We've nearly reached the end of the year. We're preparing for holiday office closures, parties, and those last minute details that pop up. As a business owner, you have probably already double checked your payroll data, vendor payment tracking, inventories, and holiday marketing. But did you check your corporate meeting minutes? What about any non-payroll, non-reimbursement money you received from the business? We're going to cover two of the most overlooked business owner requirements today, and we promise they are easy tasks that will have big impact when it's time for your corporate taxes to be prepared.
First we're going to cover corporation meeting minutes. They are the number one overlooked yearly task in nearly every small business.
Corporate Meeting Minutes
State corporation law and the corporation’s own bylaws set the rules by which a corporation holds valid meetings, takes valid corporate actions, and keeps corporate minutes. An organization’s legal standing as a corporation is risked if a corporation fails to hold corporate meetings documented by the corporation’s minutes.
Piercing the Corporate Veil
Corporations are often formed for purposes of protecting shareholders from liability. If formalities are not followed, the corporate veil can be easily “pierced” by a court, resulting in personal liability for the shareholders. Lack of adherence to corporate formalities (including holding an annual meeting evidenced by annual minutes) is a primary reason why courts may pierce the corporate veil.
Note: Generally, corporation law varies by state. The general concepts of how to properly call a meeting, give adequate notice, and correctly record corporate actions taken are often the same. However, the specific requirements may vary by state or the corporation’s own bylaws. Therefore, the following information should be used as a basic guideline only, and care should be taken to check compliance with state law
and the corporation’s bylaws.
General Requirements for All Corporations
Meetings need to be held at least annually.
Give notice of date, time, place of meeting (or retain signed waiver of notice, see next page) to all shareholders.
Prepare minutes of the meeting, including the following.
The name of the corporation.
The date, time, and place where the meeting was held.
That notice of the meeting had been properly given or waived in accordance with the bylaws.
Record of shareholders present and absent.
That the minutes of the previous meeting were presented and approved.
Any important changes to the business that happened during the year.
Election of officers (by action of the board of directors) and directors (by vote of the shareholders) according to the corporation’s bylaws and articles of incorporation, if specified that elections should occur annually.
Any other basic information covered and decisions made.
Requirements for meeting minutes are fairly simple for one shareholder corporations, but must still be kept in order to retain corporation status. Use the general requirements as a guideline and also consider the following information.
Set a date of the meeting (this can be a past date since there is no need to give notice to oneself) to be held at least once annually.
Record in the minutes that the meeting is a joint meeting of the shareholders and the board of directors.
Record in the minutes the election of directors and the election of officers (president, secretary, treasurer) for the next year (if indicated as necessary in the corporate bylaws).
Sign the minutes as the secretary of the corporation and retain copies with other business documents.
If there are two shareholders, both are on the board of directors and one person is designated as the secretary of the corporation. Use the general requirements as a guideline and also consider the following information.
Set a date of the annual meeting (if the shareholders meet often, it could be a past date with a signed waiver of notice, see next page) to be held at least once annually.
Record in the minutes the two shareholders present, and that it is a joint meeting of the shareholders and the board of directors.
Record in the minutes the election of officers (president, secretary, treasurer) and directors for the next year (if indicated as necessary in the corporate bylaws).
The secretary of the corporation signs the minutes and retains copies with other business documents.
Three or More Shareholders
When there are more than two shareholders, there is greater potential for disagreements. Steps should be taken to ensure that corporate formalities are adhered to so that one individual cannot later contend a meeting (and any decision made at that meeting) was not valid due to inadequate notice or non-attendance. Use the general requirements as a guideline and also consider the following information.
The president, chair of the board, or secretary calls the meeting and gives adequate notice. State corporation law and corporation bylaws establish how many days notice must be given for certain types of meetings.
Set a date of the meeting and give adequate notice of the date, time, and place to all shareholders. Note: State corporation law may allow a valid meeting if all who are entitled to vote attend or if all who do not attend sign a waiver of notice, see below.
For a valid meeting, a quorum must be present. The articles of incorporation, bylaws, and state corporation law establish the quorum. Generally, it is a majority of the shares (or directors) entitled to vote.
Record the type of meeting (meeting of shareholders, meeting of the board of directors, or joint meeting) in the minutes, and the shareholders in attendance and absent.
Record in the minutes any actions taken or resolutions passed and the vote in favor of each.
Record in the minutes the election of officers (president, secretary, treasurer) and directors for the next year (if indicated as necessary in the corporation bylaws).
The secretary of the corporation signs the minutes and retains copies with other business documents.
Waiver of Notice Model Language
The undersigned director/officer, appointed by the articles of incorporation of ________________________ (business legal name), consents and agrees that the joint annual meeting of the board of directors and shareholders be held on _______ (date) at _____am/pm at _________________(location). I do hereby waive all notice whatsoever of the meeting. I consent and agree that any and all business transacted at the meeting shall be valid and legal, as if the meeting was held after giving notice.
[Please note that the above waiver or notice is a sample. We are not providing legal advice or guidance with this general sample. Please consult with your trusted legal advisor for a notice that meets your state's legal requirements.]
