NPS) has released it’s 2014 Annual Report on Federal Tax Incentives for Rehabilitating Historic Buildings. The report notes that jobs stayed strong with completed projects certified in FY 2014 creating an estimated 77,762 jobs. In addition, the report states in FY 2014 the number of approved proposed projects was 1,156. The investment in these projects totaled an estimated $5.98 billion, while the investment in the 762 certifi ed completed projects totaled $4.32 billion.

Nearly 1.59 million historic buildings are listed in or contribute to historic districts in the National Register of Historic Places, with thousands of contributing resources added each year. Last year over 50% of the completed projects certified by the National Park Service were estimated to have used both Federal and state historic tax credits. Over half of the states offer historic tax credits that can be used in tandem with the Federal historic tax incentives. The four states with the most rehabilitation activity in FY 2014 wer Virginia, Louisiana, Missouri, and New York.

Read the 2014 Annual Report & Statistical Report

About the Federal Historic Preservation Tax Incentives Program : The Federal Historic Preservation Tax Incentives Program, administered by the National Park Service in partnership with the State Historic Preservation Offices, is the nation’s most effective program to promote historic preservation and community revitalization through historic rehabilitation. With over 40,380 completed projects since its inception in 1976, the program has generated over $73 billion in the rehabilitation of income-producing historic properties. The largest federal program specifi cally supporting historic preservation, the historic tax credit also generates much needed jobs, enhances property values in older communities, creates affordable housing, and augments revenue for Federal, state and local governments. The widely recognized program has been instrumental in preserving historic places that give cities, towns, and communities their special character.