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Tuesday, January 4, 2011

Breaking Up Is Hard To Do

Although you hope it won’t happen, you need to plan for the day when you and a business partner will decide to go your separate ways. Thinking it through up front can prevent a lot of angst and bad feelings later.


Generally, lawyers and tax advisors will advise a business owner to incorporate for a variety of reasons. One of the reasons why professional advisors recommend incorporating is due to the limitation on personal liability that the corporate form provides to its owners. For example, most businesses enter into contracts (e.g., leasing studio space). If the business ultimately fails to honor its contractual obligations, the amount of even a minor judgment may be more than enough to bankrupt the business. However, provided that corporate formalities have been followed (and absent a personal guaranty), the judgment creditor would only be able to recover against the business and not against the owner of the business personally.

Partnerships generally don’t provide the same limitation of personal liability as do corporations, although the tax issues associated with operating a partnership generally are simpler than those relating to corporations. It’s important to note that in most states a partnership will be deemed to exist when two people operate a business together as partners. (Partnership law generally is a matter of state law and varies from state to state. While the old Uniform Partnership Act of 1914 was adopted by all states except for Louisiana, the current, revised Uniform Partnership Act has been adopted by somewhat more than half of the states.)

A more recent business form (in the U.S.) that seems to be gaining in popularity is the limited liability company (LLC). Similar to a corporation, LLCs often enjoy the same limitation of personal liability as do corporations. They also provide more flexibility than corporations when dealing with issues such as management and distribution of profits. However, there are some disadvantages to LLCs, not least of which is the fact that the business form is relatively new to the U.S. and its court systems.

There are also tax considerations associated with each of the business forms. A typical corporation may face what’s commonly referred to as “double taxation.” First, the corporation is required to pay corporate income tax on its profits; second, dividends that the corporation pays to shareholders are taxed. There’s a legal way to avoid this sort of “double taxation,” but it requires qualifying corporations to file paperwork—commonly referred to as a Subchapter S election—with the IRS so that the corporation will be taxed like a partnership, with the corporation’s income being taxed at the shareholder level (regardless of whether the income is distributed).
...the result is that one co-owner may end up owning rights to images that the other co-owner created...
This approach also may permit owners of small businesses to avoid other tax-related problems. For instance, late last year the IRS announced its plans to crack down on corporation owners/operators who attempted to avoid paying payroll tax by compensating themselves through dividends or other non-salary distributions from the corporation.

 

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