We're trying to fix the Hobby Lobby decision the wrong way [View all]

[jmowreader]

Attempting not to sound too lawyerly here, let's try this:

One of the things you've got to decide when you set up a business is its "form." There are five, and the one you choose determines three things: who will be liable for claims against the business, the number of owners the business can have, and whether the business or the owner will be liable for taxes.

The classic "mom and pop" is a Sole Proprietorship. One person, or a married couple, owns the company and taxes are paid on that person's individual income tax form.

"Johnson Brothers Plumbing" is a Partnership. To set one up, they'll hire a lawyer and execute a Partnership Agreement that stipulates the percentage of the business each of the four Johnson brothers owns, which also sets the percentage of the profits each brother will be paid. Taxes are paid the same way sole proprietorships' taxes are: as individual income.

Of course, when the Johnsons go to the lawyer the first thing the barrister will do is to beat them all unconscious for even thinking of setting up a partnership. Sole proprietorships and partnerships have one huge drawback: all liability falls onto the owners. If Eddie Johnson installs an underground sprinkler with a defective backflow preventer and herbicide makes its way into the city water system, everyone in the partnership could lose everything they have. When and if they wake up, the lawyer will convince them to create a Limited Liability Company - which has the same tax treatment as the first two forms of business, but gives some separation between their business and personal affairs.

For extra separation between you and your business, you incorporate. This structure forms a "corpus" - a person on paper - that owns the business. (The Citizens United ruling was an outrage not because it created corporate personhood - corporations have been people ever since there were corporations, my friend - but because it decided the corporate person had the same rights a natural person did. That is an outrage and needs to be reined in, but it's not what we're here for today.) Unless your corporation commits a major atrocity, any liability falls onto this corpus. By "major" I mean REALLY major - McDonald's sold Stella Liebeck a cup of coffee hot enough to boil a sixth of the skin off her body, but at no time was there ever thought given to sending postcards to all their shareholders: "We got sued for selling coffee hot enough to melt pig iron and lost, and part of the settlement is your responsibility; stick four cents in an envelope and mail it in before Friday."

The problem with the corporation form, for small business people who might want to protect themselves, is taxation: it's a flat 35 percent on all business profits. To allow "two guys and a backhoe" companies to incorporate the IRS created a special "small business" corporation, which is called "Subchapter S," that has a tax structure like an LLC or sole proprietorship. In exchange for this protection, the IRS limits the number of owners and the kinds of stock they can sell.

Now for the problem: Subchapter S, which Hobby Lobby uses, doesn't limit revenues. You can legally run a Subchapter S corporation that brings $3 billion across the threshold...we know this because Hobby Lobby, and half the buyout shops on Wall Street, are doing it.

And how to fix the Hobby Lobby decision once and for all: Cause the IRS to determine that any business earning more than $1.5 million per year is not eligible to operate under Subchapter S.