Seventh Circuit: Class and Collective Action Waivers in Employment Arbitration Agreements Unenforceable

lewis-selectedThe Seventh Circuit Court of Appeals recently ruled that provisions in employment agreements requiring individual arbitration of wage and hour disputes are unlawful under the National Labor Relations Act (“NLRA”). The court found that such provisions violate employees’ right to engage in “concerted activities for the purpose of collective bargaining.”

In Lewis v. Epic Systems Corp., an employer required its employees to pursue wage and hour claims through individual arbitration and also waive their rights to any collective or class action proceedings. An employee later filed a class action in federal court, alleging that the employer violated the Fair Labor Standards Act (“FLSA”) and Wisconsin law by misclassifying the class members as “exempt” employees and thus depriving them of overtime pay. The trial court denied the employer’s request to compel individual arbitration. On appeal, the Seventh Circuit affirmed the trial court decision, finding the arbitration clause unenforceable because it violated the NLRA by interfering with the employees’ right to collaborate for mutual protection.

The National Labor Relations Board (“NLRB”) maintains that the NLRA prevents agreements that restrict employees from working in concert to resolve disputes and improve the terms and conditions of their employment through mutual aid and protection. Until Epic Systems, courts had not followed the NLRB’s position, instead relying on the Federal Arbitration Act (“FAA”), which permits such arbitration agreements as valid, irrevocable, and enforceable, save upon such grounds as exist at law. In issuing its ruling, the Seventh Circuit in Epic Systems found no conflict between the FAA and NLRA, finding that because the restrictions on collective or class actions are unenforceable under the NLRA, they are unenforceable under the FAA.

The Epic Systems ruling runs contrary to the other federal courts of appeals, making it quite possible that the Supreme Court will step in to resolve the conflict. Until then, class or collective action waivers in pre-dispute arbitration agreements in the Seventh Circuit (Illinois, Wisconsin, and Indiana) are unenforceable and employers should be aware that they cannot rely on such waivers.

Employers should keep in mind that arbitration agreements for employees without class or collective action waivers are still enforceable. While the holding is limited to waivers that require consent as a mandatory term of employment, the NLRB suggests that all class or collective action waivers are unlawful, even when an opt-out is provided.

If you have immediate concerns about how the decision affects your employees, contact Marcus & Boxerman at (312) 216-2720 or

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Illinois and Chicago Employment Law Update: Minimum Wage, Paid Sick Leave and Employee Retirement Accounts

punch-clockThree important employment law changes in the City of Chicago and the State of Illinois may affect your business.

Chicago Minimum Wage Ordinance

On July 1, 2016, the City of Chicago’s minimum wage increased by 50 cents per hour, to $10.50 for non-tipped employees and $5.95 for tipped employees as part of the Chicago minimum wage ordinance approved in late 2014.  The Chicago minimum wage will increase to $13 by 2019.

Employers that either maintain a business facility in the City of Chicago or are subject to at least one Chicago license requirement are bound by the ordinance and must pay all covered employees over the age of 18 the higher minimum wage after the first 90 days of employment.

Employers must post notice of the increase to all employees and must also provide notice of the increase with each employee’s first paycheck received after the effective date of the increase.  The notice can be found here.

Chicago Paid Sick Leave Ordinance

In June, the Chicago City Council passed an ordinance requiring employers to provide paid sick leave.  The ordinance goes into effect July 1, 2017.

Under the ordinance, employees earn 1 hour of sick leave for every 40 hours worked, for a maximum of 40 hours per year.  A total of 20 unused sick hours can roll over into the following year, but there is no payout for unused sick days.  Accrual periods begin after an employee works 80 hours within a 120-day period.  Employees can start using their paid sick leave hours after a 180-day probationary period. Sick leave is available, for example, when an employee or one of his or her family members is ill, injured or receiving medical care, or if the employee is the victim of domestic abuse or sexual violence.

Individuals and business entities with at least one covered employee that maintain a business facility within the City of Chicago or are subject to at least one Chicago license requirement are bound by the sick leave ordinance.  Employers with paid time-off policies that already meet the ordinance’s requirements are exempt from this new ordinance.

