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What Is Reorganization?

Reorganization is a process designed to revive a financially troubled or bankrupt firm. A reorganization involves the restatement of assets and liabilities, as well as holding talks with creditors to make arrangements for maintaining repayments. Reorganization is an attempt to extend the life of a company facing bankruptcy through special arrangements and restructuring to minimize the possibility of past situations reoccurring. Generally, a reorganization marks the change in a company’s tax structure.

Reorganization can also mean a change in the structure or ownership of a company through a merger or consolidation, spinoff acquisition, transfer, recapitalization, or change in identity or management structure. Such an endeavor is also known as “restructuring.”

Breaking Down Reorganization

The first type of reorganization is supervised by the court and focuses on restructuring a company’s finances after a bankruptcy. During this time, a company is protected from claims by creditors. Once the bankruptcy court approves a reorganization plan, the company will repay creditors to the best of its ability, as well as restructure its finances, operations, management and whatever else is deemed necessary to revive it.

U.S. bankruptcy law gives public companies an option for reorganizing rather than liquidating. Through Chapter 11 bankruptcy, firms can renegotiate their debt with their creditors to try to get better terms. The business continues operating and works toward repaying its debts. It is considered a drastic step, and the process is complex and expensive. Firms that have no hope of reorganization must go through Chapter 7 bankruptcy, also called “liquidation bankruptcy.”

Who Loses During Reorganization?

A reorganization is typically bad for shareholders and creditors, who may lose a significant part or all of their investment. If the company emerges successfully from the reorganization, it may issue new shares, which will wipe out the previous shareholders. If the reorganization is unsuccessful, the company will liquidate and sell off any remaining assets. Shareholders will be last in line to receive any proceeds and will usually receive nothing unless money is left over after paying creditors, senior lenders, bondholders, and preferred stock shareholders.

Structural Reorganization

The second type of reorganization is more likely to be good news for shareholders in that it is expected to improve the company’s performance. To be successful, the reorganization must improve a company’s decision-making capabilities and execution. This type of reorganization can take place after a company gets a new CEO.

In some cases, the second type of reorganization is a precursor to the first type. If the company’s attempt at reorganizing through something like a merger is unsuccessful, it might next try to reorganize through Chapter 11 bankruptcy.

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Our Complex Tax Code Is Crippling America

On the presidential campaign trail, the candidates seem far apart on tax policy. The Democrats favor tax hikes on high earners, and the Republicans favor tax cuts all around. But with voters currently struggling with tax-return filing, all the candidates should be addressing the tax code’s appalling complexity.

Donald Trump did complain that his tax return “would literally probably be 10 feet high if I put them together, it is so complicated and so terrible.” Most people have smaller returns, but federal tax-code compliance overall consumes more than 6 billion hours of time each year, which is like having a “tax army” of 3 million people just filling out tax returns year-round.

The problem is getting worse. Federal tax rules span about 75,000 pages today, which is three times more than when President Jimmy Carter called the code “a disgrace to the human race.” The problem is that Congress micromanages us with ever more tax credits, deductions and exemptions for education, energy, health care, saving, working and other activities.

The latest layer of complexity was added by the Affordable Care Act, which manipulates our health choices through the tax system. If you don’t have health insurance, you calculate how much you get penalized. If you do have individual insurance, you calculate the tax credits you receive. If you get advance credits during the year, then you recalculate your benefits when you file. And so on.

You can try to figure all this out by looking at the IRS’s 24-page Affordable Care Act overview, its 19-page guide for penalties and its 71-page guide for credits. Or you can go to a tax practitioner who is familiar with the thousands of pages of related regulations.

The Affordable Care Act has become a tax-filing nightmare, but so have other parts of the code, such as the earned income tax credit. The IRS guide for the earned income tax credit is 37 pages long, and the rules are so complicated that the credit’s error rate is 27%, according to the IRS. That amounts to $18 billion of mistakes every year for just for this one credit.

These days, most people get their returns done by tax-preparation firms, but that doesn’t solve the complexity problem—indeed, the pros make many errors as well. A 2014 investigation by the Government Accountability Office of 19 paid tax preparers found that most of them calculated incorrect refund amounts on sample returns. Furthermore, expert tax preparation costs money—last year the average charge for 1040 return prep was $273.

In addition to the monetary costs, the tax code’s complexity:

1. Increases avoidance and evasion. The earned income tax credit’s complexity has spawned an industry of fraudulent return filing, which costs billions of dollars a year. There is a similar problem with large corporations. We have the highest-rate and most complex corporate tax code in the world, which has created a breeding ground for widespread tax avoidance.

2. Undermines financial planning. For families, the tax code complicates decisions about retirement savings, paying for education and other life events. For businesses, the tax effects of hiring workers, investing in capital equipment, and other decisions are constantly changing as new laws and regulations are imposed. The IRS Taxpayer Advocate counted 4,428 federal tax rule changes over a 10-year period.

3. Creates “horizontal inequity.” People with similar incomes pay different amounts of tax because of all the special breaks. Homeowners, for example, can have a tax advantage of thousands of dollars a year over renters. Such inequities violate the principle of equality under the law.

Thankfully, some presidential candidates are promising to simplify the tax code. It will be a challenge because members of Congress love to add narrow breaks. The number of “tax expenditures,” or official breaks, under the income tax increased from 125 in the 1990s to about 200 today, according to the Joint Committee on Taxation. Each break has separate tax forms, instructions, regulations and other paperwork.

The best solution would be to rip out the individual income tax and replace it with a flat tax that has no deductions or credits. That would vastly simplify financial planning, reduce tax avoidance and boost the economy. Both taxpayers and the government would win as administrative costs plunged.

No president has pulled off a major tax overhaul since Ronald Reagan in 1986. But the next president will have an ace in his hole, and that is the Speaker of the House, Paul Ryan. Ryan is committed to tax restructuring, and he proposed major reforms in his past position on the House Budget Committee.

Reagan kicked off his drive for tax reform with an impassioned speech to the nation in May 1985: “We must…transform a system that’s become an endless source of confusion and resentment into one that is clear, simple, and fair for all—a tax code that no longer runs roughshod over Main Street America but ensures your families and firms incentives and rewards for hard work and risk-taking in an American future of strong economic growth.”

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The Situation’s Tax Evasion Case

Since Jersey Shore ended in 2012, Mike “The Situation” Sorrentino has had several run-ins with the law. To quote his own name and catch phrase, he’s got a situation. Though he got clearance to participate in the new Jersey Shore Family Vacation, his troubles aren’t over, and by the time the season is finished, he could be facing jail time or a hefty fine. Before you GTL, catch up on his — last time I’ll say it, I swear — situation.

March 1, 2014: Mike opens his Boca Tanning Club franchise in Middletown, New Jersey.

