Choosing the Correct Business Structure
Michael Blake, Director of Brady Ware & Company and Host of the Decision Vision podcast, interviews Anita Anand, Director of Brady Ware & Company on the decision process on a corporate business structure, how recent tax law changes might dictate a change in corporate entity selection, and other questions related to corporate structure.
Anita Anand, Esq., Brady Ware & Company
Anita Anand, Esq. is a licensed attorney and has over 10 years of experience consulting with businesses to help them align their long-term business and financial objectives with a tax strategy that minimizes their overall exposure. Anita specializes in technical international, federal, state, and local tax research and consulting. She provides taxpayer representation in matters requiring federal and state private letter rulings and is responsible for international, federal, state, and local technical tax support involving a range of clients and industries. Anita works closely with the tax team to provide quality control in all aspects of Brady Ware’s tax division. Anita is also the author of articles and white papers on various subject matters. She has presented at conferences and led training sessions and initiatives. Anita is a graduate of Georgia State University College of Law.
Michael Blake, Brady Ware & Company
Michael Blake is Host of the Decision Vision podcast series and a Director of Brady Ware & Company. Mike specializes in the valuation of intellectual property-driven firms, such as software firms, aerospace firms and professional services firms, most frequently in the capacity as a transaction advisor, helping clients obtain great outcomes from complex transaction opportunities. Mike is also a specialist in the appraisal of intellectual properties as stand-alone assets, such as software, trade secrets, and patents.
He has been a full-time business appraiser for 13 years with public accounting firms, boutique business appraisal firms, and an owner of his own firm. Prior to that, he spent 8 years in venture capital and investment banking, including transactions in the U.S., Israel, Russia, Ukraine, and Belarus.
Brady Ware & Company
Brady Ware & Company is a regional full-service accounting and advisory firm which helps businesses and entrepreneurs make visions a reality. Brady Ware services clients nationally from its offices in Alpharetta, GA; Columbus and Dayton, OH; and Richmond, IN. The firm is growth minded, committed to the regions in which they operate, and most importantly, they make significant investments in their people and service offerings to meet the changing financial needs of those they are privileged to serve. The firm is dedicated to providing results that make a difference for its clients.
Decision Vision Podcast Series
Decision Vision is a podcast covering topics and issues facing small business owners and connecting them with solutions from leading experts. This series is presented by Brady Ware & Company. If you are a decision maker for a small business, we’d love to hear from you. Contact us at decisionvision@bradyware.com and make sure to listen to every Thursday to the Decision Vision podcast. Past episodes of Decision Vision can be found here. Decision Vision is produced and broadcast by Business RadioX®.
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Show Transcript:
Intro: [00:00:01] Welcome to Decision Vision, a podcast series focusing on critical business decisions brought to you by Brady Ware & Company. Brady Ware is a regional, full-service accounting and advisory firm that helps businesses and entrepreneurs make visions a reality.
Michael Blake: [00:00:22] And welcome to Decision Vision, a podcast giving you, the listener, clear vision to make great decisions. In each episode, we’ll be discussing the process of decision making on a different topic. But rather than making strict recommendations because everyone’s circumstances are different, we’re talking to subject matter experts about how they would recommend thinking about that decision.
Michael Blake: [00:00:42] My name is Mike Blake, and I am your host for today’s program. I’m a Director at Brady Ware & Company, a full-service accounting firm based in Dayton, Ohio with offices in Dayton; Columbus, Ohio; Richmond, Indiana; and Alpharetta, Georgia, which is where we are recording today. Brady Ware is sponsoring this podcast. If you like this podcast, please subscribe on your favorite podcast aggregator, and please consider leaving a review of the podcast as well.
Michael Blake: [00:01:07] So, today, we’re going to talk a little bit a hard accounting. We haven’t done that yet on the program. We’ll probably do it in a few episodes along the way. And we’re not necessarily going to get that technical, but this just in, you may have heard that the tax law changed radically at the end of last year that has changed the way that businesses are making decisions and making businesses kind of rethink decisions they may have made last year, five years ago, 10 years ago, 20 years ago.
Michael Blake: [00:01:41] And one of those decisions that when businesses, typically, are started – and maybe they changed along the way – is the corporate form. In other words, are you a C Corporation, and S corporation, you’re a limited liability company, and so forth? And there are many reasons or factors that drive that decision initially. But, quite candidly, one of them is what is your tax liability going to be. And depending on your corporate form – if it’s done correctly, and matches up with how your business makes money, and how you make money from your business – that’s going to drive what form of corporation or what corporate form you decide to take.
Michael Blake: [00:02:21] And what we’re finding at Brady Ware is that a lot of clients now and others are coming to us and asking, “Well, given these changes in the law, am I the right corporate form to frankly maximize or optimize my tax liability?” Nobody that I know likes to pay more taxes than than they absolutely have to. I know I’m not tipping the federal government when I write mine out. But, unfortunately, I know almost zero about it other than what I just talked about for the last 30 seconds.
