An Entrepreneur’s Question on an S Corporation:
“Today, I am a sole proprietor and have a general partnership agreement with my wife. I’m not sure of the right form but think I need a real simple corporation, maybe an S corp. I do not think I’ll ever raise capital or have more than my wife as a partner. I operate this company to make a living. I might sell it down the road but to someone who wants to do the same thing. My biggest concern is that I want to protect myself. Could you please help me figure out the right type of company to set up?”
You are headed in the right direction. By setting up a corporation or limited liability company (LLC) and properly maintaining it, you will have the limited liability protection and separation that will keep your company’s creditors away from your personal assets. Your house and other personal assets will not be available and at risk to cover the liabilities of your business. In addition to this legal entity protection, you should consult with an experienced insurance broker in order to make sure that your business activities are adequately insured.
For the closely-held consulting business that you describe, an S-corporation likely would be a good entity choice for you to consider. You should consult with your tax advisor for the final say on these issues, but the S-corporation can pay a reasonable salary to you and it then can distribute any additional profits to you as a dividend distribution. If structured properly, the S-corporation will allow you to manage your employment tax liability more effectively. Another alternative would be to form an LLC, but the LLC generally will not provide the same employment tax benefits as the S-corporation. Also, in certain states such as California, the LLC is not available for certain professional activities such as law, medicine, etc.
Even though the primary objectives of your company is to earn a living and provide liability protection, a properly structured corporation also can serve as a vehicle to help finance your business activities (e.g., by selling shares) if the need arises, or sell the business in the future (e.g., through a stock sale or merger transaction).
Lastly, to save some money on state filing fees and ongoing state taxes, you should plan to incorporate in the state where your business is located. You certainly can decide later to change the domicile of your corporation to another state for corporate governance or financing purposes. But for now, keep the corporate formation process easy and simple and incorporate in the state where you run your business.
Please let us know how you have set up your company (or plan to set up)and please share any “dos” or “dont’s” with other startup entrepreneurs, so they start their companies in the right way.