June 11, 2014: TMZ reports that four employees at the tanning salon file a police report because their paychecks were bouncing. According to TMZ’s sources, the Situation says the problem is the result of switching payroll companies. (The tanning salon stuff isn’t related to the tax stuff; it’s just here because it’s a separate cause of turmoil for the Sitch.)

June 17, 2014: Mike is arrested for assault at the Middletown tanning salon. He tells reporters that the fight was with his brother Frank, and that “HR was not running the store correctly.” He agreed to take anger management classes as part of a deal that would downgrade his charges.

Sept. 24, 2014: Mike and his brother Marc are indicted on charges of filing false tax returns and conspiracy to commit fraud. According to the charges, they did not report income from their appearances, and the Situation did not file a 2011 return at all despite earning nearly $2 million that year. The trial is originally scheduled for 2015 but is postponed when the Situation’s lawyer leaves the case.

Feb. 2015: The tanning salon in Middletown is closed by its landlord, who claims the Situation owes thousands of dollars in rent. Meanwhile, Mike tweets out a photo proving that another of the family’s Boca locations is still open.

Dec. 18, 2015: Gregg Mark, Mike and Marc’s former accountant, pleads guilty to filing fraudulent tax returns for them for 2010 and 2011. Mark admits that the false returns defrauded the IRS somewhere between $550,000 and $1.5 million.

April 7, 2017: Mike and Mark are indicted on additional charges; Mike for tax evasion and Marc for falsifying records to obstruct an investigation. The new charges claim that the brothers underreported income, claimed fraudulent deductions, mixed business and personal income, and used business money to make personal purchases.

Jan. 19, 2018: Mike pleads guilty to tax evasion; Marc pleads guilty to aiding the preparation of a false tax return. Mike also admitted to concealing his income 2011 by making small cash deposits in order to evade reporting it (this is called structuring). The judge approved Mike’s trip to Miami to film Jersey Shore Family Vacation but he will be sentenced on April 25. He could face up to five years in prison and a $250,000 fine. His attorneys make a statement encouraging the judge to be lenient in sentencing: “The plea terms call for a balance between punishing the wrong committed and conditions that facilitate Mike living a productive, law-abiding life moving forward. Following through on this plea agreement, Michael intends to pay restitution before sentencing.”

Follow Eliza on Twitter.

Eliza Thompson senior entertainment editor I’m the senior entertainment editor at Cosmopolitan.com, which means my DVR is always 98 percent full.

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Current U.S. tax incentives for higher education expenses


Congress has often attempted to assist Americans in paying for higher education by using the individual income tax laws. Between 1954 and 1996, eight education-related tax benefits were added to the Internal Revenue Code. The Taxpayer Relief Act of 1997, P.L. 105-34, introduced five new education tax benefits. Recently, the American opportunity tax credit greatly expanded the prior Hope scholarship credit. Today, at least 12 income tax ­provisions are designed to provide tax benefits for the pursuit of education.1

The education-related income tax provisions can be divided into three general categories:

  1. Tax incentives to save for education;
  2. Tax relief when paying current-year education expenses; and
  3. Tax assistance with student loans.

Some of these tax provisions allow deductions for a portion or all of education expenditures. Some exclude otherwise taxable income from inclusion in the calculation of taxable income. Still others furnish tax credits that can provide a direct reduction of tax for each dollar of qualified expenditures.

It has been estimated that in 2017 the forgone tax revenue from these provisions may have exceeded $30 billion,2 yet there is reason to believe that many of them will be ineffective in accomplishing their objectives.

This article examines the requirements and limitations that taxpayers face when they seek to obtain the tax benefits of some of the most significant education-related income tax provisions.3 It then looks at the American Bar Association’s and the AICPA’s suggestions for simplification as well as the recommendations of National Taxpayer Advocate Nina Olson.

Tax incentives to save for education

Congress has enacted provisions to give parents, students, and other taxpayers a tax incentive to save for education costs. The Code provisions discussed here are:

  • Sec. 135: Income from U.S. savings bonds used to pay higher education tuition and fees;
  • Sec. 530: Coverdell education savings accounts; and
  • Sec. 529: Qualified tuition programs.

Each program is designed to encourage saving for education by excluding the earnings on those savings from tax.

Education savings bond interest exclusion

Potential income tax benefitInterest earned on U.S. savings bonds generally is taxable. Most taxpayers report the accumulated interest as income when the savings bonds are redeemed. This provision encourages taxpayers to purchase savings bonds for higher education costs by permitting the interest earned on qualifying savings bonds (up to the amount of “qualifying educational expenses”) to be excluded from taxable income. The benefit to the taxpayer is equal to the amount of income tax that would otherwise have been imposed on the savings bond interest.4

Important requirements:

  • Only certain savings bonds qualify.5
  • The owner of the bond must be 24 years old or older before the bonds are issued. As a result, bonds gifted to a person before he or she is age 24 (e.g., at birth) do not qualify.
  • Interest from other investments, including interest on other U.S. government obligations (e.g., Treasury notes, bills, and long-term bonds), does not qualify for exclusion under this provision even if the funds are used solely for education expenses.
  • The exclusion can be claimed only if the proceeds are used to pay qualified expenses for the taxpayer, the taxpayer’s spouse, or a dependent.
  • Qualifying educational expenses include tuition and required fees at eligible educational institutions but do not include expenses for room (e.g., dormitory charges) or meals. Books are not considered a qualifying expense unless a student may not attend or enroll in a course without purchasing them.
  • Qualifying educational expenses must equal or exceed redemption proceeds, not just the interest earned on the redeemed bonds. If qualifying educational expenses are less than the bond proceeds, only a portion of the interest on the redeemed bonds will be tax free.6

Income limitsThe exclusion of savings bond interest is phased out after a taxpayer’s “modified adjusted gross income” (MAGI) exceeds a threshold amount, which is adjusted each year for inflation.7 In 2018, a taxpayer who has MAGI in excess of $79,700 ($119,550 if filing a joint return) will lose a portion or all of this benefit.8

Coverdell education savings account

A Coverdell account may be established to save for the qualified education expenses of a named beneficiary. Many banks, brokerage firms, and mutual fund companies offer these accounts.

Potential income tax benefit:The earnings on amounts deposited in a Coverdell account are excluded from taxable income until the funds in the account are distributed. If distributions from a Coverdell account are equal to or less than qualified education expenses,9 earnings will be permanently excluded from tax.

