When forming a business, most people wish to protect their personal assets from all potential business-related liability. There are several different options from which to choose when selecting the best entity for your particular situation: consider a C-Corporation, a subchapter S corporation and there is also a PC (Professional Corporation); a Limited Liability Company (LLC) is another option and it has a professional side as well call a Professional Limited Liability Company (PLLC).
C corporations are recognized everywhere for their limited liability protection. This type of entity is taxed separately from that of its owners. It has a disadvantage for “start-ups” because losses of the corporation cannot flow over to the owner’s tax return. Next, subchapter S corporations start out as a traditional corporation, and then the owners elect (subchapter “S” of the IRC) to be treated as a partnership with the Internal Revenue Service on a tax form with an S-corp election; S corps have statutory restrictions for eligibility (such as number of shareholders), but they provide useful tax benefits. With an S corporation, taxation “flows through” the company (like a partnership), such that all gains and losses are reported on your personal tax return. If you are just starting out and expect to experience losses, this corporate entity may be advantageous, as you can write off all losses on your personal tax return. However, it’s important to get good legal advice before forming this type of entity, as there are many technical issues that you may miss without the help of a professional.
Unfortunately, creditors can pierce most closely held corporations (whether a traditional corporation or an S-Corp) if they are not operated according to North Carolina’s statutory requirements. Some don’t realize that you can’t use a corporate checkbook to pay for personal expenses, as this will commingle your personal and company assets. Commingling of assets will allow creditors to pierce your corporate identity and access your personal accounts. It’s also important to operate your corporation correctly by keeping regular minutes in the “corporate book,” holding an annual shareholders meeting, and electing directors. Fortunately, if your corporation is lacking in these respects, you can bring your records up to date and follow the statute prospectively. However, if you are already in a lawsuit, it is likely too late to fix these past mistakes.
Finally, LLCs are often the best asset protection entities for multi-member entities, as they have fewer requirements than corporations. Unlike a corporation, which requires that the company base its ownership interests on its capitalization, an LLC is much more flexible. Frequently, business owners are looking for another option, such as the ability for one person to invest his or her money while the other invests his or her experience. It is much easier to divide profits in an LLC, and it provides unique management advantages. LLC owners have the choice between an LLC that’s member-managed or manager-managed. A member-managed LLC is similar to a traditional partnership. A manager-managed LLC allows the owner to act as the sole decision maker, while giving ownership interests to other members (like trusted children). An LLC can be managed by a person with no ownership interest at all.
Like a corporation, creditors can also pierce an LLC if it’s not operated properly. Bankruptcy courts are quick to undermine a single-member LLC, which is why it’s better to form a C Corporation if you plan to own your business alone. To form a multi-member LLC, consider owning your business with your spouse or a trusted child. However, if you are operating as a professional LLC, you cannot own your business with anyone who is not licensed in the same capacity. This means that all owners must be licensed professionals, such as doctors, attorneys, architects, engineers, accountants, etc.
Be sure to consult both an experienced attorney and a CPA before forming any business entity. They can advise you about potential legal traps and tax implications associated with your choice. If you have already formed a limited liability entity, it’s important to have your entity structure and documentation reviewed to make sure that it protects you and your personal assets the way you think it protects you. The review that is done when you are named in a lawsuit is too late to rectify any problems that surface.
If you or your loved ones have questions about which business entity may be right for you, consider W.G. Alexander & Associates – we are experienced attorneys who offer a unique blend of asset protection, Elder Law and estate planning. You can also attend our free seminars, learn more through our website at www.wgalaw.com, or call us at (919) 256-7000.
Attorney Bill Alexander discusses these issues and more every Tuesday morning on W.G. Alexander & Associates’ radio program, “Asset Protection Today,” on TalkRadio 850 WPTK (AM). Be sure to listen from 9:00-10:00 AM.