March 2024

Business Entity Essentials Incorporating Your Business In this series, we will go over the reasons why you may want to formally organize your business and discuss the pros and cons of each kind of organization (i.e., LLC, corporation, etc.). For most small businesses, you will want to form either a corporation or a limited liability company. Why incorporate? You usually incorporate to protect your personal assets from any liability the business incurs. A corporation can also sue and be sued because it is considered a separate juridical entity under the law. Also, forming a corporation can allow the owners to take advantage of certain tax and investment strategies. When choosing between a corporation and an LLC, entrepreneurs should consider factors such as the need for investment, desired flexibility in management, tax implications, and the level of formality they are willing to maintain. Each business structure has its own unique benefits and drawbacks, and the best choice depends on the specific goals and circumstances of the business. I have personally formed LLCs and corporations, including Delaware corporations, and can share my own experiences in dealing with these different types of entities. Should you form an LLC or a Corporation? Corporation Attributes Shareholders have limited liability for the corporation’s debts and obligations, like LLC members. Corporations can issue stocks (common or preferred shares) to raise funds, making it easier to attract investors. Corporations continue to exist even if ownership or management changes, providing stability and longevity. Shares in a corporation can be easily transferred or sold, facilitating changes in ownership. C corporations are taxed separately from their owners, potentially leading to tax advantages in certain situations. S corporations allow for pass-through taxation while retaining the benefits of the corporate structure. Corporations, particularly C corporations, are often perceived as more established and credible, which can be advantageous in business dealings. Corporations can offer stock options or other equity-based incentives to employees, which can be attractive in hiring and retaining talent. Disadvantages of forming a corporation C corporations face double taxation: the corporation pays taxes on its profits, and shareholders pay taxes on dividends. Corporations require adherence to strict formalities, such as holding annual meetings, maintaining detailed records, and following complex rules and regulations. The cost of forming and maintaining a corporation is generally higher than for an LLC. This includes administrative, legal, and tax preparation fees. Corporations have a fixed management structure with directors, officers, and shareholders, which can be less flexible than the management structure of an LLC. Corporations, especially public ones, are subject to more regulatory scrutiny and disclosure requirements than LLCs. Corporations have less flexibility in how they are taxed compared to LLCs. While S corporations offer pass-through taxation, they come with restrictions on the number and type of shareholders. S corporations have restrictions on the number and type of shareholders (cannot exceed 100 shareholders and must be U.S. citizens/residents). Comparing Corporations with LLCs LLCs have more tax options and are not subject to double taxation. LLCs are easier to form and operate with fewer formalities and a more flexible management structure. LLCs may face challenges in raising capital due to the inability to issue stock and less appeal to certain types of investors. There are pros and cons of each, and tax consequences of each so you will want to consider how each is treated by your state and by the IRS so you can make a wise decision on how to organize your business. Forming Your Corporation Like the Articles of Organization for an LLC, but often require more detailed information, such as the number of authorized shares, the par value of the shares, and information about the initial directors. A shareholders’ agreement is a contract between the shareholders of a company. It outlines the rights, responsibilities, and obligations of the shareholders and governs the relationship between them. The agreement typically covers issues such as: Ownership and Share Transfer: It specifies the number of shares each shareholder owns and outlines the process for transferring shares. Management and Decision Making: It defines how the company will be managed and how major decisions will be made. It may include provisions regarding board of directors, voting rights, and decision-making processes. Rights and Obligations: It outlines the rights and obligations of the shareholders, including dividend entitlements, participation in management, and restrictions on competition. Dispute Resolution: It sets out procedures for resolving disputes between shareholders, which may include mediation, arbitration, or other methods. Confidentiality and Non-Compete: It may include provisions to protect the company’s confidential information and restrict shareholders from competing with the company. Exit Strategy: It may outline procedures for the sale or transfer of shares, including buy-sell provisions, drag-along rights, and tag-along rights. Miscellaneous: It may also include other provisions related to the operation and management of the company, such as insurance, indemnification, and amendment procedures. Shareholders’ agreements are important for privately-held companies as they help prevent misunderstandings and disputes among shareholders and provide a framework for the efficient management and operation of the company. Does my company need a shareholder’s agreement? Whether your company needs a shareholders’ agreement depends on several factors, including the size of your company, the number of shareholders, and the nature of your business. Here are some situations where having a shareholders’ agreement may be beneficial: Multiple Shareholders: If your company has more than one shareholder, a shareholders’ agreement can help clarify the rights and obligations of each shareholder and establish a framework for decision-making. Control and Management: If you want to specify how the company will be managed and how major decisions will be made, a shareholders’ agreement can provide clarity on these issues. Exit Strategy: If you want to establish a mechanism for shareholders to exit the company, such as buy-sell provisions or drag-along rights, a shareholders’ agreement can help facilitate this process. Dispute Resolution: If you want to establish procedures for resolving disputes among shareholders, a shareholders’ agreement can provide a mechanism for mediation, arbitration, or other methods of dispute resolution. Confidentiality

