They both afford the owner(s) the advantage of limited liability and are both pass through entities for tax purposes (i.e. The entities both declare their profits and losses on the individual owner’s tax returns without the need for the entity to pay a separate tax for such income). Given the strong similarities between the two entities, choosing amongst the two is often a difficult task. As such, as a restaurant and bar attorney in New York, I am repeatedly asked this question by clients.

GENERAL RULE: Choose a Limited Liability Company over the other choice of entities when opening a new restaurant, bar or hotel in New York.

While the two have very strong similarities, they are not without their differences. For example, S-Corporations are subject to stringent corporate formalities such as holding annual corporate meetings, keeping the minutes of the meetings, appointing corporate officers to serve, and issuing corporate stock to owner’s which may often be difficult to sell and/or transfer. In contrast, an LLC does not require annual meetings, appointing officers, the recording of meeting minutes, or the issuance of stock. Moreover, profits and losses distributed by an LLC need not be made in proportion to ownership share. However, in contrast, if an S-Corporation owner owns 50% of the shares, he/she MUST receive 50% of the profits and/or losses.

Additionally, the amount of S-Corporation shareholders cannot exceed 100 and all must be U.S. citizens or permanent residents. An LLC does not have these restrictions either.

A downside to forming an LLC is the publication requirement. Within 120 days after the filing of the initial articles of organization, notice must be published once each week for six successive weeks, in two newspapers of the county in which the office of the LLC is located (one newspaper to be printed weekly and one newspaper to be printed daily; both need be designated by the county clerk). If the LLC is located in New York City, this publication will cost about $1,100.00. By contrast, an S-Corporation does not have any publication requirement. This publication cost is the main disincentive to choosing an LLC when doing business in New York, but in the end, if you plan on being in business for the next 10+ years, given the flexibility of the LLC entity, this additional cost is worth it.

A recent onslaught of lawsuits involving illegal tip sharing amongst restaurant employees is rocking the restaurant industry. These lawsuits are not new to the industry but they have recently increased in numbers as a result of a few recent, and very substantial, plaintiff/employee successes.

On April 4, 2008, in what will be the largest class action suit ever brought by New York restaurant employees, employees are suing Starbucks for violating a state law that prohibits management from receiving part of workers’ tips. At Starbucks, “shift supervisors” share the pooled tips with baristas, prompting a suit from a former barista, on behalf of at least 2,000 Starbucks baristas in NY who are allegedly owed over $5 million. The lawsuit comes on the heels of last month’s California ruling, where a state judge found Starbucks liable for $105 million, finding Starbucks illegally enabled shift supervisors to take a share of the tips.

GENERAL RULE: Restaurants in New York State are allowed to pay employees who receive tips as little as $4.35 — less than the federal minimum wage of $5.85 per hour and the New York State minimum wage of $7.15. However, To use this “tip credit”, amongst other things, employers are not permitted to share tips among “agents” of the employer.

This general rule seems straightforward, but it’s not. The law fails to define who constitutes an “agent” of an employer. An owner, officer of the corporation, or a general manager clearly fit this bill and cannot share in tips. But, what about a maitre‘d? a shift supervisor? or an assistant manager? The answer is . . .it depends on their job tasks and responsibilities – not their job title. The Department of Labor (DOL) has stated that an agent, “does not include a mere supervisory employee who does not have the authority to hire or fire.” And just because a maitre‘d has “supervisory” responsibilities over the rest of the dining room personnel does not necessarily mean that the maitre‘d cannot share in employee tips. The DOL will look at each situation on an individual basis, and pay particular attention to whether the maitre‘d (or another employee) “acts in the place of the owner”, by performing such functions as hiring and firing employees, or other managerial responsibilities such as disciplining and setting wages or work schedules.

In its defense, Starbucks argued in California court and again in New York that it’s shift supervisors are not managers (although they are in charge when managers are away and can evaluate baristas in performance reviews), because (i) the customers cannot differentiate between the shift supervisors and the baristas, (ii) the shift supervisors often do the same work as baristas including serving the customers, and (iii) the shift supervisors pay is only 22 cents more per hour. However, the California Court ruled that the tasks and responsibilities given to these “shift supervisors” did indeed make them “agents” of the employer and hence, they were prohibited from sharing in the tips.

Thus, the prohibition of sharing tips with an “agent” of an employer must be very carefully adhered to as the penalties can be severe. As in the Starbuck’s cases and many others, the definition of what constitutes an “agent” is presently being defined and redefined by the courts. If you are an employer and employ a Maitre’d, Assistant Manager, captain, or shift supervisor, play it safe, compensate them fairly – or even magnificently - but keep their hands out of the tip jar.

The New York City Mayor’s Office published a terrific guide that should be read by all indiviudals that own, or plan to own, a restaurant in NYC.   Its a terrific resource for the basics of NY restaurant ownership.  Here’s the link to the guide:

http://www.nyc.gov/html/records/pdf/govpub/2737nycrestaurantguide-81606.pdf