RPF0373-Intro_to_Business_Entities
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00:00:30.000 | Today on Radical Personal Finance,
00:00:32.000 | we tackle business entities with a discussion of
00:00:34.000 | sole proprietorships, partnerships, corporations,
00:00:38.000 | and limited liability companies.
00:00:41.000 | [Music]
00:00:57.000 | Welcome to Radical Personal Finance,
00:00:59.000 | the show dedicated to providing you with the knowledge,
00:01:01.000 | skills, insight, and encouragement you need
00:01:04.000 | to live a rich and meaningful life now
00:01:07.000 | while building a plan for financial freedom
00:01:08.000 | in 10 years or less.
00:01:09.000 | Today we tackle business entities.
00:01:12.000 | And I want to set your mind at ease
00:01:15.000 | by helping you hopefully to feel a little bit more competent
00:01:19.000 | and confident in discussions around
00:01:22.000 | what type of business entities to use
00:01:24.000 | for yourself or for someone else.
00:01:26.000 | [Music]
00:01:30.000 | One of the missions that I have here
00:01:31.000 | with Radical Personal Finance is to help you feel,
00:01:35.000 | well, help you have enough knowledge
00:01:37.000 | that you don't feel bad.
00:01:38.000 | You don't feel bad about asking questions.
00:01:41.000 | This discussion over business entities came up
00:01:44.000 | in the Radical Personal Finance patron Facebook group
00:01:47.000 | a couple of weeks ago.
00:01:49.000 | And as different people were discussing,
00:01:51.000 | it just was apparent to me that we throw around
00:01:53.000 | a lot of words, and by the way,
00:01:55.000 | I'm not insulting those of you in the conversation.
00:01:57.000 | This is just a long-held thought that I have.
00:01:59.000 | We throw around a lot of words sometimes that sound good,
00:02:02.000 | but sometimes we don't know what they mean.
00:02:03.000 | And I know this was the case for me in the past
00:02:06.000 | when people would talk about, oh, you should,
00:02:07.000 | what kind of corporation do you have?
00:02:09.000 | Or, hey, I think you should have an LLC
00:02:11.000 | because of the tax benefits.
00:02:13.000 | You ever heard a statement like that?
00:02:15.000 | You definitely, oh, in this situation,
00:02:17.000 | you definitely want to use an S corporation
00:02:19.000 | because of the tax benefits.
00:02:22.000 | People say things like that, and who knows?
00:02:23.000 | Probably the majority of the time, they're right.
00:02:26.000 | There is some benefit.
00:02:27.000 | But I want to encourage you to be able to dig more deeply.
00:02:30.000 | For example, don't accept the use of the word tax benefits.
00:02:35.000 | Although it can be valid in some circumstances,
00:02:38.000 | you should ask what tax benefits.
00:02:41.000 | Or better yet would be to ask what tax implications
00:02:46.000 | because what might be a benefit for somebody else
00:02:49.000 | might be a disadvantage for you.
00:02:53.000 | Having a traditional C corporation has tax characteristics
00:02:59.000 | that could be beneficial in some circumstances
00:03:02.000 | and not beneficial in others.
00:03:04.000 | So today I'm going to give you the outline of business entities
00:03:07.000 | so that you'll feel more comfortable.
00:03:10.000 | And my goal is not to teach a master's tax law
00:03:14.000 | or a master's degree class on taxes.
00:03:16.000 | My goal is just to give you a quick framework
00:03:18.000 | so you understand what these things mean
00:03:20.000 | and so you'll have the confidence to go and ask expert advisors
00:03:23.000 | about the specifics of your situation or somebody else's
00:03:26.000 | so that you'll be able to know what to do for yourself.
00:03:30.000 | But I want to equip you with some knowledge today.
00:03:33.000 | Before I get into that, sponsor of today's show is Paladin Registry.
00:03:36.000 | Paladin Registry is a registry of financial advisors.
00:03:40.000 | I've worked at Paladin for--I should go back and check--probably a year.
00:03:43.000 | If you check the archives, you'll find the episode with Jack Waymire
00:03:46.000 | where I interviewed the founder of it, of Paladin,
00:03:49.000 | and told the story.
00:03:50.000 | But basically it's hard to find a good financial advisor.
00:03:52.000 | It really is.
00:03:54.000 | And Paladin tries to make that a little bit easier
00:03:57.000 | by doing some of the due diligence and homework and tests before
00:04:01.000 | so that you can start with a better pool of candidates.
00:04:05.000 | There's no guarantee that any particular financial advisor
00:04:07.000 | is going to be perfect for you.
00:04:09.000 | You've got to interview them yourself.
00:04:11.000 | But at least you can use a service like Paladin
00:04:13.000 | to filter through and filter out some of the bad ones.
00:04:17.000 | A bunch of ways that they do that.
00:04:19.000 | They check disciplinary records, practice structures, etc.
00:04:22.000 | But if you would like to speak to a financial advisor
00:04:24.000 | or you're in the market for a financial advisor,
00:04:27.000 | go to radicalpersonalfinance.com/paladin.
00:04:32.000 | It's also linked on the blog post for this show and is on the website.
00:04:35.000 | radicalpersonalfinance.com/paladin.
00:04:38.000 | That will forward you through to a landing page
00:04:40.000 | where you'll put in your name, your email address,
00:04:43.000 | your phone number, the amount of assets that you have.
00:04:45.000 | What Paladin will do is they'll take that
00:04:47.000 | and they'll go through their database
00:04:48.000 | and they'll assign usually two or three different advisors
00:04:51.000 | who are near to you to connect with you.
00:04:54.000 | You can interview those advisors to see
00:04:56.000 | if they might be a good fit for you personally.
00:04:59.000 | And again, the benefit here is that they have been carefully screened,
00:05:03.000 | checked for competency,
00:05:05.000 | at least as measured by professional designations.
00:05:08.000 | Their disciplinary history has been investigated
00:05:11.000 | and about 13 other factors as well.
00:05:13.000 | So they've got a good stable of candidates.
00:05:15.000 | radicalpersonalfinance.com/paladin.
00:05:18.000 | Now as we begin this discussion on business entities,
00:05:24.000 | I want to first start by focusing and saying
00:05:27.000 | you've got to keep the technical discussion
00:05:30.000 | slightly separate from the business discussion.
00:05:34.000 | Because the choice of business entity does not make you money.
00:05:39.000 | You can start with any business entity or no entity at all
00:05:45.000 | and you can have the attorneys fix
00:05:47.000 | almost all of your problems down the road.
00:05:51.000 | So don't ever let the business entity stand in your way of making money.
00:05:57.000 | Businesses have a goal of making money.
00:06:00.000 | You should go out and if you're starting businesses
00:06:02.000 | or if you're interested in starting a business,
00:06:03.000 | just go get going.
00:06:05.000 | Go get started and make some money
00:06:08.000 | and then you can fix all this stuff on the back end.
00:06:12.000 | I'm emphasizing that even to the point of perhaps going too far
00:06:16.000 | because there is definitely wisdom in taking time
00:06:18.000 | and planning and doing things in advance.
00:06:20.000 | But I'm definitely intentionally overemphasizing
00:06:23.000 | the need to get busy and build your business
00:06:27.000 | because so many of you have a business
00:06:29.000 | or a side business sitting there right at your fingertips
00:06:32.000 | but you're overwhelmed by how to do it.
00:06:34.000 | You don't know how to do it because you're thinking,
00:06:36.000 | "Well, do I need to go and set up an LLC?"
00:06:40.000 | Don't worry about that.
00:06:41.000 | Go get your business done.
00:06:43.000 | And then once you get your business starting to go
00:06:45.000 | and you start to get some money coming in,
00:06:48.000 | then you'll start to have some capital
00:06:51.000 | where you can go ahead and hire the advice.
00:06:53.000 | This kind of advice is so easy to hire.
00:06:56.000 | There are dozens and dozens of accountants.
00:06:58.000 | There's dozens and dozens of tax lawyers,
00:07:01.000 | of corporate lawyers right in your town,
00:07:03.000 | right at your fingertips who are experts at this area.
