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socrateaser, Attorney
Category: Business Law
Satisfied Customers: 37818
Experience:  Retired (mostly)
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I need to incorporate my business. I have a co-founder who

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I need to incorporate my business. I have a co-founder who is only putting in labor, no money. I am financing the business out of my pocket. I would benefit best in the short term as a S-coro, but i was told that is we start as a s-corp. my partner would be required to put in equal $ amount in form of stocks. essentially owe the company money until we become profitable. Is this true? and in that case would it be better to go C-corp for the interest of both parties?

Regardless of business form (C Corp, S Corp, LLC, LLP, etc.), if a shareholder does not contribute cash or property in exchange for his or her interest, then that person will receive taxable income for his or her share of ownership. The reason for this is that the shareholder who invests cash will have diluted his or her share ownership by distributing it to the non-contributing owner. Example:

A contributes $5,000 and receives 50 shares of the business. B contributes $0 and receives 50 shares. A's shares would have been worth $100 per share had B received no shares. But, because B receives 50 shares, A's shares are only worth $2,500 -- as are B's shares. The result is that B has a $2,500 gain from the transaction, because he paid nothing for his 50 shares.

The only practical means of creating ownership without an immediate tax liability for your "partner" is to create an agreement under which B is granted options to purchase shares of the business by some future date. Then, B can save some of his earnings from the business, and when the time is right, he can exercise the options by putting that money back into the business, and receiving shares in exchange for the predetermined price.

This can be done with any business form. If it's done with a corporation, it's easy, because corporations use stock certificates to evidence ownership. With an LLC, you would need an operating agreement that simply grants the noncontributing partner the right to make a specific contribution to the LLC at some future date, in exchange for a certain percentage ownership.

That about covers the issue. Please let me know if I can be of further assistance.

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Customer: replied 3 years ago.

To Socrateaser,


One question on the example above.. if the company were to dissolve prior to earning an income/profit. would "B" be liable for any compensation back to the corp? or would it all just be a loss?

B would have no liability to the corporation or to A, unless B and A, or B and the corporation were to enter into a written agreement which required B to make a contribution/share purchase by some future date.

Hope this helps.
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