Michigan Business Lawyer Blog

In a previous post, I discussed the case of Miller v. Allstate and the oral arguments that were held in the Michigan Supreme Court on the issue of whether those providing a service requiring a license must incorporate under the Michigan Professional Services Corporation Act (PSCA) instead of under the Michigan Business Corporation Act (BCA).

Before the Miller case reached the Michigan Supreme Court, the Michigan Court of Appeals ruled that under the language of the PSCA, any licensed professional who incorporates had to do so under the PSCA and not the BCA. The Michigan Court of Appeals' ruling caused quite an uproar and had the Michigan business law community very concerned about the possible outcome of this case in the Michigan Supreme Court and the ramifications for structuring business entities. Traditionally, only members of the “learned professions” (i.e., doctors, lawyers, and the clergy) have been required to incorporate under the PSCA. All other businesses that provide personal or professional services have had the option to incorporate under the BCA or the PSCA, even if a license was required to provide those services.

Well, all of the speculation ended when the Michigan Supreme Court issued its decision in Miller v. Allstate. To the surprise of many, the Michigan Supreme Court avoided the issue of whether those providing a service requiring a license must incorporate under the PSCA or the BCA. The Court held that the defendant (Allstate) did not have standing to challenge the incorporation status of the plaintiff (PT Works) because only the Michigan Attorney General has the authority to pursue a claim that a Michigan business entity has been improperly incorporated.

Soon after the Court's decision, the Corporation Division of the Michigan Department of Labor and Economic Growth announced that it would revert to its previous standard of requiring only members of the "learned" professions to organize their business entities as "professional" organizations (i.e., professional corporations and professional limited liability companies). This standard is supported by a Michigan Attorney General Opinion that had been followed before the Miller case.

Choosing the right form of business organization is one of the most important choices a new business can make. Given the various issues that can arise, an experienced Michigan corporate lawyer should be consulted if a business or professional has any questions about the issues raised in the Miller case, or any other issues concerning the proper incorporation of a business.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations , Corporations , Limited Liability Companies

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The Michigan Supreme Court recently heard oral arguments in the case of Miller v. Allstate. The major issue in this case is whether those providing a service requiring a license must incorporate under the Michigan Professional Services Corporation Act (PSCA) instead of under the Michigan Business Corporation Act (BCA). Before the Miller case reached the Michigan Supreme Court, the Michigan Court of Appeals ruled that under the language of the PSCA, any licensed professional who incorporates must do so under the PSCA and not the BCA.

Traditionally, only members of the “learned professions” (i.e., doctors, lawyers, and the clergy) have been required to incorporate under the PSCA. All other businesses that provide personal or professional services have had the option to incorporate under the BCA or the PSCA, even if a license was required to provide those services.

In Miller, the patient was referred for physical therapy treatments. The treatments were administered by licensed physical therapists according to prescriptions that were properly issued by the patient's doctors. The company providing the physical therapy services was incorporated under the BCA. When the physical therapy company billed Allstate, Allstate refused to pay, on the basis that it believed the physical therapy company had been improperly incorporated under the BCA instead of the PSCA.

Allstate asserted that the physical therapy company had to incorporate under the PSCA because it provided a personal service requiring a license. Allstate claimed that because the physical therapy company was incorporated under the BCA, its incorporation was defective, thus allowing Allstate the legal right to refuse to pay the physical therapy company's charges. Importantly, Allstate has asserted that if any corporation provides services that require a license and is not incorporated under the PSCA, the corporation’s incorporation is defective. If incorporation is deemed to be improper there can be negative repercussions with respect to a number of issues, including whether the corporation can collect its outstanding accounts receivable and whether shareholders may be personally liable for company obligations.

The Miller case has caused a major uproar in the business and legal communities. It appears to have caught many, including the State of Michigan, off guard. Numerous business interests as well as the State of Michigan have taken formal positions opposing Allstate’s arguments as being illogical and inconsistent with the plain language and purposes of the business incorporation acts in Michigan.

While there are several other issues involved in the Miller case, the question of defective incorporations is the most wide-reaching and has the greatest potential to disturb the status and operations of many Michigan corporations. An adverse ruling by the Michigan Supreme Court on this point could mean that any Michigan business corporation that incorporated under the BCA and has provided services requiring a license could experience some difficulties.

