Mark: Welcome to unsuitable on Rea Radio, the award winning financial services and business advisory show, that challenges your old-school business practices and the traditional business and culture. On this show you’ll hear from industry professionals who will challenge you to think beyond the suit and tie while offering you meaningful, modern solutions, to help you enhance your company’s growth. I’m your host, Mark Van Benschoten.
How much attention should you pay to the way your business is structured? What are the benefits to setting up an LLC versus an S corporation? Those are just some of the questions principal and return guest, Gene Spittle, will tackle on today’s podcast. Welcome back, Gene.
Gene: Hello Mark. How are you?
Mark: Kind of surprised you came back.
Gene: I thought it over for quite a while but … I thought it was in my best interest to show.
Mark: Gene, preparing for today, I typed your last name in, just to see the genealogy-
Gene: Oh my god.
Mark: First thing that came up was saliva. Spittle, saliva.
Gene: Oh yeah. Spittle, yeah.
Mark: I did not think that represented you well.
Gene: Eh. I don’t think so either.
Mark: That’s why we have microphone covers now but that’s beside the point. Really what did- Spittle and I don’t know how you say it in German is hospital and that makes sense to me. Caring, compassionate.
Gene: I’ve tracked our name back to Wales. I always thought we were Italian but somebody started the rumor was Spitalia at one time. I disproved that rumor.
Mark: I like that. From the United Kingdom it meant employed in a lodging house. A lodging house of care so that kind of makes sense.
Gene: Yeah. Interesting.
Mark: I like the Spitale. I’m going to call you Gene Spitale. Sounds like a soccer player.
Gene: There you go.
Mark: We’re going to talk about entity structure, and I’m an audit guy, why does it matter?
Gene: Why does it matter? Good question.
Mark: If you just talk for the next 19 minutes, I’ll be good.
Gene: Okay. Wouldn’t be the first time I did that. I was thinking on the way down, we get involved in the choice upfront when a start-up walks in the door and I’m going to say that many times I don’t have the best answer for them because I want them to go see their attorney first because I get more engaged about the legal side, the liability side of it. I’ll throw out, you know, “Hey. Here’s how a regular corporation works. Here’s how S selection works. Here’s how an LLC works.” On the flip side, we have new clients will walk in and they’ve already maybe been running as a particular entity for numerous years, we don’t always agree with the entity choice but a lot of times I think we just find a way to work around it.
When LLCs first came out I had a client say, “Well I was talking to my attorney and he said everybody should be an LLC.” I disagree with that.
Mark: For us audit guys can you explain what an LLC is?
Gene: Oh, boy. Yes. Limited liability Company. Pretty much taxed as a partnership would have been. These popped up, I’m going to say, 20, 25 years ago, more at the … Certain states had them and the IRS had to start recognizing them because they were an illegal entity in many states. In Ohio, I’m going to guess it’s been 20, 25 years, that they started recognizing-
Mark: Legal liability, limits my liability-
Gene: To your investment as well as maybe any loans or debt that you’re personally guaranteed.
Mark: Just as it says, limited liability. That I can grasp. Tax as a partnership, we’ll get into taxation later.
You mentioned sometimes we inherit a client’s early entity structure. Is there a cost to change it? If somebody came to you, and completed it wrong, is there a cost to change that?
Gene: Yes, there is. I’m not talking just professional fees.
Mark: Mental anguish?
Gene: We’ve had, probably the biggest one to change is if you’re a regular corporation and-
Mark: C Corp?
Gene: C Corp and you want to, for whatever reason you’ve heard that quote, “Everybody should be an LLC.” Then we go through the calculations and show them, depending on the assets that they have in there and the values that it’s going to cost them maybe 30 to 40% of that in tax-
Mark: To switch?
Gene: To switch. That’s why I said we have to work around situations. We don’t always get the perfect answer but you just try and get it as low as you can get it.
Mark: Make it work.
Gene: Make it work.
Mark: Don’t know who this specific attorney was, but did you think it might have been a situation where someone was just like, “Oh. I’m going to convert everybody to an LLC, Generate a little revenue?”
Gene: That’s possible. Knowing the client and I would say that the- LLCs were new in Ohio. I’m going to say that it was an attorney that was all excited about the new entity and I don’t know if it was to generate fees or not.
