To be perfectly clear:  if you formed an LLC or incorporated a business in 2012 or earlier, you have tax and other government filings that are due in early 2013 – even if you had no or very little financial activity.

Here are the most common IRS, MA (other states have similar deadlines) and DE filings and some of the consequences for late filing:

LLC Income Tax (Single Member):  This one is somewhat easy – just need to include Schedule C (Profit and Loss from Business) with your personal federal and state income tax return.  Due April 15^th.  IRS late filing consequences are penalty and interest based on your total tax liability (from all sources).

LLC Income Tax (Multi-Member):  Need to file a partnership return (Federal Form 1065 and MA Form 3) and distribute K-1 forms to the members.  These forms are not intuitive.  Due April 15^th.  IRS late filing consequence is $195 per month per member penalty.  This penalty is very difficult to abate, but worth a try if you can prove “reasonable cause”.

S Corporation Income Tax:  Need to file a corporate tax return (Federal Form 1120S and MA Form 355S) and distribute K-1 forms to the shareholders.  These forms are not intuitive.  Due March 15^th.  IRS late filing consequence is $195 per month per shareholder penalty.  This penalty is very difficult to abate, but worth a try if you can prove “reasonable cause”.

C Corporation Income Tax:  Need to file a corporate tax return (Federal Form 1120 and MA Form 355).  These forms are not intuitive.  Due March 15^th.  IRS late filing consequences are penalty and interest based on your total tax liability.

Form 1099-MISC:  All businesses need to distribute Form 1099-MISC to any independent contractors or attorneys that were paid $600 or more in 2012.  Due to the recipient on January  31^st and to the IRS and MA on February 28^th.  IRS penalty for noncompliance is $100 per form or $250 per form for “intentional disregard.”

MA Secretary of State Annual Report:  Most LLCs or corporations physically located in MA have registered with the MA Secretary of State, even if they are formed or incorporated in another state, such as Delaware.  An annual report is due:

•  Corporations (S and C):  March 15^th.  Late filing consequences are penalty and interest based on the total fee.
•  LLCs:  Annual anniversary of LLC formation date.  No monetary consequence for filing late.

DE Secretary of State Annual Report:  Many businesses incorporate or form their LLC in DE.  An  annual report is due:

•  Corporations (S and C):  March 1^st.  Late filing consequences are penalty and interest     based on the total fee.
•  LLCs:  June 1.  Late filing consequences are penalty and interest based on the total fee.

This only covers the very basics and often there are more serious consequences for late filing and/or noncompliance.  There are many “moving parts” to tax compliance and a quick call to your accountant can save you a ton of money and headaches.

_____________________________________________________________________________

IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

Here is why you want to file an 83(b) Election:
• If you think the value of your stock will increase, you will be forced to pay taxes on “phantom income” each year.

Let’s give an example to show the consequences of not filing an 83(b) election:
• You own 10% of the stock of your startup. It vests over 4 years, or 25% per year.
• You purchased this stock for $100 (fair market value) on January 1 of Year 1.
• During Year 1, the Company raised some outside financing that values the company at $10M.
• At the end of Year 1, the value of the Company is $10M and the value of your stock is worth $1M.
• You have about $250K in taxable income in Year 1 ( [value of Company at year-end, $10M less value of Company at beginning of year, $1K] * ownership percentage, 10% * vesting % in Year 1, 25%).
• You owe about $100K in Federal and State taxes.
• You will pick up additional taxable income in Year 2 through Year 4 if the value of the startup continues to increase.
• You do not get any tax relief if the value of the Company decreases.
• Remember, this “phantom income” is triggered just by the value of the Company increasing – not by exercising the options or selling the stock.

Here is how to file an 83(b) election:
• Copy and paste the 83(b) Election Form sample below and edit the fields that are highlighted in yellow.
• Copy and paste the IRS sample cover letter below and edit the fields that are highlighted in red.
• Enclose a self-addressed stamped envelope
• Mail it to the IRS address below within 30 days after the stock grant (there is no relief if you file late).
• Mail Certified Return Receipt Requested to prove timely delivery.
• Attach a copy of the 83(b) to your personal tax return in Year 1. (this means that you cannot e-file your return that year).
• If you live in a community property state, your spouse also needs to sign the 83(b) Election Form.
• Give a copy of the signed 83(b) Election Form to the Company.

