Michigan Business Lawyer Blog

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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Many entrepreneurs do not understand that the process of naming their new venture involves a number of legal considerations. These considerations are both procedural and substantive, and depend on the type of entity that is being named.

Where a business files its name depends on its legal structure. Michigan sole proprietorships and partnerships must file their names with the county clerk in the county where the business is located. These businesses must also file their name in any other county in which they have an office or conduct business. The name for these kinds of businesses cannot be the same as any business names already on file with the county clerk where the filing is made. County clerks are also supposed to refuse name filings if a business's name will cause confusion or deception.

All other types of Michigan business entities must file their name with the State of Michigan and choose a name that is distinguishable on the records of the state administrator from other active business names. The phrase "distinguishable on the records of the administrator" has been defined by guidelines promulgated by the State of Michigan. In short, a name is distinguishable if it has a different sequence of letters or numbers from other names. It is important to note that just because a name is accepted for filing by the State, you still may not have substantive rights to the use of that name, as it may infringe on the trademark or other type of protection previously granted to another business.

It is important to exercise caution in choosing a business name in order to avoid infringing on the names already filed with a Michigan county clerk or filed with the State by another business, or being used by another being used as a trademark, service mark or trade name. To provide you with the maximum protection, a Michigan business lawyer should be consulted whenever a new business is being named.

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

Posted In: Entity Selection , General Topics

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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 my last post, I noted that sometimes, unsophisticated folk in Michigan will operate their businesses as a Michigan general partnership, instead of forming a registered business entity with the State of Michigan. Put simply, that is a terrible idea. Once upon a time, many Michigan businesses were run as general partnerships. However, with the invention of limited liability companies (LLC's), the usefulness of general partnerships ended. Nowadays, there is no reason to conduct business as a general partnership, and many why you shouldn't. Instead of operating your business as a general partnership, you should consider operating it as an LLC.

An LLC is formed by filing Articles of Organization with the State of Michigan. Even though this paperwork must be filed to form an LLC, this entity is still considered an unincorporated business association. In reality, an LLC is a hybrid between a partnership and a corporation, and combines the best characteristics of both types of business entities. The LLC business structure was specifically designed to give business owners and managers with a partnership’s operational flexibility and tax advantages and a corporation’s protective shield against personal liability.

Just like with a general partnership, those who organize an LLC have almost total flexibility to set up the company in the way they wish. Like partnerships (and S corporations for that matter), LLC's are given pass-through income tax treatment. In other words, the LLC is not taxed as an entity. Instead, all items of income, loss, credit, and deduction pass through the LLC, flowing directly to the LLC's members. In spite of these tax advantages, the most important aspect of the LLC is the members' limited liability to trade creditors for the LLC's debts and obligations. Generally speaking, LLC members and managers are not personally liable for any of the LLC’s debts, liabilities, or obligations. Of course, members and managers are always liable for their own negligent acts and intentional wrongful acts, even if done during the course of conducting LLC business.

While not best in every situation, the LLC provides a terrific way of doing business for many small businesses, and many larger ones too. In fact, the LLC has become the business entity of choice for many clients, replacing the more traditional forms of business organization, including C and S corporations.

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

Posted In: Entity Selection , Limited Liability Companies

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The first step in starting your new business is to decide which entity you should use. It is important to choose the appropriate entity so that your business will be properly structured for legal and tax purposes. This post contains a discussion of some of your options.

Sole Proprietorship
If your business will have just you as the owner, you could operate as a sole proprietorship. Although it is very easy to get started as a sole proprietorship, these days it is as outdated as a Commodore 64. Those who work as sole proprietors have no legal liability protection and all income will be reported on their personal income tax returns, subject to self employment and regular income tax. Do yourself a favor and pass on this way of doing business.

Single-Member Limited Liability Company (LLC)
The single-member LLC is a great alternative to operating your business a sole proprietorship. On the surface, this type of entity will appear to be a sole proprietorship, but it will have the legal protection offered by the formation of the LLC. To form a single member LLC by filing articles of organization, you must file articles of organization with the state. Business formalities are minimal; you don't even need to have an operating agreement (although in some cases it would be advisable).

Multi-Member LLC
A regular LLC – as opposed to a single member LLC – is formed by two or more people. This is an entity that combines the tax advantages of a partnership with the legal liability protection of a corporation. An LLC offers many different options for structuring your business, and is particularly effective for real estate projects. Due to its flexibility, the LLC has become a popular choice in the past few years. However, an LLC is not suitable for all businesses. Self employment tax on the profit may apply if you are an active member and no members can take wages. If you are considering an LLC for your business, it is vital that you consult with your attorney to confirm that it would be an appropriate entity for your particular situation.

C Corporation
A C corporation is a separate taxable entity subject to federal and state income tax. Most of the major businesses you hear about in the news are C corporations. If you form your business as a C corporation, your company will pay tax, and any profits distributed to you will be taxed again on your personal income tax return. In spite of the double taxation issue, C corporations can provide good tax planning opportunities and may also have more employee benefits options available than other types of business entities. C corporations are also the preferred type of entity if you are contemplating soliciting venture capital for your company or taking your company public.

S Corporation
The S corporation has a tax structure similar to an LLC, but the legal structure of a corporation. The S corporation is formed with the state the same as a C corporation, but there is an additional step. You (and any other shareholders) must file an election with the IRS to be treated as an S Corporation for tax purposes. There will be no double taxation; all income will be passed to you on your personal income tax return. Before LLC’s were available, S corporations were generally the entity of choice for small (and even some mid size) businesses. There a number of restrictions on who can be shareholders in an S corporation (as well as a limit on the total number of shareholders), so you should check with your attorney to determine if this type of entity would be appropriate for your particular situation.

The choice of which business entity to use is one of the most important items to consider as you take the necessary steps to start your new business. As an experienced business lawyer, I would be happy to help you work through the various issues involved in your particular situation and work with you to choose the entity best suited to your business. You can contact me through my website or by calling me directly at (248) 952-0400

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

Posted In: Entity Selection

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