00:07:10.000 | You do not have to become an expert at this.
00:07:14.000 | You've just got to get the business going.
00:07:16.000 | That's what's hard.
00:07:20.000 | So go always and focus on getting the business.
00:07:23.000 | We're going to talk about the five most common forms of business,
00:07:26.000 | which are sole proprietorships, partnerships, corporations,
00:07:29.000 | both S corporations and C corporations.
00:07:31.000 | I'll explain those letters to you.
00:07:33.000 | And LLCs, which is an acronym for Limited Liability Company.
00:07:39.000 | And depending on various factors,
00:07:43.000 | all of these entities are valuable creations.
00:07:48.000 | There is no one right answer.
00:07:51.000 | Rather, you have to choose the entity
00:07:54.000 | that will most effectively handle you where you are.
00:07:59.000 | Now, you can start with any one of these types of entities,
00:08:03.000 | or you can transition through all of them.
00:08:07.000 | It's very easy to imagine that somebody could transition
00:08:10.000 | through a sole proprietorship into a partnership,
00:08:13.000 | into an LLC, into an S corporation, into a C corporation.
00:08:17.000 | And you can transition back.
00:08:19.000 | You can go from a C corporation to an S corporation,
00:08:23.000 | to an LLC, all with varying degrees of complexity.
00:08:27.000 | It's just a matter of paying the attorneys to get things done.
00:08:30.000 | But these are all doable for you.
00:08:34.000 | The key is have the business.
00:08:37.000 | The simplest business structure is always going to be
00:08:40.000 | what's called a sole proprietorship.
00:08:42.000 | And this is just a matter of you going out and starting a business.
00:08:46.000 | A sole proprietorship requires no documents.
00:08:51.000 | It requires no articles of incorporation or articles of organization.
00:08:56.000 | There's nothing that you do with anybody anywhere.
00:09:00.000 | It can just be as simple as you going and doing something in a business manner.
00:09:05.000 | If today I wanted to start a lawn mowing business,
00:09:10.000 | do you know how I would do that?
00:09:13.000 | I would walk over to my neighbor and I would ask them,
00:09:15.000 | "Will you pay me to mow your lawn?"
00:09:18.000 | And I have officially opened Joshua's Lawn Care Services.
00:09:24.000 | That's it.
00:09:25.000 | There is nothing more that you have to do.
00:09:28.000 | If you today would like to open a restaurant,
00:09:32.000 | all you need to do is put the crock pot on your counter
00:09:36.000 | or turn on your smoker or your grill on the back patio
00:09:39.000 | and make some food and see if you can sell it.
00:09:42.000 | That's all that's required to start a business.
00:09:45.000 | Now, obviously, you know as well as I do
00:09:47.000 | that there are all kinds of codes and restrictions.
00:09:49.000 | And if anybody finds out that you're selling food,
00:09:51.000 | now all of a sudden you've got to deal with all the restaurant regulations.
00:09:54.000 | Those things exist.
00:09:56.000 | And you know that there are all kinds of challenges
00:09:58.000 | of me operating a lawn care business.
00:10:00.000 | But the point is that I'm in business as soon as I decide to be in business,
00:10:04.000 | as soon as I start actively soliciting the first customer.
00:10:07.000 | And the simplest way to organize a business is as a sole proprietorship.
00:10:13.000 | In a sole proprietorship, you have one person--
00:10:17.000 | that's the meaning of the word "sole," individual, only, sole--
00:10:21.000 | who is a proprietor, the owner, the manager,
00:10:24.000 | the person in charge of the business.
00:10:26.000 | It's called a sole proprietorship.
00:10:28.000 | And from the perspective of the IRS or the federal government,
00:10:35.000 | this type of business is the least regulated of any business structure.
00:10:43.000 | That doesn't mean that you don't have to deal with regulation.
00:10:48.000 | There will be some type of business license, health code, etc.,
00:10:53.000 | in your town if you go and start that business
00:10:56.000 | and start grilling out on your back patio and selling the food.
00:10:59.000 | There will be something there.
00:11:01.000 | But that's not going to be governed based upon the business entity that you've chosen.
00:11:08.000 | They're two completely different things.
00:11:12.000 | So you can be in business as soon as you start to be in business,
00:11:15.000 | just simply somebody saying, "I'm in business."
00:11:19.000 | For legal and tax purposes,
00:11:22.000 | there is no difference between the owner of the business and the business.
00:11:29.000 | If I go down and buy a lawnmower from the lawn care store
00:11:33.000 | and go and start cutting my neighbor's lawn,
00:11:36.000 | he obviously sees no difference between Joshua and Joshua's business.
00:11:41.000 | And I could even hire five employees to go and cut my neighbor's lawn
00:11:46.000 | and hopefully a few other hundred people,
00:11:49.000 | and there's still no difference between Joshua and Joshua's business.
00:11:53.000 | The business is a reflection of me.
00:11:56.000 | There is no other existence.
00:11:59.000 | There's no separate entity.
00:12:03.000 | That's very different than the Coca-Cola Corporation.
00:12:07.000 | The Coca-Cola Corporation is a business that exists separate from any one individual person.
00:12:14.000 | It's a separate entity.
00:12:16.000 | Now, this brings in some of the simple things that people always jump to.
00:12:19.000 | So for example, the thing you always hear people talk about, liability.
00:12:23.000 | The liability of the business owner.
00:12:26.000 | Everyone's scared of liability.
00:12:28.000 | We live in a litigious society.
00:12:29.000 | Everybody's going to sue one another.
00:12:31.000 | Is that a risk? Yes.
00:12:32.000 | Should you plan for it? Yes.
00:12:35.000 | I make a little bit of fun of it
00:12:38.000 | because I see people pull back from something because of the liability
00:12:44.000 | when you haven't done anything that's worth being liable about.
00:12:48.000 | It's a lot easier to go and start a business and make a lot of money
00:12:52.000 | and then deal with the liability from something that happened.
00:12:55.000 | Not easier.
00:12:57.000 | It's a superior plan to go make a business, make a lot of money,
00:13:01.000 | and then deal with the liability on the back end if something happens
00:13:04.000 | than to not do anything at all.
00:13:07.000 | Could you lose? Yes.
00:13:09.000 | Could you get sued and have all your money taken away?
00:13:11.000 | Of course you could. Life is risky.
00:13:14.000 | But better to be in the game, in the arena,
00:13:18.000 | as one of the favorite quotes goes.
00:13:21.000 | If you're sitting on the sidelines worrying about liability,
00:13:23.000 | you never get in the game.
00:13:25.000 | Better to get in the game.
00:13:27.000 | So in a sole proprietorship, the business and the owner are the same person.
00:13:32.000 | That means that all of the profits of the business go directly to the owner
00:13:39.000 | and all the liabilities of the business are the liabilities of the owner.
00:13:47.000 | Liabilities in the sense of debts, payments owed,
00:13:54.000 | also in the sense of risk, as in somebody could--
00:13:57.000 | one of my lawn guys kicks out a rock out of the lawnmower
00:14:02.000 | and it strikes somebody in the head and they're hurt seriously or killed.
00:14:06.000 | There's a liability there because the lawn guy is part of my business
00:14:11.000 | and that rock killed somebody and that was a part of the component of the business.
00:14:15.000 | So they can sue me and depending on what the court decides,
00:14:18.000 | I might be found liable for that either in some form of civil penalty
00:14:23.000 | or I guess if there was criminal negligence or something,
00:14:26.000 | it could be a criminal penalty.
00:14:28.000 | But the point is that the liability is me.
00:14:30.000 | I am liable for it.
00:14:33.000 | One of the biggest benefits of a sole proprietorship is that I have full control.
00:14:40.000 | I can do whatever I want with my lawn care business.
00:14:42.000 | If I decide on Tuesday that we don't want to do this type of business
00:14:45.000 | and we want to go in some other decision,
00:14:47.000 | on Wednesday we can be in a different business.
00:14:50.000 | Tuesday we finished up our lawn care business.
00:14:52.000 | Wednesday we moved into snow removal.
