Masonry Magazine November 2004 Page. 40
Legal Issues
Selecting the Proper Business Entity:
The Importance of Doing It Right the First Time
John J. Matteo, Esq.
Jackson & Campbell, P.C.
Inc., Corp., P.C., LLC, PLLC, RP, LLP, RLLP, CCorp, SCorp-no, this is not a secret code from the Pentagon, and you're not looking into a bowl of alphabet soup. These are just some of the abbreviations for the types of business entities that are commonly used to own and operate a business. Getting through the maze of state and federal laws can be frustrating for individuals who are good at what they do and want to run a profitable company, but don't have the time or interest to get bogged down in legal jargon even before their first dollar is in the door. Selecting the appropriate legal entity for your business before you hang the "Open for Business" sign on your door can avoid legal hassles and more importantly can save you thousands of dollars in taxes and other expenses in the future.
So the question is: What is the best entity for the construction industry, and what are some of the basic legal issues facing these companies?
Partnership or Corporation?
Traditionally businesses were owned by a sole owner and called a sole proprietorship. If there were more than one owner, then the business was deemed a partnership. The advantage of this is that if owners had profits from one business and losses from another, they could use the losses to offset the profits, thus resulting in lower taxes. The great disadvantage of this structure is that if business owners faced any type of liability (e.g., accidents on their premises, construction injuries, workers causing injuries to others, unpaid debts, etc.), then the business owners' personal assets were subject to attachment to satisfy the obligation. In other words, if there were a construction accident and the construction business owners were found to be at fault, the injured party could seek payment from all the owners. If they couldn't afford to pay the obligation, their personal property (e.g., homes, cars, bank accounts) would be at risk, even though the personal assets were not part of the business. The law's response to this dilemma historically has been the corporation.
A corporation is a legal entity that is formed by filing Articles of Incorporation usually in the state in which the company's primary place of business is located. The Articles set forth the purpose of the business, its address, the name of a resident agent who receives any official notices on behalf of the corporation, and the number of shares of stock the corporation is authorized to issue. The great advantage of a corporation is that it is a legal entity separate and apart from its owners. Unlike with a sole proprietorship or a partnership, liabilities of the corporation do not result in any risk to the owners' personal property because the corporation is a separate entity.
The governing document of a corporation is its bylaws. The bylaws of a corporation set forth how the corporation will operate, the roles of the different officers, the composition of the Board of Directors, and procedures for election of officers and directors. State law requires that there be at least an annual meeting of the stockholders of the corporation and the Board of Directors, and most states require an annual filing with a nominal fee to remain in good standing. Sounds perfect, right? Wrong.
One problem with corporations is a risk that the corporation and the owners will be subject to what is commonly referred to as a "double level of taxation." This means that, on one hand, when a corporation makes profits, it is taxed on that revenue; meanwhile, when that profit is distributed to the owners, the payment is considered a dividend and the individual receiving it will be taxed as well. Also, if the corporation experiences losses, the owners are not able to use those losses on their individual income taxes to offset salary and other revenues they receive. Seems like a no-win situation, right? Wrong again.
The federal tax code provides a solution, though not a perfect one. The code provides that a corporation can make what is commonly referred to as a Subchapter S Election (Sub S). It gets its name from the section of the tax code and provides that a small business (less than 75 owners) can elect to be treated as a non-entity for federal tax purposes.