An experienced Michigan business lawyer should be consulted if a business or professional has any questions about the issues raised in the Miller case, or any other issues concerning the proper incorporation of a business.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations , Corporations , Entity Selection

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Michigan's state government provides some very good online resources and tools for businesses. One of these tools is a web page for filing annual reports for Michigan corporations and LLC's. As long as the corporation or limited liability company is in good standing, current and prior year annual reports may be filed online.

The deadline for submitting annual reports for Michigan LLC's is February 15. However, there is no late fee if the annual report is filed late, and it can still be filed online so long as the LLC is classified by the state as being in good standing. The deadline for submitting annual reports for Michigan corporations is May 15. There is a late fee for late filings that ranges from $10 to $50 depending on when the late filing is made.

It is important to remember that when filing annual reports only required information should be included on the report statement. If non-required information is included on the report, it could delay the filing of the annual report. Finally, a business that files its annual report online must pay the required fee using a valid Visa or MasterCard.

The state maintains a very helpful web page that explains the online filing service and has answers to commonly asked questions.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Corporations , Limited Liability Companies

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One of the main reasons businesses are conducted through corporations is to protect owners from personal liability for company obligations. Preserving limited liability is one of the most important aspects of operating a corporation because protection from liability can be lost unless certain formalities are observed.

There are three main ways liability protection can be lost:

1. Invalid incorporation.

2. Improper execution of documents.

3. Piercing of the corporate veil.

Invalid Incorporation
To form a corporation in Michigan, articles of incorporation must be completed, signed and filed with the Michigan Department of Labor and Economic Growth. In addition, certain internal corporate documents must be prepared and signed by the appropriate parties. If a corporation is not properly incorporated, stockholders may not have limited liability if a legal proceeding is brought against the corporation and may be required to personally pay if a judgment is obtained against the corporation.

How to Properly Sign a Document on Behalf of a Corporation
When signing a document on behalf of a corporation, it is important to remember that a corporation is treated as a separate individual under the law. As such, it is imperative that documents are properly signed or the person signing may find himself or herself on the hook for that obligation. Specifically, when documents are signed on behalf of a corporation, both the name of the corporation, the name of the person signing, and that person's title must be stated.

For example:

THE MICHAEL J. HAMBLIN CORPORATION
By: /s/ Michael J. Hamblin
Name: Michael J. Hamblin
Title: President

Piercing the Corporation Veil
A court may pierce a corporation's protective liability veil if the corporation is undercapitalized, or if it can be proved that the corporation is nothing more than a sham set up to defraud. If corporate stockholders and representatives do not follow the required formalities, a court could rule that the corporation is not really functioning as a corporation, but rather as what is known as the "alter ego" of the stockholders. To keep the corporate veil from being pierced, it imperative to keep proper minutes of corporate board and stockholder meetings. It is also imperative that corporate and non-corporate monies are not co-mingled.

The measures discussed in this post, among others, can help to ensure that a corporation will be treated as a separate entity under the law and protect its stockholders from personal liability for corporate obligations. To achieve the greatest level of protection when operating a corporation, it is important that an experienced Michigan business lawyer be consulted before incorporation and at regular intervals thereafter.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations , Corporations

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Although no one starts up a business with plans to fail or lose money, the success rate statistics for new businesses can be daunting. That's why Section 1244 stock should be on the mind of every new business owner who organizes their business as a C corporation.

Section 1244 stock is possible thanks to Section 1244 of the Internal Revenue Code. This is known as the small business stock provision, and was enacted to allow stockholders of domestic small business corporations to deduct losses incurred when they dispose of their small business stock as ordinary losses instead of capital losses.

The general rule is that any loss suffered by a stockholder upon liquidation of the company will be considered a capital loss. But, if the stock is Section 1244 stock, a part of the loss ($100,000 for husband and wife filing jointly, otherwise $50,000) will be treated as an ordinary loss. Since the loss is treated as ordinary, it can be used directly to offset the stockholder's investment income, passive income, wages, and self-employment income. In addition, because the use of the loss is accelerated, the tax advantage is much greater than if the loss is treated as capital.

Whether stock is Section 1244 stock depends on whether the requirements of IRC 1244 are met at the time the stock is originally issued. These requirements relate to (1) the corporation issuing the stock; (2) the stock itself; and (3) the stockholders of the corporation.

