Bob Schrader, Esq.

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Which is better if you are self-employed an S corp or LLC?

S Corporations and LLCs provide the same liability protection!

Ignore gurus that say either an S corp or LLC is better.  Your situation is unique.  For limiting your liability and protecting your assets, both an LLC and an S corp give you the same level of protection.  Just remember to maintain the formalities (as noted last week).

Ignore the marketing and urban myth that it is better to establish in a particular state, such as Delaware, Nevada, Wyoming, etc..   Those states offer no additional liability or asset protection.  Plus, if you are not located in that state you now have to register and pay additional fees for the ‘foreign’ business to operate where you are conducting business.  Remember the KISS principle.

So which should you use?

LLCs are better if the primary purpose is holding rental property or better documentation and operation of a partnership.  Limited Partnerships have other specific benefits we’ll address in a later post.  If you operate an S corp and want to create a new venture, product or brand but don’t want to complicate your taxes, a single member LLC owned by the S corp is an ideal way to establish a separate entity for the business without requiring a separate tax return.  LLCs are your default if any of the owners of the business are corporations, not US Citizens or legal permanent residents including foreign owners, or otherwise do not qualify for the S election.

Taxes

A corporation can elect tax treatment as a partnership by filing the Subchapter S election (IRS Form 2553)  and then becomes an S corporation.  This avoids the ‘double taxation’ of a “C” corporation – first paying taxes on net income at the corporate rate and then shareholders pay capital gains tax on remaining profits received as dividends.  An LLC may elect to be treated as a corporation or a partnership (S election) for tax purposes.  So both seem to offer the same tax benefits.  However, there is one tax aspect often overlooked, Self Employment tax.

The Self-Employment Tax Trap

If you ever received a pay check you know the taxes deducted – currently 6.2% for Social Security & 1.45% for Medicare.  These amounts represent 50% of those taxes paid by you.  The employer pays the remaining 50%. When self-employed you are responsible for the entire 15.3% (12.4% SS & 2.9% Medicare) tax.  This SE tax applies to ordinary net income of sole proprietors and LLC owners as well!  Ordinary income is income from the sale of products, services, commissions and short-term real estate income (attention AirBnBers).  If you have a profit after deducting your operating expenses the SE tax applies to the entire amount.

An S corp can significantly reduce the amount subject to the 15.3%  SE tax.   For an LLC all net operating income is subject to SE tax.  With an S corp the owners can take a ‘reasonable’ salary (W-2) while protecting a significant portion of net income from SE tax by reporting it profits through the Schedule K-1.  You only pay SE tax on the amount of your salary (W-2).  ‘Pigs get fat, hogs get slaughtered.’   You must take some salary if you are profitable.  Don’t abuse this or the IRS may visit!

You want your salary as low as possible to limit SE taxes but it must be reasonable.   There is no hard and fast rule.  A common rule of thumb is pay yourself about one third of the profits as salary, protecting 2/3 of the profits from SE tax.  The percentage should change based on the total net operating income.  If you are only making $20,000 net income, a reasonable salary may be $10,000 (50%).  If your net operating income is $100,000, then a $10,000 is probably unreasonable – a 30 – 40% allocation may be more reasonable.  If you’re killing it netting $300,000 or more in net operating income, a lower percentage 10-25% is probably reasonable.

Important: Consult with a CPA or accountant to determine the appropriate wage level for your situation!

What if I haven’t taken a salary for 2017?

It’s not too late!  You should immediately consult with your CPA or accountant.  There is still time to pay yourself a salary and pay applicable SE taxes over the next two months.

If you are just starting out you should seek sage legal and business advice NOW!

Please sign up for my newsletter for more details on DIY ways to keep your business legal and when to call the professionals. Feel free to email me if you have any questions or topics you would like me to address here.

Until then, Keep it Legit!

Bob

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Do you know what documents your business must prepare every year? No, it’s not your taxes!

End of year tax planning is happening.  Are there any year-end legal documents you need for my corporation or LLC? Yes, and most entrepreneurs and business owners overlook these.  Don’t wait 112 years to ‘renovate.’

