Whether to Incorporate of Form a Limited Liability Company

In the life of many small businesses, the questions usually arise: Should I incorporate my business? Should I form a limited liability company (LLC)? What are the pros and cons? As a lawyer, clients often ask me these questions. Knowing the advantages and disadvantages can help a business owner make the best choice.

Many businesses benefit from forming a corporation or limited liability company. The decision usually turns on two factors: (1) limiting liability and (2) tax planning. A business may decide to incorporate or to form a limited liability company (L.L.C.) for these reasons.

First this article will address corporations. Incorporating a business properly limits the personal liability of the business owners. If there is a claim against the business — for example, if a customer is injured or if a customer/vendor claims the business didn’t fulfill its contract — the most the owners of a properly formed corporation can lose is their investment in the business. By comparison, owners of unincorporated businesses (sole proprietors and partners) can lose their personal assets (residence, car, personal savings, etc.) in addition to losing their investment in the business. Incorporating properly avoids that big risk.

To obtain the desired limit on personal liability, the corporation must be set up and maintained properly. If it isn’t, a judge will let a claimant “pierce the corporate veil” and still reach the owners’ personal assets. In order to find a proper corporation, a judge will require the following:

  1. Proper paperwork to set up the corporation, e.g., Articles, Bylaws, and Organizational Minutes. A lawyer can assure this is done properly.
  2. Proper ongoing paperwork, e.g., annual meeting minutes.
  3. Corporate funds kept separate from personal funds, and a paper trail to show when and why funds have gone from owner to business or from business to owner.
  4. Adequate “capitalization,” which requires some explanation.

Adequate capitalization means having enough resources between corporate assets and insurance to cover most claims that could reasonably be expected against the business. Good insurance coverage for the risks inherent in a particular type of business will go a long way to meeting a judge’s requirements for adequate capitalization. Some types of businesses are more likely to have large claims and therefore need more resources to be adequately capitalized than other types of businesses. The idea is that an owner cannot create a corporation that is a mere “shell” and still escape personal liability.

Tax planning is the other factor in deciding whether to incorporate. An accountant can compare tax rates with or without incorporating. An accountant can help a business owner decide whether he can reduce payroll taxes by taking some profits from the business as “dividends” rather than as salary; dividends are available to owners of corporations, but not to sole proprietors or partners. Many businesses have a tax savings when they incorporate. If the business will become a corporation, an accountant can advise owners whether they will be better off tax-wise being a “C” corporation or an “S” corporation. The difference is how the corporation is taxed. A C corporation pays its own taxes, whereas an S corporation passes profits and losses through to the tax returns of the individual owners (called “pass-through taxation”). Pass-through taxation can often save small business owners some tax expense.

A Limited Liability Company (or LLC for short) is another option for setting up a business. An LLC is a mixture of the rules and benefits of corporations and partnerships. It is like a corporation in that it allows owners (called “members” rather than “shareholders”) to limit their liability to the amount they have invested in the business, so that owners’ personal assets are not at risk. Like a Subchapter S corporation and like a partnership, an LLC can give the owners “pass-through” taxation, meaning that the businesses’ profits and losses are taxed at the owners’ personal rates rather than at a (usually) higher corporate tax rate. Since not everyone can meet the rules for qualifying as a Subchapter S corporation (e.g., limits on the number of shareholders, requirement that S corporation shareholders be U.S. citizens), an LLC will allow those business owners to end up with a similar type of business structure.

An LLC is like a partnership in that there is flexibility to divide profits between owners many different ways. For instance, equal owners in a corporation must divide profits equally, but equal owners in an LLC or partnership may agree to divide the profits so that some owners receive more or less than others, for example, where one owner has devoted more time to the business than another.

It is important that an LLC be set up properly. This involves filing Articles of Organization with the Secretary of State, and having an Operating Agreement that accurately reflects how the LLC will be managed.

