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DECEMBER 21, 1999

SMART ANSWERS
By Karen E. Klein

S Corps and LLCs: Shields for Your Personal Assets
Choose carefully. The type of business structure you opt for will have significant tax consequences


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Q: I am an engineer and computer scientist who would like to start a recruiting business that serves software companies on the Internet. But I'm concerned about liability. What business structure would best protect my husband's and my nest egg in case of a lawsuit or bankruptcy? Can I still own property, stocks, etc., or should all my assets be placed in my husband's or my daughter's name?

---- G.V., Irvine, Calif.

A:A: Isolating one's assets and savings from the risks of owning a business is the primary reason for creating a formal entity for your company. Once you choose a business structure that shields your personal assets, there is no need to insulate your nest egg further by putting those assets in someone else's name. In fact, such transfers can create their own problems because they tend to look suspicious, says Neal B. Jannol, a business and estate-planning attorney at the Los Angeles law firm of Riordan & McKinzie.

Both S corporations and limited liability companies (LLCs) will provide you with "limited liability," meaning that if someone sues your business, plaintiffs could only the seize the assets of the business, Jannol says. If the business goes bankrupt, the creditors of the business will not be able to sue you personally. Any stocks, bonds, and mutual funds that you have in your own name would be protected from a judgment against the business, assuming you did not intentionally commit fraud in the conduct of the business (i.e. you are not entitled to limited liability if you use a corporation or LLC to defraud creditors).

It's relatively simple to set up an S corporation or LLC. Both structures are among the most common for small companies, in part because they allow you to avoid paying taxes twice on profits — at the corporate level and again at the personal level, when you distribute those profits to yourself. Still, experts always advise you to get an attorney's help to file the proper forms and decide which business structure best suits your needs. Each type of corporate structure (there are others besides the S corp and LLC) has significant tax implications — some of which will be important as soon as your company starts bringing in money, and others later on in the life of your company. It's possible to change structures as your business needs evolve.

There have been a couple of recent changes in California law that may affect your choice of a structure, says Jeffrey A. Unger, a Beverly Hills-based real estate and business attorney. The first, effective Jan. 1, 2000, allows LLCs to have one member (or owner), which makes it much easier and simpler for sole proprietors to form LLCs. The old LLC law in California required at least two members.

The second change may be even more significant for your purposes. A new California law, AB10, enacted last July, waives the minimum franchise tax (normally $800 annually) for two years for companies that incorporate in the state between Jan. 1, 2000, and Jan. 1, 2001. The waiver doesn't apply to limited partnerships or LLCs, only to corporations. "It's an awesome law that was passed in order to attract new business to the state," Unger says. The California Franchise Tax Board estimates that approximately 18,500 new corporations will benefit from the incentive. The franchise tax waiver is particularly valuable when you start your company (before it becomes profitable) because you normally owe the tax whether you're making profits or not (unlike income taxes). If you structure your California company as an LLC, you'll pay an additional franchise tax (on top of the $800) based on gross receipts. Unger explains: "LLCs pay $800 annually, plus an amount that ranges between $865 — if you're grossing $250,000 or more annually — and $7,785, if you're making $5 million and up. So if your company becomes at all successful in sales, you'll be paying a large chunk every year based on your gross — even if your company records no net profit."

That said, there are other considerations that might make an LLC the preferable structure, particularly if your company is likely to own real estate. Unger advises you to consult with an attorney familiar with small business first. Assuming an LLC isn't preferable, he suggests that you wait until after Jan. 3, 2000, and form your company as an S corp to take advantage of the franchise-tax waiver. "You'll save $1,600 over two years, and thereafter you'll pay $800 annually without regard to your gross sales," Unger says.

You can get more information about LLCs and corporations on the Internet. The California Secretary of State's Web site (www.ss.ca.gov) is a good starting point for general information.



Have a question about running your business? Ask our small-business experts. Send us an e-mail at smartanswers@businessweek.com, or write to Smart Answers, BW Online, 6th Floor, 2 Penn Plaza, New York, NY 10121. Please include your real name and phone number in case we need more information; only your initials and city will be printed. Because of the volume of mail, we won't be able to respond to all questions personally.

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