Important requirements:

  • When the account is established, the beneficiary must be 18 or younger or be a special-needs beneficiary. The beneficiary does not need to be the taxpayer’s dependent.
  • Total contributions for any year cannot exceed $2,000 and (except for a special-needs beneficiary) cannot be made after the beneficiary attains age 18. The maximum lifetime contribution limit thus ordinarily would be $36,000.10
  • Qualified higher education expenses are defined differently from qualifying expenses for education savings bonds. The costs of room and board, for instance, may be a qualified expense provided the student is enrolled at least “half-time.”11
  • When determining qualified expenses, education expenses are reduced by any tax-free educational assistance received and by expenses used in determining the American opportunity or lifetime learning credits.
  • If a beneficiary receives distributions from both a Coverdell account and a qualified tuition program in the same year and the total distributions from both are more than the beneficiary’s adjusted qualified higher education expenses, those expenses must be allocated between the two distributions to determine how much of each distribution is taxable.
  • Any unused balance in a Coverdell account usually must be distributed when the beneficiary reaches age 30 even if this results in a taxable distribution.
  • An additional tax of 10% is imposed on any taxable distribution.

Income limits:

  • The maximum amount that a taxpayer is allowed to contribute in a year ($2,000) is phased out if MAGI exceeds a threshold amount. The definition of MAGI is different from the definition for purposes of the education savings bond interest exclusion.12
  • The phaseout threshold for making contributions is $95,000 ($190,000 for joint return filers) and is not adjusted for inflation.
  • If excess contributions are made, a 6% excise tax is imposed on the excess contribution every year that those excess funds remain in the account.

In view of the many limitations on the above two programs, it is fortunate that Congress has provided another ­tax-favored way to save for college — college savings plans — established under Sec. 529.13

College savings plans

College savings plan accounts may be established to save for the qualified higher education expenses of a designated beneficiary. Only states and eligible education institutions may offer these plans.

Potential income tax benefitLike Coverdell accounts, amounts invested in a college saving plan account grow tax free until distributed. If distributions from an account are equal to or less than qualified education expenses, there is also no income tax on the distributions. While there is no federal tax deduction for contributions, many states allow deductions from state income tax.

Important requirements:

  • Unlike Coverdell accounts, there is no annual limit on contributions. State and private plans do limit total contributions to each beneficiary’s account. It is often possible to fully fund a beneficiary’s higher education expenses using these plans, because the total contribution limit for many plans exceeds $300,000.14
  • After 2017, college saving plans can be used to a limited extent for elementary and secondary school expenses as well as higher education.15 Qualified higher education expenses are defined similarly for college savings plans and Coverdell accounts.
  • If a taxpayer receives a taxable distribution (i.e., one that is not used for qualified expenses), the Code generally imposes an additional tax of 10% on the amount included in income. Unlike Coverdell accounts, the balance in the account need not be distributed by a set age.

Income limitsNone.

Compared to other programs designed to provide incentives to save for education expenses, college savings plans are flexible and simple. Perhaps it is no surprise that many Americans are now using these plans to save for higher education.

Tax relief when paying current-year education expenses

Congress has also enacted provisions that provide tax relief when paying current-year education expenses. Two important Code provisions are:

  • Sec. 25A(i): American opportunity tax credit; and
  • Sec. 25A(c):Lifetime learning credit.

American opportunity tax credit

Potential income tax benefitAn annual tax credit of up to $2,500 per student. Forty percent of the American opportunity tax credit is “refundable,” meaning a taxpayer who has no U.S. tax liability may receive up to a $1,000 refund (40% of $2,500) when filing a return.

Important requirements:

  • The amount of the credit is 100% of the first $2,000 of qualified expenses and 25% of the next $2,000. Thus, a taxpayer must have $4,000 of qualified expenses during a year to obtain the full $2,500 credit.
  • Books are considered qualifying expenses, but housing and meals are not.
  • The student must be pursuing a degree or other recognized academic credential and must have been enrolled at least half-time for at least one academic period (e.g., one semester) that begins during the calendar year.
  • The credit is available only for the first four years of higher education (generally freshman through senior years).
  • The credit is denied when certain other educational incentives are used. For example, a taxpayer cannot claim this credit for any student for whom a lifetime learning credit is claimed in the same year.
  • A student cannot claim the credit if another person has claimed the student as a dependent.
  • The student cannot have had a felony conviction for possessing or distributing a controlled substance. Conviction for any other felony (e.g., fraud, kidnapping, arson) does not result in denial of the credit.

Income limitsThe credit is phased out if MAGI16 exceeds a threshold amount, which is not adjusted for inflation. The phaseout threshold is $80,000 ($160,000 if filing a joint return).

Lifetime learning credit

The lifetime learning credit is another credit available to assist with the costs of higher education. Since it typically provides less of a tax benefit, it is generally claimed only when the American opportunity tax credit is not available.

Potential income tax benefit: The provision provides for an annual tax credit of up to $2,000 per taxpayer.

Important requirements:

  • The credit is 20% of the first $10,000 of qualified expenses. Thus, a taxpayer must have $10,000 of qualified expenses during a year to obtain the full $2,000 credit.
  • As with the American opportunity tax credit, the lifetime learning credit cannot be claimed when certain other educational incentives are claimed.
  • Unlike the American opportunity credit:• None of the credit is refundable. The lifetime learning credit only provides a tax savings to the extent the taxpayer has a tax obligation equal to or greater than the credit.• Costs for books, supplies, and equipment are not qualified expenses unless they must be paid to the educational organization.• There is no degree or workload requirement, and the credit is not limited to four years of study. Thus, the credit can be claimed for continuing education expenses.• Having a felony conviction for possessing or distributing a controlled substance (or any felony conviction) will not cause the student to lose the credit.

Income limits: The credit phases out if MAGI exceeds a threshold amount. However, the threshold for the phaseout is significantly less than that under the American opportunity tax credit. In 2018, a taxpayer who had MAGI in excess of $57,000 ($114,000 if filing a joint return) would lose a portion or all of this credit.17

Tax assistance with student loans

Congress has also enacted provisions that provide tax relief for loans used for education. Sec. 221, discussed below, is one important provision.

Student loan interest deduction

Potential income tax benefitThe payment of personal interest is not generally deductible. A taxpayer may, however, be able to claim an above-the-line deduction for up to $2,500 of interest paid each year on qualified student loans.

Important requirements:

  • The loan must have been incurred solely to pay qualified higher education expenses of the taxpayer, the taxpayer’s spouse, or a dependent at the time of the loan. The definition of “dependent,” however, is not the same as the definition used for determining the availability of a dependency exemption,18 which is unavailable beginning in 2018.
  • The loan cannot be from a related person or made under a qualified employer plan.
  • The student must have been enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential at an eligible educational institution.
  • The loan may be used for tuition, fees, books, supplies, and equipment. The cost of room and board may also qualify.
  • Only interest is deductible; however, the allocation of payments between interest and principal for tax purposes may not be the same as the allocation shown on Form 1098-E, Student Loan Interest Statement, or other statement received from the lender.19

Income limits:

  • The deduction is phased out if MAGI exceeds a threshold amount. The definition of MAGI is different from that used for the American opportunity and lifetime learning credits.20
  • In 2018, the phaseout threshold for taxpayers filing joint returns is $135,000, and the deduction is totally phased out for taxpayers with MAGI of $165,000 or more. The phaseout threshold for other taxpayers is $65,000, and the deduction is totally phased out for taxpayers with MAGI of $80,000 or more.21

Unnecessary complexity of current provisions

Albert Einstein is reported to have said, “The hardest thing in the world to understand is income taxes.”22

Our current educational income tax incentives build on that legacy. Although all were designed to assist with the costs of higher education, the provisions do not even agree as to what should be considered qualifying educational costs. Some, but not all provisions, include the costs of books and supplies. Some, but not all, include the costs of housing and meals.

