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Archive for the 'Incorporation Advice' Category
Think Twice Before Dissolving
February 2nd, 2009
By The XBanker
In times of uncertainty many owners of corporations and LLCs may consider folding up their operations. CPAs and other advisors may suggest dissolving these entities to save on fees and to be done with it all.
But hold on: The “easy” route of dissolution can have significant negative consequences.
In California, for example, shareholders can be held personally liable for corporate obligations arising before or after a dissolution. The rule is found in California Corporations Code §2011. The same rule exists for LLC members pursuant to California Corporations Code §17355.
The deadline for suing corporate shareholders or LLC members in California is either; 1) the applicable statute of limitations period or, 2) four years after the entity’s dissolution, whichever is earlier. Since many statutes of limitations in a business context can be four to six years in length, you may have four years of worries until you are safe from litigation. And don’t think that because you have a Nevada or Wyoming entity qualified to do business in California you are in the clear. California courts are notorious for applying “their” law to out of state entities doing business in California.
So what is the solution?
Do not dissolve your entity. Keep it alive until the statute of limitations period has run.
Here is an example of why it makes sense to keep your entity alive.
Joe owns Merced Consulting, Inc., a Nevada corporation qualified to do business in California. With a downturn in the economy Joe’s consulting business has suffered. His CPA suggests dissolving the corporation and eliminating the expense of an extra tax return. The CPA says his other consulting client Mary has just dissolved her entity.
But what happens in a downturn? People start to file claims over old business disputes, whether real or imagined. In good times when the money is coming in, grievances may be overlooked. In tougher times people will sue. And with business contract statutes of limitations typically being six long years, plenty of Joe’s clients may be looking for a new pocket to dip into to help pay for their current troubles.
In fact, Joe had provided Tom with project development help on a condo complex. Joe’s projections were based on the real estate market as it existed in 2006. The picture is quite different today, and Tom is suffering for it. Tom hires an attorney to sue Joe, Mary and two other consultants for their “bad” advice.
What are the consequences?
Mary, who dissolved her entity and received a distribution of corporate assets, is now personally liable for Tom’s claim.
Joe, who listened to his attorney and did not dissolve, is still protected by his corporation. While the entity does not hold a lot of assets, if Tom gets a judgment against Joe’s corporation he only gets what is inside the entity. Not much. And Joe’s personal assets are protected from the claim.
Dissolving gives a plaintiff a hopeful shot at your personal assets. Keeping your entity alive until the statute of limitations periods have run discourages plaintiffs from even filing in the first place.
Be careful in heeding the siren call of reduced filing fees and fewer tax returns by dissolving. In our current environment asset protection is more important than ever, and can only be achieved by keeping and maintaining your protective entities in place.
Regards,
Garret Sutton
www.corporatedirect.com
Garrett Sutton, Esq. is a corporate attorney and is the author of “Own Your Own Corporation” and other titles in the Rich Dad Advisor series. His firm forms and maintains corporations, LLCs and other entities and may be reached at http://www.corporatedirect.com.
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Choosing the Wrong Corporate Entity
June 11th, 2008
By The XBanker
Corporate entities come in three categories: the good, the bad, and the ugly. But even among the good, one size does not fit all. Choosing the wrong corporate entity can cost you time, money, and your personal assets.
The “bad” entity is the Sole Proprietorship, where the owner is personally liable for all claims against the business. If the business gets sued, as owner, you could lose more than just the company; you could lose your car, your house, everything. Though the paperwork required for a Sole Proprietorship is minimal and it is the cheapest entity to form, it is almost never worth the risk in today’s litigious society.
The “ugly” entity is the General Partnership, where each partner is responsible for the actions of the other. Any partner can obligate the partnership, even if one (or more) partner(s) protests a decision. And, as with a Sole Proprietorship, personal assets may be on the line. It is also important to understand that General Partnerships can be innocently formed. There is no filing requirement. A handshake or simple business arrangement – anytime you are sharing profits and splitting losses – could be seen by the courts as a General Partnership, regardless of the intent of the parties involved. Remember, with a General Partnership you have liabilities times two. You are responsible for your own mistakes as well as your partners’ mistakes. Not a good way to do business.
