If you do not elect to have your California professional corporation taxed as an S corporation, the default is for it to be taxed as a C corporation.

As a C corporation, your professional corporation would pay federal taxes on its profits and you would also pay individual taxes if you receive salary, bonuses, or dividends from the corporation.

By electing to be taxed as an S corporation, your professional corporation would instead  be a pass-through tax entity, like an LLC or a partnership.  Electing to be taxed as an S corporation may also allow you to pass losses from the business to your personal income tax return, where you can use it to offset income that you may have from other sources.

Finally, if the corporation pays you a “reasonable salary,” you may not be required to pay self-employment taxes on any additional corporate profits that are paid to you as dividends as a shareholder in addition to your reasonable salary.

You should consult with your CPA or tax professional to make sure being taxed as an S corporation is the best fit for your professional corporation, but for most California professional corporations electing to being taxed as an S corporation rather than a C corporation provides the most tax savings.

Disclaimer: This article discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Doug Bend expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

Professions that are required to be professional corporations include many of those that must have a state license, such as dentists, doctors, lawyers, optometrists, psychiatrists, and psychologists.

Professional corporations have more restrictions than traditional corporations, including who may own stock in the corporation.

Finally, while professional corporations still provide limited liability protection for claims not based on malpractice, they do not provide liability protection for malpractice.

Disclaimer: This article discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Doug Bend expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

1.  The Corporate Law Expertise Of The Delaware Court of Chancery.

Delaware has a highly respected court that focuses on corporate issues – the Court of Chancery.  Because of this specialization, the Court of Chancery has a great deal of expertise and familiarity in resolving complex corporate disputes.

No corporation wants to be involved in litigation, but if you are it is reassuring to know the dispute will be resolved by a very knowledgeable judge who is sophisticated in resolving corporate law matters.  In contrast, in other states your business dispute might be resolved by a jury.

2.  The Extensive Precedent of Delaware Corporate Case Law.

Corporate case law in Delaware is much more extensive than in other states due to the high volume of corporate cases.

More case law means increased predictability of the likely judicial resolution of a business law dispute. If there have been several similar cases to the one facing your corporation there is less uncertainty about the judicial outcome, which can be key when strategically deciding whether to settle a dispute or invest the time and capital to litigate.

3.  The Flexibility Of Delaware Corporate Statutes.

 The Delaware corporate statutes provide a great deal of flexibility in the organization of a corporation and the rights and duties of board members and shareholders.  For example, Delaware allows one person to be the only director, shareholder and officer of a Delaware corporation, whereas some other states require at least three people to fill the officer and director positions.

Many of Delaware statutes have been mimicked in other states, but the extensive case law mentioned above is an enormous asset when determining how a Delaware statute is likely to be interpreted.

4.  Investment Banks and Angel and VC Investors Prefer Delaware Corporations.

Investment banks, angel investors and venture capitalists tend to prefer companies incorporated as a C Corp in Delaware.  Therefore, if you are serious about receiving investments from these types of investors, you may want to incorporate in Delaware.

5.  You Send A Message That It Is A National Company And You Understand the Preferences of Investors.

If you incorporate in Delaware, you send a message – “This is a national company.”  From a marketing perspective, this could be important for your customers and investors.  You also send a signal to investors that you understand their preferences and are serious about receiving investments.

6.  There Are Greater Privacy Protections in Delaware Than Some Other States.

Delaware does not require officer or director names to be disclosed on formation documents.  This provides a layer of anonymity that is not available in some states.

7.  Quality Customer Service and Quick Turn Around Times.

The Delaware Secretary of State’s Office has made it a priority to provide expedited filings,  In fact, you can have your filings guaranteed to be processed in less than an hour.

In contrast, California has a 24 hour processing option, but it is not guaranteed to be completed within 24 hours.  This can be critical if you need to close a deal very quickly.

What Are The Drawbacks to Incorporating in Delaware?

1. Annual Costs For A Registered Agent for Service of Process.

If you incorporate in Delaware, you will be required to have a registered agent for service of process.  The annual fees for this service vary, but companies such as Biz Filings and Legal Zoom charge $129 to $149 each year.

2. Extra Franchise Taxes.

If you incorporate in Delaware you will not only have to pay the annual franchise tax in the states in which you are “doing business,” but also in Delaware.

For example, if your company is headquartered in California, but you incorporated in Delaware, each year you will not only have to pay the $800 annual franchise tax in California, but also the annual franchise tax in Delaware.

