Business Structures - Part II

© John J. Tormey III, Esq. All Rights Reserved.

This article is not intended to, and does not constitute, legal advice with respect to your particular situation and fact pattern. Do secure counsel promptly, if you see any legal issue looming on the horizon which may affect your career or your rights. What applies in one context, may not apply to the next one. Make sure that you seek individualized legal advice as to any important matter pertaining to your career or your rights generally.

Part I of this article discussed the process of selecting a new name for a business. Many people choose to incorporate or form an LLC, so as to minimize their personal liability for the debts and obligations of their business. There is cost to forming an entity, but the cost is often worth it. What follows is a brief discussion of "personal liability", and the types of entities that may be available.

2. Choosing an Entity.

A full description of all the differences between an S-Corporation, a C-Corporation, and a limited liability company (LLC) would be beyond the scope of this article. Besides, the distinctions are often altered - some would say "blurred" - by changes in the Internal Revenue Code and local laws. Even by the time this article is read, further changes to relevant tax laws may have been made, affecting the entity choice. The bottom line is that a choice of entity should be made upon current information only, with the assistance of a lawyer and an accountant. To do it any other way is to risk making a bad choice that one will later regret, especially when the first or successive company tax returns are filed.

The distinctions between an S-Corp, C-Corp, and LLC make sense when taken in the historical perspective. Look at them as the product of a kind of Darwinian evolution. In that vein, the S-Corp and C-Corp may someday become but historical artifacts, while the LLC could become the only "fittest" to "survive". The LLC may be the best choice of entity - if affordable, and if one is not otherwise precluded from forming it by virtue of one's home state's current restrictions on LLC's.

At some point in history it was realized that persons involved in businesses could be thereby putting their own personal assets at risk. That principle still applies, by the way. If one runs an unincorporated or non-LLC business out of one's house, that business owner may risk later losing that same house to the debts, liabilities and obligations of one's business. This is what "personal liability" is all about. A business owner wants to avoid personal liability, at all costs. The owner wants to shield its assets, like a house and a personal bank account, from the risks of the business. For these reasons, understandable and common to all humanity, the concept of a corporation was first formulated, many years ago.

The traditional and old-fashioned form of corporation in the U.S. still exists as of this writing - in the form of the C-Corporation, named after a "Subchapter-C" in the Internal Revenue Code. When properly filed and maintained, the C-Corp shields the business-owner/principal from personal liability. For example, if there is US$10,000 in the C-Corp's corporate bank account, then, in theory, only that US$10,000 amount can be used to satisfy a civil (court) judgment against the corporation - even if the President and sole shareholder of the corporation has an additional $50,000 in his/her personal bank account. A "wall", "shield", or "veil" is put up between the two sets of assets.

But the C-Corp posed historical problems, principally that of so-called "double taxation". Those C-Corp owners filed corporate tax returns as well as individual tax returns, and were thereupon disheartened to find out that they were subjected to an extra tax hit. The C-Corp would be taxed on corporate earnings. In addition, the shareholders could also be taxed personally on monies withdrawn from the corporation by way of dividends. The net effect wasn't always necessarily a 100% increase in otherwise-prevailing tax (as the somewhat-misleading phrase "double taxation" might otherwise suggest). But, on the other hand, the monies generated by the C-Corp were required to filter through two "layers" of taxation as opposed to one.

In this regard, a number of business owners realized that they would have oddly been better off from a tax perspective if not incorporated - a bizarre result if there ever was one. Some persons thereupon decided to simply not incorporate (or "un-incorporate"), and thereupon take the oft-significant risk of individual liability so as to minimize taxes. If continued, one would expect the rate of commercial litigations and personal bankruptcies to rise as result, an event which in no way would be in the public interest. Other persons instead opted out of corporate and business ownership entirely.

The next installment of this article will address how society responded to the growing dissatisfaction with the C-Corp - namely, the creation of the S-Corp and the LLC thereafter.

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My law practice includes the field of entertainment. If you have questions about legal issues which affect your career, and require representation, please contact me:

John J. Tormey III, PLLC
217 East 86th Street, PMB 221
New York, NY 10028
(212) 410-4142 (phone)
(212) 410-2380 (fax)