In addition, the provisions impose different and inconsistent requirements for a taxpayer to obtain the promised tax benefits. Just with respect to the above provisions:

  • Some require at least half-time student enrollment; others have no minimum requirement.
  • Some have age limits; some do not.
  • Some, but not all, are limited to a taxpayer, spouse, and dependents, and for those, the definition of a “dependent” varies.
  • The American opportunity tax credit is partially refundable; the lifetime learning credit is not.
  • Some, but not all, require that income be below a certain amount. The amount of income that defines “need” varies and can be almost as much as $220,000. Those provisions that have income requirements do not use a uniform definition of “income.”

Questionable effectiveness in achieving objectives

The provisions were designed to reduce income taxes for those in need to encourage the pursuit of higher education. There are significant structural reasons why the provisions may have limited effectiveness in accomplishing this goal:

Value of exclusions and deductions: When an exclusion or deduction is claimed, the tax savings are equivalent to the amount of the deduction or exclusion multiplied by the taxpayer’s marginal tax rate. A taxpayer with need often has a low marginal tax rate and, thus, will receive only a negligible tax reduction. Using exclusions and deductions to provide education benefits can in fact have the undesired effect of giving the largest tax savings to those with the highest incomes.

Lack of federal income tax ­liabilityAn inherent problem in using the U.S. income tax law to assist taxpayers is that in 2016 approximately 44% of Americans had no U.S. income tax liability.23 As a result, most of the educational tax provisions are of no value to them.24

Recommendations for change

The American Bar Association (ABA) and the AICPA tax sections have long noted the need to simplify the education tax provisions. Some of the previous recommendations were:25

  • Eliminate or standardize income ranges for eligibility of benefits;
  • Combine the education tax credits and establish a single amount of expenses eligible for the credit; and
  • Consider replacing the existing incentives with a universal deduction or credit.

National Taxpayer Advocate Nina Olson, who has served in that role since 2001, recently wrote, “If I had to distill everything I’ve learned into one sentence, it would be this: The root of all evil is the complexity of the tax code.”26 Olson has specifically noted the need to consolidate and harmonize the Code’s education provisions. In the Taxpayer Advocate Service’s 2016 annual report to Congress, she stated: “The point of a tax incentive, almost by definition, is to encourage certain types of economic behavior. However, taxpayers will only respond to incentives if they know they exist and understand them. Few, if any, taxpayers are aware of each of the education tax incentives and familiar enough with the particulars to make wise choices.”27

The recent tax overhaul legislation, P.L. 115-97, failed to fix the current state of the educational tax provisions, although early versions of the bill had proposed to consolidate the education tax credits and make other changes. Hopefully, Congress will someday heed the calls for change and provide education tax incentives that taxpayers can understand and use.

Footnotes

1Crandall-Hollick, Higher Education Tax Benefits: Brief Overview and Budgetary Effects, CRS Report R41967 (March 12, 2014). In December 2014, another provision with education tax benefits, Sec. 529A qualified ABLE programs, was signed into law.

2Estimates of tax expenditures for educational incentives vary. Estimates provided by the Joint Committee on Taxation listed total tax expenditures for these provisions of $35.4 billion for 2017 (Joint Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 2016-2020 (JCX-3-17) (Jan. 30, 2017)). Estimates provided by the Office of Management and Budget (OMB) for 2017 totaled $29.7 billion (OMB, Analytical Perspectives, Budget of the United States Government: Fiscal Year 2017, Tax Expenditures, Table 14-2B (Feb 10, 2016)). The OMB report noted that totaling the individual incentives might not reflect the potential revenue effect due to possible changes in economic behavior and the fact that tax expenditures are interdependent. The Joint Committee report also noted that it used different methodologies than OMB. See Comparisons With Treasury and Tax Expenditures Calculations Generally in that report.

3Not all of the education-related tax provisions are reviewed in this article. For the fearless, citations to many provisions not discussed are listed here. Provisions that provide incentives to save include the following: Sec. 127 (educational assistance programs); Sec. 72(t)(2)(E) (distributions from individual retirement plans for higher education expenses); and Sec. 529A (qualified ABLE programs). Provisions that assist in paying for current expenses include the following: Sec. 222 (qualified tuition and related expenses); Sec. 162 (trade or business expenses) (Regs. Sec. 1.162-5); Sec. 117(a) (qualified scholarships); and Sec. 117(d) (qualified tuition reduction). A provision that may provide tax savings upon discharge of a student loan is Sec. 108(f) (student loans).

4It should be noted that the interest rate on Series EE U.S. savings bonds issued from Nov. 1, 2017, through April 30, 2018, is only 0.10% (Treasury Direct, “May 2005 and Later (EE Bond Rates and Terms),” available at www.treasurydirect.gov.

5Series EE bonds issued after 1989 and Series I bonds (Sec. 135(c)(1)).

6IRS Publication 970, Tax Benefits for Education, p. 57 (2017).

7Sec. 135(b)(2). “Modified adjusted gross income” is defined at Sec. 135(c)(4).

8Rev. Proc. 2017-58.

9Qualifying expenses may include elementary and secondary school expenses in addition to higher education expenses (Sec. 530(b)(2)).

10While helpful, this may not be sufficient, since the average posted charges for one year of tuition, fees, room, and board at a four-year private college during 2017 to 2018 was $46,950 (College Board, Trends in College Pricing 2017, Table 1, p. 9 (October 2017)).

11Sec. 530(b)(2). See Sec. 529(e)(3)(B) and Sec. 25A(b)(3)(B).

12Sec. 530(c)(2).

13Although not discussed here, Sec. 529 also provided for the establishment of prepaid tuition plans.

14Hurley, The Best Way to Save for College, p. 44 (Saving for College LLC 2015).

15For distributions made after Dec. 31, 2017, the definition of qualified higher education expense has been expanded to include up to $10,000 per student per year for tuition in connection with enrollment or attendance at an elementary or secondary school (Sec. 529(e)(3)(A); Sec. 529(c)(7)).

16Sec. 25A(d)(3); for purpose of this provision and the lifetime learning credit, “modified adjusted gross income” means the adjusted gross income of the taxpayer for the tax year increased by any amount excluded under Sec. 911, 931, or 933.

17Rev. Proc. 2017-58.

18Sec. 221(d)(4).

19IRS Publication 970, Tax Benefits for Education, p. 33 (2017).

