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The IRS is Cracking Down on Trust Promoters

by | Nov 27, 2023 | ARTICLES, Corporate Direct

The IRS is Cracking Down on Trust Promoters

By: Ted Sutton, Esq.

There are some promoters out there who claim that they have a trust strategy whereby the trust avoids paying income taxes. But recent IRS rulings have started to crack down on this practice.

 

The most recent ruling came from Chief Counsel Memorandum (CCM) 2023-0006. The IRS made this ruling because some promoters claimed that if the trustee allocates trust income to the trust corpus, and the trustee doesn’t make distributions to the beneficiaries, then the trust income won’t be taxable.

 

However, this section misrepresents the tax law. Section 643 defines Distributable Net Income (DNI), which is the part of income that’s taxable to the beneficiaries. The promoters argue that because no distributions were made to the beneficiaries, that income held in the trust would not be taxable.

 

Even so, Section 641 says otherwise. This section of the tax code defines taxable income for estates or any kind of property held in trust. Under this section, if the trustee allocates trust income to the trust corpus, then the trust income is taxable.

 

Be very wary of promoters who suggest that they can set up trusts to help you avoid paying taxes. We here at Corporate Direct will help you be on the lookout for them.

Corporate Direct has a weekly YouTube segment called Direct Answers from Corporate Direct

In this segment, we educate people on corporate law, business formation, real estate, wealth building, and asset protection. And if you have any general questions about something, please feel free to leave a comment on one of our videos!

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The Difference Between Certificated And Uncertificated Securities

by | Nov 27, 2023 | ARTICLES, Asset Protection, Corporate Direct

The Difference Between Certificated and Uncertificated

By: Ted Sutton, Esq.

A security refers to an ownership interest in a business or a financial instrument. These ownership interests can be in a private LLC, or corporation, or in a publicly traded stock or bond. There are two choices for holding ownership interests in a security. You can either own it either as a certificated security, or as an uncertificated security. In this article, we will walk you through the differences between the two, and when it’s best to use each one. 

Uncertificated Security

An uncertificated security is a security whose ownership is not represented by a physical stock certificate. These security interests are registered on the books of the issuer, and are tracked electronically. Given technology’s role today, this is how most securities are held. Other names for uncertificated securities include book-entry securities and electronic securities.

Pros of Uncertificated Securities

Securities can be bought and sold electronically. There are many different trading platforms today that you can buy and sell from, and given the ease of trading uncertificated securities, it is the faster, more efficient option.

The advantage is that there is no need for filling out and transferring paperwork, which reduces the overall cost of buying and selling stocks. And because uncertificated securities aren’t in paper form, there is little risk that they can be lost or stolen.

Cons of Uncertificated Securities

While uncertificated securities are preferred in many situations, there are some downsides to using them. One of them is that its owners don’t have physical proof of ownership. This can be an issue when owners are perhaps concerned about hacking or a widespread loss of data. A physical certificate avoids such risks.

And most importantly, using uncertificated securities does not provide nearly as good asset protection. Courts treat uncertificated securities as “general intangibles.” General intangibles are non-physical assets, like electronic stock ownership, and courts in your state of residence can easily exercise jurisdiction over them. So, when an individual is sued in their home state, their home state court can exercise jurisdiction over their uncertificated security.

Here’s an example. Let’s say that you live in California and own an interest (that’s an uncertificated security) in a Wyoming LLC. You then get sued in California. Because your interest in the Wyoming LLC is a general intangible that follows you to California, California will apply their law to the dispute. In this case, Wyoming’s stronger charging order protection wouldn’t apply to protect your interest in the Wyoming LLC.

Certificated Security

A certificated security is a security that is represented by a physical certificate. When you buy a certificated security, you receive a physical paper evidencing your ownership. This stock certificate contains important information about the security, including the owner’s name, the number of shares owned, the date that the owner received the security certificate and any restrictions on transfer. When you sell the stock, you transfer the physical certificate to the buyer.

Pros of Certificated Securities

The advantages to having certificated securities is greater asset protection, as discussed below.

