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In this Episode, Steve and Chris continue their talk on corporate formalities and why they are important. They discuss the importance of board meetings, piercing the corporate veil, and shareholder basis record keeping.
Listen to the full episode to learn more!
Episode Transcript
Intro:
You’re listening to the Practical Tax podcast with tax attorney Steve Moskowitz. The Practical Tax podcast is brought to you by Moskowitz LLP, a tax law firm.
Steve Moskowitz:
Welcome to everyone. We’re here to talk to you about all the benefits that a corporation can provide to your business. I’d like to introduce my friend and longtime colleague, attorney and EA, Chris Housh. Chris, you have so much experience in this. What’s the benefit of being a corporation?
Chris Housh:
The main benefit is that you have what’s called a corporate shell. So by going and making where you’re treating your business as being something separate than your own individual self and having the formalities in place, you’re making it where the government and all of your creditors recognize that your personal assets are not something that can be grabbed if something happens with your corporation. Also, if something happens for you individually, your corporation, your business, is protected from your personal creditors. Now you do have to go and make sure that you follow the rules, that you actually put everything in place. But once you’ve done that, you’ve created the beneficial element of protection. You also have tax benefits, whereas, especially within current laws, as they were changed in 2018, expenses and deductions that you cannot get as an individual the corporation is allowed to deduct, as long as it’s a regular ordinary expense of the business. And that includes things like the state taxes, and other expenses that you’re incurring, that you would not be allowed to deduct as an individual.
Steve Moskowitz:
So, Chris, that sounds like really a big deal. That’s asset protection, ’cause you know, there’s a lot of risk in business. And a lot of people would like to go into business, but they don’t wanna risk everything they worked for in a lifetime. That sounds like a tremendous deal. And how does it work for taxes? Does it make a difference of your corporation for taxes?
Chris Housh:
Yes, now there’s two kinds of corporations. There’s what’s called a C corporation and a S corporation. The C is the default, but you never wanna actually be a C Corp, unless you fit into a specific category. The three times that you are forced to stay as a C corporation, is if you’re gonna have a hundred or more shareholders, if you have any foreigners that are shareholders, or if you’re planning on actually going and having your stock sold on the stock market, NASDAQ or the top 500, they require you to be a C corporation. The problem is a C corporation is taxed at the corporation level, and then taxed again at the shareholder level for any money that comes out of the corporation to the shareholder. So you’re double taxed. You don’t want that. It’s more frustrating to have to go and deal with that.
Instead you wanna be able to go down to the S corporation. An S corporation, again, you get to have all those deductions that are regular for a business, reduced down the profit that S corporation, as long as you don’t fit into the circumstances of being required to be a C Corp, you then have it where your net profit, after all those expenses, flows down into your individual tax return, the corporation doesn’t pay any tax, and then you can have your other items of income and expense deducted against what the corporate profit is. And if your corporation loses money, and you’re actively working the business, those losses can actually offset your other income. So you get definite benefit out of that, while also again, protecting your assets, protecting your interests, and making where you have the safety of a corporate shell.
Steve Moskowitz:
Well, that’s terrific. And are there any benefits that come about with a corporation, if you are looking at your state taxes?
Chris Housh:
There are many states that have been trying to figure out how to get around the state and local tax cap that was put into the 2018 tax law changes.
Steve Moskowitz:
What is that cap?
Chris Housh:
The cap is that you can only take $10,000 on your individual tax return of what you’re paying out to state and local taxes, as a deduction on your schedule A itemized deductions.
Steve Moskowitz:
So you mean, if I pay a million dollars in state taxes I can only deduct $10,000?
Chris Housh:
Yup, thanks to that 2018 law change.
Steve Moskowitz:
Ouch.
