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How – And Why – To Keep Your Investors in the Loop

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In the excitement of obtaining initial financing, many founders forget about their investors the second the first check clears. Nonetheless, your investors have a vested interest in your business and expect a return on their contribution of cash, time, expertise, and business connections. As such, keeping them informed can help you cultivate a positive, long-term business relationship. Conversely, keeping them in the dark means sowing the seeds of discontentment.

In short, your investors can be the key to business growth – but keeping them in the loop is critical to establishing a symbiotic business relationship that will see your business through major stages of financing, growth, and development.

48 Hours After Closing

Forging a positive relationship with your investors starts immediately after the deal closes. While it may be tempting to immediately announce your first round of financing, hire new team members, sign a lease, or otherwise plow forward in using your new funds, hold off until the money is in the bank and you have connected with your investors. Jumping the gun before the deal is done may make you appear impulsive and mean losing your investors’ trust before your relationship officially commences.

Once the deal is done, remain focused on your stated goals and intentions and avoid moving too far afield of what you and your investors initially discussed. Doing so will ensure that your investors know you will use their money wisely and for the reasons you initially professed needing it.

Periodic Updates

Once the check has cleared and you start using your new funds, commit to keeping your investors updated on a regular basis. A healthy practice is to create an email template that will propagate each month or quarter, providing updates on new deals, customers, revenue goals, and key performance indicators.

Sending updates on a monthly or quarterly basis instills confidence in your investors through predictability and spares them the need to ping you for updates. Not to mention, if they receive regular updates, they will know they’ll hear from you – meaning they have little reason to worry or fear that you are not using their investment wisely. It also helps you build stronger bonds with them: Cover all your bases in an email so that when you have an actual conversation or meeting, you can delve deeper on certain points like brainstorming long-term growth goals.

Here are a few items you may consider including in your monthly or quarterly update.

Statement of Appreciation

Your relationship with your investors is a social engagement and as such, start your correspondence by showing your appreciation for their contributions to your business. Before you dive into metrics, highlights, and KPIs, take a moment to express gratitude for connections your investors helped you make, provide introductions to other industry connections, and offer them feedback or assistance.

Asks

Commit to long-term business growth beyond the investors’ initial capital contributions by drawing upon their industry knowledge and connections. Ask them to help you connect with other business owners, employment candidates, or partner organizations. Additionally, share your recurring business challenges and ask them to offer their feedback, advice, or assistance.

Do not be afraid to take advantage of your investors’ connections in your industry. Although you do not want to abuse this privilege, keep in mind that if your business fails, your investors will be more likely to help you if you can show that you attempted to make the most of their investment and the opportunities they afforded you.

KPIs and Key Metrics

Your investors will want to know how their investments are performing. Offer solid figures and be transparent in sharing how your business is faring. In this section, discuss your cash flow, revenue goals and benchmarks, and long-term growth goals.

Keep this section short and easy to digest: Use a few bullet points and provide supporting data to show improvement in your metrics.

Highlights and Milestones

Share what is going well in your business, not just financially, but in terms of new opportunities and prospects, team growth, leadership opportunities, and your business’ place in the market. Ideally, these milestones will match the goals you set forth in your initial pitch deck during your fundraising round. If you did not include any, create benchmarks and back them up with data.

Low Points

In the spirit of being transparent with your investors, don’t just share the positives: Also reveal the challenges your business is facing, any losses you have sustained, and what you hope to improve in the coming month or quarter.

Your investors are not outsiders: They are your business partners. They may be the first to help you when something goes wrong. Sending out updates builds trust with them and lets them in. It also increases the odds that they will help you when you need it. If you keep them in the dark, they will expect the worse, losing confidence in you and your company.

Expectations

Share what you are looking forward to, such as conferences, plans, goals, and team updates. Additionally, give your investors a forecast of how they may be able to help you in the coming month or quarter.

Stay Organized So That They Do Not Have To.

Archive your correspondence in a separate, shared folder. Your investors are busy people, so they will appreciate having a clear paper trail that saves them from digging through their inboxes to find old messages. In each email you send, include a link to the folder so that they can refer to previous messages as needed.