20Sec. 221(b)(2)(C).

21Rev. Proc. 2017-58.

22As reported by his tax adviser, Leo Mattersdorf, in a letter to Time magazine, Feb. 22, 1963.

23Urban-Brookings Tax Policy Center, Tax Units With Zero or Negative Income Tax Under Current Law, 2011-2026, T16-0121 (July 11, 2016).

24The American opportunity tax credit is 40% refundable; however, to claim the benefit, an individual must file a U.S. tax return.

25ABA Section of Taxation, 2001 Top Simplification Recommendations, p. 6 (February 2001).

26Olson, “Complexity Is the Root of All Evil,” The Wall Street Journal, April 18, 2017, www.wsj.com.

27National Taxpayer Advocate, 2016 Annual Report to Congress, p. 322 (Jan. 11, 2017).

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EBay Tax Issues

Even if you are not running a business and only selling personal items, there are tax ramifications when selling on eBay. You should educate yourself on eBay tax issues to avoid unpleasant tax surprises from the IRS. This section goes over your income and sales tax obligations as an eBay seller. Even if you understand the issues today, there is new proposed legislation that can change everything.

eBay and Tax Reporting

The current tax laws do not require eBay or PayPal to report the sales proceeds to the Internal Revenue Service. However, in an effort to capture unreported income, the IRS is considering a proposal to classify eBay as a “broker” and require eBay to report all sales to the IRS. The logistics of doing this would be an incredibly daunting task for eBay. Sellers would need to provide eBay with a social security or federal tax ID number and report their profits to the IRS. This paperwork nightmare would likely drive many sellers away from eBay. A positive benefit is eBay seller fraud may be drastically reduced as sellers will need to verify their identity before they are allowed to sell. See internet broker tax for more information.

Currently, eBay does not provide sales tax information to any state. A 1992 Supreme court ruling declared that forcing sellers to collect sales tax in states where they don’t have a physical presence constitutes an undue burden. Imagine trying to collect sales tax for potentially 50 different states. Each state has a different sales tax rate and counties and cities within the state can have its own tax rate added in on top. It will quickly turn into a paperwork nightmare trying to keep track of it all. States are not sitting idly by watching all that sales tax revenue go untapped. In an effort to by-pass the Supreme Court ruling, several states have proposed the Streamlined Sales Tax Project. If this legislation takes hold, it will require eBay sellers to collect sales tax and pay them to each state. See eBay sales tax for more information.

Selling Personal Items

Many new eBay sellers wonder if they need to pay taxes on the items they sell. The answer is yes, but only if there is a profit on the sale. Since most used items sell for less than what they cost when they were bought new, there is no profit on the sale. If there are no profits, then there is no need to pay taxes on the sale.

If you do end up with a profit on your eBay sale, you are required to report the proceeds to the IRS. Since neither eBay nor PayPal report sales transactions to the IRS, you are on the honor system to report your eBay profits. Consider creating a business to take advantage of deductions relating to your eBay sales. This will help reduce the amount of tax you will have to pay to the IRS. See the section Create a Business for Tax Purposes below for more details. Even if you don’t set up a business, you can deduct the eBay and PayPal fees from the proceeds of your sales.

Sales Tax

Sales tax should be collected on your eBay sales if the state you live in charges a sales tax. You need to collect sales tax only from buyers that reside in the same state. You do not have to collect sales tax from buyers that live in other states. Each state has its own set of goods that are exempt from sales tax. For example, there is no sales tax on food. Some states also exempt certain types of sales transactions such as garage sales. Be sure to check with your state’s sales tax authority for more information.

When you purchase items for resale using a seller’s permit, you don’t pay sales tax on that purchase. However, when you sell the items, you need to collect sales tax. Depending on your sales volume, the collected sales tax must be paid to your state’s sales tax authority on a bi-weekly, monthly, or quarterly basis.

The question that often comes up is how will the state know about the sale if eBay does not report them? The answer is they won’t know. If you are running a business, then there is likey to be a nice paper trail to follow if the state decides to audit you. For individuals, the state will probably never know. You are on your honor system to collect the sales tax and file the necessary paperwork. Of course, most people don’t.

Create a Business for Tax Purposes

If you are going to pay taxes on your eBay profits, you should create a business so you can deduct expenses related to your eBay sales. Items that sell for a loss can be deducted from your profits. You may qualify for a home business deduction if you use part of your home exclusively for your eBay business. The camera used for photography, mileage driven to find products to sell, shipping supplies, internet access, and many other things are legitimate business expenses. Be sure to keep accurate records. At a minimum, you should use a spreadsheet to keep track of your business expenses. As your business grows, you should switch to professional accounting software such as Quickbooks.

Don’t go crazy with the deductions thinking this is a perfect tax shelter. If you don’t show a reasonable profit after a few years, the IRS could classify your business as a hobby and disallow all the business deductions you have taken. You will then be required to pay back taxes on those disallowed deductions.

For most people, setting up your business as a sole proprietorship is the best choice. Any income from the business will be treated as ordinary income on your tax return. Sole proprietors use Schedule C to file their taxes. Unfortunately, the income is subject to self employment tax. Tax preparation software can walk you through Schedule C and automatically calculate any self employment tax due.

For more information about Schedule C, see Tax Guide For Small Business, IRS Publication 334.

County/City Business Tax

Most counties and some cities require a business license in order to do business in their jurisdiction. You will then be assessed a business tax once a year. The tax is based on the value of your business property, or a percentage of your gross receipts depending on the jurisdiction. For a small business, the tax is usually less than $150. Check your county/city government website for more information.

Payroll Taxes

When your business grows to a point where you need to hire employees, you have to deal with payroll taxes. Employers must pay half of the employee’s social security and Medicare tax. The employee pays the other half. The employer is also required to withhold the employee’s federal, state, and in some cases, city income tax. Employers must contribute to federal and state unemployment funds. Depending on your payroll size, the funds collected must be deposited with state and federal agencies on a bi-weekly, monthly, or quarterly basis.

To help with the paperwork, there are several payroll services that will manage your payroll for a fee. Quickbooks sells an add-on payroll module that will handle all the calculations and generate the forms to file with the IRS. Each state has its own set of rules. Check your state’s government website for more details.

See Employer’s Tax Guide, IRS Publication 15 for more information about payroll taxes.

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Three keys to a good business reorganization

The typical reorg evokes fear, stress and suspicion — and kills productivity. Here’s how to change that.

If you have been in business or at a business for more than six months you are probably familiar with the all too frequent business reorganization. Businesses reorg when they are growing, they reorg when they are shrinking. They reorg when things are good and when they are bad. With all this reorging out there you would think that there would be a tried-and-true process for it. But you would be wrong.

The many company reorgs I have been through have been handled poorly. All but one, that is.