Michael Blake: [00:02:52] So, we’ve brought in a subject matter expert. And I’m joined by my colleague, fellow director, and good friend, Anita Anand. Anita is a Director at Brady Ware, and she’s a licensed attorney and tax director at Brady Ware. She has over 10 years of experience consulting with businesses to help them align their long-term business and financial objectives with a tax strategy that minimizes their overall exposure. She believes it is necessary to take the time to understand what her business clients have done to achieve the success they have and where they plan to go. She, then, uses her broad knowledge of US and international tax laws to develop strategies and the most efficient tax structure to keep clients fully compliant at the lowest expense.
Michael Blake: [00:03:37] Anita has worked with a broad range of companies including technology, manufacturing, renewable energy, construction, real estate, and many other industries. She has helped them craft strategies to deal with federal state and local taxes, as well as inbound and outbound international tax issues. Along with these day-to-day responsibilities, Anita contributes her expertise to a number of local government agencies, industry organizations, and nonprofits. She is a guest lecturer at Georgia State University and the University of Georgia. Anita is also the author of various articles and whitepapers on various subject matters. In fact, I think she’s the most prolific writer in the firm, and she’s always writing something.
Anita Anand: [00:04:14] You’re so sweet, Mike.
Michael Blake: [00:04:15] She is presented at conferences, authored articles, and led training sessions and initiatives. Anita is a graduate of Georgia State University’s College of Law. And on a personal note, Anita was actually the first person that I met outside of the interview process before I joined the firm. And I remember very clearly that she was kind of one of the first to kind of welcome me, and we’ve latched on to each other because the two of us are the two non-CPAs-
Anita Anand: [00:04:39] That is true.
Michael Blake: [00:04:41] … in the firm at the director level., right. And so-
Anita Anand: [00:04:45] Right, very true.
Michael Blake: [00:04:45] And that-.
Anita Anand: [00:04:45] We got to stick together, Mike.
Michael Blake: [00:04:46] We do have to stick together. But that having been said, you studied tax, I have not. So, it’s just delightful to welcome you to the program. We’re going to have some fun today while we help people work through this decision.
Anita Anand: [00:05:00] I look forward to it. Thanks for having me.
Michael Blake: [00:05:02] So, Anita, I’ve given, sort of, this introduction, but I’d like you to kind of humanize a little bit. Talk about what you do at Brady Ware, and how you’re helping clients on a day-to-day basis.
Anita Anand: [00:05:12] Yeah. So, like you, said I’m a director with the firm. I spearhead the international tax practice. And so, because I’m a lawyer by trade and not a CPA by trade, I come at it from a slightly different angle in that tax consulting really is my specialty. So, I work a lot with clients, whether they’re individuals or businesses, here in the US that are wanting to expand their operations or their work in foreign jurisdictions and vice versa, right. So, if we have, let’s say, a company that has already established their business in foreign markets, and, now, they want to expand into the US, helping them understand what US tax rules are, how they work, what the regime is like, and what kind of an impact they’re going to be probably faced with is really what I like to kind of help them plan with.
Anita Anand: [00:06:03] But outside of the international, my foundation is technical tax. That’s what my career has always been. So, I also serve as a resource to others across the firm on technical tax matters, which vary all across the spectrum. So, if there is, let’s say, a client that has maybe a little bit more of a complex issue that requires some more technical tax research, looking into trying to figure out maybe how IRS may interpret a specific set of facts and circumstances, really diving into those types of situations, and then advising the clients appropriately. So, that’s just a very nice way, I think, of saying that I’m a tax nerd, but I enjoy it. I enjoy it. My job is to understand how these tax rules work, and then help explain to clients what it means to them.
Michael Blake: [00:06:53] It’s okay to be a nerd. The nerds rule the world, man.
Anita Anand: [00:06:55] That’s okay. Right, yeah.
Michael Blake: [00:06:56] The nerds are the ones driving Teslas. The nerds are the ones with second and third homes.
Anita Anand: [00:07:00] There you go, right?
Michael Blake: [00:07:01] You know, it’s all good. So, if you’re the nerd that everybody comes to for things tax, I mean, that’s not a bad place to be. So, what does being a tax expert an advisor mean? I mean, you talked a little bit about, sort of, being a tax nerd, but it goes a little bit beyond that, doesn’t it?
Anita Anand: [00:07:18] It does. It does. And, I think, the overarching goal for any tax advisor – and this is the way I view it – is you really are taking what is a complex set of rules that in the federal income tax code, you’re taking the code, you’re taking the regulations associated with it, the guidance IRS has issued along the way, and trying to, number one, keep up with that, understand what that means, interpret it correctly. But then, more importantly, be able to communicate that to a client in a way that they understand, right. It’s no different than, for example if I go to a doctor not feeling well, and they spit out all of these medical terms that have 15-18 syllables to it. Well, he or she could be the most brilliant person on the face of the earth, but they’re not communicating to me in a manner I understand what it means.
