Corporations – and with them the invention of “limited liability” – are a legal technology that is at least partially responsible for the American Industrial Revolution. Corporation formation in Georgia is also a concept that any savvy business-person needs to understand and take full advantage of with the help of an experienced business formation lawyer.
Put simply, limited liability means that if your company is sued, a successful plaintiff can only recover the value of your corporation. They can’t get a judgment against you or against your personal property that is kept separate from your business. This is a very valuable distinction. Even if the plaintiff wins a lawsuit against your business, they can only get the items that your corporation owns – not your house or your personal bank accounts.
Your company makes a highly addictive game called EverQ, which is sold to millions of people between the ages of 5 and 90. A 10-year-old customer plays your game so much that she forgets to eat and her parents sue your company for her resulting illness. Let’s just say that the jury agrees with her side and awards them $500,000 against your corporation for creating the game and selling it to a 10-year-old, knowing that the game could result in addiction.
If your company is just a partnership and therefore does not have limited liability, the plaintiffs would be able to satisfy the judgment by seizing of your private property (house, car, life savings, etc.), and selling it in public auctions until the $500,000 judgment is paid for in full.
Note that simple partnerships are usually okay for the early stages of your company because limited liability is rarely an issue until you’re actually selling something. In the beginning, it’s often much more cost-effective to make a simple partnership than it is to form a corporation, and our attorney can help you do that.
The drawbacks of starting corporations are many: You have to respect what’s called “the corporate form.” Maintaining the corporate form, with all of its nuances, sometimes can be extremely time-consuming and often takes teams of lawyers to ensure that it is done correctly.
This maintenance includes having scheduled corporate meetings, tracking your corporate minutes (someone has to write down all the topics discussed at your meetings), keeping separate bank accounts, keeping everything ‘owned’ by the business completely separate from your own assets, etc. The costs of all this red tape adds up, but the real costs come from:
With corporations, you lose money to double taxation. When your corporation profits, it’s taxed on those profits immediately, even though you don’t see any of that money yet. Then, after your business is taxed for the profits, you are taxed on whatever money you get from the corporation! So if EverQ corporation makes $100,000 in its first year, it would be taxed, let’s say, 34%, leaving EverQ Inc. with $66,000.
Then it makes a “distribution to its shareholders,” paying its owners the remaining $66,000. Each shareholder would then have to pay their own taxes on that $66,000 based on their individual tax rate. So if your personal tax rate is 34%, and you received the full $66,000 from your corporation, you’d have to pay an additional $22,440 in taxes, leaving you with only $43,560 of the initial $100,000 that EverQ Inc. made in profits for that year.
Thankfully, there are new legal entities that, like corporations, have limited liability, but don’t suffer from the double-taxation problem. Like partnerships, they have “pass-through tax” and limited liability.
S-Corporations were created in the early 1990s as an alternative to corporations, and the double-taxation that they require. They are reserved for much smaller companies with very few shareholders. These businesses get the benefit of limited liability without the drawback of double-taxation.
Because they’ve been around for a while, CPA firms have a tendency to recommend, or even require, that startup businesses organize as an S-Corporation. Unfortunately, they still require a major cost in administrative work to keep the S-Corporation operating properly. This includes everything in the “Negative Qualities of Corporations” listed above.
There are many things to consider when deciding to start a company. If you have any questions, reach out to a lawyer to discuss corporate formation in Georgia.
