by Richard Fonfrias,
J.D. Chicago’s Financial Rescue &
Bankruptcy Lawyer
Fonfrias Law Group, LLC
MISCONCEPTION
#1: I don’t need to be a corporation or
an LLC. They are too expensive.
Wrong!
Business owners often feel that the formal structure of an LLC or a
corporation is only for large businesses.
But, to the contrary, one of an LLC’s or a corporation’s most important
benefits is the way it protects its owner from personal liability.
Let’s say, for example, that your delivery
man has a wreck and kills someone.
Unless you have an LLC or a corporation to protect you from liability,
you and your family are personally responsible to pay damages to that man’s
surviving spouse and/or relatives. That
could amount to hundreds of thousands of dollars — perhaps, even
millions. Scary, isn’t it!
I call a corporation or an LLC “very cheap
insurance” with a single premium.
Why? Because either insulates you
from personal liability for the debts, liabilities and obligations of the
business. Your single premium is the
one-time investment in legal fees needed to organize the corporation.
After you set it up, so long as you use
your corporation properly, you enjoy limited liability. This means that, beyond your investment in
the corporation, your personal assets are not exposed to the liabilities that
will arise in the business.
RECOMMENDATION: Talk with an experienced business lawyer
about the importance of using a corporation or an LLC to protect yourself and
your family from liability.
MISCONCEPTION
#2: If I set up a corporation, my taxes
will increase.
Not necessarily. A corporation is a separate legal entity that
is subject to federal and state taxes on its net income. The tax rates on corporate income are higher
than the rates paid by individuals.
However, conducting your business as a corporation does not necessarily
mean that your company will pay higher income taxes.
Often, careful tax planning from year to
year can dramatically reduce or eliminate net income. Many small businesses pay bonuses to their
owners so the corporation has no income.
These bonuses must be reasonable compensation to the owners for their
services. And, it is important to be
sure that the bonus is not veiled dividends since dividends are not deductible
from the corporate income.
A technique used by smaller corporations
is to choose a Subchapter S election under the tax code. When implemented properly, the Subchapter S
status allows all corporate income and losses to pass through to the shareholders. They, in turn, report the income or loss on
their personal tax returns.
Since many small businesses operate at a
loss for tax purposes, especially in the early years, the Subchapter S election
can actually save taxes for the owners.
These tax considerations present other planning opportunities to the
business owner, as well.
RECOMMENDATION: Talk with an experienced business lawyer who
can help you with tax planning so you use a corporation to your advantage and
minimize your tax liability.
MISCONCEPTION
#3: I own 50% of my company’s stock so I
am protected because I’m in control.
Wrong!
When two people decide to organize a business — whether as a
corporation, LLC or partnership — they often share ownership equally. But, that 50% ownership is not control. Fifth percent is not a majority and, as a
business owner, you can come face to face with many problems that confront a
business and its owners when no one has clear control. 50/50 ownership is nothing more than a
built-in deadlock. Ultimately, a deadlock
can result in the forced sale of your business under court order.
You can avoid this business stalemate in
many ways. The simplest method is to
reserve to one owner more than 50% of the ownership or voting power in business
decisions. Other methods include giving
a third party a small vote to break any deadlocks, agreeing that a greater than
majority vote, such as two-thirds or three-fourths, is necessary for certain
decisions and special buy-sell provisions.
RECOMMENDATION: Talk with an experienced business lawyer
about voting rights and potential deadlocks.
This will help assure the long-term success of your business.
MISCONCEPTION
#4: If I treat my employees as
independent contractors, I can avoid the hassles of payroll taxes.
Not a chance! One common cause of business failure is the
failure to pay federal withholding taxes.
No question, payroll tax reporting is a major headache. And, the hassles associated with the
paperwork are made worse by the added expense associated with the employer’s
contribution for FICA (social security) and Medicare, on top of the actual
compensation paid to employees.
Many employers believe they can simply
treat employees as independent contractors and avoid the requirements of
withholding and the employer’s payroll tax.
Some employers even require employees to sign an independent contractor
agreement.
These misconceptions have led to many
business failures. What’s more, even if
the business is incorporated, business owners are slapped with the personal liability
of paying the payroll taxes that should have been withheld. Plus, the Internal Revenue Service assesses
the added employer’s share of taxes, interest and penalties.
The crux of the matter is this: The employer/employee relationship is
controlled by its substance, not its form.
You cannot change an employer/employee relationship to an independent
contractor relationship merely by calling the employee an independent
contractor.
Some state laws and tax laws are involved
in determining the nature of the relationship.