00:14:55.000 | You don't have to do anything or please anybody with any of your decisions
00:14:59.000 | except your customers.
00:15:02.000 | You have total freedom to operate the business however you want
00:15:06.000 | and you don't have to answer to anybody.
00:15:08.000 | You can change at that drop of a hat.
00:15:12.000 | So that's a huge benefit of sole proprietorships.
00:15:15.000 | Next benefit of sole proprietorships is they are simple to organize and to run.
00:15:22.000 | With other forms of business, for example, a corporation,
00:15:26.000 | you have various requirements that legally are required in order for that
00:15:31.000 | to be an actual business entity.
00:15:33.000 | A corporation, you need to have corporate meetings.
00:15:35.000 | You have to have corporate minutes, records of the meetings.
00:15:38.000 | These things need to be formalized and cared for properly and very formally.
00:15:43.000 | Well, if I start Joshua's Lawn Care business and I'm mowing my neighbor's lawns,
00:15:47.000 | I don't have to have meetings.
00:15:48.000 | I don't have to have minutes.
00:15:50.000 | I don't have to have corporate documents.
00:15:51.000 | I don't have to have any of that stuff.
00:15:54.000 | I just go mow lawns.
00:15:57.000 | I do need the bare minimum records for tax purposes.
00:16:01.000 | So when I file taxes, I need to have a record of what I do.
00:16:06.000 | And if I'm audited and I can't prove some of the transactions that I report on my tax return,
00:16:11.000 | I could have a problem.
00:16:13.000 | But beyond any records needed for taxes, that's it.
00:16:18.000 | There's no more paperwork involved.
00:16:21.000 | There's no--assault proprietorship is the least regulated of any business entity.
00:16:29.000 | And really the only regulation is going to be locally.
00:16:32.000 | You might need a local business license.
00:16:35.000 | You might--if you're using a fictitious name, so instead of Joshua--
00:16:40.000 | instead of just people paying Joshua Sheets,
00:16:44.000 | they're paying the green--West Palm Beach Grass Company,
00:16:49.000 | then I would need to file a simple form with the state saying that,
00:16:53.000 | "Hey, I'm Joshua Sheets, DBA, doing business as the West Palm Beach Grass Company."
00:16:59.000 | It's possible that your state might have a requirement that you publish a notice in the newspaper to that effect
00:17:05.000 | so that creditors--and the idea here is that if you go and take out a line of credit
00:17:09.000 | under the name of West Palm Beach Grass Company, then that doesn't exist.
00:17:15.000 | And so there needs to be a public record so they could trace that through to Joshua Sheets in that circumstance.
00:17:20.000 | And you might need to register an employee identification number.
00:17:24.000 | Those are very, very simple if you have employees so that you can file their employment taxes and income taxes for them.
00:17:31.000 | But there's no paperwork that needs to be formed for the actual business entity itself.
00:17:38.000 | So it's very, very simple.
00:17:41.000 | And another huge advantage of it is the tax benefits, the taxation.
00:17:46.000 | I should stop saying tax benefits, although there are some significant tax benefits.
00:17:52.000 | If you have a sole proprietorship, the way that you file a tax return for that is on your personal tax return
00:17:59.000 | using what's called a Schedule C.
00:18:02.000 | And you can have, really, I'm sure, almost any number of Schedule C businesses.
00:18:08.000 | So you can have Joshua's Grass Services.
00:18:11.000 | You could have a separate company for Joshua's Snow Blowing Services,
00:18:15.000 | a separate company for Joshua's Land Clearing Services.
00:18:18.000 | All these can be just separate Schedule Cs.
00:18:20.000 | And you can decide that at tax time.
00:18:23.000 | You would use common sense in how things are structured, but you don't have to do anything in advance.
00:18:28.000 | So if you all of a sudden want to start a business and it's your speaking business,
00:18:32.000 | all you need to do is just simply go get customers and then make money.
00:18:39.000 | Now, when you get to tax time, you take all of the profits from the business.
00:18:42.000 | You file them on your Schedule C. You report them on your Schedule C.
00:18:45.000 | You take all the expenses and you associate those with the Schedule C, and you're done.
00:18:51.000 | So if you want to start a business as a consultant, you work for a large corporation,
00:18:57.000 | you're a middle manager, and you decide, "I'm going to start a consulting company,"
00:19:01.000 | all you need to do is get a client.
00:19:03.000 | So you look across the town and there's another middle manager or lower middle manager,
00:19:07.000 | and this person wants you to mentor them in their career.
00:19:10.000 | Well, you just sell them on the idea of paying you, and you officially have a business.
00:19:15.000 | You should track your mileage to drive over and see them.
00:19:18.000 | If you buy a plane ticket to go and travel to a consulting conference where you're hoping to get clients,
00:19:23.000 | you should track that. That will be a business expense.
00:19:26.000 | You should track any expenses associated with the website that you're putting up,
00:19:30.000 | with the Facebook ads that you're buying. You just track your expenses with that.
00:19:34.000 | I recommend as a simple step before you start any business, just open a separate checking account.
00:19:39.000 | And simply by having the records in a separate checking account,
00:19:42.000 | it'll be simple for you to be able to plan for your taxes.
00:19:46.000 | You'll have a clear, independent record of all of your business income and all of your business expenses.
00:19:51.000 | It doesn't even have to be a business checking account.
00:19:53.000 | It can just be a personal checking account that you mentally know is a business account.
00:20:00.000 | The tax advantages of a sole proprietorship are a couple of things.
00:20:06.000 | One, the business income flows to you at your personal tax rate,
00:20:14.000 | which can be lower than a corporate rate if you are in a lower tax bracket.
00:20:21.000 | Two, your losses in the business are deductible against other forms of income.
00:20:28.000 | That can be substantial.
00:20:30.000 | And it can be especially substantial in the early formative stages of a business.
00:20:34.000 | As we get to the taxation of other business entities,
00:20:39.000 | then you'll see that this is an extra advantage.
00:20:42.000 | But your business, you can actually have essentially an unlimited deductibility
00:20:47.000 | with business losses of your sole proprietorship.
00:20:54.000 | In order to use those losses, you have to qualify as a business.
00:20:58.000 | You have to be running this in a business-like way.
00:21:02.000 | I would never think that if you just simply did something for one weekend out of a year
00:21:06.000 | and all of a sudden you had a $5,000 bill and you tried to deduct it against your other business or the other income,
00:21:14.000 | probably not going to work.
00:21:15.000 | But if you have a weekend business and you're working your weekend business all the time
00:21:18.000 | and you wind up with a $5,000 loss,
00:21:21.000 | you certainly can deduct that and offset your other earned income from your job.
00:21:25.000 | So that's a huge advantage of a sole proprietorship.
00:21:28.000 | There are, of course, some disadvantages.
00:21:31.000 | One of the biggest disadvantages is that risk,
00:21:34.000 | the fact that all of your assets of any kind, your personal and business assets, are at risk.
00:21:41.000 | So if I go out and I start a business and let's say that I either wind up deeply in debt,
00:21:46.000 | I borrow a bunch of money so I'm deeply in debt,
00:21:49.000 | or I lose a lawsuit against me in some way,
00:21:53.000 | then my creditors are demanding from me a million dollars.
00:21:56.000 | Well, there's no separate business entity that they're trying to grab that million dollars from.
00:22:01.000 | They're trying to get that money from me and they're going to get it.
00:22:04.000 | If I lose my lawsuit and they have a judgment placed against me, then I'm going to have to pay that money.
00:22:11.000 | Now, it doesn't mean that the only form of planning that could be used is a business entity.
00:22:19.000 | I could purchase insurance.
00:22:21.000 | If I am running Joshua's Lawn Care Service and I purchase general liability insurance,
00:22:26.000 | and now my business is sued, first they'll collect from my insurance company if they win against me.
00:22:32.000 | So you can insure against certain risks.
00:22:36.000 | You could also intelligently plan against certain risks.
00:22:40.000 | And this is where some people, a simple example, I've been a long-time employee.
00:22:45.000 | I own no property and I have no money except I have a million dollars in my 401(k) account.
