- Start with the end in mind.
If you haven’t taken the time to form a separate business entity, then the task of selling your business later on in life becomes much more difficult. Of course you can always make thing right later when the time comes and transfer all your customers, buildings, bank accounts, receivables, business vehicles, intellectual property, other assets and liabilities, etc to your new entity but this will inevitably take mounds of paperwork and a tremendous amount of time. Forming an entity properly in the beginning makes your exit a lot easier. - Clean banking and accounting records. With a separate entity formed for your business, you can go to almost any bank and open a business bank account. It is wise to keep your business and personal banking separate so as to not blur the line between these two entities. Your accountant will be grateful for your separate records as well.
- Limit your personal liability and protect your assets. A common reason for forming a different business entity, that operates separate from you as a person, is to limit your personal liability. If a customer is trying to reach something on the top shelf of one of your stores and pulls an item down on his head, he can sue and unfortunately you’ll be personally liable unless you have the liability protection that is offered by establishing a separate entity.
- Tax advantages. With the right planning, a properly structured entity offers the business owner(s) several personal tax advantages.
- Raising money from outsiders. Most entrepreneurs, at one time or another will need money from outside investors. Investors cannot put money into a sole proprietorship in exchange for equity. If Aunt Betty wants to give you some startup money, that’s a different story but for all other cases, you have to have a separate entity in order to raise capital for your growing business.
- Credibility. Banks, customers, vendors and employees all take you more seriously when you operate as a structured entity.
- Access to loans and credit. Money sources gauge risk by analyzing several variables, one of which is stability. A structured entity has the appearance of being stable. It’s clearly not the easiest way to start a company since there are some paperwork and fees involved. Consequently, those who take the time to properly structure their businesses are taken more seriously by creditors.
The employer identification number or EIN, also often called the federal tax identification number, is the number used by the Internal Revenue Service (IRS) to identify a business. It is basically a Social Security Number for a business, and it must be included on all tax filings a business makes.
If you operated your business as a sole proprietorship or general partnership, your EIN was your Social Security Number. When you incorporate or form a limited liability company (LLC), you must apply to receive a new number from the IRS.
In order to obtain an EIN, Form SS-4 must be completed and filed with the IRS. Certain states also require corporations and LLCs to obtain a state tax identification number. To learn if your state requires this, you should contact your state taxation authority.
BizFilings has two EIN-related offerings. With the SS-4 Form Preparation Service, BizFilings will prepare this form on behalf of your business, and then send it to you for you to submit to the IRS. This service is included in our Standard and Complete Formation Service, or can be added to our Basic Formation service for $25.
With the EIN Obtainment Service, BizFilings will prepare form SS-4, submit it to the IRS, and obtain the number on behalf of your business. This service is included with our Complete Formation Service and can be added to our Standard Formation Service for $45, or selected with our Basic Formation Service for $70.
To take advantage of BizFilings’ formation services, click here to access our order form.
The standard corporation, also called a C corporation, is a very common business structure. Corporations are separate legal entities that are owned by shareholders. Conversely, sole proprietorships and partnerships are not separate legal entities. They are considered to be the same as the owner(s). In order to form a corporation, the appropriate formation documents, usually called the articles of incorporation or a certificate of incorporation, must be filed with the state and the state filing fees be paid.
The primary advantage of incorporating a business is the limited liability the corporate entity affords its shareholders. Typically, shareholders are not personally liable for the debts and obligations of the corporation; thus, creditors will not come knocking at the door of a shareholder to pay debts owed by the corporation. In a partnership or sole proprietorship the owner’s personal assets may be used to pay debts of the business.
Other advantages of incorporating a business include:
* Incorporating may establish credibility for a new business with potential customers, employees, vendors, and partners.
* The ownership of a corporation is easily transferable through the sale of stock.
* Corporations have unlimited life extending beyond the illness or death of owners.
* Certain expenses, such as insurance, travel, and qualified retirement plans are typically tax-deductible.
* Additional capital can be easily raised through the sale of stock (shares) in a corporation.
The main disadvantage to forming a C corporation is often considered to be the potential for double taxation. C corporations are considered separately taxable entities by the Internal Revenue Service (IRS), and taxes must be paid on the profits of the corporation. If a corporation then distributes its profits to shareholders in the form of dividends, the dividend income is also taxed as regular income to the shareholders. In this case, the corporation’s profits are taxed twice, first as income to the corporation and second as dividend income to the shareholder, creating the “double-tax.”