Anita Anand: [00:08:09] And so, I kind of take tax advisory in that light where our job is to really take something that the average person probably doesn’t even want to deal with. And it’s our job to make them understand how it impacts their business. But that’s also a loaded job description, right, because that includes that the advisor needs to be keeping up with all these tax law changes, which is constantly in a state of flux, not only on a federal level but international implications, state and local tax implications. So, there’s a lot to always keep up with.
Anita Anand: [00:08:43] But then, I think, what also sets maybe tax advisors apart from just true tax compliance, because I view tax compliance as you’re looking in the rearview mirror, you’re reporting what has already happened; whereas, I think, one of the key aspects of a tax advisor is to have more of a proactive approach, work with clients from the beginning, and more so on the front end, and along the way in terms of, “Hey, how’s the business going? How are we seeing things go? What is the ultimate goal here? What are things you should be aware of? How they’re going to impact you? What are you thinking about? What aren’t you thinking about that you should be thinking about?” That way, we’re making sure that clients are in the best position possible to make the best business decisions understanding tax impacts along the way.
Michael Blake: [00:09:29] I think that’s a very smart comment that you made that I want to highlight because I think it’s that important that it’s worth going off script to do that. There’s a big difference between being an analyst and an advisor, isn’t there?
Anita Anand: [00:09:43] There is.
Michael Blake: [00:09:43] And when you’re an analyst, you often talk about either, “Here’s what happened,” right, or “If A, B. C happened, then, sort of, here’s the flow chart, and here’s what will happen. Here’s kind of what the math says. And here’s what the law clearly says.” The advisor’s job is a lot less comfortable, isn’t it?
Anita Anand: [00:10:04] It is. And you have to be okay with the — You have to get comfortable with the uncomfortable. And that is difficult to do because nobody likes to be in that gray space. And in my experience, and especially in light of tax reform, a lot of tax professionals are stuck in that gray space.
Michael Blake: [00:10:23] And it’s even worse now, right?
Anita Anand: [00:10:25] It is.
Michael Blake: [00:10:25] Because you’re talking about changing rules and changing regulations. As I understand, in many ways, the IRS has not decided or, at least, has not chosen to share with us yet-
Anita Anand: [00:10:35] Correct.
Michael Blake: [00:10:35] … what they’ve decided the rules actually mean, right? So, in a lot of cases, to be perfectly candid, we’re all, not just Brady Ware but every CPA who’s being intellectually honest-
Anita Anand: [00:10:46] Right.
Michael Blake: [00:10:47] … is making a best guess based on available information that could turn out to be wrong.
Anita Anand: [00:10:52] Absolutely. And I think that’s another thing that’s going to set what I believe tax advisors into different buckets is being honest with clients. I understand we have — I’ve had to have these conversations multiple times with clients as clients are expecting an answer. When they come to you, they are expecting an answer on, “Okay, this is my issue. Tell me what I need to do.” And we need to be honest in that we are in this state of flux, and that there is so much that is unknown. But given what we know as it stands right now, this is what we believe to be where we think IRS is going to come out on it, but with the caveat that it could completely change because we just don’t know what we don’t know.
Michael Blake: [00:11:36] And does your legal training help you with that? I mean, the law is the law, but, on the other hand, the law is the law until it gets in front of a judge and jury.
Anita Anand: [00:11:43] Correct. It did, it did. But I also think it’s also experience along the way. The legal training helps you analyze what is already in front of you. It helps you interpret, okay, if you’re looking at, let’s say, 10 tax court cases on a particular issue, and eight have gone a certain way, and two have possibly gone a different way, to kind of help analyze what that really means. So, it has provided the analytical skills that I think I have, but there is still that second part of the equation, which is being okay with communicating your analysis accurately and honestly with a client, which just, I think, comes with experience.
Michael Blake: [00:12:29] So, I want to go out on a limb and say you didn’t necessarily, when you’re eight years old, say, “I want to become a tax advisor.”
Anita Anand: [00:12:37] No.
Michael Blake: [00:12:37] Is that fair?
Anita Anand: [00:12:38] That is a fair statement.
Michael Blake: [00:12:39] Some people have done that. And maybe they go and do, more power to them, you didn’t, and I didn’t grow up saying, “I was going to be a business-” I didn’t know what a business appraiser was until I graduated from business school. So, what got you into tax advisory? What captivated you that you want to make that your career and you wanted to be an expert in tax?
Anita Anand: [00:12:57] It’s really funny that you asked that question because I’ve asked that question of myself a couple of times along the way.
Michael Blake: [00:13:04] During busy seasons?