3.  Extra Reporting Requirements.

If you incorporate in Delaware, you will have a second layer of reporting requirements.  For example, if you incorporate your company in Delaware, but are headquartered in California, you would have to comply with the reporting requirements in both states.

If the benefits of incorporating in Delaware described above are not important to your company, you may want to avoid the extra expense and time of being incorporated in Delaware.

If you incorporated your company in Delaware, what have you found to be some of the biggest advantages and disadvantages?

1.  Only Authorize 5,000 Shares of Stock.

By March 1st of each year you will have to file an annual report and pay a franchise tax in Delaware.  The tax is calculated based on the authorized shares for the company by using either the Authorized Shares Method or the Assumed Par Value Capital Method, whichever is less expensive.

The Authorized Shares Method is based on the number of authorized shares and is calculated as follows:

     (i) If the company is authorized to issue 5,000 shares or less the annual franchise tax is $75;

     (ii) If the company is authorized to issue 5,001 to 10,000 shares the annual franchise tax is $150; and

     (iii) for each additional 10,000 authorized shares the annual franchise tax is increased by an additional $75.  The maximum annual tax under the Authorized Shares Method is $180,000.

You may, therefore, decide to authorize the company to only issue 5,000 shares so you pay the minimum amount of Delaware franchise tax each year ($75).

2.  Authorize Millions of Shares.

The second school of thought is to authorize millions of shares, typically 10,000,000 shares.

The rationale is individuals who receive 1,000,000 shares feel like they are receiving something of greater value and may be more motivated than individuals who receive 500 shares, even if the shares represent the same percentage of ownership in the company.

In addition, having more shares provides more flexibility in allocating shares on vesting schedules.

The drawback is in Delaware having more than 5,000 authorized shares results in a higher annual franchise tax.

If you authorize millions of shares, you will most likely calculate the Delaware annual franchise tax using the Assumed Par Value Capital Method.  The calculations under this method can be complicated, but the Delaware Secretary of State’s Office provides a good explanation and  examples of how to determine the tax here.

If you have any questions regarding how many shares you should authorize for your Delaware corporation, please contact me at Doug@BendLawOffice.com.

Who should be concerned about Section 83 of the Internal Revenue Code?

Section 83 should be of particular concern to founders and employees who receive stock that is subject to vesting.  Two examples are when a founder or an employee sign a restricted stock purchase agreement or if they agree to a stock option plan that allows them to exercise their options prior to vesting, but subject to a restrictive stock agreement.  However, these are just two examples – you should consult your tax and legal counsel to determine whether your particular circumstances raise a potential Section 83 issue before signing a stock purchase agreement.

What is Section 83 and what happens if you do not file an 83(b) election?

Under Section 83, if you purchase stock that is subject to vesting and do not file an 83(b) election, you will pay income tax on the difference between the price paid for the stock and the stock’s fair market value when it vests, even if you do not sell the stock at that time.  In addition, the holding period for determining whether the income from the sale of the shares qualify for long term capital gains treatment does not begin until the shares have vested.

How is the income from stock taxed if you make an 83(b) election?

In contrast, if you make an 83(b) election, the income from the stock is recognized at the time of the stock ”transfer” - its purchase date – rather than when the stock vests. The long term capital gains holding period also begins on the purchase date of the stock.

Why is it important when the income from your stock is recognized?

Often the purchase price and the fair market value of stock on its purchase date are the same.  Thus, if you make an 83(b) election, you may not have any income to recognize from the stock purchase and may only have to pay capital gains tax when the stock is sold.

However, if you do not make an 83(b) election, you may have substantial income tax liability when the stock vests if the stock increases in value, even if you do not sell it.

You, therefore, may want to file an 83(b) election, particularly if you believe the stock is likely to increase in value.  By doing so, the income from the stock will be recognized before it increases in value.  As an added bonus, by filing the 83(b) you will also start the one year holding period for long term capital gains treatment from the date you purchase the shares.

What is an example of how stock subject to vesting is treated under Section 83?

You and a friend start a company and purchase stock at the par value of $.0001 per share that is subject to a one year cliff and a four year vesting period.  Your friend promptly files an 83(b) election, but you forget to do so.  At the end of the one year cliff the stock is worth $1.00 per share.  Because you did not timely file an 83(b) election, you would recognize $0.99 per share as income, even if you do not sell the stock.  As the remaining stock vests, you would also recognize income equal to the difference between the fair market value of the stock and the $.0001 per share price at which you purchased it.