However, not all income a shareholder receives from a C corporation is subject to the double tax. For example, if the shareholder is also an employee of the corporation, that shareholder will most likely receive a salary payment from the corporation. As long as the salary paid to the shareholder is considered by the IRS to be reasonable (or similar to the market salary rates for that position), it is treated as a business expense and is deductible to the corporation. This helps reduce the amount of taxable income the corporation has.
In order to eliminate the possibility of double taxation, C corporations can elect to be taxed as an S corporation with the IRS. With S corporations, the profits and losses of the corporation are reported on the individual tax returns of the shareholders, and any necessary tax is paid at the individual level. This taxation method is called “pass-through” taxation, since the profit or loss of the corporation is passed through to the shareholders.
Other aspects of C corporations that can be considered disadvantages include:
* Corporations are more expensive to form than sole proprietorships and partnerships.
* There are more corporate formalities, such as annual paperwork, and more state and federal rules and regulations, than with sole proprietorships and general partnerships.
When evaluating whether the corporate structure is right for your particular business, it is advisable to first determine the goals of your business, and then to assess the advantages and potential disadvantages of the different business structures in relation to those goals. You may also wish to seek the advice of an attorney or accountant.
Every business has some or other financial implications during its tenure. The appropriate legal form of business depends on the degree or severity of these implications. Sole proprietorship or partnership is easy to form and operate but the personal risk of the business owner (s) in operating these forms is unlimited. When the transactions and risks involved in a business is considerable, it is necessary to choose a form that provides protection from unlimited personal liability. Corporations and Limited Liability Companies offer the personal liability protection to its business owners.
If the primary objective of the business form is personal liability protection, LLC form will serve the purpose. Forming LLC or Corporation needs certain legal formalities to be complied with. However, corporations are high maintenance business forms. Unless the business owners do not foresee considerable growth or intend to take the business to the public, forming and maintaining a corporation is not worth the hassle. Another plus for forming LLC is in LLC Taxation. Corporations have to file an individual tax return as a legal entity or ‘person’ and pay state and federal taxes directly. Again, when the profits are distributed as dividend among the shareholders, they have to declare it as personal income and pay tax. Sort of double taxation. The members, as the business owners of an LLC is called, can elect to be taxed as sole proprietorship, partnership or even a corporation, whichever is most beneficial to them.
How to LLC formation, the state laws regulate the formation and operation of LLCs. Each state has different rules and procedures for incorporation or organization of an LLC. Refer to your state LLC regulations to understand the requirements for forming and operating LLC. In all states one basic requirement is filing the Articles of organization. The nomenclature may change in each state but the purpose is the same. An available valid name has to be chosen for your LLC. Then file the articles of organization in that name and provide all the information in the articles as required by the state. You need a person or entity with a local address to act as your registered agent and that person’s written consent to act so must be provided. Some states stipulate an Operating Agreement duly executed and signed by the proposed members as a part of the business registration process. Even otherwise, an operating agreement is beneficial to the business in many ways. It will provide clarity to business’s operational and organizational structure and a separate identity from that of the members. A publication of the intent to form the LLC may be required in some states.
Partnership is a legal form of business which requires few legal formalities to form and operate. Merely the intention to jointly operate a business by two or more persons is enough to form a partnership. State laws govern the formation, operation and dissolution of partnerships. All states have adopted the Uniform Partnership Law but with a few variances in each state. If a question arises as to the legal existence of a partnership, the law looks for certain aspects of the business such a:
1) the intention to jointly operate
2) sharing of profits or losses
3) joint control and ownership of property.
In a partnership, unless expressly stated otherwise all partners have equal rights and responsibilities. All partners have equal right to a share in profits and are personally and jointly responsible for all the activities of the partnership at its agents. However, the rights and responsibilities of each partner can be specified through a partnership agreement. The partners can state the capital contribution of each partner, the resultant share in profits, operational responsibility of each partner, any special consideration payable to a partner for a business expertise that partner contributes to the business and such other terms and conditions of the partnership business. An important point to note here is that regardless of any stipulations in a written partnership agreement, all partners are still personally liable to the business debts and obligations without any limit. If a claim arises out of the business and one of the partners is personally not able to pay, the other partner or partners have to settle the claim with their personal assets and then sue the defaulting partner to compensate.