Anita Anand: [00:13:05] Yeah, yeah, yeah. Every year between that February and April timeframe. So, early on in my career, I never at all thought that I was going to do tax. Honestly, doing my own personal income tax return that one time a year was enough tax I ever needed to be exposed to. But I got a good opportunity in tax and, obviously, in the tax advisory role. And I went in with a certain set of expectations, and I was actually pleasantly surprised. So, I stuck around. And over time, that’s how I built my career.
Anita Anand: [00:13:40] But along the way, obviously, you learn a lot about yourself as an individual and as a professional. And when I look back at really what made me stick around in the tax space is, I think, believe it or not, in a weird way, I think, I like problem solving. And tax advisory is that every day. It’s not necessarily that a client is coming to you, “Hey, I have an IRS audit. Now, please fix this for me.” It’s advising clients along the way and what they’re trying to do. There’s a constant “problem” that business owners are constantly faced with. And so, you’re able to advise them on that.
Anita Anand: [00:14:18] So, it’s problem solving that I enjoy. And then, I enjoy working with people. So, I like getting to know my clients, and understanding what their business is, where their goals lie. And, obviously, building that kind of professional relationship where they believe that you are a valuable member to the team. So, I think all of those things put together have made tax advisory a good fit for me, which is I guess why it’s been working pretty well.
Michael Blake: [00:14:46] It has worked pretty well. You’re a brand director, so.
Anita Anand: [00:14:49] That is right. That is right.
Michael Blake: [00:14:51] Can you think of a neat success story you’ve had with the clients, something you really, really either helped them out of a bind or helped them frankly just save a lot of money that they’re going to be on the hook for?
Anita Anand: [00:15:02] Yeah. I’ve been blessed with quite a few clients’ situations where we were able to get them out of what I’m going to just call a pickle. I had a client that specifically came to me from a prior CPA firm. They were in the midst of a complete reorganization, corporate reorganization. And the amount of dollars that were involved were quite significant. And so, the way the prior CPA firm was advising them to pursue this reorganization was going to be a completely taxable event, and it was going to cost them a lot of money.
Anita Anand: [00:15:41] So, when they came to me, we had some certain discussions, and we really to dive in to some of the tax rules in terms of, could they possibly benefit from a tax-free reorganization? So, we worked very closely with our legal team to stay within the parameters of the law and what is allowed. And, in fact, what the tax liability their prior CPA had estimated to them, we were able to completely wipe it out.
Anita Anand: [00:16:08] So, that was one of the success stories that I kind of hold on to quite a bit and it saved them millions of dollars. So, quite significant on their end as well. But my success story is truly where I find the successes when you have a client that achieved success, and you’re a valuable member to the team that helped them do it, and they look at you as being a valuable member to the team. And that in and of itself is success.
Michael Blake: [00:16:35] Yeah, that’s what it’s all about, right? And that is the stimuli.
Anita Anand: [00:16:36] That’s what are in it for everyone.
Michael Blake: [00:16:38] So, all right. So, let’s talk now about entity conversions. Why are people talking about them so much now? Why is there so much chatter about, “I want to convert from C, to S, to SSC, or something else”?
Anita Anand: [00:16:51] Well, it’s this little thing called tax reform that you had alluded to.
Michael Blake: [00:16:54] Oh, yeah, I heard of that.
Anita Anand: [00:16:54] Yeah, that little thing that happened at the end of 2017. The tax cuts and Jobs Act was the tax reform package really. And it was high time for tax reform. If you go back and you think about the last major tax regime overhaul, it was back in 1986. So, the fact that this last one was done in 2017, I mean, you’re talking 30 plus years later. So, it was high time for there to be, I think, a little bit more of a look towards our tax laws, our tax rules, and modify them to be in line with the current marketplace and business realities of our country
Anita Anand: [00:17:32] So, with reform though, we had a number of different changes. And one of the most talked about is the reduced corporate tax rate. So, we went down from 35% to 21%. And, now, that has raised this conversation amongst various taxpayers, “Does it make sense for me to use a traditional corporate structure? Because before, it was going to cost me 35% at the corporate level. Well, now, it’s lower. So, should I be thinking about a conversion?” So, that’s truly what has sparked it, and all the conversations that we’re hearing and reading about.
Michael Blake: [00:18:08] And what are clients converting from and to in order to take advantage of that?
Anita Anand: [00:18:14] So, at this point, a lot of clients are thinking about converting from what’s called a pass-through entity, which is like your traditional partnership as corporation limited liability company or LLC to a C corporation. So, that’s what, I think, the conversation is and that discussion point is right now is I’m taking what — There really is no corporate entity. It’s a pass-through. And does it make sense now for me to convert that pass-through entity to a traditional C corporation?
Michael Blake: [00:18:45] Now, that’s kind of different from, at least, what I’ve encountered maybe that’s because that’s where valuation comes in, but I’m more used to seeing C to S form conversions, right?
