Employee or Independent Contractor? You Don’t Get to Choose.

My client, Marylou, has just started a small business.  In this case, we formed a corporation for her dry cleaning business.  Marylou is the new president of ABC Startup Dry Cleaning, Inc.  She barely has enough money to pay rent and buy equipment, but she can’t run a dry cleaning business by herself.  Marylou needs to hire people.  She needs someone to do her bookkeeping and someone to run the machinery.  One of her great new ideas to expand the business she just started is to hire a delivery person to pick up and deliver clothing to busy clients.  Finally, the whole store needs repainting to look fresh and new.

dry^cleaning

(Photo credit: rjs1322)

Marylou calls to ask me if I can draft independent contractor agreements for all these workers—the bookkeeper, the delivery person, the machine operator and the painters.  She would like it if they were independent contractors instead of employees because she does not want to pay all the accompanying taxes and paperwork that are required when hiring an employee.  As an employer, she would have to withhold taxes and her employee’s portion of Social Security and Medicare taxes.  The best way to do that is to hire a payroll service, another expense to add to the list of already long list of expenses her new business has generated.  She’d also have to pay and file for Worker’s Compensation and Unemployment taxes on an employee’s wages.  Independent contractors are responsible for their own taxes.  Additionally, Marylou doesn’t want to be responsible for her driver’s liabilities, in case he gets into an accident.  An employer is legally responsible for the negligence of her employees, but not her independent contractors.

I advise Marylou that while she can certainly hire a painting company as an independent contractor, and a bookkeeping service, she may have more trouble with claiming the workers running the dry cleaning machinery as independent contractors.  Should they get hurt on the job, should she fire them, they will seek Worker’s Compensation or Unemployment Insurance and a Department of Labor audit will carry very heavy fines and penalties.  This is true for administrative staff too.  While the advantages of claiming the people who work with you are independent contractors instead of employees can be great, the penalties for being wrong are harsh.

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The Best Way to Buy a Small Business

Bob, one of my business clients, wants to own a coffee shop. He calls me and tells me he has found one for sale—and in the perfect location.  That coffee shop is owned by a corporation.  The corporation is really just the owner and his wife, but the corporation is the legal owner of the coffee shop.

English: Smokey Coffee Shop in Amsterdam

(Photo credit: Wikipedia)

I suggest to Bob that we are best off structuring the small business purchase as an “asset purchase sale”, as opposed to a stock purchase.  That means we are not purchasing the business itself, but only the assets of the business.  For example:  Bob wants to buy the chairs, table, the coffeemakers, the goodwill, the recipes.  By making his purchase this way, he will avoid most of the liabilities of the coffee shop he is buying.  The current coffee shop may owe money to suppliers, taxes,  a lawsuit for food poisoning suit or a former employee suing the coffee shop. There are some tax advantages to structuring the deal this way too.  Win-win for Bob, right?

So why would anyone want to do a stock purchase (buying the coffee shop itself or the entire corporation)?  I tell Bob that if he wants ease in transferring title, there’s a certain expense in starting fresh, and if Bob needs to save a few thousand bucks, then buying the stock would be the way to go.  It might eliminate the need to transfer permits, employee agreements and leases, although even with a stock purchase, there might be costs.  I warned Bob, permits are often personal to the owner and not the business. If the coffee shop Bob is buying has a liquor license. Bob would not be able to just take that over, he would have to be personally vetted by the liquor authority here in New York.  Despite a corporation owning the coffee shop, the current owner probably has a personal guarantee clause in his lease, and the lease would have to be renegotiated anyway.

Bob agrees an asset purchase is the best alternative, the coffee shop owner understands that any purchaser will only want assets and not stock, and we are off and running on the first step to making Bob’s dream a reality.

 

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S-Corp or C-Corp? What’s the Difference?

When you first form your corporation, it comes into existence as a C Corporation.  If you do nothing more, your corporation will remain a C Corporation.

 

A C Corporation becomes an S Corporation only when special tax treatment is sought by filing Form 2553 with the IRS.

http://www.irs.gov/pub/irs-pdf/f2553.pdf

Although a small business lawyer can advise you on the choice of entities, choosing whether to elect S Corporation status is best discussed with your accountant.  This is a tax decision, and a tax professional should review your entire financial picture before you make this decision.