00:22:54.000 | If I lose a lawsuit of a million dollars in my business because the money in my 401(k) account is protected against the claims of creditors in federal law,
00:23:10.000 | I don't have to worry about the million dollars and them being able to take my million dollars.
00:23:17.000 | Now, I'm still going to have to pay it.
00:23:19.000 | It probably would be better if I had an insurance company that was going to pay it and negotiate that for me.
00:23:24.000 | I'm still going to have to pay it because they're going to have a judgment against me.
00:23:28.000 | And if I get a million dollars in my personal life, then all of a sudden now that is subject to the claims of creditors.
00:23:33.000 | But I can plan ahead and I can make sure that I've got my assets intelligently protected.
00:23:40.000 | That would be an important thing to do.
00:23:45.000 | That's the biggest disadvantage of a sole proprietorship.
00:23:48.000 | Another disadvantage is that it can make it difficult to get something like business loans and it can make it difficult to get investors.
00:23:56.000 | It's not really possible to have outside investors who actually own part of my company if it's a sole proprietorship because there's nothing separate from me for them to own.
00:24:08.000 | I can't give them shares of stock for a sole proprietorship because no shares of stock exist.
00:24:13.000 | So my access to investment capital is limited and my access to debt capital is limited.
00:24:20.000 | I can't really borrow money separately from my personal finances.
00:24:24.000 | For many businesses that doesn't matter.
00:24:27.000 | If I'm going to start a consulting business, it's really not going to matter whether I can borrow money or not.
00:24:32.000 | What are the costs?
00:24:34.000 | A couple hundred bucks to come up with a logo and some business cards and a website?
00:24:38.000 | So you should be able to do that or you put that on a personal credit card.
00:24:42.000 | That's very different, however, than if I need to start a business that's going to require $50,000 of plant and equipment before I get started.
00:24:51.000 | That's a much bigger problem.
00:24:53.000 | So there I might need to get some form of a loan and a sole proprietorship is hard to lend to.
00:24:58.000 | Another disadvantage of a sole proprietorship is that when I die, the business dies.
00:25:05.000 | When I get sick, the business dies.
00:25:08.000 | There's no continuity.
00:25:11.000 | The first statement is more accurate than the second one.
00:25:14.000 | The business could continue with my employees continuing if I'm sick.
00:25:16.000 | But if I die, the business dies.
00:25:19.000 | There's no continuity of my business and it has no ability to operate beyond me.
00:25:25.000 | If I die, all of the assets and liabilities of the business will just simply pass to my estate and pass to my heirs.
00:25:32.000 | And so you almost never see a sole proprietorship that would be able to be continued profitably after the death of the owner.
00:25:41.000 | A sole proprietorship is very appropriate for businesses that are specific to the person.
00:25:46.000 | But it's inappropriate for something that you want to continue on after death.
00:25:50.000 | That's a sole proprietorship.
00:25:53.000 | Now, the next type of entity is a partnership.
00:25:58.000 | And a partnership is also relatively simple.
00:26:02.000 | Basically, it's just a relationship between two or more people who get together to actually conduct a trade or business.
00:26:10.000 | Each partner kicks in something, money, property, labor, or skill to the partnership and in return expects to get some of the profits or losses out of the partnership.
00:26:23.000 | Hopefully, usually, there will be some kind of partnership agreement.
00:26:29.000 | But there's no – not generally requirement of a formal document.
00:26:34.000 | It could just be a simple understanding.
00:26:37.000 | You walk over to my house and I stick out my hand and say, "Hey, Bill. Let's work together. Let's go do lawns and we'll just split everything 50/50."
00:26:45.000 | We shake hands. Boom. We're in business.
00:26:48.000 | Not a good way to get into business especially if you expect the business to last for a long time.
00:26:53.000 | But it certainly is perfectly fine for an informal situation.
00:26:58.000 | There's no reason why you couldn't create a business ad hoc like that for a limited period of time and just conduct it as a partnership.
00:27:10.000 | The use of the term partnership here is kind of a legal term.
00:27:15.000 | Simply you and my deciding to share our phone bill together and go in together on a phone plan is not going to create a partnership.
00:27:24.000 | We could even rent an office building together.
00:27:27.000 | Let's say you have your business and I have mine but we rent an office building together and we're co-tenants.
00:27:31.000 | That doesn't necessarily imply a partnership.
00:27:34.000 | So, there is a little bit of a higher standard than just those basics.
00:27:39.000 | We would usually look to see are we actually doing business as designated in the partnership agreement?
00:27:45.000 | Are we actually working together?
00:27:48.000 | What are the abilities and contributions that each of us brings to the table?
00:27:52.000 | Then how much control does each of us have over the actual business activities of the partnership?
00:28:00.000 | Some advantages of partnerships are that by bringing multiple people together – and again, it doesn't have to just be two –
00:28:07.000 | but by bringing multiple people together, you usually have more of an ability to capitalize a business.
00:28:12.000 | You and I could go into a partnership business in my lawn care business.
00:28:16.000 | If I said to you, "I need $20,000 of cash to buy equipment. I'll do the work if you put up the money."
00:28:22.000 | You could just simply say, "Okay, here's $20,000. You do the work and I'll put up the money."
00:28:27.000 | That can work fine.
00:28:29.000 | We can establish this relatively simply.
00:28:32.000 | We can just simply put together a simple partnership agreement.
00:28:35.000 | We go ahead and put those assets into the partnership agreement and you're going to be entitled to your share of the profit of the company based upon the profits and I'm going to do the business.
00:28:50.000 | We couldn't do that in a sole proprietorship.
00:28:52.000 | I would have to pay you back in the form of a loan.
00:28:55.000 | But as a partnership, we could do it with a percentage basis.
00:28:58.000 | By having more people, we usually have access to more money and that can be very, very helpful.
00:29:03.000 | But because there's not really any separate entity, we're not really going to be able to partake of financing opportunities as much as another type of business entity could do.
00:29:14.000 | Now in terms of tax benefits, there can be significant tax advantages to working as a partnership.
00:29:22.000 | One of the biggest ones is simply that the money comes through directly to us on our personal tax returns just like a sole proprietorship.
00:29:30.000 | So we don't have a separate corporation that has to be paying taxes and we are going to be paying taxes based upon each of our personal income tax rates.
00:29:42.000 | So that could be a big benefit.
00:29:44.000 | That could also be a disadvantage.
00:29:46.000 | So if you're in a high tax bracket, I'm in a low tax bracket, then I don't want a separate corporation because I want to go ahead and have the money come in to me at my low tax bracket.
00:29:57.000 | You on the other hand would like to have the money paid out as at the corporate tax rates, not at your personal tax rates perhaps.
00:30:04.000 | Other disadvantages.
00:30:06.000 | The biggest one is, which should be obvious, is conflict between partners.
00:30:11.000 | Partnerships, trying to think of the proper quantity to apply to this statement.
00:30:19.000 | Partnerships rarely work and they rarely work over the long term.
00:30:26.000 | Usually this is due to a lack of planning at the beginning.
00:30:33.000 | Let me just give you some practical things that I have observed and learned about making partnerships work.
00:30:40.000 | First, when people go into business activities, they are generally by definition going to be a little bit starry-eyed.
00:30:49.000 | You're seeing the opportunity.
00:30:50.000 | That's why you're doing it.
00:30:52.000 | You know it's going to be work, but you see the opportunity.
00:30:54.000 | It's easy to let that optimism override your hopefully healthy sense of pessimism, your risk management mindset.
00:31:03.000 | It's easy to see all the good and not the bad.
00:31:05.000 | This happens in partnerships as well.
00:31:08.000 | People often whip each other up into an emotional frenzy.
00:31:11.000 | "Yeah, this is going to be great. We're going to make millions. Let's wade into it."
00:31:14.000 | When you move quickly, what happens is you get into the thick of things without a lot of thoughtful agreements.
00:31:20.000 | One of the best things you can do in advance if you're going to be in a partnership of any kind is spend a lot of time up front doing your best to think through the situations that you're going to face and plan in advance how you're going to face those different situations.