As an owner and entrepreneur you probably operate your business through an S corporation or limited liability company (LLC). Hopefully you relied on professional advice in choosing and establishing the business to ensure it best suits your needs.  LLCs are over hyped and generally an S corp is better suited and provides all the protections touted for LLCs with easier maintenance and operations. Next weeks’ post will delve into that and risk of self-employment tax for LLC owners.

The two primary factors for entity choice are personal asset or liability protection and tax benefits. Regardless of whether you relied on a professional or risked DIY, it is important to understand that after you establish your entity, you are not done!  There are ongoing record keeping requirements that can cause the loss of liability protection and tax benefits!  You must keep take these steps initially, annually, and sometimes more frequently to maintain the protections provided by a corporation or LLC.  These apply no matter where you established your business.

The greatest risk most owners and entrepreneurs face is known as ‘piercing the corporate veil.’ Regardless of what entity you use, corporation or LLC, or if you are the only shareholder or member, failing to maintain the corporate formalities creates substantial risk. The ‘corporate veil’ is the legal concept that the entity is separate from the owner(s). This is why someone suing the business can only collect against the business assets and not your personal assets. It also enables the preferential tax treatment of an S corporation or LLC. When a business fails to maintain the required corporate records, a plaintiff can seek to ‘pierce the corporate veil’ and go after your personal assets. Failure to maintain corporate records can also allow the IRS to ignore the business and treat you as a sole proprietor, removing certain deductions and creating liability for failure to pay self-employment and other taxes and eliminated possible deductions.

So, how do you avoid this and protect your assets and hard work? It is relatively simple to set up a system to ensure you have taken all steps necessary. This is also why it is advisable to have an attorney establish the entity for you, as they will ensure the required documents are properly prepared.

After establishing the entity, your corporate records should include Bylaws and Organizational Minutes tailored to your needs, and a shareholders agreement if more than one owner. If you own an LLC, at a minimum you must have an Operating Agreement.

Here is the critical point most business owners miss! Even if you have the organizational documents every year, like filing taxes, there are corporate maintenance steps you must take.  Obviously, filing the annual report and paying the annual fee to the state where you are established and where registered to do business is required.  The step most owners forget is strictly internal – an annual shareholders or member meeting. You should record minutes from the meeting that evidence any resolutions and affirming actions taken in the year.  Also, if you have not had monthly or quarterly Board of Director’s meetings, you should have an annual meeting, with recorded minutes kept in the corporate records.  How do you know when you are supposed to have those meetings?  That should be outlined in the Bylaws.

You are might be thinking, ‘I’m the sole shareholder’ or “I own a single member LLC’,  do I really have to have a meeting?  Yes!  Even if you are the sole owner, you must maintain the formalities.  Obviously, you don’t need to send yourself the required notices of board of director and shareholder’s annual meeting, but you should retain Board of Directors meeting minutes and at least a Written Resolution each year by shareholders and Directors in your corporate records.

What goes in the Board of Director and Shareholder or Member meeting minutes?

This is where having tailored bylaws is important. You must ensure that you have the required quorums and majorities for votes. If sole owner, then this is not applicable. You should note consideration and approval of any major events such as large business purchases, major contracts and leases, hiring or terminating key employees, adding new owners or investors, loan agreements, etc. Most lenders will require resolutions, but even if don’t, these should be noted in the corporate records.  For Board of Directors meetings, these should be done as scheduled in the Bylaws, and at least annually.  Shareholder/Member meetings are normally held annually.

This is what proves the business is a business and not just an ‘alter ego’ to the individual – even if you are the sole owner.

Holy Cannoli Bob, I haven’t done this for the last 5 years! What do I do now!

Fortunately, it’s not beyond repair. You should consult with an attorney that can help you prepare appropriate minutes and resolutions affirming the past actions of the owners and officers and bring your business back into compliance to provide its full liability protection and tax benefits.

Sign up for my newsletter for more details on the DIY ways to keep your business legal and when to call the professionals.

Until then, Keep it Legit!