Anita Anand: [00:18:58] Right.
Michael Blake: [00:18:58] Is going back the other way more or less complicated than C to S, or about the same?
Anita Anand: [00:19:03] So, it’s very — Okay. I want to caveat this, but it’s simpler to go from a pass-through entity like an S to a C, or a partnership to a C, or LLC to a C. But going the other way is a little bit more difficult. You’ve got a lot more considerations that go into that, and there’s usually some pain and cost associated with it. And so, that’s kind of part of the conversation that we’re having with our clients right now is, sure, we can talk about this conversion. We can do the modeling. We can certainly walk you through it. But just know that as easy as it is to maybe check the box and convert to a C corporation, in the event two years down the road, you wanted to go back, there’s going to be some cost. So, the short answer to your question is it’s really just not that easy to go back once you’ve elected to be a corporation.
Michael Blake: [00:19:59] So, you better be sure?
Anita Anand: [00:20:01] You should be sure.
Michael Blake: [00:20:02] And I mean, again, I’m not an account, but my impression is the IRS generally is not a huge fan of changing corporate forms all the time like share changes-
Anita Anand: [00:20:13] Right.
Michael Blake: [00:20:15] … outfits in a concert-
Anita Anand: [00:20:17] Absolutely.
Michael Blake: [00:20:17] … because you want to optimize your tax rate.
Anita Anand: [00:20:19] Right, right.
Michael Blake: [00:20:20] So, they’re not a huge fan of that.
Anita Anand: [00:20:22] No.
Michael Blake: [00:20:23] So, can we say there’s a bottom line or a blanket statement? Or I’m going to rephrase the question actually. And the question is, what are kind of the criteria that makes a company a good candidate for a pass-through entity conversion to a non-pass-through entity conversion? What’s kind of that checklist look like?
Anita Anand: [00:20:45] Mike, that’s a really good question. But, unfortunately, there is no one-size-fits-all. And the reason I say that is because there were so many different moving pieces in tax reform that there are new benefits that are afforded to those businesses that are operating as a pass-through entity. And, now, there are new benefits that are afforded to those that are operating in a traditional corporate structure.
Anita Anand: [00:21:11] So, it’s kind of hard because you’re not really comparing apples to apples. So, what you really need to look at, I can tell you kind of what maybe the logic should be, and the logic should be taking a closer look in terms of what is your business today; what are your near-term and long-term goals; what type of activities are you engaging in; are you expanding in international markets; are you investing in real estate? What is it? Where is your income coming from? Because those are going to help, I think, really determine whether one particular type of structure is better than others.
Anita Anand: [00:21:49] And then, from there, you really have to do modeling. It’s very easy to speak conceptually and in big picture, but, at the end of the day, what everyone wants to know is the bottom line. It’s, how much is this going to cost me? And the thing is whatever structure you choose, it’s an annual cost. There’s an annual cost associated with it. That’s your tax liability.
Anita Anand: [00:22:10] So, you got to put pen to paper or, in this case, maybe have some intricate and complex spreadsheets, but to really help understand, “Okay. Well, if I do it in a partnership form, could I maybe tap into certain benefits there?” So, for example, like under tax reform, there’s a new deduction that’s afforded to certain qualified business income of qualified trades or businesses that’s afforded in partnership, or S corporation, or even sole proprietorships that is not available to a C corporation. But, now, the C corporation has a lower tax rate. They have other benefits that could potentially be taken advantage of, let’s say, if there’s some exports or something going on.
Anita Anand: [00:22:53] So, you just have to understand what different pieces kind of fit together, and then be able to compare both of them, and see what works out better. In my experience, the conversations that I’ve had with clients, it really has been a toss you kind of go in thinking that, okay, a conversion might actually prove to be beneficial. But then, when you put that pen to paper, you see that maybe not and vice versa. So, it’s really, unfortunately, the facts and circumstances are going to dictate.
Michael Blake: [00:23:22] And, sometimes, the cure is worse than the disease.
Anita Anand: [00:23:25] Correct.
Michael Blake: [00:23:26] Right? So-
Anita Anand: [00:23:26] Yeah.
Michael Blake: [00:23:26] All right. So, I want take a step back for just a second because I’m sure some of our listeners don’t geek out on this accounting stuff. So, I want to take a step back and do a little bit of remedial tax accounting 101. And that is at the outset, generally, why do people check that box they’re going to be a pass-through entity to begin with versus a non-pass-through entity? What generally kind of drives that decision initially?
Anita Anand: [00:23:55] So, I think, first and foremost, the overarching benefit of having a pass-through entity is the fact that you truly get passed through of income loss, credits, deductions, whatever may be generated from the business. So, let’s take a structure. Let’s assume that we’ve got a partnership that owns a business. The business is profitable. And so, whatever income is generated from the business is reported at the partnership entity level.