00:31:33.000 | Put those things on paper so that you know, "During my time of cold, rational thought, we came up with this plan."
00:31:42.000 | Now, when you're in the frenzy, follow the plan.
00:31:45.000 | Generally, you're going to make better decisions if you follow the non-emotional decisions and not the emotional decisions.
00:31:51.000 | So people will be greatly served by creating that clear document governing the partnership and what each of you brings to the table.
00:32:00.000 | The other way you'll be served is by forcing communication on difficult issues.
00:32:04.000 | Forcing communication in advance makes it simpler to, when problems come, know what to do because then you're not trying to deal with things in the emotional heat.
00:32:14.000 | I'm convinced personally that in order for any kind of partnership, whether we're talking here in this formal sense or just the idea of people working together in a business or other enterprise, in order for any kind of partnership to work, there needs to be a diversity of contribution.
00:32:32.000 | If you bring skills A, B, and C to the table, and I also bring skills A, B, and C to the table, and we say, "Well, we'll just be better together," and we start working, and you're doing ABC and I'm doing ABC, chances are we're each going to think that we do ABC better than the other person.
00:32:51.000 | After all, 92% of drivers think they're above average with their driving skill.
00:32:57.000 | I made the 92% up.
00:33:02.000 | 47% of all statistics on the internet are made up.
00:33:05.000 | Abe Lincoln quoted that one.
00:33:10.000 | In order to have a diversity of contribution, I'm not going to feel like I need you if we both do A, B, and C.
00:33:22.000 | Now, if you do ABC and I don't like ABC and I'm not good at ABC, but I do XYZ and you don't like XYZ, but I'm good at XYZ, then we can come together and I can value and esteem your contributions for doing ABC, and you may value and esteem my contributions for doing XYZ.
00:33:41.000 | We're going to feel like the sum of the parts is greater than the sum of the whole is greater than the parts.
00:33:48.000 | You're going to feel like, "Man, I'm so glad that Josh was doing XYZ and I just get to do ABC," and I'm thinking, "I'm so glad that you are doing the things I don't like to do," and we can value and benefit from one another.
00:34:00.000 | So if I'm an engineer and you're a salesperson, that's a good fit.
00:34:04.000 | If you're an accountant and I'm a business manager, that might be a good fit.
00:34:10.000 | If you're a rainmaker and I'm a doer, that's a good fit.
00:34:13.000 | If you're a manager and I'm a rainmaker, that might be a good fit.
00:34:17.000 | But if you're a manager and I'm a manager, we're going to be trying to manage each other, and that's not going to work.
00:34:24.000 | If you're an accountant and I'm an accountant, well, who's going to go and make the rain?
00:34:28.000 | So consider that when getting into partnerships.
00:34:32.000 | You've really got to have a diversity of contribution so that you're going to value your partner when things get tough.
00:34:40.000 | So back to the financial framework here.
00:34:44.000 | Conflict is the biggest thing, but there are some financial problems.
00:34:48.000 | Biggest one, biggest problem of a partnership is that each of us in a partnership has an unlimited personal liability for the debts of the partnership.
00:35:02.000 | That should scare you.
00:35:06.000 | The potential liability from a partnership is far greater than that in a simple sole proprietorship.
00:35:15.000 | Because if you think that we should go and borrow $100,000 to buy this equipment that's going to make us money, and I think we shouldn't,
00:35:26.000 | the reality is I have no way to stop you if you decide that's what you're going to do.
00:35:33.000 | And if you go and borrow $100,000 in the name of the partnership, and then we lose the business and we lose the money, I'm legally on the hook for the $100,000.
00:35:50.000 | Now, it doesn't mean that all of our assets are commingled.
00:35:53.000 | It has to be done in the name of the partnership.
00:35:55.000 | You go and buy a house and you foreclose on it.
00:35:57.000 | I'm not liable for your house just because we're in a business partnership.
00:36:00.000 | But if you bought that $100,000 of equipment for the business, I'm liable for it.
00:36:05.000 | This also applies to areas of negligence.
00:36:09.000 | If you commit a negligent act, we buy tractors, and you're out driving a tractor and you destroy some property or hurt somebody, and you're negligent for that,
00:36:21.000 | I am liable for your negligence to an unlimited degree.
00:36:29.000 | Million dollar lawsuit against the company, they win, I'm liable for that lawsuit.
00:36:36.000 | Got to be your negligence associated with the business, but I'm liable for the lawsuit.
00:36:42.000 | So that can be very, very significant.
00:36:44.000 | To open yourself up to the liability for another person's actions that you don't control, that can be a significant cost.
00:36:52.000 | Now, of course, there can be some ways to insure against that, just like we talked about with the sole proprietorship, but it's a problem.
00:37:01.000 | It's a big problem, and you should be very, very slow to ever get into a partnership for that reason.
00:37:10.000 | Other problem with a partnership is that it lacks continuity.
00:37:14.000 | When one of us dies, the partnership is automatically terminated.
00:37:19.000 | Everything is disbanded, there's a final accounting done, and it's ended.
00:37:24.000 | So the business will not continue past the death of a partner.
00:37:29.000 | So you run some of those disadvantages which make it problematic.
00:37:36.000 | Now, again, partnerships can work.
00:37:39.000 | They're simpler to form.
00:37:41.000 | There are fewer startup costs necessary, simple regulation.
00:37:45.000 | But it can be hard to manage those relationship dynamics.
00:37:51.000 | It can be easy for us to blame one another for the poor health of the business.
00:37:55.000 | If you're the sole proprietor, you can't blame me for how poorly your business is doing.
00:37:59.000 | You've got to do it.
00:38:01.000 | And in fact, you know that you're responsible for everything.
00:38:03.000 | But in a partnership, unless we have clearly communicated responsibilities and expectations laid out, we can have a problem.
00:38:12.000 | That brings us on to corporations.
00:38:15.000 | And by the way, we'll talk about LLCs last, limited liability companies.
00:38:18.000 | Limited liability companies are new, but they've solved most of these problems of a partnership.
00:38:23.000 | And so more and more, there's almost no reason why you should establish a partnership.
00:38:29.000 | An LLC is almost always going to be a simpler option.
00:38:32.000 | But we'll come to those in a moment.
00:38:33.000 | Next, I want to talk about corporations.
00:38:35.000 | A corporation is just something that's made up in law.
00:38:41.000 | The idea is to have a separate entity, and it's purely created by the legal structure of the United States.
00:38:48.000 | It's not a person.
00:38:49.000 | It's just treated like a separate entity.
00:38:52.000 | And we make it up by drawing up some papers.
00:38:55.000 | The corporation is an artificial entity where we just sit down and we file articles of incorporation with the governing authorities in our state.
00:39:06.000 | And then when they accept those articles of incorporation, we now have a separate legal entity.
00:39:13.000 | It's not a person.
00:39:14.000 | It's a legal entity.
00:39:15.000 | But that separate legal entity exists and has certain rights to carry on the affairs of its business as a separate entity.
00:39:26.000 | The articles of incorporation make that entity publicly accountable.
00:39:33.000 | We adopt corporate bylaws and rules of operation, et cetera, and those bylaws are what govern the actual how the business works.
00:39:42.000 | Your corporate rules will be governed by the laws of the state where you incorporate or by the laws where you do business.
00:39:49.000 | And there are advantages and disadvantages to incorporating in different states.
00:39:54.000 | Some states seek very hard to differentiate themselves with certain characteristics that people find attractive so they'll do their business and open their corporations in that state and they'll be able to collect the administrative fees, et cetera.
00:40:07.000 | And so that's beyond the scope of today's discussion, but there are reasons why many companies are organized in Delaware.
00:40:14.000 | Even if your company is located in Florida, it might be a Delaware corporation.
00:40:18.000 | There are many reasons why companies are organized in Nevada.
00:40:21.000 | There are many reasons why companies are organized in your own state.
00:40:24.000 | So you should consider that and look into that because the state – the laws of the state where the corporation is established and incorporated and then you're also subject to the laws of other states.
