LEGAL AND TAX STRATEGIES FOR BUSINESS by F0VftI

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									               LEGAL AND TAX STRATEGIES FOR BUSINESS

I   Business Entities

    A      The concept of legal persons

           1      Persons are

                  a      natural persons (i.e. human beings)

                  b      juristic persons (persons created by statute)

                         i      includes

                                *         general partnerships

                                *         limited liability partnerships

                                *         limited partnerships

                                *         limited liability companies

                                *         corporations

                                *         joint stock company--a shareholder
                                          organization in which the shareholders have
                                          the same liability as a partnership for the
                                          debts of the entity.

                                *         syndicate or investment group--an
                                          organization composed of members (persons
                                          and/or corporations and/or partnerships)
                                          who own property jointly and whose
                                          liability (depending on how they organize
                                          themselves under local law) can have the
                                          same liabilities as the owners of a
                                          partnership or corporation

                                *         trust--a "trustee" owns the assets and must
                                          manage them for the benefit of
                                          "beneficiaries" not himself

                                *         cooperative--entity organized to provide
                                          services to their member

                         ii     The above list of juristic persons is not exhaustive
    2      Juristic persons can

           a      own property

           b      enter into contracts through agents

           c      owe duties to their owners

           d      sue other persons (including one of their owners for
                  damages caused to the firm

           e      be sued for unpaid debts and have their property seized to
                  satisfy the debts

    3      owners of juristic persons

           a      must pay rent for their personal use of the firm’s property

           b      must reimburse the firm for their personal use of the firm’s
                  funds

           c      owe a duty of loyalty to the firm

                  i       can not personally exploit profitable opportunities
                          without first offering the opportunity to the firm

                  ii      cannot personally profit at the expense of the firm

                  iii     must abide by the agreement or other document
                          establishing the firm or the default operating rules
                          established by law

B   The general nature of common business entities

`   1      sole proprietorship

           a      one owner

           b      not a juristic person

           c      The owner has unlimited personal liability for the debts of
                  the firm

    2      the general partnership
    a       The partners manage the firm

    b       Each partner has unlimited personal liability for all of the
            debts of the firm, including any tort debts that result from
            the actions of his/her partners

    c       However, creditors must first seize partnership assets to
            satisfy the firm’s debts

    d       the personal assets of the partners can be seized only if the
            creditors have unpaid debts after they have seized the
            partnership’s assets

2   limited liability partnership—same as the general partner except
    that the individual partner is not liable for the tort debts that result
    from the actions of his/her fellow partners

3   limited partnership

    a       consists of general and limited partners

    b       the general partners manage the firm

    c       Each general partner has unlimited personal liability for all
            of the debts of the firm, including any tort debts that result
            from the actions of his/her partners

    d       Limited partners are not personally liable for the firm’s
            debts

            i       creditors can seize the assets that the limited partner
                    contributes to the firm in exchange for his/her
                    partnership interests

            ii      These assets belong to the partnership, which is a
                    separate legal person, who is the debtor.

            iii     The personal assets the limited partner cannot be
                    seized.


            iv      Thus, the limited partners have limited liability for
                    the firm’s debts unless they commit a tort while on
                    the firm’s business
                 e      Limited partners risk losing their limited liability if they
                        make managerial decisions or participate in decision
                        making

          4      the limited liability company

                 a      The owners manage the firm.

                 b      The owners are personally liable only for the tort damages
                        caused by the torts (if any)that they personally commit

          5      the corporation

                 a      The firm has a document called the Articles of
                        Incorporation or Foundation Deed or Charter that lists the
                        purposes and express powers of the corporation

                 b      The owners (i.e. shareholders) elect a Board of Directors
                        who manage the company

                 c      The owners are personally liable only for the tort damages
                        (if any) that they personally commit, subject to limited
                        exceptions to be discussed later.

II   CHOICE OF ENTITY

     A    An entrepreneur’s choice of entity depends on

          1      Who can be an owner under the governing entity statute

          2      whether the ownership interests will constitute publicly traded
                 securities.

          3      the supply of capital available to the entrepreneur under the various
                 forms of business entities

          4      the potential for opportunistic behavior that multiple ownership
                 creates

          5      the likelihood that the owners will disagree regarding the
                 withdrawal and reinvestment of profits

          6      the risk that the business entity might incur debts that exceed its
                 assets.

          7      the risk of personal liability for business debts
    8      whether the entrepreneur’s personal wealth can be seized by
           creditors to satisfy the unpaid business debts of the entity

    9      the non-entity income and wealth of the owner (s)

    10     anticipated governmental taxation of the entity from inception
           through possible liquidation

    11     the gift and estate tax.

B   The capital problem

    1      A sole proprietor’s capital is limited to

           a       the business owner’s personal net worth plus

           b       the funds that creditors will advance him to conduct his
                   business.

    2      types of credit

           a       secured—the entrepreneur and creditor agree that the
                   creditor can seize specified property and retain or sell it to
                   satisfy the entrepreneur’s debt to the creditor if the debt is
                   not paid according to the agreed upon terms without the
                   need of going to court.

                   i         non-recourse debt

                   ii        recourse debt

           b       unsecured—the entrepreneur and creditor do not agree that
                   the creditor can seize certain property in the event that the
                   debt is not paid according to the agreed upon terms.

                   i         If the debt is not paid as agreed, the creditor must
                             obtain a court judgment and find property that is not
                             pledged as security to some creditor.

                   ii        Unsecured credit is riskier to the creditor than
                             secured credit.

                   iii       Thus the creditor charges a higher interest rate if he
                             extends unsecured credit instead of secured credit.
          c      A creditor who appears to have extended secured credit
                 may actually have extended unsecured credit.

                 i       Ex:

                         *      Slick has an asset worth $10,000.

                         *      Slick borrows $7000 from creditor A and
                                creditor A and Slick agrees that that creditor
                                A can seize the asset if the credit is not
                                repaid as scheduled.

                         *      Slick also borrows $8000 from creditor B
                                and agrees that creditor B can seize the asset
                                if the credit is not repaid as scheduled.

                         *      One of these creditors has extended $5000
                                of unsecured credit.

                 ii      The later creditor is the unsecured creditor provided

                         *      the later credit was NOT given for the
                                purchase of purchasing the asset that serves
                                as collateral (i.e. the secured credit does not
                                constitute a purchase money security
                                interest), AND

                         *      The earlier creditor complied with the filing
                                requirements of the Uniform Commercial
                                Code and registered their secured status.

    2     An entrepreneur can increase his access to capital at any given
          interest rate by sharing ownership of the business with others.

          a      More than the entrepreneur’s net worth is available to fund
                 the business

          b      Additionally, if the owners’ entire personal net worth is
                 available to creditors, creditors are willing to advance
                 larger sums to the business because there is more than one
                 person to whom a creditor can look for payment.

C   The problem of multiple owners

    1     When a firm has multiple owners, no owner bears the entire cost of
          a decision that imposes costs upon the firm.
    a      As a result, some of the owners may engage in
           opportunistic behavior

           i       Ex:    Slick, an owner and the Marketing
                   Manager, uses some of the marketing budget to
                   purchase a Mercedes for use in the business.

           ii      Ex:    Slick hires his wife as his personal secretary
                   and pays her 50% more than any other secretary

           iii     Both actions reduce profits, but the decline in
                   Slick’s share of the profits is 1/3 of the reduction

    b      Some of the multiple owners may not take the same degree
           of care in their management decisions that they would take
           if they were the sole owner of the business

           i       Ex: Slipshod, an owner and the Personnel Manager,
                   checks only one of the references of an employment
                   applicant.

           ii      Ex: Slipshod, an owner and Personnel Manager,
                   takes the word of an employee about how much the
                   general wage rate of secretaries have increased in
                   the area instead of ascertaining the fact from
                   available governmental statistical sources.

2   The owners may have different cash flow preferences

    a      ex:

3   Entity law attempts to prevent opportunistic or careless behavior
    by a set of governance rules encompassed in business entity
    statutes.

    a      Ex: partnerships—routine partnership decisions require a
           majority vote and strategic decisions (decisions that would
           change the nature of the firm) require a unanimous vote

    b      Ex: corporation: Routine management decisions are made
           by a Board of Directors, who are elected by the
           shareholders.

           i       Routine decisions require a majority vote of the
                   members of the Board
                   ii      Non-routine decisions require a super-majority of
                           the stock, but not 100% of the stockholders

D   The general nature of business entity statutes

    1      The statute writes rules of governance that apply to the entity
           unless the owners agree otherwise.

           a       ex: corporation—A shareholder may not withdraw profits
                   from the corporation unless a majority of the Board of
                   Directors votes to declare a dividend or to liquidate the
                   corporation.

           b       ex: partnership--a partner has an absolute right to withdraw
                   his share of the profits from the partnership

    2      Must know the default rules set by the statute in order to decide
           whether to accept them or to attempt to negotiate different
           governance rules..

    3      Also must know which rules can be changed by agreement of the
           owners and which cannot.

           a       ex: partnership rules--The rule that withdrawal of a partner
                   dissolves the partnership cannot be varied

           b       Ex: corporations: The rule that a Board of Directors
                   manages a corporation cannot be varied.

           c       If a governance rule of an entity is unacceptable and
                   cannot be altered, the entrepreneur should consider an
                   alternate form of business entity

E   Governance issues that should be considered

    1      What percentage of the firm should each owner own?

    2      What rights of withdrawal do the owners have?

           a       withdrawal at will?

           b       do the existing owners have the right to approve substituted
                   owners?

                   i       sale of interest
           ii      succession by inheritance

           iii     succession by divorce

           iv      succession by sheriff’s sale

           v       succession by sale of interest by bankruptcy trustee?

    c      Does it make sense to approve giving the original owners
           pre-emptive rights—i.e. the right of first refusal?

3   Do existing owners have the right to approve the sale of additional
    ownership interests?

4   Which owners, if any are the firm’s agents?

5   What managerial rights do the owners have?

    a      What contracts, if any, require unanimous owner approval
           before the entity’s agent has authority to enter into the
           contract.

    b      What contracts, if any, require the approval of a
           supermajority of owners (but not unanimity) before the
           entity’s agent has the authority to enter into the contract?

    c      What contacts, if any, require a simple majority of owners
           before the agent has authority to enter into the contract?

    d      What contracts, if any, do not require ownership approval
           for the agent to have authority to enter into the contract?

    e      What consultation rights, if any, do owners have before the
           entity’s agents have the right to enter into a contract?

5   What is the required frequency of ownership meetings

6   What rights, if any, do the owners have to withdraw assets from
    the firm?

    a      guaranteed payments

    b      operating profits
           c       withdrawal as a result of relinquishing an ownership
                   interest

           d       withdrawal as a result of liquidation of the firm


    7      What rights does each owner have to the firm’s assets upon
           liquidation of the firm?

F   Default rules regarding ownership and management rights (should check
    the specific state statute for individual state deviations from the general
    rule)

    1      default ownership rules

           a       general partnership—the owners have equal shares
                   regardless of the amount of capital invested or the hours of
                   work done for the firm

           b       limited liability partnership—same as general partnership

           c       limited partnership—the ownership interest depends on the
                   amount of capital contributed

           d       limited liability company-same as general partnership

           e       corporation

                   i       the ownership interest depends on the amount of
                           capital contributed

                   ii      the concept of “watered” stock

                           *      An investor who contributes 25% of the
                                  capital and receives a 40% ownership
                                  interest, and claims to have contributed 40%
                                  of the capital, is liable to the firm’s creditors
                                  for the difference if the firm does not pay its
                                  creditors

                           *      ex:

    2      default rules regarding management rights
           a       who are agents of the entity (i.e. who can sign contracts and
                   obligate the firm)
    i      general partnership—all the partners

    ii     limited liability partnership-all the partners

    iii    limited partnership—all the general partners

    iv     limited liability company—all the owners

    v      corporation—the corporation president

b   control of the agents

    i      An agent who acts without authority and harms his
           principle must pay the principal’s damages unless
           the principal ratifies (approves) the decision

    ii     general partnership

           *       Routine decisions (decisions which do not
                   materially change the nature or risks taken
                   by the partnership) require a majority vote
                   of the partners before an agent is authorized
                   to act

           *       Each partner has one vote, no matter how
                   much capital he contributed

           *       non-routine decisions require a unanimous
                   vote of the partners before an agent is
                   authorized to act

    iii    limited liability partnership—same as a general
           partnership

    iv     limited partnership

           *       routine decisions (decisions which do not
                   materially change the nature or risks taken
                   by the partnership) require a majority vote
                   of the general partners before an agent is
                   authorized to act

           *       non-routine decisions require a unanimous
                   vote of all of the partners before an agent is
                   authorized to act
    v      limited liability company—same rules as the
           general partnership, except, of course that the
           owners are called owners, not partners

e   corporation

    i      Any act within the express or implied powers of the
           corporation (other than a merger or consolidation)
           can be authorized by a majority vote of the Board of
           Directors

    ii     Any act not within the express or implied powers of
           the Articles of Incorporation requires an
           Amendment of the Articles which requires a super
           majority vote of approval by the owners (i.e. the
           shareholders)

c   right to personally withdraw from the firm

    i      general partnership—can do so at any time

           *      withdrawal results in dissolution and
                  liquidation of the partnership

           *      The default rule is that a partnership can be
                  dissolved and liquidated at any time unless
                  the partners agree otherwise

           *      Thus, in the absence of an agreement to the
                  contrary, a partner can withdraw from the
                  partnership at any time

           *      A partner who withdraws when there is an
                  agreement that the partnership cannot be
                  dissolved and liquidated for a specified time
                  period is liable to his fellow partners for any
                  damages that he causes

    ii     limited liability partnership—same as the general
           partnership

    iii    limited partnership

           *      absolute right of withdrawal
           *       withdrawal with notice (usually 6 months
                   notice) for limited partners

    iv     limited liability company

           *       an owner can withdraw by selling his
                   interest at any time without withdrawing his
                   capital

           *       can withdraw and receive his capital upon
                   giving proper notice

    v      corporation—can withdraw by selling his interest at
           any time without dissolving and liquidating the
           corporation


d   right to approve substituted owners

    i      general partnership—requires unanimous approval
           by the partners

    ii     limited liability partnership—same as the general
           partnership

    iii    limited partnership—requires unanimous approval
           of all the partners

    iv     limited liability company—requires unanimous
           approval of all the owners

    v      corporation—existing owners have no right to
           prohibit a new owner from replacing an old owner


e   right to approve additional ownership interests

    i      general partnership—requires unanimous approval
           of the partners

    ii     limited liability partnership—same as the general
           partnership

    iii    limited partnership—same as the general
           partnership
           iv     limited liability company—requires unanimous
                  approval of the existing owners

           v      corporation

                  *       requires a majority vote of the Board of
                          Directors if all of the shares of stock
                          authorized by the Articles of Incorporation
                          have not been sold

                  *       requires a super majority vote to amend the
                          Articles of Incorporation to authorize the
                          sale of additional shares if all shares of stock
                          authorized by the Articles of Incorporation
                          have been sold previously

    f      right of existing owners to maintain relative voting power,
           relative share of operating profits and relative share of the
           assets upon liquidation when the firm decides to sell
           additional ownership shares (i.e. right to have the first
           opportunity to purchase the interest)

           i      general partnership—no right

           ii     limited liability partnership—no right

           iii    limited partnership—no right

           iv     limited liability company—no right

           v      corporation—depends on the statutes in the
                  jurisdiction that issues the corporate license

3   right to examine the books and records of the firm

    a      general partnership—absolute right

    b      limited liability partnership—absolute right

    c      limited partnership—absolute right

    d      limited liability company—absolute right

    e      corporation—only for a proper purpose
4   default rules regarding the individual owner’s right to withdraw
    assets

    a      right to withdraw assets = to operating profits

           i       general partnership—absolute right

           ii      limited liability partnership—absolute right

           iii     limited partnership—absolute right

           iv      limited liability company—absolute right

           v       corporation

                   *      no right unless

                                  the Board of Directors, by majority
                                  vote, decides to pay a dividend

                                  the dividend is less than or equal to
                                  the sum of operating profits plus
                                  earnings retained from previous
                                  operating profits

                   *      shareholders are personally liable to the
                          firm’s creditors for any part of a dividend
                          that leaves the firm with insufficient funds
                          to pay creditors if they knew that the
                          dividend would leave the firm unable to pay
                          creditors

    b      right to withdraw assets equal to the value of their capital
           investment when the firm does not liquidate

           i       general partnership-requires unanimous approval of
                   all partners

           ii      limited liability partnership-same as general
                   partnership

           iii     limited partnership—same as general partnership

           iv      limited liability company—same as general
                   partnership
           v       corporation—requires majority vote of the Board of
                   Directors


    c      right to liquidate the firm (i.e. the right to sell the firm’s
           assets, pay the firm’s creditors, distribute what remains to
           the owners and to stop doing business)

           i       general partnership—requires unanimous vote of
                   the partners, which can occur at any time

           ii      limited liability partnership—same as general
                   partnership

           iii     limited partnership—same as general partnership

           iv      limited liability company—same as general
                   partnership

           v       corporation

                   *       majority of Board of Directors must agree

                   *       a supermajority (2/3 to 80%) of the owners
                           must agree, the exact percentage depending
                           on the licensing jurisdiction