In contrast, because your friend promptly made an 83(b) election, they would not recognize any income as the stock vests because the 83(b) election accelerated the recognition of the income from the stock transfer to the purchase date.

What are the drawbacks to making an 83(b) election?

If you do not pay fair market value for the stock and make an 83(b) election, you could possibly pay income tax on stock that does not provide you with any benefit.

For example, you join a company in June of 2011 that was started in May of 2010.  You purchase 1,000 shares of restricted stock at the par value of $.0001 per share.

However, the company has been running for over a year and the fair market value of the shares is no longer par value, but is instead $1.00 per share.

If you file an 83(b) election, you would pay income tax on the difference between the fair market value of the stock and what you paid for your shares.  In this example, you would pay income tax on $990.90.

If the company  later dissolves and the stock is worthless, you would not receive any benefit from the income tax you paid.  In addition, if you later forfeit the stock, perhaps by leaving the company, you will not be allowed a deduction for the income tax you paid on the stock at the time you made the 83(b) election.

However, if the purchase price and the fair market value of stock are the same and you make an 83(b) election, you would not have any income to recognize from the stock purchase and may only have to pay capital gains tax when the stock is sold.

How much time do you have to make an 83(b) election?

You must file an 83(b) election no later than 30 days after the stock has been transferred.   The stock has been transferred on the purchase date of the stock, which is when you assume ownership of the stock.  The postmark date is the date of the filing.

How do you make an 83(b) filing?

The 83(b) election must include:

1. Your name, address, and tax identification number.
2. A description of the property for which you are making the election.  For example, “25 shares of common stock in X company.”
3. The date on which the property was transferred and the tax year for which you are making the election.
4. The nature of any restrictions on the stock.  For example, “Stock must be forfeited if employment terminates before June 1, 2015.”
5. The fair market value at the time of the transfer (ignoring restrictions except those that will never lapse) for which you are making the election.
6. Any amount you paid for the stock.
7. A statement that you have provided the required copies of the election, such as: “I have provided copies of this election as required in the regulation.”

The IRS does not provide a form 83(b) election, but you can find a sample 83(b) election form here.  It is strongly recommended that if you decide to make an 83(b ) election, you send it via certified mail.

What else must you do to properly file an 83(b) election?

You should make two copies of the 83(b) election:

1. Attach a copy of the 83(b) election to your tax return for the year the stock was transferred; and
2. Provide a copy of the election to the company from which you received the stock.

If your employer transferred the stock to someone besides yourself, you must also provide a copy of the 83(b) election to that person as well.

Do you have any 83(b) tips or advice?  If so, please provide them in the comments below.

If you have any questions regarding 83(b) elections or any other business legal issue, please contact me at Doug@BendLawOffice.com.

Disclaimer: This article is intended to provide information for your general education.  It is not intended to be used and should not be used for the purpose of avoiding federal income tax penalties.  Although the article discusses general legal and tax issues, it does not constitute legal advice.  You should not act or refrain from acting on the basis of any information in this article.  Instead you should seek the advice of tax or legal counsel who can discuss the facts and circumstances of your particular business or personal needs.  Doug Bend expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

1.  The Bylaws are the Company’s Legal Backbone.

A company’s bylaws provide the framework for how it operates, including rules for the owners’ relationship.

2.  What if Your Company Does Not Have Bylaws?

If your company does not have bylaws in place, the laws of California will control how the company is run.  It is much better for the owners to determine how it would like to have the company operate than to rely on the state’s statutes.

It is similar to an individual not having a will or trust.  If they die, the state’s statutes determine how the individual’s assets are distributed.  Instead, the individual should thoughtfully think through how they would like their assets distributed and to set up the legal mechanism to enforce their plan.

Similarly, it is much better for business owners to strategically think through how they would like their company to operate than to rely on the state’s statutes, which might not always be the best fit for the company.

3.  Bylaws Provide Owners With Piece of Mind.

Every company eventually runs into challenges.  It is better to consider some of the potential turning points in your company and provide in the bylaws how you would like for the outcomes of these situations to be determined than to wait to make these tough decisions when interested parties and passions may create the perfect storm for litigation.

