Milton Thompson: Speaker for NBI Seminar

Milton Thompson: Speaker for NBI Seminar
12/07/2010

Milt was asked to be a speaker for the NBI CLE Seminar. The areas that he spoke on were LLC vs. A Corporation: What are the principal non-tax differences?, Walking The Ethical Line and Advanced Issues In Business Entity Selection. Below are the materials from one of his sessions.

LLC VS. A CORPORATION:
WHAT ARE THE PRINCIPAL NON-TAX DIFFERENCES?

By:
Milton Thompson

Our approach to assistance to business owners is inspired by the ultimate desires and aims of such owners. In other words, the lawyer’s role in support of an entrepreneur is to provide a “tool bag” from which a business owner can most efficiently start and grow their business.

Before recommending a particular legal structure, I believe it is incumbent upon the advisor to learn and understand as much as one can, the vision and nature of the business from its owner.

Some relevant questions may include the following:
1. Is the business a service, a product, or some combination of both?
2. If a product, is the product proprietary and is the proprietary nature of the product important to the ultimate success of the business?
3. If a service, is it a professional services, where a license is required? (i.e. – accounting, legal, medical, engineering, etc…)
4. Is there more than one owner?
5. Are the attributes of the owner important to a successful venture? Is being a minority, woman, disadvantaged, or veteran owner important?
6. Is there a profit motive? Is it more important than a philanthropic or charitable motive?
7. Do you have a written business plan with realistic financial projections?
8. How do you intend to capitalize the business? Debt, equity or some mixture of both?
9. What are your growth plans? Organic? Strategic partners? Mergers? Acquisitions? License or selling of property rights?
10. Do you intend to build and maintain your business long term? (5 to 10 plus years)
11. Is your business intended to transact in one state, many states or internationally?
12. Do any of your products or services contain any inherently dangerous elements?

Although these questions are in no way exhaustive, the answers to them will provide much of the information needed to help the business owner make a reasoned selection of the most appropriate legal entity.

Generally, for a new business, the preferred structures are limited liability companies
(“LLC’s”) or Corporations over traditional partnerships, and sole proprietorships. Of course, the reason for the preference is for personal liability protection shielding the owner from personal debt liabilities that are instead liabilities of the company.

The Limit on liabilities may also protect the owner(s) from certain negligence claims against the business that may not be transferred to the individuals as well.

With respect to debt insulation, the method of business financing is at issue rather than specific insulation of the owner by the corporate shield. In other words, a traditional business loan may require security in the form of a personal owner guarantee of certain non business assets.

Although this section is not intended to consider tax implications of entity selection,
I would be remiss to not mention that a Subchapter S tax election for a corporation may suit some business owners better than an LLC if the avoidance of double taxation afforded that entity over a “C” Corporation is more appropriate for certain owners from a personal income tax perspective.

The LLC also offers similar tax “pass through” protections as does the Subchapter S corporate structure, as the income from the LLC is “passed through” to the owners and reported on the owner’s personal income tax returns. Of course, a traditional C Corporation would be taxed at the corporate income tax rate, and the owners would also be taxed as when income is personally derived from distributions of dividends. The choice between Subchapter S Corporation and an LLC is aided by the answers to some of the foregoing questions. For example, if saving on employment taxes is less important in the start-up phase of a business than in operational flexibility and efficiency, the choice would be an LLC.

Further, there are more restrictions on ownership in an S Corporation than in an LLC. There is a limit of 100 owners (shareholders) in an S Corp. and all shareholders must be resident aliens nor can owners “own” or hold their shares in another corporation or LLC.

The LLC is also more flexible from an operational and profit splitting perspective.

Remember, that a subchapter S is a tax election but is still treated as a C Corporation with respect to record keeping and formalities, the use of officers and directors to manage the corporation, and to make distributions based on the pro-rata ratio of stock ownership rather than perhaps a more equitably designed distribution of profits system.

In contrast, the LLC has no restrictions on ownership nor is it subject to the formalities of an S Corp. The owners of an LLC (members) have great flexibility in company management which may include member management, or manager managed with responsibilities of operations designated by the members to other members or even to non-members.

The mangers have flexibility (pursuant to its operations Agreement) to distribute profits to members any way they deem appropriate notwithstanding the relative amount of the individual member capital contribution.

There may be employment tax benefits to a Subchapter S election, but such savings should be compared to the benefits of operational ease in a LLC before making that election.

Many start-up companies, depending on scope and plans for growth are interested in start up financing and the consequences of debt, equity, or some combination of both. The LLC may offer advantages for investor attraction because of the flexibility afforded in profit distribution.

The type of business, whether product or services, local, national, or international scope may also be considered in the entity selection process. Proprietary products may require certain protections over and above protections provided by the entity and may afford the financing options and the attractions of investment capital and from whom.

The intended exit strategy from the business is an additional consideration and may impact the need to convert ownership to other forms more suitable to the surviving company.

Of course, professional corporations and nonprofit elections are largely dependent upon the aims of the owners as well as special attributes, if part of the business vision, must be considered in such cases where owner attributes are condition precedent to business success. For example, if the ethnicity or gender of the owner is important to the execution of the business plan, ownership and control issues must be considered as a part of the entity selection process.

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