                   *       the vote can take place at any time

5   required frequency of ownership meetings

    a      general partnership--none

    b      limited liability partnership—none

    c      limited partnership--none

    d      limited liability company--none

    e      corporation—at least one per year

6   right to control the method of expansion of the firm

    a      general partnership
    i      borrowing money requires a majority vote of the
           partners

    ii     mortgaging substantially all of the firm’s assets
           requires a unanimous vote of the partners

    iii    selling new ownership interests (i.e. admitting new
           partners) requires a unanimous vote of the partners

b   limited liability partnership—same as a general partnership

c   limited partnership

    i      borrowing money requires a majority vote of the
           general partners

    ii     mortgaging substantially all of the firm’s assets
           requires a unanimous vote of the general partners

    iii    selling additional ownership interests (i.e. admitting
           new partners) requires a unanimous vote of all of
           the partners

d   limited liability company—requires the unanimous
    approval of existing owners

e   corporation

    i      borrowing money requires a majority vote by the
           Board of Directors, no matter how large the
           borrowing is

    ii     selling additional ownership interests

           *       requires a majority vote of the Board of
                   Directors if all of the shares of stock
                   authorized by the Articles of Incorporation
                   have not been sold

           *       requires a super majority vote to amend the
                   Articles of Incorporation to authorize the
                   sale of additional shares if all shares of stock
                   authorized by the Articles of Incorporation
                   have been sold previously
           iii     merger or consolidation with another corporation
                   requires

                   *       approval of a majority of the Board of
                           Directors AND

                   *       approval of a supermajority of the
                           shareholders at a properly called
                           shareholders’ meeting

           iv      purchasing all of the assets of another firm requires
                   approval of a majority of the Board of Directors.

           v       selling all of the firm’s assets to another firm
                   requires the approval of

                   *       a majority of the BOD and

                           *       a super majority of the shareholders

7   Liability of the owners for the debts of the firm

    a      general partnership

           i       the partners are personally liable for all of the firm’s
                   debts, including the torts committed by his fellow
                   partners while on the firm’s business

           ii      debts are shared equally

           iii     If one partner pays more than his share of the debts,
                   he has a right to be reimbursed for his excess share
                   of the payments by his fellow partners

    b      limited liability partnership
           i       the partners are personally liable for all of the firm’s
                   debts, except the torts committed by his fellow
                   partners while on the firm’s business

           ii      debts are shared equally except for the torts
                   committed by one’s fellow partners


           iii     If one partner pays more than his share of the debts,
                   he has a right to be reimbursed for his excess share
                   of the payments by his fellow partners
c   limited partnership

    i      the general partner(s) are personally liable for all of
           the firm’s debts, including the torts committed by
           his fellow partners while on the firm’s business

    ii     debts are shared equally by the general partners

    iii    If one general partner pays more than his share of
           the debts, he has a right to be reimbursed for his
           excess share of the payments by his fellow partners

    iv     limited partners have personal liability only for torts
           (if any)that they personally commit while on
           company business

d   limited liability company—same as the corporation

e   corporation

    i      the owners’ liability is limited to the assets that they
           have invested in the firm

    ii     owners are personally liable only for the torts that
           they personally commit while on company business

    iii    exceptions to the limited liability rule

           *       watered stock

           *       the business was risky, capital was
                   inadequate to compensate potential tort
                   victims and the firm carried inadequate or
                   no insurance

           *       corporate formalities were not observed—
                   required meetings were not held, actions
                   were taken without being authorized by the
                   Board of directors and corporate funds were
                   not kept in bank accounts in the
                   corporation’s name

           *       the corporation was used to defraud
                   creditors
                           *         A controlling stockholder used his power to
                                     have the corporation operated for his own
                                     benefit at the expense of the other owners

                           *         An owner appropriated a corporate
                                     opportunity and profited at the expense of
                                     the corporation

E   Taxation rules affecting the choice of entity

    1      A domestic unincorporated entity can elect (i.e. choose) to be taxed
           as a corporation or a pass through entity.

    2      If the domestic unincorporated entity has a single owner, it can
           elect to be taxed as

           a       an S corporation (assuming each owner meets the
                   classification required for the entity to have S status) or

           b       as a partnership

    3      If the unincorporated entity has multiple owners, it can elect to be
           taxed as

           a       an S corporation (assuming each owner meets the
                   classification required for the entity to have S status) or

           b       a partnership

    4      Limitations on the election of S status

           a       Only the following persons and entities may own shares in
                   an S corporation.

                   i       U.S. citizens and resident aliens

                   ii      estates

                   iii     certain trusts

           b       A corporation cannot elect S status if it has more than 75
                   shareholders.

           c       A corporation may not elect S status if it has more than one
                   class of stock.
4   capitalizing the entity

    a      IRC section 724 (applies to pass through entities other than
           a sole proprietorship and an S corporation)

           i       A person does not recognize any gain on property
                   that he transfers to an entity in exchange for an
                   ownership share in the entity

           ii      However, the entity’s basis in the property (i.e.
                   inside basis) is the same as the basis of the property
                   in the hands of the former owner

           iii     The basis of the ownership interest acquired in the
                   entity (outside basis) is equal to the partner’s share
                   of the total basis of the entity in the property owned
                   by the entity.

           iv      ex:

                   *          three U.S. citizens form an entity in which
                              each has a 1/3 interest and elect to have the
                              entity taxed as a pass through entity

                   *          A provides $50,000 cash for his share

                   *          B pays for his share with an office building
                              that has a fair market value of $50,000 and
                              for which B paid $30,000 and on which he
                              has taken $10,000 worth of depreciation.

                   *          C pays for his share with equipment that has
                              a fair market value of $50,000 for which C
                              paid $90,000 and on which he has taken
                              $30,000 of depreciation

                   *          IRC section 721 establishes the entity’s
                              basis in the assets transferred by A, B, and C
                              (inside basis) as $50,000 + $20,000 +
                              $60,000 = $130,000

                   *          IIRC section 721 establishes the basis of A’s
                              ownership interest as $50,000, B’s basis as
                              $20,000 and C’s basis as $60,000
     *      If A sells his ownership interest in the entity
            for $300,000 he will realize $46,667 of
            capital gain income on his/her personal
            return.

v    To prevent the conversion of ordinary income into
     capital gain, and the conversion of capital losses
     into ordinary losses, there are special rules for
     contributed receivables, inventory and losses

     *      The partnership recognizes ordinary income
            from the collection or sales of any
            unrealized receivables that were contributed
            to the entity for an ownership interest.

     *      The partnership recognizes ordinary income
            from the sale of any inventory that was
            contributed to the entity for an ownership
            interest and sold within 5 years from transfer

     *      The partnership realizes a capital loss on any
            property whose fair market value exceeds its
            basis at the date of its contribution to the
            entity if is sold as a loss within 5 years of its
            contribution to the entity.

            The amount of capital loss = min (fair
            market value on date of contribution – basis,
            sale proceeds – basis)

vi   exceptions to the non-recognition rule

     *      disguised exchanges—After X contributes
            real estate worth $50,000 to the entity and Y
            contributes stock worth $50,000, the entity
            distributes the stock to X and the real estate
            to Y.

     *      disguised sales—A contributes real estate
            with a fmv of$50,000 and a basis of $30,000
            to the entity and receives a distribution of
            $50,000 cash shortly thereafter

     *      ownership interest given in exchange for
            previously performed services
b   IRC section 351

    i     No gain is recognized on property transferred to an
          entity in exchange for stock if

          *      after the exchange, the person (or persons)
                 transferring the property in exchange for
                 stock own 80% or more of the total voting
                 of all classes of stock entitled to vote AND

          *      they also own 80% of the remaining shares
                 of stock immediately after the exchange,
                 AND

          *      the corp does not assume a liability attached
                 to the property that exceeds the property’s
                 basis

                 The transferor recognizes income equal to
                 the amount. if any, by which the liability
                 exceeds the property’s basis.

          *      The exchange does not have to be
                 simultaneous if more than one person is
                 involved if the transaction is an integrated
                 one.

          *      Stock does not have to be issued in the same
                 proportion as the value of other property, but
                 if it is not, one shareholder makes a gift (or
                 possibly a sale) to another.

          *      However, if a person who has performed
                 services for the corporation transfers a
                 property that is less than 10% of the value of
                 services that he provided and received a
                 disproportionate amount of stock, the IRS
                 may not count his stock in the number of
                 shares owned by the other property
                 transferors, resulting in the loss of the
                 benefits of section 351

                        ex:

                        A and B each transfer $50,000 of
                        property to a new corporation in
                      exchange for 1/3 of the stock and C,
                      who has provided $48,000 of
                      services transfers $2000 of property
                      for 1/3 of the stock

                      Section 351 probably does not apply
                      since C’s stock is probably not
                      counted in determining whether the
                      80% control req is met and A and B
                      have only 2/3 of the stock

                      A , B and C recognize gain equal to
                      fmv – basis on their property transfer

      *       Control can be lost immediately after the
              issuance of the stock provided there was no
              pre-arranged plan to do this

ii    The corporation’s basis in the acquired property is
      the same as the basis of the property in the hands of
      the former owner plus any gain recognized by the
      transferor on his tax return

iii   Also, the basis of the former owner’s ownership
      interest in the stock he receives is equal to the basis
      of the property that he exchanged for the stock less
      any liability assumed by the corporation plus any
      gain recognized on his tax return as a result of the
      transfer

iv    ex:

      *       three U.S. citizens form a corporation with
              one class of stock in which each owns 1/3 of
              the stock

      *       A provides $50,000 cash for his share

      *       B pays for his share with an office building
              that has a fair market value of $50,000 and
              for which B paid $30,000 and on which he
              has taken $10,000 worth of depreciation.

      *       C pays for his share with equipment that has
              a fair market value of $50,000 for which C
              paid $90,000 and on which he has taken
                           $30,000 of depreciation and on which he
                           owes a $60,000 debt, which the corp
                           assumes

                   *       IRC section 351 gives A a basis of $50,000
                           in his ownership interest, B a basis of
                           $20,000 in his ownership interest and C a
                           basis of $10,000 in his ownership interest..
                           (C also recognizes $10,000 of income on his
                           tax return).

                   *       If the corporation sells its assets and
                           liquidates, and has $300,000 remaining after
                           paying its obligations, and A,B and C have
                           the above basis in their stock, A will report
                           50,000 of income on his personal tax return,
                           B will report $80,000 and C will report
                           $90,000.

5   operating the entity

    a      partnerships, LLC’s and LLP’s

           i       member allocations

                   *       do not have to be proportionate to the
                           members capital contributions as long as
                           they have an economic effect and do not
                           reallocate pre-contribution gain or loss


                           ex: Allocating interest from tax free bonds
                           to a member in the highest tax bracket solely
                           because of his tax bracket would not be
                           permitted and would result in reallocation

                           ex: Allocating interest earned by tax free
                           bonds to a member in the highest tax bracket
                           because he exchanged these bonds for his
                           partnership interest and bargained for this
                           result sould be permitted by the IRS

           ii      guaranteed payments

                   *       is a payment for services performed by the
                           partner or for the use of his capital
      *      can be deductible or capitalized and
             amortized, depending on the nature of the
             arrangement

      *      are treated similar to salary (if for services
             or interest payments (if for use of capital)

      *      are deductible against the entity’s income
             and reduce the profits available for division
             among the entity’s members

      *       create ordinary income for the member

      *      can create an ordinary loss for the entity


iii   loss limitations

      *      a member’s operational loss deductions
             cannot exceed the amount that the member
             has at risk as a result of his investment in the
             entity

             amount at risk = adjusted basis –
             nonrecourse debt + real estate nonrecourse
             financing provided by a bank, retirement
             plan, similar party or the govt.

      *      a member’s operational loss deduction
             cannot exceed the adjusted basis of the
             member’s interest in the entity (and reduce
             the adjusted basis by the

             capital contributions, withdrawals and entity
             income is taken into account before losses in
             determining the
          *      No loss recognized on sale of property when
                 the member owns directly or indirectly more
                 than 50 percent of the entity’s capital or
                 profits

          *      If the property is later sold at a profit, the
                 previous loss can be used to offset the gain

    v     members are not considered employees

          *      Partners pay self employment tax on
                 partnership income

          *      LLC owners do not pay self employment tax
                 on LLC income

    vi    reporting operating results

          *      items that could affect individual member’s
                 personal income tax liabilities (such as
                 charitable contributions) must be reported
                 separately and allocated to the individual
                 partners

          *      Items which do not have this effect (such as
                 ordinary income) can be aggregated and
                 remain unallocated

b   C corps

    i     distributions to shareholders w/o a surrender of
          stock

          *      corp recognizes gain = fmv of the property –
                 adjusted basis in the property

          *      shareholder recognizes ordinary income if
                 the corp has E & P equal to or exceeding
                 the fmv of the distribution

          *      If the corp has no E & P, it is a non-taxable
                 return of capital as long as the distribution
                 does not exceed the basis of the shareholder
                 in his stock
      *      If the corp has no E & P, and the basis of the
             shareholder’s stock is zero, the distribution
             is a capital gain

      *      All of the above three results could occur as
             a result of a distribution depending on the
             value of the distribution, the value of the E
             & P and the value of the shareholder’s
             adjusted basis in his stock

      *      If the shareholder recognizes gain, the
             amount of gain = fmv of the property
             received – corp adjusted basis in the
             property

             ex: cash dis tribution

             ex: appreciated property distribution

ii    non-liquidating distributions in which the
      shareholder surrenders stock in exchange for the
      distribution

      *      this is a redemption

      *      shareholder recognizes ordinary income =
             value of the property received – adjusted
             basis of the property – adjusted basis of the
             stock UNLESS

                    all of the shareholder’s stock is
                    redeemed; OR

                    the shareholder is a minority
                    shareholder after the transaction and
                    surrendered at least 20% of his stock

                    Under either of these situations, the
                    income is capital gain

      *      corp recognizes income = fmv of the
             property distributed – corp adjusted basis in
             the property

iii   tax on accumulated earnings
              *      taxes earnings that have not been
                     accumulated in excess of business needs

              *      there appears to be a $250,000 safe harbor

    iv        personal holding company tax

              *      is generally considered a PHC if

                     5 or fewer persons own more tham 50% of
                     the stock at any time during the last half of
                     the year, AND

                     60% or more of the corp’s income is passive
                     income

              *      tax rate is 39.6%


              *       IRS cannot impose both the accumulated
                     earnings tax and the PHC tax in the same tax
                     year.
c   S corps

    i         An S corp that was previously a C corp has to pay a
              35% tax on any appreciated property that it had at
              the time that it made the S election .if it disposes of
              the asset within 10 years of the election in a taxable
              disposition

                     unexpired NOL’s and capital losses from the
                     C years can be used to reduce the gain

                     business credit carryovers and alt min tax
                     carryovers can be applied against the tax

    ii        Built in gain (less the corp tax paid) passes through
              to the shareholder and must be included in income

    iii       An S corp that was previously a C corp and used the
              LIFO method of inventory valuation the year before
              the election pays a tax on the difference between the
              LIFO and FIFO inventory values

    iv        limitation on loss deductions
*   a member’s operational loss deductions
    cannot exceed the amount that the member
    has at risk as a result of his investment in the
    entity

    amount at risk of shareholder = cash +
    adjusted basis of other property contributed
    to the corp + amounts borrowed for use in
    the activity for which the shareholder is
    personally liable + the net fair market value
    of personal assets that secure non-recourse
    borrowing

*   a member’s operational loss deduction
    cannot exceed the adjusted basis of the
    shareholder’s stock + any loans the
    shareholder made to the corporation(and
    reduce the adjusted basis by the amount of
    the loss)

            A flow through loss reduces the
            shareholder’s adjusted basis in his
            stock

            If the adjusted basis of the stock = 0,
            any flow through loss that is reduces
            the shareholder’s adjusted basis in
            the debt that the corp owes him

            If the stockholder has no basis in his
            stock or in corp debt owed to him,
            the nol is carried forward to
            subsequent years

            Debt basis is restored first and then
            stock basis

            A suspended loss from a previous
            year reduces stock basis first and
            then debt basis

*   A shareholder’s operational loss deduction
    cannot exceed the amount of passive income
    earned by the shareholder, with unused
    losses carried forward to future years IF
                                     a shareholder does not materially
                                     participate in the business, OR

