In nature, all life comes in two forms: plant and animal.
In the marketplace, all business entities are found in two forms: human and non-human. But unlike plants and animals, a human business can morph into a non-human entity.
A human business is a sole proprietorship or a partnership. Of the non-human species, there are three: C Corporation, Subchapter S Corporation (aka, Sub S, or S Corp) and the Limited Liability Company (LLC). All corporations begin as a C, and some, typically small businesses, “elect” to morph into the Sub S structure for reasons revealed in a minute. The LLC is the new kid on the block, only being available for about the past 30 years. It can be a very handy legal structure, but not for everyone.
So, why should your human business morph to non-human? There are at least three excellent reasons:
1. Tax advantages. There was a time when being a Sub S Corp would provide more tax advantages for almost all small businesses. But today, this is a little less true. The most recent tax law, the Tax Cuts and Jobs Act of 2017, has made some larger small businesses rethink their structure for tax purposes with the possibility of electing to drop the Sub S designation and revert to a C Corp. This move is a big decision that must be made with the counsel of highly qualified legal and tax professionals.
2. Legal liability protection. Something called the “corporate veil” provides shareholders of a corporation or members of an LLC with a shield for their personal assets from legal claims against some liability of the business. Talk with your attorney about this.
3. Business credibility. Many customers, especially larger companies, won’t take your business seriously as a vendor unless you have a legal structure.
When should you morph? If your business is very small, you might be able to spend the incorporating expense – $500 to $1,000 – on something more immediately critical, like a computer or marketing. But you probably shouldn’t delay this step for long, and one concern is that you might wait until it’s too late. Here are three organizational and operating triggers that should help you decide when to morph from a human to a non-human entity.
- When you hire the first employee.
- When you enter into any business contract, including a lease.
- When you establish any credit, including with vendors.
Non-human entities do require maintenance to be able to sustain the legal protections and operating benefits. Here are a few critical maintenance tips:
- Tell EVERYONE that your business is formed as a Corporation or LLC.
- Demonstrate the legal ownership designation – Corporation, Corp., LLC, for example – at the end of your business name on all documents, signage, etc.
- Operate the legal entity’s financial business completely separate from personal activity, especially checking accounts.
- Maintain proper, updated corporate documentation, like shareholder and annual meeting minutes
Remember that corporate veil? Think of it as you do your roof: Maintaining both will protect you from dangerous things that fall from the sky, like hail and attorneys.
And finally, a summary of key elements:
- Don’t forget the triggers.
- Be proactive, not reactive, about morphing the legal DNA of your business.
- Keep up the maintenance on your non-human entity.
- Business entity laws vary by state.
Write this on a rock ... Your business is not a plant; you can change its DNA.