Illinois Secure Choice Savings Program

Beginning July 1, 2017, Illinois will implement the Illinois Secure Choice Savings Program.
Under Secure Choice, employees may contribute to a Roth individual retirement plan through paycheck deductions.  Employees are automatically enrolled in Secure Choice but may choose to opt out.  Employers are required to facilitate contributions through the payroll process but are not required to make contributions to accounts or make any investment decisions.

Businesses with at least 25 employees and in operation for at least two years that do not currently offer a retirement plan must participate in the program.  Businesses in operation for less than two years or with fewer than 25 employees may choose to voluntarily participate.  Businesses with existing retirement plans cannot participate.  Employers have nine months from program inception to ensure their employees are enrolled or opted out.

If you have any questions about these changes, please contact Marcus & Boxerman at 312.216.2720 or

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Defend Trade Secrets Act Creates Federal Jurisdiction Over Misappropriation Claims

dtsa-selectedCongress recently passed the Defend Trade Secrets Act (“DTSA”), vesting federal courts with the power to hear trade secret theft disputes and act immediately to resolve them. The DTSA took effect May 12, 2016, and further empowers American innovators to protect their intellectual property from theft.

The DTSA defines “trade secret” as any type of information, regardless of its form and how it is stored, for which the owner has taken “reasonable measures” to maintain its secrecy.  The information must also derive “independent economic value” from it not being generally known and not readily ascertainable through proper means. Examples include customer lists, confidential formulas and manufacturing processes.

Prior to passage of the DTSA, trade secret owners were required to bring an action in state court under individual state trade secret laws or to rely on federal prosecutors to bring criminal charges under the Economic Espionage Act.  Not surprisingly, trade secret protection has suffered from a lack of uniform results nationwide and costly, ineffective enforcement.  The DTSA creates a uniform framework for federal trade secret civil lawsuits. Its provisions are consistent with the protections for other forms of federally-recognized intellectual property, such as patents, trademarks and copyrights. The DTSA does not replace state laws, but rather supplements them with additional rights.

The DTSA allows a trade secret owner to file suit within three years of a misappropriation, and provides reasonable royalties, monetary damages or injunctive relief.  Overall, the DTSA provides trade secret owners more direction in crafting consistent policies to secure their trade secrets. Companies should nonetheless maintain strong security over trade secrets, such as regularly reviewing confidential information to see if any trade secrets exist and reasonably maintaining that information to ensure it stays a secret.  Companies should also develop a response plan for both misappropriations and seizure orders.

If your company has confidentiality agreements with employees, you must provide to them written notice of the DTSA whistleblower protections.  Failure to inform employees will preclude companies from recovering punitive damages or attorneys’ fees in any actions against the employee. For more information about DTSA protections and compliance, contact Marcus & Boxerman at (312) 216-2720 or


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New Federal Overtime Rule Takes Effect December 1, 2016

overtime-selectedThe U.S. Department of Labor recently finalized a rule (the “Final Rule”) to update the federal white collar overtime exemptions.  The Final Rule, which takes effect on December 1, 2016, doubles the salary threshold—from $23,660 to $47,476 per year, or from $455 to $913 a week—under which most salaried workers are guaranteed overtime.  Hourly workers are generally guaranteed overtime pay regardless of their earnings level.  According to the Department of Labor, the Final Rule will make an additional 4.2 million workers eligible for overtime under federal law.

Overtime protections were first put into place by the Fair Labor Standards Act of 1938, and established the general rule that workers be paid time-and-a-half for any hours worked over 40 hours in a week.  In general, all hourly employees are guaranteed overtime, and salaried employees are presumed to have the same guaranteed right to overtime unless they (1) make more than a salary threshold set by the Department of Labor and (2) pass a test demonstrating that they primarily perform executive, administrative, or professional duties (the “Duties Test”).  A limited number of occupations are not eligible for overtime pay (including teachers, doctors, and lawyers) or are subject to special provisions.