New York State S Corporation Status

 

New York State also requires you file a form to be treated as an S Corporation under State Rules.  This form CT-6 Election by a Federal S Corporation to be Treated as a New York S Corporation.

 

http://www.tax.ny.gov/pdf/2007/fillin/corp/ct6_707_fill_in.pdf

New York City S Corporation Status

However, New York State does not exempt S Corporations from all NYS corporate taxes.  Again, you should check with your accountant prior to making this decision

Interestingly, New York City does not recognize S-Corp status at all. If your small business has income from New York City, you will need to pay New York City’s General Corporate Tax.

 

 http://www.nyc.gov/html/dof/html/business/business_tax_gct.shtml

 

 

Four Corners of a Contract, Demystified

What is the Four Corners Rule?


The “Four Corners Rule” states that if the language is not found within the written words of the contract, then outside evidence will not be considered.  This includes any oral agreement you’ve made.

How Does this Work?


So, for example, you’ve agreed to buy widgets from a manufacturer.  Your contract states that you will buy 100 widgets for $100, and the company must deliver those widgets to you within 30 days.  Before the 30 days is over, however, you find widgets for $80. You call the manufacturer to complain, or renegotiate, and the manufacturer verbally agrees to lower the price to $80.  Widgets delivered, you pay $80, and then you get sued for the remainder.  Your phone conversation will not change a written contract.  It can change an oral agreement, but not a written one.  If it is not written within the four corners of the contract, you lose.

Get it in Writing!!


Any renegotiation of any of the terms of a written contract must be in writing.

Long Island Small Businesses and the Onerous MTA Payroll Tax

I confess, I only incorporated my business this past year.  For a solo attorney such as myself, there aren’t as many reasons to incorporate as there are for other businesses.  I have malpractice insurance that covers most of my liability, and a corporation or LLC formation would offer little in the way of additional protection.  So, I was quite surprised when my accountant sent me a form and invoice for the MTA tax.

The tax is formally known as the Metropolitan Commuter Transportation Mobility Tax (MCTMT).  Besides the cost of paying the tax, there is no simple way of tacking on the tax to your other tax filings.  Aside from the usual federal and New York state tax forms, these additional forms must be filed quarterly.

This tax is imposed on certain employers and self-employed individuals engaging in business within the Metropolitan Commuter Transportation District (MCTD). Specifically, the tax applies to (1) employers required to withhold New York state income tax from employee wages and whose payroll expense exceeds $2,500 in any calendar quarter, and (2) individuals with net earnings from self-employment allocated to the MCTD that exceed $10,000 for the tax year (according to the Department of Taxation and Finance, this includes partners in partnerships and members of a limited liability company (LLC) treated as a partnership).

The small business owner cannot withhold any of the tax from the employee’s compensation.

The recently elected Governor Cuomo has come out  in opposition to this tax, calling it “onerous.”

Small businesses on Long Island pay $3.40 for every $1,000 of payroll. If you are a small Long Island business, you are probably not using the LIRR to commute, and your customers are probably not taking the MTA to see you.

This tax is burdensome to Long Island small businesses and is not proportional to their use of the MTA.

Small Businesses Need Minutes of Meetings

Why Does a Small Corporation Need to Keep Minutes?

Corporate minutes are a reflection of the decisions of the Board of Directors.  Even more importantly, corporate minutes are an indication that formalities of the corporation are being kept.  If involved in a lawsuit, one way an attorney will attempt to reach personal assets of the officers of the corporation is to check to see if corporate formalities are followed.  One important type of formality is keeping records, or minutes of meetings.

Even if you are a single officer of a corporation, or you are a family business, or there are just two of you and the meetings are not formal affairs, you need to keep records of these informal meetings and decisions that are being made for your corporation.  Resolutions need to be drawn up ratifying those decisions that affect the life of the business.  Corporate minutes are among the most important documents a company must produce and keep.  Failing to keep accurate and complete minutes can expose officers and board members to personal liability.

What Should the Minutes Include?

There is no required format, but minutes should include all important decisions made for the company.

  • List all directors/members attending
  • Include a brief narrative description: What issues were discussed; what significant points raised; what actions taken
  • Include record of how each director/officer/trustee voted, including whether the vote was unanimous and if anyone abstained from voting

It is important to ratify and vote on the prior meeting’s minutes.  This ensures that each director had a clear understanding of the proposed actions.