But the primary test involves determining whether the employer has the
right to control the time, method and manner of the employee’s performance of
his or her duties. If so, the employer
has the obligation to withhold income taxes and pay them to the I.R.S.
Since most employers want to control the
people employed in their business, the vast majority of working relationships
are, in fact, employer/employee relationships.
Unfortunately, in many cases, the determination of the relationship is
delayed and the business or its owners are slapped with taxes, interest and
penalties in future years.
RECOMMENDATION: Don’t try to handle this matter on your
own. The consequences can be serious, to
the point of shutting down your business.
Make sure you get help from a qualified business lawyer so you protect
yourself from this delayed — and severe — tax liability.
MISCONCEPTION
#5: If my partner or employee quits, he
can’t take my business with him.
Wrong again! Your business depends upon its relationships
with your customers or clients. Except
in the case of a sole proprietorship, these relationships are nurtured by each
person associated with the business. And
the people serving the client are working on behalf of the business.
Even though these contacts, contracts and
relationships are the property of the business, a departing employee or partner
is free to compete with you.
We work in a free enterprise economy that
encourages competition. This allows some
of your employees to start working for your competitors — or begin a new
business of their own — expecting to solicit business from your clients and
customers.
Here’s something many business owners don’t
know: The law permits you to place
reasonable limitations on partners and employees in their contracts so they
cannot unfairly compete against you if they leave your company.
RECOMMENDATION: Talk with an experienced business lawyer so
you can protect yourself from ex-employees and ex-partners who can leave your
company and take your customers with them.
MISCONCEPTION
#6: I don’t have to keep records because
I’m just a small business.
Wrong!
Few things are more important to a small business — whether an LLC, a
sole proprietorship, partnership or corporation — than keeping proper
records. All of the ideas in this
Survival Guide will, at one time or another, require business records for
substantiation and proof. In the case of
a corporation, if you hope to preserve your limited liability, you must keep
proper records that prove that you conducted business as a corporation.
Many business agreements are based only on
a phone call or handshake.
Unfortunately, because memories are not perfect, in the event of a
dispute, the parties’ recollections of the terms is always different. That’s why putting all agreements in writing
is vital to your success.
Another reason for accurate record keeping
arises from the unpleasant prospect of a tax audit. When the IRS comes knocking, one of the first
things the agent asks for is a copy of your business and, if you are a
corporation, your corporate records, including a corporate minute book. In most cases, records of corporate meetings
are required to assure that the corporate form will be recognized for business
and tax purposes.
RECOMMENDATION: Talk with an experienced business lawyer so
you don’t risk losing the liability protection afforded by your corporation.
MISCONCEPTION
#7: I’m the business owner so I can pay
my business and personal bills from the same checking account.
You’d better not! Business owners often treat their corporate
bank account as their personal checking account. But if you hope to prevent problems, don’t
fall into this trap.
First, you face the basic tax
problems. Every time you pay a personal
expense from your corporate account the payment is considered either your
salary or dividend. Rest assured, the
IRS will treat the payment as a nondeductible dividend, thus increasing the
taxes your corporation must pay. On the
other hand, if the payment is treated as compensation, the corporation is
liable for withholding and payroll taxes.
Next, you may lose your personal liability
protection. If claims are made against
the business, your commingling of personal and business funds often results in
losing the liability protection afforded by the corporation. In other words, when you commingle personal
and business assets, creditors may be able to ignore the corporate structure
and assess liability claims directly against you and your spouse.
RECOMMENDATION: Talk with an experienced business lawyer so
you handle your personal and business assets properly and don’t risk losing
your corporate protection.
MISCONCEPTION
#8: I can do anything I want with my
business and the minority shareholders or partners (those who own less than
50%) can’t do anything about it.
No way!
The fact that you own over 50% of the stock in your company does not
give you the right to run roughshod or take unfair advantage of the minority
owners.
You must understand that minority partners
or shareholders are entitled to information about the business’s operation,
finances and taxes. Minority owners are
entitled to attend and vote their shares at shareholders meetings, which must
be held at least annually. Then, if a
shareholder disagrees with major business decisions, such as the sale of
substantially all of the corporation’s assets, minority shareholders have the
right to dissent. They can then demand
payment for the fair value of their shares.
And, this may all apply to LLCs, too.
RECOMMENDATION: Talk with an experienced business lawyer so
you keep minority partners informed about the business and avoid unpleasant
legal consequences.
MISCONCEPTION
#9: I don’t need employment contracts
for my people.
Not true!
Even if you have nothing formal in writing, you already have an
employment contract with each employee.