Mark: Do you think maybe he was being an alarmist, maybe?
Gene: Yeah, maybe a little bit. Yeah, could be.
Mark: We talked about liability reasons to have a certain entity. What about succession planning? Could that drive why you might want a different entity structure?
Gene: Yes. I’ve been thinking a lot about that too. Of course, an S Corp of an LLC are pass through entities and the income gets taxed at the taxpayer’s rate and we’ve had many people that have their children involved in succession planning. You go to liquidate or sell a C Corp and many times there’s a lot of corporate tax staring you in the face-
Mark: To do that.
Gene: To do that. If you have an S Corp or an LLC, many times you can sell the assets to your successor and you get the best of both worlds.
Mark: Uh huh. Thinking about succession planning might dictate why you might pick an entity or not an entity.
Gene: I think one of the first tax people that I got to know in the firm, Ruth Berts, she always felt that as the business grows and matures that you should always be looking to see if it should switch from a regular C Corp to an S Corp.
Mark: Did you look at my notes?
Gene: No, I did not.
Mark: I have a question down here. As an entity evolves, or starts-up, should it go through progression? Should it be a different entity?
Gene: It could be. I’ve got a few right now that- You don’t think about that, you just kind of make it work. I’ve got a few on my list right now that this summer I’m going to address, “Hey, maybe it’s time to … You’ve been a C Corp. Maybe it’s time to be an S Corp.” On the flip side I have some S Corps that need to start retaining some earnings, maybe at lower tax bracket which the C Corp offers. Why not-
Mark: Convert that.
Gene: Convert it back to a C Corp and retain that income and pay 15 to 20 percent on it, rather than 35 to 40 percent.
Mark: Sure.
Gene: You know, you start out as a mom and pop’s so I’m a scheduled C. Then I become a single member LLC. Then I become an S Corp. I kind of see some progression like that. Maybe I’m a little naïve. You see that, I don’t think it’s addressed enough. We probably have a lot of single member LLCs that maybe the spouse is involved and maybe it should be a regular LLC, with two members. It needs looked at.
Mark: Something shouldn’t be static. You don’t set it. I’m going to be an LLC today and that’s the way it is forever?
Gene: I agree.
Mark: Definitely things come up. Succession planning, tax planning. Something from the ESOP world, I think I’m correct, that you have to be a C Corp to get the 1042 deferral. I think you have to be a C Corp. Or you can’t be an LLC and become an ESOP. I think if you’re contemplating ESOPs or other types of succession planning, that entity structure would be pertinent also.
Gene: Exactly. I’m not an ESOP expert but I’ve had a few clients retire via ESOP. Did my own little research on it, for being an audit guy you at least know one piece of tax.
Mark: We should have that as a podcast subject is ESOPs one day.
Gene: Let me know who you invite.
Mark: Okay. You want to sit in on that one?
Gene: Yeah. I’ll just sit in and listen.
Mark: Take notes. Then share them with me when we’re all done. Maybe we both could learn something there.
Entity structure. Somebody come is- I think most people say this is the way it’s always going to be but you and I are talking it’s going to evolve. Things change. Law change.
Gene: If you’re treating your client the way they should be treated, it should be an annual discussion-
Mark: That’s a great-
Gene: I don’t think you should have to go through and do a big analysis but at least start listing … You know, where the company’s at? What are the pros and cons of it being an entity now versus C Corp of vice versa?
Mark: I can see those conversations going. What’s the next few years look like? “Oh, I want to start giving some away. Or I want to start growing.” The point you going from an S back to a C, which you don’t really hear people talking about like, “Oh. You want to start retaining some of that equity and do it at a lower tax.” That’s tremendous.
Gene: I just had a client walk in that father had passed away and he used another accounting firm. He must have retired 15, 20 years ago but … One of the things that you don’t want to put in a C Corp is real estate that we would appreciate. I think-
Mark: Even I know that one.
Gene: Even you know that. You took the words right out of my mouth. This fella passes away and the kids, three kids inherit the stock in this C Corp and-
Mark: That holds real estate.
Gene: That hold real estate. This all happened, I didn’t know what was going on. They came in to see me after the fact. The one sibling bought the real estate-
Mark: From the corporation?