The new overtime level will be automatically updated every three years to adjust to wage growth in the country.  Based on Department of Labor projections, the salary threshold is expected to rise to more than $51,000 when the first update occurs on January 1, 2020.

As a bit of good news for employers, the Department of Labor made no changes to the Duties Test concerning the white collar exemption, and the Final Rule permits nondiscretionary bonuses and incentive payments to count toward up to 10 percent of the new salary threshold.  Workers earning more than the salary threshold are still subject to the Duties Test to determine eligibility for overtime.

Employers should review their employment and wage payment practices well in advance of the December 1, 2016 deadline to determine whether any salaried employees may lose their overtime-exempt status.  If this is the case, employers have a number of available options, including (1) increasing an employee’s salary to the new $47,476 level, thereby permitting the employee to retain his or her exempt status, (2) classifying the employee as non-exempt and paying him or her time-and-a-half for all overtime hours worked, (3) prohibiting non-exempt employees from working more than 40 hours in a week or (4) reducing the employee’s salary such that salary plus overtime equals what he or she would have earned before the Final Rule.

For any questions about the New Rule or overtime compensation, please contact us at 312.216.2731 or

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Update: Avoiding The Franchisor Joint Employer Trap

ivak-Bear-Trap-300pxIt’s an unsettling time for franchisors.  The NLRB’s new “indirect control” standard for finding a joint employer relationship (discussed here) is ambiguous and leaves many franchisors confused about how to protect their brand without becoming a joint employer with their franchisees and taking on liability for their employment decisions.  While the law surrounding the joint employer question is still developing, we offer some steps to take to protect yourself from a joint employer finding while maintaining necessary quality controls for your franchise system.

Define the Franchisor/Franchisee Relationship.  Most franchise agreements already explain that a franchisee is an independent contractor, not an employee.  Take it one step further by spelling out that the franchisor has no direct—or indirect—control over franchisee employment decisions.

Do Not Give Franchisees An Employee Handbook.  Do not provide franchisees with a sample employee handbook. Instead, advise franchisees to hire a third-party human resources professional or an attorney to help create an employee handbook and avoid unfair labor practices.

Stay Out of Employment Decisions.  Do not get involved in employment decisions such as hiring, firing, employee discipline, working conditions or wages and benefits.  Also, do not post job listings for franchisee locations or supply job applications to franchisees.

Eliminate Unnecessary Franchisor Controls.  Trim down your franchise operations manuals, training materials and communications, to ensure that you only provide mandates to your franchisees that are necessary to maintain your brand.  Leave the rest to the franchisees.  Do not set hours of operation for a location, work hours for employees or required inventory levels for your franchisees.

Limit Involvement In Franchisee Employee Training.  Make franchisor-provided training optional for franchisee employees below management level.  Franchisees should be solely responsible for training their workforce and must understand that a failure to maintain brand standards will result in a breach of the franchise agreement.  Providing “opening day” training to get a franchisee started is fine, but limit your franchisee training to things directly connected to maintaining your brand standards.

Educate Franchisor Field Personnel.  Make sure your field personnel know the current state of the law and understand what should and should not be communicated to franchisees.  Teach franchisor field personnel only to deal with management-level franchisee employees and to keep far away from franchisee employment decisions.  Also, either update your standards for inspections or consider hiring a third-party to make sure you maintain the appropriate distance.

Make Sure Franchisee Employees Know Who They Work For.  Require your franchisees to explain to their workforce that there is only one boss: the franchisee.  If any franchisee employees come to you with complaints, redirect them to the franchisee for appropriate resolution.

Avoid Monitoring Technology.  Stay away from technology that provides you with too much information about franchisee employees’ daily activities.  While it’s okay for a franchisor to recommend a specific POS system, if the system you recommend comes with software features for employee management, either unbundle that portion of the software or make clear that the use of those software features is optional.

Make Any Centralized Services Optional.  It’s acceptable to offer your franchisees centralized services for things like payroll, administration and accounting, but be sure your franchisees know these centralized services are optional and that they are free to choose a third-party provider of their choice.