Being able to issue Section 1244 stock is one of the great tax benefits of organizing a business as a C corporation. Of course, you should consult with a knowledgeable Michigan business lawyer when setting up your corporation so that he or she can advise you on the requirements for issuing valid Section 1244 stock.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations , Corporations , Financing , General Topics , Tax Issues

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One of the main reasons people form Michigan corporations and limited liability companies (LLCs) is to protect themselves against personal liability for the obligations of their businesses. Under Michigan law, the risk of an owner of either a corporation or LLC is limited to their investment in the business. See Michigan Compiled Laws 450.1317 (for corporate rules) and Michigan Compiled Laws 450.4501 (for LLC rules). This is in total contrast to the rules for partnerships, which is one reason why no one in their right mind should be conducting business in Michigan as a partnership.

As with all rules, the rules of limited personal liability for owners of Michgian corporations and LLCs have exceptions.

First, an owner of these entities remains personally liable for their own personal negligence. This is true even if they are acting on behalf of their business entity. Thus, depending on the type of business one is conducting, a corporation or LLC may not provide very much protection from personal liability as a practical matter.

Second, an owner of a corporation or LLC is liable for any debts or obligations that they personally guarantee. Unfortunately, owners of small businesses are often required to personally guarantee the business's obligations as a condition of getting bank credit, desirable leases, supplier contracts, etc. This is a reality of life that further chips away at the limited liability protection that Michigan law provides to those who conduct their businesses through corporations or LLCs.

Third, there are certain situations that can result in the protective limited liability veil of a corporation or LLC being "pierced" so that the owner has personal liability for entity debts or obligations. These circumstances include (1) failing to follow the required formalities in company administration; (2) undercapitalizing the company; (3) using the business to achieve fraud; (4) failing to properly document transactions between the company and its owner(s); and failing to keep separate financial records for the company and its owner(s).

It is important that people conducting business through a Michigan corporation or LLC consult with a knowledgeable Michigan business lawyer to ensure they are following all of the requirements for obtaining and maintaining the limited liability protections these entities offer their owners.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations , Corporations , Entity Selection , Limited Liability Companies

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One advantage Michigan C corporations have over S corporations is the ability to reinvest profits in the corporation at a lower tax cost than S corporations. This is because the current lowest corporate income tax bracket is 15% for profits up to $50,000. The individual income tax bracket of a company's owner is often higher than 15%. So if that owner wanted to reinvest S corporation profits back into the S corporation, he or she could do so only after paying personal income tax on those profits at their personal income tax rate (because of the "flow through" tax treatment of S corporations). Since a C corporation is not a "flow through" tax entity, any profits not distributed to the shareholders (such as those reinvested back into the corporation) are taxed at the corporate level only.

So, let's say a start-up corporation decides to operate as a C corporation to take advantage of the lower tax cost of reinvesting profits back into the company. At some point, the company may exhaust its desire for reinvesting its profits, and decide that it wants to start distributing its profits to its shareholders. At this point, double taxation becomes an issue because in a C corporation, profits will first be taxed at the corporation level when they are booked, then again at the shareholder level when they are distributed to the shareholders.

The answer may be to convert the C corporation to an S corporation so that profits will only be taxed one time. The mechanics of switching from a C corporation to an S corporation are simple enough. Becoming an S corporation is simply a tax election that is made by filing the appropriate paperwork with the IRS. A corporation's shareholders can make this election any time during the corporation's existence. If the shareholders elect S corporation status, all future earnings will be taxed at their individual income tax rates, without being taxed at the corporate level.

But, corporations contemplating this move must be very careful. This is because any of the corporation's earnings before the S election will forever be marked and given special tax treatment under rules governing S corporations. If those earnings are ever distributed to the corporation's shareholders, they will be taxed as dividends and, even worse, will be subject to the double tax regime imposed on C corporations.

Corporations or stockholders who are contemplating changing their C corporation to an S corporation should consult with a Michigan business lawyer who can help them work through the possible tax pitfalls of making this move.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations , Corporations , Entity Selection , Tax Issues

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My last post may have given the impression that everyone should be rushing out to structure their business as a C corporation. So, in this post, I thought I would follow up with some cautionary information regarding some of the negative tax aspects of running a business as a C corporation.

These negatives include the following:

1. Double taxation. C corporations are taxed on corporate income and then shareholders are also taxed on distributions the corporation makes to them. But, a well-advised smaller C corporation should never have to pay corporate income tax because there are legal techniques to reduce its corporate level income tax to zero by paying appropriate salaries, bonuses, and fringe benefits.