                                     the business activity consists of
                                     rental activity

           v       passive investment income that exceeds 25% of
                   gross receipts is taxed at the 35% rate if the corp
                   has accumulated earnings and profits from its years
                   as a C corp.

           vi      reporting operating results

                   *         items that could affect individual member’s
                             personal income tax liabilities (such as
                             charitable contributions) must be reported
                             separately and allocated to the individual
                             partners

                   *         Items which do not have this effect (such as
                             ordinary income) can be aggregated and
                             remain unallocated

6   liquidating the entity

    a      partnerships, LLC’s and LLP’s

           i       entity pays no tax on the appreciated value of
                   property that it owns

           ii      Any property distributed to members has the same
                   basis that it did when the entity owned it.

           iii     member pays tax no tax on the appreciated value of
                   the property that he receives in a liquidating
                   distribution unless

                   *         member receives cash or marketable
                             securities in excess of his basis in his
                             ownership interest the entity, or

                   *         his share of entity liabilities declined below
                             the basis of his ownership interest in the
                             entity or
           *         property that he contributed to the entity was
                     distributed to a different member of the
                     entity within 7 years of the contribution of
                     the property to the entity

    iv     losses

           *         partnerships--

           *         LLC’s

b   C corporations

    i      methods

           *         corp sells its assets, pays the corporate debts
                     and distribute the remaining proceeds to its
                     shareholders

           *         if it has sufficient cash, corp pays its debts
                     and distributes the remaining corp assets to
                     the shareholder

           *         a mix of the above two methods

    ii     corp level taxation

           *         corporation recognizes income on the
                     difference between fmv and basis for any
                     property that it owns any property that it
                     owns

           *         If the income is capital, capital losses can be
                     deducted to the extent of the capital gains

           *         If capital losses exceed capital gains, the
                     excess can be carried back three years and
                     forward five years

           *         capital losses cannot be used as a deduction
                     against ordinary income

    ii     shareholder level taxation

           *         shareholder pays tax on the difference
                     between fmv of any property that he
                     receives in liquidation minus his basis in his
                     stock

           *         losses

                              whether the loss is ordinary or
                              capital depends on the nature of the
                              asset

                              ordinary losses are always deductible

                              capital losses in excess of $3000
                              cannot be deducted unless the
                              taxpayer has capital gain income

                              If there is capital gain income, the
                              deduction is limited to the amount of
                              capital gain income plus $3000

                              unused capital losses are carried
                              forward (not back) to future tax years

c   S corporations

    i      corporation pays no tax on the appreciated value of
           any property that it owns

    ii     shareholder pays tax on the difference between fmv
           of any property that he receives in liquidation and
           the basis of the property

    iii    losses

           *         whether the loss is ordinary or capital
                     depends on the nature of the asset

           *         ordinary losses are always deductible

           *         capital losses in excess of $3000 cannot be
                     deducted unless the taxpayer has capital gain
                     income

           *         If there is capital gain income, the deduction
                     is limited to the amount of capital gain
                     income plus $3000
                                 *       unused capital losses are carried forward
                                         (not back) to future tax years

II   BUYING OR SELLING A GOING BUSINESS

     A    First step is for the buyer (seller) to obtain enough information about the
          target business to make initial decisions about

          1      The desirability of the acquisition (sale)

          2      the likelihood of negotiating a mutually satisfactory price

          3      the best way to structure the purchase (sale), if it occurs.

     B    Topics for investigation and inquiry re the seller

          1      financial statements and tax returns for the past several years

                 a       will reveal

                         i       the target firm’s assets

                         ii      the nature and extent of seller's obligations

                         iii     the structure of ownership

                         iv      other items of importance

                 b       Tax returns should be reviewed for consistency with other
                         financial information

                 c       Tax returns should be reviewed for for potential audit
                         problems

                 d       Both federal and state tax returns should be examined

          2      the firm’s assets

                 a       determine what assets the target business owns

                         i       obtain title reports on real property

                         ii      examine bills of sale to determine ownership of
                                 personal property
           iii     conduct a lien search on real and tangible personal
                   property

                   *      search the records of the appropriate
                          governmental office

                                  Sec of State— non-agricultural
                                  personal property except motor
                                  vehicles, aircraft and ships

                                  County Auditor—real property and
                                  some agricultural personal property

                   *      view the property

    b      evaluate the condition of the property

3   evaluate the target firm’s contracts and agreements

    a      determine

           i       the sellers commitments and entanglements

           ii      the transferability of the rights and obligations in
                   the agreement

           iii     the appropriate procedures to follow to obtain the
                   transfer of contractual rights

           iv      the length of time an obligation exists under an
                   undesirable contract (or benefits can be obtained
                   under a desirable contract)

    b      It is best to obtain third party consents to the transfer of
           rights early because the bargaining power of the third party
           increases as the closing date approaches

    c      special contractual issues

           i       supplier contracts--there may be financial criteria
                   that the buyer must meet before the seller is
                   obligated to do business or supply goods on the
                   same credit terms

           ii      customer contracts
             *       need to evaluate the financial situation of
                     key customers

             *       need to assess the continued viability of key
                     customers

             *       need to meet with key customers as soon as
                     possible and establish a personal
                     relationship

d   leases

    i        can rights under the lease be transferred

    ii       Is the seller in default

e   employment contracts

    i        Will the buyer be obligated by any long term
             contracts that the seller has with the buyer

    ii       Are key employees subject to long term contracts
             enforceable by the buyer

f   labor contracts with unions

g   loans

    i        Loans usually require the lender's approval before a
             buyer can assume the seller's obligation and obtain
             the seller's release from the obligation

    ii       loans may contain a due on sale clause

    iii      Buyer may need to negotiate new and different
             financial covenants and conditions

h   insurance

    i        Is coverage adequate

    ii       ensure the sale will not result in coverage gaps

             *       seller has a claims paid policy

             *       buyer acquires an "occurrence" policy
                           *       There is no coverage of a claim that arose
                                   prior to closing but is not asserted until after
                                   closing

                   iii     Can insurance policies be transferred to the buyer

                   iv      How should previously paid premiums be allocated

    4      claims and litigation

    5      customer lists and information

           a       historical buying habits of customers

           b       investigate significant customers

                   i       What is their financial situation?

                   ii      What is their continued viability as a customer

    6      Corporate documents

           a       Has the corporation observed corporate formalities

           b       examine minutes of stockholder and Board of Directors
                   meetings

C   If the information that the buyer seeks is not in the public domain, the
    acquiring business will have to convince the target business to disclose it
    voluntarily.

    1      The target business may be unwilling to provide the information
           without a confidentiality agreement, particularly if the information
           constitutes a business secret.

    2      Minimum contents of a confidentiality agreement

           a       specification of the persons to whom the information can
                   be disclosed

           b       a commitment that the information will be used only for
                   evaluating a potential purchase

           c       a specific commitment that the information will not be used
                   for a competitive purchase
           d       provision for return of

                   i      all tangible evidence (such as documents and copies
                          of documents) and

                   ii     certified destruction or return of all notes or other
                          records made by the party to whom disclosure is
                          made

           e       exemption of information that becomes available to the
                   acquiring party through legitimate means other than the
                   disclosure of the parties

           f       a prohibition against revealing that the acquisition is under
                   consideration

           g       express authorization of equitable relief (e.g. relief other
                   than damages such as an injunction or specific
                   performance) for any violation of the agreement

           h       If appropriate, specific agreement for special remedies such
                   as liquidated damages

    3      A violation of a confidentiality agreement may be difficult to
           prove.

    4      The need for information is a two way street—The target firm may
           also require information from the potential buyer (such as financial
           history and financial statements) in order to decide whether to
           enter into the transaction)

C   Letters of Intent

    1      is not a legally binding contract unless

           a       all the material terms of the contract are included in the
                   letter unless

           b       all the parties to the transaction agree to the terms

    2      Purposes of a letter of intent

           a       clarify the thinking of the parties regarding their intentions

           b       determine whether an agreement is feasible
           c      force the party to focus on fundamental issues

           d      ensure there is no misunderstanding once the parties have
                  reached a tentative agreement on the basic terms of the
                  transaction, such as price and the property involved

           e      provide assurance that the parties really intend to go
                  forward with the transaction

D   Valuation


    1      Theoretically, is the present value of expected future after tax
           profits of the business

    2      The business, however, may be valued differently by buyer and
           seller

           a      buyer and seller might have different opinions about the
                  value of the components that determine present value

           b      A buyer might be willing to pay a premium for the business
                  because the business is a good "fit" with the buyer's other
                  businesses--i.e. the businesses are complementary

           c      A seller might demand a premium if he sells to a given
                  buyer because the businesses are competitors (and buyer
                  might be willing to pay)

E   Structuring the Transaction

    1      possible approaches

           a      stock purchase

           b      merger or consolidation

           c      asset purchase

    2      stock purchase

           a      is the simplest approach if

                  i         the acquired business is a closely held corporation
                            and
                   ii      federal and/or state security statutes do not apply to
                           the transaction.

           b       The securities statutes may be triggered if the acquisition if

                   i       the buyer contacts the shareholders of the target
                           business, or

                   ii      the buyer uses his securities in whole or in part to
                           purchase the shares of the seller      , or

                   iii     venture capitalists are solicited to finance the
                           acquisition,

                   iv      in the distribution of the shares purchased


           c       In an acquisition structured as a stock purchase, the
                   acquiring business acquires all the assets and all the
                   liabilities of the acquired corporation.

    3      merger or consolidation

           a       is a method that allows the elimination of minority
                   shareholders in a corporation who do not wish to sell their
                   stock

           b       If the merger is approved by the Board of Directors and 2/3
                   of the shareholders, the minority shareholders can be forced
                   to sell their shares at a cash price determined by the merger
                   or consolidation agreement or to dissent from the merger or
                   consolidation and sell at an appraised price.

           c       The acquiring business acquires the assets and liabilities of
                   the acquired corporation.

           d       Federal and/or state security laws might apply to a merger
                   or consolidation.


F   Successor Liability when the parties structure the transaction as an asset
    purchase

    1      Buyer is not liable for seller's liability unless
           a       buyer expressly or impliedly agrees to assume the
                   liabilities, and/or

           b       the purchase is a de facto merger or consolidation

                   i       The selling and purchasing companies have a
                           common identity of officers and shareholders

                   ii      The consideration is sufficient when compared to
                           the value of the assets sold.

    c      the buyer is a mere continuation of the seller, or

    d      The transfer of assets is for the fraudulent purpose of escaping
           liability, or

    e      A statute or court decision provides for successor liability

           i       Product liability--buyer liable if

           ii      Federal tax liens

           iii     Washington state tax liability

           iv      labor obligations

           v       employee benefit plans

G   Product liability claims

    1      A purchaser of assets is liable for the seller's product liability
           claims if

           a       the acquiring firm acquires substantially all of the assets of
                   the selling corp.and

           b        holds itself out to the general public as a continuation of
                   the selling corp with the same product under a similar name
                   and

           c       benefits from the good will of the selling corp.

    2      The acquiring can restrict product liability claims can be to the
           value of the assets of the selling corp. if
            a         the acquiring corp. purchases the stock of the selling corp.
                      and continues to operate it, .or

            b         purchasing "claims made" insurance with limits equal to
                      the value of the outstanding claims.

H   Federal Tax Liens

    1       A lien arises at the time of assessment against all the property of a
            taxpayer

    2       The acquired assets are subject to the lien if

            a         a notice of federal tax lien has been filed properly or

            b         the taxpayer has actual notice of the lien

    3       The IRS can seize and sell assets subject to the lien (with surplus
            proceeds refundable to the purchaser of the asset).

I   State tax liens

    1       purchaser who purchases substantially all of the assets of a
            business liable for any amount of tax that the seller does not pay
            within 10 days of the sale.

    2       The buyer can avoid liability if he/she

            a         gives notice of the purchaser to the Dept. of Revenue and

            b         The Dept fails, within 6 months of the notice, to assess the
                      former owner and mail a copy of the assessment to the
                      buyer.

J   Labor Obligations

    1       A buyer of a unionized business has a duty to recognize the union
            if he/she is a successor

    2       The buyer is a successor if there is there is substantial continuity
            between the enterprises.

            a         Substantial continuity depends on

                      i      whether the business of both employers is
                             essentially the same
                 ii      whether employees are doing the same jobs

                 iii     whether the working conditions are the same

                 iv      whether the supervisors are substantially the same

                 v       whether the new entity has the same production
                         processes

                 vi      whether the same products are produced

                 vii     whether the new firm has the same body of
                         customers as the old

          b      If a buyer is a successor,

                 i       he/she has a duty to bargain with the union

                 ii      He/she may set the initial terms and conditions of
                         employment unless he/she makes it perfectly clear
                         that he/she plans to retain all of the employees in
                         the unit

    3     If the buyer wishes to avoid his/her predecessor's labor agreement
          when it buys the predecessor's assets, he/she should

          a      expressly refuse to assume his/her predecessor's labor
                 obligations

          b      avoid to the extent possible, identical management,
                 operations and equipment

    4     In order to protect himself/herself from surprises, the buyer should

          a      obtain complete disclosure of labor agreements through
                 representations and warranties of the seller and

          b      get the seller to agree to indemnify the buyer in the event
                 that any of the seller's warranties are breached.

K   Employee Benefit Plans

    1     represent one of the largest potential hidden liability of a business
          because often they are not reflected on the selling firm's balance
          sheet.
    2      multi-employer pension plans

           a      seller usually incurs liability if he withdraw from the plan
                  unless

                  i       he sells assets in good faith and at arms length to an
                          unrelated party, and

                  ii      the buyer is obligated to make the seller's payment
                          to the plan, and

                  iii     the buyer provides a surety bond or sum in escrow
                          for 5 years from the date of sale equal to one year's
                          contribution to the plan, and

                  iv      the bond or sum in escrow is required to be paid to
                          the plan if the buyer withdraws or fails to make the
                          required contributions, and

                  v       the contract of sale provides the seller is secondarily
                          liable if

                          *`      the buyer withdraws from the plan within
                                  the first five years and

                          *       fails to pay the liability when due

           b      Seller, therefore, should seek a clause in the acquisition
                  agreement requiring the buyer to pay the required
                  contribution, post the bond or escrow sum and agree to be
                  secondarily liable for the contribution.

L   Environmental Liability

    1      Buyers may face federal or state clean up liability if he/she
           acquires property that

           a      was used to dispose of hazardous waste or

           b      contains underground storage tanks or

           c      asbestos insulation or

           d      PCBs in electrical equipment.
2   The defense of innocent acquisition

    a      requires that the property be acquired without notice of past
           hazardous waste disposal

    b      the defense requires that the buyer have made appropriate
           inquiry, consistent with good commercial practices, and
           into previous ownership and uses of property prior to the
           conveyance

3   The buyer should require the seller to answer the following
    questions

    a      Has the property ever been used as a disposal sight

    b      Has the property ever been land filled

    c      If so, were hazardous wastes used as the fill

    d      Are there visible signs of potential problems, such as
           ground discoloration or stand pipes to underground tanks

    e      What wastes did the previous owners generate?

    g      How and where did the previous owners dispose of the
           wastes

    h      Did the previous seller register or fail to register any
           underground tanks with the designated state agency

    i      Are there any environmental enforcement proceedings
           affecting the property, such as consent decrees,
           administrative actions, and citizen suits

    j      Is the property listed on any federal or state list for
           hazardous waste clean up

    k      What environmental permits does the seller hold

    l      Have any environmental audits been performed

    m      What is the seller's capital and operating budget for
           environmental compliance
          n      Are there any materials incorporated into the buildings,
                 such as asbestos or foam insulation, that could be a hazard
                 to workers

          o      Do all drains connect to the sanitary sewer system

    4     The seller’s answers should become warranties in the acquisition
          agreement and he should promise to indemnify the buyer for any
          breach of warranty.

M   Accounting Considerations

    1     Will the acquisition be treated as a pooling of interests or as a
          purchase for financial (non-tax) reporting purposes?

    2     The pooling method

          a      The financial asset values and liability values of the
                 acquired corporation are carried over to the combined
                 entity.

          b      This method usually results in lower reported depreciation,
                 amortization, and expenses, and thus higher reported profit
                 on the income statement.

    3     The purchase method

          a      requires the purchase price to be allocated to the acquired
                 assets and liabilities.

          b      usually results in greater recognition of good will than the
                 pooling method

    4     The pooling method has very technical requirements for proper
          usage and accounting professionals should be brought into the
          transaction early if the method is to be used.

N   Govt Approvals

    1     Certain highly regulated businesses may require govt approval
          before key assets, such as licenses, may be transferred (e.g.
          common carriers, liquor establishments and radio or TV stations).