The “good” entities are the C Corporation, the S Corporation, the Limited Partnership (”LP”), and the Limited Liability Company (”LLC”). A corporation, LLC or LP is a separate legal entity with its own name, business purpose, and tax identity with the IRS. The corporation is responsible for the actions of the corporation, not individual owners or shareholders. As an owner or shareholder, your personal assets are protected. You are only liable for the money you put in to start the company, thus each corporation offers limited liability.
Simply filing as a corporation is not enough to protect personal assets, however. Certain corporate formalities must be followed (the same applies for LLCs and LPs) or a creditor will be able to claim that the business is a corporation in name only. In this case, the corporate veil may be pierced and personal assets claimed.
Choosing a corporate entity is a detailed, complicated process. Work with your XBanker account representative to properly set it all up. They will make sure you choose the right entity, thus avoiding a big mistake many business owners make.
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Lack of Corporate Documentation
June 4th, 2008
By The XBanker
All corporations have paperwork that must be completed and kept on file to prove the business and its owners are acting as a corporation rather than an individual. Incorporating a small business like C Corporations, S Corporations, Limited Liability Companies and Limited Partnerships all must have paperwork substantiating their existence as limited liability entities. No matter which entity you choose, you will need, at minimum, articles of incorporation or organization. But you may also need meeting minutes, a resident agent, a Federal Identification Number, and initial organizational filings.
In order for a corporation to remain legally and financially separate from its owner (which is the most likely reason you incorporated to begin with), you must have the paperwork that makes your corporation real and proves its existence. And you must file the appropriate paperwork with the appropriate parties (such as governmental agencies and regulators).
However, no matter how carefully you set up your initial corporate documents, no matter how perfect and thorough they are, you aren’t done. There are a variety of filings, records and documents due every year. Forget to file the right papers with the right people at the right time and your company is no longer independent. Paper is all that protects you and your assets from lawsuits. But the paper, done right and right on time, can be like corporate Kevlar.
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C Corporation Considerations
May 21st, 2008
By The XBanker
A C Corp has the widest range of deductions and expenses allowed by the IRS, especially in the area of employee fringe benefits. A C Corp can set up medical reimbursement and other employee benefits, and deduct the costs of running these programs, including all premiums paid. The employees, including you as the owner/shareholder, will also not pay taxes on the value of those benefits. This is not the case in a flow-through entity, such as an S Corp, LLC or LP. In each of those cases the entity may write off the costs of the benefits, but any employee/shareholder who owns more than 2% of the entity will pay taxes on the value of their benefits received. So, if having the maximum deductions and all of the employee fringe benefits on a tax-free basis is important to you, a C Corp may be your entity choice.
C corporations are great for a business that sells products, has a storefront and employees, and may or may not have a warehouse where it keeps its inventory. C Corps don’t work well with businesses that want to hold appreciating assets, such as real estate, because of the tax treatment on the sale of these assets.
The most often-cited disadvantage of using a C Corp is the “double-taxation” issue. Double-taxation happens when a C Corp has a profit left over at the end of the year and wants to distribute it to the shareholders as a dividend. The C Corp has already paid taxes on that profit, but once it distributes the profit to its shareholders, those shareholders will have to declare the dividends they receive as income on their personal tax returns, and pay taxes again, at their own personal rates.
There are many things you can do to avoid the double-taxation scenario. Structure the C Corp so that there are no profits left over — use all of the write-offs and deductions allowed by the IRS to reduce the C Corp’s net income. Offer great benefit plans! Pay higher salaries to yourself and the other owner/employees than you would if you were using a flow-through entity such as an S Corp. Yes, you will have to pay payroll taxes and personal income taxes on those monies, but you would pay personal taxes on dividends paid to you anyway. And it may be that in the big picture, the savings on one side outweigh the additional taxes paid on the other side.