2. C corporations are subject to the personal holding company tax. Basically, this is a penalty tax that the IRS imposes on corporations the IRS regards as an incorporated investment account. Active businesses shouldn't have to worry about this tax, as it targets corporations with 60% or more of their income coming from investments (i.e., dividends and royalties).

3. C corporations must deal with an accumulated earnings tax. This cuts into the C corporation's advantage over other entities to accumulate its profits to fund growth. The IRS imposes this 15% tax on C corporations that accumulate earnings in excess of $250,000.

4. C corporations are subject to the corporate alternative minimum tax. C corporations can be hit with this tax if they take advantage of certain out of the ordinary tax preference items such as income from life insurance or by postponing tax obligations by using the installment method of tax reporting.

Luckily, these four tax disadvantages are unlikely to pose much of an issue to smaller C corporations. So, companies that have net annual income over $100,000 should check with a qualified business lawyer or tax adviser to see if operating as a C corporation might be right for them.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Corporations

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Usually the most important factors that go into a business owner's decision to incorporate have nothing to do with tax issues. Rather, most business people incorporate because they want to shield personal assets from trade creditors and litigation. (Corporate stockholders, unlike sole proprietors, are not personally liable for business obligations.)

However, once the decision to incorporate is made, the next decision that must be made is whether to set up the corporation as a C corporation or an S corporation. The "C" and "S" refer to subchapters in the IRS code that govern each corporation. There are big differences in tax treatment of C corporations and S corporations.

S corporations are pass-through entities. In other words, there is no corporate income tax on an S corporation. Instead, the profits flow through to the shareholders who are taxed at their personal income tax rates on corporate profits. In addition, S corporations allow active shareholders tax advantages such as sharing in operating losses, which are common in business start-ups.

But, while S corporations are terrific for many small businesses, they are not for everyone. There are a number of possible operational and tax disadvantages to S corporations. Potential operational disadvantages include limits on the number of shareholders, limits on the types of shareholders, and the requirement of having only one class of stock. Possible tax disadvantages include immediate taxation of earnings (the downside of pass-through entities) and limited employee fringe benefits.

Depending on a business's operations and structure, a C corporation may be a better choice than an S corporation. Generally speaking, most of the "heavy hitters" out in the business world are C corporations. The reason is that C corporations allow for the widest variety of tax-advantaged fringe benefits. There is usually more flexibility in the capital structure of a C corporation, which can also be an advantage over an S corporation. Some of the tax advantages of C corporations include the ability to retain earnings for future growth, income splitting possibilities, increased options for fringe benefits, enhanced ability to claim operating losses (on the corporate level only), tax breaks on dividends received from other companies, and the ability to claim charitable deductions, which other business entities can't. Typically, once a company's annual net income exceeds $100,000, it should seriously consider becoming a C corporation if it isn't already.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Corporations

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Most Michigan businesses start off with much optimism and good will among the owners. Everyone is on the same page and shares a vision for making the business a wild success. However, as with many things, once the honeymoon phase of the venture ends, the owners may wind up not having as much in common as they thought. In fact, business owners often wind up strongly disagreeing with each other regarding a number of business issues ranging from basic operations to critical strategic planning matters.

Often, minority shareholders (i.e., those holding less than 51% of the corporation) fail to insist on having the corporate formation documents contain an adequate level of protection for them should differences arise with the majority shareholders regarding how the corporation should be managed. Often, the shareholder with the most shares ultimately winds up with control of the corporation and successfully squeezes out minority shareholders. Squeeze outs can take many forms, such as being locked out from the corporation's premises, employment termination, expulsion from board positions, discontinuation of dividends, and partial or complete denial of access to corporate information.

Michigan law provides remedies to minority shareholders who are being squeezed out of their companies, or who are being subjected to some kind of unfair oppression by majority shareholders. Shareholders who believe they are being treated unfairly may bring what is known as a Section 489 action in their local county circuit court. A Section 489 action is based on the Michigan statute found at Michigan Compiled Laws (MCL) 450.1489.

Under this statute, minority shareholders have remedies for "willfully unfair and oppressive" conduct. Potential defendants in a Section 489 action may be not only corporate directors, but also ‘‘those in control of the corporation". Those in control of the corporation are usually, but not necessarily, the majority shareholders.

