Organizing A Software Development Company?

kjh1 asks: "I am interested in forming a business with a friend of mine doing back-end Web development for potential clients across the States. I've been investigating our options as far as business structure goes (Corporation, S-Corp, LLC, partnership, etc.) and am still undecided as to which one is the best for us. Essentially, we have no real overhead or expenses but the time we spend coding. However, we would like to have some liability protection - the kind that a corporation/LLC would give us. We would also like to minimize the amount of money that we need to spend on lawyers and/or accountants."

"Here are some of the questions that came up:

1. What is the best business structure to help us meet our goals?
2. What are the tax/legal issues surrounding coding in one state for a client in another state?
3. Where is the business considered to be taking place?
4. What if one of our 'employees' is working in a 3rd state (not the state of formation or of the client)?
5. And to throw a monkey wrench into the whole mess, what if my friend is a foreign national? What are our options then?"

Comments

My 2 cents

[The Mayor]

First, let me make abundantly clear that IANAL and IANAA (accountant).

C corporations are only benefitial in special circumstances. Foreigners can't own shares in an S corp, but can in a C corp. If you have more than 75 investors, IIRC, then you can't use a C corp, either.

S corps can help you prevent paying FICA. Basically, you end up paying the owners a very small salary. Instead, you get your "pay" in the form of profit disbursements. In this way, it's not subject to FICA.

An LLP is often used as the parent company of an S corp. For the direct owner of a company, it would be a General partenership, not a Limited partnership. These can be used to disburse profits in an S corp when the profits exceed some reasonable amount (if each person expects to make more than, say, $150k per year). Basically, you let the S corp disburse profits up to the $150k per year per employee, then disburse the remainder of the profits to the LLC. Then, the LLC pays the individuals that own it, resulting in more profits w/o FICA withholding.

I don't know much about the benefits/downfalls of partnerships versus corporations. Both help protect the owners from liability. However, I usually see small companies opting for S corps instead of partnerships.

As for the management structure, you can set up a "partnership" (like a law firm or a doctor's practice) using S corps and C corps, too. Whether you're a partnership or a corporation makes no difference in terms of structuring the management of the company. For example, I wanted a partnership for my corporation. That is, people would make "partner" by putting in the years and the hard work, and existing partners could be "bought out" when the leave the corporation--making it easy to add talent to the team, and departing members could get properly reimbursed for their time without selling the entire company. Either a partnership or a corporation would work for this arrangement.

In the end, I created an S corp. If my corp makes more than $150k per year per employee, I'll set up a LLP as a parent company. And I'll pay myself a ridiculously small salary. The rest of my income comes from profit disbursements.

Re:My 2 cents

[The Mayor]

No foreigner, British included, can own shares in an S corporation. One of my colleagues is British. So we have an LLP holding company, and he owns part of that.

I think foreigners can own LLP

[The Mayor]

Oops. Forgot to directly address your 3rd question.

I think foreigners can own part of an LLP. So, for that, you can set up an LLP and an S corp. The S corp could hire the foreigner. The foreigner could own part of the LLP. The LLP could then disburse the profits to the foreigner.

That said, this is one issue I'm not too sure on.

And, for matters of taxes and the like, it only matters where the employee physically works. I currently live in the UK, but all my work comes from the States. I have to pay UK taxes instead of US taxes. Likewise, when I was a resident of Texas but worked in Virginia, I had to pay Virginia income tax (Texas has no income tax). I believe this is set up to prevent people like George P Bush from choosing Texas as their resident state, even though he spent the majority of his time in Maine (oops...he got away with it...I guess it pays to be the ex-head of the CIA--you get all kinds of perks!).

You don't need a structure

[RhetoricalQuestion]

First of all, considering that you are 2 people, you don't need very much by way of business structure. You shouldn't need a boss between 2 of you. (If you do, you guys have some serious relationship issues.) If you grow, you may need some kind of a structure, but I would not bother until you need to set up specific roles and accountabilities for people.

If you must have something formal, you can split it so that one of you gets all the deals and the other codes, or split it that you're both responsible for both things. You two may be great coders, but to get things off the ground 1 or both of you needs to be really good at marketing and selling. If neither of you have this, join with someone who does.

Getting some legal and financial advice is a good idea, and if neither of you are good with books, you probably want a payroll/admin person. You can hire a general purpose accountant to manage your invoices, taxes, etc., on a contract basis -- i.e., have someone in once a week. If you feel you can't afford that but want someone anyway, hire an accounting student from your local reputatable university.

On a anecdotal note, the company I work at was started by 2 guys (both coders) 10 years ago. For the first year, 1 of them wrote all the code (at the time, GUI widgets), and the other handled sales, marketing, finance, legal, payroll, admin, office management, etc.

1. Find Lawyer. 2. Find Accountant.

[human bean]

3. Find Insurance Agent.

Yes, I know that these folks are just one step up from being lower than a snake's belly in Death Valley, but dollar for dollar, the money you spend on these folks will save you incredible amounts of grief down the road.

You don't have to spend a lot. Look around. Find a lawyer that has just passed the bar and is looking for corporate work. To you it is confusing, but to him/her this is not rocket science.

Find an accountant the same way, and tell him your main interest is in asset preservation/tax elimination. It really sucks to work you buns off, get rich, and watch the IRS suck it all down. Don't think it can't happen to you.

Ge the insurance agent to find you some general liability insurance. They will probably insist on errors and ommissions insurance along with it, depending on the kind of work you take on. Try to wiggle out of it, but keep the general liability. Note that the insurance company may limit the kinds of jobs you can do, and this may be for good reason.

The above, a business plan, marketing, and thousands of hours of hard work and you cannot go wrong.