Rethink Pricing Controls.  Price is an important part of many brands, but when a franchisor imposes pricing controls on franchisees it affects what the franchisees can afford to pay employees.  When prices are not imperative to your brand, consider letting franchisees control their own price maximums.   Franchisors may still use price-specific, limited-time advertising that affects your system; it’s just smart to leave the franchisee with control as often as possible.

Get an Experienced Attorney.  This area of the law is rapidly changing and an experienced attorney is a valuable tool for navigating it.  An experienced employment attorney can keep you updated on changes in the law and show you how to defend yourself.

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Your Managers May Not Be Exempt Under the DOL’s Proposed Overtime Rules

overtime-clipart-4277100715_cf6ca17eebBusiness owners and franchisees, you might need to start paying your managers overtime.  The Department of Labor (DOL) is updating the overtime rules for the so-called “white collar” exemption that excludes certain executive, administrative, and professional employees from the FLSA requirements for overtime payments.  This exemption is widely used by franchisees, retail stores and quick service restaurants whose managers work far more than 40 hours per week.

Under the current rules, the salary threshold for the white collar overtime exemption is $455 per week or $23,660 per year.  Under the proposed rules, that threshold would rise to $970 per week or $50,440 in 2016, more than doubling the amount an employee has to make before qualifying for the exemption.

If the proposed changes go through, businesses and franchises with managers who make less than $455 per week will have to either have to raise salaries to meet the new threshold requirement or reclassify managers as non-exempt, which means they’ll have to clock in and out like regular employees.  The DOL also plans to update the threshold requirement on an annual basis to account for inflation.  So, you’ll have to revisit the issue yearly unless all of your exempt employees are well over the salary threshold.

In addition to updating the salary requirement, the DOL may alter the “duties test.”  The white collar exemption generally requires than an employee’s duties relate to management or require advanced knowledge.  Currently, the “duties test” does not include a limit on the amount of time an employee may spend on nonexempt duties before losing his exempt status.  The DOL has not proposed any changes yet but plans to consider requests for changes during the comment period for the rules.

The DOL is also accepting input on whether to include a portion of nondiscretionary bonuses and incentive payments that are made at least monthly when calculating an employee’s weekly salary.  Year-end bonuses will not be included.

The new overtime rules are not finalized yet, but they may come into effect sooner than you think.  The DOL recently sent the proposed rules to the Office of Management and Budget (OMB), which has 30-90 days to review the rules.  Then, the rules will be published, and employers will have 60-90 days to comply with the new requirements.  This means business and franchise owners have three to six months to prepare for the coming changes.  So, you should start planning sooner rather than later.

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Avoid Disputes with Business Partners by Planning Ahead

partnership disputes, dispute resolution, business relationshipsWhen partners embark on a new business venture there’s so much excitement about the future that most ignore the unfortunate fact that disputes are virtually inevitable.

Planning for these disputes is the best way to avoid them. We offer the following recommendations to help you avoid partner disputes:

Put Your Agreement in Writing. Whatever entity you choose, a detailed, written agreement—the business version of a prenuptial agreement—is a must. A shareholder agreement (for a corporation), operating agreement (for an LLC) or partnership agreement (for a partnership) details how the business will be managed. Although not all disputes are preventable, written agreements help minimize them by answering many questions that otherwise lead to disagreements. Your agreement should address:

  • Each owner’s equity.
  • Each owner’s role, duties and obligations with respect to the business.
  • Whether one or more owners will be primarily responsible for the day-to-day business operations and decision-making.
  • Expectations for additional capital contributions or loans to the business.
  • Whether any owners are entitled to a salary.
  • How and when profits will be distributed.
  • How to break deadlocks.
  • Whether there are any restrictions on competition with the business.
  • How to handle transfers of ownership interests in the company.
  • What happens in the event of death, incapacity or withdrawal of an owner.
  • What happens upon dissolution of the company.
  • How and where disputes will be resolved.
  • Shareholder agreements, operating agreements and partnership agreements are not one-size-fits-all, so it’s best to have your agreement carefully tailored by an experienced attorney.

