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Monday, 02.06.2012 |
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| Own Your Own Corporation |
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Product Details
Notes
two main reasons to own a corporation:
protection against law suits and excessive taxes
own nothing and control everything
work smarter instead of harder
possible legal entities:
C corporation, S corporation, limited liability company (LLC)
limited partnership (LP), general partnership, sole proprietorship
consider the following factors in choosing an entity:
1) protection of family assets and investments
2) management control
3) avoiding family disputes
4) flexibility of decision making
5) succession of children and other family members to management
6) the nature of the business to be operated
7) the nature of the asset to be held
8) the number of owners involved
9) estate planning and gifting of assets
10) who may legally obligate the business
11) effect upon an owner's death or departure
12) the need for start-up funding
13) taxation
14) privacy of ownership
15) consolidation of assets and investments
entity selection should vary depending on the business venture
sole proprietorships and general partnerships are not recommended
these two entities provide no asset protection
a business is vicariously liable for the acts of its employees
there are both known and unknown risks in running a business
establish a corporation to limit your liability, otherwise you could be bankrupt
it is hard to sell a sole proprietorship, since its value is based on the owner
when the owner dies, the sole proprietorship terminates
successors can only sell assets, not the business itself as a going concern
a general partnership is bad, you're liable for yourself and your partner
when two or more people agree to share profits and losses, it's a partnership
even if no partnership agreement was signed, it's legally a general partnership
by default, profits are divided evenly, oral agreements don't count
a handshake can form a general partnership, but you need a written agreement
if you're a general partner, you better have day-to-day management control
in 9 out of 10 cases, there are problems when only one partner puts up money
a partnership terminates when one partner dies, leaves or goes bankrupt
it's hard to sell your interest in a general partnership to any sophisticated buyer
terms: owner, senior management, organizational document, operational map
corp: shareholder, CEO, president, articles of incorporation, bylaws
LLC: member, manager(s), articles of organization, operating agreement
LP: general and limited partner, general partner(s),
certificate of limited partnership, limited partnership agreement
corporations came into common usage in the 1500s for maritime ventures
investors needed to protect their liability for ships sailing across the seas
corporations let them limit their downside risk but still have unlimited upside
to form a corporation, file a document that creates an independent legal entity
the articles of incorporation is public record, so leave secret information out
requirements for a legal corporate entity include:
1) holding regularly scheduled meetings
2) conducting banking through a separate corporate bank account
3) filing a separate corporate tax return
4) filing corporate papers with the state on a timely basis
piercing the corporate veil
this can be used when the corporation failed to operate as a distinct entity
have your attorney handle corporate filings and annual minutes
and have your accountant prepare the corporate tax return
these are minor additional costs after forming the corporation to protect it
double taxation can occur with C corporations
try to show no profits at the end of the year, use write-offs to reduce net income
S corp has flow-through taxation
but it has a max of 75 shareholders, who must all be American citizens
the shareholders cannot include other corporations or entities
and an S corp can only have one class of stock
these limitations were the reason the LLC was created
you can't issue stock options in an LLC or LP, or go public like a C corp
LLC gives you two additional features:
1) flexible management structure
2) flexible allocation of profit and loss
with an S corp, the profits and loss have to flow through evenly to partners
note that financial allocations must be made for a legitimate economic reason
you can't just arbitrarily shift profits and losses from one taxpayer to another
with an LLC, employees will pay self-employment tax but investors won't
with an S corp, self-employment tax is only on the salary portion, not profits
member-managed LLC - all members have management control
manager-managed LLC - only certain members have management control
often building owners or the SBA want you to personally guarantee a loan
you must sign any agreements as an officer of the LLC
sign as "John Doe, Manager, Company Name, LLC"
use a manager-managed LLC in the following cases:
1) a member just wants to be an investor, doesn't want to do decision making
2) family member gifts their interest to children but doesn't want them to manage
3) a nonmember lent money and controls the funds - they are the manager
4) you hire an outside professional manager to run the business
one drawback to the LLC is that it's relatively new, so it's not court tested
fees for an LLC in California are very high and can depend on gross revenue
in a limited partnership, the general partner can be a corporation or LLC
a limited partner could own 99% but have zero management control
each real estate property is put in a separate LP to minimize exposure
if the general partner is an individual, they can be personally liable
so usually you want the general partner to be a corporation or LLC
an LP is common with estate planning, the kids own but don't have control
you can restrict transfer of partnership interests to outside parties
an LP can accelerate family wealth transfer through IRS-approved discounts
C corp has maximum tax deductible fringe benefits including:
1) medical insurance premiums
2) group life and disability insurance
3) reimbursement of employees' medical expenses
a C corp can make contributions to plans even if it's creating a net loss