Business Owners—Taking Money Out of a Business
When taking money out of a business, transactions must be carefully structured to avoid unwanted tax consequences or damage to the business entity. Business owners should follow the advice of a tax professional to make sure financial transactions are controlled and do not cause unanticipated taxation or other negative effects.
For example, a shareholder of a corporation can make a loan to the corporation, and subsequent repayments of principal are not taxable to the shareholder. This may seem straightforward. However, if the loan and repayments are not set up and processed properly, with specific documentation in place, the IRS can reclassify the funding as nondeductible capital contributions and classify the repayments as taxable dividends, resulting in unexpected taxation. A weak loan structure can also create a danger zone where a court can “pierce the corporate veil,” resulting in personal liability for the business owner. These negative effects can occur in several different situations.
One of the most dangerous financial mistakes a business owner can make is to intermingle funds, such as paying personal expenses from the business checking account, or paying business expenses from the owner’s personal account. This can be done with the best of intentions with the business owner making adjustments in the books to separate the business and personal transactions, but the behavior can leave openings for the IRS or courts to question the integrity of the business entity or the transactions. Failure to maintain complete financial separation between a business and its owners is one of the major causes of tax and legal trouble for small businesses.
Unintended consequences can occur when personal and corporate funds are intermingled. When a shareholder purchases an item for a corporation with personal funds, that shareholder is considered to have provided funds or made a contribution to the corporation. When a shareholder provides funds to or on behalf of a corporation, there are several different types of tax treatment that may apply, depending on the circumstances, and can be classified as one of the following transactions.
Loan to the corporation.
Repayment of a loan from the corporation.
On the other hand, when an individual takes funds from a corporation, the transaction can be classified as:
Taxable dividend or distribution of profits.
Nontaxable expense reimbursement.
Loan to the shareholder.
Repayment of a loan from the shareholder.
Failure to carefully structure transactions can result in otherwise nontaxable transactions becoming taxable, in addition to a court piercing the corporate veil.
Personal Use of Corporate Assets
If corporate assets are used for personal purposes, the IRS can reclassify expenses reported on the corporation tax return as expenses attributable to the shareholder rather than the corporation. On the other hand, if a corporation uses personal assets owned by the shareholder, this could indicate lack of separation of the shareholder and corporation.
Taking Money Out
A sole proprietor is taxed on self-employment income without regard for activity in the business bank account. A sole proprietor should never pay himself or herself wages,
dividends, or other distributions. A sole proprietor may take money out of the business bank account with no tax ramifications.
One way for a business owner to take money out of a corporation is through wages for services performed. Wages are appropriate only for C corporations and S corporations, not for sole proprietorships or partnerships. Owners are treated as employees, payroll taxes and income taxes are withheld, and the corporation issues Form W-2, Wage and Tax Statement, to the business owner.
For C corporations and S corporations, there are incentives to skew wages one way or the other for purposes of tax savings.
In a C corporation, wages are deductible by the corporation but dividends are not, creating incentive for a C corporation shareholder to inflate the wages for higher deductions.
In an S corporation, wages are subject to payroll taxes but flow-through income is not, creating an incentive for artificially low wages. Both C corporations and S corporations are required by law to pay reasonable wages, which approximate wages that would be paid for similar levels of services in unrelated companies.
Guaranteed payments to partners are the partnership counterpart to corporate wages. One major difference is with guaranteed payments, there is no withholding for payroll taxes or income tax. These amounts are computed and paid on the partner’s individual Form 1040.
Dividends are generally the means by which a C corporation distributes profits to shareholders. Amounts up to the C corporation’s earnings and profits are taxable to the
shareholder. Although flow-through income from S corporations or partnerships are often called dividends, they are not treated as dividends under tax rules.
Flow-Through Income—S Corporations and Partnerships
Net income from S corporations and partnerships flows through to the shareholder or partner’s individual tax return. Flow-through income is reported without regard for whether or when the income is distributed to the shareholder or partner. Distributions of cash to an S corporation shareholder or partner are not taxable to the individual until
the person’s cost basis reaches zero.
An S corporation is allowed to have only one class of stock. If an S corporation does not make distributions to all shareholders based on the percent of stock owned, this rule may be violated and the S corporation status may be terminated. The one-class-of-stock rule must be adhered to whenever making distributions from an S corporation’s bank account.
A corporation or partnership can receive loans from shareholders or partners and, on the other hand, a corporation or partnership can make loans to shareholders or partners. There is generally no taxable event when a corporation or partnership repays a loan from a business owner, and no taxable event when a corporation or partnership makes a bona fide loan to a shareholder or partner. However, failing to adhere to necessary formalities can put these transactions in danger, allowing the IRS to step in and reclassify the transactions, resulting in taxable income for the business owners.
If you've taken any money out of your business and you're not sure how to account for it, give us a call. Our specialists are happy to answer your accounting questions now so you can celebrate the end of the year with peace of mind!
Legal Disclaimer: This post contains general information for taxpayers and should not be relied upon as the only source of authority. Taxpayers should seek professional tax advice for more information. This information was current at time of posting; we are not responsible for updating this or any blog post/article for subsequent changes in the law or its interpretation.
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