Corporate Matters: Delaware or New York L.L.C.?

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When a client is considering commencing business operations in New York, we are often asked whether it is preferable to form a limited liability company (“L.L.C.”) in New York or in Delaware. As we have mentioned in a previous issues, Delaware is generally the preferred jurisdiction for incorporation and the jurisdiction we typically recommend.

We thought it might be helpful to set out a short summary of issues that one will encounter in choosing between a New York or a Delaware L.L.C. and the relevant advantages and disadvantages of using either state.

Filing Fees

The fee for filing the articles of organization for a New York L.L.C. is $200, while the fee for filing a certificate of formation in Delaware is only $90.00. However, if the Delaware L.L.C. intends to conduct business in New York, it must file an application of authority for a foreign limited liability company, accompanied with a certificate of good standing from Delaware.

The determination of whether the Delaware L.L.C. is conducting business in New York is largely fact specific. The filing fee for the application for authority is $250, and the Delaware fee for a certificate of good standing can range from $50 (for a short form certificate) to $175 (for a long form certificate).

I.R.S. Issues New Form 1023-EZ: Streamlined Exemption for Small Charities

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On July 1, 2014, the Internal Revenue Service (“I.R.S.”) introduced a new, shorter application form to help small public charities apply for recognition of tax-exempt status, under §501(c)(3) of the Internal Revenue Code (“the Code”), more easily.

Ruchelman P.L.L.C. used the new Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, for a client and received recognition of tax-exempt status in less than three weeks. Recognition of tax-exempt status ordinarily can take months, if not years (in the case of charities operating abroad). Prior to the introduction of Form 1023-EZ, expedited processing was available only under certain circumstances, generally in the case of a mass disaster (e.g., terrorist attack, hurricane, etc.).

The new procedures may reduce the need for small charities to engage in fiscal sponsorships with larger public charities. Under a fiscal sponsorship, the larger charity agrees to sponsor the start-up charity, receiving and administering charitable contributions on behalf of the sponsored organization, for a fee.

The new Form 1023-EZ, is three pages long, compared with the standard 26-page Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. Most small organizations (which the I.R.S. estimates to be as many as 70% of all applicants) qualify to use the new streamlined form. Most organizations with gross receipts of $50,000 or less and assets of $250,000 or less are eligible. These are the same organizations that are eligible to file an “ePostcard” annual return on Form 990-N.

The Form 1023-EZ must be filed using pay.gov (the secure electronic portal for making payments to Federal Government Agencies) and a $400 user fee is due at the time the form is submitted.

Tax 101: Updates to Procedures Relating to Withholding Foreign Partnership or Trust Agreements as a Result of F.A.T.C.A.

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Chapter 3 of the Internal Revenue Code requires withholding on payments of certain types. These include “fixed or determinable annual or periodic income” (“F.D.A.P.”) to foreign persons, disposition of U.S. real property interests by foreign persons, and U.S. effectively connected income attributable to foreign partners of a partnership engaged in a U.S. trade or business. Historically, withholding agreements allowed a foreign partnership or trust to become a Withholding Foreign Partnership (“W.P.”) or a Withholding Foreign Trust (“W.T.”) and to assume the withholding and reporting responsibilities of a withholding agent under Chapter 3.

Chapter 4 of the Internal Revenue Code (regarding F.A.T.C.A.) generally requires foreign financial institutions (“F.F.I.’s”) to provide information to the Internal Revenue Service (“I.R.S.”) with regard to account holders who are U.S. persons. Chapter 4 also requires certain non-financial foreign entities (“N.F.F.E.’s”) to provide information on their substantial U.S. owners to withholding agents. Chapter 4 imposes a withholding tax on certain payments to F.F.I.’s and N.F.F.E.’s that fail to comply with their F.A.T.C.A. obligations. (For a more detailed discussion of F.A.T.C.A., please see our Insights monthly F.A.T.C.A. 24/7 column.)