Cons of Certificated Securities

There are more obvious cons to owning a certificated security. Selling a certificated security is more difficult and time consuming. Given how easy it is to buy and sell uncertificated securities online, trading certificated securities for public companies is not the best option for investors. Another downside is the cost associated with physically transferring the security certificate from a seller to a buyer. And because they’re in paper form, these certificated securities can easily be lost or stolen. But for your own personal investments let’s consider Armor-8.

Armor-8

At Corporate Direct we offer certificated securities for your own personally held Wyoming LLCs with our Armor-8 protection.

There are many states that offer weak asset protection (like California). However, if you are a resident of one of those states, there is a little wrinkle in the law that can protect you. Under the UCC Article 8, if the certificated security is delivered and kept in one state, then that state’s law will apply to how a creditor can reach its assets. Said another way, this means that if the security certificate is delivered and kept in Wyoming, then the out of state court must apply Wyoming’s charging order, a much stronger asset protection remedy.

We have a safe deposit box at a Wyoming bank to ensure that the security certificate is delivered and kept in Wyoming. This places the security certificate out of reach from your home state creditors. And the only way for them to reach it is to have a lawyer in Wyoming get a court order to release the paper certificate. This is a cumbersome process for an attorney on a contingency fee. The hassle factor gives you better asset protection.

Conclusion

Holding a certificated security can come in handy when you don’t want to sell your interest and want to protect your assets. However, uncertificated securities are helpful where they are regularly bought and sold on an exchange. Knowing this difference may be able to help you before you set up your business.

We here at Corporate Direct can help you protect your assets with our Armor-8 protection. This will provide you with a certificated security interest held in Wyoming for your protection from creditors.

For more information on our Armor-8 protection, schedule a consultation with us.

Corporate Direct has a weekly YouTube segment called Direct Answers from Corporate Direct

In this segment, we educate people on corporate law, business formation, real estate, wealth building, and asset protection. And if you have any general questions about something, please feel free to leave a comment on one of our videos!

For more of these updates, click the link below and subscribe to our YouTube channel.

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The CTA Applies to Your HOA

by | Nov 1, 2023 | ARTICLES, Corporate Direct, CTA

The CTA Applies to Your HOA

By: Ted Sutton, Esq.

 

The Corporate Transparency Act (CTA) will apply to many different types of entities. It even extends to Homeowners Associations (HOA’s), including condominiums, community associations, and co-ops. This means that if you own an interest in an HOA, or you serve on the HOA board, you will need to report your information to FinCEN.

 

There are currently 23 exemptions under the CTA. One of which is the tax-exempt entity exemption, which includes three types of entities. The first is that the entity is an organization described in section 501(c) and exempt from tax under 501(a). Second, the entity is a political organization defined in section 527(e)(1). And lastly, the entity is trust described in section 4947(a).

 

Most notably missing under this exemption is Section 528 of the tax code, which applies to most HOAs. While there has been talk about exempting HOAs who file tax returns under Section 528, nothing has materialized as of yet. And we’re not holding our breath.

 

As it stands right now, most HOA’s will have to comply with the CTA. And in order to comply with the CTA, they will need to report some information to FinCEN.

 

The first piece of information is the “reporting company information,” which is the HOA body itself. The HOA will need to report its name, address, jurisdiction of formation, and its EIN Number.

 

The second piece of information is the “company applicant information”, which includes the person or business who is responsible for filing the information. The company applicant will need to report their name, birthdate, street address, and a driver’s license or passport.

 

The third piece of information is the “beneficial ownership information.” A “beneficial owner” is someone who owns at least 25% of the company, or someone who exercises “substantial control” over the company.

 

Some HOA boards have what are called “bulk owners.” And if these bulk owners own more than 25% of the HOA, they qualify as beneficial owners. As for the “substantial control” requirement, anyone who serves on the HOA board will have the required “substantial control” to qualify as a beneficial owner. In both situations, both groups will have to report their beneficial ownership information to FinCEN.

 

Another issue for HOA boards should look out for is when there is a change in ownership. Under the CTA, when there is any change in ownership or management, the HOA must report that information to FinCEN within 30 days. This may be a difficult task for many HOA’s, as some HOA’s have rapidly changing compositions. But once something changes, the clock starts ticking.