This is because verbal agreements of employment create an employment “at
will”, which can be terminated by either party with or without good cause. Without a written contract, you have none of
the protections from unfair competition discussed in this guide. You have nothing to rely on in a dispute over
compensation or bonus or vacation time.
Don’t you think you would be wise to enter
into a written employment contract, rather than leaving your business
unprotected?
Certainly, this is true with any contract
or business relationship, but even more so when it involves employment.
Your written contract should include the
basics of compensation, duties and service hours. In addition, a properly drawn agreement can
go beyond these basics to include protections for business trade secrets and
prohibitions against unfair competition.
I cannot overstate the importance of these agreements in resolving
future misunderstandings and disputes.
RECOMMENDATION: Talk with an experienced business lawyer who
can discuss how you can protect yourself from liability exposure by having
contracts with your employees.
MISCONCEPTION
#10: My partner and I don’t need a
written partnership agreement.
Wrong!
My comments about employment contracts are even more important to people
in business together no matter what the business form. The basic agreement should address the issues
of compensation, division of profits, allocation of duties and
responsibilities, and control.
In addition, the agreement should also
deal with sensitive issues, such as an owner’s withdrawal from the business and
what happens in the event of an owner’s death.
Not many owners want to be forced to continue the business with the
spouse of a deceased owner. Nor would
they want to be forced to dissolve the business.
A properly written ownership agreement
should deal with all of these issues, and more.
And, you need one whether you are an LLC, a corporation or a
partnership.
IMPORTANT NOTE: If you do not have a written agreement, the
law will apply certain rules to your relationship. Unfortunately, in most cases, these rules do
not reflect the true understanding between the owners. It’s better to have the agreement you want
than to have your business run by the laws of the state.
RECOMMENDATION: Talk with an experienced business lawyer and
learn how a comprehensive agreement can protect you and your family from
unforeseen consequences in your business.
MISCONCEPTION
#11: Non-compete clauses in contracts
are not worth the paper they are written on.
Not true.
Earlier I discussed the fundamental concept of our free enterprise
economy. But free enterprise and
competition are not the same as unfair competition.
When you share with an employee your trade
secrets, business processes, or customer lists, you have the right to protect
yourself. Further, under current law,
you are allowed to limit an employee’s future use of this information, as long
as your limitations are reasonable.
You can use a written agreement to limit
an employee’s ability to solicit a customer’s business for himself or future
employers. These agreements can limit
solicitation only within a specific territory for a certain period of
time.
When the agreements are carefully drawn,
the courts will enforce them.
RECOMMENDATION: Talk with an experienced business lawyer and
discover how you can use non-compete clauses so you don’t lose your customers,
customer lists and trade secrets.
MISCONCEPTION
#12: If my business is a corporation or
an LLC, I won’t ever have personal liability.
Wrong!
You can never get rid of your personal liability. If you perform a service and things aren’t
right, you’re still liable. If you hire
an employee to be your delivery person and they have a serious accident and you
knew he/she has a drinking problem, you can be held liable.
RECOMMENDATION: Talk with an experienced business lawyer and
discover what you can do to protect yourself in such a situation.
MISCONCEPTION
#13: I don’t need a lawyer. I can get my legal forms at an office supply
store.
You probably suspect this already. The basic forms you get at office supply
stores — such as contracts, leases and deeds — are generic. They are not geared to your specific
needs. When you go to the office supply
store, you find that the legal documents are worth exactly what you pay for
them — almost nothing. Sadly, you often
get much more than you pay for in the way of problems, headaches and hassles
because generic forms often cause more trouble than they prevent.
Business owners often ask me when they
should seek the help of a lawyer. My
answer is, “Whenever you cannot afford to lose the amount of money at risk —
and whenever you are absolutely sure you are not exposing yourself to
additional legal liability.”
If you can afford to lose the money — and
if you don’t accept any added risk — then you probably don’t need to see a
lawyer. But if you’re concerned about
the legal consequences of a contract or another legal document, calling an
experienced business lawyer could be the best investment you’ll ever make.
If you make a bad decision that allows an
ex-employee to steal your customers —
If you make a bad decision that allows IRS
to slap you with tens of thousands of dollars in additional taxes —
If you make a bad decision that allows
creditors to invalidate your corporation and hold your personally liable —
…you’ll wish you had called your lawyer
BEFORE making that decision.
RECOMMENDATION: Do yourself
and your family a favor. Whenever you
have a question or concern about your liability, don’t hesitate to call your
lawyer. Without exaggeration, it could
be the best business decision you’ll ever make.