What Needs to be Documented in your Minutes?

Is every item as important to record as all others?  Absolutely not.

The general rule is if the transaction is in the ordinary course of your business, the kind of transaction you engage in all the time, then there is no need to add those discussions to the minutes.  However, if the action is one that enables the business to engage in its business, the discussion of that action should be voted on and added to the written records.

Some major decisions that should appear in the minutes:

  • leases–for office space or equipment rental
  • significant contracts
  • elections of officers and directors
  • taking out loans or other kinds of financing
  • marketing and advertising campaigns
  • mergers, reorganizations or transactions involving the bulk of the corporation’s assets
  • providing employee benefits

LLC requirements

Although LLCs are generally not required by law to keep minutes or have formal meetings, a writing is always helpful in establishing that the members were in agreement on the actions that are taken.

Conclusion

Finally, if you keep your minutes on your computer, make sure you have a back-up.  Discard your notes since they are not a final accounting.  Minutes should be kept for at least seven years.

Operating your corporation properly by following state law allows you to focus your attention on running your business, and removes concerns about having to defend lawsuits and losing the limited liability protection that was your purpose for incorporating.

Using an Online LLC Incorporation Service

This past month, I have had numerous Long Island clients calling me and asking me to fix their corporations and LLC’s that they ordered and paid for online.  It seems that these online documents come complete with any number of their forms left blank.  I have seen two this week where the first page of the bylaws or the operating agreement still reads “Sample.”

I can tell why people are accessing my blog, what search terms they use when they find me.  The biggest “hits” to my blog are the ones looking for Long Island publications to fulfill the LLC publication requirement.  So, I know many of you are attempting to do this on your own.

And then you get sued.  Or you apply for non-profit status.  Or you just read something that advises you that if you don’t do proper recordkeeping, your personal assets are not protected from your business liability.  And then I get called and you need me to amend your Articles of Incorporation, or help piece together all your corporate actions since you incorporated five years ago.   Now how much money have you saved by incorporating online?

If you are looking for the convenience of online incorporation or LLC formation and don’t have the time to meet a lawyer at their office, many of us, myself included, can do your incorporation by phone, and fax and e-mail.

It angers me when small business owners like myself are paying for services that they are not receiving.  And then having to pay again to do it correctly.

If you have corporate books that have been sitting on your shelf, and many of the pages are still blank, or you have never updated that book by having annual meetings, adding resolutions about opening bank accounts, taking out leases, contracting with employees or vendors or any other of a number of corporate acts, please call to schedule an appointment to ensure you will get the protection you originally sought for your personal assets.

Obama Calls Small Business The Little Engine that Could

President Obama gave a speech Thursday directed towards small business owners, calling them “the engine of job growth in America.”  In his continuing efforts to get the nation behind his health care initiative, Obama addressed not only small business owners and organizations from across the country but also members of the U.S. Chamber of Commerce and the National Federation of Independent Business.

The text of the speech can be found in its entirety at  The White House Press Secretary’s website,  or you can see the video of the 15-minute speech at the White House blog .

After months of criticism directed towards the White House for ignoring the needs of small businesses, the President has begun to address this issue.  Prior to the speech, the President had announced new incentives and assistance aimed at easing lending to small businesses, including higher caps on loans guaranteed by the Small Business Administration (SBA).

Many small business owners have stopped offering health care to their employees, and may even have canceled their own insurance in an effort to save money.   Employees who have health insurance in their current jobs may be reluctant to strike out on their own and open a small business because health care premiums are prohibitive.

The President’s proposal includes numerous benefits for small businesses that already have health care employee benefits in place.  For those businesses that currently are not offering benefits, the President is proposing forming an “exchange” to pool small businesses together for greater bargaining power with the insurance companies.

The bad news is that businesses of a certain size will be required to contribute to the costs if they choose not to offer coverage to their employees.

I expect there to be much criticism of the mandate to penalize businesses that do not provide health care insurance for their employees, however, companies with payrolls under $500,000 (income after business expenses) would be exempt from the requirements.

So, what do you think?  Will the President’s proposal help small businesses succeed, or are you still feeling like the little engine chugging up the hill on your own with no help?

Overpromising? “Limited” Liability and Small Business

If you are just starting a small business or have a sole proprietorship, you have probably thought about and received advice about either incorporating or forming a limited liability company (LLC).

