Making an S Corporation Election as a Married Business Owner

If you’re a married business owner and you want your business to be taxed as an S corporation, there are several things you need to know.

The difference between community property and co-ownership of an asset

Let’s take the example of owning a car. If you and your spouse are both on the title to a car, you co-own the car. This means both of you have the right to use the car, sell the car, or do anything you’d like with the car. It also means you are both responsible for paying off any debt or liabilities that arise from the car.  If one of you passes away, the survivor automatically becomes the sole owner of the car, without needing to take any additional actions.

But let’s say only one spouse has his or her name on the title. That spouse is the only owner of that car and is the only one (with certain exceptions) with rights and responsibilities attached to the car. When the owner spouse dies, the car would have to be transferred to the surviving spouse via the applicable estate plan or post-death or probate proceeding; it isn’t already owned by the other spouse like in the previous example.

However, ownership of the vehicle may look a little different depending upon your state of residence. In many states, such as California, there are rules that make most assets acquired during the marriage “community property” of the married couple. In this situation, each spouse has rights to the property, no matter whose name is on the title.  All assets that are considered community property are split up equally between the divorcing parties. In our car example, if the car is considered community property, it’ll be put into the big pot of community property and split evenly. That can result in either one party getting the car and the other spouse getting something of equal value to offset it, both parties splitting the ownership of the car, or the car being granted to both parties but one buys out the other’s share. The main point of community property is that the parties get an even split for assets acquired during the marriage.

Community property rules apply to all assets owned by either spouse, including ownership of a business. Spouses can co-own shares of a business, and, in fact, there may be legal and tax benefits for doing so. However, in the typical case of one spouse being involved with the business while the other is not, it usually does not make sense for the spouses to co-own the shares. Alternatively, if one spouse owns the shares individually, the other spouse may still have a community property interest, even if they’re not an owner.

How to fill out your Form 2553 S Corp Election

If your corporation or LLC decides to be taxed as an S corp, you must file a Form 2553 with the Internal Revenue Service (IRS). The tax code states that anyone with a community interest in the stock must consent to the tax election, and Form 2553 asks for a list of all owners. If the business owner’s spouse has a community property interest, it seems as though he or she must be listed on the form as well. However, he or she is not an owner, so they shouldn’t be listed as an owner, right? Be warned, if you list your spouse as an owner of the business when he or she is not, there could be serious consequences down the road. So how do you comply with the conflicting rules?

The answer is to list your spouse in the shareholder section, but note that he or she is not a shareholder. As you list all of the owners and their information, do include your spouse in the list, and do get his or her signature. However, unlike the actual owners, you will not list any ownership percentages or shares, or any dates those shares were acquired. Instead, you should note that the spouse is a “consenting spouse,” and you can also note that he or she owns 0% or zero shares of the business. This way, you are satisfying both requirements: you are getting affirmative consent to the tax election, but you are not claiming that they are an owner when they are not.

Special considerations for professional corporations

If you are forming a professional corporation, properly completing Form 2553 is especially important. The rules governing professional corporations vary from state to state, but generally, the rules will dictate that only members of that particular profession may be owners of the company. For example, if you’re starting a professional veterinary corporation, only licensed veterinarians can be owners of the business (or may have to own a majority of the business). If a non-professional is an owner, the status of the company can be put in jeopardy, and you could lose your entire business entity.

It is of the utmost importance that you comply with the ownership requirements in your state in order to be considered a professional corporation. If you incorrectly complete Form 2553, you’re putting your entire entity at risk. So professional corporations, be warned: If you are considering electing S corp status, make sure you consult with a professional. You are quite vulnerable if the form is filled out improperly. Problems are easier to prevent than solve!

The Employee Handbook: The Holy Grail of Your Business

Employee handbooks address the who, what, where, why, and how of your business operations.  Your employee handbook will protect you and your business by setting appropriate expectations, and providing consistency for your employees when situations arise.

What Information Should an EmployeeHandbook Include?

Ideally, employee handbooks address anything significant related to your company, employees, operating policies, and applicable laws – as well as how rules and policies are followed and/or enforced.  The following topics are commonly addressed in employee handbooks:

  • Equal Employment Opportunity (EEO) Laws.  Business owners must comply with EEO laws concerning all forms of discrimination and harassment in the workplace based on various protected classes under federal, state and local law, such as race, color, religion, gender, sexual orientation, gender identity or expression, national origin, age, genetic information, disability, or veteran status.

