Before
You File Your Corporation or Limited Liability Company (LLC): 5 Things
to Consider!
By: Darius M.
Barazandeh, Attorney at Law / M.B.A.
POINT # 1: Many
investors believe that they can create a limited liability company (LLC)
or file a corporate charter with the state and always have liability
protection. This is SIMPLY NOT TRUE. The truth is that each of
these business entities (the LLC, the corporation and even the limited
partnership) require certain key steps after the structure is
created. I always like to compare business entities to a fancy
Italian sports car or a new baby…they WILL DEMAND PROPER CARE AND
FEEDING! They are fun on the first day, but you had better know how
to maintain them. You can’t neglect the baby or take the fancy
Italian sports car for a spin without any oil in the engine. If you
do then a disaster is coming! Many new business owners believe that
because they hired an attorney or service to create their new business
entity, the work is done. The truth is that what you do after the
entity is created is most important. There are countless nuisances,
details, traps which must be understood in order to MAINTAIN LIABILITY
PROTECTION.
POINT # 2:
If you plan on going into business
with another investor or what you might call a partner, consider this:
What happens if there is a disagreement? Do you have to sue, do you
use mediation, do you have procedures in place to require efforts to
settle things out of court? What happens if one of the parties in
the business wants to sell their ownership interest? Who will buy
it? What will they sell it for?
HERE IS A TYPICAL SCENARIO:
Assume that you go into business with your best friend Tom. Things
are going great but Tom decides that he needs to spend more time with
his elderly parents. He wants to sell you his part of the business
but you tell him, “Just wait a bit, Tom”. “Things will get
less stressful soon”. He agrees but shakes his head in
doubt. The next day you learn that he has sold shares in the
business to his uncle. You now have a new co-owner. You never
would have started the business if you were going to have to work with
Tom’s uncle. These types of situations can be avoided by
utilizing proper ‘buy back’ agreements between co-owners and
limiting transfer rights. Sadly, most business owners never learn
about these precautions until it is too late.
POINT # 3: For real
estate investors there are always risks when the owner of a property
decides to make repairs on the property or hire someone to make repairs
for them. It does not matter if you have a business structure or
not: A business owner is always personally liable for
negligence. So if you are negligent when you make a repair or
negligently ‘hire’ someone to make a repair, you can be sued
personally. Don’t ever forget these words: “Business
owners can be sued personally for negligent acts”. It’s really
important that you spend just as much time learning about the
limitations of business entities, rather than just hearing about all the
benefits!
Tax
and Asset Protection Choices –
Possible
Contradictions?
POINT # 4: When
trying to choose a business entity: BE WARNED! There are a number
of opinions out there depending on who you ask. I’ll try to make
this really simple so remember the following: You are fighting two
battles. The business and tax structure you choose is your
weapon/protector. WHAT ARE THESE TWO BATTLES?: 1) a tax battle and
2) a liability or asset protection battle. In other words, when you
choose a business structure type (corporation, LLC, limited partnership)
the choice for the real estate investor will depend on the tax issues
which are associated with the business, and how well the business
structure protects personal assets from the activities of the
business. Certain structures can protect the assets of the business
from personal liabilities (please see my article, ‘Corporations and
Limited Liability Companies (LLC’s): Charging Orders and the
Differences in Protection’.
Most real estate investors will go to their
attorney in order to find out which business structure makes the most
sense from a legal standpoint. Usually the main question is, “Mr.
Lawyer or Ms. Lawyer which business structure will protect my personal
assets if my business is sued?”.
Later that week, the same investor also travel
across town to an accountant’s office and ask, “Mr. Accountant or
Ms. Accountant, which business structure will save me the most in
taxes?”.
Notice a few things:
- There could be different answers. Most
attorneys will have a dynamite understanding of the legal issues (in
this instance personal liability protection issues), however they
may not be as informed on the complex tax issues associated with
real estate or other industries. So their answer may be help
you from a liability standpoint, but hurt you from a tax standpoint.
- The same is true regarding the
accountant. They may have great choice for you when it comes to
taxes, but a bad choice when it comes to personal liability
protection. Usually, the biggest trap comes in the form of a
good liability protection choice, but a horrible tax
choice. This is especially true in real estate.
If you ever receive conflicting advice be sure to
understand exactly why it is conflicting. For example, are there
really contradictions or perhaps is the professional giving you legal
advice, but not considering the tax issues. The same is true
regarding tax advice. I like to say that you need to educate
yourself on all the options available and some of the most common issues
and structures that investors like yourself use – day in and day
out.
POINT # 5: All
professionals are not created equally. In order choose a capable
attorney or accountant you need to be able to evaluate them. How do
you do this? An excellent way is to ask them questions which relate
specifically to your business/industry. While some investors have a
pretty good understanding of the tax and liability issues…many do
not. Because of this many business owners choose an inadequate
attorney or accountant for their business. After all how can you
evaluate the accountant or the attorney for you if you don’t
understand all your options? How can you really ask pertinent
questions? How can you evaluate their skill level? How can you
really be sure what they are telling you is up-to-date?
You really need to have some knowledge before you
walk into the plush law or accounting office. It will not only help
you make the right choices, but it can also SAVE YOU MONEY! If the
attorney does not have to create an entire set of forms for you…then
you will save several hundred dollars or more. If you have run your
entity properly and understood accounting rules and IRS requirements,
then there is less work for the accountant to do. With the right
information you can choose the best professional and usually save a good
deal in professional fees. You make your life and their job
easier! Get educated first!
