Why Is This Topic Important to Financial Professionals? This article discusses the benefits and detriments of corporation business structures for use in financial planning.

Advantages

Perhaps the most advantageous reason for the formation of a corporation at the state level is the “corporate veil”—a term of art meaning that corporate shareholders are not held personally liable to the creditors of the corporation for any and all debts of the corporation.  On the other hand, a sole proprietor is personally liable for the debts of his or her business.  If the business incurs significant debts that the business does not satisfy, then the issue arises of who will the creditors pursue for the money?  A traditional corporation is one way to protect personal assets from the liabilities incurred by the business enterprise.

Another advantage of a corporation is the going concern concept.  A corporation, as a separate legal entity from its owners, will not automatically dissolve upon the death of the owner(s), unlike a sole proprietorship.  Succession planning often takes into consideration multiple generations, and the ongoing concern of the business is generally an integral part.

Access to capital is also an advantage of corporate structures.  Generally, investors are more likely to invest in a corporation that is a going concern than a sole proprietor.  Banks and other institutions may have separate lending standards for incorporated organizations.

Disadvantages

The most common concern with corporations for most people is the issue of double taxation.  This occurs when the corporation is required to pay corporate income tax on its profits each year.  Once distributions are made to shareholders, taxes are again levied on the personal income of the stockholder, which includes the distribution.  Therefore, a tax is levied at the corporate level and the personal level on the same income, hence the term double taxation.

To avoid this issue, in 1958 Congress “acted on President Eisenhower’s recommendation” and created a Subchapter S of the Internal Revenue Code.[1] Subchapter S-Corporations (commonly referred to as “S-Corps”) have several advantages for small businesses over traditional corporations (which are known as Subchapter C-Corporations), including the elimination of double taxation.

Generally, the expense to form and maintain a corporation will be higher than costs associated with sole-proprietorships.  Corporate filing fees in the first and subsequent years will be incurred.  As well, the costs related to the accounting and tax preparation will usually be higher with a corporation than a proprietorship.  (Financial planners with an accounting background may provide their clients the accounting and tax preparation services for additional fees).  Also, stockholder annual meetings and recording minutes can add additional costs to corporate structures.

Alternatives

Since there are limitations on the structure of an S-Corporation, most states now offer alternative structures that have several advantages over S-Corps.  These may include Limited Liability Companies (known as LLCs) and Limited Liability Partnerships (known as LLPs).  In general, for an LLC there is no limitation on the number of shareholders or classes of stock such as with S-Corporations.  The S-Corporation Association notes that “the number of LLCs has grown nearly ten-fold since 1995, rising from fewer than 120,000 to more than a million today.”

For a detailed analysis of the tax and non-tax Advantages of a Close Corporation see AdvisorFX Main Library Section 14. Close Corporations G—Professional And Executive Corporations

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[1] S-Corp.org, “S-Corp History” Link.  http://www.s-corp.org/asp/products/product_3_4.asp.  Last Accessed 6/17/10.

Why Is This Topic Important to Financial Professionals? Common estate plans may include a business structure.  Helping clients form and manage structures allows a financial professional to more fully participate in clients’ planning.

Do your clients’ business, income and estate plans include corporate structures?  Generally, a client’s business, income and estate plan will include a corporate enterprise.  When the benefits of incorporation can be understood and maximized, the range of the client’s planning may expand.  To begin, a basic understanding of private corporate affairs is essential.  This should include a general understanding of corporate structures, as well as the steps necessary to form and to administer corporations.

Traditionally, the business will apply for corporate status, file yearly forms and keep certain records.  However, there are other considerations for corporate formation and administration, such as form of the structure, state of incorporation, and the tax status.  Many states also offer at least one form of incorporation such as the Limited Liability Company, also known as an LLC, that may offer similar benefits of corporate ownership while avoiding some of the traditional downfalls, such as double taxation.

Establishing The Legal Structure. It is essential to learn how to incorporate a business in your state, including filings with state departments and with the Internal Revenue Service. There is usually a small state fee for the first year of incorporation which may increase in subsequent years.  Most fees and forms can be filed online through state divisions of corporations, taxation or revenue, or departments of similar name.  The forms are general and usually ask for the principal’s name and address, social security number, business name, address and purpose.  You should also have your client file an SS-4 with the IRS, which is an Application for Employer Identification Number.[1] Once the forms are filed with your state and the Internal Revenue Service, the business is technically open for business.

Clients Stay Here. By providing these services, financial planners have found success in not only dollars, but also client retention.  Ted Robinson, a Certified Financial Planner in New York, notes that this is because the client is forced to take his or her business elsewhere when these services are not offered in-house.  “I can do this,” said Robinson, before he started offering basic incorporation services to his clients.  “Why let business go out the door?” he said to himself.  Further, Mr. Robinson notes, it makes “little to no sense” to pass up lucrative business practices that can be accompaniments to your core business.  Therefore, by doing a little research and offering such basic services as filing forms, new doors have opened for financial planners looking to expand their businesses.