Employee handbooks need to detail which laws are applicable, state that the company complies with them, and address the procedures for employees to voice concerns (e.g., filling out a form, consulting with a supervisor, or bringing something to the attention of Human Resources).  

  • Compensation / Benefits.  Business owners should also describe the types of compensation and benefits that are available to employees, including information related to eligibility and procedures for receiving them. Several important topics to address in an employee handbook are:
  • Bonuses
    • Deductions for benefits (availability and eligibility for health insurance, retirement plans, and wellness programs)
    • Disability (long and short time)
    • Lunch and break periods
    • Overtime pay
    • Pay schedules
    • Performance reviews
    • Wage increases
    • Sick/vacation pay
    • Tax deductions (federal and state)
    • Timekeeping policies
    • Workers’ compensation
  • Work Schedules.  Explain your business’s policy regarding an employee’s work schedule.  Discuss absences, attendance, regular and flexible schedules, punctuality, reporting, telecommuting, and how the company handles non-compliance.
  • Standards of Conduct.  Describe expectations (and consequences) for employee conduct regarding ethical behavior, dress code, demeanor, communications, disciplinary measures, performance improvement programs, termination, and anything applicable to government regulations.
  • Physical Safety.  Illustrate how your company complies with the Occupational Safety and Health Administration (OSHA) and outline how employees should report and respond to accidents, injuries, potential safety hazards, bad weather conditions, health and other safety related issues.
  •  IT Safety.  It is also incredibly important that you address technology and internet security issues (involving both hardware and software) by having clear and concise rules stated in the employee handbook. Included in these rules should be steps to keep company data safe (e.g., updating passwords, installing firewalls, storing and locking computers when not in use, guidelines for installing anti-malware software, and policies regarding personal use of a business-owned computer).  It’s also a good idea to outline the consequences of non-compliance.
  • Leave Policies.  Describe your company’s policy on the various types of leave: medical leave covered under the Family & Medical Leave Act (FMLA), jury duty, military leave, vacation, holiday, sick time, bereavement, maternity and paternity leave, and any other types of leave your company offers.  It goes without saying, but make sure your company’s policies are compliant with federal and state laws.

Does Every Business Need A Handbook?

If you operate a sole proprietorship with no employees, a handbook isn’t necessary. However, if you add just one employee, the game changes.  Every employee (even if it’s just one) needs to understand the company’s rules, what is expected of the employee, the consequences for failing to adhere to the rules, and any benefits the employee is entitled to.

Make sure that every employee receives a copy of the handbook and signs a document stating that he or she has read, understands, and will comply with the policies.  There’s nothing like ending up in court and having an employee say, “I didn’t know that was against the rules….”

What to Do Next

If you need help creating a new employee handbook or revising your existing employee handbook, give us a call. We are here to assist you so the relationship between you and your employees can be a happy and prosperous one.

I’m Starting a New Business – Should I Use an LLC (Taxed as a Partnership) or an S Corporation?

Entrepreneurship has been called the new American dream. Hanging a shingle starts with an idea that develops into a business plan, but not without careful financial and legal considerations. Among the decisions that new business owners grapple with is whether to form a limited liability company taxed as a partnership (LLC) or a corporation making an S election (S corp).* There are similarities and differences between LLCs and S corps that business owners should understand before choosing between the two.

Similarities

  • Both entities are created by filing the necessary paperwork with the state. Unlike a sole proprietorship or a general partnership, LLCs and corporations are not recognized under state law until the filing has been made. In addition to state filings required to form the corporation, a special filing on Form 2553 is required for the state-law corporation to elect S status for federal tax purposes.
  • Both entities provide owners with limited liability, meaning the owner’s personal assets are protected from any business creditors’ claims.
  • Assuming an LLC does not make an election to be taxed as a corporation, both LLCs and S corps are pass-through tax entities, allowing business profits and losses to flow through and be reported on the owners’ personal tax returns.

