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Law Educator, Esq.
Law Educator, Esq., Attorney
Category: Business Law
Satisfied Customers: 115464
Experience:  All corporate law, including non-profits and charitable fraternal organizations.
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I am starting a new business venture which will include a total

Customer Question

I am starting a new business venture which will include a total of 5 investors including myself. The business will be a distillery in the Denver metro area. All of the investors will invest equal monies and split 50% of the business for an 10% equity share. I will retain the remaining 50% of the business in addition to my 10% equity stake.Two of the investors (myself and one other) will work for the business and draw a nominal salary. Two other investors (who will not be working for the business) will be investing in the business from within their IRAs.
I would prefer to operate the business as an S-corp, however, it would appear that this is not possible because of the investors using their IRA's.
The business is not projected to make any significant profit until year 3. One option is to start the business as a C-corp and then after two years convert to an S-corp when the investors are able to purchase shares from outside of their IRAs. Does this seem viable?
Another option is to form as an LLC. This option seems less appealing to me because of the lack of formality with this organization, as well as the self employment tax. I understand that an LLC can choose to be taxed as a different entity (C-corp, S-corp, etc.). Is it possible to operate as an LLC, but choose to be taxed as an S-corp and avoid the above mentioned issues of investing in an S-corp from within an IRA?
Are there other options that would suit my situation better?
I would also like to know the best way to handle payment of the nominal salary. It seems silly to invest money into the business and then have it taxed before getting it back as salary. What is best way to handle this?
Submitted: 1 year ago.
Category: Business Law
Expert:  Law Educator, Esq. replied 1 year ago.
Thank you for your question. I look forward to working with you to provide you the information you are seeking for educational purposes only.
For this type of business, I would consider starting with a C-corp and keeping it a C-corp. The reason being is that these types of businesses can expand rapidly or require possibly additional investors and you can more readily sell shares to raise capital if needed in the future. Even though people go crazy about double taxation of a C-corp, the S-corp runs into more issues as it is more feasible for a smaller business with less owners. Also, payment of only dividends to owners of an S-corp can raise red flags and reasonable salary would be based on what is reasonable in the industry for a person doing the same job as you or the other owners are doing. The C-corp just makes more sense for a business like this with the 5 investors and unequal ownership where there will be owners working in the corporation as well.
You are going to have to take some salary that is reasonable in the distilling industry for the work you do (in other words if you had to hire someone to do the job what would be their reasonable pay), which you can reinvest into the corporation, even though you may end up taxed on it, but in this type of operation starting as a C-corp is best from the beginning.
Customer: replied 1 year ago.
Hi Law Educator,Thanks for the quick response. I am familiar with the "peculiarities" of operating an S-corp, I have previously operated a distillery as an S-corp. Assuming that everything goes according to the business plan (everything always does right?), there will be significant tax savings after year 3 by having S-corp status (even after taking reasonable salaries). The main issue here is the investors using their IRAs. Are there any issue with starting as a C-corp and then transitioning into a S-corp a couple years down the road when the investors are more liquid and can invest from outside of their IRAs?
Expert:  Law Educator, Esq. replied 1 year ago.
Thank you for your reply.
Everything always goes to plan...right, I get you on that one. Without seeing the actual numbers, I cannot tell you if there is any significant tax savings after the 3rd year, it depends on profits. If profits are high enough, there may not be any significant tax savings between the two. There are no real issues if you later decide to transition to the S-corp if you find based on profits it would be feasible.