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C Corps / S Corps Articles and Resources

Is a B Corporation or a Benefit Corporation Right for You?

by | Feb 2, 2015 | ,

You have a great idea that will help your community. You want to benefit the environment, as well as your bottom line. Everything looks promising. But how should your social entrepreneurial venture be organized?

Many are starting to use the new benefit corporation – or “B corp.” These special corporations are created to both benefit society and make profits, and are now allowed in 31 states. In time, the B corp will be available in all 50 states. As well, versions of the B corp are allowed in England and more and more European countries. It is an idea whose time has come.

Have Questions? Get a Free 15-Minute Consultation

The B corp is a unique way for businesses to operate. In the past, a corporation had a duty to its shareholders to only maximize profits. The company’s directors (those in charge) could get in trouble for also considering the environment and other social factors over profits. The B corp changes all that.

In a B corp, the directors can consider society and the environment, in addition to profit. The organizing documents can even name specific public benefit purposes the company seeks to achieve. Some of the specific benefits include:

  1. Providing low-income or underserved individuals or communities with beneficial products or services
  2. Promoting economic opportunity for individuals or communities beyond the creation of jobs in the ordinary course of business
  3. Preserving the environment
  4. Improving human health
  5. Promoting the arts, sciences, or advancement of knowledge
  6. Increasing the flow of capital to entities with a public benefit purpose
  7. The accomplishment of any other particular benefit for society or the environment.

The directors can then freely consider the effect of their decisions, not only on the shareholders, but on the community, the environment and other stakeholders.

A key requirement for operating as a B corp is a Benefit Report. Every year, this report is prepared to assess the enterprise’s social and environmental performance. The Benefit Report should be transparent, independent and credible. It should also be provided to all shareholders and (with proprietary data removed) to the Secretary of State’s office and your public Web site.

To make sure that the public benefit is paramount, some states allow a right of action. The shareholders can sue the company for a failure to pursue the public benefit, violations of duty and failure to meet the transparency requirements. As well, a change in the B corp’s purpose, requires a two-thirds majority vote. The new laws allow for public benefit to reign supreme in the B corp.

Is a B corp right for you?

It depends. If the idea of an annual report on all you’ve done for all to see seems like a burden, think twice. You can still do good things in a small, closely held company without the extra reporting. But if you have investors who will only put in money if the beneficial restrictions of a B corp are in place, the die may be cast, which is fine. The B corp is there to accomplish your goals.

For more information on forming a B corp, please fill out the form on this page or call our offices at 1-800-600-1760 or sign up for a free 15-minute consultation.

Why You Should Never Hold Real Estate in a C Corporation

by | Jan 8, 2015 |

I once made the comment:

“Never hold real estate in a C corporation… and fire the advisor that even suggests such a thing.”

Many people asked, “Why not?” Well, there are three reasons.

Reason #1: Capital Gains Taxes Will be Higher When Selling

First, for tax reasons we don’t recommend that you ever hold real estate in the name of a C corporation.  Your C corporation will pay considerably more in capital gains when you try to sell that property than would a flow-through entity, such as an LLC.

Reason #2: Asset Protection is Not as Secure for Property Held in a Corporation in Most States

The second reason is if your C (or S) corporation is holding the property and you are sued personally, a judgment creditor (except with a Nevada corporation) may be able to reach your shares in the corporation and effectively take control of those shares and through them, control of the corporation and its assets. If properly structured, using Nevada and Wyoming LLCs and limited partnerships (LPs), you will have much better asset protection than with other entities. For these reasons we recommend that real estate be held in either an LLC or LP.

Reason #3: Transferring Property Out of a Corporation is Taxable

As well, transferring property out of a C or S corporation is a taxable event whereas it is not taxable in an LLC or LP. When it comes time to refinance, you will appreciate an LLC or LP.

However, you can have your corporation buy real estate. One method is to have your corporation pay rent for an office building which is owned by a separate LLC that you own.  The rent paid by the corporation is a tax deduction for the business and the income from the rent is offset by operating expenses as well as the phantom expense of depreciation.

loopholes of real estate 65For more information on this topic, please read my book Loopholes of Real Estate, which will teach you how to open up the tax loopholes available only to real estate investors and close the legal loopholes of unlimited personal liability. Click here to order it on Amazon.

Learn 3 Essentials for Using an S-Corporation

by | Jan 8, 2015 | ,

By Garrett Sutton, Esq.

If you have been considering forming a corporation or other business entity to provide yourself with limited liability and financing options in your business venture, you have made an important first step.

