Archive for April, 2009

LLCs and corporations are different in more ways than just letter combination. Each derived from different types of laws, and therefore come with significant baggage.

Corporations, owned by shareholders and ruled by a Board of Directors through hired officers, are the result of centuries of entrepreneurs using other people’s money to produce profits. This led to protection of those investors from unforeseen events caused by the entrepreneurs. The Board was developed as an oversight of the operation, to protect the shareholders from unscrupulous managers, and therefore is strictly liable to look after the shareholder’s investment. Like a corporate republic, shareholders are the “citizens” of the company, with one vote for each share of stock they own. They use the total number of shares to vote for the directors they favor to govern the republic.

Boards hire managers to run a company day to day. Although top management is usually on the board as well, prudent shareholders also want independent directors to ensure that the insiders are not putting their interests before that of the owners. Shareholders themselves are forbidden from running the company – that has been delegated to the board members and the management they hire. Shareholders also cannot just walk into their investment’s place of business and grab something off the shelf; they can only receive benefits granted by the managers – primarily the dividends granted from profits generated from the company or capital gains from selling shares of the company at a higher price than what they bought the shares for. Shareholders are not liable for anything done by the corporation beyond the risk of the capital invested (the definition of “limited liability”), in exchange for which the shareholder has no control over the management of the invested company.

The application for authority and what it really means

The filing of an application for authority in a state means that the company is allowed to do business there. The laws that administer how the company is run are unaffected – this is covered by the laws of the state where it is incorporated. However, within the ‘new’ state the company must follow the same rules and regulations as a local company, and generally will pay the same taxes.

To illustrate:

Company A is a New York corporation, Company B is a Delaware corporation. Both are neighbors in an office building in Albany. Company A filed its Certificate of Incorporation with the Secretary of State of New York, has 200 shares with no par value which are issued to one person, who is also the director and the president. Company B filed its Certificate of Incorporation with the Secretary of State of Delaware, then obtained a certificate of goodstanding and prepared an application for authority to do business in New York, filing the goodstanding and application with the Secretary of State of New York.

Each year, the New York corporation and the Delaware corporation will file their corporate tax returns with the IRS and NYS Dept of Tax and Finance, and will have to follow essentially the same tax rules for each. Every two years, they will have to file a biennial report to the New York Secretary of State, listing the Chairman and directors, the address for process and other information. However, Company B will also pay a registered agent in Delaware to provide a registered address within the State, will file an annual report and pay a Delaware franchise tax of at least $100. Each year, the two corporations will be required to hold annual meetings of the shareholders and the directors; however the rules governing these meetings, and what is allowed to be approved and by whom will be different.

Because the laws governing these corporations are different, there will be times these differences matter. For example, after five years, both Company A and Company B have faced difficult times and are looking to close up. The shareholder of Company A, out of money and out of business, is personally liable for the unpaid wages of his employees, while the shareholder of Company B, incorporated in Delaware, is not.

Often we get asked, where should we incorporate? What’s all this about Delaware?

Here’s our rules of thumb:

• If you just have one location, and sell locally, you’re probably best off incorporating in your state, acting as your registered agent. (Standard rule applies, of course: get a good lawyer and a good accountant first, before anything is set in stone.)
• If you are doing business in different states things are no longer so clear, but the rule of thumb changes to: consider incorporating in Delaware. There are several advantages for doing so, among which are a competent legal system of professional judges (hence, consistent rulings that make sense), straightforward laws and very prompt service. A lesser known advantage is that Delaware protects its reputation by demanding that its registered agents be responsible, responsive and honest. If there are any consumer complaints, the Secretary of State will contact the agent to get the issue sorted out.

If you do business in different jurisdictions, or incorporate in a state different from your current location, you will have to file for authority to do business in your state. This document, which may have somewhat different names in different states, registers your company (LLC, corporation, not for profit or whatever type of entity you are) officially, and prevents any other company from using your name in that state.

If a husband and wife are both members of an LLC and file their (US) tax return jointly, are they considered one taxpayer or two? If they are one taxpayer, it would mean that the LLC is a single-member LLC, and therefore a disregarded entity who need only add the LLC’s profits and losses on their Schedule C. If they are considered separate members for tax purposes they are a partnership, and must file a Form 1065 and prepare separate form K-1s.

The answer is: two members for tax purposes and therefore a partnership. There’s important tax consequences for this, particularly related to self-employment tax and the deductibility of health insurance!