    2     The seller should
           a      determine what govt approvals are necessary for the
                  transfer

           b      how to obtain the necessary approvals, and

           c      when (at what point in time) the approvals are necessary

    3      The buyer should

           a      require the seller to represent and warrant that he has
                  obtained all necessary approvals for the transfer and

           b      determine what licenses, permits and approvals he (the
                  buyer) must have before assuming control of the seller's
                  business

O   Approvals from private parties

    1      Lessors sometimes forbid assigning or subletting leased property.

    2      Secured creditors sometimes have due on sales clauses if the
           collateral securing the credit is sold.

    3      Inability to obtain consent to the transfer of a key asset may require
           the transaction be structured as a stock acquisition.

P   Ancillary Agreements

    1      covenants not to compete

           a       buyers may demand such agreements from

                  i        sellers

                  ii       key employees

           b      motives for such covenants

                  i        ensure that the seller or key employee does not
                           compete with the buyer, thus preserving the value
                           of the good will that the buyer purchased

                  ii       obtain tax benefits

                           *         payments for covenants not to compete are
                                     immediately deductible
                 *       payments for good will are not

                 *       However, a deduction for a payment for a
                         covenant not to compete will be challenged
                         by the IRS if the taxpayer cannot
                         demonstrate that it has economic substance.

    c     enforceable in Washington if

          i      it is reasonably necessary to preserve the business
                 or good will of the protected party

          ii     is not greater than necessary

                 *       reasonable in duration

                 *       reasonable in terms of geographic scope

          iii    the injury to the public is not sufficiently significant
                 to warrant non-enforcement

    d     A court might reform an illegal covenant not to compete if
          it thought that the parties had intended to make enter into a
          legal covenant but make an innocent error

    e     Buyer and Seller have different interests regarding the
          timing of the payments

          i      seller wants payment up front

          ii     buyer wants installment payments

                 *       Seller will have a more powerful incentive
                         to keep the agreement

                 *       Installments minimize immediate cash
                         outlays

                 *       installment allocate deductions to later, and
                         presumably, more profitable years

2   Consulting agreements

    a     Buyers may find such agreements attractive because of
                  i      practical benefits

                  ii     tax benefits (immediate deduction of expenditures)

           b      In order to provide tax benefits, the agreement must have
                  substance

                  i      should be written

                  ii     should provide a limited but definite commitment to
                         provide advice and expertise (ex: seller agrees to
                         provide advice as buyer may require up to a
                         maximum of 20 hrs/month for 24 months beginning
                         on--)

           c      The tax interests of buyer and seller may conflict because
                  the seller may not want to convert capital gain income into
                  ordinary income

    3      employment agreements

           a      buyer may want to have seller execute enforceable
                  employment contracts with key personnel as a condition of
                  the sale.

           b      The contracts will then be assigned to the buyer at closing

           c      The assignment will be enforceable as long as

                  i      the contract itself is enforceable

                  ii     The contract doesn't contain an anti-assignment
                         clause

                  iii    The assignment is not prohibited by statute

                  iv     The assignment does not significantly increase the
                         duties, burdens or risks of the employee, and

                  v      The contract is not for personal services.

Q   Federal Tax Considerations

    1      A merger or consolidation might qualify as a tax free
           reorganization, if certain requirements are met.
    2      A sale of assets will result in the recognition of gain by the seller to
           the extent that the proceeds allocated to the asset exceeds the
           sellers basis in the asset and losses to the extent that adjusted basis
           exceeds proceeds

           Depending on whether the various assets are capital or non-capital
           assets, the losses might offset the gains.

    3      Purchasers prefer allocations of proceeds to assets that can be
           depreciated or expensed

R   State Tax Considerations

    1      Consider forming a new corporation, transferring the assets to be
           sold to the new corporation in exchange for stock, and selling the
           stock in the new corporation to the purchaser.

           a       The transfer of assets to the new corporation would
                   probably be considered an adjustment of beneficial interest
                   and escape taxation.

           b       The sale of stock in the new corporation would be
                   considered a sale of an intangible asset and escape sales tax
                   and B&O tax.

           c       Any real estate involved would probably escape real estate
                   excise tax.

           d       Will Dept of revenue challenge this approach?

    3      An alternate approach

           a       Allocate the purchase price to items not subject to tax

                   i       allocate the purchase price to intangible personal
                           property such as contract rights and good will

                           *       These sums will be exempt from sales tax

                           *       They will also be exempt from B & O tax.

                   ii      Allocation of the purchase price to inventory

                           *       The sums allocated will escape sales tax
                                   because inventory is held for the purpose of
                                   resale.
                         *       Allocating some of the purchase price to
                                 inventory, however, will not prevent
                                 application of the B & O tax.


S   Financing the Agreement

    1     Buyer makes a cash purchase

    2     Seller extends credit to the buyer

          a      buyer pays cash, preferably equal to the value of the seller's
                 good will

          b      buyer signs a promissory note for the balance, generally
                 promising to make regular payments.

                 i       The note should contain an acceleration clause.

                 ii      The note should be negotiable


          c      Seller takes and perfects a security interest in all tangible
                 personal property transferred to the buyer

          d      Seller takes and perfects a security interest in all intangible
                 personal property transferred to buyer that is subject to the
                 security interest provisions of the U.C.C.

          e      Seller, through a mortgage, deed of trust or real estate
                 contract, retains a security interest in any real property
                 transferred to buyer.

          f      If possible, seller requires buyer to provide a gurantor or
                 surety who signs a written promise of guaranty or
                 suretyship for some or all of the purchase price.

          g      If possible, seller obtains a security interest in the other
                 personal or business assets of the seller to secure, in whole
                 or in part, the unpaid part of the purchase price

    3     Buyer engages in a leveraged buyout

          a      Buyer borrows money against the acquired assets and uses
                 the money to pay some or all of the purchase price.
           b       This method exposes buyer and seller to the risk legal
                   liability to unsecured creditors.

                   i       The risk of liability arises because value of existing
                           and contingent liabilities after the buyout might
                           exceed the value of the firm's assets due to a
                           deliberate withdrawal of assets from the firm..

                   ii      Unsecured creditors who suffer damages might
                           argue that

                           *       The transaction might violate the state
                                   Fraudulent Conveyance Act.

                           *       The transaction could violate the fraudulent
                                   Conveyance provisions of the Bankruptcy
                                   Code.

                           *       The transaction could violate the preference
                                   provisions of the Bankruptcy Code.

                           *       If the selling firm is a corporation, the
                                   transaction could violate the provisions of
                                   the Corporation Act forbidding corporations
                                   from making distributions to shareholders if
                                   the effect of the distribution is to render the
                                   corporation insolvent..

T   Finalizing the Agreement

    1      The risk of loss between execution of the acquisition agreement
           and closing should be clearly assigned.

    2      Usually, the agreement provides that the buyer has no obligation to
           purchase if the seller cannot deliver specified assets in good
           working order at closing.(i.e. the seller assumes all risks).

    3      However, sometimes abandonment of the transaction is not
           acceptable to the buyer, seller, or both, if the specified assets are
           only partially destroyed.

    4      Alternative approaches to partial destruction of specified assets

           a       buyer pays full price if
                 i       insurance covers the loss or damage and

                 ii      insurance proceeds are made available to the buyer

          b      adjustment of the purchase price, perhaps by assigning
                 values to the assets and pro-rating the purchase price for the
                 loss or damage

          c      some combination of (a) and (b)

U   Legal Opinions

    1     both the buyer's and seller's attorney may be required to deliver
          formal legal opinions

    2     The attorney will want to limit his legal opinion to opinions of law,
          not opinions regarding facts to avoid becoming an insurer of the
          transaction

    3     Ex: of opinions that counsel might be willing to give

          a      corporate client is duly incorporated in the State of
                 Washington

          b      corporation is in good standing in the state of Washington

          c      corporate records, such as minute books, are complete and
                 accurate

    4     Ex of opinions that counsel might not want to give

          a      seller has good and unencumbered title to all assets

          b      seller is not subject to any pending litigation or govt
                 investigation

V   Closing

    1     involves

          a      ascertaining that all necessary documents are present in the
                 proper form

          b      execution of the documents

          c      exchange of documents
    d     disbursement of funds (if any)

2   The necessary documents might include

    a     deeds

    b     a bill of sale for all personal property

          i       The bill should say something like "all property
                  held by the seller and associated with the business
                  including but not limited to the property on the
                  attached list"

          ii      a provision requiring the seller to execute any
                  documents necessary to perfect the transfer of assets
                  (e.g. certificates of title for autos)

    c     assignment of all intellectual property rights (if any)

    d     assignment of all lease rights

    e     consents from lessors to the lease assignments

    f     assignment of intangible property tights, such as contract
          rights and accounts receivables

    g     assignments of licenses and govt authorizations, if
          possible

    h     transfer of bank accounts and safety deposit boxes

    j     Endorsements and delivery of promissory notes and other
          negotiable instruments

    k     proof that buyer has the agreed upon insurance policies or
          assignment of the seller's policies to buyer (with the written
          consent of the insurance co.)

    l     An assignment of any residual insurance rights of the seller,
          such as the right to be defended against any product
          liability claims that may have accrued at the time of closing

    m     An assumption of liabilities agreement (if the buyer and
          seller so agreed)
                    n       endorsement and delivery of stock certificates to buyer (if
                            the acquisition was by stock purchase)

III   Insulating Oneself from Personal Liability for Debt

      A      Entities that provide owners with limited liability for business debts offer
             the first line of defense against personal liability

             1      Entities that offers limited liability include the

                    a       limited partnership

                    b       limited liability company

                    c       corporation

                    d       trust

             2      These entities will not provide protection against personal liability
                    for business debts if the entity conducts business in a manner that
                    removes the limited liability shield

                    a       To maintain limited liability while operating as a limited
                            partnership

                            i       register the partnership with the state and maintain
                                    the registration

                            ii      Do not allow your name to be listed in the
                                    partnership name

                            iii     Do not participate in management

                    b       corporation

                            i       keep the corporation in good standing with the state

                                    *       file the annual report

                                    *       keep it registered

                            ii      observe the corporate formalities

                                    *       hold meetings of the Board of Directors and
                                            keep minutes of the meetings
                           *       have the Board authorize transactions for
                                   which their authorization is necessary

                           *       hold the annual stockholder’s meetings and
                                   have them authorize those actions for which
                                   their authorization is needed.

                           *       place corporate revenues in corporate bank
                                   accounts.

                           *       Pay corporate bills out of corporate bank
                                   accounts

                           *       If corporate funds are insufficient to pay
                                   bills, lend money to the corporation or sell
                                   additional stock to yourself and document
                                   the transaction with signed promissory notes
                                   or stock certificates and have minutes
                                   showing the necessary Board/stockholder
                                   approval

                           *       When corporate funds are used for
                                   purchases, have the bills of sale or title
                                   documents reflect corporate ownership of
                                   the asset

                           *       Do not use corporate assets for personal
                                   purposes

                   iii     do not thinly capitalize it

           c       LLCs

                   i       keep it registered

                   ii      observe the LLC formalities

                   iii     do not thinly capitalize the LLC

           d       trusts (same as corp and LLC’s)

B   Conducting business through a limited liability entity will not protect the
    personal assets of a person who

    1      personally guarantees payment of corporate debts, or
    2      commits a tort

C   Protecting the personal assets of a person who commits a tort

    1      Purchasing insurance

           a      Insurance provides protection against tort liability for
                  negligence.

           b      However, a person cannot buy an insurance policy that
                  protects himself/herself from liability for intentional torts

           c      Having the business purchase insurance against torts
                  committed while on company business is a deductible
                  business expense for the purchaser of insurance.

           d      Purchaser cannot deduct insurance premiums for non-
                  business related torts because this is a non-deductible
                  personal expense

    2      Bankruptcy

           a      Chapter 7 (liquidation)

                  i         The filing of the petition stops all action to collect
                            debts

                            *       The bankruptcy court issues an order to
                                    creditors to stop all collection action unless
                                    the creditor obtains the court’s permission to
                                    collect the debt.

                            *       A violation of the order constitutes contempt
                                    of court

                  ii        The person declaring bankruptcy turns over all non-
                            exempt personal assets to a trustee who sells the
                            assets and divides the proceeds among the
                            unsecured creditors

                            *       exempt assets—equity in a personal
                                    residence = $7500, cash = $4200, limited
                                    value of household goods, auto with $500
                                    equity etc., pension assets in a certain
                                    amount.
           *       debtor can choose between federal and state
                   exemption schedules

                           ex: O.J. Simpson

           *       pro-rata—a creditor who has 60% of the
                   unsecured debts gets 60% of the proceeds of
                   the asset sales

           *       Unsecured creditors include tort victims,
                   including tort victims who have won court
                   judgments against the person committing the
                   tort

    ii     After the trustee has sold the debtors assets and
           distributed the proceeds among the unsecured
           creditors, the remaining unsecured debts are
           discharged—i.e. the unsecured creditors cannot take
           any steps to collect the unpaid sums

           *       Only individuals can obtain a discharge

           *       The discharge does not apply to liability for
                   certain specified unsecured debts—e.g.
                   debts due to intentional torts, unpaid child
                   support etc.

b   Chapter 13 (wage earner plan)

    i      The filing of the petition stops all collection efforts

    ii     The debtor proposes a plan to pay the debts

           *       The plan debtor reports his income, his
                   family’s living expenses, and the amount of
                   income left over that can be applied to his
                   debts

           *       The left over income is divided [pro rata
                   among the unsecured creditors for the
                   duration of the plan.

           *       The maximum length of the plan is five
                   years.
                           *       At the end of five years, the unpaid
                                   unsecured debts (with certain specified
                                   exceptions, debts due to intentional torts
                                   child support etc) are discharged

                  iii      A creditor has the right to object to the debtor’s plan

                           *       The creditor can request that more of the
                                   debtor’s income be directed to payment of
                                   unsecured debts.

                           *       The creditor can request sale of part or all of
                                   the non-exempt assets and distribution of the
                                   funds to the unsecured creditors

                           *       If the plan is for less than 5 years, a creditor
                                   can request that the plan be extended

                  iv       The bankruptcy court may or may not grant the
                           creditor’s requests

C   Collecting judgments

    1      Methods of collecting

           a      judgment debtor (or his insurer, surety or guarantor)
                  voluntarily pays

           b      judgment creditor seizes non-exempt property of the debtor

                  i        writ of execution

                  ii       writ of garnishment

           c      It is the creditor’s responsibility to locate the non-exempt
                  property of the debtor

    2      locating property of the judgment debtor

           Text of CR 69 EXECUTION

           (a)    Procedure. The procedure on execution, in proceedings
                  supplementary to and in aid of a judgment, and in
                  proceedings on and in aid of execution shall be in accordance
                  with the practice and procedure of the State as authorized in
                  RCW 6.13, 6.15, 6.17,
(b)    Supplemental Proceedings. In aid of the judgment or
       execution, the judgment creditor or his successor in interest
       when that interest appears of record, may examine any
       person, including the judgment debtor, in the manner
       provided in these rules for taking depositions or in the
       manner provided by RCW 6.32.


Text of RCW 6.32.010 .

At any time within ten years after entry of a judgment for the sum of
twenty-five dollars or over, unless the time is extended in accordance
with RCW 6.17.020(3), upon application by the judgment creditor
such court or judge may, by an order, require the judgment debtor to
appear at a specified time and place before the judge granting the
order, or a referee appointed by the judge, to answer concerning the
same; and the judge to whom application is made under this chapter
may, if it is made to appear to him or her by the affidavit of the
judgment creditor, his or her agent or attorney that there is danger of
the debtor absconding, order the sheriff to arrest the debtor and bring
him or her before the judge granting the order. Upon being brought
before the judge, he or she may be ordered to enter into a bond, with
sufficient sureties, that he or she will attend from time to time before
the judge or referee, as shall be directed, during the pendency of the
proceedings and until the final termination thereof. If the judgment
debtor or other persons against whom the special proceedings are
instituted has been served with these proceedings, the plaintiff shall
be entitled to costs of service, notary fees, and an appearance fee of
twenty-five dollars. If the judgment debtor or other persons fail to
answer or appear, the plaintiff shall additionally be entitled to
reasonable attorney fees. If a plaintiff institutes special proceedings
and fails to appear, a judgment debtor or other person against whom
the proceeding was instituted who appears is entitled to an
appearance fee of twenty-five dollars and reasonable attorney fees.

Text of RCW 6.32.050, procedure on examination.

Upon an examination made under this chapter, the answer of the
party or witness examined must be under oath. A corporation must
attend by and answer under the oath of an officer thereof, and the
judge may, in his discretion, specify the officer. Either party may be
examined as a witness in his own behalf, and may produce and
examine other witnesses as upon the trial of an action. The judge or
referee may adjourn any proceedings under this chapter, from time to
time, as he thinks proper.
           Text of RCW 6.32.015, order to require judgment debtor to answer
           interrogatories.

