Can Incorporation be a Disadvantage?

There are numerous articles addressing the advantages of incorporating your business. I would like to point out some disadvantages of incorporating a business under certain circumstances under California law.

Corporate Formalities
Running a business in corporate form requires far more formalities than running unincorporated businesses. Corporations must hold an annual shareholders' meeting and an annual directors' meeting. In addition, if a corporation contemplating an extraordinary transactions, should hold a special meetings of shareholders and directors to approve the same. All corporations incorporated under California law (or foreign corporations qualified to do business in California) must annually file a Statement of Information with the California Secretary of State and pay the $25 filing fee. In the Statement of Information--which is a public document--the corporation discloses its address, the names and addresses of its officers, directors and agent for service. By contrast, sole proprietorships and general partnerships are not subject to the above formalities.

Federal Taxes
A corporation is considered a separate legal entity from its shareholders. Therefore, a corporation's income is taxed once at the corporate level, an again at the shareholder level when the money is distributed to the shareholders. A significant portion of the corporate income can be lost in such a "double taxation". Some corporations may qualify to make "Subchapter S" election which will eliminate double taxation.

California Taxes
A corporation formed under California law (or a foreign corporation that qualified to do business in California) will have its income subject to California franchise taxes. Section 23151(d) of the California Revenue and Taxation Code sets the minimum franchise tax rate at 8.84 percent. Except for the initial year of formation, a corporation must pay a minimum franchise tax of $800, as estimated tax, by the 15th day of the fourth month of a corporation's taxable year. As well, the income will be subject to a second level of taxation at the shareholder level.

Local Law Restrictions
Sometimes being incorporated hinders you under local ordinances. For example, some rent control laws allow a property owner to evict a tenant from the rental property for landlord's own use (commonly referred to as "owner occupancy"). However, rent control laws in Los Angeles, Santa Monica and West Hollywood will not allow use of owner occupancy if the property's title is held by a corporation (or a partnership). This is true even if there is the corporation has one single shareholder and that shareholder will move into the unit after the tenant is evicted. These are clear instances where incorporation can be a disadvantage under the local ordinance.

Appearing in Lawsuits
In California, a corporation can appear in a lawsuit only through a licensed attorney. In fact, it is misdemeanor for a non-attorney to reprsent a corporation in a lawsuit. Therefore, if your corporation is sued or wishes to bring a lawsuit, you must first retain a lawyer before you can appear in the legal action. Moreover, if a corporation is not in good standing with the California Secretary of State, is will lack standing to appear in a lawsuit whether as a plaintiff or as a defendant. These restrictions do not apply to unincorporated entities such as sole proprietorships and general partnerships.

The subject of incorporation and selecting a proper business form is very expansive. For more information you can refer to Forming and Operating California Limited Liability Companies (published by Continuing Education of the Bar - California), or Advising California Partnerships (published by Continuing Education of the Bar - California), or consult your own attorney.

Robin Mashal is a partner at the law firm of Hong & Mashal, LLP, and can be reached at (310) 286-2000. His practice focuses on business law, real estate law and civil litigation. Hong & Mashal LLP is a California business law firm.

Who Needs a Lawyer Anyway?

Parties to civil lawsuits often ask whether it is necessary to retain a lawyer, or they can litigate their own case (known as "in pro per" or "pro se" litigant). This is ultimately a party's own decision. The following are some points to help guide you through your decision making process.

Sometimes it is Not Your Decision
Sometimes is not your choice whether or not to retain a lawyer. For example, in California a business entity (such as a corporation or an LLC) can appear in a case only through an attorney. In fact, it is a misdemeanor in California for a non-lawyer to represent a business entity in a case. If your business entity sues or gets sued in the Superior Court, you have no choice but to retain an attorney. On the other hand, California court system allows disputes of $7,500 or smaller to be brought in the Small Claims Court. If you get sued in the Small Claims Court or you wish to bring your claim in the Small Claims Court, you may not be represented by an attorney. In these scenarios, the law dictates whether or not legal representation is possible.

Costs of Retaining a Lawyer
In scenarios other than the above examples, you need to decide whether it is cost-beneficial for you to retain a professional (i.e., an attorney) to litigate the case for you. Your cost-benefit analysis must considers two factors: your incremental costs and your incremental benefit. The costs of retaining a lawyer can vary, depending on the complexity of the case and the experience level of the lawyers you consider. Some simple matters may be performed for a small flat fee, and more complex litigation matters handled by specialized attorneys may cost several hundreds of dollars every hour. These costs you need to balance against the benefits of retaining a lawyer.

Benefits of Retaining a Lawyer
Litigation can often be intricate and complex. Litigating a case requires knowledge of the procedural rules, knowledge of the substantive laws, experience and some common sense. It is possible for a party who had a stong case to lose in court because the proper legal procedures were not followed. For example, if you file your lawsuit beyong the statute of limitations, you will simply have no case at all. On the other hand, when a defendant properly brings a demurrer motion to a complaint, she may be able to dispose of plaintiff's lawsuit in a very early stage. When the parties are involved in multi-million dollar lawsuits, they do not hesitate to retain the best attorneys money can buy. With smaller disputes, parties consider less expensive alternatives. In either scenario, a lawyer's assistance can prove invaluable. Just as you would seek a physician's help with a surgical operation, you should get professional legal help in litigation matters.

The Wisdom of Old Adages
We have all heard the saying “he who is his own lawyer has a fool for a client”. There is a good deal of truth to this. Litigation requires technical knowledge and skills, and proper focus. Parties to a lawsuit often get too involved in the dispute to be able to see the big picture. Retaining a lawyer not only provides you the lawyer's knowledge and skills, but also adds this element of "focus" to your lawsuit. Since your attorney is not a party to the disputes, your attorney can keep a "cool head" and advise you about the pitfalls and opportunities. As the saying goes "cooler heads will prevail."

Conclusion
The bottom line is how important is the outcome of this civil lawsuit to you. Say you have a $250,000 claim for damages, or your are faced with defending a $250,000 lawsuit. Do you feel you have sufficient knowledge, skills and focus to handle the lawsuit? Would you risk losing the case in order to save legal fees?

Photograph from Wikimedia, under creative commons license.

Robin Mashal is a partner at the law firm of Hong & Mashal, LLP, and can be reached at (310) 286-2000. His practice focuses on business law, real estate law and civil litigation. Hong & Mashal LLP is a California business law firm.