CHOICE OF BUSINESS ENTITY (cont.)

Although the basic actions necessary to incorporate are similar, it is important that you observe and follow corporate characteristics. Failure to follow protocol and ceremony can result in what is called “piercing the corporate veil” and leave you with what amounts to a sole proprietorship or general partnership. That in turn may lead to far ranging and expensive consequences. A simple example would be personal liability for intended corporate obligations.

S Corps.

The S Corp was designed to provide the insulation of the general corporate form of governance and the tax treatment of a sole proprietorship or general partnership. In other words it is hybrid. There are specific requirements and forms to file to qualify for the tax treatment but the day to day formality and operation requirements of a C-Corp are observed for actual operation of the S-Corp.

After meeting the guidelines and filing requirements the S-Corp results in a pass through to the shareholders of all income and losses on a pro rata basis and avoids double taxation experienced in C-Corps. Since tax rates applied to a C-Corp are generally higher than individual rates the result is lower taxes. You can also convert your C-Corp to an S-Corp status if you meet the IRS filing deadlines.

An S-Corp is typically used in small business settings and may work better in that environment than a C-Corp. However, it does require more formality than a limited liability company which we will discuss next.

Limited Liability Companies.

Although first introduced less than thirty years ago, the Limited Liability Company (“LLC”) is now recognized in every state and has become extremely popular. It is another hybrid combining both corporate and partnership advantages while seeking to avoid the disadvantages of both. Initial formation is by filing Articles of Organization with the applicable state. These are typically short and simple in form and result in modest costs for formation.

The essence of the LLC is covered in the Operating Agreement (“OA”) which is signed by the owners, called Members in an LLC. The OA is similar to the By-laws of a corporation but most analogous to a limited partnership agreement. If the Members fail to establish an OA the applicable state has “default rules” established in the LLC section of its code of laws. These default rules may be undesirable for your particular business operations, so you want to make certain an acceptable OA is in place.

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