Incorporating a Business

S Corporation OR C Corporation
Many real estate investors find themselves being hammered by advice on what type of business entity to form in order to hold and protect their assets. Two similar entities are the S Corporation and C Corporation. An S Corporation is simply a C Corporation (standard business corporation) that files IRS Form 2553 in order to elect small business tax treatment. The Articles of Incorporation that are filed with the state to set up a C or S Corporation are the same.

Both the C and S corporation are separate legal entities that are created by state action and offer the same limited liability protection. In both cases the owners are not personally responsible for the debts and liabilities of the businesses. In addition, both are required to follow the same formalities; they must hold annual shareholder and director meetings and must keep minutes of these respective meetings.

The major difference between the S Corporation and C Corporation is in terms of taxation. The S Corporation is a pass-through entity. This means that the income or loss generated is reported on the personal tax return of the owners. Their percentage of profit or loss is allocated based on the percentage of investment. Therefore, if two individuals form an S Corporation and each contributes an equal share of capital then the percentage share of profit and loss is 50% each.

A C Corporation is a separately taxable entity. The profits and losses are taxed directly at the corporate level. In addition, the money taken out by the owners or shareholders is considered a dividend and is taxed at the individual level. This leads to the concept of double taxation.

The ownership of an S Corporation is restricted while the C Corporation does not possess these same limitations. The C Corporation can have an unlimited number of shareholders while an S Corporation is restricted to no more than 100. S Corporations cannot be owned by C Corporations, other Corporations, many trusts, LLCs, partnerships or non-U.S. residents. In order for a Corporation to become an S Corporation, it must make a timely election of S Corporation status. The election, which is made by filing Form 2553, must be made within 75 days from the date of incorporation.

In the world of corporate entities, the new kid on the block is the Limited Liability Company or LLC. An LLC is a separate legal entity created by state filing, offers limited liability protection, and for tax purposes is a pass-through entity. While the ownership of an S Corporation is restricted the LLC posses more flexibility. An LLC can have an unlimited number of members (owners). In addition, other corporations, many trusts, LLCs, or partnerships can be members of an LLC.

An S Corporation does have a few advantages over an LLC. One person can form an S Corporation, while in a few states at least two people are required to form a LLC. An LLC typically has a limited life span and most states require that an LLC list a dissolution date in its articles of organization. In addition, certain events such as the death or withdrawal of a member can cause the LLC to dissolve. The stock of an S corporation is freely transferable while the ownership of an LLC is not, in most cases the approval of the other members must be received.

An LLC may be managed by its members or by selected managers. If the LLC is to be managed by its members, it operates much like a partnership. Each member has an equal say in the decision making process of the company. If the members choose, they may elect a manager or managers to act in a capacity similar to a corporation’s board of directors. These managers are in charge of the affairs of the corporation. Lastly, the division of profit and loss in an LLC can be allocated independently of capital investment unlike an S Corporation.

Irregardless of the entity that one chooses for his or her assets please follow these simple rules:

*Don’t Put All Your Eggs in the Same Basket.  Create a different entity for each asset, so if you are sued, all your assets are not wiped out. 

*Be very cautious of General Partnerships A general partner can commit the partnership to any legal contract; whereby all general partners are jointly liable.

*Never Ignore a Lawsuit.  People are sued almost everyday for frivolous matters Even if it seems frivolous, if you are served or threatened with a lawsuit, get legal advise immediately.  Even if the case is groundless, you could spend big bucks just proving that.

*Keep Adequate Insurance.  One of the more valuable conditions of a good policy is that the insurance company must provide your defense in the event you are sued.

*Develop a Plan.  Take time to understand what you have, what you can lose and what the best way to protect it is.  Be sure to find out what assets are protected by your state law.

*KeepControl. An asset protection plan should be structured so that you never get into a position where another person can manipulate your assets