What made the exception so successful was that the leadership of the organization followed three simple principles. Your next business reorganization can be a positive experience too, if you follow these three principles — but I am going to warn you.

They aren’t easy to follow. None of them.

The three keys to a successful reorganization are:

  1. Transparency
  2. Speed
  3. Participation

Transparency

I remember one company I worked for that traditionally had a reorg first quarter of every year. People didn’t know who their new boss would be, what the logic behind the reorganization was or where they were going to be in the organization. Projects stopped because people didn’t know if they would be on the project come March, so why work on it. Stress was high. Everyone at this company just assumed that January and February would be an unproductive time.

Gossip needs secrecy to survive.

The antidote to this paralysis? Share everything you know in a business reorganization. (I told you this wouldn’t be easy.)

Transparency is typically scary for leaders. They have to share their vulnerability. They have to say, “We know these things … and we don’t know these things.”

It may be hard, it may feel uncomfortable, it may go against just about everything you believe about management. Do it anyway.

Gossip needs secrecy to survive. When people don’t know something and everyone thinks someone else has some tidbit of information, they gossip. When all the information that is to be known is out in the open, there is nothing to gossip about. Stress is reduced and people can focus on other things. When you start a reorganization, it’s imperative to tell everyone. Not a few people … everyone. Tell them why you are reorganizing, tell them what you plan to focus the reorganization around and what you are not going to focus on.

Early in the game you won’t know who is going where or what managers are doing what or anything. Tell everyone you don’t know. They want to know. If you have done a lot of reorgs the cloak-and-dagger way, they likely won’t believe that you are telling them everything the first time you tell them. You will need to reinforce it and reinforce it and reinforce it.

Be ready for the questions. Get used to answering, “I don’t know.” You will soon discover that it is freeing when you can say that and not feel like you have to cover up or pretend like you know everything. Initially you may think it will hurt your credibility, but it will actually have the opposite effect. People will respect you more when you admit what you know and don’t know.

The next thing you need to do is move swiftly.

Speed

There are two people in an organization who are important to every employee: the CEO and the employee’s direct manager. Of the two, the employee’s manager is the most important in a business reorganization, because reorgs often represent a change at the managerial level.

If word gets out — and it will get out — that a reorg is happening, people begin to worry about who their new boss is going to be. If an organization tries to keep it secret, people will talk around the water cooler or on Facebook, or on the internal chat utility. Productivity will go down, and stress will go up. All of which is bad for getting any work done at the office.

Transparency mitigates some of the disruption in the flow of work, but people are distracted during a reorg, so be quick about it. The faster you can get through the reorg the faster you can get back to productivity.

Simple in theory but, again, hard in practice.

Most reorgs I have seen take months and months. They don’t have to. A reorg is a serious effort that affects the lives of a lot of people. Some may argue that we need to take it seriously and take the time necessary to make good decisions.

Well, yes, this is serious business, but do the decisions need to take a lot of time?

The answer to this problem is principle No. 3: participation.

Participation

One of the things that slows down a reorg is that the decisions are all made by a small number of high-level people. It is believed that this is the best and in fact the only way to handle such important decisions. There are many decisions in a business reorg that need to be made by high levels in the organization, to be sure. Things like:

  • Why are we doing this reorg?
  • What should the overall structure look like?
  • What are we optimizing for in this reorg?
  • What are we not optimizing for in this reorg?
  • What does success look like in this reorg?
  • How will we measure success?
  • What is this worth to us as an organization?
  • Who are the key high-level (close to the top) people in the new structure?

But there are a plethora of other decisions that do not need to be made by these people that often end up getting made by them, taking up important time and slowing down the process. Decisions like:

  • Who will report to those key high-level people?
  • Who will report to the people who report to the key high-level people?
  • What will their roles be, by name, by person?
  • How will we maintain technical integrity?
  • What new governing bodies do we need?
  • How will this affect governance?
  • How will budgeting be impacted?

And a million other things. I am not saying that the top leadership abdicates responsibility for these decisions completely. But mostly. Many of them should be given over to task forces, and in a cascading ladder of responsibility. Just as the top leaders decided who should report to them, the next level should work out who reports to them, and so forth. The rest of the work should be assigned to taskforces that are formed of volunteer teams.

Now you may be thinking that these volunteer teams will take time away from people’s work, but remember that these people are already thinking about the reorg. When you give them something productive to do on the reorg you accomplish three things. First, they are given something important to do related to what they are already thinking about, so you make good use of that time. Second, you take some of the workload off the high-level leadership who are already overworked. Finally, and possibly most important, you are moving the decisions closer to the level of the organization which has the information necessary to make good decisions.

Not only does participation help the process go faster, by giving people a vital active role in the reorg you give them a reason to believe in the reorg. They have a hand in the decision-making process so they have a vested interest in it going well. Participation is not just nice to have, it is critical to the perception of success of the reorg.

As business grow, shrink, merge, or realign strategy, they will need to reorganize. Reorgs always take your team’s attention off the work that they need to be doing so take advantage of that. Tell them everything you know and everything you don’t know, move quickly and get them involved to make it go faster and to create engagement. If your organization will keep these three simple principles in mind — transparencyspeed and participation — you will greatly increase your likelihood of having a positive reorg. The concepts are simple, but they are not easy.

When you are getting ready for your next reorg, see if you can do it this way and tell me how it goes: joseph@whitewaterprojects.com.

About the author:
Joseph Flahiff is an internationally recognized leadership and organizational agility expert at 
Whitewater Projects Inc. He has worked with Fortune 50 and Fortune 500 companies, government agencies, startups and publicly traded firms, where he has been recognized as an experienced, pragmatic and innovative adviser. He is the author of Being Agile in a Waterfall World: A practical guide for complex organizations. Learn more at www.whitewaterprojects.com.

Next Steps

Previous management tips from Joseph Flahiff:

Destroying your way to organizational agility

Fire your managers! Practice supportive leadership

Three characteristics of great senior leadership teams

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Valuing a business

Learn the different techniques you can use to value a business before you commit to buying it.

If you’re thinking about buying a business, you need to make sure you’re paying a fair price for it. These are four of the most commonly used business valuation methods.

Understanding them will help you with your own research and when you get independent advice from a business valuer or broker.

1. What is the asset valuation method?

This method tells you what the business would be worth if it closed down and was sold today, after all assets and liabilities were accounted for.

How it works:

Assets such as cash, stock, plant, equipment and receivables are added together. Liabilities, like bank debts and payments due, are then deducted from this amount. What’s left is the net asset value.

For example, Richard wants to buy a manufacturing business. It has $300,000 worth of assets and $200,000 of liabilities. Its net asset value is $100,000, so with the asset valuation method, this business is worth $100,000.

What about goodwill?

Goodwill is the difference between the true value of a business and the value of its net assets. Goodwill represents the features of a business that aren’t easily valued, such as location, reputation and business history. It’s not always transferred when you buy a business, since it can come from personal factors like the owner’s reputation or customer relationships.