Anita Anand: [00:24:26] So, the partnership itself will file a tax return, but the partnership itself does not pay an income tax. Instead, the partners get their pro-rata share of income, and all the other items of tax that are allocated to the partners. And then, they report their income on their personal income tax return based on whatever tax bracket they may be in. So, that’s your traditional pass-through. You don’t have the two layers of taxation, but you’re afforded, obviously, limited liability, right, with having a certain type of a limited liability in their partnership or S corporation.
Anita Anand: [00:25:00] Nowadays, like I was mentioning earlier, because of tax reform with this new deduction now, there’s an additional reason or an additional benefit to operate in the form of a pass-through, which is called this qualified business income deduction, which is up to a 20% deduction on certain types of income from certain types of qualified trades or businesses. The thing you need to know about tax is when the I–RS is offering a tax credit or a deduction, they’re qualifying it. So, you need to make sure you truly are eligible. But-
Michael Blake: [00:25:30] You can’t just say, “Hey, it’s all good.”
Anita Anand: [00:25:33] Exactly, right. You can’t just assume you’re going to be eligible for anything. So, there are quite a bit of caveats. And so, you want to make sure you’re eligible for it. But that is another benefit that’s afforded to pass-throughs that isn’t afforded to your traditional corporation.
Anita Anand: [00:25:48] And then, if you kind of go to — Let’s go to like an LLC structure, right. If you have an LLC with just one So, like I set up an LLC, I’m the only one in it, well, I’m afforded the limited liability from a legal standpoint, but for tax purposes, that LLC is treated as a disregarded entity. So, what that means is I don’t even have a compliance requirement at that LLC level, but I still get the benefit of the flow through.
Anita Anand: [00:26:17] So, flow-throughs have quite a bit of benefits, and there’s a little bit more flexibility associated as well with pass-through entities that aren’t necessarily available in the corporate structure. But I think those are kind of, I think, your main points that have had people gravitate towards a pass-through structure as opposed to some others.
Michael Blake: [00:26:38] Okay. Now, a big part of your practice, an increasing part of your practice is international, and you do a lot of work particularly in Latin America, but a bunch of other places too. Is this change in the law, this discussion of corporate form conversion, having an impact in companies doing a lot of international business?
Anita Anand: [00:26:58] It most definitely is. So, if you take a step back and try to understand part of what was going on from the legislative side in tax reform, I think, a lot of what the US was realizing was that US companies are choosing to do business in foreign jurisdictions because of the tax rates in the US. It’s that they were just too high. And so, there was an effort to try to incentivize businesses to bring those operations back into the US.
Anita Anand: [00:27:31] And so, part of it is bringing the corporate tax rate down from 35% to 21%. But then, there were other incentives that were added as part of the tax reform package that are only afforded to corporations that have an international presence that are not afforded to those that are operating through a pass-through entity.
Anita Anand: [00:27:50] So, for example, now, obviously, because the corporate tax rate has come down, it’s making it, (1), just more attractive; but (2), if you have, let’s say, a US company that is providing services or selling goods to an unrelated third-party, that happens to be a foreign person for ultimate foreign use and consumption, they’re eligible to tap into a tax deduction benefit that is only afforded to corporate taxpayers, not afforded to a partnership or an S corporation.
Anita Anand: [00:28:22] So, there’s that benefit that, again, if that’s, kind of, the line of business you’re in, that may tip the scale in the favor of operating in a corporate form. Other types of benefits, especially in the international space, what we have is a lot of US corporations that have ownership and controlled foreign corporations. And so, now, there’s received deduction for those dividends that are truly foreign-sourced. So, that’s an added benefit, again, only to corporate taxpayers.
Anita Anand: [00:28:56] But, also, in light of tax reform, there were also some new taxes that IRS decided, or Congress decided to go ahead and enact. And so, to to help offset the overall tax cost, there are deductions to help, like I said, offset that tax liability, but that deduction is only available to corporations not available to pass-through. So, a couple of those different pieces put together are making an impact, especially for those with an international presence. So, I think, the analysis is slightly different for those with a multinational footprint than those with just a domestic operation.
Michael Blake: [00:29:34] Okay. Let me switch gears here a little bit. I’d like to talk about a topic near and dear to my heart, which is startups. In my experience, most startups — Well, if a startup is going to start — If they think they’re going to raise venture capital, they may start out as a past-through, but they wind up migrating to being a C corporation.
Anita Anand: [00:29:55] Right, right.
Michael Blake: [00:29:55] They do that because, one, it allows them to issue multiple classes of stocks, like preferred shares; and the other is that venture capitalists don’t want to have passed-through gains.
Anita Anand: [00:30:06] Right.
Michael Blake: [00:30:07] They’re profits that they have to pay taxes on.
Anita Anand: [00:30:08] Right.