Informed investors are generally happier investors, and staying organized and proactive will make their jobs far easier. As such, they will be more likely to help you in the future.

Experienced Business Formation Attorneys

Wilson Ratledge assists clients in various aspects of business planning. There are numerous considerations to evaluate before making significant decisions for your business, especially when it comes to pursuing financing and working with investors. Our experienced business law attorneys can discuss your options and help you decide how to manage your business affairs. Contact one of our attorneys today at 919-787-7711.

Joint Bank Accounts: What You Should Know

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A common useful estate planning tool is a joint account, a situation whereby family members jointly hold an account with a “right of survivorship.” This means that when one joint owner passes, the other owner automatically takes ownership of the account funds. Under North Carolina law, these funds generally pass outside of the decedent’s estate. As such, joint accounts can be particularly useful for individuals who hope to help their heirs sidestep the probate process.

Still, the use of joint accounts warrants caution: Family disputes can easily erupt over the use and abuse of jointly held accounts.

A Common Dispute: Ownership of Funds

Although two (or more) individuals can jointly own an account, it does not follow that they jointly own the funds within the account. While this may seem like mincing words, it can seriously impact the proper use of account funds: A court may look askance at certain account transactions if challenged and as such, it is vital to understand who owns what funds in an account.

In these cases, context is key: In determining the ownership of funds within a joint bank account, courts consider factors like:

·  Who deposited funds into the account, and when;

·  The source of the funds (gifts, income, etc.); and

·  The intent of the person who deposited the funds, i.e., did that person intend the funds to be shared, or did he or she deposit a gift check or income for safekeeping within the account?

In some cases, funds deposited into a joint account are deemed shared, for instance, when the account holders are married and the funds comprise shared income. However, in other cases, funds may constitute the depositor’s sole property, for example, if an adult child is helping an elderly mother manage her finances. In the latter case, the mother would be deemed the owner of the funds, even though she shares the account with her adult child.

When Abuse Arises

Unfortunately, issues of ownership are often muddy and can lead to legal disputes.

Consider the example of an aging parent who asks his adult child for help managing his finances and makes her a joint owner on his bank account. Each month, the father’s pension and social security income is deposited into the account, and the daughter uses the funds to pay his monthly bills. However, as the months pass, the daughter starts to add a few extra items for herself to her father’s shopping list and even writes checks to herself from the joint account, erroneously believing that because she is a joint owner named on the account, she has the right to spend her father’s money.

Should the family end up questioning the father’s mental capacity one day, the sister’s conduct may be called into question: Did the father authorize these financial transactions? If so, how much? Did he even know about it? Did he intend for the funds to pass to his daughter by right of survivorship after his death? These types of questions leave family members in the difficult position of evaluating a sibling or parent’s conduct, which can often lead to familial strife and even legal action.

In considering how a joint account has been managed, courts will generally make a fact-intensive inquiry into who owned the funds, whether the funds were used in both account holders’ best interest, and whether the account owner approved of the use of the funds. These questions are particularly difficult to answer when one owner suffers from diminished mental capacity and can strain familial relationships.

Experienced Estate Planning Attorneys

Wilson Ratledge assists clients in various aspects of estate planning. There are numerous considerations to evaluate before making significant financial decisions, like adding a family member to a joint bank account. Our experienced estate planning attorneys can discuss your options and help you decide how to best manage your financial affairs. Contact one of our attorneys today at 919-787-7711 or via our contact form below.

How A Special Needs Trust Can Help Your Family

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special needs trust

Families with special needs members have more options today than ever before. As caretakers age and special needs family members reach adulthood, it’s critical to plan for the well being of all family members. Fortunately, you have many options at your disposal.

Your loved one with special needs may qualify for important government benefits. While it’s important to set funds aside for your loved one’s care, it’s also important to structure the funds in a way that your loved one doesn’t lose eligibility for government benefits.

U.S. and North Carolina law allow you to do just that. If you have a special needs family member, you can create a special needs trust that can help your loved one get the help that they need while they remain eligible for government assistance programs. Here’s how a special needs trust can help your family:

What is a special needs trust?