 

Corporate Direct has a weekly YouTube segment called Direct Answers from Corporate Direct

In this segment, we educate people on corporate law, business formation, real estate, wealth building, and asset protection. And if you have any general questions about something, please feel free to leave a comment on one of our videos!

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California Residents: We Don’t Recommend Forming Wyoming & Delaware Statutory Trusts for Your Holding Entity

by | Oct 1, 2023 | Corporate Direct

California Residents: We Don’t Recommend Forming Wyoming & Delaware Statutory Trusts for Your Holding Entity

By: Ted Sutton, Esq.

 

Sean and Scott are very successful entrepreneurs who live in San Francisco. They have had good fortunes investing in tech startups, and both have become very wealthy. Being shrewd with their money, they both decided to invest $5 million of their net worth into paper assets. Wanting to protect these holdings, Sean set up a Wyoming LLC. Because Sean is a California resident, Sean registered his Wyoming LLC in California and paid the $800 franchise tax. Scott found out that out of state trusts do not have to pay that dreaded fee, so he set up a Wyoming Statutory Trust for his portfolio. He named himself as the trustee, and he and his wife as the beneficiaries. By setting up the trust, Scott thought that he would end up paying less tax than Sean. As it turns out, he ended up paying more. A lot more.

 

As all our California clients know, a Wyoming holding LLC owned by a California resident must register with the California Secretary of State and pay the annual $800 franchise tax. The state’s position is that if a California resident is owning and managing a Wyoming LLC, then that entity is doing business in California. Their position infuriates a good many people, and we are frequently asked if there are any ways to avoid this fee. One potential solution, mentioned above, is the Wyoming Statutory Trust. Some use a Delaware Statutory Trust, or “DST,” but the problematic results are the same. We will use Wyoming as the example from here on out.

 

What exactly is a Wyoming Statutory Trust? It is a trust registered with the secretary of state that combines attributes of a standard trust and an LLC. Like a trust, a grantor puts assets into the Statutory Trust, to be held by one or more trustees, for the benefit of one or more beneficiaries. Like a Wyoming LLC, a Wyoming Statutory Trust has the same charging order protection if the beneficiary is personally sued. This trust is created by filing a Certificate of Trust with the Wyoming Secretary of State. Both the certificate and the annual report each cost $100. As a perceived bonus, California does not require these foreign trusts to pay the $800 franchise tax every year. Forming Wyoming Statutory Trusts will save our clients hundreds of dollars every year, right?

 

Wrong. The California Franchise Tax Board classifies out of state Statutory Trusts as “business trusts.” In two of their recent Chief Counsel Rulings, the FTB held that while these out of state “business trusts” are not subject to the franchise tax, they are subject to California’s 8.84% corporate income tax.[1] On top of this, a California Court of Appeals case recently held that trustees who are California residents are taxed at California rates on trust property located in another state.[2]

 

Do we really want our clients to pay this tax? As explained below, paying the $800 fee is a much better option.

 

Back to the example above. For simplicity’s sake, let’s say that Sean and Scott each earned $1 million in taxable income from their Wyoming entities in their first year. The diagram below shows how much each must pay to California and Wyoming.

 

WY Licence Tax
CA Franchise Tax
CA LLC Fee
CA Corporate Income Tax (8.84)
TOTAL:
Sean (LLC)
$1,200
$800
$6,000
None
$8,000
Scott ( Statutory Trust)
None
None
None
$88,400
$88,400

 

Because Sean has an LLC now worth $6 million, he will have to pay a $1,200 license tax to Wyoming.[1] This fee arises from assets held in Wyoming. If they were held outside of the state, the fee wouldn’t apply. If he used a Nevada LLC, which has no such license tax, the annual fee would be $350. In addition to the $800 franchise tax, California also requires LLCs who make $1 million a year to pay a fee of $6,000. Sean’s total here is $8,000. However, Sean will be able to deduct the $800 California fee on his tax returns.

