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A. A limited liability company (LLC) is like an S corporation. Generally, business owners form an LLC rather than an S corporation if one or more of the following situations apply:

  • ANY owner of the company is another business entity or non-resident alien (a person is a nonresident alien if he or she is neither a resident nor a citizen of the United States).
  • The company will be owned by more than 75 persons.
  • The company plans to issue more than one CLASS of stock (for example, special allocations of
  • profits and losses will be made that are not proportionate to the equity percentage of each owner.)
  • The owners desire to use business debt (money borrowed by the (company) to increase their tax basis.
  • The state where your business is located imposes an entity level income tax on the profits of an S corporation and does not impose such a tax on the profits of an LLC.

If these situations do not apply to you, than an S corporation should do the job. Generally, the LLC is treated like a partnership for tax purposes and there is no entity level tax. Under the recently approved IRS check-the-box regulations, an LLC will be taxed like a partnership unless the members elect to have the LLC taxed like a C corporation (association). Prior to the check-the-box system, to be taxed like a partnership, an LLC could have no more then two of the following four characteristics of a corporation:

  • Limited Liability;
  • Centralized Management;
  • Continuity of Life;
  • Free Transferability of Ownership Interests.

Most LLC’s have only the first two characteristics.

Formation of an S corporation or an LLC can offer many benefits including limited liability and tax savings. An LLC also provides liability protection like a corporation.

A. Some start-up companies benefit by starting out as an S corporation, while others remain as C corporations because the owners desire to deduct 100% of medical expenses, the corporation fails to qualify for S corporation status, or the shareholders desire to have the opportunity to exclude from gross income 50% of the gain from the sale of “qualified small business stock” (explained below). Generally, a corporation fails to qualify for S corporation status if one or more of the following situations apply:

  • ANY owner of the company is another business entity or a nonresident alien (a person is a nonresident alien if he or she is neither a resident nor a citizen of the United States).
  • The company will be owned by more than 75 persons.
  • The company plans to issue more than one CLASS of stock (for example, special allocations of profits and losses will be made that are not proportionate to the equity percentage of each owner).

If the above situations do not apply to you, than the corporation may apply for the S corporation status by timely filing IRS Form 2553. The law requires submission of form 2553 for the S election within 75 days after the corporation first has assets, shareholders or starts doing business. If you miss the deadline, you may file Form 2553 within 75 days after January 1, but there might be tax consequences. If a corporation fails to qualify for S corporation status, than the corporation must be a C corporation. With a C corporation, 100% of the medical expenses incurred by you (as a shareholder and employee), your spouse and your children are tax deductible. In a sole proprietorship, only 45% of such medical expenses are tax deductible for the 1998 tax year.

In 1993, Section 1202 of the Internal Revenue Code was enacted to provide a 50% exclusion of any capital gain from the sale of “qualified small business stock.” For shares to qualify for the exclusion, several tests must be met. For instance:

  • Shares must be purchased directly from a C corporation and the shares must be held for at least five years (shares do not qualify if purchased in any later trading market).
  • A “qualified small business” must have not more than $50 million in assets at all times before and immediately after the issuance of stock.
  • At least 80% of the corporation’s assets must be used in the “active conduct of one or more qualified
  • trades or businesses” throughout the holding period.

There are also limitations on the persons who may use the exclusion. You should consult your own tax advisor as to the availability of the capital gains tax exclusion.

A. With an S corporation, the distribution of S corporation profits is exempt from the 15.3% social security/Medicare tax that is imposed on wages. The shareholder of an S corporation saves about $1,530 for every $10,000 profit distribution ($10,000 x 15.3% = $1,530) because the entire profit distribution is exempt from the social security/Medicare tax. The tax savings strategy is commonly called “wage reduction.” Remember to pay a reasonable wage if you implement the wage reduction strategy. By contrast, in a sole proprietorship, all self-employment income is subject to the 15.3% social security/Medicare tax (called self-employment tax in the context of a sole proprietorship). If you are the sole owner of a business that has not incorporated, your business is considered a sole proprietorship. The 15.3% security/medical tax is comprised of a 12.4% social security tax and a 2.9% Medicare tax. Wages higher than $76,200 are exempt from the 12.4% social security portion of the tax.

Note, however, that the 2.9% Medicare portion of the tax is applied to all wages (and self-employment income), without an upper limit. In addition to the tax savings benefit explained above, there are liability protection reasons for choosing to run your business as an S corporation. With an S corporation, your liability is limited to the money you invest in your business. With a sole proprietorship, you have unlimited personal responsibility and all of your personal assets are subject to the rights of creditors to seize or place a lien against your personal assets and treat the S corporation like a C corporation:

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A. Depending on the business marketing strategy, a business may need to use a “doing business as” name, also known as a “d/b/a” or a “fictitious business name.”

For instance, a sole proprietor runs the business alone and the business’s legal name will be the sole proprietor’s full name. But the sole proprietor may market the business as AA Appliances. In that case, the business’s legal name is different than the name under which it operates and is known by customers. The sole proprietor is using a “doing business as” name. A “doing business as” or “d/b/a” name is also known as a “fictitious business name.” Most states require that businesses register fictitious business names or d/b/a names.

Using a “doing business as” name is common practice for businesses. The d/b/a name will usually be the cornerstone for marketing efforts, and will work much more effectively than the business’s name. Some business entities may be barred from using a d/b/a name in some states, however. This usually involves professional business entities that must be known by the names of their owners. In most other cases, using a “doing business as” name or “fictitious business name” is permissible, as long as it is registered with the state.