The asset valuation method doesn’t take goodwill into account. If a business is underperforming and has no goodwill, then using net asset valuation could be an accurate way to value it.

2. What is the capitalised future earnings method?

This is the most common method used to value small businesses.

When you buy a business, you’re buying both its assets and the right to all profits it might generate in the future, which are known as future earnings. The future earnings are ‘capitalised’, or given an expected value. The capitalisation value gives the expected rate of return on investment (ROI), shown as a percentage or ratio. A higher ROI is a better result for the buyer.

The capitalised future earnings method lets you compare different businesses to work out which would give you the best ROI.

How it works:

  • Work out the business’s average net profit for the past three years. Take into account whether there are any conditions that might make this figure hard to repeat
  • Work out the expected ROI by dividing the business’s expected profit by its cost and turning it into a percentage
  • Divide the business’s average net profit by the ROI and multiply it by 100. Use this figure as the value of the business

For example, David is considering buying a bakery with an average net profit of $100,000 after adjustments.He wants an ROI of 20%. He divides $100,000 by 20% and multiplies it by 100 to get a business value of $500,000.

3. What is the earnings multiple method?

This is a method that helps compare different businesses, where the earnings before interest and tax (EBIT) are multiplied to give a value. The ‘multiple’ can be industry specific or based on business size.

How it works:

  • Find the earnings before interest and tax (EBIT) of the business
  • Seek advice from a business valuer for an accurate business earnings multiple
  • Multiply your EBIT by your multiple to find the business value

For example, Mary wants to buy a sporting goods store. It has an EBIT of $100,000 and an industry value of 2. This means she values it at $200,000.

4. What is the comparable sales method?

You can get a realistic idea of what you may need to pay for a business by checking out comparable sales. This is the price that similar businesses have sold for.

How it works:

Check out the sales of recent businesses in your industry and location. You can get this information from:

  • Business brokers, who can also give you an idea about the value of the business you’re interested in
  • Business sales listings in industry magazines, newspapers or websites

For example, Susan wants to buy a cafe. Recently, cafes in her location have sold for $150,000, so she knows this is a realistic value for a similar business.

For a detailed understanding of a business’s value, contact a business valuer or broker.

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Tax Relief Services Offered By Tax Relief Companies

When you run into problems with your taxes there are many services offered to help clear up your problem. It is best to talk with a tax professional to find the best solution for your unique tax problem and financial situation. The IRS has many different filings to help people through different problems. Below is a list of tax services that our partnered tax companies offer to help individuals through particular problems.

How Tax Relief Companies Work: What to Expect With Services

Understand how tax relief companies work. Understanding how their services work is important before making a decision on hiring a company to help you. Most companies work in the same manner, but it is important to not be pressured into signing up with them and it is important to get all your options before making a decision.

Tax Debt Settlement Services

If you would like to settle IRS and/or state taxes a tax relief company can analyze your financial situation and find which tax settlement method would work best for your particular tax situation. There are many different forms of settlements and it is important to get a professional opinion before selecting which one is best for you.

  • Offer in CompromiseWith an offer in compromise a taxpayer can settle their taxes owed for far less than they owe. For this reason, it is one of the most difficult filings to make. Using a tax professional to make this filing greatly increase the likelihood of this filing being accepted.
  • Penalty AbatementIf you would like to remove penalties owed you can have them forgiven with the appropriate filings and showing appropriate proof. Tax professionals are trained and experienced in knowing what the IRS looks for when people file for an abatement.
  • Innocent Spouse ReliefThe IRS does realize that there are times it would be unfair to hold a spouse liable for taxes owed due to a joint tax filing. Innocent spouse relief is a difficult filing and tax relief professionals can ensure the proper paperwork is filed and follow through with filing to ensure all tax liabilities have been lifted from the “innocent spouse”.
  • Payment Plan Negotiation and SetupIf you do not qualify for a method to pay less than you owe a tax professional will find the best method to pay back the taxes you owe under a payment plan authorized by the IRS. A tax professional can find what payment method works best for you and work out an affordable payment plan to pay back the taxes owed for federal and or state taxes.
  • Hardship/Uncollectible ServiceIf you cannot pay your taxes owed it is possible to temporarily stop collection actions of the IRS and be declared uncollectible for a period of time until your financial situation improves enough where you can pay the IRS. In order to do this proper paperwork must be filed to prove your poor financial situation with the IRS.

File Back Taxes Service

If you have outstanding returns that have not been filed for any amount of time, even if you are missing important tax documents, a tax professional can ensure these returns are filed appropriately with the IRS, while ensuring maximum deductions. If you find you owe more taxes than you owe a tax professional can also set you up with a tax settlement.

Remove a Tax Levy

If the IRS has begun to seize assets from you, either through your bank account, wage garnishment or physical seizure of assets a tax professional can halt the IRS. A tax professional can find the appropriate tax settlement method and file the proper paperwork to ensure the IRS does not seize any assets.

  • Stop IRS Wage GarnishmentIf your wages are being garnished by the IRS a tax professional can quickly stop the wage levy and come up with the best solution for you. A tax professional will analyze your tax, financial, and work situation to determine the best course of action.
  • IRS Bank Account Levy HelpIf your account has been frozen, our partnered tax professionals can quickly analyze your situation and come up with the best method to resolve your tax problem and prevent the bank account levy. Find out more on how our service works.

Remove a Tax Lien

A tax lien will remain in place until you have paid off your taxes or until you have made some other agreement with the IRS. A tax professional will be able to find the best way for you to get back into good standing with the IRS to release a tax tax lien while not creating financial hardship for you.

Audit Representation

Did you receive a notice of audit? If you have one of our partnered tax relief firms can represent you in your audit and make sure everything is presented in the correct way. Did you know audits go both ways, a tax professional will review your tax filing to see if there is any other deductions you missed to potentially offset what the IRS finds. Tax professionals have many tactics in audits to ensure things go over smoothly.

Disclaimer: The content on this website is for educational purposes only and does not serve as legal or tax advice. For specific advice regarding your tax situation, contact a licensed tax professional or tax attorney.

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7 Types of Corporate Reorganization

Corporations reorganize and restructure for various reasons and in numerous ways. The bottom line usually is, well, the bottom line. Companies reorganize to increase profits and improve efficiency. The reorganization of a company typically addresses the efficiency component in an attempt to increase profits. It’s not unusual for a corporation to reorganize on the heels of changes at the top. A new CEO often sees reorganization as a cure for a company’s ills, and companies sometimes hire a new leader based specifically on his vision for reorganization.

Possible Reorganization Reasons

Corporate reorganization normally occurs following new acquisitions, buyouts, takeovers, other forms of new ownership or the threat or filing of bankruptcy, according to the Thinking Managers website. The VC Experts website reports that reorganizations involve major changes in a corporation’s equity base, such as converting outstanding shares to common stock or a reverse split – combining a company’s outstanding shares into fewer shares. Reorganizations often occur when companies already have attempted new venture financing but failed to increase company value.