The decision as to what entity is best for you really does, in so many cases, hinge on taxes, and that is why, with any corporate-related decision, you are wise to seek the advice and assistance of a good CPA.
Some quick things to note on C Corps:
- They can have an unlimited amount of shareholders, from anywhere in the world.
- For Nevada and Wyoming corporations, officers and directors can reside anywhere in the world;
- They can have several different classes of shares.
- They are the most widely recognized business entity in the world, and are the premier entity for going public.
In Nevada and Wyoming, nominee, or stand-in, officers and directors can be utilized, adding extra levels of privacy.
While we like and often use S Corporations, we keenly appreciate that C Corporations have their merit and place in your entity structure strategy.
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The Downside to the S Corporation
May 14th, 2008
By The XBanker
A downside to S Corps is the limitation on who can be a shareholder, and what kind of shares it can issue. There can be no more than 100 shareholders in total, and no one may take their shares in anything other than their personal names (or in their living trust’s name). So, forget transferring your S Corp shares into an irrevocable trust, limited partnership or children’s trust. And, you can’t have any non-U.S. resident shareholders, either. Everyone who holds shares in an S Corp must file a U.S. resident tax return. And, you can only have one class of shares, which can be confining, especially if your plans include taking your company public or looking for outside investors. If you breach any of these requirements the IRS will strip your company of its S Corp status, and automatically turn it into a C Corporation, which may have a negative tax consequence.
Another downside is asset treatment. Both C and S Corps are not great vehicles if your business will hold appreciating assets, such as land, buildings, stocks, bonds, etc. The tax on them upon sale or upon distribution will be much greater if held in a corporation than if held in a limited liability company or a limited partnership. This is further explained in the book How to Use Limited Liability Companies & Limited Partnerships, written by Garrett Sutton and available at www.successdna.com.
The steps to create a C or S corporation are the same. Articles of Incorporation are prepared and filed, Bylaws are prepared, directors are elected by the shareholders, officers are elected by the directors, and shares are issued to the shareholders. This may sound difficult but we will be there to guide you through it all.
The S Corp Declaration, the IRS Form 2553, should be filed within 75 days of the incorporation date, so don’t delay if this is how you see your company proceeding. If you don’t file within that 75 day period, the IRS can deny you S Corp status for a full year, meaning that your first year of operations will be conducted at C Corporation tax rates.
The shareholders, directors and officers of the company must remember to follow corporate formalities. They must treat the corporation as a separate and independent legal entity, which includes holding regularly scheduled meetings, conducting banking through a separate corporate bank account, filing a separate corporate tax return, signing all documents related to the business in their official capacity and filing corporate papers with the state on a timely basis. If these steps are not followed, a business creditor may be allowed to “pierce the corporate veil” and seek personal liability against the officers, directors and shareholders. Adhering to corporate formalities is not at all difficult or particularly time consuming. In fact, if you have our affiliate handle the corporate filings and preparation of annual minutes and direct your accountant to prepare the corporate tax return, you should spend no extra time at it with only a very slight increase in cost. The point is that if you spend the extra money to form a corporation in order to gain limited liability it makes sense to spend the extra, and minimal, time and money to insure that protection.
And remember, while there are some downsides to the S corporation there are some significant benefits as well. Work with your advisor to see if the S corporation is right for you.
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Appreciating the S Corporation
May 6th, 2008
By The XBanker
The Subchapter S Corporation (or S Corp) is structurally the same as a C corporation (i.e., it has officers, directors and shareholders), but with one key difference. An S Corp files an election with the IRS, called a Form 2553, that provides it with a flow-through tax structure as found in entities such as partnerships and limited liability companies. That means, the company’s income (and corresponding expenses, write-offs and deductions) will flow through to its shareholders, and be split among them according to each shareholder’s ownership percentage. The S Corp’s taxes will actually be paid by its shareholders, at their individual tax rates, and in proportion to their individual ownership percentages.