           At any time within ten years after entry of a judgment for a sum of
           twenty-five dollars or over, unless the time is extended in accordance
           with RCW 6.17.020(3), upon application by the judgment creditor
           such court or judge may, by order served on the judgment debtor,
           require such debtor to answer written interrogatories, under oath, in
           such form as may be approved by the court. No such creditor shall
           be required to proceed under this section nor shall he or she waive
           his or her rights to proceed under RCW 6.32.010 by proceeding
           under this section.

D   Techniques to avoid paying judgments involuntarily

    1      Let the statute of limitations expire without making any payments
           (10 years in Washington state)

    2      Own assets exempt from execution

           a      State personal exemption statutes forbid seizure of certain
                  types of assets (See RCW 6.15.050 et. seq.)

           b      ERISA pension funds are exempt from execution

    3      keep assets encumbered with secured debt.

           a      make certain all assets serve as collateral for loans equal in
                  value to the value of the assets and that the security
                  interests are perfected

           b      as the assets were out, replace them with new encumbered
                  assets

           c      Freitag v. McGhie, 133 Wn.2d 816, 947 P.2d 1186 (1997).

    4      Own property in a different state or country from the state or
           country that issued the judgment.

           a      owning property in a different state from the state that
                  issued the judgment

                  i       Constitutions’ full faith and credit clause requires
                          the court in State B to recognize a judgment in state
                          A.
           *      In order to enforce a California judgment in
                  Washington, the judgment must be filed in
                  the office of the court clerk.

           *      Notice of the filing must be sent to the
                  judgment debtor

           *      The judgment creditor can take no action for
                  10 days

           *      Within the 10 days the judgment debtor has
                  the opportunity to begin a legal proceeding
                  to show that the judgment should not be
                  enforced or enforced only partly.

    ii     If the judgment debtor takes no action, the creditor
           can executes or garnish the debtor’s Washington
           property

    iii    The debtor can take advantage of the time lag by
           removing his assets from Washington

    iv     To prevent the debtor from removing his assets
           from Washington state, the creditor can request a
           pre-judgment writ of attachment or a temporary
           restraining order forbidding the sale and removal of
           the assets

           *      the writ of attachment seizes the asset prior
                  to judgment

           *      The Constitution allows the temporary entry
                  of such an order but it will expire within 10
                  days unless

                          the debtor is given an opportunity to
                          show cause why the order is not
                          necessary and

                          The creditor demonstrates a strong
                          likelihood that he will prevail at trial

b   Owning property in a different country
           i       There is no international equivalent to the full faith
                   and credit clause of the U.S. Constitution
           ii      Some foreign jurisdictions do not recognize foreign
                   judgments at all


           iii     It may be possible to enforce a judgment in a
                   different country if the United States and the foreign
                   country have a treaty that provides for enforcement
                   of the judgment

           iv      In general, the procedure for enforcing a judgment
                   internationally is similar to the procedure for
                   enforcing one domestically

                   *       However, many countries will not enforce
                           the entire amount of the judgment if it
                           contains compensation for damages that the
                           country does not recognize or is based on a
                           theory of liability that the country does not
                           recognize (e.g. strict liability for product
                           defects or punitive damages for a defective
                           product)

                   *       Additionally, a country may not have a
                           procedure such as the pre-judgment writ of
                           attachment or temporary restraining orders

           v       There is a movement to have an international
                   convention signed by the major economies
                   delineating the conditions under which a foreign
                   judgment will be enforced.

5   Separate the possessory right to an asset from the use and transfer
    rights right (i.e. own no assets)

    a      lack of ownership does not mean an inability to enjoy the
           asset

           i       Property consists of rights that the state will protect.

           ii      A person does not “own” an asset.

           iii     He/she owns certain rights with respect to the asset.
    iv     The three general rights constituting
           “ownership”are

           *       possession--i.e. the right to exclude others
                   from exercising any rights with respect to
                   the asset

           *       use--the right to use the asset

           *       the right to transfer possession or use to
                   other persons.

    v      The right to possession does not necessarily include
           the right to use the asset.

           *       ex: I hire a security guard to prevent
                   persons from entering my office while I am
                   on vacation.

           *       The security officer has the right to exclude
                   others (i.e. a right of possession) but not the
                   right to use the office

    vi     Each of the three general rights can be subdivided
           further

           *       A farmer grants a contractor the right to use
                   his land as a short cut for the contractor's
                   machinery.

           *       The right to use the land as a route for an oil
                   pipeline has not been granted

           *       The farmer retains it.

           *       Thus, the use right has been split

b   strategies for using assets without “owning” assets

    i      have a partnership own the three rights constituting
           “ownership” of the asset and purchase, i.e. lease, the
           use rights to the assets from the partnership

           *       establish a partnership with a relative or
                   friend
*   transfer personal assets to the partnership in
    exchange for an ownership interesting the
    partnership

           The relative or friend has a “small”
           interest in the partnership, say 5%.

           The partnership agreement dispenses
           with majority voting for management
           decisions and the partner with the
           95% interest the “managing” partner
           with the right to manage the
           partnership w/o consultation with the
           other partners

           lease the personal assets from the
           partnership

*   Although this might increase the taxes one
    pays, it dispenses with the need for liability
    insurance

           the net out of pocket cost might be
           less the insurance premium,
           depending on the riskiness of the
           business activity.

*   The judgment creditor cannot seize the
    partnership assets and cannot exercise
    management rights.

*   The best the creditor can do is to seize the
    ownership interest in the partnership and
    obtain a charging order from a court that
    requires the partnership to pay whatever
    profits are due to the judgment creditor

           However, if the partnership
           agreement is drafted to require the
           unanimous agreement of the partner
           to distribute the partnership
           operating profits, the charging order
           will produce nothing.

           If the creditor obtains a charging
           order, the creditor will have to report
                            the profits earned by the partnership
                            on his tax return even if he does not
                            actually receive them.

                            This serves as an incentive to forgo
                            the charging order.

    ii       The owner of the personal assets forms a
             partnership that lends money to him/her and secures
             the loan with his/her personal assets.

    iii      Form a trust and transfer personal assets to the trust.


c   trusts

    i        To establish a trust, the owner of an asset, called the
             settlor, trasnsfers ownership to a person called the
             trustee who must control and manage it according to
             the terms of the trust document for the benefit of the
             beneficiary of the trust.

             *      This sounds strange, but keep in mind that in
                    a corporation the owners of assets transfer
                    ownership to an entity called a corporation
                    and corporate management must manage the
                    assets under the terms of a document called
                    the articles of incorporation for the benefit
                    of the shareholders

             *      If corporate management does not comply
                    with the articles of incorporation, the
                    shareholders can recover damages from
                    management

    ii       A trustee who does not manage the assets in
             accordance with the trust instrument is personally
             liable to the beneficiary, just as a corporate officer
             is personally liable to shareholders if he takes action
             which violates the articles of incorporation


c   Using trusts to insulate one's assets from personal liability
    for one's debts
i    Under U.S. law, if the person transferring property
     to the trust (called the settlor) and the beneficiary of
     the trust are the same person, creditors (and tort
     victims are considered creditors) can seize the
     assets of the trust to satisfy the debts of the trustee-
     beneficiary

     *       Alaska and Delaware do not follow this rule.

     *       In these states, a settlor can transfer property
             to a trust, be a beneficiary of the trust, and,
             with appropriate language, insulate the
             property from creditors

     *       However, the transfer to trust must not
             violate the state Fraudulent Conveyance Act

     *       It is questionable whether an Alaska or
             Delaware trust would insulate trust property
             located outside of the state, such as a
             California brokerage account, from a
             creditor who has a judgment in California
             because the law that applies to property is
             the law of the jurisdiction where the
             property is located and California has a
             greater interest in applying its trust law than
             Alaska and Delaware have in applying their
             trust law .

ii   If the settlor is a different person from the
     beneficiary, it is possible under U.S. law for the
     beneficiary to enjoy the assets without fear that
     creditors of the trustee or creditors of the
     beneficiary will seize the assets.

     *       The trust instrument must prohibit the
             voluntary or forced sale (w/o replacement)
             of of the trust assets

     *       It must also give the trustee complete
             discretion in deciding whether to distribute
             the trust income or allow the beneficiary to
             use the trust assets.

     *       These provisions create what is called a
             "spendthrift" trust.
                         *       If the trustee has complete discretion in
                                 distributing the trust income or principal, the
                                 trustee can exercise his discretion by
                                 refusing to honor a writ of execution or
                                 garnishment.

                         *       The reason that the trustee can ignore the
                                 writs, is that he has legal title, but has no
                                 right to take any actions which contravene
                                 the trust instrument.

                         *       He has no use or transfer right which
                                 permits him to transfer the assets of the
                                 trust.

                 iii     Thus, a person can transfer property in trust for the
                         benefit of his children or friends and these
                         beneficiaries can take possession of the income and
                         gift it to the settlor.

                 iv      Additionally, a parent can gift or will property to a
                         spendthrift trust when his/her child faces personal
                         liability for torts or contracts and the child's creditor
                         cannot reach the assets.

E   The Fraudulent Conveyance Act

    1     Text of RCW 19.40.041, Transfers fraudulent as to present and
          future creditors.

          (a) A transfer made or obligation incurred by a debtor is fraudulent as
          to a creditor, whether the creditor's claim arose before or after the
          transfer was made or the obligation was incurred, if the debtor made
          the transfer or incurred the obligation:

          (1) With actual intent to hinder, delay, or defraud any creditor of the
          debtor; or
          (2) Without receiving a reasonably equivalent value in exchange for
          the transfer or obligation, and the debtor

          (a)     Was engaged or was about to engage in a business or a
          transaction for which

          (i ) the remaining assets of the debtor were unreasonably small in
          relation to the business or transaction; or
    (ii) Intended to incur, or believed or reasonably should have believed
    that he or she would incur, debts beyond his or her ability to pay as
    they became due.

    (b) In determining actual intent under subsection (a)(1) of this
    section, consideration may be given, among other factors, to
    whether:

    (1) The transfer or obligation was to an insider;
    (2) The debtor retained possession or control of the property
    transferred after the transfer;
    (3) The transfer or obligation was disclosed or concealed;
    (4) Before the transfer was made or obligation was incurred, the
    debtor had been sued or threatened with suit;
    (5) The transfer was of substantially all the debtor's assets;
    (6) The debtor absconded;
    (7) The debtor removed or concealed assets;
    (8) The value of the consideration received by the debtor was
    reasonably equivalent to the value of the asset transferred or the
    amount of the obligation incurred;
    (9) The debtor was insolvent or became insolvent shortly after the
    transfer was made or the obligation was incurred;
    (10) The transfer occurred shortly before or shortly after a substantial
    debt was incurred; and
    (11) The debtor transferred the essential assets of the business to a
    lienor who transferred the assets to an insider of the debtor.

2   RCW 19.40.071 Remedies of creditors.

    (a)In an action for relief against a transfer or obligation under this
    chapter, a creditor, subject to the limitations in RCW 19.40.081, may
    obtain:

    (1) Avoidance of the transfer or obligation to the extent necessary to
    satisfy the creditor's claim;
    (2) An attachment or other provisional remedy against the asset
    transferred or other property of the transferee in accordance with the
    procedure prescribed by chapter 6.25 RCW;
    (3) Subject to applicable principles of equity and in accordance with
    applicable rules of civil procedure:

    (i)An injunction against further disposition by the debtor or a
    transferee, or both, of the asset transferred or of other property;
    (ii) Appointment of a receiver to take charge of the asset transferred
    or of other property of the transferee; or
    (iii) Any other relief the circumstances may require. (b) If a creditor
    has obtained a judgment on a claim against the debtor, the creditor, if
    the court so orders, may levy execution on the asset transferred or its
    proceeds.

3   RCW 19.40.081 Defenses, liability, and protection of transferee

    (a) A transfer or obligation is not voidable under RCW
    19.40.041(a)(1) against a person who took in good faith and for a
    reasonably equivalent value or against any subsequent transferee or
    obligee.
    (b) Except as otherwise provided in this section, to the extent a
    transfer is voidable in an action by a creditor under RCW
    19.40.071(a)(1), the creditor may recover judgment for the value of
    the asset transferred, as adjusted under subsection (c) of this section,
    or the amount necessary to satisfy the creditor's claim, whichever is
    less. The judgment may be entered against:

    (1) The first transferee of the asset or the person for whose benefit
    the transfer was made; or
    (2) Any subsequent transferee other than a good-faith transferee or
    obligee who took for value or from any subsequent transferee or
    obligee

    (c) If the judgment under subsection (b) of this section is based upon
    the value of the asset transferred, the judgment must be for an
    amount equal to the value of the asset at the time of the transfer,
    subject to adjustment as the equities may require.
    (d) Notwithstanding voidability of a transfer or an obligation under
    this chapter, a good-faith transferee or obligee is entitled, to the
    extent of the value given the debtor for the transfer or obligation, to:

    (1) A lien on or a right to retain any interest in the asset transferred;
    (2) Enforcement of any obligation incurred; or (3) A reduction in the
    amount of the liability on the judgment.

    (e) A transfer is not voidable under RCW 19.40.041(a)(2) or
    19.40.051 if the transfer results from:

    (1) Termination of a lease upon default by the debtor when the
    termination is pursuant to the lease and applicable law; or
    (2) Enforcement of a security interest in compliance with *Article 9
    of Title 62A RCW.

    (f) A transfer is not voidable under RCW 19.40.051(b):
           (1) To the extent the insider gave new value to or for the benefit of
           the debtor after the transfer was made unless the new value was
           secured by a valid lien;
           (2) If made in the ordinary course of business or financial affairs of
           the debtor and the insider; or
            (3) If made pursuant to a good-faith effort to rehabilitate the debtor
           and the transfer secured present value given for that purpose as well
           as an antecedent debt of the debtor

F   Offshore Asset Protection Trusts

    1      The Cook Island Offshore Trust Law

           a       applies to international trusts, not trusts established for the
                   benefit of Cook island residents

           b       makes spendthrift trusts fully enforceable against creditors
                   even if

                   i       the settlor is the beneficiary of the trust

                   ii      the settlor retains the right to revoke the trust

           c       provides that no Cook Island court shall recognize or enforce
                   a foreign judgment against a Cook Island trust, or a settlor,
                   trustee or beneficiary of the trust if the judgment is based on
                   an application of foreign law that is inconsistent with the
                   Cook Islands Offshore trust statute

    2      The Cook Island Fraudulent Conveyance Act provides

           a       No conveyance is fraudulent if the settlor was solvent at the
                   time of the transfer

           b       The statute of limitations on fraudulent transfers is one year
                   from the date of the transfer.

    3      Other offshore jurisdictions have adopted, to varying degrees, the
           Cook Island statutory scheme.

G   Use of offshore trusts in combination with other entities

    1      Suppose a settlor establishes a Cook Island Offshore Asset Protection
           Trust.

    2      He then establishes a limited partnership designating himself as the
           general partner and the asset protection trust as the limited partner

    3      The general partner has a 1% interest in the partnership.

    4      The asset protection trust has a 99% interest in the partnership paying
           for its interest with the trust assets.

           a       The general partner has the right to manage the partnership's
                   assets as long as it is in furtherance of the partnership
                   business.

           b       Thus the general partner has significant control over the
                   assets of the trust

    5      The partnership agreement contains a provision that allows the
           general partner to retain the earnings and not make distributions

           a       A charging order against the partnership for the general
                   partner's interest produces no distribution

           b       However, the creditor will have to pay taxes on the income
                   because partners are taxed on partnership income even if no
                   distribution is made

    6      Note: If the general partner commits a tort, the assets contributed by
           the limited partner can be seized to satisfy the tort victim's damages.

H   US Courts response to offshore trusts

    1      Bankruptcy courts refuse discharge to debtors who have transferred
           assets to such trusts (In re Portnoy, 201 BR 685 S.D.N.Y. 1996)

    2      civil contempt for refusal to apply trust assets towards repayment of
           the settlor's obligations (Federal trade Commission vs. Affordable
           Media LLC, ).

I   A judgment creditor cannot obtain a court order requiring the judgment
    debtor to use the assets of an offshore trust to pay a judgment unless he can
    prove that the judgment creditor is the beneficiary of such a trust.

