The current economic climate has severely hindered, if not paralyzed, many clients.  Fear and the scarcity of risk capital have brought virtually all extraordinary business transactions to a complete standstill.  For strategic-thinking clients, however, now is the perfect opportunity to undertake a number of basic tax-planning transactions that can save significant dollars in the future.  Put differently, there are many silver linings amongst all the dark clouds out there. 

Set forth below are a few examples of these basic tax-saving transactions:

• Subchapter S Elections — For eligible C corporation clients, a subchapter S election by March 16, 2009 (thus retroactive to January 1, 2009) may be a tremendous tax saving strategy.  Recall that the built-in gain rules apply to C corporations converting to S corporations.  Currently, though, valuations are incredibly low, thus minimizing potential built-in gain.  Furthermore, the rules regarding eligible S corporation shareholders have been greatly relaxed in recent years.

• Convert To An LLC - Again, low valuations present an opportunity to convert corporate clients, especially S corporation clients, to LLCs.  We recently encountered an S corporation client with an inside and outside basis of $40M, but with a current fair market value of $35M.  By filing a few simple documents with the Georgia Secretary of State, we converted the client to an LLC thereby freeing up $5M of losses to be used against future income.  Further, because this client had been an S corporation for 7 years, we permanently eliminated any BIG tax under the special rule enacted this year in the AR&R Act of 2009.

• Consider Partnership Freeze Transactions — If a subchapter S election or conversion to an LLC is not viable, C corporation clients would be well advised to consider a so-called “partnership freeze” transaction.  In such a transaction, the  C corporation contributes its assets to a partnership in exchange for a preferred partnership interest of equal value, while the common interests in the partnership are acquired by the shareholders.  Carefully planned and implemented, this strategy is an effective way to remove subsequent appreciation from corporate level taxes.  We have undertaken several such transactions, especially for longstanding C corporation clients holding real estate.

• Succession Planning Redemptions — For closely-held corporate clients interested in succession planning, today offers a tremendous opportunity to redeem stock from the senior generation to allow subsequent appreciation to inure to the benefit of the junior generation.  If the client is a C corporation, the redemption generally will be taxed at capital gains rates even if it does not satisfy the substantially disproportionate test of Code Section 302.  Further, for S corporation clients, the redemption can be entirely tax free as a reduction of the S corporation’s AAA account and a corresponding reduction in the redeeming shareholder’s basis. 

• Intra-Family Gifts and Sales — The applicable federal rates and Code Section 7520 rates are at historic lows.  Further, capital gains rates remain at 15% for 2009 (but may increase in 2010).  Accordingly, gifting and/or intra-family sales can be undertaken at minimal, if any, tax cost.  In particular, leveraged gifting strategies (e.g., GRATs and sales to IDGTs) require very little subsequent appreciation in the gifted asset to be successful.  Even if a gift is not possible — for example, the donor has used his or her entire $1M gift tax exemption — an intra-family sale can be entered between a senior generation and a junior generation for a three-year promissory note with an interest rate as low as .72% (the short-term AFR for March).  A nine-year promissory note need only carry a 1.94% interest rate (the mid-term AFR for March).

If you would like to discuss how these new developments may affect you or your clients, please contact one of us listed to the left.