Which Format is Right for Yoru Business?

When you go into business, you will realize that each business form has its advantages and disadvantages. Your goal is to operate in a business format that provides maximum tax advantages, profit and protection! Each has its own section of the Internal Revenue Code and applicable case law. The state laws in which it is organized affect each. Let’s examine some of the common possibilities.

This is the least complicated form of business organization from the standpoint of operations and taxes. One person can form it without any documentation at all. A basic business license is all that is required to operate in any state in the union.

This is formed by two or more people under an agreement which may be oral or written, depending upon state law. All partners are the General Partners. The General Partnership is usually subject to state law and requires registration with the state. A General Partnership may have other partners called silent partners, secret partners or nominal partners. A General Partnership files a Partnership return, Form 1065. It is a flow-through entity, meaning that all of the profits and losses flow through to the partners.

Limited Partnership:

This is similar to the General Partnership, but only the General Partner is personally liable for the debts of the partnership. Limited partners do not have a say in management. They simply invest money in the partnership. They can only lose the amount of their investment. Assets are protected inside the Limited Partnership via a charging order.

Each of these entities falls short when it comes to overall tax and limited liability advantages. Although the limited partnership offers very good asset protection, the LLC is stronger!

No business can become a fortress unless it operates with the correct business organization. Why gamble your personal wealth on the success of your enterprise? The odds are that 80% of businesses fail in this country, making this is a poor gamble. When you engage in any business activities, those activities must be kept separate from the assets held by you or other businesses. Since business activities carry a high potential for lawsuits, you will want to isolate and remove those activities from the entity where the other assets are kept (all assets should be held by an LLC, not a corporation).* The corporation is one of several vehicles that are a part of the asset protection plan.

*This is certainly better than holding them in your own name. Assets are at risk when they are placed in a corporation. Don’t be fooled by what other companies may tell you. What could go wrong? In Nevada it is very difficult to locate the shareholder. Let’s consider the worst case scenario. Unfortunately, you just injured or even killed someone in a car accident. The judge determines that you are the major shareholder of the corporation. Your insurance will only cover a portion of the claim. Now the creditor is looking for more money from you and wants all your assets. If he finds out that you own the stock (at least 51%), the creditor will seize the stock, then proceed to liquidate the corporation and get all of the assets held in the corporation!

What if the corporation itself gets sued, and the insurance doesn’t cover the lawsuit? The same result occurs in that the corporation will lose all of its assets! The only difference here is the fact that in this situation your personal assets are protected. As you will learn, corporations have tremendous tax benefits and provide some liability protection. Actually, corporations and limited liability companies work very well together.

Corporations, like Limited Liability Companies, are created by the state. First, you must realize that a corporation consists of four groups of individuals: officers, employees, and a board of directors and shareholders. Of course, it is possible for a person to wear all four hats, as in a one-person corporation. It is imperative for the corporation to maintain a separate and distinct identity from the individuals operating the corporation. And of course, it should be formed for business reasons.

The shareholders own the corporation. This gives them the right to elect the directors and to approve or reject corporate actions. These actions might include a merger or liquidation. Essentially the directors are the elected representatives of the shareholders. It is their job to watch over the corporation between meetings of shareholders.

The directors report to the shareholders about what the company has done since the last meeting. The corporate officers who are appointed by the board of directors conduct the day to day business of the corporation.

If a corporation is formed and operated properly, the creditors of the corporation can only look to the assets of the corporation for recovery. This is known as "limited liability". The owner’s liability is limited to the capital contributed to the corporation. There are conditions to limited liability. It is not absolute. Creditors may attempt to seek recovery from the shareholders or officers (if they can locate them). The creditor may attempt to pierce the corporate veil by trying to prove the corporation was merely the "alter ego" of its operators. There are simple steps you can take to guard against this. Namely, it is very important to maintain accurate corporate records. These should include, but are not limited to, holding regular shareholder and director meetings, holding annual meetings, keeping an up-to-date minutes book and issuing stock. It is also important to use the corporate name, not your name, in all business contracts and business dealings. In fact, many attorneys won’t even allow their clients to operate as a sole proprietorship or partnership! Corporate funds are for the business only! Do not commingle funds! Corporate money is separate from personal money.

Property! Why? Because of the EPA (Environmental Protection Agency). If you have ever been in the legal chain of title of a piece of property, even if you owned the property 20 years ago, the EPA can go after everyone personally for any violations! They make the IRS look like the Boy Scouts. Can you see how it would make sense to have a "fall guy" like an entity take the hit for any unforeseen EPA problems that might develop in the future when you are long out of the picture?

What about having high levels of insurance to protect your assets from a lawsuit? Is it enough to have a $10 million umbrella policy and other insurance’s to protect you in case of a lawsuit? Absolutely not! Is insurance valuable? Yes, but only to a certain extent. By no means should anyone rely on it as his or her main asset protection plan. Why not? Because there are law suits today that no one’s insurance will cover. Does your insurance policy cover you in case of discrimination in the work place? What about sexual harassment? What about punitive damages? This can be devastating and in many cases is not covered by any insurance plan! Unfortunately, your assets can be lost by the false sense of security that insurance provides!

Here’s the bottom line; if you operate a sole proprietorship and your business is sued, you stand to lose both your business AND personal assets! With a corporation, only the business assets are at risk (that’s why it’s called limited liability). You may want to take things a step further and form an LLC to protect the assets inside the business. If you operate a business that has more than one component (i.e., boat rentals and Jet Ski rentals), it would make sense to form two separate corporations to limit the exposure of each individually.

If both divisions were under one corporation and one division was sued, that could contaminate the other division. In other words, Don’t put all your eggs in one basket!

A corporation can theoretically live forever because it is a separate entity from the owners. A corporation only goes out of business when the shareholders deem that action is appropriate.

The corporation is a separate entity from its shareholders. The shareholders do not operate the corporation. Responsibility for operation rests with the board of directors (who are elected by the shareholders). They appoint officers to carry out the day-to-day business of the corporation. The operation of the corporation is centralized in the hands of the officers, who are the managers of the corporation.

Corporate ownership of shares are technically freely transferable. The operation of the corporation is not disrupted by the transfer of shares. The shareholders must act only through the power to vote to affect the operation of the corporation. In some cases, transferability may be limited by federal or state security laws.

The corporation is a great tool for protection against claims of negligence arising out of an employer-employee relationship. If one of your employees injures someone in a car accident while picking up supplies for you, you are likely to be responsible for the damages. However, if that employee is an employee of a corporation, the corporation, not the officers or directors, will be liable for the injury!

When a corporation buys goods and the customer gets injured the corporation is liable not the principals. If the corporation sells goods or services, liability will usually be limited to the corporation. For example, if the corporation is providing contracting services to fix a home, only the corporation would be liable for faulty service! For these reasons, the corporation provides a very useful shield against personal liability in connection with the sale of products and services.

Absolutely, if you have more than one business or business parts! Especially if you have a profit-making part of your business and another part makes no profit. Why put the problem part of your business in the same basket as the profit part of your business?

If the problem part of your business gets sued, the profit-making part will not be affected. For example, suppose you had two successful gas stations in your hometown, and you now open a third.

If they are all in one corporation and that corporation is sued, you could lose your entire business because all your eggs were in one basket! There is typically no tax advantage when owning multiple corporations if you own more than 80% of two corporations. Keep in mind that a corporation must be operated as a separate legal entity from you or you may lose the corporate protection.

Now let’s enter the world of Limited Liability Companies and see how they compare with corporations. Click here.

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Which Format Is Right for Your Business?

Which Format Is Right
for Your Business?