Legal Experts Can Help in Deciding Business Structure

Question: The owners of the small company I have worked at for 20 years are retiring and selling it to me. I need advice about how to structure the company, which is currently categorized as an S corporation. Should I hire an attorney, CPA or other professional?

Answer: Deciding how to legally structure your business is a complicated matter that includes tax consequences and has serious implications for your company’s future.

You would be wise to discuss the business you’re acquiring with an attorney familiar with business purchases and their tax characteristics, said Julia Caputo Stift, a lawyer at Nossaman Guthner Knox & Elliott in Los Angeles.

“The most appropriate [business entity] for you depends on a variety of facts, including the type of business, whether you intend to use any form of equity to incentivize employees, the type of assets held by the business and your strategy for divesting of the business when you no longer wish to operate or own it yourself,” Stift said.

Here’s a primer on common business structures:

Many small businesses establish themselves as general partnerships, limited partnerships or limited liability companies, rather than as corporations. Income generated by these entities is “passed through” to the owners and reported as income on their personal tax returns, so there’s no federal income tax on the business.

Each of these entities has its own pros and cons, depending on specific circumstances, and some types of businesses cannot operate as certain entities because of licensing or other requirements, Stift said.

There are two basic forms of corporations: C corporations are commonly established for companies that have a large number of shareholders and different classes of stock offered to the public. One major drawback of a C corporation is double taxation: The corporation is subject to tax on its income when earned, plus its shareholders are taxed on the corporate income when it is distributed to them.

The entity your current owners have established, an S corporation, operates for tax purposes just like a pass-through entity such as a general partnership. S corporations are not subject to federal corporate income tax, though there is a California tax on their income. S corporations are limited in their number of shareholders and are allowed to have only a single class of stock.

Every business owner would benefit from professional advice before deciding on a business structure. Take this opportunity to establish a relationship with a legal professional -- it’s a relationship that will serve your company well in the long run.

Out-of-State Website May Not Be Tax-Exempt

Q: I am starting up a small commercial website. Would it make sense to be based outside California for this kind of business, given the onerous business tax in this state?

A: Yours is a question that comes up frequently among would-be entrepreneurs who often read claims that incorporating in one state is more beneficial than incorporating in another.

“Many people consider incorporating in Delaware or Nevada to avoid California taxes because they believe that they will save money,” said Brian Lee, managing director and co-founder of the legal services website LegalZoom.com Inc.

The rule of thumb, however, is that you should incorporate or form an LLC in the state where you live and work. “Regardless of where you form your company, you still have to pay California state taxes if you are doing business in California,” Lee said. “Unfortunately, there is no way around that.”

Will your company have a physical location (such as an office or shipping facility) in California? Will you conduct any business in California -- including listing contact information here or having computer servers or banking accounts in the state? If the answer is “yes” to either question, then most likely you will want to incorporate in California, Lee said.

If the answer is “no” and your business is truly a virtual commercial website, you may find that it is advantageous to incorporate in a more tax-friendly state such as Delaware or Nevada. “Some people ... incorporate in Delaware or Nevada because of the strong pro-business laws and legislation in those states, but there will be additional fees and costs because you will have to ‘qualify’ to do business in California,” he said.

Only you can determine, preferably with help from your accountant or tax preparer, whether it would be financially worthwhile for you to incorporate out of state or not.

Got a question about running or starting a small enterprise? E-mail it to karen.e.klein@ latimes.com or mail it to In Box, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012.