What protections do these business entities actually offer to the small business owner?

The Promise

You have probably heard that by incorporating or forming an LLC,  you, as the owner, will be protected from personal liability, whether  through contract (from creditors) or tort (from intentional or negligent wrongful act, injury or damage other than breach of contract).

This is true to a great extent.  However, as a small business owner you are probably not totally shielded from personal liability even if you do incorporate or form an LLC.

The Reality

Leases

Commercial landlords will often demand a personal guarantee from the principals or owners of the small business despite business entity status.  A lease is a contract between a landlord and a tenant.  If you have not been in business for very long or your business assets are limited, you can expect to be asked to personally guarantee a lease.  Your spouse may also be asked for a personal guarantee.  Depending on how long you have been in business or how in demand the property is, this may be a negotiable point. You might want to contact a business attorney to review and negotiate your commercial lease.

Loans

Bank loans. Whether you need a loan to finance inventory or to expand, a lender may require you  put up your personal property as collateral.  Even  if your business were to dissolve, you would remain personally liable for paying back the loan.  However, depending on the business’ creditworthiness, this too is open to negotiation.

Small Business Administration loans.  The SBA requires that all loans they guarantee must be collateralized with both the business assets and a personal guarantee.  Often you may need to take out a second (or third) mortgage on your home.  Nevertheless, SBA loans often have excellent terms.

Credit Cards

Most business credit card issuers will not approve a business application unless the owner personally agrees to be liable for any debt incurred.  Take note that any default on your business card will impact your personal credit.  After several years of being established, you may want to ask the issuer to allow you to separate your business and personal liability.

Torts

Your own acts.  Corporate/LLC formation provides protection for corporate acts;  it may not provide protection for your own acts.  Even if you are acting for the corporation, if you are negligent you are potentially personally liable. You can’t commit intentional wrongdoing even in the guise of your corporate self.  You can’t embezzle, defraud or assault someone.

Your employees’ acts.  Although in theory, the corporation or LLC should shield your personal assets from your employees’ bad acts, in reality, if the act is egregious enough you are likely to be brought into the lawsuit.  Negligent hiring, failure to ensure the person you sent on an errand has a clean driving record, or negligently maintaining your property are just some of the ways you personally can be brought into litigation, even though you’re incorporated.  This doesn’t necessarily mean you will lose the lawsuit, however, even good defenses cost money.

Taxes

You can be held personally liable if  the corporation neglects to pay over to the IRS  the employees’ share of withholding and social security taxes.  Many states also will hold corporations personally liable for failure to turn over retail sales taxes due from the corporation.

The Solution

Despite some pitfalls and incomplete protection, it is still worthwhile to either incorporate or form an LLC.  Business formation will protect your personal assets to a great extent.  The longer your business exists,  the more creditworthiness your business can show, the better your bargaining power will be with landlords, credit card companies and lenders.

Insurance

It is a good idea to ensure you have sufficient personal insurance coverage on your assets to cover any business liability.  Consider buying an umbrella policy for your cars and home.  Insuring your business is also a necessity.  Should you get sued, the insurance company will defend you, pay for your attorney and pay up to policy limits.

Small Businesses and Federal Tax Help

I love recommending government resources.  Many of us wonder where our tax dollars go.  It helps a bit to realize that there are resources provided by the federal government specifically designed to help the small business owner.

The Internal Revenue Service maintains a Small Business and Self-Employed Center section on its website dedicated to providing tax help and information to small business owners and sole proprietors. The site  links to workshops designed to help small business owners understand their federal tax responsibilities.  If a small business owner is unable to attend a workshop in person, virtual workshops are available in both DVD and streaming media formats. Locally in October free courses are being offered at the Patchogue Library, including how to start and grow your own business, how to write a business plan and for more advanced business owners, how to market or franchise your small business.

The IRS Small Business Center also  has a helpful tutorial designed to help small business owners determine if people providing services to you are independent contractors or employees.

Additionally, there is a dedicated section for information new business owners need to know about federal taxes.  The site includes information on recordkeeping, selecting an accounting method, establishing a retirement plan and suggestions on how to choose a tax year.

Both sites feature a link to an online classroom that includes audio and video presentations, a tax calendar and a tutorial on how to recognize and avoid tax scams.

If you have any questions about taxes prior to starting a business or changing the form of your business entity, the IRS.gov website is a good place to start your research.