Relief available under Section 489 includes injunctive relief, forced purchase of the minority shareholder's stock at fair value, liquidation and dissolution of the company, and monetary damages. Section 489 has been the subject of much litigation and occasional legislative action. Those who believe they are the victims of minority shareholder oppression should carefully choose a Michigan business litigation attorney to assist them with resolving their matter.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Corporations , General Topics , Litigation

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A typical Michigan business owner has invested a tremendous amount of time and energy into building up his or her business. But, many neglect one of the most important things they can do to protect their business and their families: succession planning.

Although it can be daunting to undertake business succession planning, it is truly critical for business owners to face this issue head on. One of the worst things a business owner can do is to wait to tackle business succession planning until circumstances force the owner or his or her family to consider the future of the business. This is because by then it might very well be too late to prepare and implement the desired or appropriate succession plan. Even in the best of circumstances it can sometimes take between three to five years to put a comprehensive business succession plan into place.

Many business owners think that succession planning is concerned only with naming a successor. But, there are a number of other issues that are addressed in a comprehensive succession plan. A good plan should address such issues as how the business owner plans to reduce his or her role, how the business owner communicates his or her departure to employees, and what will happen to the employees' benefits.

It is important to remember that business succession planning is a process, not a one time event. It is also important to use the appropriate professionals to assist in the process, such as knowledgeable business lawyers, accountants, financial planners, and even investment bankers in certain situations.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Corporations , General Topics , Limited Liability Companies

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While limited liability companies (LLC's) are the right choice of entity for many Michigan businesses, in some situations, using a corporation instead of an LLC may be the better choice. This post discusses some of the specific advantages for a Michigan business to use a corporation instead of an LLC to conduct its affairs.

1. Unlike LLC's, corporate profits are not subject to Social Security and Medicare taxes

As with sole proprietorships or a partnership, profits and salaries of an LLC are subject to self-employment taxes. Self-employment taxes are Social Security and Medicare taxes. The rate of these taxes are currently equal to a combined 15.3% rate. Unlike LLC's, with a corporation, business owners will have to pay Social Security and Medicare taxes only on salaries, not profits. This may provide for greater planning opportunities for entrepreneurs to legally avoid paying higher Social Security and Medicare taxes.

2. Corporations enjoy greater respect and acceptance

LLC's are still a relatively new business entity form. As such, not everyone (including some accountants) is as familiar with them as they are with corporations. In some cases, banks, financing companies, and certain kinds of vendors may be hesitant to extend credit to LLC's. Also, a number of states, including Michigan, restrict the type of business an LLC may conduct.

3. Corporations are able to offer a greater variety of fringe benefits at a lower tax cost

One of the biggest advantages corporations have over other business entities, including LLC's, is in the area of fringe benefits. Thanks to the tax code, corporations can offer a better variety of fringe benefits than other business entities. A number of retirement, employee stock purchase, and stock option plans are available only for use only by corporations. In addition, sole proprietors, partners and employees owning more than 2% of an S corporation are required to pay taxes on fringe benefits such as group-term life insurance, medical reimbursement plans, medical insurance premiums and parking. Stockholder-employees of a C corporation are not required to pay taxes on these kinds of benefits.

4. Corporations can lower taxes through a process called income shifting

One of the drawbacks of the corporate form is that C corporations (the type of corporation that has the most options for fringe benefits) are subject to double taxation. In other words, the corporation is taxed on its profits, and then the stockholders are taxed on any distributions the corporation makes to them. Despite this double taxation issue, in some situations corporations can offer greater flexibility for tax planning than LLC's. For example, a closely held C corporation with competent legal and accounting advisers rarely pays tax on its profits due to a number of techniques. Moreover, a C corporation can employ a very useful technique called income shifting to take advantage of lower income tax brackets and shift income from high tax brackets to lower tax brackets.

Choosing the right entity for a business is a serious decision that should only be made in consultation with a trusted business attorney. The stakes are high and the wrong decision can cost a business dearly.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Corporations , Limited Liability Companies

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As the end of this year approaches, you are likely involved in reviewing the various aspects of your business's financial and operational health. Likewise, you should consider giving your business a legal checkup. Legal checkups, or legal audits, are something like an accountant's financial audit or medical examinations given by a physician.