On August 8, 2014, the I.R.S. released Rev. Proc. 2014-47, which provides guidance on entering into W.P. and W.T. agreements and for renewing such agreements under F.A.T.C.A., thereby essentially integrating the two reporting systems. Rev. Proc. 2014-17 permits a W.P. and W.T. to assume the withholding and reporting responsibilities of a withholding agent under both Chapter 3 and Chapter 4. Rev. Proc. 2014-47 publishes revised W.P. and W.T. agreement procedures, which apply to W.P. and W.T. agreements effective on or after June 30, 2014. Additionally, existing W.P. and W.T. agreements are updated to coordinate with the withholding and reporting requirements of F.A.T.C.A.

Tax 101: Taxation of Foreign Trusts

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INTRODUCTION: WHAT IS A FOREIGN TRUST?

In General

A trust is a relationship (generally a written agreement) created at the direction of an individual (the settlor), in which one or more persons (the trustees) hold the individual's property, subject to certain duties, to use and protect it for the benefit of others (the beneficiaries). In general, the term “trust” as used in the Internal Revenue Code (the “Code”) refers to an arrangement created either by a will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts.

Trusts can be characterized as grantor trusts or ordinary trusts. Ordinary trusts can be characterized as simple trusts or complex trusts; U.S. tax laws have special definitions for these concepts. A simple trust is a trust that is required to distribute all of its annual income to the beneficiaries. Beneficiaries cannot be charitable. A complex trust is an ordinary trust which is not a simple trust, i.e., a trust that may accumulate income, distribute corpus, or have charitable beneficiaries. Ordinary trusts are “hybrid” entities, serving as a conduit for distributions of distributable net income (“D.N.I.”), a concept defined in the Code,52 to beneficiaries and receiving a deduction for D.N.I. distributions, while being taxed on other income (e.g., accumulated income, income allocated to corpus).

A trust can be domestic or foreign. This article will focus on the U.S. tax consequences with respect to “foreign grantor trusts” (“F.G.T.”) and “foreign nongrantor trusts” (“F.N.G.T.”).

New York Enacts Major Corporate Taxation Reforms

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New York enacted major corporate tax reforms on March 31, 2014 when Governor Andrew Cuomo signed the final New York State budget legislation for Fiscal Year 2014-2015. Generally, the provisions are effective for tax years beginning on or after January 1, 2015. The new law changes do not automatically affect New York City taxes; conformity by New York City will require additional legislation. Significant changes are outlined below:

NEW NEXUS STANDARD

Historically, New York State taxed out-of-state corporations that had a physical nexus with the state, although physical nexus could be indirect or attenuated. The reform abandons the concept of physical nexus and adopts a new economic standard based on an annual dollar threshold of receipts derived from the state. By doing so New York significantly expands the number of corporations that will be subject to tax in the state. Corporations will now be taxable in New York for purposes of the corporation franchise tax and the metropolitan transportation business tax (“M.T.A.”) surcharge if they have $1 million or more of receipts from activity in New York. Furthermore, a corporation that is part of a combined reporting group and has receipts derived from New York of less than $1 million but more than $10,000 satisfies the threshold requirement if the New York receipts of all group members who individually exceed $10,000 equal $1 million or more in the aggregate.

FOREIGN (NON-U.S.) CORPORATIONS

Foreign (non-U.S.) corporations, referred to as alien corporations, will only be subject to New York tax if they are considered as U.S. domestic corporations under Internal Revenue Code (I.R.C.) §7701 or have effectively connected income under I.R.C. §882 for the tax year. This may have the effect of reducing the tax base of those foreign corporations that are subject to New York tax.

New York State Makes Major Changes to Estate and Gift Tax Law

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New Exclusion Amount: Prior to April 1, 2014, an estate was required to file a New York State estate tax return if the total of the federal gross estate plus the federal adjusted taxable gifts and specific exemption exceeded $1 million (the “basic exclusion amount”) and the individual was either: (i) a resident of the state at the time of death or (ii) a resident or citizen of the U.S. at the time of death but not a resident of the state, whose estate includes real or tangible personal property located in the state. (Other rules apply to individuals who were not residents or citizens of the U.S., but who died owning real or tangible personal property located in the state.)