A. For companies that rely heavily on equipment to produce their products or services, deciding whether to buy or lease equipment can be a critical aspect of the business plan. Even for businesses that rely more heavily on retail or other business models, financing equipment to start the business can be expensive. This issue should definitely be resolved before owners approach investors and others for financing.

Buying equipment guarantees ownership over important resources for the business for the long term. But purchasing equipment outright can be very expensive. And especially in fields where equipment and technology rapidly become obsolete, it can be cost-prohibitive to maintain the newest and most advanced equipment. Thus, business owners who decide to buy equipment must also face the fact that the equipment will depreciate over time.

Leasing equipment, on the other hand, offers more flexibility for updating outdated equipment and may be cheaper in the short term. The downside to leasing is that over time, the costs of leasing may outweigh the costs of owning the equipment outright. Each business owner must consider the needs of the business and the amount of money that will be invested before deciding whether to lease or buy.

A. Many family businesses struggle with the question of transferring ownership or control of the business to children. The Small Business Administration (SBA) estimates that only a third of all businesses are successfully transferred from one family member to another. But the SBA also estimates that family businesses make up almost 90 percent of all business in the United States and pay a large portion of American wages, so their contributions add a lot to the American pocketbook.

Family businesses face at least four hurdles to successful transfer of control of the business: lack of planning, unwillingness on the part of the owner to transfer control, unwillingness on the part of the child to manage the business and dwindling prospects for the business. Unless these hurdles can be overcome, the odds are against successful transfer of control within the family.

Experts advise that for an owner to successfully transfer a business to children or other family members, the owner must carefully consider the following: strategic planning for the business, knowledge of the family and its members’ strengths and weaknesses, choosing a successor and willingness to make succession work. Through careful succession planning, a business owner can successfully transfer control and ownership to the next generation. An experienced business attorney can assist a business owner desiring to transfer the business to the next generation.

A. Many entrepreneurs are faced with a dilemma when trying to start up their businesses; how can they obtain the capital they need to begin? In many cases, entrepreneurs are not able to convince banks and lenders to loan money for an untested business idea. Business owners may approach investors for capital, but the investors may show little interest or offer outrageous terms for the capital. Business owners can use their own money to finance their ideas, but for those with limited savings, this can prove a problem. Therefore, an entrepreneur may choose to bankroll business expenses with credit cards. Obviously, this method of financing comes with great risks. Many credit cards offer less favorable terms than a traditional bank loan. Credit card companies can demand double-digit interest rates and may freeze credit with little notice to the credit card holder.

Financing start-up expenses through credit cards can offer some advantages. Disciplined business owners who pay off their balances each month can take advantage of a credit card’s easy use and can earn interest on their own money before they pay their balances. But because of the financial risks with credit cards, entrepreneurs may want to exhaust all other avenues for financing including friends, family or small business loans before resorting to financing their businesses on credit.

A. Many employers use independent contractors to carry out essential aspects of their businesses. Many independent contractors enjoy the freedom of self-employment as they perform freelance work for various companies. But who is considered an independent contractor and what implications does that have?

The term “independent contractor” has its primary implications in the tax arena. An independent contractor works for a business and performs distinct tasks for the employer. An independent contractor could be a writer in a marketing company who writes for certain projects as the need arises. An independent contractor is generally not guaranteed work but may be tapped for certain jobs on an “as-needed” basis.

The Internal Revenue Service’s rule for determining who is an independent contractor is that the employer has control over the end result, but the independent contractor has control over how the work will be completed. In all cases, the IRS has the final say on whether a worker is an independent contractor.

A. Many entrepreneurs balk at the idea of drawing up a business plan, preferring to get elbow-deep in their businesses rather than consider the potential and risks of their ideas. But many, if not most, businesses would benefit from the serious consideration and planning that are required to draft a business plan. Besides this advanced planning, businesses also gain a valuable tool to present to lenders, investors and interested third parties to obtain financing or other backing.

A business plan is a formal document that includes information on the business’s products or services, the financials, a marketing analysis, the business owners and management and any funding requests, along with other information that interested parties may find helpful. Because of its comprehensive details on the business and its products or services, the business owner will want to control access to the plan.

Drafting a business plan takes time and effort, but business owners can optimize business potential by carefully considering the elements of the business plan. As the business grows, the business plan can serve as a reference for professional contacts and a future road map for growth and development. An experienced business attorney can assist a business owner to draft a formal business plan.

A. Depending on the nature of the business entity, a business may need several types of insurance to guarantee coverage in the event of a claim. A business may need contents insurance to cover inventory and supplies. Second, general liability insurance may be necessary to cover accidents that occur on the property. Business owners may also want to obtain coverage on motor vehicles used for business purposes.

Besides insurance for the business itself, a business owner may want to obtain insurance for the business’s products and actions. If the business performs repairs or services, completed operations insurance may be necessary to cover occurrences when a customer claims injury or damages after using something that was fixed by the business. To cover claims arising from the business’s products, the business owner will want product liability insurance for injuries or damages stemming from product malfunction. For professional services, such as a law firm or medical practice group, professional liability insurance may be necessary to cover damages.

For business owners running their businesses from their homes, it is especially important to obtain insurance on the business. In fact, business activities in the home may even void a homeowner’s policy, so home-business owners should consult with their insurer about their insurance coverage. Home-business owners may be able to obtain a rider for a homeowner’s policy, a new in-home business insurance policy or a Business Owner’s Package (BOP) policy.

Peter Bronstein

Call Now For A Personalized Case Evaluation
(310) 203-2249

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