Set Clear Expectations for Financial Contributions. Establish clear expectations about how much each owner is expected to contribute and whether contributions—be they cash contributions, equipment to be used in the business or sweat equity—are to be treated as capital contributions or loans. However the contributions are characterized, put it in writing. Document any loans. Also, create rules for future contributions and discuss penalties for a partner’s failure to contribute. These details should be set forth in your agreement.

Define Owners’ Duties. Whether your partners are active or passive, it’s a good idea to have written descriptions for each partner’s duties, as well as the amount of time they are expected to devote to the business to prevent disputes about who’s doing their fair share.

Disclose all Partners in a Franchised Business. If your business is a franchise, be sure to identify all partners on the franchise documents to avoid a default under your franchise agreement and to protect all partners’ rights.

Decide on Compensation and Profit Treatment. Spell out in advance how much money will be paid as salaries or guaranteed payments, how much will be reinvested into the company for expansion or improvements, and how much will be distributed at the end of the year. In addition, agree upfront as to whether distributions will be made to pay owners’ tax bill for company earnings.

Make Company Financial Information Available. Even if the owners don’t have equal control over the company checkbook, it’s important for all of them to have access to company financial information. Many business relationships go sour because of mistrust, but doubts about fairness can be dispelled by giving each owner full access to the company’s financials. Also, be sure to agree in advance on a trusted CPA or accountant to handle bookkeeping and tax matters.

Address Disagreements Directly. If a dispute arises, sit down with your partners to address it. Focus on finding solutions instead of placing blame, and remember that it’s not about winning the argument; it’s about making the best possible choices for your business.

Discuss Worst-Case Scenarios in Advance. Don’t be shy about discussing how things might go wrong. Discussing issues such as what to do if an owner wants to leave the business or isn’t pulling his weight, or how to handle an owner’s death or disability may be uncomfortable at the outset, but talking in advance of a dispute is preferable to fighting it out in court.

Choose the Right Partners. Lastly, remember that friends and family members don’t always make good business partners. It’s important to choose partners whom you trust, who agree with your general vision for the company, who have complementary skill sets and whose strengths make up for your weaknesses.

For more information about building a successful business relationship and how best to avoid disputes, contact us at (312) 216-2720 or

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Limiting Employee Hours to Avoid the Affordable Care Act May Violate ERISA

affordable care act, employment lawUnder the Affordable Care Act (ACA), employers with 50 full-time equivalent employees (those working 30+ hours per week) must offer at least minimal healthcare to employees and their dependents.  Employers, including many franchised businesses, may attempt to avoid this requirement by reducing employee hours and relying more on part-time employees.  While that decision may make economic sense in the short-term, it could lead to an ERISA class action suit.

ERISA prohibits employers from discriminating against employees for exercising their rights under a benefit plan or for the purpose of preventing employees from acquiring those rights.  In a recent New York case, a district court judge refused to dismiss an ERISA class action suit brought by employees whose hours were seemingly cut to avoid healthcare liability under the ACA.

The law in this area is new and is still developing, but franchisees should be careful when making staffing and scheduling changes because courts might look unfavorably on employer staffing decisions made primarily to avoid the ACA.  No matter what changes you’re planning, consider having any discussions regarding staffing decisions with your attorney to make sure you’re protected.

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A Warning to Business Owners: Your Limited Liability Is Not Limitless

limited liability, personal liabilityLimited liability shields shareholders of corporations and members of limited liability companies from personal liability for company debts.  The companies and their owners are treated as distinct legal entities, each responsible for only their own debts.

Limited liability, however, is not limitless. There are exceptions.

In some circumstances, courts will “pierce the veil” of your entity, destroying the shield of limited liability.  Observing certain formalities demonstrates to creditors and courts the distinction between your company and its owners—showing that your company is a legitimate business separate and apart from you.  To protect yourself before creditors seek to hold you personally liable for company debts, follow our suggestions below.