Bob

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Do your Terms of Use and Privacy Policy links on your website protect you?

It depends on the purpose of your website – information, marketing, landing page, e-commerce, subscription, etc. You might need more.

The Terms of Use, Terms of Sale, Subscription Agreement, Privacy Policy, etc. are all contracts you ask visitors to your site to accept. Legally, they are classified as either “clickwrap” or “browserwrap” agreements. How binding are they?

A browserwrap agreement is typically a hyper link to your Terms of Service, Terms of Use, Privacy Policy,etc. Your customer is not required to read or acknowledge before they access your website, you can not prove they read. It puts them on notice of your policies, sometimes. Do you have them hidden away in the footer with a bunch of other links? A brick & mortar analogy is a sign saying ‘All sales final, no returns,’ ‘local checks only’, etc.

Clickwrap agreements take it a step further. There is a box you must affirmatively check. This active action by the user is an acknowledges that they read and agree to the terms of the contract (even if they didn’t actually read them). You are familiar with these and courts generally uphold them as binding. From weakest to strongest they include: a box you click saying “I agree” with a proximate hyperlink to the terms; a box containing the terms you scroll through followed by an “I agree” button, and box containing terms that you must scroll through to the end before you the “I agree” click box becomes live. Note that in all of these, there is still no requirement that you actually read the terms. Regardless of whether you have read, once you click “I agree” it creates a binding contract. The brick & mortar analogy would by your typical contract, purchase order, etc. that you sign. In both cases whether you read or understood it is generally irrelevant.

Two of the most litigated provisions in online agreements are Venue and Mandatory Arbitration clauses. Venue dictates where any lawsuits must be brought – you obviously want this where you are based. Mandatory arbitration is common because it is less expensive, usually confidential (less negative PR) and less likely to result in huge damage awards.

Tips – what should you do?
To make your Browserwrap agreements stronger:
The links are prominent (highlighted, bold, larger font, etc.) and on every page. Don’t bury them at the bottom of the footnote.
A disclaimer that continued use of your website binds them to the linked agreement is placed near each link.
The links go directly to the agreement. Recommend that it be a PDF available for your customer to download, save or print the agreement.
Use plain English in the agreement – good lawyers can draft easy to understandable agreements. (Yeah, that’s a throwdown!)
Use the same font as rest of the site, no fine print (make it smaller). Like traditional contracts, critical clauses should be bold, capitalized or otherwise highlighted
Links on shopping carts, payment / personal information pages are conspicuous and proximate to the Buy, Subscribe, or Checkout buttons.

To make your clickwrap agreements stronger:

Require the user to check a box or button clearly labeled I Accept or I Agree before they can purchase, subscribe, download, or take further action.
Offer an I Decline option, which takes them back to home page, exit page or pop-up.
Provide the agreement, or a highlighted hyper link, proximate to the I Accept button
The links go directly to the agreement. Recommend that it be a PDF available for your customer to download, save or print the agreement.
Use plain English in the agreement – good lawyers can draft easy to understandable agreements. (Yeah, that’s a throwdown!)
Use the same font as rest of the site, no fine print (make it smaller). Like traditional contracts, critical clauses should be bold, capitalized or otherwise highlighted
Links on shopping carts, payment / personal information pages are conspicuous and proximate to the Buy, Subscribe, or Checkout buttons.

It will cost you much less to have an attorney prepare a strong contract (Terms of Use, Privacy Policy, etc.) than to litigate a vague DIY agreement. Never just copy these agreements from another website, you are infringing their copyrights and creating more liability for you rather than reducing it!

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10 Startup business questions checklist. Have you answered these?

You’re ready to launch!   You designed your domain, blog or website designed, and are ready to start your online empire.  Before you do, here make sure you have considered these 10 basic steps for startups and establishing your online business, limit your liability, protect your assets, and keep your business legit. 

Is someone else using my business name? 

This really is your first step even before deciding what type of business structure you will use.  If you don’t properly research the availability of the name you want to use for your business, product or service, you may find yourself the recipient of a cease and desist letter from someone owning the trademark on your wonderful new business name!  If the name is available, you want to protect your rights and keep others from using your name. 