SAMPLE SECTION 83(b) ELECTION FORM:
Election Under Section 83(b) of the Internal Revenue Code

The undersigned hereby makes an election pursuant to Section 83(b) of the Internal Revenue Code with respect to the property described below:

1. Name and Address of Taxpayer:

XXXXXXXXXXX
XXXXXXXXXXX
XXXXXXXXXXX
Taxpayer SSN # :
XXXXXXXXXXX

 
2. Description of property with respect to which election is being made:

XXXXX shares of the common stock of XXXXXXX, (the “Company”) ($X.XXXX par value).

 
3. Date on which property was transferred is XXXXXXX.

 
4. The taxable year for which this election is being made is calendar year 20XX.

 
5. Nature of restrictions to which property is subject:

YOU CAN COPY AND PASTE FROM YOUR RESTRICTED STOCK GRANT THE RESTRICTIONS, SUCH AS VESTING, ETC.

 
6. The fair market value at time of transfer (determined without regard to any restrictions other than restrictions which by their terms will never lapse) of the property with respect to which this election is being made is $X.XX per share, for a total aggregate value of $XXX.XX.

 
7. The amount paid by the taxpayer for the property is $XXX.

 
8. A copy of this statement has been furnished to [Company name].

 
Dated: XXXXXX XX, 20XX

Signed,

 
___________________________________
XXXXXXXX X XXXXXXXXXXXXXX

 
____________________________________
SPOUSE SIGNATURE, IF COMMUNITY PROP STATE

____________________________________
SPOUSE NAME PRINTED

SAMPLE TRANSMITTAL LETTER TO IRS:

Name and Address of Taxpayer:
XXXXXXXXXXX
XXXXXXXXXXX
XXXXXXXXXXX
Taxpayer SSN # :
XXXXXXXXXXX

 
Dated: XXXXXX XX, 20XX

 
IRS Service Center Address From Below

 
Dear Sir or Madam:

 
Pursuant to Treasury Regulations Section 1.83-2(c) promulgated under Section 83 of the Internal Revenue Code of 1986, as amended (the “Code”), enclosed please find a copy of an election under Section 83(b) of the Code.

Also, attached are a self-addressed stamped envelope and a signed copy of my 83(b) Election Form. Please date stamp the copy of the Election Form, enclose it in the attached envelope and mail it to me.

 
Thank you,

 
________________________________
XXXXXXXX X XXXXXXXXX

 
Enclosures

 
WHERE TO MAIL THE LETTER AND 83(b) ELECTION FORM TO:

 
If you live in:

Alabama, Georgia, North Carolina, South Carolina, Kentucky, Tennessee, Missouri, New Jersey, Virginia, West Virginia, Connecticut, Delaware, District of Columbia, Maine, Maryland, Massachusetts, New Hampshire, New York, Pennsylvania, Rhode Island, Vermont:

Department of the Treasury
Internal Revenue Service
Kansas City, MO 64999-0002

Florida, Louisiana, Mississippi, Texas:

Department of the Treasury
Internal Revenue Service
Austin, TX 73301-0002

Alaska, Arizona, California, Colorado, Hawaii, Nevada, Oregon, Washington,Arkansas, Idaho, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Ohio, Oklahoma, South Dakota, Utah, Wisconsin, Wyoming:

Department of the Treasury
Internal Revenue Service
Fresno, CA 93888-0002

A foreign country, U.S. possession or territory* or use an APO or FPO address, or file Form 2555, 2555-EZ, or 4563, or are a dual-status alien:

Department of the Treasury
Internal Revenue Service
Austin, TX 73301-0215

_____________________________________________________________________________
IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

Recently, Smartco ran into a serious cash flow problem due to a late-paying customer.

Most startups will experience cash flow problems. They often rear their ugly head when the business just becomes cash flow positive and is no longer living off investor life support money. For many companies, especially if the investors and owners are tapped out after a long development stage, it can be the final straw.

Smartco was exactly at that juncture. Many years and millions of dollars to develop the product had finally come to an end. They had real customers and a working product. Cash flow was tight, but improving when a major customer went south on a large receivable that jeopardized Smartco’s future existence.

Like many tech startups, most of Smartco’s expenses were payroll. They did not want to lay off employees, though, but needed a temporary 20% reduction in payroll cost to survive.

Luckily, Smartco was located in a state (such as MA and about 25 other states) that have a Work Share program. These programs let a business reduce the hours of certain or all workers and allow the employee to collect Unemployment Compensation from the state for the hours cut.

