Business Planning FAQs
Q. I am starting my own business. When should I create a separate business entity?
A.
1. Creating a separate entity is important for protection from personal liability when you hire employees, for example, or if you are in a business that is subject to strict liability (meaning that negligence or your part does not have to be proven), such as businesses involving certain hazardous materials.
2. Small business owners may create a separate entity for estate planning purposes to facilitate transfer of ownership shares to others.
3. Many businesses benefit from the tax advantages that a separate entity may offer.
4. Where ownership is shared among two or more partners, the law imposes various partnership rules that do not necessarily accommodate the needs and expectations of its co-owners and investors; these rules can be modified by a well-written partnership agreement.
5. See below for more information about partnership agreements.
Q. Which protects me better from personal liability: forming a corporation or forming an LLC?
A. Both of these legal entities effectively protect business owners from personal liability for business debt as long as the owners consistently treat their new business entity as separate from themselves. For example:
1. You should sign agreements in your capacity as officer or manager with your title and the name of the business indicated.
2. The entity should maintain its own separate bank accounts and accurate financial records.
3. The entity should have a separate address, phone line, and email address apart from those of the business owner.
4. You should endeavor to build a credit history separate from the business owner so that, in time, the business may be able to borrow money based on its own credit reputation rather than the owner’s.
5. See below for more information regarding corporations and LLCs.
Q. How do I choose between a corporation and LLC?
A.
1. Both these business forms offer protection from personal liability. The principal differences between them are in their tax treatment and management structure.
2. Federal tax law allows owners of an LLC to elect tax treatment as that of a partnership, where net profits ”pass through” to the individual owners and are not taxable to the business entity.
3. Net profits to the corporation, however, are first taxable to the corporation and then taxable again to owners when received by them in the form of dividends. (This “double taxation of corporate profits can be avoided, however, by election of Subchapter “S” status, which also allows “pass through” treatment similar to partnerships.) See the question below for more information on Subchapter “S” corporations.
4. The management structure of an LLC involves far fewer statutory formalities than a corporation and, consequently, creates less risk for non-compliance.
5. LLCs offer considerable management flexibility, allowing the managers to operate as a partnership or to hire a manager to run the business for them.
6. Corporate structure separates the ownership function (shareholders) from general management function (directors) and day-to-day operations (officers), which adds complexity to every major corporate decision.
7. The corporate structure has some advantages that an LLC does not; for example, a corporation can offer incentive stock options for employees.
8. A corporation ensures perpetuity of the separate business entity regardless of changes in ownership and, therefore, easier sale or transfer of the business.
Q. What is the difference between a “C” corporation and an “S” corporation?
A.
1. Under federal tax law, a traditional “C” Corporation pays income tax on corporate profits; when those same profits are distributed to shareholders in the form of a dividend, the shareholder pays individual income tax on the dividend received. Moreover, the dividend is not a deductible expense to the corporation. (Do not confuse dividends with corporate salaries, however. Salary and employee benefits are corporate expenses not taxable to the corporation; they are taxed only once, as taxable income to the employee.)
2. Electing “S” Corporation status, on the other hand, allows shareholders to report corporate profits and losses on their individual income tax return almost as if the corporation were a partnership. Therefore, business profits are taxed only once. Shareholders with significant income from other sources can reduce their tax liability by reporting corporate losses on their individual tax return.
3. One disadvantage to an “S” Corporation is that a shareholder pays taxes as profits are earned, rather than when the money is actually received, which can create an extra tax burden for the shareholder. Another is that eligibility for “S” Corporation status creates various restrictions on the corporation, such as allowing only one class of stock.
Q.I am starting a business with a friend. What kind of agreement do we need?
A.
1. If you do not chose an independent entity such as a corporation or LLC, business partners need a written partnership agreement addressing such issues as:
a. Each partner’s proportionate contribution to the business;
b. Each partner’s share of profits, losses, capital gains, or other business revenue (which each reports on his or her individual tax return);
c. Whether each will have an equal voice in management decisions or whether a limited partner may be involved;
d. How to resolve management disagreements between managing partners;
e. Distribution of assets or losses if the business fails;
f. Perhaps most importantly, what occurs when the partnership entity is dissolved by the death or departure of one of its managing partners.
2. A Buy and Sell Agreement, often funded by insurance, is commonly used to address the latter concern, ensuring that remaining partners can continue the business without interruption
Q. I am selling or buying a business. What pitfalls should I be aware of?
A.
1. Due diligence is the process by which a potential buyer of a business finds out as much as possible about that business prior to closing the deal.
2. The seller must give the buyer access to a wide range of information and is obligated to disclose known business problems (ideally presented along with possible solutions).
3. The buyer must have access to virtually all records and documents, and have opportunities to question employees and to conduct on-site observations or inspections.
4. The seller must have assurance of confidentiality in this process and certainty that the new owner can pay existing business debts.
5. Other factors often include: negotiating an installment sale, developing a non-compete agreement, and perhaps hiring the seller as an employee or consultant to the buyer after the sale.
At Lotter & Associates- our main goal is to assit, counsel and represent our clients in the best way possible. Contact the professionals at Lotter & Associatestoday.
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