A special needs trust is when you set property aside in a separate legal entity. One person manages the assets in the trust for someone else’s benefit. The funds are the property of the trust, and the trustee uses them for the good of the beneficiary. The person who manages the assets in the trust is called the trustee. The person who receives distributions of property from the trust is called the beneficiary.

In the case of a special needs trust, the trust exists to help someone who lacks the ability to manage their own finances. Because of a physical or mental disability, the beneficiary needs help providing for their basic needs and managing their finances. A special needs trust is the primary way that families arrange finances to care for someone who is unable to care for themselves.

What can a special needs trust cover?

You can tailor a special needs trust to meet the needs of the beneficiary. The trust can provide for the needs of daily living, or it can provide for supplemental care like vacations, education, vocational training, recreation and more. You may create the trust to be very generic or specific depending on the needs of your loved one.

How do you structure a special needs trust to keep the beneficiary eligible for government benefits?

One of the primary purposes of a special needs trust is to ensure that your loved one remains eligible for government assistance. When you have a loved one who has special needs, there’s a good chance that they qualify for government assistance programs like Medicaid, housing or cash benefits. Medicaid can be a welcome relief for a person who may have unique and extensive medical care needs. When you set up your trust, you want to make sure that the trust doesn’t impact their eligibility for benefits.

If a person receives assets directly in their name, these assets count against them when the government determines eligibility for assistance programs. The government requires them to spend their own funds first before they’re eligible for public help. By placing the funds in a separate trust with a separate legal entity, the funds are not the property of the beneficiary. They don’t count against the beneficiary when the government looks at their assets in order to determine eligibility for assistance programs. A special needs trust is an important way that families can make sure that what they set aside for their loved ones truly goes to help their loved one and enhance their quality of life.

As you prepare the special needs trust, it’s important to pay attention to the language that you use. The trust should state that it provides supplemental care beyond what government resources already provide. You should state that the trust is not intended to provide basic support. Your trust should reference relevant portions of U.S. law that are required to protect government benefits and make your intentions clear.

What if I don’t think my loved one needs government benefits?

Even if you don’t think that your loved one needs government benefits, you never know what might happen in the future. It’s likely a good idea to structure the trust in a way that leaves the door open if they need government help in the future. Special needs trusts are an important and common wealth-management tool for people of all economic groups. An experienced special needs trust attorney can help you examine your situation to determine the best path for your family.

Who can serve as trustee of a special needs trust?

Family members can serve as trustees, or you can work with a professional third party to manage the trust. There are pros and cons to each choice. A special needs trust is often a labor-intensive asset to manage. Family members may quickly tire of all of the work involved in managing the trust. On the other hand, a professional third party may charge fees for their services that can quickly add up.

There may be restrictions on who can serve as a trustee depending on who stands to receive the trust’s funds when the beneficiary dies. If the trustees are the beneficiaries, it might create a conflict of interest. In addition to these options, you might join a pooled trust where you join with other families to pool your resources under one management company. If you use a pooled trust, you still have your separate account, but you share management expenses and fees.

Can the beneficiary fund the trust with their own property?

If the beneficiary plans to fund the trust with their own property, there are a few special things to be aware of. Yes, it’s possible for the beneficiary to fund the trust with their own resources. In most cases, a self-funded trust must provide for reimbursing the government for Medicaid expenditures when the beneficiary dies.

When the beneficiary dies, the remaining trust property goes to the government to reimburse them for their medical expenditures through Medicaid coverage. In addition to the Medicaid reimbursement requirement, a self-settled trust is only an option when the beneficiary is disabled under the government definition of disabled.

How long does a special needs trust last?

A special needs trust typically lasts until the beneficiary dies or the funds run out. You can arrange for additional transfers of property to the trust in a way that doesn’t hurt your loved one’s eligibility for government benefits.

You can structure the trust to provide whatever your loved one might need including vocational training, recreation and vacations, communication equipment, accountants, attorneys and animal service. An experienced estate planning attorney can help you create a trust that meets your loved one’s needs and gives you the peace of mind to know that your loved one is cared for in the years to come.