Depending on the nature of your business, an accountant may be able to recommend whether an LLC or a corporation gives you tax advantages. That may be the deciding factor whether to form an LLC or a corporation. An LLC can be preferable in some circumstances for the following reasons: (1) A judgment creditor of a member can only access money that would be distributed to the member, and cannot take ownership of the member’s share (whereas a judgment creditor of a corporate shareholder can take the shareholder’s shares), (2) It is easier for an LLC to distribute profits some way other than ownership interest percentages (e.g., 50/50 owners who agree to a 60/40 division of profits for some reason), or (3) One cannot qualify as an S Corporation, but one desires pass-through taxation (e.g., if one owner is not an American citizen). Remember that corporations have existed for many decades, so there is certainty in the rules such as how corporations are taxed, and what rights owners have among themselves. LLCs have only been around since the 1990s. There are some unsettled issues about LLC taxation and about their owners’ responsibilities as to each other, which can be a disadvantage. That uncertainty may or may not outweigh the advantages of an LLC, depending on the other circumstances present.

Each business client’s needs are unique. Attorneys and accountants can help you decide which type of business organization is best for your business.

Job Protections for Returning Military Personnel

Q: What job protections exist for military reserve and National Guard personnel returning from active duty?

A: With recent events in the Middle East, many reservists and National Guard personnel have been called to active duty. Fortunately, some are beginning to return home. A federal law called the Uniformed Services Employment and Reemployment Rights Act of 1994 (USERRA) provides job protection and prescribes rules that all employers and all reservists and National Guard personnel must follow.

USERRA applies to all employers, regardless of size. It applies to all military personnel who have served and been honorably discharged from the uniformed services and those who currently serve in the Reserves or National Guard. The Act prohibits discrimination by employers because of past, current or future military obligations. Its protection extends to hiring, promotion, reemployment, termination and benefits.

An employee is entitled to reemployment after active duty if (1) the employee has given advance written or verbal notice to the employer, (2) the cumulative absences for military service do not exceed 5 years, and (3) the employee reports back to the employer within a set time after returning from active service. The employer can require reasonable documentation of the employee’s military orders as active duty begins. After military service, the time to report back to the employer depends on the length of active service, varying from 8 hours (when returning from active duty of less than 31 days) to 90 days (when returning from active duty of more than 180 days). If the employee is prevented from reporting to the employer within the required time through no fault of his/her own, the time will be extended.

In general, the employee must be returned to the job position and seniority he/she would have held had the employment not been interrupted by active service. USERRA protects employee benefits. For shorter military absences, employers must continue health insurance on the same terms it does for other employees. For military absences between 31 days and 18 months, the employer may require the employee to pay up to 102% of the full premium under the plan. Pension plan rights and contributions under ERISA plans must continue as if the employee had not been absent for military service. An employee on military leave does not continue to accrue additional vacation or sick time while on leave, unless the employer allows employees on other types of leave to accrue vacation or sick time.

USERRA does not require employers to provide paid leave during military absences. If an employee wishes to use his/her earned vacation or personal time off during his/her military leave, the employer must allow it. However, an employer cannot require the employee to use his/her earned vacation or personal time during military absences.

The spirit of USERRA is to treat the employee engaged in and returning from active military service fairly and to prevent discrimination. The rules of USERRA help both employers and employees know what to do and what to expect.

Legal Protections for Military Service Members

In December, 2003, the Servicemembers Civil Relief Act (SCRA) was enacted to update the Soldiers’ and Sailors’ Civil Relief Act (SSCRA) of 1940. The new act clarifies the old law, updates it to reflect changes in American life since 1940 (e.g., the existence of car leases), and includes judicial interpretations handed down in the meantime.

The SCRA improves upon and broadens the legal protections given to military servicemembers. Like its predecessor, the SCRA is intended to allow active duty military personnel to perform their duties without undue interference or distraction from legal or financial difficulties.

Here are the highlights of the SCRA:

  • Upon a servicemember’s request, a court must grant a stay of all hearings, for at least 90 days. Additional stays are in the judge’s discretion.
  • Interest rates (including fees and service charges) are capped at 6% per year. Interest above that rate must be forgiven, not merely deferred. To receive this benefit, the servicemember must request the reduction in writing, including a copy of his/her orders, no later than 180 days after returning from service. On a case-by-case basis, a court may allow a creditor to charge more than 6% per year interest if the court finds that the servicemember’s ability to pay more than that rate is not materially affected by reason of military service.
  • Vehicle leases entered before service can be terminated by the servicemember if he/she is called to active duty for a period of 180 days or more.
  • Residential leases can be terminated by active duty soldiers who receive permanent change of station orders or who are ordered deployed for at least 90 days.
  • Eviction protection for military families is extended. Under SCRA, evictions from rental housing are prohibited when the monthly rent does not exceed $2,400 per month, unless a court finds that the military service does not materially interfere with the servicemember’s ability to pay this obligation.
  • Mortgage foreclosures shall be stayed upon application by a servicemember. A foreclosure, sale or seizure of the property shall not be valid if made during, or within 90 days after, the period of military service, except by court order or by agreement. Anyone who knowingly causes a foreclosure, sale or seizure of property to be made in violation of SCRA is guilty of a misdemeanor.
  • Real or personal property owned by a servicemember (individually or with a spouse) may not be sold to collect property taxes, unless a court determines that military service does not materially affect the servicemember’s ability to pay the tax.
  • If a servicemember is personally liable for a debt for his/her business, his/her personal assets that are not related to the business are off-limits to the creditor during the military service.
  • A servicemember can waive SCRA’s protections in writing during or after the period of military service (but not before).
  • SCRA makes clear that its provisions extend to National Guard members who are called to active duty for 30 days or more pursuant to a contingency mission specified by the President or Secretary of Defense.

The SCRA reflects a renewed appreciation for what our military servicemembers do for all of us. In recognition of the many sacrifices made by the servicemembers who protect and defend our nation, the SCRA removes some of the financial and legal worries they would otherwise face back home.

What is the “Family and Medical Leave Act”?

This article is a Q&A on the Family and Medical Leave Act. While space does not permit explaining all of the details of the Act, the column explains general answers to some common questions.

What is the Family and Medical Leave Act?

The Family and Medical Leave Act (FMLA) is a federal law, enacted in 1993. Its purpose is to allow employees reasonable unpaid leave to care for a new child or for a serious health condition affecting the employee or his family, while accommodating employers’ reasonable needs.

Who is covered by the FMLA?

It applies to employers with 50 or more employees, so many smaller businesses are not covered.

Which employees are eligible?

To be eligible, the employee must have worked for the employer for at least 12 months (but not necessarily 12 consecutive months), AND the employee must have worked at least 1,250 hours during the year prior to the start of the leave (which is more than half-time but less than full-time).

What type of leave is allowed?

An employee can have up to 12 weeks of unpaid leave during a year. An employer can require that an employee take all of his paid leave (vacation or sick time) first, as a part of the 12 weeks, and then provide the remainder of the 12 weeks as unpaid leave. This means that an employee cannot tack vacation or sick leave onto the twelve-week unpaid FMLA leave. With an employer’s consent, an employee can take leave intermittently or by having a reduced work schedule.

What events qualify for FMLA leave?

Any of the following: (1) birth of a child, (2) adoption or foster care placement of a child, (3) caring for a spouse, son, daughter, or parent with a serious health condition, or (4) the employee’s own serious health condition that makes the employee unable to perform his job functions. There are rules defining a “serious health condition.” Examples of conditions that are usually “serious health conditions” are cancer, stroke, asthma, diabetes, incapacity due to pregnancy, and injuries or illnesses requiring inpatient care. Common routine conditions like colds, flu, injuries requiring only emergency room care, and minor ulcers would not qualify.

What happens to an employee’s health insurance while on leave?

The employer must maintain the same health insurance benefits as if the employee were not on leave. The employee must continue to pay his usual share of the premium, and the employer must continue to pay its usual share, if any.

Is the employee’s job protected?

Except in unusual circumstances, like key executives or serious hardship for the employer, the employee has the right to return to the same or equivalent position. Upon return, the employee must receive equivalent pay, benefits, and working conditions he had at the start of the leave. Employees do not usually accrue seniority while on leave.

What kind of notice and documentation can the employer require?

If possible, the employee must give the employer 30 days’ advance notice of a request for leave. If advance notice is not possible (e.g., injury, sudden illness), the employee should notify the employer as soon as possible. The employer can require a certification from the doctor about the need for the leave. To return from leave, if the leave is due to the employee’s own incapacity, the employer can require the doctor to certify (as to that condition only) that the employee can return to his duties.

These are the general rules on basic FMLA requirements. There are many exceptions and details that may make a difference on how FMLA applies in any given case. If you have questions about the particulars of FMLA, contact an attorney or call the Department of Labor.

2411 Old NC 86, Hillsborough NC 27278 | Phone: 919-732-7300 | Fax: 919-732-7304 | Wordpress site design by LeGa Design Group