 

Scott, on the other hand, does not have to pay the license tax, the franchise tax, or the LLC fee. However, because the Wyoming Statutory Trust is a “business trust,” Scott’s income is subject to the 8.84% corporate income tax rate, even though this income came from Wyoming. On the $1 million Scott earned from his Wyoming Statutory Trust, he is footed with the California corporate tax. This means Scott must cough up $88,400. While Scott “saved” $2,000 by not paying the taxes Sean had to, Sean ended up saving $80,400 in taxes altogether. To make matters worse, this example doesn’t even account for other federal and state taxes that affects them both.

 

Whose situation would you rather be in: The person who paid the franchise tax, or the person who avoided it?

 

As it stands right now, there is a lot of inconsistency in how California chooses to tax out of state trusts. Some will argue that if the trust distributes income to the California beneficiaries, the income is taxed at the beneficiary level. But what if the income is held in the trust? What if it is reinvested? Some people will claim their DST has never been assessed an 8.84% tax. But this area is filled with unsettled law and strategy uncertainty.

 

A key point to remember when seeking to reduce minimum franchise taxes: The trust tax here is on the books. And California is always searching for more tax revenue. Should a favorable ruling come out, we will reconsider using Statutory Trusts for our clients. But we aren’t holding our breath. We advise our California clients to stay away from the Statutory Trust ambiguities. If you don’t, you could end up like Scott: paying costly and unnecessary taxes.

_____________________________

 

[1] Franchise Tax Bd. Chief Counsel Ruling 2016-01 (February 17, 2016), and Franchise Tax Bd. Chief Counsel Ruling 2016-02 (February 17, 2016).

[2] Steuer v. Franchise Tax Bd., 51 Cal.App.5th 417 (2020).

[3] For Wyoming LLCs, the Annual Report License Tax is the greater of $60, or two tenths of one mil on the dollar ($.0002).

 

Corporate Direct has a weekly YouTube segment called Direct Answers from Corporate Direct

In this segment, we educate people on corporate law, business formation, real estate, wealth building, and asset protection. And if you have any general questions about something, please feel free to leave a comment on one of our videos!

For more of these updates, click the link below and subscribe to our YouTube channel.

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Is Your Business an “Inactive Entity” Under the CTA?

by | Oct 1, 2023 | Corporate Direct, CTA

Is Your Business an Inactive Entity Under the CTA

By: Ted Sutton, Esq.

 

Introduction

Sam was a young man who began buying stocks at a young age. As he got older, his stock portfolio kept growing. But because he held the stocks in his personal name, Sam was concerned about the portfolio being exposed in a lawsuit. In order to protect his investments, Sam formed a Wyoming LLC in 2021.

Sam’s best friend was Ricardo, a Spanish citizen whom he met in college. Ricardo also loved to invest in stocks, and wanted to invest alongside Sam. So in 2023, Sam gave Ricardo a 30% interest in the Wyoming LLC. Ricardo contributed $5,000 worth of stocks into the LLC.

From that point on, it was all downhill for Sam and Ricardo. The Corporate Transparency Act (CTA) took effect in 2024. And because Sam and Ricardo didn’t timely report their Wyoming LLC, they were hit with a $10,000 fine.

What Are Inactive Entities?

Under the new CTA, companies are required to report information about their business and its “beneficial owners” to the Financial Crimes and Enforcement Network (FinCEN) at the U.S. Department of the Treasury. However, the CTA carves out 23 exemptions for certain entities.

One of these exemptions is the “inactive entities” exemption. Many business owners may try to argue that their company meets this exemption. But the exemption’s requirements are a lot stricter than you think.

“Inactive entities” are entities that:

  • Were in existence before January 1st, 2020.
  • Are not engaged in active business
  • Have no ownership held by a foreign person
  • Have had no change in ownership in the last 12-month period
  • Have not sent or received funds over $1,000 within 12-month period; and
  • Do not hold any type of assets

Your business must meet all of these requirements to be classified under the “inactive entities” exemption. And if it doesn’t, it must report information to FinCEN.

