The tax advantages of including debt in a C corporation capital structure
Let’s say you plan to use a C corporation to operate a newly acquired business or you have an existing C corporation that needs more capital. You should know that the federal tax code treats corporate debt more favorably than corporate equity. So for shareholders of closely held C corporations, it can be a tax-smart move to include in the corporation’s capital structure:
- Some third-party debt (owed to outside lenders), and/or
- Some owner debt.
Tax rate considerations
Let’s review some basics. The top individual federal income tax rate is currently 37%. The top individual federal rate on net long-term capital gains and qualified dividends is currently 20%. On top of this, higher-income individuals may also owe the 3.8% net investment income tax on all or part of their investment income, which includes capital gains, dividends and interest.
On the corporate side, the Tax Cuts and Jobs Act (TCJA) established a flat 21% federal income tax rate on taxable income recognized by C corporations.
Third-party debt
The non-tax advantage of using third-party debt financing for a C corporation acquisition or to supply additional capital is that shareholders don’t need to commit as much of their own money.
Even when shareholders can afford to cover the entire cost with their own money, tax considerations may make doing so inadvisable. That’s because a shareholder generally can’t withdraw all or part of a corporate equity investment without worrying about the threat of double taxation. This occurs when the corporation pays tax on its profits and the shareholders pay tax again when the profits are distributed as dividends.
When third-party debt is used in a corporation’s capital structure, it becomes less likely that shareholders will need to be paid taxable dividends because they’ll have less money tied up in the business. The corporate cash flow can be used to pay off the corporate debt, at which point the shareholders will own 100% of the corporation with a smaller investment on their part.
Owner debt
If your entire interest in a successful C corporation is in the form of equity, double taxation can arise if you want to withdraw some of your investment. But if you include owner debt (money you loan to the corporation) in the capital structure, you have a built-in mechanism for withdrawing that part of your investment tax-free. That’s because the loan principal repayments made to you are tax-free. Of course, you must include the interest payments in your taxable income. But the corporation will get an offsetting interest expense deduction — unless an interest expense limitation rule applies, which is unlikely for a small to medium-sized company.
An unfavorable TCJA change imposed a limit on interest deductions for affected businesses. However, for 2024, a corporation with average annual gross receipts of $30 million or less for the three previous tax years is exempt from the limit.
An example to illustrate
Let’s say you plan to use your solely owned C corporation to buy the assets of an existing business. You plan to fund the entire $5 million cost with your own money — in a $2 million contribution to the corporation’s capital (a stock investment), plus a $3 million loan to the corporation.
This capital structure allows you to recover $3 million of your investment as tax-free repayments of corporate debt principal. The interest payments allow you to receive additional cash from the corporation. The interest is taxable to you but can be deducted by the corporation, as long as the limitation explained earlier doesn’t apply.
This illustrates the potential federal income tax advantages of including debt in the capital structure of a C corporation. Contact us to explain the relevant details and project the tax savings.
© 2024
8 key features of a customer dispute resolution process for businesses
No matter how carefully and congenially you run your business, customer disputes will likely happen from time to time.
Some of the complaints may be people looking to negotiate a discount, “game the system” or even outright defraud you. But others could be legitimate complaints arising from mistakes on your company’s part, technological glitches or, perhaps worst of all, fraudulent actions by a third party.
Whatever the case may be, you can protect your business’s reputation and even strengthen its brand by creating and maintaining an effective customer dispute resolution process that includes eight key features:
1. Easily accessible channels of communication. Post easy-to-find and clearly written directions on your website, social media accounts and other channels detailing how customers can report problems, suspected errors and fraud on their accounts. The directions should include up-to-date contact info for your company and identify any forms or documentation required. Also provide a succinct description of your dispute resolution process, so customers know what to expect.
2. An efficient timeline. Naturally, it’s imperative to respond as quickly as possible to customer concerns or complaints. Today’s technology allows businesses to immediately send automated replies confirming receipt of the customer’s message and assuring the sender that you’re investigating. If the matter appears legitimate, you can follow up with a resolution timeline stating the next steps in the process.