Differences

  • Unlike LLCs, which can have an unlimited number and type of owners, S corps are subject to strict ownership rules. S corps can have no more than 100 shareholders, may not have non-U.S. citizens as shareholders, and cannot be owned by corporations, LLCs, partnerships, or many types of trusts.
  • As opposed to LLCs, which have flexibility in structuring the economic arrangement among its owners, S corps cannot issue classes of stock with different economic rights. However, an S corp can issue voting and non-voting classes of stock.
  • S corps are subject to mandatory requirements as to how the entity is managed. For example, S corps are often required to adopt bylaws, issue stock, hold regular meetings, and maintain meeting minutes within its corporate records. LLCs, on the other hand, are not subject to these types of requirements.
  • Owners of S corps, unlike LLCs, may be able to reduce or eliminate the need to pay self-employment tax. An S corp owner can be treated as an employee and paid a reasonable salary. Employment taxes are withheld from the reasonable salary, while corporate earnings in excess of that salary may be distributed to the owners as unearned income, free of self-employment tax.
  • S corp owners must share profits equally based on their percentage of ownership, while LLC owners have wide latitude to split profits and losses in any manner that is agreed upon.
  • LLCs are generally cheaper to form and operate.
  • S corps generally provide enhanced asset protection, as the structure creates more separation between the owners and the company.

*For the sake of simplicity, this brief overview is based on the assumption that (i) any reference to “LLC” is to an LLC taxed as a partnership, and (ii) any reference to “S corp” is to a corporation taxed as an S corporation. These entities are easily confused, in part because an LLC can make an S election. In that case, you have a state law LLC taxed as an S corporation under federal law. Why would anyone choose to do that? In many cases, it is the business owner’s desire to avoid strict state law corporate compliance coupled with the desire for favorable S corp taxation. 

Each business has its own set of circumstance to consider. Don’t go it alone. We are here to discuss how to properly structure, form, and protect your business. Please give us a call to schedule a consultation today.

Employee Misclassification: The Fine Line between Non-Exempt & Exempt Employees

For as long as the Fair Labor Standards Act (FLSA) has governed the rules of employee classification, the confusion surrounding non-exempt and exempt classifications has continued.  Although many people generally view “non-exempts” as non-managers and “exempts” as managers, the truth is that there is a fine line between the two.  That line often gets employers into hot water and can cost them significantly in terms of fines, back overtime pay, and future Department of Labor (DOL) monitoring.

Defining Non-Exempt & Exempt Employee Status

Before looking at how non-exempt versus exempt status has become muddled, let’s define each. 

Non-Exempt:

Non-exempt employees are generally entitled to minimum wage and overtime and have jobs that do not meet the requirements of the FLSA’s exemption tests: 

  • Minimum Wage.   Non-exempt employees must be paid the minimum wage or  more.  The current federal minimum wage is $7.25 per hour.  Some states have rates that are higher or lower than the federal rate and employees are entitled to whichever is greater.  If an area has a living wage (a wage that is high enough to maintain a normal standard of living and which is generally much higher than either the federal or state rate), the living wage prevails.
  • Overtime Pay.  Non-exempt employees are entitled to overtime pay (time and a half) for any time worked beyond 40 hours in a given week.  Some states, such as California, Nevada and Alaska, require overtime after working eight hours in one day.  Others, such as Colorado, require overtime pay if an employee works more than 12 hours in one day.
  • Type of Work.  Contrary to popular belief, the type of work an employee performs is not generally a defining factor of a non-exempt classification.  Instead, employers should look at exempt classifications.  If the employee’s duties don’t fall into one of the exempt categories (listed below), then the employee is likely non-exempt.

Exempt:

Exempt employees are not entitled to overtime pay. They generally tend to perform higher-level jobs within an organization that are either executive, professional, or administrative.  To qualify as exempt, certain FLSA tests must be met.