For example, what will happen if there is a legal dispute between the owners?  Do you want the company to be tied up in the expense and distraction of litigation or would you prefer arbitration?  What happens if one of the owners dies?  What if one of the owners wants out of the company?

The bylaws present an opportunity to calmly and objectively reflect on these issues before they occur.  It is wiser to answer these types of questions ahead of time and determine what might be the best solutions for your company than to rely on the default rules in the state’s statutes or to try to resolve them when clear heads are less likely to prevail.

 4.  Bylaws Help Protect Your Company’s Limited Liability Protection.

One of the primary reasons to form a corporate entity is to possibly have personal limited liability from the potential business debts and judgments against your company.

If a company does not have bylaws and is sued, a plaintiff could try to “pierce the corporate veil” by claiming the company should not be provided with the shield of limited liability protection because its owners did not follow corporate formalities.

In determining whether to pierce the corporate veil, the court would evaluate a number of factors to determine whether your company is legitimate, including whether you have the proper corporate documents and records.  By not having bylaws, a business owner is risking not being provided limited liability protection if it is sued.

5.  Bylaws Help Avert Misunderstandings Among Owners.

Communication and clear expectations are key to any successful relationship, including the relationship between business owners.  Bylaws clearly lay out how the company will be run, which can be crucial in preventing misunderstandings over how the owners expect the company to be managed.

6.  You May Need Bylaws To Set Up A Bank Account and to get Loans and Insurance.

Finally, if you would like to open a business account or apply for loans most banks will require you to provide a copy of your bylaws.  In addition, insurance companies may require you to provide a copy of your company’s bylaws before providing certain types of polices.

As a business owner it is often tempting to cut corners to lower costs. A strategically thought out set of bylaws should not be one of these cut corners.   Instead, bylaws should be recognized for what they are – one of the wisest investments a business owner can make to ensure the long-term effectiveness of their company.

If you have any questions regarding bylaws or any other business legal issue, please contact me at Doug@BendLawOffice.com.

Disclaimer: This post discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Doug Bend expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this post.

A business owner does not need a physical location to incorporate in Delaware, but they do need to have a registered agent for service of process.

Biz Filings ($129), Legal Zoom ($159), The Company Corporation ($235) and a number of other companies provide a registered agent for service of process in Delaware.

However, you will also need to register your business in each state you are doing business.  Most states have a very low registration threshold because they not only want to know which businesses are operating in the state, but to also maximize revenue from franchise and other business taxes.

If you have any questions regarding incorporating in Delaware or any other business legal issue, please contact me at Doug@BendLawOffice.com.

Disclaimer: This post discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Doug Bend expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this post.

The California Online Privacy Protection Act requires a website to “conspicuously post” a privacy policy if it “collects and maintains personally identifiable information from a consumer residing in California.”

“Personally identifiable information” is defined very broadly to include a first and last name, a physical address, an e-mail address, a telephone number, or any other information that permits the contact of an individual.  So, even if you are not selling a product, your website will need a privacy policy if visitors can submit their e-mail addresses to receive news and updates from you.

What Must Be In Your Privacy Policy?

If a privacy policy is required, it must contain five items:

1. Information Collected – The categories of personal information the website collects.
2. The categories of third-parties with whom the company shares the information.
3. How the consumer can review and request changes to their information collected by the company.
4. How the company notifies consumers of material changes to its privacy policy.
5. The effective date of the privacy policy.

Where Should Your Privacy Policy Be Posted?

If you are required to have a privacy policy, it must be “conspicuously posted.”  The policy is conspicuously posted if it:

1. Appears on the homepage of your website – usually not an aesthetically pleasant option.
2. The website can have an icon on the home page that contains the word “privacy” – not a bad option.
3. The most popular option is to have a link at the bottom of the homepage that contains the words “Privacy Policy.”

What Can Happen If You Don’t Have A Privacy Policy?

Under the California Unfair Competition Law, website operators who do not comply with the California Online Privacy Protection Act could be sued by the California Attorney General, District Attorneys, County Counsel, or City Attorneys for ”unfair competition.”

There Is Not A Template One Size Fits All Privacy Policy

Privacy policies vary depending on how the website collects and uses consumer information.  The key is to not only make sure the privacy policy complies with the law, but to also have the policy be easy to understand so visitors do not get frustrated with legalese when trying to determine how their personal information is being collected and used by your website.

If you have any questions regarding privacy policies or any other business legal issue, please contact me at Doug@BendLawOffice.com.