Financing Your New Business Venture

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Last month, we detailed the entity types you may select for your new business venture. Now, we turn our attention to financing. Once you have selected your entity type, officially organized your new entity, and started gaining customers, how are you going to fund your new venture?

There are two primary categories of funding: through debt, and through equity. In order to pursue the option that is best for your business, it is important to carefully consider the pros and cons of each.

Financing through Equity

Equity financing involves selling an investor a share of your business in exchange for money, connections, or industry knowledge. The two primary types of equity financing are angel investors and venture capital firms.

In order to select the option that is best for your particular business goals, do your homework: There is no easy way to score financing, and seeking the support of an angel investor or venture capital firm is not a get-rich-quick scheme. There are strings attached in both options, so carefully consider whether – and how – you want to cede control of your day-to-day business operations to investors.

In particular, there are three considerations you should weigh when deciding to finance your business by offering equity to an investor:

  • What is the investor’s industry? In other words, what are the types of companies in which this investor typically invests?
  • Based on their investment portfolios, how much cash are these investors likely to give you?
  • What investment strategies will the investors employ for companies like yours?

Carefully considering the answers to these questions will help you ensure that you are choosing a partner who is suited to help your business grow and thrive.

Angel Investors

If you have ever seen the hit show Shark Tank, you are likely familiar with how angel investors work. However, contrary to what popular media may suggest, this financing scheme is rare and patently unsuitable for many businesses.

In short, an angel investor is a wealthy individual, entity, or network that supports new businesses by investing cash, providing connections with other investors or experts in the industry, or by sharing technical knowledge. As such, angels provide value beyond the initial financing.

However, it is a two-way street: In exchange for their investment, angels will seek a share in your business. In negotiating an amount with your investor, be wary of offering too much control in exchange for too small an investment. While it may be tempting to accept a large amount of cash upfront, giving up a large share of your fledgling business means losing control – something a new business owner may want to keep.

Venture Capital

People tend to confuse and conflate angels and venture capital, but in reality, the two financing schemes are distinct: While angels will invest in young companies, venture capital firms are typically hesitant to give cash to new ventures or lifestyle companies without immediate growth potential.

As with angel investors, venture capital funds will seek a share in your business in exchange for their investment of cash, industry knowledge, and network connections. In many cases, the firm will place someone on your board and will demand preferred stock. For this reason, many smaller companies or single-member LLCs are generally not attractive to venture capital firms.

Financing through Debt

Debt may sound like a dreaded four-letter word, but it is a legitimate and viable way to fund a new business – so long as you have a solid, short-term payoff plan. Funding a business through debt involves seeking loans, lines of credit, or convertible debt to use as seed money. For a lifestyle business or a founder who opts not to pursue outside funding, debt financing can prove a quick way to get some cash upfront.

There are several types of loans available to businesses, from simple business bank loans to seeking a loan from a colleague or family member. Some founders use low-interest loans from the Small Business Administration (SBA Loans) to fund their new entities. Also, founders who need just a small amount of startup capital can take out a very small loan – an option that is not available with VC funding, which generally occurs on a much larger scale. If you would like to learn more about how to apply for an SBA loan, check out the SBA website.

Considerations in Financing Your Entity:

  • What type of entity have you set up? Remember, if you are an LLC, you are unlikely to attract angel investors or VC funds.
  • How do you plan to pay your employees? If you are funding your enterprise through equity, consider that this will affect the way you compensate your co-founders and employees. Conversely, if you are funding through debt or you are bootstrapping your entity, you will have more leeway in determining how to use your capital.
  • How do you plan to use the funding? Are you more interested in quick cash to purchase inventory? Or, are you diving into unfamiliar territory and would benefit from the industry knowledge and connections an angel investor or VC firm would offer you?
  • How much control do you want to keep? Many founders are protective of their new businesses. Are you setting up a family business that you want to run and control yourself? Or, are you looking to quickly scale and eventually exit?