Adequately Capitalize—or Fund—Your Company.  Companies have bills to pay.  When yours has enough money to meet its regular obligations, courts are more likely to see it as a separate entity and less likely to see your company as just a shell created to protect you from liability.  Courts measure adequate capitalization at the time you form your company, and companies may become undercapitalized later for many legitimate reasons.  It’s smart to keep sufficient funds to pay company bills because business owners may be found personally liable if they withdraw amounts from the business that render it insolvent.

Maintain Separate Bank Accounts.  Always keep your and your spouse’s personal assets separate from the company’s by maintaining separate bank accounts.  Handle all official business through the company account and never commingle company and personal monies.  Remember, moreover, that while distributing dividends and paying salaries from the company’s account is perfectly fine, never directly withdraw from the company’s account for personal purposes and do not charge personal expenses on a company credit card.  Lastly, any deposits of your personal funds to the company should be documented as a loan to avoid commingling.

Keep Your Personal Affairs Separate from Your CompanyKnow when you’re acting as an individual as opposed to a representative of your business, and make sure clients, customers and creditors know too.  Be sure to use your exact legal company name when conducting business with third parties.  Further, when signing a contract, loan application, or vendor or credit agreement, always write your official company title, not just your name, to make it clear that you are signing in your official capacity, not personally.  And be sure to always include the entity designation “Inc.” or “LLC.”

Keep at Arm’s Length.  Ensure that courts see a distinction between you and your business by keeping at arm’s length during all transactions.  To do this, when conducting transactions between the company and its owners, observe the same formalities and create the same documentation you would for a third-party business deal.

Keep Your Companies Separate from Each Other.  When you own multiple companies, to prevent one company from becoming liable for the debts of another company you must keep each company’s affairs separate from your other companies.  Treat each company as a separate and distinct entity and conduct all transactions between your businesses at arm’s length.  Never commingle company funds, do not pay one company’s bills from another company’s account (unless it’s documented as a loan), keep separate records and be clear about which company you represent in any dealings with clients, customers and creditors.

Observe Corporate Formalities.  Make sure your company looks like a real business.  Corporations should issue stock, adopt company bylaws, elect officers and board members, hold annual meetings, keep annual minutes and maintain company books and records.  These formalities may seem trivial when you’re running a small operation, but observing them makes a big difference in the eyes of a court.  While LLCs are not required to follow many formalities by law, it is important to observe at least a few to maintain limited liability status.  Every LLC needs a clear operating agreement along with well-maintained company books and records.  LLCs should also hold formal meetings and keep minutes when making important business decisions such as changes in ownership.

Find out how to maintain the appropriate degree of separation between your personal interests and those of your business by contacting us at (312) 216-2720 or

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Choice of Entity: LLC or S Corporation?

business structures, entity choice, llc, s corporationChoosing the right business structure makes a big difference for your business.  Most of today’s small business and franchise owners opt for one of two structures, the limited liability company (LLC) or the S corporation (S corp.).  While these business structures offer many of the same benefits, there are distinct advantages and disadvantages to each.

Common Benefits.  Two key benefits offered by LLCs and S corps. are limited liability and “pass-through” taxation.  Limited liability means that owners generally are not personally liable for the debts and liabilities of the business.  “Pass-through” taxation allows these business entities to avoid double taxation—neither LLCs nor S corps. pay corporate-level taxes.  Instead, all profits and losses are passed through to the business owners and applicable taxes are paid on their individual returns.

Member & Stockholder Eligibility.  LLCs are more flexible when it comes to owner eligibility.  Almost any individual or entity may be a member of an LLC.  There is no limitation on the number of members or how the ownership interests and specific benefits may be distributed.  S corps., on the other hand, are limited to a maximum of 100 individual shareholders who cannot be nonresident aliens, corporations, partnerships, LLCs, or non-qualifying trusts.  S corps. are also limited to one class of stock and must distribute dividends, benefits and detriments related to ownership in proportion to each shareholder’s ownership interest.