So, Smartco temporarily reduced everyone’s pay to 4 days. They remained open 5 days, as they are able to dictate what day each employee can take off. Some of the hourly and lower paid employees actually received most or their entire regular payroll, as overtime plays into the benefit calculation. All of Smartco’s employees, though, were happy to collect for the other day and spend it skiing or at the beach.

The details of these Work Share programs vary by state, but can be incredibly valuable in retaining employees while going through cash flow problems. Recently, Congress passed a bill that federally funded these programs, so most states currently without a Work Share program will probably implement one soon.
______________________________________________________________________
IRS Circular 230 Disclosure
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

Dumbo Corp is a 2-year old startup that recently started selling product to a few large customers.  They have 30 employees and a $250K monthly payroll.  The employees are paid on a monthly basis and Dumbo runs its own payroll through QuickBooks.   

Recently, Dumbo ran into a serious cash flow problem due to a late-paying customer. To bridge the cash flow problem, they delayed paying the IRS $50K in payroll taxes just withheld from the employees’ most recent paycheck. The customer said they would pay within a week and Dumbo would then make the IRS whole.

You know the rest of the story – customer never pays, cash flow problems get worse, Dumbo continues to fund operations with employees’ payroll taxes, Dumbo goes bankrupt.

Now, why is financing operations, when there is a cash flow problem, by not paying the IRS “the dumbest and most dangerous startup financing”?  Big companies often string out vendors to fund operations.  Plus, in a worst-case scenario, bankruptcy dissolves all debts and the corporate veil personally protects employees – right?  No one going to jail here – right?

Wrong and wrong.  Corporate bankruptcy will not discharge this type of IRS tax debt. Even personal bankruptcy will not discharge this type of IRS tax debt.  The IRS will chase you forever.  Plus, the corporate veil is pierced very easily by not paying the IRS.

For trust fund taxes (i.e., withheld payroll taxes), the IRS holds every “responsible person” personally and criminally liable for “willfully” failing to ensure that payroll taxes are paid.  They move very quickly when a quarterly payroll tax return is not filed or there is a payroll tax deficiency. They can demand full payment from any “responsible person” without first trying to collect the payment from the employer or other “responsible persons”.

Oh by the way, a “responsible person” is broadly defined as anyone with substantial authority over business operations even if somebody else has the ultimate authority over which bills get paid.  The IRS has successfully prosecuted CEOs to AP clerks under this “responsible person” definition.

The penalty becomes criminal when a “responsible person” intentionally violates a legal duty – knowingly not remitting withheld payroll taxes.

So, any “responsible person” at Dumbo who knew the IRS was not being paid while vendors, such as the landlord or electric company were being paid is personally and criminally liable.

The IRS process always starts with a notice.  If you receive one regarding payroll taxes – do not take it lightly, even if you never had a payroll.  Get professional help (preferably a CPA) to respond to the notice immediately.  The IRS acts very quickly, including personal visits to the business and bank account liens.

(One fool-proof way to avoid this temptation and a good business practice is never to do your own payroll.  Use a payroll service provider, such as MassPay, Paychex or ADP).

___________________________________________________________________________

IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

• Get an Employer Identification Number (EIN) from the IRS.  You have an SSN – this is the corporate equivalent.  Get it here https://sa1.www4.irs.gov/modiein/individual/index.jsp

• Register your business with your State’s DOR.  Most states require you to file and pay taxes and unemployment insurance online.

• Understand your Secretary of State filing requirements.  And you may have more than one Secretary of State filing if you incorporated in one state, such as Delaware, and are physically located in another state.

• If you are selling stuff, understand that you may need to charge sales tax.  Forty-five states, DC and Guam have sales tax and each have very different, unique rules.   Also, some states may have the “Amazon” tax, whereby online retailers need to charge sales tax even though they have no physical presence in the state.

• Know which workers are independent contractors and which workers are employees.  The IRS slap you really hard when you get caught “pushing the envelope” with independent contractors.  If you have employees, you need Workers’ Comp insurance.  NEVER PAY ANY WORKER UNDER THE TABLE.

• If you have employees, engage a payroll service, such as MassPay (ADP and Paychex are good but overkills for startups) and use their tax service to file and pay your payroll taxes.

• Open a business bank account and pay all of your bills from this account and make all of your deposits into this account.  If you are running a payroll, open an additional checking account and ensure “Payroll Account” is somewhere in the name of the account (it is an IRS thing).