3. Empathy and understanding. Train employees to listen patiently and acknowledge to customers the inconvenience of potential errors or fraud on their accounts. Remind customer-facing staff to keep open minds and not automatically assume any customer is making a false report.
4. Rigorous investigatory techniques. Thoroughly investigate disputes to ascertain root causes. Precisely how you should do so will depend on the nature of your industry and operations, as well as the specifics of the complaint.
To ensure consistency and build a robust document trail, however, require employees performing investigations to first gather all available account information and transaction records. Investigators should also carefully preserve emails and other electronic messages, as well as record or transcribe phone conversations with complaining customers and, if applicable, other involved parties.
5. Strong data protection. Your business should already have up-to-date cybersecurity safeguards in place to prevent data breaches and identity theft. But your customer dispute resolution process should include additional layers of protection. For example, apply “the principle of least privilege,” which means, in this case, only authorized employees directly involved in investigations have access to pertinent data.
6. Transparency and proactive follow-ups. Keep customers informed throughout the entire process. Don’t “leave them hanging” and wait for them to follow up with you. Provide them with regular updates on investigations and inform them of outcomes as soon as they’re available.
7. Timely resolution. If a dispute is found to be in the customer’s favor, quickly make the necessary corrections — such as refunds or account adjustments. Also consider providing a temporary discount, free replacement items or complementary services. Many companies also issue an apology, though you may want to consult your attorney on the language.
If you deny a claim, provide a detailed explanation of the evidence and your reasoning. Consider allowing some customers to appeal decisions not in their favor by submitting supplemental information.
8. Documentation and analysis with an eye on continuous improvement. Last, be sure to continually learn from incidents. Retain records of all customer disputes and fraud claims to identify patterns and trends. Use this data to improve your internal controls and investigatory processes, make decisions on technology upgrades, and train customer-facing teams. By doing so, you may be able to prevent disputes in the future or at least lessen their frequency.
© 2024
Businesses must face the reality of cyberattacks and continue fighting back
With each passing year, as networked technology becomes more and more integral to how companies do business, a simple yet grim reality comes further into focus: The cyberattacks will continue.
In fact, many experts are now urging business owners and their leadership teams to view malicious cyberactivity as more of a certainty than a possibility. Why? Because it seems to be happening to just about every company in one way or another.
A 2023 study by U.K.-based software and hardware company Sophos found that, of 3,000 business leaders surveyed across 14 countries (including 500 in the United States), a whopping 94% reported experiencing a cyberattack within the preceding year.
Creating a comprehensive strategy
What can your small-to-midsize business do to protect itself? First and foremost, you need a comprehensive cybersecurity strategy that accounts for not only your technology, but also your people, processes and as many known external threats as possible. Some of the primary elements of a comprehensive cybersecurity strategy are:
- Clearly written and widely distributed cybersecurity policies,
- A cybersecurity program framework that lays out how your company: 1) identifies risks, 2) implements safeguards, 3) monitors its systems to detect incidents, 4) responds to incidents, and 5) recovers data and restores operations after incidents,
- Employee training, upskilling, testing and regular reminders about cybersecurity,
- Cyberinsurance suited to your company’s size, operations and risk level, and
- A business continuity plan that addresses what you’ll do if you’re hit by a major cyberattack.
That last point should include deciding, in consultation with an attorney, how you’ll communicate with customers and vendors about incidents.
Getting help
All of that may sound a bit overwhelming if you’re starting from scratch or working off a largely improvised set of cybersecurity practices developed over time. The good news is there’s plenty of help available.
For businesses looking for cost-effective starting points, cybersecurity policy templates are available from organizations such as the SANS Institute. Meanwhile, there are established, widely accessible cybersecurity program frameworks such as the:
- National Institute of Standards and Technology’s Cybersecurity Framework,
- Center for Internet Security’s Critical Security Controls, and
- Information Systems Audit and Control Association’s Control Objectives for Information and Related Technologies.
