Entrepreneur in Residence: Entrepreneur Pathways by USCIS

The United States Citizenship and Immigration Services Director Alejandro Mayorkas unveiled a new online portal for entrepreneurs under the USCIS Entrepreneur in Residence program last week.  The portal is essentially an information source for entrepreneurs for immigration purposes. They have named it Entrepreneur Pathways.  It outlines all options that exist under the current laws that may be suitable for entrepreneurs starting new companies in the United States. 

This is indeed helpful for the foreign entrepreneur to consider various options open to him.  From my legal-eagle attorney perspective, I was hoping to see guidance on how existing laws will be utilized for these visa options that allow flexibility of the stringent rules.  I hope guidance will follow soon. When it does, we will duly post the information here. 

Does an LLC that has elected to be taxed as a corporation need articles and bylaws?

This is kind of trick question, because LLCs don’t have articles of incorporation or bylaws, they have limited liability agreements, sometimes called operating agreements.  An LLC that has elected to be taxed as a corporation is a weird animal.  It’s a corporation for federal tax purposes but an LLC under state entity organization law.  Even though it is taxed as a corporation, its governing documents must comply with the LLC statute.  That means all of the rules that govern organization, issuance of units, relationship of owners, duties of management, requirements for distributions, dissolution and liquidation — they are still found in the LLC act, not the corporation act.  For Washington that would be RCW 25.15, rather than RCW 23B.  One of the most material differences is that the fiduciary duty of loyalty can be waived with LLCs, something that is sometimes desirable for real estate management firms but would generally not be recommended for a tech startup.

An LLC that has elected to be taxed as a corporation needs a limited liability company agreement designed for its situation.    If the company has made an S corp election, it is very important that the LLC agreement have  protective language in the document providing, among other things, that investors may not join who would blow the S-election because of their status (e.g., an entity or a foreign citizen).  Disclosure and communication to members is critical with this kind of entity, because the distinctions are not widely understood, and investors/members may have incorrect assumptions.

The take away for a startup company is that if you are an LLC and you are being advised to make an S election, or even a C corp election, understand that you will become kind of a hybrid entity that isn’t always well understood.  Also, once a corporate election is made, that is what you are in the eyes of the IRS.  You can’t switch back to being taxed as a partnership without consequences – you will be treated as liquidating the corporation for tax purposes and may have tax liability as a result.  

Do S corporations need to pay employment tax?

It is a common misconception that S corporation owners do not have to pay any employment taxes. This is because S corporations distribute earnings as a flow-through entity that are taxed in the current year and are not subject to self-employment tax. In fact, the IRS has ruled that the managing owner of an S corporation must pay themselves a salary that represents reasonable compensation for services rendered. The business must withhold payroll taxes just like any other paycheck received from an employer. It is only the remaining profits after salary expense that can be passed through as a distribution not subject to payroll taxes.

Should I create a C-Corporation?

The main reason on entrepreneur would want to become a Corporation is to raise capital because you want to issue multiple classes of stocks such as options and warrants to attract investors or you intend to sell your corporation in five years. Other secondary reasons to become a Corporation are because you have a foreign owner or you would like to take advantage of certain fringe benefits. The primary disadvantage to becoming a C Corporation is that there is a second level of tax on C corporation profits.

Should I create a limited liability company (LLC)?

There are two main reasons to become a limited liability company the first one is to protect your assets and the second is to legitimatize your business. Similar to a Corporation, the main advantage of an LLC is that it creates a legal structure around your business that makes it difficult for someone to sue you and obtain your personal assets as a result of a liability from the business. In fact, an LLC can offer better asset protection then a Corporation because it is easier to maintain the formalities of an LLC and if someone is successful in a lawsuit against you they can only obtain future profits interests, they cannot obtain shares in your stock as in a Corporation. LLCs also make an ideal structure to contain real estate investments.

The second reason to establish an LLC is to enhance the perception of legitimacy to your customers or to the public. Often times, a sole proprietorship does not convey to the public that a legitimate business venture is being undertaken. In fact many people believe that if you aren’t a Corporation or an LLC then you’re not legally a business. Although this is not true perception can be more important than reality for the small business that is trying to gain a foothold in their market.