Should you form an LLC or a corporation? That is a question a lot of people ask including myself.  Which is easier?  Which is cheaper and which saves the most in taxes. As far as asset protection goes and protecting your personal assets from seizure, they both offer about the same protection. But forming a corporation is more involved and more expensive to maintain. With a corporation, you have a lot more formalities to deal with compared to a limited liability company.  A corporation requires a board of directors and a shareholder agreement. Corporations also must file their own tax returns with the IRS and possibly your state.  How much money in self-employment taxes can be saved by switching from flow thru LLC to s-corp tax status? Switching from a flow-through Limited Liability Company (LLC) to an S-Corporation (S-Corp) tax status can potentially save you money on self-employment taxes, primarily Social Security and Medicare taxes. However, the exact amount saved depends on various factors including your business’s net income, salary you pay yourself, and other deductions. Here’s a simplified overview of how savings can be calculated: Self-Employment Taxes for LLCs: As an LLC, all business profits pass through to the owners (members), who report this income on their personal tax returns. The entire profit is subject to self-employment taxes (Social Security and Medicare), which is 15.3% (12.4% for Social Security on income up to the Social Security wage base, and 2.9% for Medicare with no cap, as of my last update in April 2023). Taxes for S-Corps: S-Corps also pass through income to owners, but owners are required to pay themselves a “reasonable salary” for the work they do in the business. This salary is subject to Social Security and Medicare taxes, but it’s split between the employee and employer (the S-Corp), each paying half. Profits distributed beyond the salary are not subject to self-employment taxes, only income tax. Example of Potential Savings: Let’s say your LLC earns $100,000 in profit. As an LLC, the entire amount is subject to self-employment taxes. If you elect S-Corp status and determine a reasonable salary is $50,000: As an LLC, you’d pay 15.3% in self-employment taxes on the $100,000, which equals $15,300. As an S-Corp, you’d pay Social Security and Medicare taxes on your $50,000 salary, which totals about $7,650 (split between you and the S-Corp). The remaining $50,000 in profit distributed to you would not be subject to these taxes. In this simplified scenario, switching to S-Corp status could save around $7,650 in self-employment taxes. However, there are additional considerations: S-Corps require more administrative work, including payroll tax filings. You must pay yourself a reasonable salary, which the IRS scrutinizes. There may be state-level tax implications. To get a precise calculation and ensure compliance with all tax regulations, it’s recommended to consult with a tax professional or accountant who can provide advice tailored to your specific situation. What are the elements or factors IRS looks at to determine whether a salary is reasonable? The Internal Revenue Service (IRS) considers several factors to determine whether the salary paid to an S-Corporation shareholder-employee is “reasonable” for the services rendered. This assessment is crucial because it affects the taxes owed by both the S-Corp and the employee. While the IRS has not provided a definitive formula for calculating a reasonable salary, the following factors are commonly considered in making this determination: Industry Comparables: Salaries paid to employees in similar positions within the same industry can provide a benchmark for what is considered reasonable. Employee Qualifications: The employee’s education, experience, training, and responsibilities within the company are considered to gauge if the salary is commensurate with their qualifications and contributions. Nature and Scope of the Employee’s Work: The complexity and scope of the work performed by the employee are assessed. More responsibilities and higher-level tasks generally justify a higher salary. Time and Effort Devoted to the Business: How much time and effort the employee puts into the business also plays a significant role. Full-time dedication often warrants a higher salary. Dividend History of the Company: The IRS may look at how profits are distributed between salaries and dividends. A pattern that minimizes salary in favor of dividends may raise red flags. Compensation Agreements: Formal agreements or policies for compensation within the company can provide a basis for determining reasonableness. Financial Condition of the Company: The company’s profitability and revenue can influence what is considered a reasonable salary. The salary must be sustainable by the company’s financial performance. Payment to Non-Shareholder Employees: Salaries paid to non-shareholder employees for similar roles can also serve as a guideline for what is reasonable. Comparison with Previous Years: The employee’s salary history, especially if they have been with the company for many years, can be a factor in assessing reasonableness. The IRS may use a combination of these factors in their evaluation and has discretion in their interpretation. It’s important for S-Corporations to document the rationale behind the salaries paid, ensuring they can justify the amounts as reasonable based on these factors. Given the subjective nature of what constitutes a “reasonable salary,” S-Corporation owners are often advised to seek guidance from tax professionals to ensure compliance and minimize the risk of audits and penalties.