    1      sources of evidence

           a       testimony of the judgment debtor taken during post judgment
                   proceedings

           b       documents
          i       customs declaration forms—must be filled out if one
                  removes more than $10,000 in cash or monetary
                  instruments from the country

          ii      bank reports of transactions involving withdrawals
                  and deposits of more than $10,000

          iii     personal tax return

                  *       Form 1040, schedule B asks whether the
                          taxpayer has signatory authority over, or an
                          interest in a foreign bank account

                  *       Form 1040, schedule B also requires one to
                          list his sources of interest and dividend
                          income

                  *       Form 1040 also asks whether the taxpayer has
                          an interest in a foreign trust

          iv      the judgment debtor’s bank deposits and receipts

2   The judgment debtor can attempt to frustrate the post judgment
    process by

    a     perjuring himself ( a criminal offense) when asked if he is a
          beneficiary of a foreign trust or owns interests in foreign
          entities

          a       perjury is the making of a materially false statement
                  under oath

          b       material—a matter of consequence to the outcome of
                  the proceeding

    b     fail to make or keep copies of his tax returns

    c     give false answers to the questions involving foreign trusts
          and bank accounts on his tax returns (a criminal offense)

    d     perjure himself when asked where he banks

    e     committing bankruptcy fraud by filing false asset schedules
          with the court or falsely answering the questions of creditors
     J     Taxation of Trusts

           1      Must report its entire income

           2      Taxation of the trust

                  a       business expenses of the trust are deductible

                  b       Income that is distributable to the beneficiaries or paid to
                          them or credited to them is a deduction against income.

                  c       simple trust has a $300 personal exemption and a complex
                          trust has a $100 personal exemption

                          i       A simple trust is a trust that

                                  *       must distribute all of its income currently

                                  *       has no provision for charitable contributions
                                          in the trust document

                          ii      All other trusts are complex trusts

                  d       trust is taxed on income minus (business expenses +
                          distributions to beneficiaries + trust’s personal exemption)

                          i       The tax rates range from 15% to 39.6%

                          ii      The maximum rate of 39.6% begins at $8650 of
                                  taxable income

           3      The income distributed, paid or credited to a beneficiary

                  a       retains the characterization it had in the hands of the trust and

                  b       is taxable to the beneficiary in the year of allocation.

IV   Enforcement of Federal tax Laws

     A     Methods of frustrating the federal tax laws

           1      Accurately reporting the amount of tax owed but failing to pay it.

           2      Inaccurately reporting the tax owed

                  a       Underreporting income
           b       Mischaracterizing income

           c       Overstating deductions

           d       claiming tax credits when the taxpayer is not eligible to do
                   so

B   Collecting the tax when the taxpayer does not pay it voluntarily

    1      In order to collect an unpaid tax, the IRS must

           a       assess the tax timely, and

           b       collect the tax timely

    2      There are two relevant statutes of limitations

           a       The Statute of Limitations on assessment

           b       The Statute of Limitations on collection

    3      Assessment

           a       There can be no collection w/o a timely assessment.

                   i      Assessment can be based on a tax return

                   ii     can also be based on

                          *       agreement on the tax liability after an audit

                          *       an uncontested Notice of Deficiency after an
                                  audit

                          *       a final Tax Court court judgment

           b       timely assessment

                   i      The statute of limitations on assessment is three
                          years from the date that the return was due or filed,
                          whichever is later, if

                          *       the taxpayer filed a non-fraudulent return,
                                  AND
                  *       any understatement of gross income is less
                          than 25% of the gross income that is
                          reported; AND

                  *       There is no written request for prompt
                          assessment (applies only to decedent’s
                          estates and a corporation in dissolution)

                                  statute is 18 months from the date of
                                  the request for prompt assessment if i
                                  and ii are satisfied.

           ii     The statute of limitations is 6 years on assessment if
                  there is a 25% understatement of gross income on a
                  non-fraudulent tax return

           iii    there is no statute of limitations on assessment if

                  *       the taxpayer failed to file a return, or

                  *       the return was fraudulent

           iv     An amended return does not extend the statute of
                  limitations on assessment.

    c      Extension of the statute of limitations

           i      The statute of limitations on assessment is
                  suspended by the number of days, if any, that the
                  IRS cannot, by law, assess or collect the tax (ex:
                  during a Tax Court proceeding) + 60 days

           ii     The statute can be extended by agreement with the
                  taxpayer

4   Collection

    a      notice of assessment and demand for payment must be sent
           to the taxpayer

    b      If the taxpayer does not pay within 21 days of the notice
           and demand (10 business days if the amount demanded is
           $100,000 or more), the IRS can

           i      levy (i.e. seize) the taxpayer’s property, or
                 ii      begin a court proceeding for a personal judgment
                         against the taxpayer for the amount owed, OR

                 iii     can use both (a) and (b)

          c      Filing a notice of tax lien is not a pre-requisite to seizing
                 property.

                 i       Assessment simultaneously creates a tax lien on all
                         the debtor’s property

                 ii      A notice of tax lien, when filed in the proper office,
                         warns potential creditors that the IRS might seize
                         and sell the debtor’s property for unpaid taxes, thus
                         denying a potential secured creditor of his collateral

                 ii      The failure to file a notice of tax lien in the proper
                         office does not prevent the IRS from seizing the tax
                         debtor’s property but it may mean that a secured
                         creditor, who extended secured credit without actual
                         knowledge of the lien, has first claim on any funds
                         produced by the sale of any asset seized by the IRS

          d      There is a 10 year statute of limitations on seizing property
                 to collect a tax assessment which runs from the date of
                 assessment.

          e      A personal judgment does not extend the statute of
                 limitations.

C   The Jeopardy Assessment Procedure

    1     Assessment can be immediate if

          a      The District Director believes that assessment or collection
                 will be jeopardized, and

          b      There is no final Tax Court judgment or timely filed appeal
                 of a tax court judgment for the tax years at issue.

    2     A notice of deficiency for the amount of the jeopardy assessment
          must be mailed to the taxpayer who can then contest the deficiency
          in the Tax Court.

    3     A notice and demand for payment also must be sent to the taxpayer
          for the amount of the jeopardy assessment
    4      The taxpayer has 10 days to pay the assessment or file a bond
           equal to the assessment.

    5       If the assessment is not paid and a bond is not filed, collection
           efforts can be undertaken (e.g. a levy can be made on the
           taxpayer’s property).

    6      If the subject of the jeopardy assessment is an alien, he cannot
           depart the country unless he obtains a certificate of compliance
           from the District Director stating that he has paid the assessment.

D   Treatment of transferees of the taxpayer’s property

    1      A transferee of property is liable for the transferor’s accrued taxes
           to the extent of the value of the property transferred if


           a       The transferor was insolvent at the time of the transfer and
                   the transferee did not pay fair market value for the
                   property, OR

           b       The transfer made the transferor insolvent

    2      If there are several transferees, the IRS can proceed against any of
           the transferees to the extent of the value of the property received.

    3      A transferee of a transferee is liable to the same extent as the
           original transferee.

    4      The IRS has the burden of proof in transferee litigation.

E   Civil penalties for failing to comply with the tax laws

    1      Penalty for failure to file a tax return

           a       applies to returns that are not filed on the due date

                   i       filing date is postmark date if return is filed on or
                           before the due date

                   ii      otherwise date of filing is date of receipt by the IRS

           b       The penalty is imposed unless the taxpayer can show
                   reasonable cause for the late filing.
    c       amt of penalty

            i        5% per month of the net tax owed (i.e. gross tax –
                     withholding –estimated tax etc), not to exceed 25%,
                     provided the return is not more than 60days late

            ii       If return is more than 60 days late, penalty may not
                     be less than $100 or 100% of amt of tax due

2   Penalty for fraudulent failure to file

    a       penalty is 15% per of the underpayment for each month the
            tax return is unfilled up to a max of 75% of the
            underpayment.

    b       govt has the burden of proving fraud.

3   failure to pay

    a       penalty is ½ of 1% per month on the amount owed -
            (withholding + est tax + partial payments)

    b       max penalty is 25%.

    c       penalty does not apply to a failure to pay est taxes

            i        penalty for failure to pay est tax is the interest that
                     would accrue on the underpayment for the period of
                     the underpayment

    d       willful underpayment is a criminal offense

    e       If both the failure to file and the failure to pay penalties
            apply for the same month, the failure to file penalty is an
            offset to the failure to pay penalty

4   failure to make deposits or overstating deposits-applies to
    employment, excise taxes, estimated income taxes and required
    employment taxes

    a       penalty = the amount of tax that should have been withheld
            and paid minus amt actually withheld and paid minus
            amount paid by taxpayer (if any) on that income
    b      payment is called the 1005 penalty because it = 100% of
           the amount that should have been withheld but was not
           withheld

    c      In order to be liable for the penalty, the business official
           must

           i       be a responsible party—i.e. have the actual
                   authority, in view of his status within the company,
                   to withhold and pay over the taxes.

           ii      act willfully when he/she fails to withhold and pay
                   over the required sums.

                   *        lack of funds is not a defense when a
                            responsible party pays some creditors but
                            not the govt.

                   *        Intentionally paying private creditors instead
                            of the govt is a conscious choice—i.e. a
                            willful decision.


    d      Vinick v. CIR

5   failure to make correct information return (ex: form 8300) or file
    correct statements (e.g.: the 1099 forms, the W-2 form etc.) w/o
    reasonable cause

6   failure to furnish correct payee statements (e.g. the w-2 form, the
    1099 forms, the K-1 forms etc) w/o reasonable cause

7   failure to comply with other information reporting
    requirements(ex: failure to list taxpayer I.D. no. on return) w/o
    reasonable cause

8   negligence or disregard of the rules and regulations

    a      applies to any

           i       careless, reckless or intentional disregard of the
                   rules or regulations, or

           ii      a failure to make a reasonable attempt to comply
                   with the provisions of the tax law
    b      no penalty if

           i       there was reasonable cause for the underpayment
                   AND

           ii      the taxpayer acted in good faith

    c      Roy v. Cir

    d      Beall c. CIR

    e      Addington v. CIR

    f      Barmes v. CIR

9   substantial understatement of income tax

    a      substantial understatement occurs if the understatement
           exceeds the greater of

           i       10% of the tax required to be shown on the return or
                   $5000 ($10,000 in the case of a C corp that is not a
                   personal holding co.)

           ii      The amount of understatement is reduced by the
                   portion attributable to

                   *       any underpayment resulting from the
                           taxpayer’s treatment of an item which was
                           supported by substantial legal authority for
                           the taxpayer’s treatment; OR

                   *       any underpayment resulting from the
                           taxpayer’s treatment of an item where the
                           taxpayer adequately disclosed the relevant
                           facts regarding the item on the return or in a
                           statement attached to the return AND..

                   *       There was a reasonable basis for the
                           taxpayer’s treatment of the item

9   substantial valuation misstatement

    a      applies if
            i       the claimed value (or adjusted basis) of any
                    property is 200% or more of the amount
                    determined to be correct

            ii      also applies to transfer price misstatements that are

                    *       200% of the amount determined to be
                            correct, OR

                    *       decrease taxable income by the lesser of
                            $5,000,000 or 10% of the year’s gross
                            receipts

     b      no penalty unless the underpayment due to the
            overstatement exceeds $5000 ($10,000 in the case of a C
            corp that is not a personal holding co.)

     c      Addington v CIR

11   substantial overstatement of pension liabilities—applies only if the
     actuarial determination of pension liabilities is 200% or more of
     the amt determined to be correct

10   substantial gift or estate tax valuation understatement--applies if
     value of any property reported on the return is 50% or less of the
     value determined to be correct

11   income tax return preparer penalty

     a      penalty can be imposed for

            i       willful attempt to understate a client’s tax liability
                    on a return or a claim for refund ($1000 penalty),

            ii      negligently disregard rules ($250 penalty),

            iii     failure to furnish a copy of the return to the taxpayer
                    ($50),

            iv      failure to sign a return as the return preparer ($50)

            v       failure to retain a copy of the return prepared ($50),

            vi      disclosing information furnished in conjunction
                    with the preparation of the return ($250),
    vii    failure to use due diligence in preparing refund
           claims involving the earned income credit,

    viii   $500 for indorsing or negotiating a refund check

b   Who is a return preparer?

    i      preparer is any person

           *      who prepares a return for compensation ,

           *      who employs one or more persons to
                  prepare, for compensation, all or a
                  substantial portion of an income tax return
                  or claim for refund under the income tax
                  provisions of the code

           *      only one person is a return preparer with
                  respect to a single return

           *      If two or more persons prepare a return, the
                  one with the supervisory authority is the
                  preparer

    ii     income tax return is any return or claim for refund
           completed under the income tax laws, including
           flow through returns of non-taxable entities such as
           partnerships

    iii    preparation generally means

           *      obtaining information from the taxpayer
                  AND

           *      determining what tax rules apply AND

           *      computing the tax AND

           *      completing the form

    iv     However, an employee of a computer processing
           service who makes independent determinations of
           what items to enter into the computer or how to
           categorize items can be a return preparer

c   Wilfong v. United States
    14     civil fraud

           a       penalty is 75% on any underpayment of tax due to fraud

           b       govt has burden of proving fraud

           c       Wedvik v. Commissioner 87 T.C. 1458 (1986)

F   Criminal penalties for failing to comply with the tax laws

    1      Origin of a criminal case

           a       Criminal violations are usually discovered by revenue
                   agents during a routine examination of a return (ex: U.S. v.
                   Arthur Young et. al.).

                   i      suspicious circumstances

                          *       bank deposits that exceed gross receipts

                          *       expenses that exceed reported income

                          *       net worth that is inconsistent with reported
                                  income

                          *       concealment of bank accounts

                          *       holding property in another name

                          *       making false entries on the firm’s
                                  accounting records

                          *       making false invoices

                          *       keeping a double set of books

                          *       destroying records

           b       If the agent concludes a criminal violation has occurred, the
                   case is referred to a special agent from the Criminal
                   Investigation Division

           c       If the special agent agrees, he will conduct a joint
                   investigation with the revenue agent and attempt to gather
                   evidence that is admissible in court and, when he thinks he
    has enough, refer the case to the Justice Dept for
    prosecution

d   investigative procedure

    i      obtain returns

    ii     obtain taxpayer’s books and records

    iii    reconcile books and records to returns

    iv     examine taxpayer’s bank records

    v      examine taxpayer’s invoices

    vi     examine taxpayer’s brokerage accounts, if any

    vii    interview return preparer

    viii   interview taxpayer to

           *       determine net worth, cash on hand, non-
                   taxable income, assets, liabilities


           *       give taxpayer opportunity to explain
                   discrepancies

    ix     interview third parties

e   Methods of obtaining documents and witness statements

    i      search public property records

    ii     interview the taxpayer and third parties and request
           the voluntary production of documents

           *       should the taxpayer voluntarily comply with
                   the investigation?

           *       advantages of complying

                            keep agents from reaching faulty
                            conclusions about the facts
                    suspicions of the agent may be
                    allayed

                    cooperation may tip the balance
                    against prosecution if the agent is
                    uncertain about whether to
                    recommend prosecution

                    If prosecution is recommended,
                    cooperation may make a favorable
                    impression upon the jury

                    If the taxpayer is convicted,
                    cooperation may result in a lighter
                    sentence at sentencing

      *      disadvantages of complying

                    Cooperation may provide evidence
                    that strengthens a weak case

                    It may provide an element of proof
                    (such as opening net worth or
                    wilfulness) that could not be
                    established w/o the taxpayer’s
                    cooperation

      *      prevailing wisdom is that cooperation is not
             a good idea when

                    there is a reasonable probability that
                    the taxpayer committed a crime (or
                    the advisor is not certain whether
                    he/she committed a crime) AND

                    it is unlikely that the govt can make a
                    criminal case w/o the taxpayer’s
                    cooperation

iii   use the summons power to obtain interviews and
      documents

      *      can consist of an order by an Internal
             Revenue Agent to a taxpayer or a third
             party, such as a return preparer, to produce
             documents within their custody and control
           *       can consist of an order by an Internal
                   Revenue Agent to the taxpayer or a third
                   party to appear and answer questions under
                   oath

           *       The person being summoned can assert any
                   evidentiary privileges, such as the Fifth
                   Amendment against self incrimination, or
                   the attorney client or work product
                   privileges that may excuse non-compliance
                   with the summons.

           *       Fisher v. United States

           *       Swidler and Berlin and James Hamilton v.
                   United States

    iv     grand jury subpoena

    v      search warrants

f   the accountant-client privilege

    i      There is no such privilege in federal criminal
           investigations

           *       Couch v. United States

           *       Arthur Young & Co. et. al. v. United States

    ii     There is a such a privilege in civil investigations by
           the U.S. govt . that are NOT being conducted by
           federal agencies such as the SEC

    iii    IRS civil investigations are an exception--There is
           such a privilege in civil investigations

    iv     24 states recognize such a privilege

f   the attorney client privilege

    i      Confidential communications made by a client to an
           attorney for the purpose of obtaining legal advice
           may not be disclosed by the attorney to a third party
           w/o the permission of the client.
                  *       Fisher v. United States

                  *       Swidler and Berlin and James Hamilton v.
                          United States

           ii     agents of the attorney, such as an accountant who
                  the attorney has hired to assist him in representing a
                  client during a tax audit or prosecution and who is
                  present at an interview of the client by the attorney
                  may not disclose the communication w/o
                  permission of the client

           iii    Likewise, the presence of an agent during
                  conversations between the attorney and the client
                  about legal matters does not make the
                  communications non-confidential

           iv     exceptions

                  *       crime-fraud exception

                  *       testamentary exception

                  *       others

    f      the attorney work product exception

           i      documents prepared by the attorney in anticipation
                  of litigation, or by a person acting as his agent, are
                  not normally producible in a tax investigation or
                  prosecution

           ii     Thus, a tax return prepared by an accountant for an
                  attorney who is representing a non-filer is probably
                  immune from disclosure.