From a taxation standpoint, an S Corp is a great fit for a company that offers a service, because in many cases the revenues can be split and paid to the shareholders in two categories: salary and distribution (or profits) earnings. A flow-through tax structure means that the profits and corresponding losses, deductions and expenses are divided up among the shareholders, in proportion to their ownership percentages, and reported on each shareholder’s personal income tax return. Therefore, if your income from an S Corp is split into two streams, salary and profits, each stream will be taxed differently. Your salary stream will be subject to both income tax and payroll taxes which amount to a whopping 15.3% for Social Security and Medicare. However, the profit income stream will be subject only to income tax. So, by taking a reasonable salary from the S Corp and the rest in profits your taxes will be lower than if you were take your entire share of the earnings as salary. By allowing a percentage to flow through to you as profits you can save thousands of dollars a year in payroll taxes which, as we all know, we will never see the benefit from since Social Security is broken and bankrupt.An S Corp is also a great entity for businesses with low start-up costs that do not have to purchase a significant amount of assets to begin operations. For example, buying a working laundromat would be an excellent choice for an S Corp. You are purchasing a turnkey business – it’s already operating, and you aren’t going to be laying out significant cash to get it up and running. So, you will have a pretty good income stream immediately, and that income stream can best be disbursed to you and your partners, if any, through the S Corp structure. Two other great matches for an S Corp are network-marketing and Internet-only businesses. In each case, the business is likely to have no storefront, low operating costs, and probably doesn’t maintain a warehouse. Most network marketing and Internet-only businesses drop-ship from their suppliers directly to the end consumer when they are delivering products at all. Again, as these can be high-income, low cost operations, they work great in the S Corp structure.
Here’s another reason we suggest S Corps for many service-oriented businesses: To avoid being characterized as a Personal Service Corporation, or “PSC” by the IRS. PSCs are C corporations that are classified by the IRS as providing a service, such as consulting, to the general public. Now, as you may know, the United States government, in an effort to boost the economy and keep business working, assesses C corporations with a pretty low initial rate – 15% on earnings up to $50,000. That’s quite a bit lower than you would pay personally, if you were receiving that same $50,000 as salary. And that 15% rate is also lower than you would pay if your business was an S Corp. So, to head off the anticipated revenue drain, the IRS closed that loophole by designating C corporations that provide services to be PSCs. The additional tax rate for PSC earnings can be a flat 35% or the regular C Corporate rate plus 15% of the corporation’s undistributed personal holding company income. That may be higher than you would pay through your S Corp, if you took a reasonable salary and the rest as profit income. And, it’s enough, in many cases, to make the difference between choosing an S Corp and C Corp. Next week we’ll look at one significant downside to the S Corporation.
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The Nevada Law on Corporate Privacy
April 16th, 2008
By The XBanker
Many promoters will tout the complete privacy offered by Nevada corporations and LLCs. But what they won’t tell you is that the law has changed and privacy has been somewhat compromised.Here is the law for corporations:
- In addition to any records required to be kept at the registered office pursuant to NRS 78.105, a corporation that is not a publically traded corporation shall maintain at its registered office or principle place of business in this state:
- A current list of its owners of record; or
- A statement indicating where such a list is maintained.
- The corporation shall:
- Provide the Secretary of State with the name and contact information of the custodian of the list described in subsection 1. The information required pursuant to this paragraph shall be kept confidential by the Secretary of State.
- Provide written notice to the Secretary of State within 10 days after any change in the information contained in the list described in subsection 1.
- Upon the request of any law enforcement agency in the course of a criminal investigation, the Secretary of State may require a corporation to:
- Submit to the Secretary of State, within 3 business days, a copy of the list required to be maintained pursuant to subsection 1; or
- Answer any interrogatory submitted by the Secretary of State that will assist in the criminal investigation.