Plug any of those terms into your favorite search engine and you should be able to get started.
Of course, free help will only get you so far. For customized assistance, businesses always have the option of engaging a cybersecurity consultant for an assessment and help implementing any elements of a comprehensive cybersecurity strategy. Naturally, you’ll need to vet providers carefully, set a feasible budget, and be prepared to dedicate the time and resources to get the most out of the relationship.
Investing in safety
If your business decides to invest further in cybersecurity, you won’t be alone. Tech researcher Gartner has projected global spending on cybersecurity and risk management to reach $210 billion this year, a 13% increase from last year. It may be a competitive necessity to allocate more dollars to keeping your company safe. For help organizing, analyzing and budgeting for all your technology costs, including for cybersecurity, contact us.
© 2024
When do valuable gifts to charity require an appraisal?
If you donate valuable items to charity and you want to deduct them on your tax return, you may be required to get an appraisal. The IRS requires donors and charitable organizations to supply certain information to prove their right to deduct charitable contributions.
How can you protect your deduction?
First, be aware that in order to deduct charitable donations, you must itemize deductions. Due to today’s relatively high standard deduction amounts, fewer taxpayers are itemizing deductions on their federal returns than before the Tax Cuts and Jobs Act became effective in 2018.
If you clear the itemizing hurdle and donate an item of property (or a group of similar items) worth more than $5,000, certain appraisal requirements apply. You must:
- Get a “qualified appraisal,”
- Receive the qualified appraisal before your tax return is due,
- Attach an “appraisal summary” to the first tax return on which the deduction is claimed,
- Include other information with the return, and
- Maintain certain records.
Keep these definitions in mind. A “qualified appraisal” is a complex and detailed document. It must be prepared and signed by a qualified appraiser. An “appraisal summary” is a summary of a qualified appraisal made on Form 8283 and attached to the donor’s return.
While courts have allowed taxpayers some latitude in following these rules, you should aim for exact compliance.
The qualified appraisal isn’t submitted to the IRS in most cases. Instead, the appraisal summary, which is a separate statement prepared on an IRS form, is attached to the donor’s tax return. However, a copy of the appraisal must be attached for gifts of art valued at $20,000 or more and for all gifts of property valued at more than $500,000, other than inventory, publicly traded stock and intellectual property. If an item of art has been appraised at $50,000 or more, you can ask the IRS to issue a “Statement of Value” that can be used to substantiate the value.
What if you don’t comply with the requirements?
The penalty for failing to get a qualified appraisal and attach an appraisal summary to the return is denial of the charitable deduction. The deduction may be lost even if the property was valued correctly. There may be relief if the failure was due to reasonable cause.
Are there exceptions to the requirements?
A qualified appraisal isn’t required for contributions of:
- A car, boat or airplane for which the deduction is limited to the charity’s gross sales proceeds,
- Stock in trade, inventory or property held primarily for sale to customers in the ordinary course of business,
- Publicly traded securities for which market quotations are “readily available,” and
- Qualified intellectual property, such as a patent.
Also, only a partially completed appraisal summary must be attached to the tax return for contributions of:
- Nonpublicly traded stock for which the claimed deduction is greater than $5,000 and doesn’t exceed $10,000, and
- Publicly traded securities for which market quotations aren’t “readily available.”
What if you have more than one gift?
If you make gifts of two or more items during a tax year, even to multiple charitable organizations, the claimed values of all property of the same category or type (such as stamps, paintings, books, stock that isn’t publicly traded, land, jewelry, furniture or toys) are added together in determining whether the $5,000 or $10,000 limits are exceeded.
The bottom line is you must be careful to comply with the appraisal requirements or risk disallowance of your charitable deduction. Contact us if you have any further questions or want to discuss your charitable giving plans.
© 2024