Observing Corporate Formalities.  LLCs are also attractive because of their relative simplicity and flexibility.  LLCs require fewer forms and documentation at the outset of formation and throughout the life of the business or franchise.  They are not required to observe corporate formalities and may be run either by the members or a group of selected managers, who need not be owners of the company.  While corporate formalities generally are not required, LLCs still must be careful to keep business operations separate from the members’ personal affairs to prevent the piercing of the company’s limited liability veil.

S corps. are far more rigid.  They are managed by a board of directors and must observe corporate formalities such as annual director and shareholder meetings, keeping meeting minutes, adopting bylaws and issuing stock.  S corps. are also limited in their investments and cannot have more than 25% passive income (such as income from real estate investments).  S corps. must meet all of the entity requirements or risk being converted to a C corporation, with highly adverse tax consequences.

While all of the extra formalities and paperwork required by S corps. may sound like a pain, they are often beneficial in the end.  The corporate formalities and careful records provide concrete proof of decision making processes and demonstrate that the board acted in the best interest of the company, proving very helpful when tax, liability or internal governance issues arise.  S corps. may also seem more legitimate to investors, who generally view the corporate structure as more stable than the LLC.

Tax Implications.  S corps. are attractive for highly profitable business ventures because they reduce employment taxes on your profits.  An LLC must pay employment tax on its entire net income, but S corps. only pay employment taxes on wages paid.  S corps. must pay employees reasonable salaries (based on the market rate) but additional profits may be distributed as dividends, which are typically taxed at a lower rate.  Plus, S corps. can write off certain employee/shareholder benefits for more savings.

On the other hand, distributions of an LLC’s appreciated property are generally tax free.  In S corps., those distributions are taxed on the shareholders’ individual tax returns based on the fair market value of the assets.  LLCs may also provide member-level tax adjustments for LLC liabilities such as real estate that is subject to debt and may allocate tax benefits related to depreciation and losses without regard to members’ proportional ownership interests. S corps. may be subject to additional state taxes.

Greater Limited Liability.  While LLCs and S corps. both enjoy limited liability, an LLC may be preferable when facing judgment creditors.  When a creditor obtains a personal judgment against a member of an LLC, the creditor cannot directly seize the assets of the LLC.  Instead, the creditor may obtain a “charging order” requiring distributions that would normally be made to the member to be made to the creditor until the judgment is satisfied.  This does not give the creditor the right to participate in management of the LLC or vote on any LLC matters.

When a creditor obtains a personal judgment against the shareholder of an S corp., the creditor may acquire title to the stock owned by the shareholder.  This does not give the creditor the right to participate in management of the corporation, but the creditor will be able to vote on company matters.  If the creditor only obtains a small number of shares, this does not make much of an impact, but it may be problematic if the creditor obtains a large enough interest to make a real impact during shareholder votes.

Duration.  LLCs have limited durations, and when a member dies or undergoes bankruptcy, the LLC must dissolve.  S corps. exist in perpetuity and have clearer lines between the business entity and its shareholders.  So, if a shareholder dies, sells his or her shares, or leaves the corporation, the S corp. can continue with business as usual.

Combining the Benefits.  Business owners and franchisees should keep in mind that LLCs can request S corp. tax status.  This allows your business or franchise to remain an LLC for legal purposes but gain the tax benefits of an S corp.  To gain S corp. status, an LLC must comply with the S corp. ownership rules but need not follow corporate formalities.  So, an LLC with S corp. tax status still has more operational and ownership flexibility than a traditional S corp.

To receive S corp. status, you must file a special election with the IRS using Form 2553.  You have to file within the first two months and fifteen days of the year.  If you file later, your election will not apply until the next year.

Which to Choose?  LLCs, S corps., and LLCs with S corp. tax status are all popular choices for new businesses.  Which choice is right for your business or franchise depends on your specific needs.  If you’re having trouble deciding between an LLC and S corp., contact us at (312) 216-2720 or to consult with one of our experienced attorneys about the pros and cons of each today.

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