Disclaimer: This post discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Doug Bend expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this post.

1. Where do I start to find a business attorney?

The best method for selecting a great business attorney is to consult other business owners and your trusted advisors.  Does a business owner you trust have an attorney they would recommend?  Does your CPA, financial planner, or banker have an attorney they know and trust?  An attorney who has the money or aptitude to have their website on page one of a Google search is not necessarily the attorney who is best suited to help your business.

2.  Is the attorney well qualified to handle your specific legal needs?

Once you have a list of attorneys your biggest concern should be whether they are qualified to handle your legal needs.  An attorney who is fresh out of law school may be inexpensive, but it may be worthwhile to pay more for an attorney who has experience with your industry or navigating the nuances of your city and state.  For example, a family law attorney may be well qualified to handle a child custody dispute, but they may not be the best attorney to set up a new business entity.  It is important to keep in mind that attorneys are business owners as well and some are reluctant to turn away new business – even if they are not particularly well qualified to handle your legal needs.

How can you determine if an attorney is well qualified to handle your legal needs?  The first step is to review the attorney’s biography.  Do they seem like they would be a good fit for your company’s legal matters? If so, contact the attorney and interview them for the position for which they are “applying” – one of the most important roles in your company.  Some questions you may want to ask include: 

• How long have you been practicing law?
• Have you had any ethics complaints filed against you?
• Have you done this specific type of work before?   
• How many times? 
• Can you please give specific examples of work you have done in the past that is similar to the work you would be doing for me?
• Can you please put me in contact with a client with whom you have done similar work?

You should also ask the attorney specific questions that are relevant to your legal needs to determine if they have the necessary background knowledge.  For example, if you are setting up a new company, you may want to ask the attorney to describe the difference between a S corporation and a LLC or how much the annual franchise tax is for a corporation in California.  These types of questions can be a good method to gauge the knowledge base of the attorney and whether they are best suited to help your business. 

 3.  Are the business attorney’s rates reasonable?

Good business attorneys in the Bay Area typically charge between $275 to $375 per hour.  Partners in large law firms can charge as much as $1,200 per hour.  This can lead to large, unexpected legal bills.  What may seem like a simple legal question can result in you receiving a ten page memo and a three thousand dollar invoice.

However, some attorneys are willing to offer flat project rates, which can better allow you to budget for your legal needs.   An attorney may also be willing to put a cap on the amount they charge for a project.  For example, an attorney might say that it typically takes them three to five hours to set up a corporation.  If an attorney will not provide a flat rate for the project, they might be willing to agree to a cap that the project will not cost anymore than fives times their hourly rate.  Having a flat project rate or cap on the legal costs for a project can be key in helping you prevent surprise legal bills.

 4.  Prioritize Your Legal Needs.

It is easy to forget that an attorney is a small business owner and may encourage you to buy additional legal services that your business may not immediately need.  You should ask the attorney how they would prioritize the timing of the legal projects they recommend.  For example, can you pay to set up your company now, but wait to file for a trademark until you see if your business is actually viable?

5.  Is the Business Attorney Not Only Well Qualified, But Someone You Would Enjoy Interacting With?

It is important to not only find an attorney who is reasonably priced and well qualified, but someone you feel very comfortable working with.  Is the attorney someone you want to develop an ongoing relationship with over the years as your business grows?  Will you enjoy interacting with them or will you dread having to contact them?

6.  The Business Attorney Should Be A Member of Your Team of Trusted Fiduciary Advisors.

The attorney should be a member of a trusted group of fiduciary advisors who provide your company with quality advice for a fair price.  This team of trusted fiduciaries will vary from business to business, but will often include a business attorney, a CPA, a financial planner, a personal banker, and other individuals who cannot only provide you with sound advice, but who will genuinely care about the success of your business. 

7.  Meet With Several Business Attorneys and Trust Your Instincts.

You should meet with several business attorneys.  Selecting the right business attorney is extremely important and you should take the time to make the right decision.  Most business attorneys provide a free initial consultation.  Take that opportunity to meet with several attorneys.  You are no doubt very busy, but finding a good fit early on can save dozens of hours down the road.  Trust your instincts in determining which business attorney is going to best help your business grow and succeed.

If you have any questions regarding hiring a business attorney or any other business legal issue, please contact me at Doug@BendLawOffice.com.

Disclaimer: This post discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Doug Bend expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this post.