BARRY: Number three is incorrect entity selection. Can you shed light on why entity selection matters at all? Why can’t you just knee-jerk into going on Sunbiz, filing a company, and just crushing it?

CHAD: Well, there’s two sides to the table of this. There’s the legal implications of the entity selection in terms of exposure to yourself personally, and there’s also the tax side of it, because you can be classified as one type of entity for legal purposes, but be classified as another for tax purposes. You know, it’s very common that for legal purposes, businesses will be classified as a limited liability company (an LLC), but still elect S status for tax purposes. And there are financial reasons for doing so, in terms of not having to pay self-employment tax, you know?

But at the end of the day, one of the big choices also is: are you going to have a flow-through entity where the profits of the business are still going to flow through to you individually, or are you going to have a C corp where it’s really two separate entities? You have the business, you have you, and there’s reasons for and against being a C corp.

It used to be a lot less common that people would elect to be a C corp because there was a much higher corporate tax rate. But when the tax law changed — and Barry, correct me if I’m wrong, I believe it was 2017 — the Tax Reform Act, the corp rate got substantially reduced. Where now, for some individuals who are in the highest tax bracket, it could potentially make sense to have C corp status at a 20% tax rate because less money would be flowing through to them on the individual tax rate side of things.

BARRY: Let me add to that. The 2017 Act did substantially lower the corporate rate to make it, what I would say, on its face look more attractive. But you’ve got to do the math at the end of the day, right? Because if you recall, you have the double taxation of C corps, which is that the corp is a standalone taxable entity. It pays its own taxes; it does not flow through to the 1040. So, it pays taxes once. Then, when the dividends come out to you as a shareholder, you’re going to pay capital gains on them, which is the second taxation of that money. That money gets taxed twice.

CHAD: Correct.

BARRY: So, it just comes down to whether or not — I wouldn’t say it just comes down to, but one consideration is: is the double taxation worth it? Because you still actually might be better off with double taxation than pass-through depending on your income and other factors.

Another thing I would say is there are other non-tax reasons to do a C corp. I’d like to mention two, and one of them is really awesome and fun and exciting. I’d love to have a whole section on it by itself. That will not be the first one.

The first one is that you can qualify for some insurance-related benefits. There are benefits you can qualify for as a company that you can actually do more advantageously through a C corp than you can through other entities. It’s a non-tax consideration.

And the second thing, which I’m going to add to the list… actually, you can add to the list–

CHAD: And one financial reason is the business owner can actually — we’ll talk about this — can actually executive bonus themselves money and get the deduction, as opposed to an S corp or an LLC where you can’t do that to yourself.

BARRY: Yeah, there’s a lot of nuances that really go into the selection. One thing I’ll note is that there’s something called Section 1202, which I’m sure you’re familiar with. It’s a Qualified Small Business section where if a lot of factors and elements are met, a company can sell after 5 years and have 100% of the gains be tax-free. 100% of the gains can be tax-free! A lot of hurdles, a lot of conditions, but a lot of interesting ways to use that for planning.

CHAD: That’s something at a later date to learn more.

BARRY: I think we should jump into that. I think get some experts on that to come and talk. But that’s a really interesting thing.

I would — correct me if I’m wrong, though. When it comes to entity selection, as far as C corps go, in my opinion, generally speaking, you don’t do a C corp.

CHAD: Correct. The reason why I don’t do them is — I think you mentioned it a minute ago — there’s other entities. They all have their advantages and disadvantages. We can get into that in a whole other video. I’ll put in my notes: don’t be a sole proprietor. We don’t need another video for that one.

BARRY: We can skip that one.

CHAD: Yeah, we can skip it. That’s one thing I can tell everyone: do not be a sole proprietor.

BARRY: But I would like to talk about that when we do the entity selection. Well, I would say C corps are not necessary unless you’re going to be a publicly traded company or you’re going to raise equity capital in a certain way, because LLCs can elect to be taxed as a C corporation. And so you can have the best of both worlds both legally and tax-wise. We’ll get into that another day.

But incorrect entity selection — kind of pushing aside C corps, what else comes to mind in terms of why that’s just a total mistake in terms of incorrect entity?

CHAD: Yeah. Because you know what? A lot of people go to their accountant — and I’m not trying to knock on accountants or CPAs — but sometimes CPAs are giving the legal advice of which entity to form because they say, “Oh, S corp, do an S corp.” And then they just do an S corp, and that’s kind of the end of it. There’s no discussion or dialogue with the attorney and the CFP, you know?

BARRY: Yeah. Well, from the legal side, I’d love to hear your take on the differences from the legal side of it.

CHAD: Okay. I’ll give you a Twitter summary, but again, it’s a breakout session. Because a lot of it comes down to liability to the owner, right?

BARRY: It does not. It does not actually, because here’s why. So, again, you’re not going to be a sole proprietor because that doesn’t ever make sense, really. So we’re talking about limited partnerships and a variety of different ways limited partnerships can be organized, because there’s a bunch of different numbers of L’s before the P.

CHAD: They didn’t even get off the wall with floor limited with the word, man! There’s like L, L, DL, triple L, limited liability, limited partnership, or whatever.

BARRY: Yeah, right. They’re all interesting; they all have their advantages. I think that they’re more traditional. They were used in the ’80s for tax reasons. I’ll get into that another time.

There’s LLCs, there’s LPs, there’s C corps. And I say S corp, but that’s really a tax designation; it’s not a legal designation. If you’re an S corp, you’re either a C corp who makes an election or you’re an LLC who makes an election. Legally, you’re either one of those two.

So entity selection-wise, all those types of entities have the same limited liability with respect to the business, except for an LP has a general partner as the managing partner. That’s why the general partner is always an entity itself, because that general partner carries all the liability of the partnership. Pushing that aside, all of those entities have the same limited liability with respect to the business operation. So if there’s a slip and fall, or there’s a breach of contract, or there’s an employee conflict, it’s all just a company liability.

Where they differ, and where I think it’s frequently overlooked, is on the asset protection benefits to the owners of the business. So, as you know — Chad the business owner, Barry the business owner — if I get sued or Chad gets sued having nothing to do with the business (like you hit a Ferrari or something on the way home from work and your insurance doesn’t cover it, and they sue you for the deficiency), they’re going to go after your assets. And on the list of assets on that menu will be your businesses.

And they are not all treated the same. Some of them can be taken away from you to satisfy a debt; others cannot. So there’s very important asset protection considerations when it comes to entity selection.

And I got to tell you, it’s very hard to fix later. I have a lot of people come to me and they’ve already made the mistake of forming a C corp and making a selection due to the advice of somebody else or nobody at all. And it’s really hard to fix because if you’re converting these entities, there’s a lot of tax consequences.

CHAD: Blow-up advice! “A friend of mine gave me that advice.” How often do you hear that one?

BARRY: What’d you say again?

CHAD: How often do you hear, “Oh, well, why’d you do that?” and they’ll say, “Oh, well, my friend told me that’s what he did”?

BARRY: You know, I hear water cooler advice. I call it water cooler advice. I went to Panera a couple times for coffee and I was just listening to people next to me, and they’re talking about wills and trusts. “Oh, my friend said to do this,” and “My friend said to do that.” And I just kept my mouth shut because I just don’t want to deal with it. But yeah, water cooler advice.

Entity selection, I think, is a whole window into another area that we could talk about.