Corporations:
KEEP UP WITH CORPORATE FORMALITIES

Since we are the registered agent for almost every corporation we represent, we receive an incredible number of Notices of Involuntary Dissolution from the Secretary of State. In other words, after we send our client the Annual Report which needs to be signed and filed with the Secretary of State's Office (with a $40 check), oftentimes the clients are too busy with their day-to-day activities to file the Annual Report.

As a result, the Secretary of State threatens, and ultimately follows through, on the dissolution of the corporation. Once the corporation is involuntarily dissolved by the Secretary of State, the owners of the corporation can no longer operate with the corporate shield which insulates their personal assets. The owners are completely exposed to suits against creditors and a plaintiff seeking to recover the shareholder's personal assets. As such, this brief article is a reminder to keep up the corporate formalities, to ensure that creditors and other litigants will never be able to "pierce the corporate veil" and recover against your personal assets.

1. Annual Report: Every year, in the anniversary month of your corporation, you must file an Annual Report with the Secretary of State. The failure to file this simple, two-page report will result in the dissolution of your corporation.
2. Annual Minutes: There is at least one Wyoming court that pierced the corporate veil solely because the corporation failed to have an Annual Meeting and memorialize that meeting with annual minutes. While there are no Illinois cases that pierce the corporate veil solely for the failure to prepare annual minutes, why provide evidence for the opposing party in litigation? Every year, annual minutes must be prepared for a corporation and they must be maintained in the corporate minute book.
3. Personal Expenses: Do not pay personal expenses directly from the corporate checkbook. As an employee of the corporation, corporate funds must first transfer to you as salary or a dividend, and then once the funds are deposited in your personal bank account, you should then pay personal expenses from your own bank account. If you pay non-business expenses directly from the corporate bank account, you certainly cannot take them as a federal tax deduction, but in addition to the tax analysis, you are creating evidence that the corporate shield is not in existence.
4. Pay Yourself A Salary: While we just stated that you can take money out of your corporation via a dividend, you first must realize that you are an employee first. As an employee, you must pay yourself a salary. There are very few instances where you can take money out of the corporation without ever first taking a salary. Further, you, the shareholder, cannot be an independent contractor to your own corporation. This tactic is generally used to save employment taxes (and by the way, it does not work well) but there are tax cases on point that directly state that a shareholder who works in the business must be an employee of the corporation, and not an independent contractor.
5. Document Shareholder Loans: Any loans made between the shareholders and his or her corporations must be documented properly. A note must be prepared, a security agreement must be prepared (if collateral is involved), and your accountant must document the monetary transfer as a loan in the accounting records of the corporation. Remind your accountant to accrue interest pursuant to the terms of the loan. Without the right documentation, a loan from the corporation will be treated as a dividend and a loan from a shareholder to the corporation will be treated as a capital contribution, both of which could have a devastating tax impact upon audit.

The above list contains just a small portion of the subtleties of operating a small business that need to be followed in order to ensure the corporate status and to avoid any suits to pierce the corporate veil. Remember, the penalty for failing to maintain these corporate formalities is that you are placing your personal assets at stake for all known and unknown potential business liabilities.

Federal Taxation:
IS THE TAX WITHHELD BY YOUR EMPLOYER SUFFICIENT TO AVOID A SURPRISE NEXT APRIL?

If you have more than one employer or your spouse is employed, you could be in for a large tax bill next April unless you are having your employers withhold more tax.

To best understand the effect of multiple employers to either you or you and your spouse, we will use a simple example as follows: both husband and wife are employed with jobs paying $30,000.00 each year. Both husband and wife identified to their employer that they are married and claim no exemptions (to minimize their April 15th tax "bite"). However, since each husband and wife work for different employers, each employer does not know what the other spouse's income as well as withholdings are. Therefore, each employer withholds as follows:

Adjusted Gross Income Circular E Withholding x 2 taxpayers Total Tax Withheld

$30,000 $3,540 $7,080

Assuming each employer uses the withholding tables correctly, both husband and wife will have withheld taxes totaling $7,080.00.

However, when husband and wife file their return, they will show as follows:

Adjusted Gross Income Standard Deduction Exemptions Taxable Income Total Taxes

$60,000 $6,550 $5,000 $48,450 $8,496

As you can see from the above, the taxpayers will have a tax liability next April of $1,416.00 despite the fact that both were claiming zero exemptions. The reason for this is that each employer does not know what the other spouse is making and does not withhold taxes to account for the other spouse's income. In order to avoid this tax liability, it may be advisable to: increase the amount of taxes withheld, make quarterly tax estimated payments, or increase your cash flow by placing the amount that would normally be withheld in your savings account (and have that money earn interest for the year) until you have to pay the taxes in April.