Michael Blake: [00:30:09] Because it deprives the company of cash. Is that calculus now changing because of the tax law? The tax law, now, driving something else.
Anita Anand: [00:30:20] Yes and no. And, I think, some of the considerations as it relates to startups remain the same. Typically, startups, what we see is that in the first few years, there’s just a lot of losses. And so, a pass-through structure is attractive for the reason that, as a name implies, is you get the pass-through of those losses to the individuals versus that getting trapped at a corporate level, right. So, if they had set it up as a corporation from the beginning, whatever losses are being generated, they get stuck at that corporation level, and they don’t really, or they’re not able to be realized, or benefits are not able to be realized at the individual shareholder level.
Anita Anand: [00:31:04] So, I think that consideration still holds true. But I think, to your point, what we have seen in the past and what we will probably continue to see is, over time, as they get closer to raising capital, there is going to be maybe not necessarily a tax decision that’s the primary driver but more so a business decision to elect to be treated as a C corporation instead, and more so because of the VC money. If the VCs are expecting it to be a corporate structure, they’re the ones that are bringing the money to the table. So, naturally we want to please them, right?
Michael Blake: [00:31:40] Yeah.
Anita Anand: [00:31:40] So, that’s what we’ve seen in the past, and I think we’ll continue to see that. I think, our experience has been that some VCs – and this is maybe where I defer to you – Some VCs, I think, are starting to get maybe a little bit more comfortable than what we used to see 10 years ago with a pass-through entity structure but, still, traditionally, I think, most still expect to see that corporate form in place.
Michael Blake: [00:32:00] Yeah. In my experience, I see Angel investors, particularly if they only have one or two investments, they’re okay with an LLC because when there are pass-through losses, they can actually use them, right, but if you’re an investor, and you’ve got eight of these startups, right, you’ll never be able to use all the losses. They’ll just expire before you’ll be able to use them, right?
Anita Anand: [00:32:24] Right, right.
Michael Blake: [00:32:24] So, you may as well go ahead, at least, in some of these entities, make it a C Corp because you can’t benefit from the past-through losses anyhow.
Anita Anand: [00:32:30] Right, right. The only thing that is just going to make that decision a little bit easier is that, obviously, if you’ve got a company that’s now choosing to be a C Corp because of VC money or whatever other reasons might be associated with it, it’s not that 35% income tax rate that you’re looking at that’s glaring at you with flashing lights and everything. It’s 21%, which seems to be a little bit more tolerable.
Michael Blake: [00:32:55] By the way, I’m going to note something to our listeners. This is the first time in my life I’ve said three correct accounting things in a five-minute period.
Anita Anand: [00:33:01] We’re so proud of you, Mike.
Michael Blake: [00:33:02] Thank you very much.
Anita Anand: [00:33:02] We are so proud of you.
Michael Blake: [00:33:03] Thank you very much. I’m going to give myself a little present at the end of the day. All right. So, this is, obviously, very complex, right? This is not something we can solve for anybody over a 30-minute — I don’t think you could solve with a 30-minute conversation directly with a client, right?
Anita Anand: [00:33:20] Right, right.
Michael Blake: [00:33:20] So, can you provide some guidelines on how to think about this decision, right? At least, some of these interests now piques like, “Gee, I’m a C. Maybe I ought to be a pass-through and start not pay so much in taxes.” What can they think about to make that decision to e-mail you, call you, decide if this is kind of a worthwhile pursuit on their part?
Anita Anand: [00:33:45] Right. I think, first and foremost, I think, you need to really sit down and take a step back. I think a lot of business owners, they kind of know what they’re expecting and what they want out of their business, but because they get involved sometimes in the day-to-day, we don’t necessarily just take a step back and really think about, “What is our strategic goal? What is our strategic vision for the business? What are we doing today? What am I wanting to do tomorrow, 5 years down the road, 10 years down the road?
Anita Anand: [00:34:14] Think of that. Map that part out because talking to your tax advisor or talking to your legal team, they’re not going to be able to give you those answers, right. That needs to be driven by the business owner. But once you have that strategy laid out, then, I think, it’s prudent to go ahead and initiate those conversations with a tax advisor and say, “Hey, you know what. This is kind of where I’m at right now. This is my current structure. This is what I’m expecting to do.”
Anita Anand: [00:34:39] Obviously, we understand we plan, and life a different plan for us. So, we understand that, but I think if you have a roadmap to start with, that, at least, prompts the conversation for discussion and considerations. And then, from there, talk about the benefits of kind of what benefits are they currently realizing versus what are the benefits that they could be realizing under a different structure.
Anita Anand: [00:35:04] And then, you really have to do the modeling. You really do. I would go on record and say that, I think, any type of a conversion without modeling is a little scary because, again, you’ve got to put the pen to paper and really see how it all shakes out. So, do the modeling. And then, once you kind of know how the numbers shake out, then, I think, there’s still a second layer of considerations in terms of, okay, now, administratively, what is the cost of conversion? What are going to be my legal fees? What are going to be my tax fees? Other non-tax considerations for example.
