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.

I Need to Hire Someone for My Business; What Do I Need to Know?

I Need to Hire Someone for My Business; What Do I Need to Know?

The goal of most businesses is to grow – at least somewhat.  However, in order to grow or to be able to step away from the business for a personal life, vacation, or other ventures, you’ll need help with day-to-day operations.  If you’ve never hired someone before – or it’s been a long time – don’t worry – here’s the information you need to get started.

Comply with Federal & State Regulations

Hiring a new employee means complying with federal and state regulations.  Although the following list may seem long, it won’t be a daunting process when you have our assistance.

Here’s an overview of what’s generally required.  You are invited to check out the U.S. Small Business Association (SBA) or call our office for assistance. We commonly walk businesses like yours through the hiring process.

  • Obtain an Employer Identification Number (EIN). Often referred to as an Employer Tax ID or Form SS-4, this nine digit number is issued by the S. Internal Revenue Service (IRS) and used when paying taxes or reporting information to state agencies.
  • Keep Records. The IRS requires employers to keep the following employment tax records for at least four years:  1) federal income tax withholding, 2) federal wage and tax statements, and 3) state wage and tax statements.  Additional records may be required.

See the IRS Employer Tax Guide and the IRS State Government Website links for specifics.

  • Verify Employee Eligibility. All employers must verify an employee’s eligibility to work in the United States.  This is done via the I-9 form that can be obtained and filed online or completed using the paper form.  Verification must be completed within three days of employment and kept on file for three years.
  • Register with Your State’s New Hire Reporting Program. All employers must report new and re-hire employees to their state’s New Report Hiring System.  The U.S. Department of Health & Human Services (DHHS) publishes a list of state new hire reporting websites.
  • Obtain Workers’ Compensation Insurance. All employers must carry workers’ compensation insurance when they have employees.  The insurance can be obtained through a commercial carrier, through their state’s workers’ compensation program, or on a self-insured basis (where the employer assumes the financial risk for providing benefits to employees).
  • Post Required Notices.  Employers must display posters in their workplace that inform employees of their employer’s responsibilities and employees’ rights.  For example, you must use posters identifying federal and state minimum wage (Fair Labor Standards Act, “FLSA”), equal employment opportunity (“EEO”), and safety (Occupational Safety & Health Administration, “OSHA”).
  • File Your Taxes. Employers who pay wages are generally subject to taxes and income tax withholding, Social Security, and Medicare taxes.  The specific form(s) needed depends upon the facts and circumstances of your situation.

Be sure to discuss your situation with our experienced business law attorneys to make sure you’re in federal and state compliance.  Failing to do so could result in unnecessary fines, fees, and litigation.

Retirement Planning for Business Owners

Retirement Planning for Business Owners

For many employees, saving for retirement is usually a matter of simply participating in their employer’s 401(k) plan and perhaps opening an IRA for some extra savings.

But, when you’re the owner of a business, planning for retirement requires pro-activity and strategy. It’s not just the dizzying array of choices for retirement accounts, there’s also planning for the business itself. Who will run the business after your retirement? Additionally, your estate plan must integrate into your retirement and business transition strategy.

Owners of businesses (like employees and everyone else) want to make sure they will have enough money in retirement. Business owners recognize the value of their businesses, so they are often tempted to reinvest everything into the enterprise, thinking that will be their “retirement plan.” However, this might be a mistake.

Retirement Accounts for Business Owners

Rather than placing all your eggs in one basket, it makes sense to have some “backup” strategies in place. There are many retirement account options open to business owners. Although the number of options can make things confusing, a tax and financial professional can often quickly make a recommendation for you.

For example, you may consider opening a 401(k), SEP-IRA, SIMPLE, or pension plan. This can reduce your income taxes now, while simultaneously placing some of your wealth outside your business. From a financial perspective, these account are tax-deferred, so the investment growth avoids taxation until you retire, which greatly boosts returns. The “best” plan really depends on how much income your business earns, how stable your earnings are, how many employees you have, and how generous you want to be with those employees. You must consider how generous you’ll be with employees because the law requires most tax-deferred plans to be “fair” to all employees. For example, you can’t open a pension or 401(k) for yourself only and exclude all of your full-time employees. When making this decision, consider that many employees value being able to save for their retirement and your generosity may be repaid with harder work and loyalty from the employees.

Depending on how many employees you have, you may even consider “self-directed” investment options, which can allow you to invest some or all of your retirement funds into “alternative” investments, such as precious metals, private lending arrangements, real estate, other closely held businesses, etc. These self-directed accounts are not for everyone, but for the right person, they open up a wide world of investment opportunities. The tax rules surrounding self-directed tax-deferred accounts are very complex and penalties can be incredibly high. So, if you choose to do self-directed investments, always work with a qualified tax advisor.

Outside of your business, you can likely contribute to an IRA or a Roth IRA. This can allow you to add more money to your retirement basket, especially if you’ve maximized your 401(k), SEP, or SIMPLE plan. Like the other tax-deferred accounts, self-directed IRAs are also an option, opening up a broad world of investment options.

As a business owner, you likely have a great deal of control over your health insurance decisions. If you’re relatively young and healthy or otherwise an infrequent user of health care services, consider using a high deductible health plan (HDHP) and a health savings account (HSA) to add additional money to your savings. These plans let you set aside money in the HSA which can be invested in a manner similar to IRAs. At any time after you setup the account, you can withdraw your contributions and earnings, tax-free, to pay for qualified medical expenses. And, after you turn 65, the money can be used for whatever purpose you want, although income tax will need to be paid on the distributions.

Selling or Transferring the Business

Many business owners dream of a financially lucrative “exit” when a business is sold, taken public, or otherwise transferred at a significant profit for the owner. This does not happen by accident – a business owner must first create and sustain a profitable enterprise that can be sold. Then, legal and tax strategies must be coordinated to minimize the burdensome hit of taxes and avoid the common legal risks that can happen when businesses are sold. When a business is sold, the net proceeds can form a significant component of the owner’s retirement. When supplemented by one or more of the retirement accounts discussed above, this can be a great outcome for a business owner.

On the other hand, other businesses are “family” businesses where children or grandchildren will one day become owners. Like their counterparts who will sell their businesses, these business owners must also focus on creating and sustaining a profitable enterprise, but the source of retirement money is a little less clear. In these cases, clearly thinking through the transition plan to the next generation is essential. Although the business can be given to the next generation through a trust or outright, there are also transition options to allow for children, grandchildren, or even employees to gradually buy-out the owner, if the owner needs or wants to obtain a portion of the retirement nest egg from the business.

The Importance of Estate Planning

Regardless of which retirement accounts (401(k), SEP, SIMPLE, IRAs, HSAs) you select, it is wise to integrate them into your estate planning. You’ve probably already considered who you want to take over your business after you retire (perhaps a son or daughter or a sale to a third party). For your retirement accounts, an IRA trust is a special trust designed to maximize the financial benefit, minimize the income tax burden, and provide robust asset protection for your family. These trusts integrate with the rest of your comprehensive estate plan to fully protect your family, provide privacy, all while minimizing taxes and costs.

Leverage the Team Approach

Let us work with you, your business advisors or consultants, your tax advisor, and your financial advisor to develop a comprehensive retirement, business transition, and estate planning strategy. When we work collaboratively, we can focus on setting aside assets for retirement, saving as much tax possible, while freeing you to do what you do best – build your business!

Give us a call today so we can help you craft a retirement, business transition, and estate planning strategy.