It is a truth universally acknowledged that accountants and lawyers are not always on the best of terms. Given that some lawyers know little or nothing about tax, you should maintain a good working relationship with your clients’ lawyers. A simple example: Your client decides to form an S corporation. There are 9 other shareholders. Clearly a shareholders’ agreement is necessary. The lawyer will draft it, but you should review it. A partial list for review and comment should include:
A provision that any amendment to the shareholders’ agreement that causes a termination of the S election is void and of no effect.
A provision listing inadmissible transfers by a shareholder, for example, an individual who is a nonresident alien. (Also include a bucket provision which states that ANY transfer that would cause the termination of the S election is null and void ab initio.)
A provision that all of the corporation’s debt instruments must be “straight debt” under Code section 1361(c)(5), thus avoiding any issue that such debt is a second class of stock.
A provision that if there is an inadvertent termination, the corporation may request from the IRS a waiver of the inadvertent termination under Code section 1362(f) and each shareholder must agree to any adjustments by the IRS to avoid the inadvertent termination.
A provision that if there is a proposed revocation of the S election, stating the percentage of the shareholders with outstanding voting shares that must consent to the revocation.
A provision that any shareholder who violates the shareholders’ agreement and causes the termination of the S election will indemnify and hold harmless the other shareholders for any damages they may incur (including taxes, interest, and penalties) because of the termination.
A provision stating the percentage of shareholders necessary to make the elections under Code section 1362(f)(4), Code section 1362(e)(3), Code section 1377(a)(2), and Code section 1368(e)(3).
A provision requiring the corporation to make pro rata distributions of cash to pay federal and state taxes in a timely manner (using the highest tax rate of a given state for the state distribution to avoid a distribution which is not pro rata).
A provision permitting the board of directors to make additional distributions (in addition to the tax distribution described above).
A provision listing permissible transferees for estate planning purposes
If you review the shareholders’ agreement, you will not get that awful call from a now former client asking you why you didn’t review the lawyer’s draft of the shareholders’ agreement. The former client then tells you that the agreement (now final) was badly drafted.