I am currently working on a negotiation course that I plan to offer on Udemy and on my own platform Podnah. Here is the current draft of the outline: How to Win in Business Negotiation Introduction In this course we will focus primarily on business negotiations and negotiations you will encounter when making significant purchases or sales. When you are negotiating, your instincts can be relied on and you can draw from them.  It is important to remember though, like any other skill, these instincts can be honed and your negotiation abilities can be improved by learning the process of how to prepare for and work through a complicated negotiation.   I discovered this when I first started trading with people.  Sometimes you make a good trade, sometimes you regret the trade.  You should learn from each trade. When you experience your first win at a negotiation, you may well become hooked.  You may want to negotiate all the time.  But know that negotiation doesn’t have to always be adversarial nor does it have to be in a “winner takes all” format.  Many successful negotiations end with both sides feeling like they made the best deal. My experience negotiating took me from working at a pawn shop while in college, where I had to buy and sell merchandise on a daily basis, to working as an insurance and injury lawyer where I had to negotiate large civil litigation settlements between two warring parties. What I learned at the pawn shop would stay with me for the rest of my life.  And I would apply those lessons as a lawyer, real estate investor and startup founder. As I entered the workforce as a young lawyer, I was often lured away from my instincts in order to follow what other lawyers were doing.  I found myself moving away from my instincts and it seemed like I had lost my edge.   After finishing law school I found myself negotiating with other lawyers to settle personal injury or property damage cases.  These negotiations might be on the phone, by correspondence or in the form of a mediation that was typically administered by a mediator or a judge. I noticed that negotiating on behalf of a client was very different from negotiating for myself.  I also noticed that negotiating a personal injury settlement was very different from haggling over price when buying something on behalf of the pawn shop.   In a personal injury case, there are multiple considerations in play: will any of the money be taxable?  Will it be enough to cover future surgeries or treatment?  Will the defendant require the plaintiff to sign a confidentiality agreement? To name just a few. I discovered that negotiating on behalf of other people, as lawyers or professional negotiators often do, seemed much more difficult than if I personally negotiated to buy a house or commercial building as an investment property for my own portfolio.  Why was that? I believe it was for several reasons.  First, the lawyers are not the actual parties, but representatives of the parties tasked with the responsibility and duty of negotiating on their behalf and in their best interests.  This dynamic changes things – a lot.    When you are negotiating for someone else, you may feel a duty to not make things worse, or you may feel like pushing the envelope perhaps too far.  Everyone is different but in my own experience, I find myself a little more conservative when negotiating on a client’s behalf because I don’t want to make things worse. Also, interjecting lawyers and mediators complicates the process because now there are more cooks in the proverbial kitchen.  It adds another layer of complexity to an already complex situation.   How does the client know who to trust?  How does the client know the lawyer or mediator isn’t looking out for their own self-interests over theirs?  If the lawyer is pushing the client towards settlement, is it because the lawyer needs money now, or is it because they don’t think they can win at trial? Your instincts tend to be suppressed and your “duties to your client” take charge.  This inner conflict I believe is counter-productive.   Fear of messing up your client’s case can cause you to be too conservative.  On the other hand, if you are overly confident without a rational basis, you can maybe bypass a good outcome in settlement and decide to try the case instead. Also, I learned that in particularly long negotiations, like we might experience in a multi-party, and multi-day wrongful death mediation, exhaustion can set in and the parties may agree to an unfavorable deal simply because they want the process to end. In my experience, the more people that get in the way of me trying to negotiate, the worse I perform.  I do best when I deal with my own interests directly with the other person and their interests. If you are taking this course, you will probably be negotiating on your own behalf or on behalf of your company.  I will share with you the approach and techniques I’ve used that have worked in the past and also the mistakes I have made along the way. What I’ve learned negotiating for a living is that negotiating is more an art than a science.  And, like any art, the more you do it, especially with the help of some training, the better you’ll get at it.  Like learning to play guitar, winning at negotiation can be learned intellectually, but it really needs to be practiced in order to improve your skills. Let’s get started! Key Concepts / Definitions Distributive Negotiation Distributive Negotiation is the type used when each side is trying to maximize their own benefits without regard to any ongoing relationship. Integrative Negotiation “Integrative Negotiation,” on the other hand, is when the negotiating parties have a relationship they value and so they want to explore outcomes where both parties maximize benefits.  This is also known as a “win-win” approach. Mixed