Business Start Up And Organization Representation
Starting a business requires thorough planning and professional advice. Our firm assists business owners and entrepreneurs in the formation of legally sound business entities and helps them devise business strategies that drive and support their business goals. We advise on the business startup and formation process as well as issues related to selection of entity type and jurisdiction, including:
Subchapter C-Corporate Formation
Benefits Associated With A Subchapter-C Corporation
Up until recently, the most common form of corporate entity in the United States was a Subchapter-C Corporation. The most basic type of American corporation is governed under Subchapter C of the Internal Revenue Code so they are called or referred to as C Corporations.
There are a few important reasons for opting to create a C Corporation as opposed to other business structures that include some of the following advantages and/or considerations:
- The opportunity to use a medical reimbursement plan. Owners of a C Corporation can receive health coverage on a tax-free basis. The corporation can fully deduct its premiums. In contrast, an S Corporation’s shareholders must report the benefit as income and then deduct the premium from gross income on their personal returns- this is merely a wash.
- A C Corporation can also set up a medical reimbursement plan to pay a fixed amount of dollars for out-of-pocket medical costs for their employees. As long as the plan is non-discriminatory (i.e., it does not favor the owners), the reimbursements are not taxable to employees, while they are deductible by the corporation.
- The ability to raise equity capital or go public. If there is an intention of growing the business to such a level that it could attract financing to ultimately become a public company traded on a national exchange (such as the New York Stock Exchange), the business must be an C Corporation. Additionally, the Jumpstart Our Business Startups (JOBS) Act of 2012 allows the Securities & Exchange Commission (SEC) to revise its rules to enable businesses to raise equity capital through crowd funding. This means that small businesses may be able to raise capital from numerous small investors without having to comply with onerous registrations requirements. It is likely that only a C Corporation will be able to take advantage of these new unique equity funding platforms because an S Corporation is limited to and can have no more than 100 shareholders.
- Foreign investors. In a recent report released by the Small Business Administration, about two-thirds of immigrant-owned businesses reported that the most common source of startup capital was personal or family savings. In order to facilitate the use of foreign investments - for immigrant entrepreneurs or any other companies - a C Corporation would be the best entity of choice in this case. S Corporations, by definition, can not have any non-resident alien shareholders.
- The ability to use multiple classes of stock. Not all owners are created equal. Some may be entitled to a greater voice in the operations of the business, or have more of a say about certain strategic activities, such as a merger. In order to effectuate the distinctions among owners, it is not enough merely to have majority and minority owners. In a C Corporation, there can be different classes of stock to reflect the desire for only some shareholders to participate in the company business. This may be helpful to keep decision-making in one class of stock but enable participation in earnings with additional classes.
- Minimize employment taxes. Currently, self-employed individuals (including partners and LLC owners) pay self-employment tax to cover their Social Security and Medicare taxes obligations on all of their net earnings from self-employment. In contrast, shareholder-employees of S and C Corporations pay FICA (Social Security and Medicare) taxes only on wages they receive.
Drawbacks Associated With A Subchapter-C Corporation
There are also several reasons that argue against using a Subchapter-C Corporation if your business has the option to form under a different legal structure. These would include the following:
- The potential for “double taxation.” The chief drawback of a C Corporation is the so-called “double taxation” potential. Profits are first taxed to the corporation at various corporate rates ranging from 15% to 25% and then when they are distributed to shareholders in the form of dividends, they are taxed again. A C Corporation cannot deduct dividend distributions.
- The requirement to file more paperwork. Subchapter S corporations are required to hold formal board and shareholder meetings and keep accurate minutes of these meetings. In addition, there are a series of tax forms that may need to be filed with federal, state, and even local officials, including corporate taxes (IRS Form 1120), taxes on salaries and other employee compensation (W-2s) and profit distributions to shareholders (Form 1099-DIV).
- Filing a corporate tax form may require an accountant. The tax forms for a corporation can be complicated and may require the assistance of an accountant. In addition, corporations have to pay federal taxes by March 15-a full month before the individual federal tax deadline.
- A need for written by-laws and shareholders agreements. To operate a Subchapter-S corporation, there must be by-laws and other written guidance as dictated by the law in Georgia and by basic sound business practices. By-laws are the governing rules for the corporation. By-laws stay in existence as long as the corporation does and are usually amended from time to time to address issues in the growth of the corporation. It may be also necessary and advisable to have a shareholders agreement that governs the rights of shareholders in the corporation. For example, what happens when one shareholder wants to sell his shares, retire, or dies inadvertently? How are those shares accounted for, valued and acquired by other shareholders of the corporation? These are just common examples that would be governed by a shareholder agreement including which shares are entitled to voting rights and which shares are not.
Subchapter S-Corporate Formation
Benefits Of A Subchapter-S Corporation.
An S Corporation is a corporation that is treated, for federal tax purposes, as a pass-through entity through an election made with the Internal Revenue Service (IRS) to be considered an S Corporation. As a corporation, an S Corporation is c reated through filing Articles of Incorporation with the Secretary of State in Georgia. It issues stock and its shareholders are protected from personal liability just like a Subchapter-C Corporation. An S Corporation shareholder’s personal assets, such as bank accounts, cannot be seized to satisfy business liabilities. However, like a sole proprietorship or LLC, an S Corporation passes through most of its income and loss items to the shareholders. Each shareholder is subject to his or her own individual tax rate on the income (or losses) passed through to him or her.