You may have compared the tax benefits of corporations and limited liability companies or limited partnerships. If you have done so, you likely realized that corporations are taxed twice, while limited liability companies and limited partnerships are taxed once. While a corporation’s profits are taxed once as the corporation’s income and again when the profits are distributed as dividends, a limited liability company or limited partnership’s profits flow through the entity and are only taxed once as personal income to the individual member of the limited liability company or partner in the limited partnership. This is referred to as flow-through taxation.

Based solely on the tax treatment of corporations, you may be prepared to use a limited liability company or limited partnership for your business. While limited liability companies and limited partnerships feature outstanding charging order protection, Nevada has recently extended such protection to corporations with between two and seventy-five shareholders.

Before you decide which business entity to use, there is one more option for you to consider. If you choose to use a limited liability company or a limited partnership, your business may limit its financing options. Financing for a limited liability company or a limited partnership may not be as readily available as financing for a corporation, because interests in such entities are not as transferable as interests, or shares of stock, in a corporation. An S-corporation is the alternative that provides both financing options and flow-through taxation; however, to be treated as an S-corporation, your business must do the following:

  • Incorporate the Business – As with a regular corporation, referred to as a C-corporation, an S-corporation must prepare and file Articles of Incorporation with the state, prepare and operate under Bylaws, operate under a Board of Directors and corporate officers, and engage in corporate formalities.
  • File an S-Corporation Election Form – To be eligible for S-corporation tax treatment, the corporation must (1) be a corporation organized in any U.S. state, (2) not be an ineligible corporation (certain types of businesses are not eligible), and (3) have only one class of stock. If eligible, the corporation may file an S-corporation election form, Form 2553, with the Internal Revenue Service within forty-five days after incorporating. While this will allow flow-through federal taxation, it is important to note that five states do not recognize S-corporations and may tax the corporation as a C-corporation. It is also important to note that S-corporations are not eligible for certain tax deductions that C-corporations may enjoy.
  • Notice and Obey S-Corporation Limitations – Once the corporation has made its S-corporation election, it must notice and obey the limitations on S-corporations to maintain its flow-through tax status. If the corporation violates any of the following limitations, it will lose S-corporation status and will not be eligible for flow-through taxation for five years: (1) it must have one hundred or fewer shareholders; (2) all of its shareholders must be individuals, descendants’ estates, estates of individuals in bankruptcy, or certain trusts, because business entities may not be shareholders; and, (3) all of its shareholders must either be United States citizens or resident aliens in the United States (nonresident aliens may not be shareholders). If the corporation loses its flow-through tax status, the Internal Revenue Service will treat it as a C-corporation.

Every business is unique. Your business’s form should be based on your specific circumstances. While the limitation on the number and types of shareholders allowed in S-corporations may affect financing options, such limitations may have less practical importance than the limitations on financing options created by using a limited liability company or a limited partnership. Accordingly, S-corporations’ tax benefits, management structure and transferability of shares may provide the benefits that your business needs in an entity that also provides you with limited liability.

By considering your business’s options and choosing the best available business form, you will ensure that you take advantage of available opportunities.

C-Corporation Considerations

by | Jan 8, 2015 | ,

By Garrett Sutton, Esq.

A C-Corp has the widest range of deductions and expenses allowed by the IRS, especially in the area of employee fringe benefits. A C-Corp can set up medical reimbursement and other employee benefits, and deduct the costs of running these programs, including all premiums paid. The employees, including you as the owner/shareholder, will also not pay taxes on the value of those benefits.

This is not the case in a flow-through entity, such as an S-Corp, LLC or LP. In each of those cases the entity may write off the costs of the benefits, but any employee/shareholder who owns more than 2% of the entity will pay taxes on the value of their benefits received. So, if having the maximum deductions and all of the employee fringe benefits on a tax-free basis is important to you, a C-Corp may be your entity choice.

C-corporations are great for a business that sells products, has a storefront and employees, and may or may not have a warehouse where it keeps its inventory. C-Corps don’t work well with businesses that want to hold appreciating assets, such as real estate, because of the tax treatment on the sale of these assets.

 Double Taxation Issues

The most often-cited disadvantage of using a C-Corp is the “double-taxation” issue. Double-taxation happens when a C-Corp has a profit left over at the end of the year and wants to distribute it to the shareholders as a dividend. The C-Corp has already paid taxes on that profit, but once it distributes the profit to its shareholders, those shareholders will have to declare the dividends they receive as income on their personal tax returns, and pay taxes again, at their own personal rates.

There are many things you can do to avoid the double-taxation scenario. Structure the C-Corp so that there are no profits left over – use all of the write-offs and deductions allowed by the IRS to reduce the C-Corp’s net income. Offer great benefit plans! Pay higher salaries to yourself and the other owner/employees than you would if you were using a flow-through entity such as an S-Corp. Yes, you will have to pay payroll taxes and personal income taxes on those monies, but you would pay personal taxes on dividends paid to you anyway. And it may be that in the big picture, the savings on one side outweigh the additional taxes paid on the other side.