Chris Housh:
Exactly. But if the corporation has to pay those taxes and does the action properly, then you can go and actually have it where the corporation has that deduction, ’cause it has the ability to deduct all of its taxes. The government set it up that a corporation that’s only making $20,000 a year gets the same benefits of a corporation that’s making $20 million a year. Gets to take the full deduction of whatever taxes its paying and other expenses. You have that runoff of the corporation, you’re able to go and do that. And then a lot of states to find ways to work around it, California, New York, a lot of these states that have higher state taxes, that are likely to have more than $10,000 paid, have been making specific rules on how to go and make it where you can have your corporation take a bigger chunk of state tax. So you have it, with the IRS’s blessing, to go and have the deduction come out at the corporation level, and then pass down into your individual return, while still allowing you still to have even, whatever you’re paying individually for your state taxes still be on the schedule A.
Steve Moskowitz:
So basically then what it sounds like, if a person had a business and they were a sole proprietor, like so many people are, they’d be limited deducting, no matter how much they paid in state taxes, 10 million to $10,000. But if they did the simple act of incorporation and made an S election, they’d effectively be able to deduct these taxes?
Chris Housh:
Correct.
Steve Moskowitz:
Wow, that’s incredible. And tell us some of the other benefits that a corporation enjoys. For example, what about if you’re looking at other areas? What other areas would this do for us?
Chris Housh:
Well, one of the things that I especially like about it is- now I hope every one of my clients are gonna be great successful businesses, but the average of how many businesses survive the first five years, is unfortunately relatively low. So I look for how to protect my client in the worst case scenario, if the business isn’t gonna be successful, one of the things is that the expenses and debts of the corporation, as long as you do everything properly, you don’t go and commingle your personal income and expenses out of the corporation. You keep all the formalities going, of making sure you do your meetings every month, and things like that, which we’ll talk about in a different podcast.
As long as you’re doing everything properly, the debts of the corporation, if the corporation is not able to go and continue living, can all be locked inside the corporate shell. There’s a few that escape. Anything that you put a personal guarantee on. So if they sign loan for the corporation, but they ask you to go and personally guarantee it, obviously you guarantee it personally, they get to kind of go and still ask you to pay individually. If you took out a corporate credit card, the Truth in Lending Act says, a corporation actually cannot own a credit card, that it is solely the people that are either the co-signer owner, or the person assigned to actually buy something with that credit card, are the ones that are responsible if the corporation can’t do it. So that breaks out of the corporate shell.
And then the third thing is what’s called trust fund taxes, which is either sales tax, or wages withheld out of an employee’s paycheck. The employer share of those taxes stays in the corporate shell, but anything that a person paid to you, and according to the government, that person trusted you to pay it over to the government. That part can follow you outside of the corporate shell. But I’ve successfully locked in loans from banks, lines of credit from different stores, even a wage claim of unpaid wages. I’ve been able to lock inside a corporate shell for businesses that weren’t able to keep going and keep meeting their expenses. And that comes also to an element of, if you do a corporation versus a LLC, limited liability company, when the going gets tough, a limited liability requires its members to pay in to the LLC, so it can finish paying its bills before it can close. But a corporation can have the bills out there, and you just have to sell off your assets, have a board meeting saying that you’re gonna go and close up, properly notice everybody. And after you’ve liquidated, whatever wasn’t paid is locked inside the corporate shell. They can’t come after you individually as an owner
Steve Moskowitz:
As a practical matter, that would probably cover most businesses, because let’s face it, most businesses, most of their expense, I think like vendors, and most vendors would probably be dealing with the corporation. So if something didn’t work out, the owner would be protected. That sounds fantastic.
Chris Housh:
Yeah, so once you’re ready to actually start up as a corporation, what you’re supposed to do, is let your vendors know that you’re gonna be a corporation. Let them know your name, let them know the date that you’re forming. And as long as they know that they’re dealing with a corporation, then they are start having to do the rules and about, that they’re dealing with a corporation, and that they can’t come after you individually.
