Q: Is it possible to change the type of organization my business is?
A: Yes, it certainly is. For example, my book publishing business started out as a sole proprietorship. Later, I converted it to a corporation. Initially, the corporation was an S corporation; then I changed it to a traditional corporation in order to build up assets within the corporation at a lower tax rate.
I later changed it back to an S corporation, and then put the shares of stock inside a Massachusetts Business Trust, which was a relatively obscure trust entity that allowed me to skip the double taxation in Massachusetts. Just before I sold the business, Massachusetts disallowed the Massachusetts Business Trust, essentially doubling overnight the tax I was required to pay when I sold the assets of the business.
There may be significant tax liabilities incurred in changing the structure of your firm, but a knowledgeable CPA or tax lawyer should be able to help you either avoid or minimize that liability.
Also, if you eventually sell your corporation, the tax situation can get very messy if you have changed legal structures. For example, when I sold Adams Media I had to hire an outside valuation firm to substantiate the value of the company several years before, when a key change was made to the legal structure.
If you switch to a corporate structure to protect against a specific legal action, you are unlikely to protect yourself from the ramifications of any incidents that occurred shortly prior to your incorporation.
Q: Can my corporation buy stock in other corporations?
A: A corporation can buy stock in other companies. It can borrow money from banks or conduct any type of financial transaction permitted an individual. Note, however, that an S corporation may not own more than 80 percent of another corporation.
Q: Can I loan money to a corporation that I own?
A: Yes. One of the advantages of formally loaning money to a corporation that you wholly own is that you will have a greater chance of recouping your money as a debtor than as a shareholder should the company experience difficulties.
Another advantage is that you can pay yourself interest that is tax deductible for the corporation. Remember, though, that you have to pay taxes on the interest. The interest you charge should be at market rate at the time of the loan.
If your loan balance is too high and your equity investment is too low, the IRS can reclassify part of the loan as equity, and your interest payments will become nondeductible dividends. You can pay yourself a salary as well. Make sure that it is within reason. If the tax authorities consider it to be excessive, they will restate the “excess” salary as a dividend and tax it as both corporate and personal income.
If you think that either your loan to or salary from your company is tipping the scales, check with a qualified tax advisor.
Q: Can I buy assets in my own name and then lease them to my corporation?
A: Yes. This is usually done for two reasons. One is for tax purposes. If you own assets such as machinery, buildings, or vehicles, they may be depreciated. Depreciation, under most circumstances, allows you to reduce your tax bill. Check with your accountant to see whether your current salary and non-salaried income levels allow you to qualify for income offsetting depreciation under the latest tax laws.
Another reason to personally own assets is to protect them from seizure should the corporation get into trouble. Also, if the personally owned asset is real estate, for instance, you will personally realize the profits from any appreciation in value. Remember, though, if you own the assets, you are in a personally liable position.
Leasing assets to your own corporation is one way to get money, other than salary, out of the corporation. There are special tax rules, however, that prevent you from using leasing as a method to avoid the “passive loss rules” in the tax code.
Q: Is it easier to dissolve a partnership or a corporation?
A: Legally, it is easier to dissolve a partnership. Remember, a partnership is merely an agreement between two or more people. A corporation, however, is a distinct legal entity. Dissolving it will require a modest expense.
The biggest hurdle in dissolving a partnership is arriving at an agreement with the other partner or partners regarding distribution of assets and liabilities and who, if anyone, will continue to run the business.
If you see your business as having a limited life with low risk you should run it as a sole proprietorship. If you are short on funds, try borrowing from friends before forming a partnership.
Q: Will forming an LLC or a corporation really keep my personal financial assets protected if my business goes bust?
A: Not necessarily.
For example, if you are an officer of the corporation and your company defaults on payroll taxes or sales taxes you could be held personally liable. Note that with payroll or sales taxes you are collecting them as a fiduciary responsibility for the government, unlike income taxes, which are more or less a debt the corporation is incurring.
Also, in extreme circumstances, a creditor might be able to “pierce the corporate veil.” For example, if the corporation violated the law and did not buy required worker’s compensation insurance, an officer of the corporation could be held responsible for an unpaid medical claim. Or if as an officer of the corporation you committed fraud, such as in applying for a bank loan, you could be held responsible for the unpaid loan.
More commonly, though, the founders of small corporations risk their personal financial assets in the course of operating a corporation by personally guaranteeing the debt or bills of a corporation. This is because the bank is going to look for a personal guarantee of the founder of a small start-up if it is an LLC or a corporation, assuming the bank is willing to loan money at all. You may have to be in business for five or 10 years and be making a lot of money before the bank will even consider dropping this requirement. Also, some key suppliers or vendors may demand a personal guarantee to grant you credit initially, or to continue to grant you credit if your business is experiencing some difficulty.