During a legal checkup, your lawyer examines business records and practices and recommends steps that you can take to protect the legal health of your business. In a typical legal checkup, your lawyer will review documents such as your corporate charter, corporate minute book, purchase order forms, sales contracts, employment agreements, and loan agreements. Afterward you may get a written report summarizing findings and recommendations. An audit may uncover legal problems that should be corrected. For example, it may reveal that the company should revise sales contracts to limit warranties and liabilities or revise its employment applications to preserve the right to fire unsatisfactory employees.

Besides a written report, your lawyer can meet with you to explain the audit findings and recommendations and tell you how to avoid potential legal problems. At the meeting you can also learn which problems need immediate attention and which ones are less serious. Having a legal checkup can help you prevent and remedy a variety of problems that could get in the way of your business's success. Consider contacting a good Michigan business lawyer to schedule a legal checkup for your company.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Corporations , General Topics , Limited Liability Companies

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In my last post, I discussed the basics of buy sell agreements. In this post, I will explain some of the specific advantages to having a buy sell agreement between the owners of a closely held Michigan business.

1. Creating a Market for Selling Partner's Interest. When a buy sell triggering event does happen such as the death or disability of an owner, there is an automatic market for selling that owner's interest in the business. The importance of this cannot be overstated since it can be difficult to locate buyers for interests in closely held companies. Without a buy sell agreement, it might be possible to sell the interest of a deceased or disabled partner only at a bargain basement price.

2. Establishing a Transition Plan. Having a buy sell agreement allows the owners to plan in advance for a smooth transfer of the business when an unexpected triggering event occurs. This allows the business to continue operating and growing in an organized fashion while at the same time limiting disruptions to customers in what will likely be a very hectic and difficult time.

3. Generating Funds for the Selling Partner and/or His or Her Family. The proceeds from the sale of a business interest under a buy sell agreement can be a life saver for the deceased or disabled owner's family. In the event of the business owner's death, buy sell proceeds can be used to defray certain estate-settlement expenses such as death taxes and administration costs. Also, part of the proceeds can be allocated to help pay living expenses of the deceased partner's family. If the partner is disabled, the proceeds can be used to pay the living expenses for the entire family.

4. Establishing Value for Estate Tax Purposes. The price set in the buy sell agreement may be used to establish a valuation of a deceased partner's business interest for estate tax purposes. There are certain requirements that buy sell agreements must meet in order for the values set therein to be respected by the IRS, so for this reason alone (although there are many others) it is imperative to have a competent Michigan business lawyer prepare these agreements.

A buy sell agreement is a tremendous tool that allows partners in closely held businesses to do advanced planning for their business and personal affairs in a way that can benefit all involved. But, preparing these kinds of agreements should not be a "do it yourself" project. Contact a good business lawyer to assist you.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations , Corporations , General Topics , Limited Liability Companies

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Most entrepreneurs have their hands full actually running their businesses. It's not uncommon for entrepreneurs to leave planning for contingencies for later. But, it is important to make plans to protect your family should the unthinkable happen. One way to do this is to have a buy sell agreement with your business partners that will protect your family's interests if you become disabled or die. Not only will a properly drafted buy sell agreement protect your family, it can also help to protect your partners and the business you have worked so hard to grow.

In a nutshell, a buy sell agreement is a legally binding contract that provides for the orderly disposition of a business interest when a specified event happens. Typically, a buy sell agreement is prepared so that the triggering event is the death of one of the business owners. But, a triggering event can also be a disability, retirement, or some other kind of major event in the lives of the owners. When the triggering event happens, the disabled or retired owner or the deceased owner's family will sell their interest to either the business itself or the remaining business owners. A properly prepared buy sell agreement is a win-win situation for all involved. A market is created for the business interest of the selling owner or their family, the remaining owners are able to keep control of the business as agreed on by everyone before a major event occurs, and the business can continue to operate and grow in an orderly and organized fashion.

The exact details of how this transition happens depends on the kind of buy sell agreement that is used. There are three basic kinds of buy sell agreements:

1. Cross-purchase agreement.
2. Redemption agreement.
3. Hybrid agreement.

A cross-purchase agreement is used when the remaining or surviving owners basically agree to buy each other out. For example, if a business has three partners, under a cross-purchase agreement, if one of the partners dies, the other two partners would purchase the deceased partner's interest in the business from his or her estate.

When a redemption agreement is used, the business itself buys the interest of the deceased or departing partner.

A hybrid agreement is often used and typically provides the remaining business owners the first option to buy the deceased or departing partner's interest, with the business itself obligated to purchase that interest if the remaining partners do not exercise their option.

