Assets, Taxes and the Business Structure

By Barbara Coenson
Attorney at Law

When the entrepreneurial spirit hits and business plans are formed, selecting the right business structure can be as important as location, financing, and customers. If you are starting a new business or own an existing one, you should consider the impact your business structure will have on your assets and taxes. By choosing the right business structure, you can protect your personal assets from business creditors and reduce your tax liability.

Are Your Assets Protected?

The type of business structure you choose will determine if your business will protect your assets. Many small businesses operate as a sole proprietorship, which offers no protection of personal or business assets. If you have a sole proprietorship, a business creditor can claim your personal assets and a personal creditor can claim your business assets.

For example, a condo owner sues Ed Jolly Handyman after Ed damages the condo while painting. Ed’s sole proprietorship will not protect Ed’s personal bank accounts, investments, and vehicles if the court enters a judgment against Ed. The condo owner could acquire Ed’s personal assets.  

One way to protect your personal assets from business liabilities is to form a corporation. Creditors of your corporation will not have access to your personal assets unless you, as an individual, personally guarantee a loan or credit line issued to your corporation. The assets owned by your corporation are safe from claims by your personal creditors; however, your personal creditors can claim your shares in the corporation. Thus, your personal creditors could end up owning your corporation.

For example, Lisa owns all the shares of Lisa’s Flowers, Inc. Lisa, while driving to the grocery store, hits another car. The driver of the other car sues Lisa for injury and damage caused by the accident. Lisa must pay a $150,000 judgment. If Lisa cannot pay the judgment from personal assets, she may lose her shares in Lisa’s Flowers, Inc., to the other driver.

Another business structure that offers asset protection is a limited liability company (LLC). Similar to the corporation, a creditor of your LLC will not have access to your personal assets unless you personally guarantee a loan or credit line issued to your LLC. Also, similarly, your personal creditors will not have access to the assets owned by your LLC. Your interest in your LLC may be subject to a creditor’s lien; however, unlike the corporation where the creditor can claim your company shares, a personal creditor cannot receive your LLC interest unless you receive distributions from the LLC. A creditor can claim only what is distributed. You can protect your investment by your LLC not making any distributions; however, this may cause a hardship if you rely on those distributions as your primary income source.

For example, Juan invests $50,000 and owns 50% of J & P Hardware, LLC. Juan is sued as an individual for non-repayment of a personal unsecured loan. Juan’s creditor issues a charging lien against Juan’s $50,000 investment in the LLC. The creditor will not receive the $50,000 as long as it remains in the LLC. If the LLC issues a distribution to Juan, the creditor will receive the distribution.

A limited partnership protects assets similar to an LLC.

Can Your Taxes Be Minimized?

You can minimize your taxes with an S corporation or LLC. S corporations and LLCs are both tax pass-through structures, which mean that the owners report the company’s net income on their individual tax return and pay their ordinary tax rate. The pass-through structures are desirable for business owners who want to avoid the double taxation of a C corporation. A C corporation pays taxes on its income. The shareholders pay taxes on the same income when the corporation distributes dividends.

For example, Paula is a shareholder in a C corporation named Home Stuff, Inc. The corporation pays taxes on $130,000 profit earned in 2007. After taxes, the corporation distributes the profit as dividends to shareholders. Paula receives $20,000 in dividends. Paula pays taxes on the $20,000 she receives.

An S corporation offers an additional tax benefit. As an owner of an S Corporation, you can save on employment taxes by taking some distributions as salary and some as dividends. Salary is subject to a 15.3% FICA tax. Dividends are not. By limiting your salary, you limit your FICA tax liability.

For example, Donald is an accountant starting his own firm. By structuring the firm as an S Corporation, he can pay himself a low, but reasonable, salary and, at some point, pay himself dividends. The dividends are not subject to FICA; thus, Donald would save the 15.3% tax on the dividends that he pays on his salary.

Starting a new business is exciting, but requires much forethought and attention to details. If you are starting a new business, or own an existing business, it is important to examine how your business structure could impact your assets and tax liability.

Lake Mary Life, 2007

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