We recently spoke to Ken Creighton who is Of Counsel at the commercial law firm, Guild, Gallagher & Fuller, Ltd. in Reno, NV. He handles business formation, capital raising, employment matters, and serves as an arbitrator for the Financial Industry Regulatory Authority (FINRA). Creighton has been practicing law since 1985.
Creighton provided a detailed update on current issues with business formation:
The initial responses to the pandemic, in the form of stay-at-home orders and shutdowns, sent shockwaves through the business community and capital markets. But as things began to open up a bit, we have seen a modest uptick in new business entity filings. It is a credit to the resiliency of entrepreneurism.
There are many reasons to use a formal entity to operate your business. Two principal reasons are to minimize: i) individual liability, and ii) your tax burden. We suggest retaining not only a lawyer to draft the appropriate organizational documents, but also a tax advisor to determine the most effective tax strategy. What works for one under a corporation format may not work well for another.
The Three Principal Entity Formats
The three principal entity formats are:
i) Limited Liability Company (“LLC”)
ii) Corporation (and its variant the Subchapter S corporation)
iii) Limited Partnership.
The Limited Liability Company (LLC)
The LLC has become the most popular choice. This is largely due to its flexibility and its tax treatment as a partnership (“pass-through”). There is no taxation to the business. Corporations have become somewhat more popular in recent years because of the 21% effective tax rate, but this is bound to change under the new Federal Administration. While LLCs are creatures of statute, as are corporations and limited partnerships, there are far fewer statutory requirements and restrictions for LLCs. Much of the detail in an LLC is left to the parties who contract their rights, duties, obligations, and benefits through an operating agreement. This agreement is a combination of by-laws and a buy-sell agreement. It is confidential and not filed with the state filing agency (Secretary of State in most jurisdictions).
A C-Corporation’s negative is double taxation. First, the corporation is taxed on its profits, and its shareholders are taxed on any distributions (dividends, for example). An S-Corporation is treated as a partnership for tax purposes and therefore avoids the double taxation conundrum. But a limitation here is that there can be no more than 35 shareholders. Clearly, this will not work for a large public company or even for a smaller company that intends to raise capital from more than 35 investors.
Which choice of entity is the right one? Some of this turns on the purpose of the business venture. The most common business entities for real estate investors, for example, are the LLC or a limited partnership. Either provides some legal protection against individual liability and affords pass-through tax treatment – all income, deductions, etc., are passed to the individual members/partners. Some use a hybrid where an LLC serves as the general partner of a limited partnership and the individuals are limited partners.
Regardless of the form you choose, be sure to involve legal and tax professionals to properly organize your entity. If you would like additional information, please feel free to contact us or Guild, Gallagher & Fuller, Ltd.
Schultz Financial Group Inc. (SFG) is a wealth management firm located in Reno, NV. Our approach to wealth management is different from many other wealth managers, financial advisors, and financial planners. Our team of fee-only fiduciaries strives to help our clients build their wealth across four capitals: Financial Matters, Physical Well-being, Psychological Space, and Intellectual Engagement. We provide family office and wealth management services to clients located in Nevada, California, and other states. If you’d like more information, please check out our website or reach out to us via our contact page.