• Buy QuickBooks Pro and figure out how to use it.  It is not difficult.  Do not buy any of the QuickBooks’ industry specific products and definitely do not sign up for QuickBooks Online.  As good and inexpensive QuickBooks Pro is, these other QuickBooks’ products are the opposite.

• If you want a business credit card, read the fine print – you are signing personally, even though the business’ name is on the card.  It is a real horror story when you leave the business, do not cancel the cards and the business does not pay the bill.  The credit card company, especially AMEX, will aggressively come after you.

• Set up a Stock Plan to legally and tax-efficiently compensate workers, consultants and directors with stock options or restricted stock grants.  The plan should hold about 15%-20% of the outstanding equity of the business on a fully-diluted basis.  Engage a lawyer who is familiar with these plans, as there can be several legal and tax pitfalls and these plans have many moving parts.

Now smile.  It does not get better than this.  Even if grow this business into a mega-corporation, there is no more fun than starting a business and setting it up properly.  Good luck.

___________________________________________________________________________________

IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

When reading this, keep in mind one simple concept – Common Stock (CS) is typically owned by the founders/employees of a Company and the VCs typically own Preferred Stock (PS).  It is called “Preferred” Stock because there are many preferences over “Common” Stock.  The terms below all pertain to PS. 

Series A Convertible Redeemable Participating Preferred Stock (PS) – a real mouthful.  Let’s break this down:

• Series A – the first round of equity financing by VCs.  The next, or second round, will be Series B, and so on.
• Convertible – these PS shares convert to Common Stock (CS), usually on a one-to-one basis.  If you own 100 shares of PS, you can convert these to at least 100 shares on CS (usually only done when the Company goes IPO).
• Redeemable – PS holders can force the Company to buy back their PS for the money they invested plus dividends.  This usually does not kick in until about five years from closing.
• Participating – upon the Company being acquired (not an IPO), the first money paid by the acquirer is paid to the PS holders (see Liquidation Preference below) to recover their investment plus dividends.  Then they “participate” in the remaining money based on their stock ownership % (i.e., they get two bites of the apple).

Liquidation Preference – if the Company is sold, the PS holders get back the amount they invested in the Company plus dividends first.  Then they “participate” in the remaining proceeds through their PS ownership.  1x liquidation preference means they get back one times their investment, 2x means they get back twice their investment, etc.

Anti-dilution – the PS holders cannot get diluted.  If they bought 1M shares for $2 per share and the Company later sells shares for less than $2 per share, say $1 per share, the PS holders get additional shares (see ratchet for the amount of shares they get).

Ratchet (i.e., full-ratchet, partial ratchet) – if anti-dilution kicks in and there is a full ratchet, the PS holders in the example above would now effectively own 2M shares ($2M invested divided by $1 per share – rather than divided by $2).  If there is a partial ratchet, the amount of shares the PS would effectively own is a weighted average function based on the amount of stock purchased and the total amount of shares outstanding.

Drag-along (or Bring Along) – forces CS holders to vote for an acquisition that has been approved by the PS holders.

Right of First Refusal – if the Company does a new equity round, the current PS holders have the right (but not the obligation) to participate in the new round to maintain their current equity ownership %.

Pay-to-Play – this typically kicks in the second and subsequent rounds in deals where there are more than one VC.  It forces all the present VCs to participate in the new round based on their current pro rata share.  If not, they get punished. The punishment can take the form of losing certain rights, such as liquidation preferences, anti-dilution, voting rights, or even forcing their current PS to convert to CS.

Now, before you jump to the conclusion that the VCs have a much better deal than the founders/employees, remember that in most of these startup Companies, the VCs are the only shareholders who invested real cash and because of the inherent risk with all startups, they deserve the potential for a high rate of return on these funds.

________________________________________________________________________

IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

So, we have prepared six questions that will make you look really smart and help you understand your equity compensation.  It may also make you a lot richer when your Company is acquired.

Assumption: You have been offered an incentive stock option for 100,000 common stock shares at an exercise price of $0.05 per share that vests 25% after the first year and then monthly for the next three years.

Questions: 

1.    How many shares are outstanding on a fully-diluted basis?

2.    Can I receive restricted stock, rather than incentive stock options?

3.    Based on the current burn rate, when does the Company plan to raise the next round of equity?

4.    Will the Company refresh when the next round is raised?

5.    What is the liquidation preference that is in front of the common shares?

6.    Is there any acceleration of vesting upon a change in control?

Analysis:

1.    Your slice of the pie.  Obviously, there is a huge difference in the size and value of your slice if the pie (total shares outstanding) is 1M shares vs. 100M shares.  Fully-diluted just converts all preferred stock shares and warrants to common stock shares.