Recent N.Y.S. legislation has increased the basic exclusion amount as follows:

• For individuals dying on or after April 1, 2014 and before April 1, 2015 - $2,062,500
• For individuals dying on or after April 1, 2015 and before April 1, 2016 - $3,125,000
• For individuals dying on or after April 1, 2016 and before April 1, 2017 - $4,187,500
• For individuals dying on or after April 1, 2017 and before January 1, 2019 - $5,250,000

After January 1, 2019, the basic exclusion amount will be indexed for inflation from 2010, which should link the state exclusion amount to the federal amount.

U.S. Tax Treaty Update→

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At a business meeting on April 1, 2014, the Senate Foreign Relations committee approved two proposed treaties with Hungary and Chile, tax treaty amendments (“protocols”) with Switzerland and Luxembourg, and a protocol amending the Multilateral Convention on Mutual Administrative Assistance in Tax Matters.

As in recent years, improved information sharing and limitations on “treaty shopping” (the inappropriate use of a tax treaty by residents of a third country) continue to be important U.S. objectives.

Highlights of the approved measures include the following:

• The proposed treaty between Hungary and the U.S. encompasses a comprehensive “Limitation on Benefits” provision, unlike the current treaty with Hungary, of 1979, which contains no such limitation, and also provides for a full exchange of information. The new Limitation on Benefits provision includes a measure granting so-called “derivative benefits” similar to the provision included in all recent U.S. tax treaties with European Union members.

Tax 101: Financing A U.S. Subsidiary - Debt vs. Equity

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INTRODUCTION

When a foreign business contemplates operating in the U.S. through a U.S. subsidiary corporation, it must take into account the options available for funding the subsidiary. As a practical matter, a foreign-owned subsidiary may encounter difficulty in obtaining external financing on its own, and thus, internal financing is often considered. It is a common practice for a foreign parent corporation to fund its subsidiary through a combination of equity and debt.

Using loans in the mixture of the capital structure is often advisable from a tax point of view. Subject to the general limitations under the Internal Revenue Code (the “Code”), financing the operations with debt will result in a U.S. interest expense deduction, often with a meaningful reduction of the overall tax rate applicable to the operation. (It should be noted that the U.S. has one of the highest corporate tax rates in the world.) Additionally, repayment of invested capital (in the form of debt principal) will be free of U.S. withholding tax if the investment qualifies as a debt instrument for U.S. tax purposes. If the lender is a resident of a treaty jurisdiction and eligible for treaty benefits, the interest payments will be subject to a reduced rate of taxation – or a complete elimination of taxation – under the treaty. Another reason multinational entities use debt to finance their subsidiaries is the possibility for tax arbitrage resulting from the differing treatment in various countries of debt and equity.

In the Matter of John Gaied - New York State's Highest Court Pushes Back New York Taxing Authorities

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New York State will tax as a “resident” of New York: a domiciliary of the State and a person treated as a “statutory resident.” A domiciliary is generally a person whose permanent and primary home is located in New York. A statutory resident is a person who is not a domiciliary, but maintains a permanent place of abode in this state and spends in the aggregate more than 183 days of the taxable year in New York. In other words, to be a statutory resident for New York tax purposes, the person must be present in New York for more than 183 days (in the aggregate) AND maintain a permanent place of abode in New York.

New York’s highest court was asked to determine what it means to “maintain” a permanent place of abode in New York. The New York State taxing authority’s position is that a person can have a permanent place of abode, which he or she does not necessarily have to own or lease, if the person can stay there whenever he or she wants, even if he or she stays there occasionally or not at all. Special rules apply to corporate apartments, college students, and the military.

New York Enacts New Legislation For New York Nonprofits

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New York’s Governor Andrew Cuomo has signed the Nonprofit Revitalization Act of 2013 into law, effective July 1, 2014, making a number of key reforms to New York law that have long been sought by the charitable sector and legal practitioners. Nonprofit organizations will now be able to incorporate, dissolve and merge more easily; communicate and hold meetings using modern technology like Skype and videoconference; and effect various transactions without the need to seek Court approval. The new law has added new governance provisions to provide crucial oversight and governance reforms. Nonprofit boards will have to perform stricter oversight of insider deals, and the Attorney General will be better able to hold insiders accountable for abuse. The new law requires the adoption of more robust financial oversight requirements, conflict of interest policies, and, for certain charities, whistleblower policies to protect nonprofit employees from retaliation when they identify wrongdoing.