2   Types of criminal violations

    a      attempted evasion

           i      requires proof of a tax be due and owing

                  *       taxpayer did not pay the tax shown on the
                          return
      *      taxpayer’s return understated the tax due and
             owing

ii    requires proof of an affirmative act

      *      The return or amended return does not
             report all of the taxpayer’s income

      *      The taxpayer expensed an item that should
             have been capitalized

      *      The taxpayer classified an ordinary income
             item as a capital gain

      *      taxpayer knowingly made false statements
             to revenue agents

      *      concealed bank accounts

      *      holding property in the name of others

      *      taxpayer had sufficient assets to pay the tax
             shown on the return but did not do so

      *      Spies v. United States

      *      Sansone v. United States

      *      In re Griffith

iii   requires proof that the taxpayer acted willfully

      *      willful—intentional violation of a known
             legal duty (Pomponio v. United States)

      *      sometimes is proven by direct evidence—
             i.e. by evidence of the fact at issue, such as
             an admission by the taxpayer that he knew
             that he received income that he did not
             report or took a deduction that he knew he
             was not entitled to take (ex: Spies v. U.S.

      *      is normally proven by circumstantial
             evidence—i.e. evidence from which a
             person can deduce that the individual knew
             he was not complying with his legal duties,
                    such as selling items for cash and depositing
                    the funds in a bank account under a false
                    name (Spies v. United States).

b   willfully signing a false return

    i       the return was not accurate

    ii      the taxpayer inaccuracies were willful

    iii     The offense is committed if the above two elements
            are present regardless of whether a tax is due and
            owing

c   willfully aiding and assisting in the preparation of a false
    returns

d   willful failure to file a required return

    i       Govt must prove that

            *       the accused was required to file a return

                            person may have a duty to file a
                            return even if he/she owes no tax

                            a natural person must file a return if
                            his/her income = exemption amt +
                            standard

                            corporation, estate or trust must file a
                            return if its gross income equals or
                            exceeds $600

            *       the accused did not file a return

                            govt meets its burden of proof by
                            showing there is no return on file for
                            the tax year at issue provided the
                            jury believes the govt’s evidence that
                            there is no return on file

                            govt also meets its burden if the jury
                            believes there is no return on file and
                            disbelieves the accused’s evidence
                            that he mailed a return to the IRS
                                 A form 1040 that does not report
                                 income and claims a Fifth
                                 Amendment privilege against
                                 reporting income on the form does
                                 not constitute a return

                 *       the failure to file was willful

          ii     note that the government does not have to prove
                 that a tax is due and owing

    e     willful presentation of false documents to an IRS employee

    f     willful failure to collect, truthfully account for or pay over
          any tax

    g     willful failure to pay any estimated tax or tax, keep
          required records or supply required information

    h     willfully failing to furnish or furnishing an employee a
          false statement about the amount of tax withheld on wages


    i     the disclosure or use of return information, by a person in
          the business of preparing tax returns, or by a person who
          provides services in connection with preparation of returns,
          for purposes other than return preparation

    j     One who willfully induces another to commit a crime (i.e.
          aids or abets a crime) may be punished for the crime even
          though he did not perform the act (18 U.S.C. section 2)

3   methods of proof

    a     specific items (Sansone v. United States)

    b     bank deposits method

          i      the underlying theory

                 *       bank deposits (with some adjustments)
                         ought to equal gross income
          *      If there is a discrepancy between bank
                 deposits (with adjustments) and gross
                 income) the difference is unreported income

    ii    application of the theory

          *      need to know the taxpayer’s deposits during
                 the year.

          *      need to know which deposits are non-
                 income items (such as gifts)

          *      need to know which deposits represent non-
                 taxable income

          *      need to know the amount of cash that the
                 taxpayer receives but does not deposit

          *      need to know the cash received from non
                 taxable sources

    iii   The sum of deposits, minus non-income and non-
          taxable items + cash received but not deposited
          minus cash received from non-income and non-
          taxable sources = the taxpayer’s gross receipts

    vi    may need to classify checks, withdrawals and
          expenditures from non-deposited cash as deductible
          or non-deductible items (depending on the charge
          being investigated)

c   net worth method

    i     underlying theory

          *      A taxpayer can increase his/her net worth
                 only if he/she has income or receives gifts or
                 inheritances

          *      Thus, if the taxpayer’s net worth increases
                 by more than his reported income (adjusted
                 for non-income or non-taxable income
                 items), he/she has unreported income

    ii    application of the theory
          *      need a starting net worth

          *      need an ending net worth

          *      compare the difference to reported taxable
                 income + any non-taxable income revealed
                 by the investigation

    iv    The govt must prove a likely source of taxable
          income to meet its burden of proof in court if it
          relies on the net worth method of proof

          *      The govt can satisfy its burden of proving a
                 likely source of taxable income by proving
                 an intensive investigation which turned up
                 no sources of non-taxable income

          *      However, the investigation will not be
                 considered to be intensive enough if the govt
                 does not follow up on leads to non-taxable
                 sources offered by the taxpayer.

    v     Note that this method of proof will be ineffective if
          the taxpayer uses his concealed income to purchase
          services instead of assets

                 the Cuban travel agent

d   The expenditures method

    i     underlying theory

          *      expenditures must be financed by taxable
                 income, non-taxable income, gifts,
                 inheritances or the sale of assets owned at
                 the start of the tax year

          *      Thus, if expenditures, adjusted for non-
                 income or non-taxable items exceed
                 reported income, the taxpayer has
                 underreported his/her income

    ii    application of the theory

          *      determine net worth on the first day of the
                 tax year
                                    *       determine closing net worth

                                    *       compute the difference in net worth

                                    *       determine the tax payer’s total spending
                                            during the tax year

                                    *       deduct non-taxable income from the
                                            taxpayer’s expenditures during the period
                                            and add any decline in net worth to the
                                            resulting expenditure figure

                                    *       compare the resulting figure adjusted
                                            expenditure figure to reported income.

V   International Business

    A      What is an international business?

           1      An international business is any business that engage in
                  international trade and investment.

           3      Modes of conducting international business

                  a          exporting (importing)

                  b          licensing

                  c          franchising

                  d          foreign direct investment

    B      Sources of law governing exports and imports

           1      The U.N. Convention on the International Sales of Goods

           2      Depending on the choice of law rules in the jurisdiction in which
                  litigation begins,

                  a          contract law in the jurisdiction in which the parties formed
                             the contract OR

                  b          contract law in the jurisdiction in which one of the parties
                             allegedly breached the contract.
C   The United Nations Convention on Contracts for the International Sale of
    Goods (CISG)

    1      adopted in 1980

           a      represents the work of more than 62 states and 8
                  international organizations

           b      the nations included developing countries and countries
                  that were under Communist rule at the time

           c      incorporates rules from the major legal systems

    2      Transactions covered

           a      international sales of goods

                  i       international

                          *       buyers and sellers must have their places of
                                  business in different countries

                          *       In addition, both states

                                          must be parties to the convention,

                                                 or

                                          the rules of private international law
                                          must lead to the application of the
                                          law of a contracting state

                          *       ex: Seller has his place of business in
                                  country A, a signatory to the convention and
                                  Buyer has his place of business in Country
                                  B, also a signatory to the convention and
                                  they enter into a contract to do business in
                                  country C, which is also a signatory. If a
                                  contract dispute develops, the CISG will be
                                  used to resolve it.


                          *       ex:

                                  Seller has a place of business in country A
                                  (a country that is not a party to the
             convention), Buyer has a place of business
             in country B (also a non country that is not a
             party to the convention) and the two enter
             into a contract in country C (a party to the
             convention)

             Seller breaches the contract in country C

             Buyer sues seller in country B whose choice
             of law rules point to the laws of country C as
             applying to the contract.

             Because C is a contracting party and the
             transaction is international, the CISG
             applies.

     *       Note: The parties can agree in their contract
             to have a particular law (such as the UCC or
             the French Civil Code) apply to disputes
             instead of the CISG

ii   goods

     *       there is no definition of goods

     *       instead, there are six categories of sales that
             the convention excluded from coverage

     *       excluded transactions

                     goods bought for personal, family or
                     household goods

                     auction sales

                     sales of property seized by authority
                     of law

                     sale of stocks, shares, investment
                     securities, negotiable instruments, or
                     money

                     ships, hovercraft or aircraft

                     electricity
                   *       sales of intellectual property are not covered
                           by the convention

           iii     mixed sales and service contracts

                   *       are considered sales of goods unless the
                           preponderant part of seller’s obligations
                           consists of labor or other services

                   *       preponderant is undefined, but probably
                           means more than half, but half of what (cost,
                           sales price etc?)

3   Contractual issues excluded from coverage of the convention

    a      illegality of the subject matter

    b      incompetence of a contracting party

    c      third party claims

    d      personal injuries caused by the product

4   Excluded transactions and excluded issues are covered by local
    law (i.e. by the laws of the contracting parties or by where the
    dispute arose.

5   Differences between U.S. law on the sale of goods (the Uniform
    Commercial Code, Article 2) and the CISG)

    a      contract formation requires offer and acceptance under both
           bodies of law but

           i       contract formation theory differs

                   *       U.S. - objective theory of contracts

                   *       CISG – subjective theory of contracts

           ii      the rules governing firm offers (offers by a
                   merchant that are held open to a definite date) are
                   different

                   *       U.S. – firm offers must be written

                   *       CISG – firm offers can be oral or implied
    iii    when acceptance is effective is different

           *       U.S. – acceptance is effective on dispatch

           *       CISG – acceptance is effective upon receipt

b   Whether sales contracts must be written is different

    i      U.S. – must be written if contract value exceeds
           $500

    ii     CISG – does not have to be written

c   rules for determining place of delivery is different

    i      U.S. (in order of application)

           *       as specified in the contract

           *       seller’s place of business if contract does not
                   specify place of delivery

           *       seller’s residence if seller has no place of
                   business

           *       known location of goods if seller has no
                   residence

    ii     CISG (in order of application)

           *       as specified in contract

           *       carrier’s place of business if contract does
                   not specify place of delivery

           *       known location of goods

d   Use of parole (oral) evidence to interpret contracts

    i      U.S. – no

    ii     CISG - yes

e   Does waiver of seller’s duty to deliver goods conforming to
    contract require specific words?
                   i      U.S. – yes

                   ii     CISG – no

           f       Remedies

                   i      Is breaching party entitled to notice before invoking
                          remedies?

                          *         U.S. – no

                          *         CISG – yes

                   ii     If the contract is breached, do buyer’s remedies
                          include price reductions

                          *         U.S. – yes

                          *         CISG – no

                   iii    Scope of specific performance decree is to

                          *         U.S. – deliver the promised goods

                          *         CISG – depends on local law

D   Legal rules governing international licensing

    1      Licensing is a contractual arrangement whereby one party gives
           another party the right to use intellectual property for a given time
           period in exchange for a fee called a royalty

           a       intellectual property

                   i      patents

                   ii     trademarks

                   iii    copyrights

                   iv     trade secrets

           b       issues that should be addressed by the licensing agreement
i    whether the licensor has an obligation to provide
     services to the licensee and, if so, at what price

     *      examples

                    assistance in setting up an assembly
                    line

                    training

                    technical support


     *      business issues

                    will such assistance increase
                    royalties

                    what is the cost of providing such
                    assistance


ii   What restrictions should the licensor impose on the
     licensee

     *      geographic limitations on the licensee’s
            manufacturing and marketing activities

                    purpose is to prevent the formation
                    of “grey markets” in which the
                    licensee (or former licensee)
                    competes with the licensor

                    In the U.S. and the EU, the licensor
                    can prevent the sale of the good only
                    if

                            The products are so different
                            that the quality of the
                            domestic product is called
                            into question

                            The licensor has
                            independently developed
                            good will in its own country
      *      limitations on the licensee’s applications of
             the intellectual property

                     ex:     licensee shall use the licensed
                     laser technology only for medical
                     applications

      *      output restrictions

      *      customer restrictions

      *      marketing quotas for the licensee

      *      requirement that access to key parts of the
             intellectual property be restricted within the
             licensee’s company

      *      requirement of non-disclosure of the
             intellectual property during and subsequent
             to the period of the license by company, its
             employees and its former employees

iii   What efforts should the licensee be required to
      make in order to market the product

      *      requirement of best efforts?

      *      requirement of minimum advertising
             expenditures?

iv    The issue of exclusive rights for the licensee

      *      The licensor does not want to grant
             exclusive territorial rights in a large market
             because this put all its eggs in one basket.

      *      The licensor will want exclusive rights to
             any improvements to the licensor’s
             technology or to any new inventions
             developed with that technology

      *      Is the licensor obligated to disclose
             improvements in technology to the licensee
             and allow the licensee to use the
             improvements?
           v       How should the parties resolve disputes?

                   *      which country’s law applies to a dispute

                   *      Will the dispute be resolved by arbitration
                          vs. litigation

                   *      If litigation, which forum will be used?

                   *      Does the licensor (licensee) have assets in a
                          jurisdiction that will enforce a judgment
                          based on the licensing agreement?

2   Govt regulatory schemes that restrict how the parties to a licensing
    agreement resolve these issues

    a      types of regulatory schemes

           i       no regulation

           ii      notification/registration schemes

           iii     prior approval schemes

    b      notification/registration schemes

           i       The general rule that prior approval of transfers is
                   that approval is not required.

           ii      However, there are exceptions to this general rule

                   *      Licensing agreements between companies
                          and their foreign subsidiaries sometimes
                          require approval.

                   *      Transfers of certain types of technologies
                          sometimes require approval.

           iii     Registration/notification does not mean that the
                   provisions of the agreement will be enforceable
                   under the foreign country’s laws.

                   *      Non-disclosure agreements that survive
                          expiration of the license, for example, might
                          be unenforceable
           *      License royalties might be ruled excessive.

    iv     Registration carries the risk that the licensor might
           disclose technological or proprietary secrets

           *      The notification/registration documents
                  might be a public record available to the
                  public.

           *      Even if not a public document, a bureaucrat
                  might intentionally or unintentionally
                  disclose key technology to another firm

           *      If detailed specificity is required in the
                  registration statement, there is a risk that the
                  disclosure of the registration statement will
                  disclose the firm’s intellectual property will
                  to its competitors or potential competitors

c   prior approval schemes

    i      the schemes cover a broad range

           *      In India, licensing agreements must be
                  approved by the Indian Foreign Investment
                  Board

                          The Board must seek the opinion of
                          each government agency that might
                          be concerned with the product
                          involved.

                          The Indian licensee should be free to
                          sublicense the technical know how

                          minimum guaranteed royalties are
                          forbidden

                          The Indian licensee should be able to
                          export the products it makes with the
                          license

           *      In Columbia,

                          no licensing agreement can extend
                          beyond 5 years and
                                     no licensing contain confidentiality
                                     obligations extending beyond the
                                     term of the license

                                     These schemes can be used to delay
                                     licensing until locally owned firms
                                     can develop competing technologies
                                     to make them competitive with the
                                     foreign firm (e.g. Japan’s 4 year
                                     delay in approval of a Texas
                                     Instrument’s license to a wholly
                                     owned TI subsidiary in Japan)

3   International Protection for Intellectual Property

    a      GATT Agreement on Trade Related Aspects of Intellectual
           Property Rights (TRIPS)

           i       requires every member of the World Trade
                   Organization (WTO) to

                   *          abide by the Paris and Berne Conventions,

                   *          abide by the protocols to the Paris and Berne
                              conventions

           ii      makes patent protection available to

                   *          products and/or

                   *          processes

           iii     that are

                   *          non-obvious AND

                   *          useful (i.e. capable of industrial application)

           iv      requires a min of period of protection of 20 years
                   for patents

           v       requires the signatories to establish effective
                   enforcement provisions under their laws to prevent
                   infringement of intellectual property rights
    vi     allows states to initiate a dispute before a WTO
           panel if it believes that another state is out of
           compliance with the treaty

    vii    allows states to refuse to patent inventions to protect

           *      public order

           *      public morality

           *      human, animal or plant life or health

           *      to avoid serious prejudice to the
                  environment

           *      However, cannot refuse to issue a patent
                  because local law prohibits the commercial
                  exploitation of an idea

                          Brazil or South Africa can refuse to
                          patent pharmaceuticals if it decides
                          that it is immoral to grant a
                          monopoly in pharmaceuticals but not
                          because local law prohibits the
                          commercial exploitation of medical
                          knowledge

b   The Paris Convention—The Convention for the Protection
    of Industrial Property

    i      Foreign patent and trademark applicants will
           receive the same protection as domestic applicants.

    ii     A trademark holder in a signatory country has a 12
           month period of priority for filing in other signatory
           countries.

c   The Patent Cooperation Treaty

    i      supplements the Paris Convention

    ii     A patent applicant who files an international patent
           application using the Treaty format has a priority
           patent claim in other countries for eight months.
           d        Berne Convention for the Protection of Literary and
                    Artistic Works

                    i      covers copyrights

                    ii     Each signatory must afford foreigners the same
                           protection as its own citizens.

                    iii    required minimum protections

                           *       prohibitions against copying literary and
                                   artistic works w/o the author’s permission

                           *       granting exclusive rights to authors to
                                   adaptations and broadcasts of their works

           e        World Intellectual Organization (WIPO) Copyright Treaty

                    i      is a protocol to the Berne Convention

                    ii     defines computer programs as literary works
                           protected by the Berne Convention

                    iii    also covers access to literary works via the Internet

                    iv     Issue: Is temporary reproduction covered by the
                           treaty?