Choosing the Option that is Right for Your Business

No matter which option you pursue, remember that there is no quick solution when it comes to building a successful business. Do your homework, understand the territory, and be honest about your growth goals. At Wilson Ratledge, we assist our clients in pursuing the financing scheme that is best for their business goals. Contact one of our experienced North Carolina startup attorneys today at 919-787-7711 or via our contact form below.

Tax Planning for 2020: What You Need to Consider

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tax blocks on a calculator

As the holidays come and go and the year draws to a close, businesses and individuals alike turn their attention to finances. While it can be tempting to bury your head in the sand when it comes to your personal or business taxes, it is best to start getting organized sooner than later, particularly in the wake of Trump’s Tax Cuts and Jobs Act, which brought monumental changes to the tax code. The Act, which caps state and local deductions, limits the deductibility of home equity debt, and changes the tax brackets, gives taxpayers much to consider when it comes to organizing their taxes. As such, it is never too early to start compiling your financial information.

Here are our seven tips to help you prepare your taxes well in advance of Tax Day.

#1: Check out your paycheck.

Double-check the withholding amounts on your paycheck, as the Act has revised the withholding tables. If you are having too little withheld, you will owe Uncle Sam come April 15. On the other hand, if you withhold too much, you will be entitled to a refund. To determine whether you are withholding the proper amount, consult the IRS tax withholding estimator. This is particularly important if you made a significant transition in 2019, like a job change or a new business venture.

#2: Decide who will prepare and file your taxes.

If 2019 brought a significant status change like a marriage or new employment situation, your taxes may look a bit more complicated than they did in the past. If this is the case, consider hiring an accountant, even if TurboTax proved sufficient in the past.

Keep in mind that some professionals may increase their rates as tax season approaches – not to mention, they will be much harder to access as their “busy season” sets in. As such, reach out to your preparer before the end of the year to ensure you will have the help you need.

If your income falls below a certain threshold, consider organizations like Free File Alliance, a company that partners with the IRS to help individuals file their taxes. Alternatively, explore the IRS online location tool to seek free preparation services in your area.

#3: Max out your IRA or 401k contributions.

Padding your retirement accounts in the fourth quarter will reduce your taxable income for the year, which will also reduce the taxes you owe. For 2019, contribution limits for 401ks are $19,000, plus $6,000 in catch-up contributions for those who are aged fifty and over. Limits will increase by $5,000 apiece in 2020. For a traditional IRA through a broker or bank, limits for 2019 are $20,000 plus $6,000 in catch-up contributions. If it is financially feasible for you, consider making these maximum contributions to reduce your tax bill.

#4: Protect yourself from tax scams.

As tax season approaches, you may receive phone calls from companies purporting to be the IRS – but rest assured that they are not. Generally, the IRS will only communicate with you through U.S. mail and as such, arbitrary phone calls are likely bogus. Additionally, avoid tax preparers who promise you a “bigger refund,” as few reputable accountants will make these claims.

To create additional layers of protection, consider setting up safeguards like direct online payments to the IRS. Additionally, consult the IRS list of registered preparers to ensure yours is legitimate before sharing your personal financial information.

#5: Consider the benefits of bunching your deductions.

The threshold for standard deductions has nearly doubled, so it can be hard to itemize. To help, consider “bunching” your deductions to meet the new threshold. Bunching is a practice that entails pushing deductible expenses – like charity donations or mortgage payments – into the same calendar year so that you can itemize them. For instance, you may consider prepaying your January mortgage payment in order to meet the threshold for 2019. As with any significant financial decision, however, consult your accountant or financial planner before taking this step.

#6: Review your medical expenses.

If you accrued substantial medical expenses in 2019, you may be entitled to deduct certain out-of-pocket expenses related to your treatment, such as transportation, lodging, and home healthcare. Speak with your tax preparer or an experienced tax attorney to determine which – if any – expenses are deductible.

#7: Pay attention.

If the IRS contacts you because you failed to file a return or pay taxes on time, you may face penalties – most significantly, losing your property. As such, do not ignore the IRS or delay paying your taxes. Additionally, once you have paid, save any and all correspondence with the IRS, as well as your U.S. Post Office records, in the event you need to prove that you made timely payments.