00:40:37.000 | Corporations are much more complex than a sole proprietorship or even a partnership.
00:40:45.000 | There are many more regulations and there are many more requirements from how to do business.
00:40:52.000 | A corporation as a separate entity has more people involved.
00:40:58.000 | For example, in a corporation – and we're going to first talk about what's called a C corporation.
00:41:05.000 | This is a traditional corporation.
00:41:07.000 | There's also an S corporation, which I don't know if it actually stands for simplified or not, but that's what – it's governed by subchapter S of the code, of the tax code.
00:41:19.000 | But I think of it as just simple corporations.
00:41:22.000 | That's what helps me to remember it.
00:41:27.000 | And they work similarly, but there is difference especially from taxation.
00:41:32.000 | In a corporation, a corporation is going to have different people involved.
00:41:36.000 | And so you're going to have at the minimum shareholders.
00:41:40.000 | The shareholders are the people who own the shares of stock of the business.
00:41:45.000 | But they don't necessarily have to be people managing the business.
00:41:49.000 | Their only job is electing the directors of the corporation and voting on any major corporate issue that the directors bring to a ballot of the shareholders.
00:41:58.000 | So when you go and purchase a share of Coca-Cola stock, you are now a shareholder of Coca-Cola.
00:42:05.000 | Any of your stocks or any of your mutual funds that own stock have turned you into shareholders.
00:42:12.000 | You don't only have to go and purchase those types of stocks.
00:42:16.000 | You could become a shareholder in my lawn business if you wanted to.
00:42:21.000 | I could create Joshua's Lawn Services as a corporation.
00:42:25.000 | I could issue shares of stock.
00:42:27.000 | And if you felt that you would benefit by owning the shares of stock in Joshua's Lawn Services, you could buy them and you would become a shareholder.
00:42:35.000 | Now, the second type of person that's involved in a company is a director.
00:42:40.000 | A director is – just think of this as the board of directors, a member of the board of directors.
00:42:45.000 | The directors, they could be shareholders, but they don't necessarily own the business.
00:42:51.000 | Or at least they don't own the business in their function as a director.
00:42:55.000 | They are responsible to make the major business decisions of the corporation.
00:43:00.000 | The biggest thing that they do is appoint and supervise the officers of the corporation.
00:43:06.000 | The officers are the people who are actually working in the company and who are responsible for the day-to-day operation of the business.
00:43:13.000 | This would be people like the president, the vice president, the CEO, the secretary, the treasurer.
00:43:19.000 | These types of functions are the officers of the company.
00:43:23.000 | They can be shareholders and they can also be directors, but they don't have to be.
00:43:32.000 | I can establish a corporation for Joshua's Lawn Services.
00:43:37.000 | I can issue shares of stock that I own.
00:43:41.000 | I can be a director of the company and I can also be the chief executive officer and the primary grass cutter.
00:43:49.000 | All of those are possible. Or all those things can be different.
00:43:54.000 | I can establish a corporation, make my children and all of my relatives the shareholders,
00:44:02.000 | hire my best buddy as a director to sit on my board of directors and serve as the officer,
00:44:09.000 | or I can do any combination of those things, but those are the three people involved, the shareholders, directors, and officers.
00:44:16.000 | The biggest advantage and one of the most important advantages of using a corporation to run a business
00:44:25.000 | is that there is limited liability for the shareholders of a company, also limited for the directors and the officers.
00:44:37.000 | But everybody has their liability limited.
00:44:41.000 | The corporation exists as a separate entity.
00:44:46.000 | And so if I've created Joshua's Grass Services and you've bought a share of my stock and paid me for that,
00:44:53.000 | if I wind up going deeply into debt and I'm sued and they won the judgment,
00:44:59.000 | your liability is limited to the value of the money that you paid for the share of stock.
00:45:06.000 | Your stock might become worthless, but you can't be sued because the corporation went into trouble.
00:45:18.000 | If you own shares of Coca-Cola Corporation and Coca-Cola Corporation is sued into oblivion or they go bankrupt,
00:45:24.000 | you lose your money in the company, but that doesn't mean that they can come after you for more assets.
00:45:32.000 | That's a real advantage. And that's an advantage for everybody involved.
00:45:38.000 | It's an advantage for the directors, an advantage for the officers.
00:45:40.000 | As an officer of the company, you might be able to hire somebody to come and manage the business,
00:45:45.000 | but they're not responsible for the actual total value of the business.
00:45:49.000 | This is a huge deal when it comes to attracting investors and capitalizing your business.
00:45:54.000 | A corporation is how you can raise millions of dollars because your investors know,
00:46:01.000 | "As investors, I'm just going to get profits. I have no liability."
00:46:05.000 | And they can be completely, entirely passive.
00:46:07.000 | They don't have any responsibilities other than to give you money. A huge deal.
00:46:12.000 | A corporation, another huge advantage, can have a perpetual existence.
00:46:17.000 | In theory, a corporation can last forever.
00:46:21.000 | Now, obviously, that won't happen, but in theory, there's no reason why it can't
00:46:26.000 | because it's not connected to the life of any one person in that company.
00:46:34.000 | That can be a big, big deal and a huge benefit.
00:46:38.000 | You don't have to worry about a corporation terminating because somebody dies.
00:46:43.000 | You can just simply keep the business going. You can bring in different directors.
00:46:47.000 | You can get rid of certain directors. The shareholders can sell their shares.
00:46:51.000 | You can bring in and remove officers. It's a separate entity.
00:46:56.000 | Another big benefit is the diversity of people that can be involved
00:47:00.000 | and the ability of the people to buy, sell, trade, otherwise dispose of their shares.
00:47:07.000 | In a partnership, you can't bring on a partner without the consent of all the partners in the business.
00:47:12.000 | Whereas if you own shares of Coca-Cola stock, you can give that away.
00:47:17.000 | You can sell it. You can trade it. You can do whatever you want with that Coca-Cola stock
00:47:22.000 | subject to the stockholder agreements with the actual company.
00:47:27.000 | That can be a huge benefit because it allows you to shift your dividends around by shifting the assets.
00:47:34.000 | You can transfer that stock to your kids.
00:47:36.000 | You can hold that stock in your estate and pass it along to your heirs.
00:47:40.000 | This is a huge deal. So when you are going to run a big business,
00:47:44.000 | it's almost always going to be some form of corporate entity because it allows you to raise a lot of money
00:47:50.000 | by attracting investors and it allows you to -- those investors -- to be able to dispose of their shares when they want to.
00:47:59.000 | Now in taxation, you've got advantages and disadvantages.
00:48:03.000 | The use of a corporate entity can increase the amount of tax paid or can decrease the amount of tax paid.
00:48:09.000 | That has very much to do with how the corporation is taxed and also how you as a person are taxed.
00:48:18.000 | One of the biggest problems with the corporate structure is, especially in the United States,
00:48:23.000 | you have -- for a C corporation, you have what's called double taxation.
00:48:27.000 | So if we have Joshua's Lawn Care Services, Joshua's Lawn Care Services is going to be paying taxes as a C corporation
00:48:34.000 | at the corporate tax rates. So let's just say we're in the 35% corporate tax bracket.
00:48:39.000 | Well, that means that every dollar of profit is going to pay that 35% tax.
00:48:45.000 | And then I'm going to send the money out, the profit, after it's taxed, out to my shareholders as a dividend.
00:48:52.000 | And now you as a shareholder are going to pay tax on that profit from the company under the dividend tax rates.
00:49:00.000 | Now, currently, dividend tax rates are lower than income tax rates, but we still wind up with potentially a significant problem.
00:49:08.000 | If you're paying a -- if we're paying at the corporate level a 35% tax rate and at the dividend tax rate you're paying 15%,
00:49:15.000 | now we've got a substantially high income tax problem. That's the basic problem of double taxation.
00:49:22.000 | And it's a huge problem in the United States. The United States is losing a ton of business all around the world
00:49:27.000 | because of the corporate tax rate. Corporations are working very, very diligently to keep the money offshore,
00:49:33.000 | not to bring the money into the United States, so to keep it sheltered in other companies.
