August 29, 2018
If you operate your law firm as a C corporation, you may be required to conduct an annual corporate meeting and keep minutes of the proceedings. The requirement to keep minutes is sometimes viewed as a burdensome task, but there’s some good news: Minutes can also be used to document the firm’s intentions for transactions that have major tax significance.
Such matters include (but are not limited to) the following:
- Year-End Bonuses for Shareholder-Employees. Ratifying the amounts of year-end bonuses paid to shareholder-employees is an important step. It helps ensure these outlays will be respected as compensation payments, which are deductible on the corporation’s Form 1120, rather than shareholder dividends, which are not deductible by the corporation and therefore subject to double taxation. If your firm has a written year-end bonus plan, its adoption and any subsequent amendments should be reflected in the firm’s corporate minutes.
- Shareholder-Employee Compensation in General. If some of your firm’s operating profits (before salary and bonus payments to shareholders-employees) are generated by the activities of employees who aren’t shareholders, it can be helpful to use the corporate minutes to document the amount of those profits. If they are considerable, there might be an issue with the IRS regarding how much of those profits can be paid out to shareholder-employees as deductible compensation (as opposed to being paid out as double-taxed dividends).
- Firm-to-Shareholder Loans. Without adequate documentation, the IRS might claim that disbursements of purported proceeds from firm loans to shareholders were actually disguised dividends — resulting in taxable income for the shareholders.
- Shareholder-to-Firm Loans. Without sufficient documentation, the IRS might claim that purported shareholder loans to the corporation were actually disguised contributions to the firm’s capital. That could result in amounts paid back by the firm being treated as dividends to shareholders — resulting in extra taxable income for them. In addition, the corporation would lose out on interest deductions that could have been written off on the firm’s return.
- A Buy-Sell Agreement. Corporate minutes should reflect the adoption or amendment of any buy-sell agreement between the corporation and the shareholders (also called a stock redemption or liquidation agreement). Such an agreement should clearly specify the valuation method that will be used to determine amounts paid for the stock of exiting shareholders. If payments will be made in installments, an appropriate interest rate should be specified for deferred payments.
- Related Party Transactions. The firm’s corporate minutes can be used to ratify the terms of — and document the reasonableness of — significant “related party” transactions. Let’s say your firm is interested in leasing and occupying a building owned by some of the shareholders. You want to make sure the lease payments will be treated as deductible expenses on the corporate tax return. If the IRS claims the payments are excessive, it could treat part of the payments as double-taxed dividends and/or additional shareholder compensation, which would result in extra payroll taxes for affected shareholders and the firm. This is just one example of the many types of related party transactions that can have important tax implications.
Your tax adviser can provide more guidance if you have questions about the tax implications of corporate minutes.