Application

As you can see, Sam’s Wyoming LLC failed all of the requirements. Sam created the entity in 2021. Ricardo, a Spanish citizen, acquired an interest in the Wyoming LLC within the past year and placed $5,000 worth of stocks into it. And, of course, the LLC owned assets in the form of stocks.

The only argument that Sam could make here is that the LLC was not engaged in any “active business.” But because the Wyoming LLC failed every other prong, it does not meet all of the “inactive entity” requirements. As such, it needed to report its information to FinCEN.

Beneficial Ownership Requirements

Another thing worth mentioning is the beneficial ownership requirements. A “beneficial owner” is someone who owns at least 25% of the company, or someone who exercises “substantial control” of the company. If someone meets the requirements of a “beneficial owner,” they must report their beneficial ownership information to FinCEN.

In the example above, Sam owned 70% and Ricardo owned 30% of the Wyoming LLC. Because both owned greater than 25%, they both qualify as “beneficial owners.” As such, both must report their beneficial ownership information, including copies of a passport or driver’s license, to FinCEN.

Conclusion

The CTA is a new law that nobody is talking about. It is complex and convoluted. Even worse, many business owners will be left in the dark about the law and its requirements.

Luckily, we here at Corporate Direct will help you navigate the CTA. For more information, click the link here.

 

Corporate Direct has a weekly YouTube segment called Direct Answers from Corporate Direct

In this segment, we educate people on corporate law, business formation, real estate, wealth building, and asset protection. And if you have any general questions about something, please feel free to leave a comment on one of our videos!

For more of these updates, click the link below and subscribe to our YouTube channel.

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Texas: The New Hotbed For Business?

by | Sep 1, 2023 | ARTICLES, Charging Order, Corporate Direct, Start a Business

Texas: The New Hotbed For Business?

By: Ted Sutton, Esq.

 

In the business realm, Texas has become the lone star that is burning brighter. And it may become a top state for business in the near future.

 

They say that everything’s larger in Texas. This also includes a larger demand to form a business in the Lone Star State. Forming a business in Texas has become a popular alternative to other larger states like California and New York. Given its thriving economy and a favorable tax climate, Texas has seen an increase in new LLC formations.

 

These formations may increase further. Under the recently-passed Senate Bill 2314, Texas now recognizes the charging order as the exclusive remedy for both single-member and multi-member LLCs.

 

The charging order apples when an LLC member is personally sued and loses in court. But in order for the lawsuit winner to collect anything from the LLC, they must wait until any distributions are made from it. So, if no distributions are made, then the winner doesn’t collect anything from the LLC. This is true, even if the loser is the only member of the LLC. This new law takes effect on September 1, 2023.

 

This new law overrules Devoll v. Demonbreaun, a 2016 Texas Court of Appeals case[1]. Devoll held that the charging order was not the exclusive remedy, even if it was charged against an LLC’s membership interest. This new Senate Bill changes this outcome. Now Texas LLC owners are better protected in the event they are personally sued.

 

On top of this, Texas has also just formed the Texas Business Court. Similar to the Delaware Court of Chancery, this new court system will handle corporate disputes and complex litigation matters. Texas will eventually set up these courts in Austin, Dallas, Fort Worth, Houston, and San Antonio. This court will help expedite lawsuits and provide case law to resolve these disputes. But most importantly, this will attract even more business to the state. These new courts are set to start on September 1, 2024.

 

Another thing Texas has is its large population and rapid population growth. Currently, Texas is the second largest state with 30 million people. And since 2010, Texas has had the third-fastest growth of any state at a whopping 20%. Given these recent trends, it could take that top spot in the not-too-distant future.

 

Could Texas overtake Delaware and Wyoming as the best state for businesses? Only time will tell. However, these recent developments show that it may be possible.

_______________________________

[1] Devoll v. Demonbreun, No. 04-14-00331-CV (Tex. App. Aug. 31, 2016).

 

 

Corporate Direct has a weekly YouTube segment called Direct Answers from Corporate Direct

In this segment, we educate people on corporate law, business formation, real estate, wealth building, and asset protection. And if you have any general questions about something, please feel free to leave a comment on one of our videos!

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