Should I use an S corporation, LLC, C corporation, or something else?

One of the most critical steps is to decide what type of entity to use for your new business.  You must consider your long-term goals for the business, plus the legal and tax benefits of each business structure.  There are substantial differences in limitation of liability between operating as a sole proprietor, limited partnership, “C” Corporation, “S” Corporation, “B” Corporation, not-for-profit 501(c)(3) corporation, or LLC.  If you are based outside the US, you have the same considerations but different structures. 
 
To pick the right entity, you need to understand how each may limit liability and protect your personal assets, the ability to take on new investors, sell shares, or even issue an IPO.  The tax consequences for each are substantially different.  Also, what are your plans for retirement accounts, passing the business onto your heirs, exit strategy, etc?
 
You can set up your corporation, partnership, LLC, etc. in a matter of minutes online through your state’s corporate office (names vary by state), by completing the forms and paying the required fee.   That alone will NOT protect you.  The biggest risk of being sued personally and losing your personal assets is failure to comply with corporate formalities – what you have to do AFTER you set up the business.  You should invest in retaining an attorney to advise you on the best entity for your business, ensure the ancillary forms and formalities are properly prepared and develop a system to ensure you file required documents annually.

Do I need a Privacy Policy.  

This is not an option!  If you do not have a privacy policy, you are exposing yourself to criminal and civil liability!  A privacy policy assures your website visitors that you are operating a professional and legitimate business. 

“Can I just copy the policy from FB, etc.…”  NO!  If you cut and paste the privacy policy from another website, whether it’s Google or Joe’s Online Rare Orchids Bookstore, you are violating their copyrights.  Yes you can find free templates and cobble together your own, but are you sure it addresses everything that is required?

Do I need Terms of Use or Terms of Service?

Like the Privacy Policy, this is not an option! Terms of use, whether a browserwrap agreement or clickwrap agreement, is the contract between your business and your visitors, whether they become customers or not.  Just like the Privacy Policy, not having a Terms of Use, or having an inadequate Terms of Service, can expose you and your business to criminal and civil liability.   For some businesses, you need a ‘clickwrap’ option, to provide greater protection and proof that your customers agreed to your Terms of Use.

Should I file a Trademark or Copyrights for my name or product?  

There are common law trademark rights and Federal registered trademark rights (denoted by ® ).  They are different.   Registration of a Federal Trademark is based on the first use in commerce principal.  Without proper due diligence you could file a Trademark Registration with the USPTO and have it denied because someone was using the name before you, even if they did not register the name with the USPTO.  This is why it is important to conduct name clearance due diligence, not just with USPTO, but state corporate registries and online searches for common law trademark usage.
 
Copyrights belong to the creator of the work – picture, drawing or writing.  You cannot simply cut and paste text from other websites, or use images available on the internet, without prior permission.  Similarly, it is always a good idea to provide a copyright notice on your website.  Even the basic “Copyright 2017 All Rights Reserved” puts the world on notice that you are claiming the copyright in the information contained on your website.  

My domain name was available, do I need anything else?

Just because you can register your name as a domain, does NOT mean you can use the name for your business or product!  You need a full name search and clearance before you buy domain names or establish your business entity.

Who can I email?

The Federal Trade Commission (FTC) regulates business advertising in the US and publishes numerous guidelines on their website that also apply to online retail and e-commerce websites. (FTC advertising guidelines). You also should understand the requirements of  CANSPAM and other regulations regarding unsolicited emails.  Be sure your subscription emails and newsletters provide the required opt-in and opt-out language and links.

Do I need to encrypt my website?

If you maintain any information from your customers, clients, users, etc. be sure your website is encrypted to protect information and ensure you do not have any data breach.

Do I need an attorney to do this or can I do it myself? 

Honestly, some things entrepreneurs safely can do themselves.  Do you have the experience to do it correctly?  What are the costs of a mistake?   Sign up for my newsletter for more details on the DIY aspects of keeping your business legal and when to call the professionals.
Until then, Keep it Legit!
 
Bob