There some forms of partnership that limits the personal liability of partners such as a limited partnership or limited liability partnership. Despite the similarity in name, both forms are distinct in its nature. A limited partnership has a general partner and one or more limited partners. Only the general partner is active in business operations and has complete decision making power and is personally responsible for the partnership’s activities. The limited partners have a share of business but have no active involvement in the operations. Generally this form is used in a family limited partnership to protect joint family property. The dominant member of the family acts as the general partner and other members as limited partners. In a Limited Liability Partnership, all partners have limited personal liability to the partnership activities. This form is used in professions where misconduct or negligence of one partner may affect the whole partnership and to protect other partner or partners for being personal responsible for such misconduct or negligence.
For an aspiring entrepreneur the path towards growth is to attract capital for business. Investors generally look for a few qualities in the business they want to invest. For any investor, the return on investment is the foremost criterion. The returns can be in the form of regular cash flow or appreciation in the value of investment. For attracting such investors, the best form of business is a corporation. The advantage of a corporation is that the shares are freely transferable. The investor can invest or divest in a corporation and there are very few formalities to be observed. Another advantage of a corporation is the personal liability protection it offers to the shareholder. Due to these advantages, investors are readily willing to invest in corporations and hence the ease in attracting capital for expansion.
The state laws govern the incorporation of your small business. The incorporation rules vary in each state. The key procedure for incorporating a business is to file a certificate of incorporation with the state and pay a filing fee. In some states the certificate of incorporation is also called the articles of incorporation. The ownership in a corporation is structured as units of stock or shares, which is subscribed to and promised to pay for by the shareholders. The corporations can be of two types namely an S Corp or a C Corp. The basic legal structures of both forms are similar. The main differences are the share holding and taxation. Shares in an S Corp are restricted to natural US citizens and limited to a maximum of 100. There are no such restrictions in a C Corp. C Corporations are subject to corporate taxation where as the S Corporation advantage is that the profits are passed through to the share holders and taxed as their personal income.
Limited Liability Companies also offer personal liability protection to its owners who are called members. The advantage in LLC Vs. Corporation is that in the eyes of the general public, corporations are ‘perpetual’. LLCs are considered to be bound to the life of its members. One advantage in LLC is that procedure for taxation can be decided by the members and they can elect to be taxed as a partnership or a corporation. The advantage in LLC Vs. S Corp is that LLCs are relatively easy to form and less cumbersome to operate. Members of an LLC can elect to be taxed as an S Corporation and avoid the double taxation of a C Corporation.
Incorporation is no more a mystery and the domain of lawyers. The common man is very well equipped to handle matters such as incorporation or organization of a business. Thanks to our public friendly state administrations. All states have provided online resources for business registrations with clear instructions on how to proceed. You may contact the state agency handling business registrations over phone or in person also to clear you doubts. You may check with your state agency whether corporate seals are legally binding in your state.
A legal business structure is imperative in operating a business in any of the states. Some forms of business do not involve many legal or statutory formalities in formation and its operations. Sole Proprietorships and General Partnerships can be formed by simple intent of the principal(s). However you will need to obtain all the obligatory permits and licences to operate the business. Forming a Limited Liability Company or a Corporation entails formal procedures. The organisation of LLC or the incorporation of a corporation is governed by state statute. These rules and regulations vary in each state. For forming a LLC you have to select a name and file an Articles of Organization with the state agency handling business registrations and pay a filing fee. Some states have a few more requirements for forming LLC such as filing an LLC Operating Agreement and publication of the intent to form LLC.
Forming a corporation involves lengthier procedures than forming a LLC. A corporation has a separate legal entity from that of its business owners, formally termed as share holders. The corporation is constituted by units of stocks or shares which each share holder subscribes to and promise to pay for. The basic charter for operating business as a corporation is its Articles of Incorporation. The promoters or incorporators have to provide all critical information on the purpose of formation and the organizational structure as required by the state. There are two types of corporations, C Corp and S Corp.
Taxation formalities in each of the business form vary. The sole proprietorship is considered as having no individual existence or a ‘disregarded entity’ and the business owner files business tax returns along with personal returns. Partnerships have a similar system where the profits or loss from business is declared proportionately through partner’s personal tax filing. Partnership has to file an information return separately. LLCs or S Corps has a pass through taxation system as that of a partnership. Corporations are taxed directly and have to file separate tax and information returns.
