New Company Formation Service Available

Customers for legal services are increasingly segmented, just like customers for any other product or service. Many consumers of legal services like to do things themselves, on their own schedule. In recognition of this fact, we now offer online company formation services for DIY-oriented consumers. You can now form an LLC or corporation online in any state, through our website.

Also, you will get a one-hour consultation with me, where you can ask questions about forming and running an LLC or corporation. Other online company formation services may not provide such an opportunity.

One thing to keep in mind is that this service is limited – you get your company formed, but essential post-formation documents are not included. For example, if you are forming an LLC, you really should have an operating agreement, particularly if you will have co-founders. Similarly, with a corporation, you will need resolutions appointing directors and officers, you will need bylaws, and other post-incorporation documents may be necessary. We can provide all of those, customized to your needs, but they aren’t included in the online formation pricing.

We also offer registered agent services in all 50 states, as well as compliance services in those states where annual report filings may be required (such as Delaware and California).

Ready to get started? Simply go to our Business Formation page.

Will Trump Kill the LLC?

There is an interesting provision in Donald Trump’s tax reform proposal. Specifically, he proposes to lower the corporate tax rate to 20%, while setting the maximum tax rate for LLC’s and S-corps at 25%. In essence, his proposal would penalize businesses that elect a pass-through entity structure over the traditional corporate structure. So the question is, will this kill the LLC?

Of course, this is only a proposal, and given the track record of the current administration and Republican-led Congress, there may be no tax reform at all. Or, something will pass, but whatever it is will differ in key ways from the original proposal. It’s still worth considering whether it makes any sense to have different tax rates for different entity structures, and what effect that will have.

If the differential tax rate does pass, I expect many of my existing clients who have set up LLCs to engage in some serious tax planning. They will need to compare their tax bill at the new 25% LLC rate, vs. what they would pay if they were a corporation. This may lead a number of these firms to convert to corporations, to take advantage of the preferential tax treatment. Even more profoundly, it may lead new entrepreneurs to ignore LLCs completely when starting a new business. The LLC form is only about 30 years old, and it has become wildly popular for most kinds of businesses, but this new tax scheme may kill it.

Let’s keep an eye on this issue.

The Myth of the S-Corporation

I often hear potential clients say things like, “I want to form an S-corp,” or “should I form an LLC, S-corp, or C-corp?” This illustrates a very common misunderstanding about the nature of an S-corp. In today’s post, I hope to clear up this misunderstanding, once and for all.

The first thing to understand is this: LLCs and C-corps are things, and an S-corp is a choice. The best way to understand this is to go to any state’s website for forming businesses, and look at the different kinds of business entities available. For example, California allows you to form corporations, LLCs, limited partnerships, general partnerships, and limited liability partnerships. Under the category of corporations, you have for-profit corporations and non-profit corporations. Nowhere is forming an S-corp a possibility. The same is true for Delaware, too. When you are looking at the different kinds of business entities, an LLC is an entity, and a C-corp is an entity (although it will simply be called a “corporation”), but an S-corp is not an entity. So what is an S-corp?

An S-corp is a tax election that you make with the IRS. When you form a business at the state level, you have to choose a kind of entity – for example, an LLC or a corporation. Those two types of entities are taxed in different ways, however, and that’s where the S-corp tax election comes in. An LLC is a pass-through entity, meaning that the LLC’s net taxable income or loss is passed through to the owners in proportion to their ownership percentages, and the individuals report the income or loss on their personal tax returns. In the case of a corporation, the corporation itself must pay taxes on its taxable income, and its shareholders only incur tax liability with respect to corporate income that is distributed to them as a dividend. This is often referred to as “double taxation,” one of the most dreaded things since, well, peanuts in an elementary school.

If a corporation wants to be taxed more like an LLC, meaning it wants to be treated as a pass-through entity, it can make an S-corp election. There are some restrictions – the corporation can only have one class of stock, cannot have more than 100 shareholders, and in general, all shareholders have to be individual persons and US citizens or permanent residents. A corporation that has a stockholder who is a Chinese citizen and resident, therefore, would be disqualified from making an S-corp election. The fundamental thing to understand here is that you have two layers – the entity layer and the tax treatment layer. At the base is the entity layer – that’s the corporation. Laying on top of the entity layer is the tax treatment layer – that’s the S-corp election.