Steve Moskowitz:
And I know that sole proprietors can have a pension, and there’s over 20 different types. And I use the terms pensions and retirement accounts interchangeably. There really are some differences, but for our purposes we’ll use them interchangeably. that if you are a corporation, that gives the pension a lot more flexibility, that you do even more than you could if you were a sole proprietorship. And it looks like there’s just one advantage after the next, we’ve talked about asset protection. That’s a big deal because when people go into business they might say, well, look, I’m willing to risk X number of dollars, but they’re not willing to risk everything they have, not to mention if you’re married, it might drag the spouse in, especially if you’re in a community property state or another state as well. So that seems like an advantage. And then we have the tax advantages, those workarounds seem tremendous. And then we just mentioned about the pension. Is there anything else that our listeners should know about?
Chris Housh:
Well, when you’re gonna do the formation of a corporation you do wanna actually talk with a tax professional or a business law professional. Because the last thing you want, is to have a corporation formed that doesn’t actually meet your needs. There’s a lot of people that try and do a cookie cutter version, but you really need something that’s tailored.
Steve Moskowitz:
You mean those popups where you pay some very low price and some non-attorney pop something together?
Chris Housh:
Exactly, because unfortunately what happens is that the moment that you’re in trouble, because you weren’t advised what to do on an annual basis, what you needed to go and do to make sure that your corporation is good. But also I have now been the attorney representing somebody in multiple court cases, including one this week, where the corporate formation documents came out and they said, did you actually read this? This element that’s part of your business, your documents say you’re not supposed to do, or that this person doesn’t actually have that role, and therefore leaving a giant gap for something to happen. I actually had a person who had their business partner listed as vice president. Their papers said the vice president only did things if the president was sick, and therefore all the vice president’s business connections and his commissions were actually seized by a creditor, because they were going in, able to show that the president hadn’t been going in, running his personal expenses through the corporate bank account. And they declared that the vice president was a person of no status inside the corporation, because the corporate formation documents didn’t show it. So you want to have things show up properly. Also, if you’re in a niche business, I’ve been doing specialized ones for cryptocurrency businesses, or ones that are dealing with NFTs, making it where you can have things that are specific.
Steve Moskowitz:
What’s an NFT Chris?
Chris Housh:
An NFT is a non fungible token, which is digital art or digital souvenirs that are kind of like cryptocurrency. It’s something where you’re passing it through electronically. And it’s a hot market right now. And a lot of people become afraid of getting tied into a corporation because you don’t have the flexibility to move large assets without going having a board meeting. But if you tailor your board bylaws and your corporate bylaws to say, here’s what you can do. All of a sudden that fear people have is removed, because you have something that legally says you can do this and then ratify it later. So that is a strong benefit. Also those cookie cutter ones, if you’re in the cannabis industry. So the standard writing is that you have to get a bank that has the FDIC logo on it, but no federal deposit insurance bank will touch a cannabis company. So you need to go and have a tailored corporate bylaw, allowing you to go and set up at a different kind of bank. Knowing what the industry is, and knowing what you plan to do with your business, looking at not just next year, but bringing that dream of what’s it gonna be the next five years, is something that you want to be able to have so that your papers properly reflect, and if there is a problem, that it’s a proper shield, a proper defense.
Steve Moskowitz:
Suppose a couple people came in to see and said, Chris, you know, C Corp, S Corp, LLC, partnership. What’s the difference? What should we be? Would you actually explain the differences to them?
Chris Housh:
I do. That is to me a standard part of- if someone hires me to do that, along with sending them a questionnaire asking them, hey, tell me some of the basic startup elements. Here are the easy questions to answer. I then schedule a time to have a conversation with them. That conversation goes a half an hour to an hour, where I’m going explaining, here’s the different benefits of C corporate, S corporate, and LLC. What is it that they’re looking for, and therefore, what I would recommend to them, and also talking with them about timeframes, about what elements they wanna do, what assets we’re gonna put inside that entity, versus what we leave out. And I have to go and explain to people often, no, you can’t put your personal boat that you’re planning on just taking around as a vacation element. Can’t put it in the corporation when that boat is not gonna have any function for that, it leaves you exposed. So I have those conversations with a client. I try to make sure that, if you’re gonna have me do that, that you understand what you’re getting into, and you understand the benefits of what you’re getting.