The decision as to what entity is best for you really does, in so many cases, hinge on taxes, and that is why, with any corporate-related decision, you are wise to seek the advice and assistance of a good CPA.

 

The Coming of the B Corp

by | Jan 8, 2015 | ,

By Garrett Sutton, Esq.

When Ben & Jerry’s, the socially active ice cream maker, was put up for sale in 2000, the company faced a challenge, both internally and externally: To whom could it sell, and to whom did it owe a duty in the sale?

The company received two offers. One came from a socially minded purchaser with values that were closely aligned to those of Ben and Jerry’s. The other came in from the huge multinational corporation Unilever, the makers of, among numerous other brands, Slim-Fast, Lipton Tea, Dove, Axe, Vaseline, VO5 shampoo, and Hellman’s Mayonnaise.

The Unilever offer was at a higher price. But the lower offer was a better fit in terms of the company’s existing culture and mission. They had a real dilemma on their hands. The choice was up to Ben & Jerry’s board of directors. Their corporate attorneys advised them that by accepting the lower offer, they could be sued by the shareholders. The board was reminded that to maximize shareholder value and to uphold their fiduciary duties to their investors, they had to accept the highest bid.

Technically, this was the correct counsel. Numerous court cases have upheld the requirement that directors do what’s best for the shareholders. (See eBay Domestic Holdings, Inc. v. Newmark 16A.3d1 (Del. Ch. 2010), a Delaware case holding that corporate directors are obligated to maximize shareholder value.)

And so Ben & Jerry’s was sold to Unilever.

But the issue of whom the company must benefit—the shareholders, or other groups and interests—was raised once again. The business judgment rule protects directors who act in good faith and with loyalty to the company. Loyalty to others causes a loss of that protection, as Ben & Jerry’s directors were keenly aware.

At the same time, a growing number of entrepreneurs and investors seeking to remedy environmental and social problems had begun to form. There was a percolation of ideas on how best to do this. A key issue for many of these forerunners was how to solve problems in a business context, without worrying about generating the highest profit. Profits, yes. The business had to be sustainable or else no one would benefit. Otherwise, there was no point to it. But maximum profits? No, there had to be a way to be profitable without worrying whether you’d left a dime or a dollar on the table, without worrying you’d be sued for failing to maximize shareholder value.

A nonprofit group known as B Lab took up the cause. Their position was this: If you could tweak the traditional model a bit, perhaps you could change the whole business dynamic. Perhaps problems could be efficiently solved in ways never before imagined.

And that’s what is now happening.

But before we look into the new Benefit Corporation, let’s explore why its primary alternative never really worked in this environment.

The not-for-profit (or nonprofit) corporation is familiar to most. Upon obtaining a 501(c)(3) designation (named after the applicable IRS code section), certain tax benefits are granted. Contributions by supporters are tax-deductible. Any monies raised by the nonprofit are tax-exempt. So a 501(c)(3) charity that raises $10,000 from each of its ten donors won’t pay taxes on the $100,000 raised, and the ten donors will each get a tax deduction on that $10,000 contribution. A nonprofit that pursues a clearly defined charitable purpose and follows all the rules will be fine.

But there are certain restrictions that limit the usefulness of nonprofit corporations. First, they can’t distribute their profits, which makes it impossible to attract investors.

You will never hear someone say: “You can’t believe the dividends I’m raking in from Ronald McDonald House!” It simply doesn’t work that way. As a contributor to a 501(c)(3) nonprofit corporation, your dividends are spiritual (doing good) and practical (reducing your income tax bill), but they are not actual (cash back).

Additionally, in spite of the United Way scandal pertaining to misuse of funds, nonprofits must limit the amounts they pay their employees. Thus, it’s much harder for nonprofits to bring in, benefit, and keep talented people. Social capitalists seeking to solve big hairy problems will need the best and the brightest, and they are going to have to pay them. The need for world-class human capital makes nonprofits unsuited for the big challenge.

Finally, the nonprofit rules limit activities that generate revenue. Sustainable and expanding operations that are the norm in the private sector are severely restricted by the federal tax laws in the nonprofit realm.

So the need to attract investors, pay talented people, and grow a business, along with the need to benefit groups other than exclusively shareholders, led to the creation of the Benefit Corporation.

Benefit Corporations are traditional corporations (featuring limited liability protections and the same taxation) with three additional changes.

Benefit Corporations must have:

  1. A corporate purpose to positively impact society and the Environment;
  2. An expanded fiduciary duty to consider the interests of workers, communities, and environments (as well as shareholders); and
  3. An annual report describing the company’s overall social and environmental performance.

