help me help the man

September 8, 2006 9:55 AM

I'm trying to make my new web project legal in California. After reading through the Nolo press book(s), we thought that perhaps the LLC was the best corporate structure (we are going to issue stock and give the primary developer a portion in lieu of payment). While the Federal government taxes LLCs like sole proprietorships - you aren't taxed unless you make profit, and I don't see our profit outpacing our costs for a year - the State of California charges an LLC "tax" (really a fee) of $800, due almost immediately after your incorporation paperwork goes through, so...

Is there a way to legally put off the incorporation until we can afford to exist as a corporate entity? If we have $799 in startup costs before then, can we defer the deduction of those until after we incorporate and pay the $800? Is the $800 in California state tax fee deductible as a business expense on our federal return?

I'd like to consult an attorney but of course cannot afford to, as this project is, at least during its early development, on a shoestring budget. Any suggestions on other tax resources for small businesses?

posted by luriete to work & money (9 answers total)

LLCs don't issue stock although your developer could be one of the partners. I don't know what Nolo book told you that. I strongly suggest you consult an attorney. Check the California Bar Assn. website for a local referral. I did that once and, for $25, got to consult an attorney for an hour. Check the Secretary of State's website (http://www.ss.ca.gov) for helpful information. There is a lot of information out there for free.
posted by Lockjaw at 10:11 AM on September 8, 2006

If we have $799 in startup costs before then, can we defer the deduction of those until after we incorporate and pay the $800?

Sorry, what do you mean by this? What does deducting business expenses have to do with paying corporate organization fees? To answer (part of) your question, you can't "defer" expenses until future years*, but any deductions can be carried forward and applied against future profits, which is basically what you're looking for. And you, personally, can deduct business expenses against any other income prior to your incorporation, if you'd like to structure it that way.

In general, though, I have a hard time believing you can't come up with $800 to start a corporation. It's quite steep (I think you can start an LLC for, like $50 in Michigan), but don't you have a credit card or something? Other income with which you're going to finance general startup expenses, like equipment? Anyway, I guess it's up to you, but if it were me I'd do something like set up the LLC on my credit card, apply for a new credit card for the business, and then bounce the personal balance to the business via balance transfer at a low rate, and then pay that off as required. Whee, you're starting with negative equity!

* In fact, as any competent accountant or tax attorney will tell you, you CAN defer tax liability to future years, or concentrate it in the present year, or structure your tax payments in damn near any schedule you want, as long as you finally, one day, pay the full amount due. However, it would involve things like depreciating equipment that have very strict and rather complex rules. And anyway, like I said, I don't see how it's relevant for paying the organization fee.

(BTW, you're not "incorporating" or starting a "corporate entity." The point of LLCs and similar structures is to avoid the complicated corporate income & tax scheme by using "pass through" income to the principals, while still providing the limited liability benefits that accrue to corporations. It's the best of both worlds! It's just a technicality but you probably don't want to start holding yourself out as a corporation when you don't intend to become one.)
posted by rkent at 10:12 AM on September 8, 2006

Business expenses (including incorporation expenses) are tax deductible. Is that your question?

If you have a loss the first year (expenditures, but no revenue) you can carry that forward and use it to offset your revenues when you do make money.

Affording the $800 is a separate matter. If you don't have the money, you don't have the money. You need not incorporate to do business, you know; the corporation is a recent invention.

In any business venture with people who are not your spouse or blood relatives, I would have a lawyer do the paperwork. There's too much room for problems and bad feelings.
posted by jellicle at 10:16 AM on September 8, 2006

... and, in conclusion, sorry for using words like "corporation" and "incorporate" and then saying how wrong it is to use those words. It didn't occur to me 'til the end of the post, and I should've gone back and fixed it throughout.

P.S. Lockjaw - LLCs do indeed have shareholders rather than partners, and I don't see why you couldn't write someone else (like the primary developer) into the organizing documents.
posted by rkent at 10:17 AM on September 8, 2006

The LLC is necessary only to shield you from personal liability. If you're comfortable with carrying some personal liability, set the business up as a partnership at first and then incorporate later.

Still, $800 is not a lot of money. If you don't have $800, I find it hard to imagine you are in any position to start a business. Perhaps you should just wait until you have some seed capital. Alternatively, you probably know someone who would give you $800 in exchange for a share of the company.

Yes, corporate filing fees are business expenses and deductible on your income tax.

If we have $799 in startup costs before then, can we defer the deduction of those until after we incorporate and pay the $800?

I'm not sure what you're asking here. Why would you want to defer any deduction? It's going to be taxed at your personal tax rate whether you're a partnership or an LLC. And what does $799 have to do with it?
posted by kindall at 10:20 AM on September 8, 2006

Huh! I'll be damned, the $800 really is a tax. The organization fee is only $70, and the $800 is due annually to the franchise tax board, presumably from the organization itself. So I guess that would count as a business expense.

Maybe if you can't afford $800 per year of limited liability tax, you should defer formal organization until you've secured some business. In the interim you could just set up an agreement with your primary developer that "for all work related to XYZ, parties ABC will equally share all income and expenses" or something to that effect.

I am not your lawyer, this is not legal advice.
posted by rkent at 10:27 AM on September 8, 2006

Thanks for the very good advice. I think I need to read a bit more before I talk to an attorney, but I will do that.

Yes, the $800 is a tax, although it "behaves" like a fee; the organizational fee is actually sliding scale, so it is more like a tax than a fee. Slightly confusing!

I think that California is basically charging all LLCs $800 annually for the privilege of doing business in the state.
posted by luriete at 10:39 AM on September 8, 2006

IANAL, and this is not legal advice. But I have been a shareholder of LLC and S corporations.

The LLC form of organization is pretty loose, but it is important to back it with an appropriate shareholder's agreement, which covers various partnership and succession issues, so that all shareholder's interests are equitably balanced into the future. For example, a shareholder's agreement usually specifies how shares may sold or redeemed in the future, giving existing shareholders preferential rights to purchase under specified terms, so that a disgruntled shareholder does not sell his shares at a loss, or to a disagreeable 3rd party, thus affecting the other shareholders ability to operate or capitalize the business, or carry it through emergencies, unduly. A shareholder's agreement is usually pretty specific to the business and people involved, and if it is ever questioned by any of the shareholders or their estates, will be the certain subject of lawsuits. So, you want your shareholder's agreement to be bulletproof and understood by all, going in, and phrased so as to be likely to prevail in court.

This is one good reason you see an attorney about setting up your operation from the outset. Bad shareholder agreements are disastrous.
posted by paulsc at 10:43 AM on September 8, 2006

*NOT A LAWYER, SO THIS IS NOT TO BE CONSIDERED LEGAL ADVICE*

LLC's are flow through/pass through entities. They are taxed in several manners, depending on the structure. A single owner LLC would be a sole prop. and multi-owner can be done as a partnership.

You are allowed to operate at a loss for 3 tax years. At this point, your business is considered a hobby, not a business venture. You are then not allowed to take business tax deductions and are not able to write off business expenses. For one year of a loss, you will be fine.

As for the stock issuing...not certain if an LLC is able to do this. When I set mine up (both times in SC and then in GA), there was nothing about defining stock or ownership by stock. I believe a S-Corp allows stock...but a true Corporation would be your best bet for stocks.
posted by criticman at 1:32 PM on September 8, 2006