- If a corporation fails to comply with any requirement pursuant to subsection 3, the Secretary of State may take any action necessary, including, without limitation, the suspension or revocation of the corporate charter
- The Secretary of State shall not reinstate or revive a charter that was revoked or suspended pursuant to subsection 4 unless:
- The corporation complies with the requirements of subsection 3; or
- The law enforcement agency conducting the investigation advises the Secretary of State to reinstate or revive the corporate charter.
- The Secretary of State may adopt regulations to administer the provisions of this section.
It is important to note that Nevada is not asking for the owners of the entity up front. The requirement is that the registered agent either keeps a list of the owners or the name of a contact person who has a list of the owners. The Secretary of State will request the ownership list only when a law enforcement agency needs it for a criminal investigation. Not for a civil case mind you, but only for a criminal case. What this means is that if your business and asset protection plans are on the up and up, your privacy will be protected. (If you are engaged in fraud and other crimes, we would ask that you go elsewhere.) But for the good guys, you will still maintain your privacy. Two points are worthy of further note. First, for limited partnerships the only owners the new legislation aims for are the general partners. While the generals do indeed control a limited partnership, frequently they only own 2% or less of the entity, and are usually just a management corporation or LLC. The limited partners will own 98% of the limited partnership and, except for management, are the economic beneficiaries of the entity. Whether the new law intentionally just wanted information only on the general partners or will be corrected to include the limited partners’ identities remains to be seen. But for now, people very concerned about privacy may want to use Nevada limited partnerships. The second point has to do with Wyoming. The corporate law of Wyoming does not have such an ownership disclosure procedure. Yet. Apparently the federal authorities are working to get a similar legislation approved in other states, including Wyoming. We will keep you informed of such developments. Until then, once again, those very concerned about privacy may want to use Wyoming entities.
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Continuance
April 4th, 2008
By The XBanker
Continuance is a unique Wyoming corporate rule that you need to know about. Through the process called continuance, the State of Wyoming allows a corporation, limited liability company or limited partnership to domicile in the State of Wyoming as if it had been organized there initially. Say you have great corporate credit and a good business history. You don’t want to lose these benefits but at the same time you are sick of your home state’s taxes. By filing what is termed the “Articles of Continuance” with the State of Wyoming, your existing entity can redomicile in Wyoming without losing a beat.There are many advantages to being able to relocate your business to a friendlier state. One important benefit that many business owners do not consider has to do with the statute of limitations. All lawsuits have time limits. The statute of limitations refers to the legal deadline by which a lawsuit must be filed. These deadlines vary based on upon the type of claim being asserted. For instance, the statute of limitations in many states is six years for asserting a claim on a written contract, and four years for an oral contract. So if your business made a blunder, you could be held accountable for it, several years after the fact. Thus, it is important to maintain your entity for at least as long as the longest applicable statute of limitations. If you are thinking of closing shop, go ahead, but keep your entity active in the low annual fee sate of Wyoming. Let’s look at an example.Tom had owned and operated Ajax Construction, Inc. in Illinois for nearly twenty years and he was ready to retire. He knew that with a corporation there were some steps he needed to take before he closed shop, so he made an appointment with his attorney to ask about the best way to wind things up. Among the recommendations his attorney gave, Tom was informed that the statute of limitations in Illinois for construction issues could be ten years. Thus, Tom needed to keep his corporation active for ten years after he stopped working. Because it was a Illinois corporation, this was going to cost Tom $500 per year. Tom was understandably aggravated about this – after all, he was trying to retire. Tom, however, had a good attorney. After explaining the situation to Tom, he offered a solution to the financial drain of Illinois fees. Tom could continue his company into Wyoming. By continuing Ajax Construction, Inc. into Wyoming, Tom could maintain his limited liability status without a break and get away from Illinois’ high rates. Wyoming would charge him only $50 annually. That means Tom could leave his corporation intact for ten years for $500 rather than $5,000! Tom gave his attorney the go-ahead to complete the necessary paperwork and retired a much relieved entrepreneur.It should be noted that, as is typical, California is difficult in this regard. They won’t allow you to continue into Wyoming. Instead, you have to form a new Wyoming entity to merge with your old California. When the merger is complete the California entity goes away, but the new Wyoming entity does not have the old California incorporation date. Still, you are better off implementing this strategy and saving the $800 annual California fees than not taking these steps.
