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Commentary- SB 101: Structuring your new company

Commentary- SB 101: Structuring your new company
May 03
16:18 2018

By Algenon Cash

I’ve always been a huge promoter of small business [SB] and entrepreneurship, so I routinely help others who want to launch their own business.  My grandmother ran several businesses; she was a beautician, cook, baker, child care provider and seamstress.  But she never actually owned a company and didn’t realize she was an entrepreneur.  Many people have “side hustles” and may not understand how to actually incorporate their businesses.

It’s important that you properly structure your new company because it will determine if your business is paying taxes on profits before they are distributed or will the profits flow straight through to the owner’s individual tax returns.

Here are few structures to consider when developing your corporation:

1. Limited Liability Company. This structure essentially merges a partnership with the limited liability protection offered by a corporation.  The LLC is a new innovation – most states did not recognize it until the mid-’90s – but lawyers often recommend the structure because it provides great flexibility.  Be careful of a small hurdle that prevents LLC members from receiving profits without being subject to Social Security and Medicare taxes.

2. Subchapter C Corporation. This is a basic structure highly used all over the country, but also has relatively high tax rates.  However, corporate shares can be traded freely among an unlimited number of owners.  The C corporation is the most tax-efficient vehicle for taking a company public.  It also provides the best structure for a tax-free merger in a stock swap.

3. Subchapter S Corporation. This is a long-used structure that offers a method to avoid the C corporation’s double taxation, but the more flexible LLC still provides more flexibility.  However, some companies are legally prevented from organizing as LLCs.  Also S corporations cannot deduct the cost of benefits provided to employee-owners holding more than 2 percent of the company.

Selecting the most advantageous structure is not completely about minimizing your current tax burden; it’s more about planning for the future.  For example, if you’re a technology entrepreneur building a new company and you anticipate a public offering or merger once the venture matures, it will be in your best interest to setup as a C corporation.

However, if you envision selling the business outright, an LLC or S corporation, is a better pathway, simply because most buyers prefer to structure a deal as a sale of assets, not as a sale of corporate stock.  A sale of assets means a much higher tax burden for the seller of a C corporation because the profit is considered ordinary income to the company and is therefore taxed twice.

In the case where you plan to dissolve of the company at some future milestone, an LLC is a superior option.  The IRS considers an LLC’s assets to belong to its members, so when a business is dissolved and its property distributed, the IRS does not recognize a taxable event.

Regardless of the structure that you choose for your new company, always draft a buy-sell agreement that determines how partners can exit the deal.  If you wait until later, then it may become more difficult to negotiate.

Contact me directly with any questions, comments, and ideas.  Good luck!

Algenon Cash is a nationally recognized speaker and the managing director of Wharton Gladden & Company, an investment banking firm. Reach him at acash@nullalgenoncash.com

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