B Lab managed to get the Benefit Corporation ball rolling in Maryland, which first authorized its use in 2010. A number of other jurisdictions have followed, including Nevada, California, Arizona and New York. Legislation is pending in even more states, and we can expect Benefit Corporations to spread to all 50 states, much like LLCs did in the 80s and 90s. Plus, since 2005, the laws in Britain have similarly allowed for “community interest companies.” Comparable legislation is now being considered in other countries as well.

B Lab also has a certification process for companies that voluntarily meet a high standard of social and environmental performance. It is known as the Certified B Corporation. One does not have to be a Benefit Corporation to be a Certified B Corporation, and vice versa. And know that there is confusion afoot: Both Benefit Corporations and Certified B Corporations are commonly known as B corps. (Note: From here on, we will refer to Benefit Corporations as B corps.)

Several key B corp issues will get to be worked out in the coming years. Will investors take to B corps? The movement toward socially responsible investing is certainly impressive. Over $2 trillion, or nearly 10 percent of all U.S. assets under management, are committed to socially responsible investments. Will investors be willing to receive lower returns for a greater good? Time will tell. To date, B corps have gotten off to a somewhat slow start. There are still some issues to work through.

The stated purpose of a Benefit Corporation must be to create a “general public benefit.” B corps are also allowed to identify one or more specific public benefit as their purposes. Section 102(a) of Model Legislation (a template for states to follow when drafting their B corp law) allows for a number of specific public benefits:

  1. Providing low-income or underserved individuals or communities with beneficial products or services
  2. Promoting economic opportunity for individuals or communities beyond the creation of jobs in the ordinary course of business
  3. Preserving the environment
  4. Improving human health
  5. Promoting the arts, sciences, or advancement of knowledge
  6. Increasing the flow of capital to entities with a public benefit purpose
  7. The accomplishment of any other particular benefit for society or the environment.

The idea is that by combining a general and specific public benefit, the corporation is protected from answering solely to the financial interests of various stakeholders. But how far does that protection extend? Do B corps have an 80 percent duty to shareholders? A 51% duty? Or do they have zero responsibility to shareholders? Since the law is so new, we don’t yet know. To be safe, we suggest that you always remember the investors (and their money) who brought you to the dance. Again, this is why selecting the right investor from the start, one whose involvement won’t later lead to mission drift, is crucial.

Similarly, the directors of a B corp must review a number of issues when considering what is best for the company. Section 301(a)(1) of the Model Legislation requires that directors:

shall consider the effects of any action or inaction upon: (i) the shareholders of the benefit corporation, (ii) the employees and workforce of the benefit corporation, its subsidiaries and its suppliers, (iii) the interest of customers as beneficiaries of the general public benefit or specific public benefit purposes of the benefit corporation, (iv) community and societal factors, including those of each community in which offices or facilities of the benefit corporation, its subsidiaries and its suppliers are located, (v) the local and global environment, (vi) the short-term and long-term interests of the benefit corporation, including any benefits that may accrue to the benefit corporation from its long-term plans and the possibility that these interests may be best served by the continued independence of the benefit corporation and (vii) the ability of the benefit corporation to accomplish its general benefit purpose and any specific public benefit purpose.

That is a lot to consider. How do you weigh all of them to arrive at the right decision? You can be sure that some directors will miss the old days when all they had to do was maximize shareholder value. That was easy. Now they have to factor in the workforce, the community, the environment, the purposes, and more. And in what order? By what percentage? What if you benefit the environment to the detriment of your workers? Can someone sue over too low a weighting being given to one issue on the board’s decision? The old one-dimensional business judgment rule just became a three-dimensional societal matrix.

Again, with any new legal development, there will be unknowns. As with the duty to shareholders, the directors’ requirement to consider all factors will be fleshed out and refined by court cases and future legislation. Our system can certainly deal with it, as it always has. But these unknowns may be contributing to the slower than expected coming of the B corp.

Of course everything takes time. Importantly, the framework is in place. The B corps have the potential to be a transformational force in business and society. As their uses spread, and as entrepreneurs tackle new challenges in new ways, you some day may see a swarm of B corps working for the good of the hive.

Garrett Sutton is an attorney and author living in Reno, Nevada. Garrett is the author of six popular business books including Start Your Own Corporation, Loopholes of Real Estate and Writing Winning Business Plans. He is a graduate of the University of California, Berkeley and Hastings College of the Law. Garrett serves on the boards of the Nevada Museum of Art and the Sierra Kids Foundation. Garrett’s firm, Sutton Law Center, handles asset protection, estate planning and corporate law.