It is important to note, that an LLC does not change your tax status. That is, an LLC can be a sole proprietor, a corporation, or a partnership. This is why they call the LLC a wrapper. Because it just wraps and protects business entity that’s inside the LLC, it does not change the tax status of of the business. Once you are in an LLC you can pick and choose however you would like to be taxed; a sole proprietorship a Corporation or even an S Corporation can all be LLC’s.

Should I create a partnership?

A partnership is similar to a sole proprietorship, except you are running the business jointly with somebody else. What is misunderstood about partnerships is how easy it is to become one. As soon as you shake hands and decide to make profits together, you become a partnership. In fact, your children’s lemonade stand is a partnership that should file a partnership tax return. The partners to a partnership will also pay self employment tax on their share of the income generated by the partnership.

What is great about a partnership is that it is a very flexible entity. Oftentimes, when two or more people get together to start a business, it is unclear as to who will make the greatest contributions, do the most work, or bring in most of the business. In fact, it is common that the performance of a partner is not quite what was expected which leads to problems in the business. The partner you thought was wonderful becomes something very similar to a messy roommate. Partnerships can be structured so that even under a 50-50 profit split arrangements, a disproportionate distributions can be taken from the partnership to compensate partners for their contributions that are inconsistent with the original 50-50 agreements. These disproportionate distributions are impossible under an S Corporation arrangement which is quite common structure for new entrepreneurs to use. S corporations and C corporations must make profit distributions according to the number of shares owned by each owner.

How important is it for the new entrepreneur to pick the right entity structure for tax purposes?

The first thing to understand about this decision is that even if you’ve done nothing, by the mere fact that you are engaged in a business you are already a sole proprietorship. In tax this is known as your default classification. The reason that this is important is that from a tax perspective your classification is already determined and you do not need to worry about getting the entity structure rights before you start your business.

A sole proprietorship is filed on your schedule C of your form 1040. It tracks your revenue and expenses from your business and arrives at a profit. This profit is taxed at self-employment tax rates of 13.3% in 2012. This self-employment tax is in addition to your income tax. These taxes replace the employment tax deductions that are taken out of your paycheck. Employment taxes include Social Security and unemployment taxes. Self-employment taxes become a problem after profits are being generated in your business and changing your structure to optimize taxes become important after you are making at least $50,000 in profit in your sole proprietorship. As long as profits are low, the sole proprietorship offers an easy, flexible, low-cost, structure for your business.

What is an H-1B visa?

H-1B visas are the one of the most popular employment-based visas in the United States.  These are for skilled professionals.  There is an annual numerical limit of 65,000 for H-1B visas and an additional 20,000 H-1B visas for foreign nationals holding U.S. advanced degrees.

H-1B visas are valid for up to three years. Maximum time allowed is six years.  Once an H-1B visa is approved, the foreign national can change employers without falling within the numerical cap again. There are limited exceptions allowed for extending an H-1B visa beyond the six years until permanent residency is obtained.  

Generally, an employer must sponsor the H-1B visa.  Since August 2011, one can apply for a self-employed H-1B visa. More information about this will follow in a different post. 

What visa options are available for working at a start-up company?

There are several employment-based visas available under the current immigration laws.  Generally, an employer must sponsor the employee for such a visa. Each visa has specific requirements depending on the nature of the employment.  The options may also depend on the when you want to start working.  The most popular work visa, for example, an H1b visa is only available from October 1st of each year (more information to follow on this visa in a different post). Other visas that might be suitable are O, L, E, or TN visas. It is best to consult an immigration attorney to understand the various options available and the best option for you. 

Why is immigration law important for a start-up company?

Black’s Law Dictionary defines immigration as “the coming into a country of foreigners for purposes of permanent residence”. Immigration law is a the set of federal laws that govern immigration. How immigration law affects you depends on your role at the start-up company. 

If you are the owner of the start-up company and you are a U.S. citizen, then you might need to know what visas are required for possible employees.  If you are the owner or partner of the start-up company and you are NOT a US citizen, you will need to know your visa options to work at your Start-Up Company.  If you are an employee, you need to know what visa options are available so that the start-up company can sponsor you.

One must always have a valid visa to work in the United States. So, whatever your status is in the U.S. and whatever your role is at the start-up company, immigration law should be one of the top considerations.