Additional Income and Diversify Sources of Revenue.  Some law firms charge thousands of dollars to incorporate.  However, there is not a law that requires only attorneys to incorporate organizations.  Some do-it-yourself websites list a price of merely $29 plus filing fees.  Nevertheless, there is a middle ground between the expensive legal fees and the cheap do-it-yourself service.  A reasonable fee can be charged for your time plus any costs associated with filing.  Financial planners in general can charge much less than what an attorney would to do the same job.  It is also the case that most states allow for easy access to processing facilities online with departments and knowledgeable individuals that can help over the telephone.

For a detailed analysis of the non-tax characteristics of a Close Corporation see AdvisorFX Main Library Section 14. Close Corporations A—Brief Survey Of The Corporate Form

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] Internal Revenue Service. “Application for Employer Identification Number.  http://www.irs.gov/pub/irs-pdf/fss4.pdf. Last Accessed 8/9/2010.

Why is this Topic Important to Financial Professionals?  Look in most local business journals that report on the formation of new business entities and you will see 95% of new businesses are formed as an “L.L.C.”  This company structure is the primary one for entrepreneurs, professionals, and small businesses.  However, after twenty years of significant usage, many questions about this form of entity are still novel.  The financial professional should be able to explain to a client the basics of the Limited Liability Company.

What is an LLC?

Limited Liability Companies (commonly called “LLCs”) are state statute sanctioned legal business entities.  The business entity is similar to a limited liability partnership except that it has members and not partners (no need for general partners).  Moreover, some states allow for only one member, known as a single-member LLC, an option not available in partnership entities that require at least two partners.  The members can be persons but may be other business entities, such that an LLC can be a member of another LLC.

The LLC can be established and managed so as to offer the benefits of a corporation such as limited liability and continuation after a member’s death, but without the impact of corporate taxation.

What is the benefit of an LLC?

The LLC properly managed provides for the protection of personal financially liability in connection with the business liability.  Proper management generally includes following the annual requirements of corporation law, such as holding an annual directors and members meeting, and recording corporate minute (this will be discussed in future blogticles).

Additionally, the LLC avoids double taxation because of it can elect to be a “pass-through” entity for federal and state tax purposes – like a partnership or a sole-proprietorship is treated.

Also, most LLCs do not have a restriction on the number of members as S-Corps have (albeit rarely will the number of members or shareholders be an issue for a financial professional’s client).  To learn more details and nuances of each business structure see the AUS Main Section 10. Basics Of Business Insurance, A—Forms Of Business Organization.  More detail on LLCs specifically is provided in AUS Main Section 14.1, I—The Limited Liability Company (LLC).

What are some limitations of the LLC?

Aside from the fact that LLCs have essentially developed as a hybrid of older forms of business organizations, and are relatively new in the history of corporation law.  The LLC is not a corporation in the traditional sense of the word.

Sometimes businesses start as an LLC but expand to a point of eventually considering receiving outside equity with the goal of a public offering such as listing on a stock exchange.  The LLC is not suitable for “going public”.  Thus at the stage of soliciting equity investment for a business a client may have outgrown the LLC and should convert into a C-Corporation (a topic that will be addressed in a future blogticle).

The Federal Government allows the business owner(s) of the LLC to choose how the LLC will be characterized for tax purposes.  The LLC may be taxed as a Corporation (both Subchapter C and S), partnership or sole-proprietorship. This process is generally referred to as “Check the Box”.[1] The IRS Check the Box Form is Number 8832[2] and the business owners literally check one of the included boxes on that form and then file the corresponding tax returns.

What are some other uses of LLCs?

LLCs are used in many transactions by high-net worth client.  Sometimes clients use an LLC in place of a trust in the irrevocable life insurance trust (commonly called an “ILIT”) structure.  By example, in a situation where a client wants less restriction on the direction of the assets of the vehicle, the LLC is a more popular choice than the ILIT.  As a result, the LLC has become a common tool for the financial planner.  A detailed discussion of one of these transactions is examined in the AUS Main Section 14.1, I-The Limited Liability Company (LLC). “LLC as an Alternative to a Life Insurance Trust”.

For a detailed analysis of the tax and non-tax Advantages of a Close Corporation see AdvisorFX Main Library Section 14. Close Corporations I—The Limited Liability Company (LLC) http://www.advisorfx.com/articles/f14_1_2_2080.aspx?action=13

Tomorrow’s blogticle will address Accounting for Corporations and Limited Liability Companies and How it Relates to Insurance.

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[1] Treasury Regulations Section §301.7701-3.

[2] Internal Revenue Service Form 8832, http://www.irs.gov/pub/irs-pdf/f8832.pdf.  Last Accessed 7/1/2010.