As further illustration of how this all works, an LLC can make an S-corp election too. You might ask, “since an LLC is already a pass-through entity, why on earth would it want to make an S-corp election?” That’s an excellent question. The reason is that when an LLC makes an S-corp election, its owners (the LLC members) can become employees of the LLC, so they can have taxes withheld from their paychecks, saving them the hassle of quarterly estimated tax payments. Also, they will pay a reduced self-employment tax on the money they take out via distributions, vs. if they had not made the s-corp election.

One final note: the S-corp election is not written in stone. You can inadvertently blow your S-corp election, by taking on a disqualifying shareholder or exceeding the 100-shareholder limit, for example. You can also voluntarily give up the S-corp treatment, when it no longer is advantageous, or when it interferes with bigger goals, such as when a tech startup needs to take on venture capital investment.

Choosing the Right Entity

One of the most important decisions to make when starting a business is what form the business entity will take. There are a number of options – sole proprietorship, partnership, limited liability corporation, corporation, S-corporation, etc. There are a number of different factors that go into the choice. These factors include legal considerations, tax considerations, nature of the business, growth plans, and capital requirements, among others. Some are easier to set up than others.

Sole Proprietorship

A sole proprietorship is easy to set up. As the name implies, there is just one owner. Depending on the state, you may need nothing more than a tax ID number, a business license, and a fictitious name filing. There is only one level of taxation – all the revenues, profits and losses flow through to the owner and show up on his or her tax return. The downside is that the owner doesn’t have any corporate form to shield him or her from liability.

Limited Liability Corporation

To shield themselves from liability, many entrepreneurs choose some form of corporation – either an LLC, a C-corporation, or an S-corporation. The LLC, or limited liability corporation, is a relatively new entity that is becoming increasingly popular. It combines the limited liability of a conventional corporation with the pass-through tax treatment associated with a partnership or sole proprietorship. You can have one or more members, and it can be managed either by the members, or by non-member managers. There is a great deal of flexibility in how you can organize and run an LLC, which will be reflected in an operating agreement. A single member LLC’s operating agreement can be fairly simple and straightforward, but multiple-member LLC’s typically have more complex operating agreements, to handle the allocation of profits and losses, capital accounts, etc.

Corporation

The corporation, or C-corporation, has been an option for many years. The corporate form shields the stockholders’ assets from corporate liabilities, under most circumstances, and you can have an extremely wide base of ownership. You also have the double-taxation issue, however. The corporation is a separate legal entity, and it pays tax on its profits. Any dividends to shareholders are then taxable income to the shareholder. Therefore, the same money is being taxed at two different levels. Of course, corporations are not required to make dividends, and many do not. In the high-tech industry, it has been fairly standard practice for corporations not to pay dividends to their shareholders.

S-corporation

The S corporation is merely a C-corporation that has made an election under the Internal Revenue Code to have pass-through tax treatment for its shareholders. There are limitations on being eligible to make such an election. Only domestic corporations qualify, and there can be only one class of stock and no more than 100 shareholders. Also, the shareholders have to be individuals or certain trusts and estates. Corporations, partnerships, and non-resident aliens cannot be shareholders of an S-corporation.

LLC or Corporation?

Anyone starting a business should consult with his or her legal and tax advisors before making a decision. There are a number of subjective considerations and factors which will weigh in favor or against any particular choice. For example, if one is planning to seek venture capital or to go public, forming a C-corporation rather than an LLC is the better choice. Venture capital firms don’t care for the unpredictable and unique management of LLCs, and prefer the familiar structure and management of a conventional corporation. In addition, VC’s cannot invest in an LLC. If you set yourself up as an LLC, and then seek VC funding, you will have to spend a lot of money changing from an LLC to a C corporation. Also, the LLC ownership structure simply isn’t a good fit for a publicly-traded company. It’s better to understand these nuances at the outset, and choose the right entity at the start. Otherwise, a great deal of expense will be required to convert or merge the LLC into a C-corporation. That’s money that could be better spent growing the business.

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