Buy sell agreements are often funded with life insurance policies taken out on the lives of each of the business's partners. This provides for ready capital to purchase a deceased partner's interest without burdening the finances of the business or surviving partners. It is imperative that an experienced business lawyer be consulted regarding the preparation of a buy sell agreement. There are many legal, tax, and practical issues that must be accounted for when using these types of agreements and an improperly prepared buy sell agreement can be worse than not having one at all.

In my next post, I'll discuss some of the specific advantages to having a buy sell agreement.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations , Corporations , General Topics , Limited Liability Companies

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These days, Michigan entrepreneurs ultimately wind up deciding to structure their new business as either a Michigan limited liability company (LLC) or as a Michigan S corporation. There are some similarities to these two entities. For example, both LLC's and S corporations offer limited liability and tax treatment friendly to startups. However, there are important differences that must be taken into account when making the all important entity selection for a new business.

An S corporation is really just a "regular" business corporation that elects a special tax treatment. This special tax treatment is elected by filing a form with the IRS after the S corporation is formed by filing the appropriate paperwork with the State of Michigan.
Other than its special tax election, an S corporation has the same characteristics as a regular business corporation.

The special tax treatment afforded to S corporations is the same "pass through" tax treatment that partnerships and LLC's receive. In contrast, C corporation are taxed at two separate levels. This is what is commonly known as double taxation. The first level tax on a C corporation is a corporate income tax on the C corporation's income. The second level of tax is levied when the C corporation distributes profits to its stockholders, who then must pay personal income tax on their dividends. Under a S corporation, there is only one level of taxation. The corporate profits "pass through" to the stockholders, who then pay personal income taxes on those distributions at their individual tax rates.

Certain restrictions are placed on S corporation formations, which is why they are not always the best entity for new businesses. These restrictions include the following:

● An S corporation cannot have more than 100 stockholders. Further, each shareholder must consent to the corporation becoming an S corporation.

● Each stockholder in an S corporation must be an individual who is either a U.S. citizen or resident. In the alternative, an S corporation can be an estate or qualifying trust of an individual U.S. citizen or resident.

● An S corporation cannot have more than one class of stock. However, it is permissible to have voting differences within a class of stock. Having preferred stock is prohibited.

● All S corporations must use the calendar year as its fiscal year unless it can prove to the IRS that another fiscal year satisfies a business purpose.

Depending on your circumstances, an S corporation may be just the ticket for your business. However, caution should be had as choosing the entity for a new business is one of the most important decisions that you can make.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Corporations , Entity Selection

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In an earlier post, I noted that those who are operating their business as a general partnership should consider forming a Michigan limited liability company (LLC) to operate their business. I have also made a number of other very positive posts regarding the LLC entity for conducting business. While LLC's are very innovative, and useful in many situations, entrepreneurs should not automatically assume that an LLC is the best choice of entity in all situations. In some circumstances, the good old corporation may be the best choice of entity for a new business.

In spite of the ever increasing popularity of LLC's, the corporation is still one of the most popular forms of business entity used for the organization and operation of small business firms in America. There are a number of reasons for this. First, a corporation is fairly easy and inexpensive to set up. Second, the corporate entity affords its owners protection from personal liability for the debts and obligations of the business. (Even better, for certain qualifying small business corporations, favorable pass-through tax treatment may be available under the federal tax laws.) Third, the ownership interests in a corporation are represented by shares of stock, which are generally freely transferable.

Although it is relatively easy to set up a corporation, certain formalities must be observed in order to maintain the personal liability shield that corporations provide to their owners. For example, actions by a corporation's board of directors and shareholders must be taken at meetings or by written consent, and records of any such must be maintained. In addition, stockholders in corporations traditionally have not been able to get the same favorable tax treatment that is available to LLC members. This is one reason why corporations have been viewed as less flexible than other business entities like LLC's. However, recent amendments to the Michigan Business Corporation Act allow for different treatment among corporate investors, thus significantly reducing the differences in this regard between closely held corporations and LLC's.

Entrepreneurs should not overlook corporations as a possible entity for operating their new businesses. This is especially true if there is any possibility that company may go public in the future, as almost all public companies are corporations. Entrepreneurs should counsel with an able Michigan business attorney before starting their business in order to determine the best entity for their venture.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Corporations

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