7

Organizational Forms and Law

Pathways is incorporated as a privately held S corporation under Ohio law and subject to internal revenue service (IRS) provision for taxation of income. S corporations elect to pass corporate income, losses, deductions, and credit to their shareholders for federal tax purposes. Shareholders of S corporations report the flow of income and losses on their personal tax returns and are assessed at individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive incomes.

To qualify for S-corporation status, the corporation must meet the following requirements:

· Be a domestic corporation

· Have only allowable shareholders, which includes individuals, certain trusts, and estates, but not partnerships, corporations, or nonresident alien shareholders

· Have no more than 100 shareholders

· Have one class of stock

· Not be an ineligible corporation, such as certain financial institutions, insurance companies, and domestic international sales corporations

ESOP, which Pathways follows, is a tax-qualified retirement plan that enables a corporation to reward and motivate employees with ownership in the corporation. Available only to corporations, ESOPs provide a number of benefits, including significant tax advantages.

Pathways allocates its ESOP contributions to individual employees in proportion to their compensation. The contributions go into a trust account and employees become entitled to an increasing percentage of their accounts over time. Pathways employees’ ESOPs vest at five years of continued full-time employment. An ESOP employee who reaches the age of fifty-five and who has at least ten years of participation in the plan, has the option of diversifying his/her

ESOP account up to twenty-five percent of the value. This option continues until age sixty, at which time the employee has a one-time option to diversify up to fifty percent of his/her account.

The form of distribution of a privately held firm such as Pathways is governed by the corporate by-laws. Pathways makes the distribution in stock, giving the employees a “put option” on the stock for sixty days after the distribution. If the employee chooses not to sell at that time, the company must offer another put option for a second 60-day period starting one year after the distribution date. After this period the company has no further obligation to repurchase the shares.

Employees receive the vested portion of their accounts at termination, disability, death, or retirement. These distributions may be made in a lump sum or in installments over a period of years. If employees become disabled or die, they or their beneficiaries receive the vested portion of their ESOP accounts right away.

If at the time of receiving their accounts there is no public market, the company must purchase the employee’s shares at their present valuation. The corporation is generally given the option of paying for the shares in a lump sum or in installments over a period of years.

As an S Corporation, Pathways is a corporation that elected to be taxed under Subchapter S of the Internal Revenue Code and received Internal Revenue Service (IRS) approval of its request for Subchapter S status. As a legal entity, the S Corporation is separate and distinct from the corporation's owners, who are the stockholders.

Pathways gains several advantages from its S Corporation status. These advantages are

· As an S Corporation, the continuation and sustainability of the company is ensured because it cannot be impacted by the death of one or more stockholders.

· Distributing stock shares through the ESOP allows restructuring of corporate ownership without interruption of business operations.

· The Pathways S Corporation pays no income taxes and corporation income or loss is passed to stockholders.

· To the extent the corporate shield is maintained and other investments and savings of the stockholders are not at risk, the personal life of stockholders is simplified.

· Depending on the corporation's business record and the policies and practices of prospective lenders, access to credit and the ability to secure needed resources is improved.

· Earnings representing return on investment (interest, rental payments, etc.) are not subject to self-employment tax as long as stockholder-employees receive adequate compensation for labor and management of the business.

The S Corporation status also has some disadvantages:

· Lenders may require personal guarantees from corporate officers as a condition of credit which negates to some extent the limits of liability.

· Disagreements among employee stockholders could impede the decision-making process of Pathways.

· The appreciated assets owned by Pathways could become significant income tax liabilities to shareholder-employees if the corporation is dissolved.

· • Employment benefits such as life insurance, health insurance, and housing costs are taxable income to Pathways’ stockholder-employees with two percent or more stock ownership.