00:49:38.000 | And a lot of it is based upon tax avoidance schemes. So it's a huge problem.
00:49:43.000 | And double taxation is -- I'll leave it there for now, but it's a major problem.
00:49:48.000 | Now, there are disadvantages to a corporation, significant disadvantages.
00:49:53.000 | You lose a lot of control. Your situation is no longer simple.
00:50:00.000 | When you were a sole proprietor -- when I was a sole proprietorship running Joshua's Lawn Services,
00:50:04.000 | if I want to change -- if I wanted to change tomorrow from lawn services to snowblowing services,
00:50:10.000 | I could do that immediately. I didn't have to ask anybody.
00:50:13.000 | But in a corporation, given all the different people involved, the officers, the directors, and the shareholders,
00:50:19.000 | the officers and the directors have to get together and make that decision together
00:50:23.000 | because the officers are answered to the board of directors.
00:50:27.000 | And the board of directors answer to the shareholders.
00:50:31.000 | So we've got to make sure that if we're going to change the future of the company
00:50:35.000 | and we're going to make substantial business decisions, that those decisions are approved by everyone involved.
00:50:40.000 | And even if I were 100 percent of the shareholders, the director of the -- on the board of directors,
00:50:49.000 | and the officer of the company, even in that situation, I still -- I can make all the decisions.
00:50:56.000 | I still have to follow the technical formalities of corporate management.
00:51:02.000 | So there still has to be a detailed recordkeeping of the meeting that I held with myself
00:51:07.000 | to sit down and draw out the future of the company with the other directors.
00:51:12.000 | There still has to be the minutes of those. We have to have our quarterly meeting.
00:51:15.000 | All of these things need to be carefully monitored and recorded.
00:51:21.000 | And it's especially important, and they have to be done regularly.
00:51:24.000 | It's important because if they're not being done, you lose the benefits of the corporation.
00:51:30.000 | If you wind up in a situation where you're subject to some lawsuit or other legal judgment,
00:51:37.000 | if you're not operating the corporation appropriately, then the corporation can be dissolved.
00:51:43.000 | The technical term is piercing the corporate veil.
00:51:46.000 | I can say this is a sham corporation. You're Joshua's Lawn Services. You're not a corporation. You're Joshua.
00:51:51.000 | You're one dude. You have a lawnmower and you're mowing people's lawns,
00:51:55.000 | and you've got this ridiculous sham corporation. It's not a corporate entity.
00:52:00.000 | You're just trying to protect yourself from liability, but you're liable.
00:52:05.000 | That can't happen. It does happen.
00:52:08.000 | So you've got to follow all of the requirements of quarterly meetings, good minutes,
00:52:13.000 | all of the records of the corporation. Those are spelled out in your state.
00:52:18.000 | And then we also have the problem of the taxation.
00:52:21.000 | So you can see here the benefits of the corporation can be significant.
00:52:25.000 | But the other thing is just the expense.
00:52:28.000 | The expense, you have to file separate corporate tax returns.
00:52:30.000 | You have to file separate corporate fees with the state government that you're registered under
00:52:36.000 | and potentially other state governments. So all of that can add up.
00:52:40.000 | But you can see here the problem. People want the corporate benefits, want the limited liability,
00:52:44.000 | want the protection, want the separate entity status, want to be able to work with multiple people.
00:52:50.000 | But some of those corporate things are problematic.
00:52:54.000 | And that leads us to the S corporation and the LLC.
00:52:57.000 | So first is S corporation. The S corporation is a corporation.
00:53:03.000 | It's important to remember that.
00:53:06.000 | So it has many of those same requirements of the corporation we just talked about, the C corporation.
00:53:13.000 | But it does have a few simplifying things.
00:53:17.000 | In order to qualify as an S corporation under the IRS rules, you have to have fewer than 75 shareholders.
00:53:26.000 | All of the shareholders need to be individual people generally.
00:53:32.000 | You can't have other companies owning the company generally and you can't have foreign entities.
00:53:38.000 | You have to be individual people and U.S. citizens.
00:53:41.000 | You can only have one class of stock in an S corporation.
00:53:45.000 | The shareholders must decide that yes, we actually will take on the S corporation status.
00:53:51.000 | And then you file the forms with the IRS to become an S corporation.
00:53:55.000 | These are significant restrictions.
00:53:58.000 | I didn't mention with C corporations the shares of stock.
00:54:02.000 | You can have voting shares in a C corporation and non-voting shares.
00:54:06.000 | You can have different classes of stock that have different ways the dividends flow to them.
00:54:10.000 | Some are dividend receiving, some are not.
00:54:13.000 | You can have all kinds of unique customized approaches based upon what you're trying to accomplish with the corporation.
00:54:19.000 | So the S corporation does retain, however, a lot of the benefits.
00:54:23.000 | It retains the limited liability.
00:54:26.000 | It retains the structure where you can have shareholders that are different from people that are involved in the company.
00:54:33.000 | It retains a lot of those benefits.
00:54:35.000 | But it also retains some of the disadvantages.
00:54:38.000 | So it retains the disadvantage of having to file corporate forms, follow corporate formalities.
00:54:46.000 | Although they're simplified, you still have to file all the corporate formalities.
00:54:50.000 | The big benefit of an S corporation is that the taxation is not done at the separate business entity level.
00:55:03.000 | The taxation of the company flows through to the individuals just like a partnership, just like a sole proprietorship.
00:55:13.000 | The taxation continues and passes through.
00:55:16.000 | So if the company makes a million dollars and we have 10 shareholders in the company, that $100,000 is not paid at the level of the company.
00:55:29.000 | It passes through to the shareholders' individual tax returns.
00:55:34.000 | And you and me and the other eight people that are in our company, all of us report that $100,000 on our individual tax returns.
00:55:43.000 | That's a huge potential benefit.
00:55:45.000 | And that is the biggest reason why most people should consider using an S corporation.
00:55:51.000 | It's because you can get out of those onerous corporate tax rates and back into the personal tax rates, which can be more helpful and more beneficial.
00:56:02.000 | This is also the reason why there's this huge political argument that comes up always during usually presidential and other political elections about the fact that, well, most small business owners are taxed rich people.
00:56:16.000 | And it's true that most small business owners have their businesses structured as an S corporation.
00:56:22.000 | And thus, the profits of their business are being reported on their personal tax returns.
00:56:27.000 | That's where that argument comes from.
00:56:30.000 | Which brings us to the LLC.
00:56:33.000 | Now, LLCs are relatively new, as in – I didn't research any specific dates – but as in the past few decades.
00:56:43.000 | And for many years, it was only available in some states.
00:56:47.000 | Now, there is – each state, each of the 50 states in Washington, D.C., has LLC rules associated with each of them.
00:56:57.000 | The big benefit of an LLC are basically three things.
00:57:02.000 | Number one, you get the limited personal liability that you get with a corporation.
00:57:08.000 | Owners of the LLC are not – the business is a separate entity, and people who own member units of the LLC are not subject to unlimited liability.
00:57:21.000 | Second big benefit is you can get pass-through taxation.
00:57:25.000 | We'll talk about that in a moment.
00:57:27.000 | So you can get pass-through taxation just like the S corporation.
00:57:30.000 | And the third benefit is that you have a simplified operating structure.
00:57:35.000 | You don't have so many corporate formalities to file.
00:57:39.000 | The filing requirements are really simple.
00:57:41.000 | You don't have to have quarterly meetings necessarily.
00:57:43.000 | You have very, very simple requirements.
00:57:47.000 | So this is a big, big benefit, and limited liability companies are extremely useful.
00:57:53.000 | Now, you can have different numbers of owners.
00:57:57.000 | You can have owners and members, some of whom are actively involved and non-actively involved.
00:58:03.000 | You can hire managers in the company.
00:58:05.000 | You have a number of different benefits.
00:58:09.000 | When you bring in the fact that the risk is limited and that you can divide up things like the profits, so you can take a business.
00:58:22.000 | And let's say that I have Joshua's Lawn Care Services, but I can establish an LLC, and Joshua is running the business.