The advantages of an S Corporation often outweigh any perceived disadvantages. The S Corporation structure can be especially beneficial when it comes time to transfer ownership or discontinue the business. These advantages are typically unavailable to sole proprietorships and general partnerships. S Corporation advantages include the following:
- Protected assets. An S Corporation protects the personal assets of its shareholders. Absent expressed personal guarantee, a shareholder is not personally responsible for the business debts and liabilities of the corporation. Creditors cannot pursue the personal assets (house, bank accounts, etc.) of the shareholders to pay business debts.
- Pass-through taxation. An S Corporation does not pay federal taxes at the corporate level. Any business income or losses is “passed through” to shareholders to report on their personal income tax returns. This means that business losses can offset other income on the shareholder’s tax returns. This can be extremely helpful in the startup phase of a new business.
- Tax-favorable characterization income. S Corporation shareholders can be employees of the business and draw salaries as employees. They can also receive dividends from the corporation, as well as other distributions that are tax-free to the extent of their investment in the corporation. A reasonable characterization of a distribution as salary or dividends can help the owner-operator reduce self-employment tax liability, while still generating business-expense an wages-as paid deductions for the corporation.
- Straightforward transfer of ownership. Interest in an S Corporation can be freely transferred without triggering adverse tax consequences. The S Corporation does not need to make adjustments to property bases or comply with complicated accounting rules when an ownership interest is transferred.
- Heightened credibility. Operating as an S Corporation may help a new business establish credibility with potential customers, employees, vendors and partners because they see the owners have made a formal commitment to their business.
Drawbacks Associated with a Subchapter-S Corporation.
An S Corporation may have some potential disadvantages including:
- Formation and ongoing expenses. To operate as an S Corporation, it is necessary to file Articles of Incorporation with the Secretary of State in Georgia, obtain a registered agent for service of process and pay all appropriate advertising and filing related fees. In Georgia, there are also annual registration fees that must be paid to the Secretary of State in order to maintain the corporation status. (April 1 of each calendar year) Although these fees usually are not expensive and can be deducted as a cost of doing business, there are certainly some upfront startup expenses.
- Tax qualification obligations. Mistakes regarding the various election, consent, notification, stock ownership and filing requirements can accidentally result in the termination of an S Corporation status. Although this is usually very rare and can be easily remedied, it is still an issue that is not a factor with other business entities.
- Stock ownership restrictions. An S Corporation can only have one class of stock, although it can have both voting and non-voting shares. Therefore, there can not be different classes of investors who are entitled to different dividends or distribution rights. Also, there cannot be more than 100 shareholders. Foreign ownership is prohibited, as is ownership by certain type of trusts and other entities.
- Closer IRS scrutiny. Because amounts distributed to a shareholder can be dividends or salary, the IRS scrutinizes payments to make sure the characterization conforms to reality. As a result, wages may be re-characterized as dividends, costing the corporation a lost deduction for compensation paid. Conversely, dividends may be re-characterized as wages, which subjects the corporation to employment tax liability.
- Less flexibility in allocating income and loss. Because of the one-class-of-stock restriction, an S Corporation cannot easily allocate loss or income to specific shareholders. Allocation of income and loss is governed by stock ownership, unlike a partnership or LLC where the allocation can be set up in the Operating Agreement. Also, the necessary accumulated capital accounts can be cumbersome to maintain, requiring input from an accounting professional.
Benefits Of An LLC.
The benefits of creating an LLC typically outweigh any perceived disadvantages and are typically not available in sole proprietorships or general partnerships.:
- Protected assets. LLCs provide limited liability protection to their owners (members) who are typically not personally responsible for the business debts and liabilities of the LLC. Creditors cannot pursue the personal assets (house, savings accounts, etc.) of the owners to pay business debts.
- Pass-through taxation. LLCs typically do not pay taxes at the business level. Any business income or loss is “pass-through” to owners and reported on their personal income tax returns. Any tax due is paid at the individual level.
- Heightened credibility. Forming an LLC may help a new business establish credibility with potential customers, employees, vendors and partners because they see you have made a formal commitment to your business.
- Flexible management structure. LLCs are free to establish any organizational structure agreed upon by the company owners. LLCs can be managed by the owners (members) or by managers, unlike corporations which have a board of directors who oversee the major business decisions of the company and officers who manage the day-to-day affairs.
- Few restrictions. There are few restrictions on who can be an LLC owner or how many owners an LLC can have unlike an S Corporation.
Drawbacks Associated with an LLC.
- Formation and ongoing expenses. To form an LLC, Articles of Organization must be filed with the Secretary of State for Georgia and all appropriate filing fees must be paid. Additionally, there are ongoing fees on a yearly bases in order to maintain the status of the LLC with the Secretary of State.
- Transferrable ownership. Ownership in an LLC is often hard to transfer than with a corporation. With corporations, shares of stock can be sold to increase ownership. Typically with LLCs, all owners must approve adding new owners or altering the ownership pursuant to existing owners.
We also advise on and draft shareholder agreements, by-laws, membership agreements and partnership agreements as part of the entity formation process.