I am frequently asked whether it is advisable for an ongoing horse related business operated by a family or small partnership, to incorporate--an increasingly important question today when many horse owners are hard pressed to comply with complicated IRS regulations that look to the businesslike nature of your activity. First, my clients want to know whether incorporating their activity will better enable them to withstand IRS scrutiny in the event of an audit. And second, they are interested in protecting themselves from liability in the event of a lawsuit, creditor claims, and the like. Today the options have extended to LLC entities, which have substantially the same features as a corporate entity. Either way, incorporating an ongoing horse activity or transferring it into an LLC entity has the following advantages:
1. Incorporating Looks More Businesslike. By transferring a horse related business into a corporation or LLC entity you automatically change the method of operation to what looks like, from a business standpoint, a more organized and businesslike vehicle. This ties into one of the main factors scrutinized by the IRS--and makes it easier to prove that the activity is conducted in a "businesslike manner."
Transferring your activity into a corporate or LLC entity automatically means that the it will be conducted in a more businesslike fashion because you will have a Corporate Minute Book--which takes additional time and effort to maintain--in which the books and records of the business are compiled and kept. If you are audited, this will make a much stronger impression because it presumably will be well-organized and consist of all the essential details and developments relevant to an ongoing business.
2. Corporate Procedures are Flexible. Any corporation can operate more than one type of activity. In other words, you can have one or more other businesses operating under the same corporate auspices. And if you ever decide to quit the horse activity the same corporate vehicle can be retained for utilization in another venture without incurring costs of setting up a new corporation. Closely held corporations have great flexibility in the methodology of hiring personnel, making day-to-day decisions, and getting consensus from the shareholders on major issues.
3. Setting Up a Corporation is Relatively Simple. The procedure for setting up a corporation or LLC is to contact an attorney familiar with corporate law and tell him or her that you want to transfer an existing horse activity (or new horse venture) into a corporate entity. You decide on a name for the corporation. You discuss with your attorney how real estate and livestock assets are to be handled, and whether the corporation will lease property from you individually. The attorney will draft the Articles of Incorporation in conformity with state law, and institute Bylaws that govern the day-to-day operations. Corporate stock is issued in accordance with the proportionate interests held by each principal. Often the majority of stock is owned by one individual. The Board of Directors can consist of one person, or of family members. In some instances a separate Shareholder Agreement is established to define the duties and responsibilities of each shareholder. A filing fee is paid to the Secretary of State, and there are attorney's fees as well.
4. Limitation of Liability Feature. One of the most important features of operating your horse activity as a corporation or LLC entity is that you and the other shareholders are insulated from personal liability in a variety of situations. For example, if a horse owned by the corporation injures a third party in an accident and the injured party becomes a judgment creditor, the judgment cannot be enforced against you personally, but only against the assets of the corporation.
5. Electing "S" Status. Generally, any closely held corporation can eliminate worry in connection with compensation to the principals by electing Subchapter "S" status. The typical situation involves a husband and wife who form a closely held corporation, electing "S" status--which means that the tax deductions are taken directly by the husband and wife as shareholders, and the corporation itself pays no tax. This also frees the corporation from any restrictions on the amount of interest, dividends and rents stockholders can receive. Also, a retirement plan can be implemented for added financial benefits.
When all is said and done, becoming a corporation or LLC is an appropriate way to enhance your ability to comply with IRS regulations pertaining to horse activities, and it is the best way to insure that you and other principals will be insulated from personal liability. It is important to obtain legal advice in connection with matters of this kind. If you are audited in connection with your horse activity, the fact that you are operating in a corporate entity or an LLC entity, assuming that your minute books are kept up to date and that you have a clear business plan, will make a difference.
John Alan Cohan is an attorney who has served the horse industry since 1981 in all states. He can be reached for legal consultations at 310-278-0203 or e-mail at email@example.com. This article was first published on EquiSearch.com.