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Entity Structuring vs. Money Structuring
March 27th, 2008
By The XBanker
When we talk about entity structuring we are focusing on the proper use of legal entities to protect your assets. Creating the right structure for you is a correct and acceptable thing to do.But if you engage in money structuring – well, you are headed for big trouble. The case of Eliot Spitzer has certainly taught us one thing: It is getting harder and harder to discretely pay for sensitive transactions. What caught the former governor of New York with his pants down were these new post 9-11 anti money laundering rules.Deposits on withdrawals that total more than $10,000 within the same day automatically prompt a currency transaction report to the federal government. But if you slice up the transactions – say deposit $9,000 into different bank accounts – to avoid detection that is called money structuring, which is strictly illegal.I know – it’s hard to imagine. But take the case of a newlywed couple who received $40,000 in cash at their Greek wedding. Rather than deposit it all at once and wait in lines to provide the bank with a bunch of information, they deposited it over time in smaller amounts. The new Big Brother software caught them and soon they were being investigated by the IRS. After a great deal of money spent in attorney’s fees they were eventually not charged.But here’s the lesson, if you know about the $10,000 requirement and attempt to avoid it, you have committed a crime. And let’s be honest, thanks to Eliot Spitzer, we all know about the $10,000 requirement now.There are still a few ways for untraceable transactions to occur, at least until the feds find a way to shut them down.Eliot Spitzer would still be governor if he had used a prepaid or stored value card. You can buy an American Express gift card with cash at a retail store in amounts as high as $500. For now there is no limit on the number you can buy.Of course, cash is still a good way to go. But remember, if you withdraw more than $10,000 in cash in one day a report is sent to the feds. And once again, if you slice up withdrawals to avoid detection – money structuring – you are breaking the law. The best way to get your cash out is in smaller and more frequent transactions.But listen to what we are discussing: How to get your money out of your own bank account without breaking a draconian law. Will this ever end, or only get worse?
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Insurance
March 19th, 2008
By The XBanker
Is insurance enough to protect your assets?
Only if you believe in the Easter Bunny, the Tooth Fairy and commission earning insurance salesmen.
Insurance is the first line of defense in protecting your business and real estate assets. You should always have a reasonable amount of insurance coverage to protect against standard claims.
But you should never forget that insurance companies do not want to cover certain claims. They are certainly not willing to cover every imaginable claim. As well, they are quite clear about excluding these claims from your policy. While it may not be detailed in bold capital letters, and more often than not is in eye numbing miniscule print, the exclusions will be laid out somewhere in your policy.
As such, you will always need a second line of defense, which is the proper use of LLCs, LPs and corporations to protect your assets. The use of a second line of defense may be at odds with your insurance agent, who may stridently assert that your policy completely covers you. Such agents may further assert that with such a bulletproof policy you do not need to implement asset protection strategies.
First and foremost, you need to know that many commissioned insurance agents are less concerned with your asset protection needs than their need to sell lucrative, commission laden policy. Secondly, you need to know that they are not licensed to give legal advice. So feel free to questions their motives when they practice law without a license by saying you don’t need asset protection because insurance is enough.
Insurance policies may cover most situations, but there is no absolute 100% guarantee that you will be covered in every imaginable situation.
Which is why you need to use the proper mix of entities to supplement your asset protection planning. And, why you need to steer clear of insurance ‘professionals’ who would tell you that insurance is all you need.
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