WELCOME SAN DIEGO BUSINESSPEOPLE:
I think the question I hear the most from start-up San Diego entrepreneurs is” ‘What form should my company take?’. In order to make your life easier, I have written this article, explaining corporations, and linking to information about starting LLCs, partnerships, and sole proprietorships. When we meet, you will already be a step ahead and we can make the consultation more personalized to your own needs, rather than addressing the general question of what form your company should take.
CORPORATION INTRODUCTION: Corporations come in two varieties: the regular, or ‘C’ corporation (think huge companies) or the Subchapter S Corporation.
C CORPORATION: A C Corporation is a standards corporation, for lack of a better word. You are an individual and you have this ‘box’ called a corporation. You conduct business under the name of the corporation and follow the rules of corporations. You have limited liability and all is great. This applies to both C and S corporation. The drawback to C corporations is double taxation. For example, if the corporation makes a million dollars, it is taxed, for the sake of argument, 40%, leaving $600k. You are paid 600k for that year and you are taxed 40%; you are left with .6 x 600k = $360,000 after starting with a million dollars. With a Subchapter S election, this does not happen because of the ‘Pass-through’ effect of a Subchapter S corporation.
SUBCHAPTER S CORPORATION:
Let’s talk about the SubChapter S Corporation and then we will take you to the LLC or Limited Liability Company. One of the reasons that people choose the Limited Liability Company or LLC is because of the simplicity of running it. Not quite the case with a Subchapter S Corporation. The other reason is that you can allocate percentage losses to members of an LLC that are not equal to their percentage ownerships. This is not possible with a SubChapter S Corporation. A corporation is a corporation is a corporation. So, the main difference between a C and an S Corporation is that you make an ‘election’ with the IRS to be treated as an S Corporation. This allows you to pass through profits and losses to your own personal income.
The requirements of running a C or an S Corporation are very similar. It’s like saying you have two dogs…a German Shepherd and a Maltese. They are both very different in many ways, but at the end of the day, they are both very much dogs. What I mean by this is that both of them require a set of ‘articles’. These help form the C or S corporation. Then, you must have meetings and keep notes of what occurred in what are called Minutes; these are made by the corporate Secretary. If you don’t follow all of the requirements, you can find that later on down the road your C or S corporation is not recognized. You also need to have annual meetings. However, you ‘can’ operate as a ‘close’ corporation if you have 35 or less shareholders, and that allows you to be a bit more casual in the running of the firm. This election can allow you to dispense with annual shareholder and directors’ meetings, a Board, and even having corporate officers. If you form a corporation for example, where some people invest their money and others invest their talents, then you are able to distribute profits that do not match the percentage ownership of the corporation.
Unlike an S Corporation, with a C corporation if you pay yourself out and no money is left, there will be no taxes due on the corporation itself. However, if the corporation keeps some of the money, it is taxed, but starting at about 15%; if you then pay this out as a dividend, you the individual are taxed again. You can also add a section to your articles that protects the directors from liability or that they be indemnified by the corporation should that occur, even if they are sued for not properly performing their role as directors (with the assumption they acted in good faith).
As you may know, stock in a corporation can be sold, not only for cash, but you can also offer it for services rendered, debts that are owed, or for another benefit the corporation may have had. When you are ready to visit us, come with 3 possible names for your corporation. Your corporate name does not have to state the word limited or Inc etc. unless a name of a person is used in the corporate name. However, in all of your contracts and dealings, you must make it clear that you are a California Corporation or you will lose the protection you seek by filing in the first place. If you prefer to have a different name for your corporation and your actual business, simply file a fictitious name that your corporation will own and then you can use both names.
CALIFORNIA CORPORATION TAXATION:
A smaller company benefits from what is called the Subchapter S election (an IRS document) because it allows for what is called Pass-Through. In other words, it is treated for tax purposes very similarly to a sole proprietorship in that you can write off all of your losses and costs against your income. However, there are a number of rules you must follow and it’s a great idea to have a lawyer’s assistance because although you can figure this out and file online or file on your own, the problem you face is that you have no access to information that affects your S Corporation specifically, you only have general information. In law, information is everything. If you do not run your S Corporation properly you can face a problem called Piercing the Corporate Veil, in which a court can invalidate your S Corporation. The bad news is that you won’t find this out until you are in court trying to obtain protection from liability, only to find out you have none. Would you like to know how many calls of this nature I have received in the past 23 years, both by people who did it themselves in the past and people who use an online service today?
CREATING AND FILING YOUR NEW SAN DIEGO BUSINESS:
I don’t have a problem with online filing as long as you know the law. It makes sense to save money. However, sometimes what looks cheap in the beginning can be very costly at the end. Look at immigration law, an area we deal in. In my opinion, the smartest thing the CIS did in order to clear the country of people was to offer online fillable forms. Would you like to know how many hundreds of people have called just our law firm telling us that they filed the forms, one of the people went outside of the country for an interview and was stuck outside with a 10-year bar? Brilliant maneuver by the government. My point: educate yourself please. Another good example is a recent caller to our firm. He and 2 others started a corporation online in the mortgage lending business. One of the three left them on bad terms with all the corporate books. They don’t even know who they nominated as the CEO with signing authority. They now owe taxes for the last 4 years and on top of that do not know where the other member is. For all they know he could be running another business with that corporation, making both of them liable for issues that could pierce the veil, or even worse, taxes on the revenue. You must guard the running of the corporation closely.
FOR AN EXPLANATION OF HOW TO START A:
For a complimentary consultation with an attorney regarding your issues, feel free to call (619) 793-4827.