2.    The answer will probably be no, but ask the question anyway.  Restricted stock just means that you actually own the stock (vs. an option to purchase the stock) with restrictions (vesting schedule).  It is a much better deal for taxes.

3.    The answer to this is important, as it is a back-door way to ask when does the Company run out of money?

4.    When the Company raises additional equity, they issue more shares, so the pie grows and your slice shrinks.  This is just an intelligent sounding way to ask if they plan to make you whole by issuing you additional options.  This is worth negotiating.

5.    Preference is the amount paid to the investors when the Company is acquired, before any amount is paid to stockholders.  It is often 1X which means if there was $10M invested in the Company, that amount (plus dividends) is the first money paid, before anything flows down to stockholders, including option holders.

6.    Sometimes, companies will accelerate your unvested stock options upon an acquisition.  This can be huge to negotiate if you anticipate an acquisition in the near future.

Good luck and remember if you have gotten to the point where there is an offer on the table, the Company wants you and this will be the best­ and maybe only time to negotiate your equity compensation.

___________________________________________________________________________

IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

Under both proposals, capital gain treatment remains in place for gains attributable to cash or property contributed by service partners in an “Investment Partnership” (more than 50% of the capital is contributed by passive investors).

The problem arises when the service partner’s capital contribution is provided by a loan (recourse or nonrecourse) made or guaranteed (directly or indirectly) by the partnership, another partner or a related party.  In these cases, any attributed gain from this capital contribution is taxed as ordinary income.

The planning opportunity to repay these loans or refinance them with a qualified loan is different under the two proposals.  Under the Obama bill, the loan needs to be repaid by January 1, 2013.  Under the Levin bill, the loan needs to be repaid by date of enactment of the legislation.

Three significant issues to be aware of:

• The service partner’s capital contribution is tested (for capital gains treatment) only once, at the time of the original contribution.  So, if you have a disqualified loan now and it is not repaid by the respective dates, any attributed gain will be ordinary income, even if this loan is repaid/refinanced before the gain from this capital contribution is realized.
• Any violation of these regulations will result in a 40% (as opposed to the usual 20%) tax penalty.   This penalty can only be avoided by attaching a disclosure to the service partner’s tax return of the tax position and detailing that the taxpayer is more likely than not to prevail on the merits.
• There is a good chance that neither bill will be enacted in 2012, as it is an election year.  It seems likely, though, that there will be some change/compromise regarding the taxing of carried interest in 2013 or thereafter.

___________________________________________________________________________

IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

One of the “usual suspects rounded up” was taxing Carried Interest at ordinary tax rates rather than the capital gain rate.  Carried Interest is the amount of gain that an Investment Firm (Venture Capital, Private-Equity, Buyout Firm, Hedge Fund, etc.) gets to keep on a successful investment and distribute to its employees.  It is usually 20% of the gain.

So, if the Firm invested $1M in a business and after several years, cashed out of this investment by selling its share for $3M, there would be a $2M gain.  The Investment Firm gets to keep and distribute to its employees 20% or $400K of that gain. The remaining 80% or $1.6M of the gain is distributed to the Investment Firm’s investors (pension plans, endowments, high-net worth individuals, etc. – called Limited Partners or LPs)

Under current tax law, this $400K distribution is taxed to the employees as a capital gain at 15% and the tax is $60K.  Under the Obama proposal, this gain would be taxed as ordinary income.  Assuming the top rate of 39.6% (Obama FY2013 Budget), that bonus would cost the employee $158K in taxes, an increase of 164%.

The argument for taxing this gain at ordinary income tax rates is that the funds used for this investment were contributed by the Investment Firm’s investors, not the Investment Firm’s employees.  Therefore, these employees did not have any money at risk.