the self-employment tax is now split between the individual and the corporation
two more disadvantages of a sole proprietorship:
1) all retirement contributes are subject to self-employment taxes
2) there is no ERISA (Employee Retirement Income Security Act) protection
the tax rate for a C corporation can be lower than your flow-through tax rate
an S corporation is often recommended by advisors
but be careful, you can accidentally lose your S status if you break any rules
shareholder loans can create a second class of stock, terminating the S status
if you lose your status, you become a C corp and can't revert for at least 5 years
some states do not recognize S corporations, possibly including:
Michigan, New Hampshire, New York City, Tennessee and District of Columbia
Nevada has no state corporate or personal income tax
you can use a nominee to serve as director, keeping your record private
directors, officers and shareholders don't have to live in Nevada
no minimum capital is required to incorporate
big Fortune 500 companies should incorporate in Delaware
they have a well-defined corporate law and specialized courts
but if you don't have several billion dollars in revenue, Nevada is better
you still have to pay taxes in your home state and qualify there
so you pay extra to Nevada for the following benefits:
1) no sharing of corporate information with the IRS
2) greater protection for officers and directors
3) flexibility in corporate management
4) flexibility in capitalization and corporate structuring
5) privacy
watch out for controlled group status, tricky area defined by the IRS
also be careful of "fraudulent conveyance" when encumbering assets
set up your asset protection early before there is any trouble
note: the Supreme Court said it's legal and proper to pay the minimum taxes
legal tax avoidance is encouraged, tax evasion is illegal
designate a resident agent who can receive any summons or complaints
this is important, otherwise you won't know if you're being sued
you can serve as your own resident agent if you live in the state
charging order applies to LLC and LP
the creditor can't get title to property, just the interest holders' distributions
phantom income - allocate profits on a K-1 but no money to pay tax on gains
this costs the creditor money during the period they are trying to collect
so instead, they often will settle for a fraction of the debt
some general rules:
1) segregate assets
2) keep the operating entities away from the asset-owning entities
3) the operating entity holds fewer assets, lease assets from the other entity
4) check with your accountant to avoid any controlled group status
it's important to follow "corporate formalities" to avoid personal liability:
1) annual filings - annual report and fee
2) minutes of meetings - keep records of these to prove you met annually
3) corporate notice - sign as an officer and notify the world with Inc. or LLC
4) separate bank account - required since the corporation has its own tax ID
5) separate tax returns - same thing, it's separate from your personal taxes
to maintain separateness, follow these rules:
1) never see corporate assets as your own, they aren't, you only own shares
2) never commingle corporate and personal assets or money
3) never divert corporate funds to noncorporate uses - intention doesn't matter
4) never sell corporate stock without board authorization - securities violation
5) never start out undercapitalized - it can pierce the corporate veil
6) never go a year without holding an annual meeting - you must have minutes
you can use templates for meeting minutes, it's not that complicated
the first meeting and organizational meeting are more detailed
but after that, the annual meeting minutes are pretty simple
do a trademark search before choosing a corporate name
other parties must aggressively enforce their trademark or they lose the rights
the annual rate of return on Social Security is only 2%
you can raise money by selling interest in your company
but you must provide "full disclosure" of the history, projections and risks
many states require a full merit review of private placement offerings
this can be very expensive and time consuming
Illinois is not on the list according to this book as of 2001
you can use a private placement memorandum to sell founders' shares
note there are limits to how many nonaccredited investors you can have
accredited investors can presumably afford to lose their investment
Regulation D defines an accredited investor as: (simplified examples)
1) a natural person with a net worth greater than $1 million
2) a natural person with an income greater then $200,000
3) a business entity with assets greater than $5 million
4) an entity in which all equity owners are accredited investors
some terms:
net tangible assets = total assets less total liabilities
market capitalization = amount to be raised under the initial public offering
public float = shares held by outsiders, not officers or directors
round lot shareholders = shareholders holding a block of 100 shares or more
market makers = independent dealers who regulate the market to avoid swings
corporate governance = requirement to disseminate information to the public
qualified professionals often want D&O (directors and officers liability insurance)
a buy-sell agreement lets you buyout other shares often at book value
this prevents spouses or former partners from claiming an unfair price
plan for the dissolution of the business at the beginning just in case
note: sometimes it's better to delay dissolving the business
it's providing limitation of liability, so wait until the statute of limitations runs out
there are some special cases to watch out for:
1) personal service company
the employee-owner provides service
the corporate tax rate is then a flat 35%, not the usual corporate rates
2) personal holding company
the company earns passive income that's not distributed to owners
it can be assessed with a 39.6% tax on top of the normal tax rate
3) accumulated earnings
earnings held within a C corporation for future operations or working capital
it might be taxed an extra 39.6% if the earnings aren't distributed to shareholders
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