Legal Structure

Let me start with the caveat that I am not a lawyer and you should not construe this article as legal advice and you should seek legal counsel on all matters of corporate governance and taxes. In addition the laws may be different from state to state so do your research and consult an appropriately licensed expert.

Summary

That all being said, having spent a lot of years in business and having owned and managed several different start-ups and private equity groups, I have a strong opinion on what might be the best legal structure for most individuals wanting to start a health and fitness business.  Check with your accountant or attorney on this matter but in most cases the answer to this is going to be to create a Limited Liability Company (LLC) which is essentially recognized as a partnership for tax purposes unless you are the only member (owner) which then the IRS ignores the entity and treats you like a sole proprietorship simplifying your tax return. Note that being a single owner LLC does not affect its legal status and the protections it provides.

The LLC structure gives you the most amount of flexibility on how the entity will be run and governed as well as allowing for virtually any profit or loss distribution sharing arrangement or cash distribution priority irrespective of which partner owns what percentage of the LLC. This allows for members to consider not only money invested, but also time and work invested when distributing profits.

Definitions

For purposes of an LLC, the terms "Partner" or "Shareholder" may be used to describe the equity owners but the proper legal term is "Member".  An owner of an LLC is a Member of the LLC. A Managing Member is a legal term that gives responsibility to a certain individual or entity to manage the affairs of the company on behalf of all the other members. Note that the Manager of the LLC does not have to be a "Member" or owner in the LLC. So you can hire and designate an outside independent firm to be your Non-Member Manager of your LLC to manage your business operations, tax and legal affairs.

Members can be working members or merely financial investors that never step foot in the business. This distinction becomes important for tax purposes. Members have limited liability for the debts of the business, unless they personally guarantee loans.

Structure and Flexibility

So for example, I could give 99% of the equity in the LLC to my children and keep 1% but yet I can create an operating agreement that states I get 100% of the profit distribution and or losses until which time the Managing Member and or the shareholders of the LLC decide to change that language.  In addition I can designate myself, the 1% owner as the only Managing Member (see below) that gets to make any decision on how the business is run and profits are shared barring any overriding state laws that may take precedent.  

Salaries or Draws

Technically an owner takes a draw or a guaranteed payment from the LLC and not a Salary as they are not an employee of the LLC.

Owners/Members in an LLC are prohibited from being an employee of the LLC. This doesn't mean an LLC cannot have employees, they just can't classify an owner as an employee.

A guaranteed payment compensates people for their time, while a Draw typically compensates people for their ownership percentage. Guaranteed payments and Draws do not have any taxes withheld, it is much like paying an independent contractor.

The distinction is that a Guaranteed payment is not associated with the profits of the business. In other words the Member is paid a fair wage for their job duties irrespective of if the company makes a profit or not. Meaning the money to pay that person their Guaranteed Payment must come from Members equity investment or borrowed funds (debt). This is often found when one partner is a sweat equity partner and one is a financial investment partner. This situation often does not go well when the entity is losing money for reasons I wrote about Sweat Equity Partners - 1 and Sweat Equity Partners - 2.

Guaranteed payments are typically deductible by the entity on Form 1065 as a business expense.

Tax Liability

The downside of an LLC is the business profits are subject to Self-Employment taxes (Social Security and Medicare taxes) like all other income except you get to pay both the "employers" and the "employees" portion, so essentially double what it would be if you were an employee of a company you don't own.

The distinction as to what type of Member or Partner you are is important when it comes time to distribute profits and pay taxes. The IRS has taken the position that limited liability company (LLC) members who participate in management or provide significant services are subject to self-employment (SE) tax on their distributive shares, even if a substantial portion of that income is attributable to returns on invested capital. Simply, if you work in the business and are active you are subject to self-employment taxes.

Limited partners or members such as financial investors are treated differently. They are only subject to self-employment tax on guaranteed payments for services they provide to the partnership as noted above. So if a financial investor provided a consulting service for a business he/she has an investment in as well, that compensation would be a guaranteed payment. But they’re otherwise exempt from Self-Employment taxes on their distributive shares of partnership income. Limited partners, who have no management authority, are  essentially passive investors and otherwise not active business participants.

If your LLC loses money this could change your total taxes owed depending on the partnership agreements and how losses and capital accounts are settled at year-end. Get a qualified tax accountant to work with you to optimize your tax position.