                           *       Internet browsing works by sending packets
                                   of material into temporary memory.

                           *       So does web radio and video

E   Franchising

    1      Usually involves a license to produce a trademarked product

    2      Issues

           a        the geographic scope of the franchise

           b        whether the franchisee has exclusive sales rights within the
                    franchise area
           c      Are the quality assurance provisions of the franchise
                  agreement (such as tied purchases) enforceable under local
                  law?

           d      repatriation of profits in countries with currency control

                  i       Can payment be made in hard currency outside the
                          country?

                  ii      Is counter trade (payment of fees in goods instead
                          of currency) possible?—e.g. Pepsi being paid in
                          mushrooms by Russian franchisees which it uses in
                          its Pizza Hut subsidiary.

           e      language politics—requirement to conduct business in a
                  certain foreign language(s)—e.g. Canada and Quebec

F   Foreign Direct Investment

    1      Legal issues

           a      Does the investing firm’s government restrict investment
                  and trade in the target country

           b      Does the target country allow foreigners to own assets of
                  the type contemplated by the investing firm?

           c      choice of entity

                  i       Do government regulations in the target company
                          require a joint venture?

                  ii      a limited liability entity is advisable

           d      How should the investment be structured

                  i       firm’s wholly owned subsidiary owns assets in the
                          target country

                  ii      firm’s wholly owned subsidiary leases assets from
                          local nationals in the target country

                          *       lease should contain a condition subsequent
                                  discharging the lessor from any obligations
                                  in the event of nationalization or destruction
                                  of the property due to political unrest
                           *        leasing, and limitation of ownership to
                                    easily moveable items near a transportation
                                    center or port are useful devices for reducing
                                    political risk

                   iii     firm forms a subsidiary which enters a joint venture
                           with a foreign firm

G   U.S. Taxation of U.S. firms and persons who engage in international
    transactions

    1      Incorporating a Foreign Business

           a       section 351 applies but transfer of the following assets will
                   result in the recognition of gain

                   i       inventory

                   ii      accounts receivable

                   iii     others

    2      Special tax entities

           a       foreign sales corp

                   i       a foreign managed subsidiary corp. established to sell
                           U.S. produced products for a fee, and deduct the fee
                           as a business expense.

                           *        Note that a U.S. firm that sells a product to
                                    Europe that is manufactured in Brazil cannot
                                    take advantage of the special tax treatment
                                    available to profits on the sale by selling
                                    through a foreign sales corp.

                           *        It may, however, be able to take advantage of
                                    the special provisions available to controlled
                                    foreign corporations, discussed in (b) below.

                   ii      Taxation of the FSC

                           *        The fee is income of the foreign sales corp
           *       The foreign sales corp deducts its cost of
                   operation from the fee, declares a dividend
                   equal to its profit and, after paying tax to the
                   foreign jurisdiction, pays a dividend to its
                   owner, which is the U.S. corp.

           *       Up to 15% of the U.S. company’s export
                   earnings can be exempted from taxation in
                   this manner

           *       Congress is currently contemplating changing
                   this special tax treatment so that it is available
                   to both foreign and US corporations as a
                   result of a WTO decision that found this to be
                   an illegal export subsidy

b   Controlled foreign corp.

    i      is a foreign corp. in which over 50% of the stock is
           owned by U.S. shareholders

    ii     taxation of active income earned by the CFC is
           deferred until received by the U.S. shareholder

    iii    Active income is income derived from the direct
           conduct of a trade or business, for example, income
           derived from sales of products manufactured in a
           foreign country.

    iv     Passive income is immediately taxed to the U.S.
           shareholder regardless of whether the CFC pays a
           dividend to the shareholder

           *       passive income = dividends, rents, royalties,
                   gains on the sales of stock, and income from
                   selling goods on which the CFC has not
                   performed any significant operations.

           *       service income is treated as passive income if
                   it results from performing technical,
                   managerial or similar type services outside of
                   the country of the CFC’s corporation for a
                   company in the CFC family.
           *      Too much passive income might subject the
                  corporation to taxation as a foreign personal
                  holding company.

c   Foreign Personal Holding Companies

    i      is a corporation

           *       in which 5 or fewer U.S. citizens or resident
                  aliens own (directly or indirectly) 50% or
                  more of the stock, by vote or value, AND

           *      60% or more of the company’s income is
                  foreign personal holding company income

    ii     U.S. persons who own stock on the last day of the
           corp’s tax year must report their pro rata share of the
           corp’s foreign personal holding income whether the
           income originates as active business income or
           passive business income

d   Foreign Investment Companies

    i      is a corporation

           *      is registered under the Investment Co. Act of
                  1940 as either a management company or a
                  unit investment trust OR

           *      is engaged primarily in the business of trading
                  in securities or commodities AND

           *      50% of the corporate stock (by value or by
                  vote) is owned (directly or indirectly) by U.S.
                  persons

    ii     A taxpayer’s gain on the sale of stock in a Foreign
           Investment Company is ordinary gain to the extent of
           the taxpayers’s share of post 1962 accumulated
           earnings and profits unless the FIC has elected to
           distribute 90% or more of its income currently

e   Passive Foreign Investment Companies

    i      is a corporation that has U.S. stockholders whose
     *      passive income = 75% or more of the corp’s
            gross income for the corp’s tax year OR

     *      whose passive assets = 50% or more of total
            corp assets for the corp’s tax year

     *      there is no min % of U.S. ownership
            necessary for the classification

ii   U.S. shareholders who elect to do so are taxed on
     their pro-rata share of undistributed earnings for the
     tax year, even if they are not distributed

     *      earnings must be classified as ordinary
            income or capital gains depending on their
            character in the hands of the corp.

     *      Once the tax is paid, distributions of the
            previously taxed earnings pass tax free to the
            U.S. shareholder

ii   An investor who does not elect to be taxed on current
     earnings, whether distributed or not, is taxed on
     “excess distributions”

     *      An excess distribution is a distribution that
            exceeds 125% of the average distribution for
            the three previous years OR

     *      a gain on a disposition of the corp’s stock

     *      portion of the payment allocated to profits for
            the current year (or any year in which the corp
            was not a passive foreign investment co. is
            included in the taxpayer’s income as ordinary
            income

     *      any portion of the payment allocated to a
            prior year’s profits when the corp was a PFIC
            is taxed at the highest rate applicable to the
            taxpayer for that year

     *      An interest charge = to the charge for
            underpayment of taxes is added to the tax due
            on the portion of the payment charged to non
            current years for which the corp was a PFIC
    f      Passive Foreign Investment         Company treatment         for
           stockholders of CFC’s

           i       Persons who are 10% shareholders of CFC that is
                   also a PFIC will not be taxed as a PFIC.

           ii      Persons who are shareholders of a CFC that is a PFIC
                   may elect to recognize gain or loss annually on the
                   difference between the fmv of his stock and adjusted
                   basis regardless of his % of ownership if the stock is
                   marketable

                   *       The taxpayer may recognize such gain or loss
                           on an annual basis

                   *       losses, however, are limited to the prior year’s
                           recognized gains

3   Taxation of international activities by multiple sovereigns

    a      Both the U.S. and the foreign country might tax the activity.

           i       U.S. citizens and corporations controlled by S.S.
                   citizens are taxed on world wide income, wherever it
                   is generated.

           ii      Other countries also tax U.S. persons and U.S.
                   corporations on income generated in that country

           iii     These rules potentially create a situation in which an
                   individual, or U.S. corporation, that does business in
                   a country (e.g. Sweden) could be taxed on its income
                   by both Sweden and the United States and the total
                   tax due could approach or exceed 100% of income.

           iv      The U.S. has negotiated treaties with approximately
                   40 to eliminate the double taxation of profits earned
                   on international transactions

           v       the parties to the treaty agree to grant tax credits for
                   income taxes paid to the other country on profits
                   earned in that country
      *       credit means that every tax paid to the foreign
              government reduces the U.S. tax by one
              dollar.

      *       deduction means that the dollar of tax paid to
              a foreign government is deducted from
              revenue which reduces income and taxes
              owed to the U.S govt.

      *       tax credit is the better treatment, provided
              taxes are due.

ii    In order to take advantage of the credit, the foreign
      tax must be the equivalent of the U.S. income tax or a
      tax levied in lieu of an income tax. (i.e. be a substitute
      for an income tax an not in addition to an income tax)

iii   The max credit = foreign source taxable
      income/world wide taxable income x pre-credit U.S.
      tax

iv    If the max credit is less than the income tax paid to
      the foreign govt, the unused credit can be carried
      back two years and forward up to five years

v     The max credit must be computed and applied on a
      separate basis for 9 income categories

      *       passive income

      *       high withholding tax interest (i.e. interest
              subject to a 5% or more withholding tax
              levied by a foreign govt or a U.,S. possession)

      *       financial services income

      *       shipping income

      *       dividends from an uncontrolled section 902
              corp. (i.e. a domestic corp. that owns 10% or
              more of the stock of a foreign corp and has
              income described in 26 USC sec. 902)

      *       certain dividends from a DISC or former
              DISC
                  *       Foreign Sales corp income attributable to
                          foreign trade income

                  *       Certain distributions from an FSC or former
                          FSC

                  *       general limitation income

           vi     ex of general income calculation

                  *       country Z taxes profits and other income
                          earned in country Z at a rate of 10% and the
                          U.S. taxes the profits of the US firm at a rate
                          of 18%

                  *       Total firm profits = $400X, of which $100X
                          is attributable to country X

                  *       The firm pays $10X of income taxes to
                          country X country

                  *       The firm’s pre-credit U.S. tax obligation is
                          $72X obligation

                  *       Max tax credit = 100X/400X x $72X =
                          $18X

                  *       Actual tax credit = min of actual tax, max
                          tax credit = $10X

                  *       Total tax obligation to the two govts = $10X
                          + $72X – $10X = $72X

    *      Without the tax treaty, the total tax obligation would equal
           $10X to Z and $16 to the U.S for a total of $26X.

           vii    If there is no tax treaty, and if the business is
                  organized as a U.S. corporation, the corporation gets
                  a tax credit equal to any corporate income tax paid to
                  the foreign govt.

4   foreign income exclusion for wages and salaries received by U.S.
    citizens who live outside the U.S continuously for more than one
    year

    a      Up to $76,000 can be excluded
                    b       a housing allowance equal to the difference in housing costs
                            for comparable housing also is excludable



VI   Professional liability of accountants

     A      Accountants are professionally liable to their clients if

            1       The accountant breaches his contract with his client

            2       The accountant is negligent, meaning that

                    a       the accountant breaches a duty of due care, and

                    b       The client suffers damages which are proximately caused
                            by the breach of duty—i.e. the breach of duty sets in
                            motion the forces causing damage.

            2       The accountant commits fraud

                    a       The accountant makes a material misrepresentation (i.e. a
                            statement of consequence to the client)

                            i      The misrepresentation can be express

                            ii     misrepresentation by silence

                    b       The accountant knows he has made a material
                            misrepresentation

                    c       The client reasonably relies upon the false statement

                    d       The client suffers damages as a proximate result of the
                            statement.

            3       The accountant misuses client information

                    a       The accountant fails to keep client information confidential,
                            OR

                    b       The accountant uses the information for a purpose other
                            than the client’s best interest

     B      Professional liability of Accountants to persons who are not their clients
    1      States follow three different approaches in determining whether
           accountants are professionally liable to third parties for negligence

           a       Ultramares rule—The accountant is liable to the third party
                   if

                   i       he knows the identity of the third party AND

                   ii      Knows the third party will see his work product
                           AND

                   iii     Knows the third party will rely on his work product
                           for a particular known purpose

           b       The foreseeability rule—The accountant is liable to the
                   third party if

                   i       It is reasonable for the accountant to foresee that the
                           third party will receive financial statements from
                           the client AND

                   ii      the third party relies upon these statements

           c       The Restatement rule—(Majority Rule)The accountant is
                   liable to a third party and to anyone in the same class as the
                   third party if he knew the third party would rely on the
                   information.

    2      An accountant is liable to any foreseeable user of his work product
           if he commits fraud.

    3      In certain limited circumstances, the accountant may have liability
           to persons who are not his clients under the federal securities laws

C   Liability of accounts under the federal securities acts

    1      Section 11 of the Securities Act of 1933 makes auditors liable for
           any material misstatement or omission in the financial statements
           that they provide for a registration statement.

    2      Section 10A of the 1934 Act requires an auditor to notify the board
           of directors when he suspects that a corporate client has performed
           an illegal act.
    3      Section 10(b) of the 1934 Act makes an auditor liable for knowing
           or reckless misstatements of fact that the plaintiff relies upon in
           purchasing OR selling a security.

    4      The liability is joint and several if the auditor acts knowingly.

    5      The liability is proportional if the auditor does not act knowingly.

D   There is a split in authority among the United states Courts of Appeal
    regarding accountant’s liability under section 10-b of the 1934 Securities Act

    1      15 U.S.C. Section 78(j)(b), commonly referred to as section 10b of
           the Securities Act, states

           It shall be unlawful for any person, directly or indirectly, . . ..
           (b) To use or employ, in connection with the purchase or sale of
           any security . . . any manipulative or deceptive device or
           contrivance in contravention of such rules and regulations as the
           Commission may prescribe as necessary or appropriate in the
           public interest or for the protection of investors

    2      The Securities and Exchange Commission promulgated Rule 10b-5
           pursuant to this grant of statutory authority.

    3      17 C.F.R. § 240.10b-5 states:

           It shall be unlawful for any person, directly or indirectly, by the
           use of any means or instrumentality of interstate commerce, or of
           the mails or of any facility of any national securities exchange,

           (a) To employ any device, scheme, or artifice to defraud,

           (b) To make any untrue statement of a material fact or to omit to
           state a material fact necessary in order to make the statements
            made, in the light of the circumstances under which they were
           made,                not             misleading,               or

           (c) To engage in any act, practice, or course of business which
           operates or would operate as a fraud or deceit upon any person,
           in connection with the purchase or sale of any security.

    4      Ninth Circuit case law interpreting section 10 b

           a       In re ZZZZ Best Sec. Litigation

                   i       facts
           ii     legal rule

           iii    application of facts to legal rule

    b      In re Software Toolworks Inc. Sec. Litigation

           i      facts

           ii     legal rule

           iii    application of facts to legal rule

5   Second and Tenth Circuit case law

    a      Shapiro v. Deloitte, 123 F.3d 717 (1997)

           i      facts

           ii     legal rule

           iii    application of facts to legal rule

    b      Anixter v. Homestake Production Co.

           i      facts

           ii     legal rule

           iii    application of facts to legal rule

6   Comparison of Ninth Circuit and Second Circuit case law

    a      Ninth Circuit--a plaintiff must prove

           i      damages

           ii     caused by reliance on misrepresentations or
                  omissions of material facts which the defendant

                  *       made OR

                  *       substantially created OR

                   *      was intricately involved in the creation
                          thereof, AND
    iii       which were made with scienter -- intent to deceive,
              manipulate, or defraud, or reckless disregard for
              the resultant deception, AND

         iv   which were made in connection with the purchase
              or sale of securities, And

         v    which were furthered through the defendant's use
              of the mails or a national securities exchange.

b   Second circuit--a plaintiff must prove

    i         damages

    ii        caused by reliance on misrepresentations or
              omissions of material facts which the defendant

              *      actually made AND

              *      which can can be attributed to him/her by
                     the person who received the erroneous
                     information AND

              *      which were made with scienter -- intent to
                     deceive, manipulate, or defraud, or reckless
                     disregard for the resultant deception,

              *      which were made in connection with the
                     purchase or sale of securities, AND

              *      which were furthered through the
                     defendant's use of the mails or a national
                     securities exchange.

c   hypotheticals

								
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