Tax Planning for the Future

To ensure you are equally organized for the next tax year, start a habit of tracking – and keeping – all of your financial records. Compile W2s, 1099s, medical expense receipts, charity donations, canceled checks, previous year returns, and other vital financial records so that you are prepared in the event of an audit. It is a good practice to keep these records for at least three years. For your own peace of mind, you may opt to keep them even longer.

Experienced Tax Attorneys

Wilson Ratledge assists clients in financial and tax planning. There are numerous considerations to evaluate before making significant financial decisions. Our experienced tax attorneys can discuss your options and help you decide how to manage your money wisely. Contact one of our attorneys today at 919-787-7711 or via our contact form below.

Entity Types When Starting A Business: Corporations, Partnerships, And More!

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A very important consideration for someone who is starting a business is the choice of entity. Wilson Ratledge has experienced attorneys that will help counsel you with regard to which entity is the right choice for your business.

Corporations (C corps and S Corps), partnerships (general and limited), LLCs, and sole proprietorships differ significantly in many areas, including formation, ownership, taxation, governance, asset preservation, and liability protection. Below is a brief discussion of each type, but by and large, the most common choices are S Corps and LLCs.

Sole Proprietorships

Sole Proprietorships arise without any formality when one person begins to conduct business. This simplicity comes at a great cost: the sole proprietor is personally liable for the debts of the business and his or her personal assets are exposed to creditors when the business is insolvent.

Comprehensive insurance coverage for the business and the individual are very important, but not a reliable asset preservation plan for the sole proprietor. The business’s tax items are reported on the Schedule C of the sole proprietor’s individual income tax return.

General Partnerships

General Partnerships also arise without any formality when two or more persons (or entities) conduct business jointly. Again, the simplicity comes at the cost of the general partners being personally liable to business’s creditors just like the sole proprietor and regardless of whether that partner actually participated in the act(s) or omission(s) giving rise to the liability. Again, comprehensive insurance coverage is very important, but not a reliable asset protection plan.

Also, the partners are free to allocate risk, management duties and many other aspects of the business between them via a partnership agreement; therefore, one is strongly advisable in nearly every instance.

Partnerships (and S Corps for that matter) are “flow through” entities for tax purposes, meaning that taxable income and other tax items of the entity are passed through to the owners and taxed only at the owner (partner, member or shareholder) level. Partnerships are taxed under Subchapter K of the Internal Revenue Code.

Limited Partnerships

Limited Partnerships are formed by filing a Certificate of Limited Partnership with the Secretary of State. Limited Partnerships consist of limited partners and at least one general partner.

Liability is limited for the limited partner(s), but not for the general partner(s); however, limited partners can become personally liability if they actively participate in management of the business. The tax treatment, and the need for a partnership agreement and liability mitigation for the general partner(s), are the same as for general partnerships.

Limited Liability Partnerships

Limited Liability Partnerships (“LLPs”) are formed by filing an Application for Registration with the Secretary of State. LLPs can provide limited tort liability for all partners, allowing partners to actively participate in management without completely losing limited liability.

Professionals should keep in mind that state regulations may prevent any limited liability for malpractice. In most states, an LLP will shield partners against liability for the malpractice of other partners, however, this is not the case in every state.

The tax treatment for LLPs is the same as for general partnerships, and the need for comprehensive insurance coverage, particularly professional malpractice or errors and omissions, cannot be overstated.

Limited Liability Companies (LLCs)

An LLC is formed by filing Articles of Organization with the Secretary of State and may have one or an unlimited number of members (subject to certain securities restrictions). Unlike corporations, they are not bound by corporate formalities such as holding regular ownership and management meetings.

However, in contrast to corporations, they do not operate under a well-defined regime of uniformity and legal precedent. An operating agreement is entered into by members of the LLC. LLCs offer limited liability to all members, and do not require the formalities of corporations. They also offer considerable flexibility with respect to control and management. Different LLCs will be taxed differently according to certain criteria:

Single-member LLCs: If the LLC has only one owner (owners of LLCs are referred to as “members”), it will be treated by default as a sole proprietorship for tax purposes. The “single member LLC” can choose (or “elect”) to be treated as a corporation (by default a C corp, discussed above), and further elect to be treated as an S corp (discussed below), for tax purposes.