There is much more to the legal structure and how it is set up and what you can do,  but suffice to say, you get the personal protection of working within a legal structure (as much as the laws of your state allow), yet the flexibility to run the business virtually any way the Operating Agreement among the partners dictates.


Pro Tip: Obtain Your EIN

An EIN is an Employer Identification Number. This is also known as the Federal Tax Identification Number, and is a very important number to have if you're setting up a business!

You can get an EIN from the IRS - and you can register for it online right now. 

Click here to apply for your EIN.

Dean
A graduate of Loyola University and MBA from The University of Chicago.
Pre-med LSU and post graduate at A.T. Still University.

His love of technology started right out of school. As a new hire for Arthur Andersen's Consulting group, the largest accounting and consulting firm in the world at that time, he led the first implementation of one of the very first IBM and Apple personal computers ever used in the business environment quickly becoming the world wide expert in analytical implementation of personal computers for business. Eventually moving on to a widely successful leveraged buy-out and then returning to Arthur Andersen and becoming a Partner in the Chicago office, he specialized in health, fitness, nutritional and food businesses managing some of the largest strategic food industry restructuring deals at the time. As COO of a successful Midwest Venture Capital firm, he was responsible for the operational management and success of over 25 investments each averaging $2-5 million over 5 years yielding returns in excess of 1000%.

He served on the board of many businesses in the health and nutrition sector as well as the educational and certification industries, including the board of Nutrisystems and one of the largest licensing and certifying bodies in the US. Achieving a modest level of success he decided return to school to increase his scientific and technical knowledge and launch an investment company targeting startups in the health and fitness sectors. During this time he became one of Infusionsoft's first Certified Partners providing digital marketing consultation and implementation for many industries including the health, fitness and hospitality service sectors. Having custom developed some of the very first website to Infusionsoft CRM integrations, he implemented over 50 Infusionsoft installations and one of the first website membership systems providing targeted content to clients based on funnel tagging and online behaviors. While UltraFit Systems has incubated and exited several fitness concepts, he noted a need for better digital marketing and client management systems as well as analytical tools for health practitioners to use to chart a scientifically valid path to achieving their goals and objectives.

He is a founding member of Six Sigma Fitness (SSF), an online science and technology company with multiple distribution channels. SSF is a Cloud based SaaS health technology platform for Athlete Management and sub-clinical Health, Wellness and Fitness evaluations for the Health and Fitness industry. It is also a health practitioner educational resource that certifies practitioners in the SSF proprietary methods and business processes. He has created proprietary scientific algorithms, custom CRMs and integrated technologies using API integrations and behavioral logic for marketing and conversion strategies in the health sector. This platform and technology is currently being adopted and customized for a small muti-location mobile technology retail organization as well and B to B telcom provider.

A wrestler in high school and for a brief time in college until realizing the challenges of studying and playing sports at a high level while constantly having to cut weight, he decided to coach and master the challenges of health and fitness through weightlifting and martial arts while pursuing careers in consulting and eventually the venture capital and private equity business specializing in food and nutrition industries.

He is a multiple blackbelt having studied martial arts for over 30 years including kickboxing, Muay Thai, BJJ, Krav Maga, Kenpo Karate, Kung Fu, Northern (Longfist) and Southern Shaolin (Hung Gar Tiger and Crane), Tai Chi, Qigong, Traditional Weapons and Chinese philosophical studies including Taoism, internal arts and energy systems from an Eastern medicine perspective.

He has had the good fortune to train with and or under the direct lineage of some of the greatest martial artists in the world including Master Ed Parker, Master Jinheng Li, Kru Pol and Master Eddie Cha.

He is also the author of the Six Sigma Fitness™ Scholar Warrior Program which brings together the Eastern and Western sciences as well as the training of both traditional strength and conditioning with martial arts programming.

He is currently the Research Physiologist with UltraFit Systems, Physiologist/Consultant to many professional athletes specializing in combat sports, weight cutting and physiological adaptation. Authored and developed The Scholar Warrior Program for Six Sigma Fitness™ and The Six Sigma Fitness™ Methodology.

Past certifications are too numerous to list but more include Six Sigma Fitness™ Certified Practitioner, Certified Personal Trainer (C.P.T.), CrossFit Level 1, Precision Nutrition, Poliquin Biosignature, Poliquin PICP, BioForce HRV, BioForce Certified Conditioning Coach

He is available for consults, private self-defense training and speaking engagements.

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