Business Structures 101

After all of this research, it looks like the structure that will fit our business model better is an S Corporation rather than an LLC.

It all has to do with the fact that we want to get paid wages for the number of hours that we spend working for the business. As it turns out, the IRS is very sensitive to LLCs that make "special allocations" to give profits to members in ways that don't simply represent their ownership interest in the business.

The IRS guide says, "The rules governing partnership allocations (IRC section 704(b) and its accompanying regulations) have been criticized as being some of the most difficult and complex."

Oh, yippee, sign me up for THAT!

So instead, we're going to be an S-Corp, which allows its shareholders to be treated as employees, and it has certain tax advantages over the two LLC models as well. (You don't have to pay the 15.6% self-employment tax on profits.)

Because I'm sure you were dying to know!

You know you're an adult when......you start your own company

This week, I'm in the process of filing out the paperwork for our LLC. The three of us (myself, my husband, and one of his friends from work) will be providing sales support, customer training, and consulting services on behalf of two software companies that make special engineering applications. For right now, I will be the only one working full-time for the new company, since they're both keeping their corporate jobs, but they'll also be doing some part-time consulting work and providing their expertise with one of the software applications.

There are lots of things to learn about starting a new company. Today I put together a summary to explain our options to my partners. (Yes, of course, I could explain this all to my husband without typing it up, but our other partner lives in New Hampshire.) And they say that the best way to learn something is to synthesize it, so I guess I'm benefiting from this experience as well.

Here's what I've learned so far this week:

1. LLC's have a choice between being taxed as a Partnership or as a Corporation.
   
   
   • Partnership - The IRS default is for an LLC to be treated as a Partnership for tax purposes, which is also referred to as "pass-through" taxation. As far as taxation goes, this is pretty straightforward. The owners of the LLC simply pay personal income taxes on whatever money they receive from the business. They still have to file tax forms for the LLC every year, including Schedule K-1 forms, which summarize the profits (or losses) for each member, but the LLC doesn't actually pay any taxes to the government.
     
     In this model, owner-members of the LLC are not considered employees, and they do not receive a salary or wage. Instead, they generally get paid by receiving their share of the profits, based on the amount of capital that they have invested. Members can, however, create "special allocations" in their operating agreements, to redistribute profits in ways that are different than just the percentage of the business that they own, but they have to be able to convince the IRS that there are legitimate business reasons for doing so. We're planning to do a special allocation because we all want to get paid a fee based on the number of hours that we work for the company, but beyond those fees, we plan to split the profits equally, because we're all contributing equal amounts to get the business off the ground. My next step will be to check with a lawyer to make sure this is all legit in the eyes of the IRS!
   
   
   
   • Corporation - The downside to this option is that the tax situation gets more complicated. For this structure, it is assumed that the active members receive salaries from the business, and that a significant amount of the profits will be reinvested in the business from year to year. The business writes off the member's salaries as an expense, so the business isn't taxed for that amount, and the members pay personal income tax on their salaries. That's simple enough. But when it comes to the profits, things get a bit more convoluted. The LLC pays taxes at a corporate rate (just 15% for up to $50,000) on all of the profits generated by the business, and then individual members pay additional taxes (aka "double taxation") on the profits or dividends that they receive.
     
     So essentially, if you're reinvesting most of your profits, you might save money by being taxed at a reduced business income rate rather than paying taxes at the personal tax rate. (With pass-through taxation, you wind up paying taxes at the personal tax rate on profits that you never really received because they were reinvested in the business.) The good news is that you can change from Partnership to Corporate taxation at any time, by filing a simple form with the IRS, but the BAD news is that you're not allowed to convert back to Partnership taxation for at least 5 years. So generally, most LLC's don't make the change until they're well established and making a significant profit from year to year.



2. Management Methods - LLC's have a choice between Member-Managed or Manager-Managed.
   
   
   • Member Management - Most LLC's are managed by all of their members, and this is exactly what we want to do. The key requirement here is that all of the members (owners) play an active role in managing the business. Otherwise, everyone's share in the business could be considered a "security" (i.e. an investment, like stock, where you expect to make a profit based on other people's efforts) and then you might have to file for an exemption with the SEC. Or, worse yet, you might not get an exemption and you'd have to comply with all of the disclosure requirements.
   
   
   • Manager Management - This structure allows an LLC to be managed by a) a subset of the LLC members; b) a mixture of some members and some non-members; or c) a person (or group) who isn't a member. In the case of Option A, an LLC could be managed by two members who work in the business full-time, while three other members (who aren't interested in actively managing the business) just invest money and hope to make a profit. Option B - An LLC receives some capital from an outside investment group, and, in exchange, that group asks to have one of their partners or employees involved in running the business. Option C - The owners of an LLC hire a CEO to manage the business on their behalf.
     
     In the case of Manager Management, the shares in the company will certainly be considered securities, but there can be some tax advantages for the non-managing members. Members who are managers of an LLC have to pay self-employment taxes, including the full tax amounts for Social Security and Medicare. (If you're an employee of a corporation, your company pays half of these taxes for you.) Non-managing members get to skip these.