Steve Moskowitz:
And would you also advise somebody as to what form they should be and say, look there’s all these different things, mumbo jumbo. Can you tell me what’s best for me?
Chris Housh:
I can give a recommendation, but I also do always wanna have my client be able to get what they want. If I think a corporation is best versus an LLC, I’ll tell them that.
Steve Moskowitz:
And why?
Chris Housh:
I’ll explain to them the benefits of it. But if a client still wants the LLC instead of the corporation, I’ll make that LLC.
Steve Moskowitz:
But you’ll explain the whys to it. Not just choose this, you wouldn’t understand it.
Chris Housh:
Exactly, I’ll go and say, here are what I think are the benefits, what the drawbacks are on both sides. And that’s part of why it takes an hour to do that, right? Because I don’t want person not knowing what they got. The last thing that I’ll ever wanna hear, and unfortunately, I’ve been in depositions where I hear it. The question, so did you actually read this document? Did you actually understand what it was that you were signing off on? I want my client to know it. I want them to understand it. And especially, I feel that you should have a better understanding of your business and what is happening with taxes, and how it’s gonna function as I’m working with you. I don’t like the idea of someone going, I don’t know. I just followed the instructions with somebody. I want them to know things.
Steve Moskowitz:
Excellent, excellent. And also that’s so vitally important, because all the time I’ll ask people, especially when they’re in the wrong type of entity for them, I’ll say, well, why are you a C instead of an S? And so many times I’ll hear, they don’t know, or they, well that’s the way somebody set it up, or they bought the business, and that’s the way it was. Suppose you have that situation. Suppose somebody says, well, you know what? They’ve been a C corporation for years, and now that you’ve explained it, an S Corp would be so much better. Is there some way to fix that?
Chris Housh:
There is, the IRS does allow you to go and fill out a form to go and do what what’s called a late election S corporation. So you have to meet certain criteria. You have to treated it as being an S corporation during the years in question, and therefore that is just a easy fix. Or if you were going in being fully treated as a C corporation, you had a reason, like you had a foreign owner or something like that. The IRS will let you make the change only after you’ve made all the necessary adjustments to make it where you would not be forced that way. But you fill out a form, you ask the government’s permission and either you have, because you didn’t match earlier, now it’s only after the change is made or you can potentially even get a back year changed over and make it where you can do redo the tax return to have that better circumstance.
Steve Moskowitz:
And because Chris and I have worked together for over 20 years, I know all the cases where he saved people so much money when he did things like that. And that’s something that we’d like to do for you. We’d like to give you the protection. We’d like to save you money. And what we set out to do for small and medium sized businesses, is what the Fortune 500 has, where- look at them. So many of them make profits, billions with a B, and they legally don’t pay taxes and have all kinds of protections. And you read about it in the newspaper all the time. All these things may be available to you. It’s just, the numbers are smaller but the concepts are the same. I’d like to thank my friend and colleague, attorney and EA, Chris Housh. And folks, stay tuned for part two, because now we’re gonna tell you what you need to do to make this work. Thanks very much, Chris.
Chris Housh:
Thanks.
Outro:
You’ve been listening to the Practical Tax Podcast, with tax attorney, Steve Moskowitz. To hear more podcasts, go to Moskowitzllp.com/practicaltax. The information contained in this podcast is based on information available as obtained at the date of it’s release. MoskowitzLLP and it’s affiliates are under no obligation to update this information as changes occur. Applying this information to your specific situation requires careful consideration of all factors, which may be applicable, and any information is not to be considered tax advice or legal advice. Further, this is attorney advertising and the facts and circumstances displayed in this case are dependent entirely on the facts of that particular case. Please consult your tax advisor before acting on any matters discussed.
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