Anita Anand: [00:35:41] So, if you have a client that’s got a partnership, and modeling the C corporation might be a more advantageous tax structure. Okay. Now, you’ve got to think about corporate formalities, articles of incorporation. Do I need to have annual shareholder meetings? How are my minutes going to be recorded? So, there’s other stuff to think about that’s not necessarily just tax considerations. And so, the conversation needs to be not only with your tax advisor but also your legal team because all these pieces need to fit together like a proper puzzle.
Michael Blake: [00:36:14] And to be clear, when you say modeling, we’re not talking about getting on a runway and strutting down, but rather, it’s doing the math, right?
Anita Anand: [00:36:22] Absolutely.
Michael Blake: [00:36:23] Opening up a spreadsheet. And just, at some point in business, there’s just no substitute for grinding out the number, right?
Anita Anand: [00:36:31] Right, right.
Michael Blake: [00:36:32] And one of the things that you guys are doing, and we do, is we help you grind through the numbers.
Anita Anand: [00:36:36] Absolutely.
Michael Blake: [00:36:36] So, if somebody wants to — If someone’s not sure, the listener to this podcast who think, “I’m not sure, but I don’t want to waste Anita’s time. She seems really nice and busy,” can they just sort of call you and get kind of a consultation to see if it makes sense.
Anita Anand: [00:36:53] Oh, absolutely, absolutely. I mean, that’s what we’re doing for so many. And, honestly, I would encourage it because as a business owner, you should be thinking about it. At least, ask the question. The answer may be you’re absolutely fine, but be thinking about it, and have these conversations. And I will say that I don’t believe that this conversation is going to be a one conversation and be done with it because as we’ve spoken about earlier in this conversation is there’s still so much to be learned in light of tax reform. We’re still waiting on more guidance to come out.
Anita Anand: [00:37:26] So, the conversation may actually be more of a continuing conversation because, again, ultimately, you want to be making the best decision for you out of a position of being in possession of as much knowledge as you’ve had.
Michael Blake: [00:37:41] Being informed, right?
Anita Anand: [00:37:41] Right. You want to be informed. You want to be educated. And, like I said, if you convert you can’t really go back without there being some tax pain and cost associated with it. So, you want to be really sure. And then, also, weigh the fact that some people are talking about, what’s the certainty? Will tax law change again? Okay, if we go ahead and convert, down the road, now, the rules are completely different, then what happens? And that is a risk, that is a factor, but you’ve got to weigh that with maybe some of these other considerations and really see how the scale tips.
Michael Blake: [00:38:16] That sounds cool. Somebody got to really do a podcast about making informed decisions. Well, never mind.
Anita Anand: [00:38:21] Yeah.
Michael Blake: [00:38:23] So, if someone wants to ask you, if someone wants to reach out to you and pursue this, how can somebody get a hold of you?
Anita Anand: [00:38:29] Well, the good thing is I think I’m pretty flexible. People call all the time, e-mail all the time, LinkedIn, Facebook. I mean, I’ve got clients that reach out to me a form of different ways. And so, I would encourage anyone to reach out in however they feel fit. Email, call, and want to schedule an in-person meeting, happy to do that as well. But I would encourage that conversation with someone, whether it’s me or whoever, just people you feel comfortable with but, at least, be having that conversation with your tax advisor because I think it is high time. And if they haven’t brought it up to you, you should probably bring it up to them.
Michael Blake: [00:39:07] And what’s your e-mail address?
Anita Anand: [00:39:08] It’s aanand@bradyware.com. So, aanand@Brady.com.
Michael Blake: [00:39:17] All right. So, there you have it. Everything that you want to know about corporate form conversion but may or may not have been afraid to ask. But you shouldn’t be afraid asking more because Anita really knows her stuff, and she’s pretty cool too. So, do ask.
Anita Anand: [00:39:28] Thanks, Mike.
Michael Blake: [00:39:28] Do ask to ask her about it.
Anita Anand: [00:39:31] Happy to help.
Michael Blake: [00:39:33] So, I’m going to thank Anita for coming on. This is great. This is, literally, thousands of dollars of free advice that you’ve just given. So, that’s awesome. And that’s going to wrap it up for this program. I’d like to thank Anita so much for joining us and sharing her expertise with us.
Michael Blake: [00:39:33] We’ll be exploring a new topic each week so please tune in. So, when you’re faced with your next business decision, you have clear vision when making it. If you enjoy these podcasts, please consider leaving your review with your favorite podcast aggregator. It helps people find us, so that we can help them. Once again, this is Mike Blake. Our sponsor is Brady Ware & Company, and this has been the Decision Vision Podcast.