The above example is not only applicable to married individuals but to individuals who change employers during the year or who have more than one employer. Of course, married individuals, where each spouse has more than one employer during the year, would compound this potential tax liability problem.

Therefore, in order to avoid a financial surprise next April, you should check to ensure that your employer(s) is withholding enough tax so as to allow you to pay your taxes in full next April.

One of the most frequently asked questions at our law office is: How does the IRS select tax returns for audits?

First and foremost, the IRS uses the Income Matching System to determine if there is a blatant error in your income or certain deductions. For example, omitting 1099 or W-2 income will generate a correction notice and possibly an audit from the Internal Revenue Service.

Next, the IRS computers select tax returns worthy of examination by means of a scoring system known as a Discriminate Income Function (DIF). Each return is assigned a DIF score which measures the probability of error. Accordingly, the higher the chance of error, the greater the chance of audit.

A very thorough audit called a Taxpayer Compliance Measurement Program (TCMP) audit is the most thorough of all audits. This is an audit picked at random by the Internal Revenue Service for statistical purposes. In this audit, the revenue agent will audit every line of the tax return. The findings of these statistical audits are reported to Congress. They are then used to set IRS budgets. Another reason individuals or businesses are audited is due to complaints and disclosures that are initiated by estranged spouses, former spouses, former business partners and other individuals that act as informants for the government. While this seems unimaginable, the IRS is very receptive to such information.

Moreover, while most taxpayers read the annually published reports of the statistical average for interest deductions, charitable contribution deductions, and medical expense deductions, such blatant single deductions that far exceed the national average do not necessarily trigger audits. More importantly, the Internal Revenue Service looks at ratios. For example, the most critical ratio derived from your tax return is the Schedule A ratio, which is computed by dividing your total itemized deductions by your adjusted gross income on your 1040. If the ratio is less than 35 percent, your chances of being selected by the IRS computers are slim. If it is higher than 44 percent, you are almost certain to be selected for review. An internal IRS review does not make an audit a certainty.

The other ratio closely scrutinized is the Schedule C ratio. The Schedule C ratio equals your total expenses listed on your Schedule C over your Schedule C gross income. If that ratio is less than 52 percent, you are probably safe. If it is higher than 67 percent, your chances of being selected are much higher.

The way to avoid such "red flag" ratios is to shift deductions (when allowable) from one schedule or by deferring expenses.

Also, when high ratios are unavoidable, it helps to explain the unusual items in an attachment to your tax return.

There is no doubt that the biggest mistake individuals make in dealing with the Internal Revenue Service and other governmental taxing bodies is volunteering information. It has always been our position that taxpayers are best served in audits by having their attorneys or accountants represent them. This way the tax professional acts as a "buffer" to delay the disclosure of information and to fully synthesize the questions and demands of the auditor.

Lastly, as you have probably heard, statisticians tell us that you will reduce your risk of being audited the later you file your tax return every year.

Bankruptcy:
TREATMENT OF MARITAL DEBTS UNDER THE BANKRUPTCY REFORM ACT OF 1994

In October, 1994, President Clinton signed into law The Bankruptcy Reform Act of 1994 that contained several changes in existing bankruptcy law. Among the areas receiving new treatment, the issue of the dischargeability of marital debts received the most consistent legislative pressure.

Prior to the changes, for marital debts to be considered nondischargeable or payable by a debtor seeking relief under the Bankruptcy Code, the liability created by the divorce decree or property settlement had to be in the nature of "child support". Alimony or property settlements were considered dischargeable unless they could be proven to be intended by the parties to be "in the nature" of child support.

On the one hand, the reason for this was that the debtor seeking a discharge was entitled to a fresh start, and no overriding societal concern existed for the payment of alimony or property settlements to be superior to the debtor's fresh start. On the other hand, concerns did exist that by allowing spouses to transfer property or to continue to make payments to ex-spouses, other creditors suffered unequal treatment. Meanwhile, child support payments had as their obvious concern the well-being of children, rights that Congress had to protect over those of the debtor's need for a fresh start.

Under the new law, a new priority, ahead of taxes, has been created for debts that are in the nature of alimony, maintenance or support. In Chapter 13 reorganizations, such debts must be paid in full unless the recipient spouse agrees to receive a lesser amount. Although the debtor may challenge whether the debt should be treated as a priority debt, courts almost uniformly require such treatment.

In Chapter 7 liquidation bankruptcies, such debts will now not be discharged unless the debtor can show one of two things: first, that after providing support for the dependents, the debtor is unable to pay the remaining amounts due; or second, if the benefit of the discharge to the debtor outweighs the detriment to the creditor spouse. Irrespective of how the parties label these debts in the divorce decree and property settlement, the courts will make inquiries to ensure that the debtor is not using bankruptcy as a maneuver to avoid marital obligations when he or she has the financial ability to make the required payments.