Type A: Mergers and Consolidations

Section 368 of the IRS Revenue Code identifies seven types of corporate reorganizations. As reported by Tax Almanac, the first recognized reorganization type is a statutory merger or acquisition. Mergers and consolidations are both based on the acquisition of a corporation’s assets by another company, according to the firm Greenstein, Rogoff, Olsen & Co., LLP.

Type B: Acquisition – Target Corporation Subsidiary

A Type B reorganization is the acquisition of one company’s stock by another corporation, with the acquired company becoming a subsidiary of the acquiring corporation. The acquisition plan must be carried out in a short time period, such as 12 months, and the acquisition has to be only one in a series of moves comprising a larger plan to acquire control. The transaction also must be made solely for the purpose of acquiring voting stock.

Type C: Acquisition – Target Corporation Liquidation

Unless the IRS waives the requirement, a targeted corporation must liquidate as a condition of a Type C acquisition plan, and target-corporation shareholders become shareholders in the acquiring company. Reorganization provisions dictate tax consequences, not liquidation rules contained in Tax Code Sections 336 and 337.

Type D: Transfers, Spinoffs and Split-Offs

Type D transfers are classified as acquisitive D reorganizations or divisive D restructurings, which include spinoffs and split-offs. For example, if Corporation A contains the assets of former Corporation B and of Corporation A, Corporation B goes out of business, and former Corporation B shareholders control Corporation A.

Type E: Recapitalization and Reconfiguration

A recapitalization transaction involves the exchange of stocks and securities for new stocks, securities or both by a corporation’s shareholders. The move concerns just one company and the reconfiguration of the company’s capital structure. Possible scenarios include a stock-for-stock recapitalization plan, a bonds-for-bonds move and a stocks-for-bonds transaction.

Type F: Identity Change

A Type F reorganization plan is defined in the Internal Revenue Code as “a mere change in identity, form or place of organization of one corporation, however (a)ffected.” F reorganization rules generally apply to a corporation that changes its name, the state where it does business or if it makes changes in the company’s corporate charter, in which case a transfer is deemed to occur from the prior corporation to the new company.

Type G: Transfer of Assets

Type G reorganizations involve bankruptcy by permitting the transfer of all or some of a failing company’s assets to a new corporation. One caveat is that the stock and securities of the controlled corporation are distributed to the previous company’s shareholders under Type D – transfer reorganizations – rules for distribution.

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3 Types of Business Bankruptcy

Most new small businesses don’t survive and are faced with the decision concerning whether they should file for some form of business bankruptcy. About one-fifth of new small businesses from 2005 to 2017 survived only one year.

Bankruptcy is a process a business goes through in federal court. It is designed to help your business eliminate or repay its debt under the guidance and protection of the bankruptcy court. Business bankruptcies are usually described as either liquidations or reorganizations depending on the type of bankruptcy you take.

There are three types of bankruptcy that a business may file for depending on its structure. Sole proprietorships are legal extensions of the owner. The owner is responsible for all assets and liabilities of the firm. It is most common for a sole proprietorship to take bankruptcy by filing for Chapter 13, which is a reorganization bankruptcy.

Corporations and partnerships are legal business entities separate from their owners. They can file for bankruptcy protection under Chapter 7 or Chapter 11, which is a reorganization bankruptcy for businesses. The different types of bankruptcies are called “chapters” due to where they are in the U.S. Bankruptcy Code.

Chapter 13 – Adjustment of debts with individuals with regular income

Chapter 13 bankruptcy is a reorganization bankruptcy typically reserved for individuals. It can be used for sole proprietorships since sole proprietorships are indistinguishable from their owners. Chapter 13 is used for small business when a reorganization is the goal instead of liquidation. You file a repayment plan with the bankruptcy court detailing how you are going to repay your debts. Chapter 13 and Chapter 7 bankruptcies are very different for businesses.

Chapter 13 allows the proprietorship to stay in business and repay its debts and Chapter 7 does not.

The amount you must repay depends on how much you earn, how much you owe, and how much property you own. If your personal assets are involved with your business assets, as they are if you own a sole proprietorship, you can avoid problems such as losing your house if you file Chapter 13 instead of Chapter 7.

Chapter 7 – Liquidation

Chapter 7 business bankruptcy may be the best choice when the business has no viable future. It is usually referred to as a liquidation. Chapter 7 is typically used when the debts of the business are so overwhelming that restructuring them is not feasible. Chapter 7 bankruptcy can be used for sole proprietorships, partnerships, or corporations.

Chapter 7 is also appropriate when the business does not have any substantial assets. If a business is a sole proprietorship and an extension of an owner’s skills, it usually does not pay to reorganize it. and Chapter 7 becomes appropriate. Before a Chapter 7 bankruptcy is approved, the applicant is subject to a “means” test. If their income is over a certain level, their application is not approved. If a Chapter 7 bankruptcy is approved, the business is dissolved.

In Chapter 7 bankruptcy, a trustee is appointed by the bankruptcy court to take possession of the assets of the business and distribute them among the creditors. After the assets are distributed and the trustee is paid, a sole proprietor receives a “discharge” at the end of the case. A discharge means that the owner of the business is released from any obligation for the debts. Partnerships and corporations do not receive a discharge.

Chapter 11 – Business reorganization

Chapter 11 may be a better choice for businesses that may have a realistic chance to turn things around. Chapter 11 business bankruptcy is usually used for partnerships and corporations. it is also used by sole proprietorships whose income levels are too high to qualify for Chapter 13 bankruptcy.

Chapter 11 is a plan where a company reorganizes and continues in business under a court-appointed trustee. The company files a detailed plan of reorganization outlining how it will deal with its creditors. The company can terminate contracts and leases, recover assets, and repay a portion of its debts while discharging others to return to profitability. It presents the plan to its creditors will vote on the plan. If the court finds the plan is fair and equitable, it will approve the plan.

Reorganization plans provide for payments to creditors over some time. Chapter 11 bankruptcies are exceedingly complex and not all succeed. It usually takes over a year to confirm a plan.

Small Business Reorganization Act of 2019

Recently, the Small Business Reorganization Act of 2019 was passed by the U.S. Congress and signed by the President. It enacted a new subchapter V of Chapter 11. The Act will go into effect on February 20, 2020. This subchapter of Chapter 11 seems to favor the side of the applicant for business bankruptcy. It only applies if the applicant wants it to apply.

Subchapter V, for example, does not require that a committee of creditors is appointed or that creditors have to approve a court plan.

Sole proprietorships or incorporated entities should consult with a good business bankruptcy attorney before deciding on which type of bankruptcy you will file or whether you need to file bankruptcy at all. There may be other options that can be explored.

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