Now, we do not have a “horse in the race” here, as we are not an Investment Firm, but feel taxing carried interest at ordinary income tax rates, especially for Venture Capitalists (VC), is very unfair.  Our reasons:

• The typical VC is paid somewhat modestly (taking into account their education, experience, and other employment opportunities available to them).  According to salary.com, below is a chart of their median annual salary and bonus (we will assume this bonus is from the carried interest):

• Assuming these amounts are somewhat reflective of reality (and we do understand that these are median amounts and that some VCs earn considerable more than these amounts), carried interest represent about 41% of an experienced VC’s total compensation versus only 12% for an entry level VC.
• Therefore, if there is any fallout from this tax change, it will be the more experienced VCs leaving the industry or retiring.  In our opinion, this can be harmful to the VC industry and the US economy for the following reasons:
  • More experienced VCs make better investment decisions (for obvious reasons).  Therefore, fewer successful companies will be funded.  Thus, there will be fewer US jobs created.
  • VC firms and the VC industry are dependent upon their LPs to continue to allocate a part of their portfolio to Venture Capital investments.  If VC firms cannot raise money for new funds because of this “brain drain” fewer companies will be funded and fewer US jobs will be created.
  • If VC firms raise their carry to 30-35% to compensate for increased taxes, the returns for LPs will decrease, forcing them to allocate less of their portfolio to VC investments.  Thus, fewer companies will be funded and fewer US jobs will be created.
• VCs invest in start-up firms that often take five to ten years to mature before they can be taken public or sold.  VCs are not passive investors.  They are actively involved in their portfolio companies, yet there is a high probability their investment will be worthless, due to the high risks inherent in these start-up companies.  Thus, their risk and reward reflect sweat equity that should be treated as a capital asset.
• The employees of the companies that VCs invest in receive capital gain treatment on their gain from stock options and stock ownership.  Treating carried interest as ordinary income would unfairly tax an equivalent gain by these VC employees at a rate that is 164% higher than the employees of the portfolio companies.
• Unlike many Hedge Funds, the carry in a VC firm is accumulated and created over many years which is one of the requirements to receive capital gain treatment.  Hedge Funds often create value in a very short-time through high frequency trading or derivatives, which is regarded as ordinary income.
• Assuming no changes in the current tax system, capital gain rates will increase to 18.8% in 2013 due to the 3.8% Federal Tax surcharge for unearned income, including capital gains as a result of ObamaCare.  Therefore, the Treasury will already receive 25% more in tax revenue from this carried interest.

In our opinion, the Venture Capital industry has created millions of good paying American jobs and this Administration and President are totally out of touch penalizing the talent in this industry for being successful.  Doing so, will result in fewer good paying US jobs being created and be harmful to the US economy.  Also, we feel that more money in the hands of taxpayers, rather than in the hands of politicians, is a better way to stimulate our economy.

__________________________________________________________________________________________

IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

Based on our experience of often, “picking up the pieces”, we have developed three rules for these entrepreneurs.  (Note that these do not apply to sponsor-backed (VC/PE/Angel) companies, but strictly to “bootstrapped” businesses that are funding operations with personal funds).

• Before you make the decision to incorporate or form an LLC, visit an accountant who is familiar with closely-held businesses and discuss, quantify and  thoroughly understand the following and ensure these additional and often substantial costs justify the corporate benefits:
  • Income Taxes differences of a C Corporation, S Corporation, LLC, Proprietorship
  • Secretary of State initial registration fees,
  • Secretary of State annual fees/taxes
  • Resident Agent fees
  • Minimum annual State Income Tax
  • Income Tax compliance fees

• If you decide to incorporate or form an LLC, do not get talked into incorporating or forming in Delaware or Nevada – do it in the state where you are physically located.  Delaware and Nevada are fine choices for sponsored-backed companies or companies about to go public, as the do have certain advantages, such as the Delaware business law flexibility and the Nevada indemnification benefits.  For bootstrapped companies, though, these advantages are not worth the additional registration fees, annual fees and compliance costs – you will get a better return from these funds by investing them in your business.  If you raise VC/PE/Angel funds, you can always choose to change your state of incorporation very inexpensively and with someone else’s funds.

• Do NOT incorporate too soon. Even though your lawyer may be pushing the personal liability protection of corporations and LLCs – there is a good chance that no one will sue you, especially if you do not have substantial assets (such as college students).  If you do get sued for Negligence or Fraud, the corporate veil will not protect your personal assets.  If you decide not to incorporate, ensure that you register the business with your city or town (file a DBA) and have the proper Property and Casualty insurance.  Also, if you have other partners, ensure that you develop and sign a comprehensive agreement that details issues, such as ownership of IP, ownership percentage of business, funding issues, tax allocations, withdrawal of a partner from the business, and all other potential issues involving the business.  It is best to agree to this early in the life cycle of the business and then draft the agreement and, then, present to a lawyer to edit, finalize and memorialize.

__________________________________________________________________________________________

IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.