00:58:29.000 | But I can make – I can give 25 percent of the member units to my son, 25 percent of the member units to my daughter, 25 percent of the member units to my wife.
00:58:39.000 | And each of them will receive their profits from the company.
00:58:42.000 | I still have 25 percent shares.
00:58:44.000 | We can adjust our income and we can use an LLC as a way to adjust those profits and to distribute them differently.
00:58:54.000 | There are a number of disadvantages.
00:58:58.000 | Number one is you've got different rules in different states.
00:59:02.000 | You need to make sure that you check on your different states.
00:59:05.000 | One challenge with an LLC can be how to continue the business in the death of a person.
00:59:10.000 | You can set this up.
00:59:12.000 | And some states are now allowing limited liability companies to exist into perpetuity like a corporation.
00:59:21.000 | But that can be troublesome.
00:59:24.000 | And especially if you have a single-member LLC, just one person, then basically the person can – if the person dies, then the business ceases to function.
00:59:34.000 | And so you have that problem.
00:59:40.000 | A huge benefit on the LLC has to do with the way that you can set up the member units.
00:59:47.000 | You can set up different ways that the profits and losses are going to be distributed out.
00:59:52.000 | And then another benefit is that you can choose the model of taxation that you want as an LLC.
00:59:59.000 | So you can choose to have an LLC that is taxed as a sole proprietorship.
01:00:06.000 | You can choose to have an LLC that's taxed as an S corporation.
01:00:10.000 | And you can choose to file – have an LLC that's taxed as a C corporation.
01:00:16.000 | So this is – those are all options. And you choose that based upon a form that you file with the LLC.
01:00:23.000 | The LLC for many businesses and most people will probably be the best solution.
01:00:31.000 | You don't necessarily – and there are two aspects to this when it comes to actually setting one up.
01:00:37.000 | Most businesses, especially most complicated businesses, need to spend a lot of time on getting their articles of incorporation if they're establishing a corporation.
01:00:48.000 | Or in an LLC, they're called the articles of an organization.
01:00:52.000 | You need to get those things right.
01:00:54.000 | And if you're going to use an LLC as a complex entity where you're going to run some kind of investment fund out of it and you're going to have different units that are different people,
01:01:04.000 | and you're going to share the funds out differently and you want to put certain restrictions on the owners and certain restrictions on the managers,
01:01:10.000 | this is the type of thing where no question you need good legal advice.
01:01:15.000 | And so you definitely need good legal advice.
01:01:18.000 | If you're just going to start Joshua's Lawn Care Services, however, you don't quite need such an important legal advice, I don't think, generally.
01:01:27.000 | So you can file with most states. In my state, it's very, very easy.
01:01:31.000 | You go to sunbiz.org, and Sunbiz is the Florida website for business management.
01:01:37.000 | And I can file an LLC in about 10 minutes.
01:01:41.000 | You just go on there. You can use the boilerplate articles of incorporation.
01:01:45.000 | Click start, and we can set up Joshua's Lawn Care Services in about 10 minutes for -- I didn't check the price, but I don't know, $100, something like that.
01:01:52.000 | So if you want to set up an LLC for your business, it's very, very simple to do.
01:01:56.000 | And if you have a business that you're establishing, there's probably a few reasons not to do that.
01:02:03.000 | Really, there are very few reasons not to do it.
01:02:07.000 | Sole proprietorship has a few benefits from a taxation perspective, but it also has some disadvantages.
01:02:13.000 | And many of you will be best served by establishing an LLC and choosing to be taxed as an S corporation where you have a pass-through entity.
01:02:22.000 | The benefit of being taxed as an S corporation is that you will receive both wages and dividends, which are representative of your profits.
01:02:29.000 | And your wages will be taxed where you'll pay employment taxes and income taxes.
01:02:34.000 | Your dividends, however, will be only subject to income taxes.
01:02:38.000 | That's the biggest benefit.
01:02:40.000 | So it's very, very simple to file something where if you have a simple business.
01:02:45.000 | If you're going to have a more complicated business, that's where you want to get in legal advice.
01:02:50.000 | But with the prevalence of the LLC now and with the ability to choose the taxation model, LLCs are very, very compelling.
01:02:59.000 | You can always see circumstances in which you would want to look at a few different entities.
01:03:06.000 | But in general, if somebody's steering you towards an LLC, taxed as an S corporation, for most small businesses, you're probably getting decent advice.
01:03:16.000 | At least that's my opinion.
01:03:18.000 | Now, there are other forms of companies.
01:03:20.000 | There are other specializations.
01:03:22.000 | So, for example, when we were talking about partnerships, we were talking about a general partnership where everybody was together.
01:03:29.000 | However, you can establish a limited partnership where you have some partners who have an unlimited liability but other partners who have a limited liability.
01:03:41.000 | So you can set up a limited partnership.
01:03:43.000 | You can set up a limited liability partnership.
01:03:48.000 | In different states, those limited liability partnerships are generally an entity that's reserved for somebody who's working in a licensed profession, such as an attorney, an accountant, or an architect.
01:04:01.000 | There's also a limited liability limited partnership in some states.
01:04:06.000 | So you could have an LP, an LLP, and an LLP.
01:04:10.000 | With your limited liability companies, you can have an LLC.
01:04:13.000 | You can also have a professional limited liability company depending on some states' rules, again, about service providers, people who are doctors, lawyers, accountants, etc.
01:04:24.000 | With corporations, you can have a corporation.
01:04:26.000 | Some states permit you to have a professional corporation.
01:04:30.000 | So, again, licensed professionals, if you are an attorney, architect, accountant, doctor, etc., that's where you fall into a special form and depending on your state, you'll have different rules governing you.
01:04:44.000 | But all of these are options.
01:04:46.000 | All of these are options for you and all of them are things that should be considered.
01:04:51.000 | So my hope for you is we – as we close the show here, my hope is that you will focus on the business first.
01:05:04.000 | Again, one afternoon with your accountant should really be enough for you to handle most decisions.
01:05:13.000 | Focus on the business first but at least hopefully this gives you an outline of the business and entities so you won't be intimidated and overwhelmed by the people saying, "Oh, you can use an LLC in such and such a way."
01:05:26.000 | There are some advanced financial planning techniques using these types of entities which can be incredibly powerful because what you can do is you can layer different levels of ownership for different entities.
01:05:41.000 | You can have an LLC that owns another business.
01:05:45.000 | And so without getting into any specific examples right now because I didn't prepare any, you can use an LLC that owns an investment company.
01:05:56.000 | You can manage the investment company and you can put the shares out and you can distribute the shares to all of your nieces and nephews or to your grandkids.
01:06:02.000 | And you can use this type of approach, the creation of a separate entity to start to allow you to split out profits and to get profits sent to where you want them to be.
01:06:13.000 | You can have a partnership, a limited partnership where the limited partners are other investors or family members.
01:06:23.000 | And as the general partner or partners, you have full operating control of the company and nobody can tell you what to do with the company but you have the legal mechanism for them being the owners of the company.
01:06:35.000 | So there are some more advanced – there are tons of advanced techniques that you can use these entities for.
01:06:40.000 | They're just the foundation.
01:06:41.000 | Hopefully now you have a bit of an idea of the foundation of these entities.
01:06:45.000 | That's it for today's show.
01:06:46.000 | If this information has been useful to you, please consider becoming a member or a patron of the show.
01:06:50.000 | Details of that at RadicalPersonalFinance.com/patron.
01:06:53.000 | I try to keep the show pretty free of ads.
01:06:55.000 | I did an ad read at the beginning today.
01:06:57.000 | But I try to keep the show pretty free of ads and I can do that only because listeners support me directly at RadicalPersonalFinance.com/patron.
01:07:04.000 | If you would like to get my specific advice on your situation, you can set up a consulting phone call with me.
01:07:10.000 | Details can be found at RadicalPersonalFinance.com/phonecall.
01:07:13.000 | But I do accept individual consulting calls with individual listeners.
01:07:17.000 | RadicalPersonalFinance.com/phonecall.
01:07:20.000 | And until tomorrow, y'all have a great day.
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