Multi-Member LLCs: If the LLC has more than one member, the LLC will be treated by default as a partnership for tax purposes. The multi-member LLC, like the single-member LLC, can elect to be taxed as a C corp or S corp.
C CORPS

Corporations, whether C corporations or S corporations, are formed by filing articles of incorporation with the secretary of state. The owners are called shareholders, and are issued shares of stock. The shareholders elect a board of directors, which in turn elects officers to carry out the day to day business of the corporation. When only a single owner or small number of owners create a corporation, the same individual or individuals can serve as shareholders, directors, and officers. Various formalities must be attended to in order to properly create and maintain the corporation.

Both C corporations and S corporations provide limited liability to shareholders. Shareholders agreements can be used to govern transfers of ownership and deadlocks. C corps have well-defined structural accountability, with governance responsibilities held separate and apart from the owners. Management is accountable to the board of directors and therefore has the ability to transact business without stockholder participation in each decision.

However, corporations are required to pay attention to formalities that legislatures and courts have determined to be significant (e.g., meetings of boards of directors and maintenance of corporate bylaws,corporate minute books, stock ledger books, separate bank accounts, etc.). A C corp will report and pay tax on its income at the entity level. When the corporation goes on to pay dividends to its shareholders, the shareholders will report those dividends as income, and pay income tax on those dividends.

This is the infamous “double tax” that many wish to avoid by forming an S Corp or LLC. You should, however, consider your individual case before deciding to avoid the double-tax on principal alone. The C Corp structure can be advantageous where a company intends to retain its earnings and grow its business rather than pay dividends, because the C corp flat rate structure may result in a lower rate of tax than if the income were to “pass through” to its shareholders as it does in other tax structures.

Also, if the corporation will initially generate tax losses, again, you should seek appropriate advice to determine if those losses are going to be more advantageous being retained with the corporation to offset future income, or if individual owners will be able to benefit more from the losses in a pass through entity. C corporations may offer several tax advantages, however, with respect to deductibility of retirement contributions, group insurance premiums, and other benefits.

S Corporations (S Corps)

As mentioned above, S Corps are “flow through” entities, like partnerships. Unlike partnerships, however, S corps must allocate tax items (mainly profits and losses) to the shareholders in direct proportion to their ownership percentages.

An advantage over the partnership for tax purposes is that shareholders who also work for the corporation can receive compensation (which must meet or exceed a level considered “reasonable’ for the services rendered) through a salary, whereas a partner in a partnership cannot.

This allows a shareholder to benefit from the business’s additional profits via a distribution that is not subject to self-employment taxes. In contrast, all of a partner’s income from the partnership is subject to self-employment taxes. Taxable losses at the entity level may be used to offset other taxable income of the shareholders, but only to the extent of the shareholders’ tax basis in their shares. As noted above, a shareholder will receive basis for loans to the entity only if the loan is made to the shareholder and shareholder in turn loans the funds to the entity.

A shareholder does not receive basis for loans to the entity guaranteed by the shareholder. S corporations are subject to several restrictions including on the number of shareholders, other corporations cannot serve as shareholders, foreign citizens cannot be shareholders, and only one class of stock may be issued. If these restrictions do not interfere with business plans, an S corporation is often a good starting point for a start-up business.

Unlike C Corps and LLCs, S corps are limited in the number of shareholders they may have, and who can be a shareholder. Generally speaking, shareholders must be non-foreign individuals (US citizens or residents), or a qualified trust, estates, or exempt organization. Ownership transferability is flexible and similar to that of C corps.

Which Should You Choose?

Wilson Ratledge assists clients in making one of the most important decisions upon formation of their business – the choice of entity. There are many considerations to evaluate before making this choice, such as self-employment tax costs, benefits, liability, and creditor protection are also among the chief concerns in determining choice of entity.

Contact one of our experienced North Carolina startup attorneys today at 919-787-7711 or via our contact form below.