Here’s a look at those tests:

  • The employee must be compensated on a salary basis (as defined in the regulations) at a rate not less than $455 per week;
  • The employee’s primary duty must be managing the enterprise or managing a customarily recognized department or subdivision of the enterprise.
  • The employee must customarily and regularly direct the work of at least two or more other full-time employees or their equivalent; and
  • The employee must have the authority to hire or fire other employees or the employee’s suggestions and recommendations as to the hiring, firing, advancement, promotion or any other change of status of other employees must be given particular weight.
  • The employee must be compensated on a salary or fee basis (as defined in the regulations) at a rate not less than $455 per week;
  • The employee’s primary duty must be the performance of office or non-manual work directly related to the management or general business operations of the employer or the employer’s customers; and
  • The employee’s primary duty includes the exercise of discretion and independent judgment with respect to matters of significance.
  • To qualify for the creative professional employee exemption, all of the following tests must be met:
  • The employee must be compensated on a salary or fee basis (as defined in the regulations) at a rate not less than $455 per week;
  • The employee’s primary duty must be the performance of work requiring invention, imagination, originality, or talent in a recognized field of artistic or creative endeavor.
  • To qualify for the learned professional employee exemption, all of the following tests must be met:
  • The employee must be compensated on a salary or fee basis (as defined in the regulations) at a rate not less than $455 per week;
  • The employee’s primary duty must be the performance of work requiring advanced knowledge, defined as work which is predominantly intellectual in character and which includes work requiring the consistent exercise of discretion and judgment;
  • The advanced knowledge must be in a field of science or learning; and
  • The advanced knowledge must be customarily acquired by a prolonged course of specialized intellectual instruction.

Note:  There are also exemptions for outside sales positions, computer-related occupations, and others which have their own FLSA requirements

Misclassifications Cost Employers Cash

Employers who misclassify employees may be liable for back pay, retroactive benefits (such as healthcare, 401(k), memberships) and more.  The issue can become exacerbated when more than one employee or department is involved, which is generally the case. In fact, it can affect thousands of employees if a national company has wrongly classified employees.

Case in point: Walmart.  The retail giant misclassified 4,500 managers and coordinators as exempt at stores nationwide.  In fact, they were actually non-exempt and were entitled to $5.3 million in penalties, damages, and back wages for overtime violations at stores nationwide.

What to Do Next

As part of our legal services for business owners, we’re happy to guide you in ascertaining whether your employees are exempt or non-exempt as well as provide guidance with other day-to-day business operations matters. Please call the office to schedule a meeting.

Business Trademarks: What’s Really in a Name?

Business Trademarks: What’s Really in a Name?

If you’re thinking of starting a business (or already have a business in the works), make sure that the name you use is not already taken.  Original names are essential for three reasons:  marketing power, clarity, and trademark infringement avoidance.  For example, if you’ve decided to open a coffee shop, it’s fairly easy to determine that the name “Starbucks” is not an option.  But, what about “Smith’s?”  And what happens if the “Smith’s” trademark is an auto insurance company in your town?

What’s Really in a Name When it Comes to Business Trademarks?

Before attempting to trademark your business’s name, find out if the name is available on the U.S. Patent and Trademark Office’s website.  TESS, the Trademark Electronic Search System database, will indicate whether someone else has already claimed the name or symbol you want to use.

  • While U.S. trademark protection is granted to the first company to use it in its operational geographic area (regardless of registration), a company that grabs the trademark first will generally have a stronger case in court.
  • In some situations, the similarities between names or symbols may be negligible. That’s where an experienced business attorney with intellectual property experience can help.

Often, there’s generally a way to accommodate both companies – especially when it comes to businesses with similar names, but dissimilar products (the “Smith’s” example above); those whose geographical locations may not conflict; and those whose names are too generic (for example, “The Clothing Store”).

Domain Extensions as Trademarks

In today’s marketplace, many businesses have both a physical location and an online presence.  The question then becomes whether to trademark the company name (for example, Amazon), the URL (www.amazon.com), or both.  It’s generally recommended that companies with an internet presence not register their web extensions (such as .com, .net, etc.) with their name unless planning to register the mark both with and without the web extension.  The reason is that other businesses registering the same name can do so by just adding a different (non-registered) extension and cause a great deal of confusion for customers.

A prime example is Craigslist.  The multi-purposed classified ad site is technically a “.org” site, but those who searched for craiglist.com or craiglist.net were often led astray.  The company now has trademarks for all, so typing in the latter extensions now brings you to the main .org site.

If you have questions about business trademarks, call our office and we’ll guide you through trademark protections so your business and your efforts are protected.