Gene: From the corp. The money goes into the Corp. The county firm hands them the tax return a month ago and they own 60 or 70 grand at the corporate level. Where they’ve already distributed out the cash to everybody.
Mark: Here’s this guy. Bought the real estate personally, now he’s going to have to pony up some money to pay the tax.
Gene: Yeah. I was trying to be very professional about it but knowing the family I’m thinking, they could have switched to an S Corp, I think it’s five years now, and that appreciated real estate would have come out, taxed once and it would have been at the individual level.
Mark: I saved a bunch of money. Did you tell them.
Gene: Oh, I told them but they were looking for me to do something after the fact but there was just nothing I could do.
Mark: Gene, you’re good. I don’t know if you’re that good though.
Gene: Sometimes it doesn’t pay to be honest.
Mark: If you had listened to one of our most recent, we had Denny Lynch form Corporate Crisis Communications and he’s like, “Always be honest.”
Gene: Yeah. I agree.
Mark: I agree. Right. You never want to promise something that you can’t back up.
The ownership I find to be intriguing. There’s limits on S Corps. How many S Corps you can have. I think a lot of people start into business, like, “Oh. I’m going to go public. I’m going to start this. This is the next whiz bang thing. This is the next Google. This is going to happen.” You can only have- Your shareholders are limited in an S Corp, right? Is it 35 still?
Gene: No. It’s up to 100.
Mark: Up to 100. You still can’t obviously, be publicly traded at 100 shareholders.
Gene: Right. That’s why most of your publicly traded are-
Mark: C corps.
Gene: C corps. Yeah
Mark: Right. You tell people that like, “oh well if you want to be a C Corp … That’s what I want.” But that’s not what they should be when they first start out.
Gene: Again it goes back to what are your aspirations? What stage of business development are you in? Are you past the start-up stage? When you have losses up front, that’s a good time to have-
Mark: Flow through, right?
Gene: Flow through. LLC or S Corp. You put your money in.
Mark: You put the benefit of the loss.
Gene: Current benefit. Whereas the first couple years of losses on a C Corp, they sit there and carry forward to capita profit.
Mark: Correct.
Gene: It’s a cash flow item and each circumstance is different.
Mark: Gets back to your comment, your suggestion that this needs to be communicated on a regular basis, not some detailed evaluation but just a discussion. What are you seeing? What are your goals? What do you want to accomplish? That can change from year to year.
Gene: Yes it does.
Mark: Making sure that- Be attentive to that as to what might cause change. Like, “Okay. We’re going to stay the course today, but next year let’s see if you still feel the same way. Well we can make a change at that point.”
Gene: If somebody hasn’t changed, it’s not like anybody has screwed up, right.
Mark: As you say, you can deal with it.
Gene: Yeah. We deal with it. You don’t want to leave that much money in your C Corp? Bonus it out and then loan it back.
Mark: Correct.
Gene: There’s-
Mark: You could make it work.
Gene: You could make it work.
Mark: Might not be the most efficient but you could make it work. Great point.
Gene, question here. Since we already know what your super power would be, you answered that last time, today we want to know, if you could be someone else for a day, who would it be and why?
Gene: Oh, that’s a good one.
Mark: I didn’t come up with it myself so.
Gene: I knew that. I could be somebody for a day. I wouldn’t mind being the President of the United States.
Mark: Interesting.
Gene: Probably just to confirm that everything we read and hear and see over there going on in Washington DC is actually going on.
Mark: I assume you listened to Kyle Stemple’s latest podcast and he said the same thing. Did you guys confer, this is what you’re going to say?
Gene: Well, he thinks he is on the road to being president.
Mark: That’s a great point. I wish I had mentioned that to him.
Gene: What’s the shouts Bernie … Bernie. Kyle … Kyle.
Mark: In his mind.
Gene: In his mind, yeah. He’s a legend in his own mind.
Mark: Gene, thanks for joining us today on unsuitable. Thank you to our listeners for tuning in. If you want to learn more about business structure, we have some great information on our website at www.reacpa.com/podcast. Don’t forget to subscribe to unsuitable on iTunes or SoundCloud. Till next time, I’m Mark Van Benschoten for unsuitable on Rea Radio, encouraging you to loosen up your tie and think outside the box.