P.S. I am not in any way an expert on this subject, and I am certainly not offering any legal or tax advice here. I just thought that this was sort of interesting, in a convoluted sort of way, and since I had already done the work, I thought I'd share it, in case anyone out there is interested in learning something new. Or not.

God Hates Shrimp

I probably shouldn't be doing this, but it's just too good not to share...

My sister has a science blog that discusses ocean ecology and overfishing. In her most recent posting, she had a link to the God Hates Shrimp website.

Yep. It's true. Shrimp are an abomination. So are lobsters, crabs, scallops, and clams. Roadkill is also verboten, and, as my friend Tracie likes to point out, we're also not supposed to boil a goat in it's mother's milk. (See Deuteronomy 14:21. In fact, you might want to glance through all of Exodus, Leviticus, and Deuteronomy before you start making any plans for dinner.)

But wait, it gets even better! From that website, you can find a link to this website, which you can bookmark under either "Irreverent" or "I'm SO going to Hell for this..."

Of course, don't forget to check out the link to Real Church Signs.

And so my work here is done. Have fun, and don't get into too much trouble!



P.S. My sister's blog is called Shifting Baselines. I think it's informative and entertaining, so I recommend checking it out once in awhile. And in all seriousness, please spend a little bit of time exploring the Monterey Bay Aquarium Seafood Watch website and their Pocket Seafood Guides. If you're going to eat fish, pick something like Tilapia and not Orange Roughy or Chilean Sea Bass.

Life, in a Nutshell

I realize that it's been a very long time since I've posted anything on this blog, and there are some very good reasons for why I haven't been writing. This past year has been extremely difficult, and it seems like most of the things that have happened were just too personal and too emotionally draining to try to share on a blog. But since these things were major events in my life, I would have felt dishonest if I had continued to write about trivial stuff, pretending that everything was OK and normal when it clearly wasn't.

So here's the (simplified) update of everything that has happened in the past year:

• Jobs - I no longer work for a Fortune 50 company, and I hope that I never will again. For awhile I worked part-time for a small company (~20 employees) and that was a learning experience too. After that, I took some time off. Now I'm working on starting up my own LLC. I'm really, really excited by the idea that I'll be working for my self, from my home. I'll have a hard-wall office with a door and a window-- the dream of every cube-dweller-- and I'll also have the option of working from my back deck or pretty much anywhere else I want to be. There's no dress code, I can bring my dog to work with me, and I won't have to worry about what my boss will think if I have to go to a doctor's appointment or if take an hour and a half to have lunch with friends.
  
  My self-confidence was really shaken by losing my "dream job" last year, but I've come to realize that I am an intelligent, responsible, hard-working, talented engineer, and so I deserve something better than being treated like a replaceable cog in a corporate juggernaut that grinds out far more bureaucratic sludge than productive results. I hate corporate politics, and I hate that my roles have been defined and my worth has been determined by managers and directors who are inept at best. (I won't even try to describe the worst bosses... I know. You know. We'll leave it at that.) I know that I can be far happier and more productive working for myself, and I now I see that my true "dream job" is SO much bigger than anything that could fit into a 6x6' cubicle.



• Pets - I am no longer the proud parent of a tubby tabby and a cross-wired wiener dog. We still have the dachshund, but my sweet fuzzy cat was stricken by cancer at Christmas time, and she died in March. At the same time, I suffered through a difficult health issue of my own, and I wound up depressed. I tried some medication, but the side effects seemed as bad as the symptoms, so I quit my job and got a puppy instead.
  
  Her name is Bella. The rescue folks told us that she was a Border Collie / Golden Retriever mix. Now that she's grown up a bit, we think it's more likely a that she's a Border Collie / Labrador Retriever mix, since she looks just like a small black lab, but with white toes. We've been talking about getting another cat, but I think we'll probably wait until Bella settles down a bit.



• Travel - I have done a quite a bit of traveling in the past six months or so.
  
  In February, we did our annual ski vacation in Tahoe. There couldn't be a better group of friends to ski with, but things went badly for me at the end of the trip, so the memories of this trip aren't as fond as they have been in previous years.
  
  At the end of April, I tagged along on my husband's business trip to Zurich, so I got to wander around the town while he was working. I really enjoyed Switzerland, and since my new LLC will be partnering with a software company there, I hope that I'll be able to go back again.
  
  In June, we went back to Longboat Key for a week with my mom's extended family. This year we got to spend time with my mom, my grandparents, my grandmother's sister, her three daughters, two of my aunts, two of my uncles, two of my cousins, and one of my cousin's kids. The weather was nice. I got to feel tall for a week. It was a good trip.
  

So that's my life, in a nutshell. Now that things are looking up, I have a feeling that I'll be writing more often. Not to mention that now I'll be able to blog from work without having to worry about getting busted by my boss and I can blog about work without violating any stupid corporate policies!