Despite the tightening of the rules, clients must be aware that procedural steps must still be followed to ensure that marital debts are declared nondischargeable. A non-filing spouse may elect to return to divorce court to argue that the obligation should be enforced, but runs the risk that the judge may accept the debtor's argument that because no Bankruptcy Court order was obtained excepting this particular debt from discharge, the debt no longer exists.

Other changes in the Bankruptcy Code affecting marital obligations deal with jurisdictional issues, such as the modification of the automatic stay to return to Divorce Court for proceedings to determine paternity or to modify existing orders for support. Although such issues may eventually have an impact on the debtor's financial situation, the Code's intent is to allow the administration of related issues while the bankruptcy is pending. A bankruptcy judge, provided with enough compelling evidence, might allow a spouse to return to divorce court to enforce an order even though such enforcement would have an impact on the debtor's finances, but such relief is entirely discretionary.

On March 9, 1995, Governor Jim Edgar signed into law the Civil Justice Reform Amendment of 1995. In doing so, Illinois became the fifth state to pass tort reform legislation in a growing movement for tort reform. In fact, tort reform legislation is now being considered by approximately two dozen other states.

While Illinois may be one of the leading states in enacting tort reform legislation, the substance of the tort reform may not have a significant impact on most tort cases. One of the keystones of the act is a cap of $500,000.00 in non-economic damages. Non-economic damages include pain, suffering, disability, disfigurement, loss of enjoyment of life and loss of consortium. As a result of the caps on damages, minutes after Governor Edgar signed the tort reform bill into law, a lawsuit was filed, challenging the constitutionality of the law.

In addition to a cap on non-economic damages, the new act also places caps on attorney fees, punitive damages, and abolishes joint and several liability. Also, in the area of products liability, the act provides for new defenses for defendants, as well as other procedural changes that favor defendants.

Since the new law is less than four months old, there is no case law to guide in its application and how it will effect tort claims. It should be noted that the award caps are estimated to effect less than 1% of all tort lawsuits. However, should the law survive its constitutional challenges, we should interpret it as a first step in tort reform in Illinois.

Immigration:
EMPLOYMENT BASED IMMIGRATION

Major changes in United States' immigration law involving employment-based immigration formed a part of The Immigration Act of 1990 and the 1991 Amendments. Prior to the Act and the Amendments, only two classes, or "preferences", of employment or worker visas were available: one for professionals and persons of exceptional ability, and another for skilled and unskilled workers. Congress has created three new classes to add to the existing two classes and also increased the number of visas available under the worker preferences from 64,000 under the two-class system to 140,000 in the new five-class system. The reason for the change is that Congress believed that the U.S. economy would benefit from an increase in immigration of skilled workers.

The first preference is for priority workers. Employees comprising this class include: 1) persons with extraordinary ability, 2) outstanding professors and researchers, and 3) certain multinational executives and managers. This preference group is allotted 40,000 of the total 140,000 visas available. Because there is no perceived negative impact on U.S. workers, labor certification for workers in this class is unnecessary. Also, this class rarely experiences backlogs in the processing of such visa applications, unlike other preferences.

Professionals holding advanced degrees or possessing exceptional ability in sciences, arts or business are eligible for second preference treatment. Second preference applicants must provide proof that their entry will "substantially benefit the national economy, cultural or educational interest, or welfare of the U.S." Employer sponsorship is required under this preference, although waivers are possible, but labor certification is required. Like the first and the third preferences, 40,000 visas are allotted to the second preference.

Preference three is for skilled workers, professional and "other" workers. Each of these groups requires labor certification and employer sponsorship (without waivers) for the 40,000 available visas (plus any unused visas from the first two preferences). Two years' job experience is also needed. In most years, unlike the first two preferences, this category will experience an overload of applications and the resultant backlog in processing.

The fourth preference contains only 10,000 visas, with no available spilldown from the first three preferences. This category includes ministers, religious professionals and other religious workers. This preference, however, shares its allotment with other "Special Immigrants" such as certain dependents of the juvenile courts and certain employees of the U.S. mission in Hong Kong.

The fifth and final preference is a new creation for persons who intend to engage in a new commercial venture. There is a 10,000 limit annually for these visas, with the added caveat that at least 3,000 of these visas will be set aside for "targeted employment" areas. Derided as the "millionaire visa" because of the requirement that a minimal investment of usually at least $1,000,000 in the venture, this class has experienced minimal application activity. At least ten U.S. citizens or employment authorized immigrants (exclusive of the principal alien and his or her family) must be employed in the enterprise. This preference is also replete with graduated requirements that seek to ensure that the enterprise is a valid one and not simply a loophole for the wealthy.

This newsletter is a publication of Lavelle Legal Services, LTD. We attempt to highlight and discuss areas of general legal interest that may lead to planning opportunities. Nothing contained in this Newsletter should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein.