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If you have been thinking about starting your own business, now is the time to do it. In this economy, you can never be sure what the future holds, even if you have a steady day job. That is why it’s time to start doing what you are passionate about and be your own boss. The process of starting your own business may seem daunting; you may be unsure what to do and where to begin. Fortunately, we are here to help. We will give you a detailed business consultation, answering any questions you may have about the process of starting your own business, and answer any follow-up questions by phone or email.
Type of Organization
To start your own business, you will need to make several important decisions, including deciding on the type of organization for your business. Type of business entity affects the rights and responsibilities for you and the employees of your business, as well as the tax treatment of your business.
Corporate Entities vs. Non-Corporate Entities
Corporate entities and non-corporate entities have several important distinctions:
1. Corporate entities are created by sovereign, whereas non-corporate entities are created by contract between two or more people.
2. Corporate entities are considered to be a legal person separate from its shareholders; non-corporate entities are usually considered to be an aggregation of the owners, but not a separate legal person.
3. Corporate entities possess limited liability, which shields personal assets of the shareholders from debts, obligations, or judgments of the corporation; non-corporate entities have unlimited liability, so that personal assets of owners can be used to satisfy debts or obligations of the entity.
4. Unlike non-corporate entities, corporate entities do not terminate when an owner ceases to be an owner or dies.
5. In corporate entities, ownership interest is denominated in shares, which are freely transferable unless restricted by agreement; in non-corporate entities, ownership interest is denominated in terms of the percentage that each owner’s contribution bears to the total contributions of all owners.
6. Corporate entities are liable as an entity for taxes on income; non-corporate entities are not liable as an entity for taxes – tax liability is “passed through” to owners.
7. Shareholders of corporate entities are not agents unless authorized by resolution; each owner of non-corporate entities is an authorized agent for the entity.
Non-Corporate Business Entities
Forms of non-corporate business entities include Sole Proprietorship, General Partnership, Limited Partnership, Limited Liability Company, Limited Liability Partnership, Limited Liability Limited Partnership, Business Trust, and Cooperatives.
Sole Proprietorship is a form of business organization in which all assets of the business are controlled and owned by one person, who receives all profits but is also personally liable for all losses. Sole Proprietorship is the easiest form of business enterprise, meaning that the owner is not required to file any government papers or maintain any organizational formalities. Sole proprietor’s income is taxed at the individual level, while the entity is not taxed.
A partnership can be formed by two or more partners (co-owners), where a partner can be an individual or an entity. Each partner is individually liable for debts and obligations of the partnership that cannot be satisfied out of the partnership’s assets. A partnership is managed according to an agreement between the partners.
Partnerships are not taxable entities for federal tax purposes, but must report to the Internal Revenue Service (IRS) the information on the partners’ annual incomes.
Limited Partnership (LP) is an entity formed by two or more persons, where at least one partner is the general partner who is subject to unlimited liability for the partnership’s debts and obligations, and at least one partner is the limited partner, whose liability is limited to the dollar value of his contribution. Limited Partnership is similar to General Partnership in many respects, including in terms of taxation, but provides the benefit of limited liability for the limited partner(s).
Limited Liability Company
Limited Liability Company (LLC) is a legal entity that is separate from its members; as such, members are typically not personally liable for the company’s losses. An LLC is structured and managed according to its written Operating Agreement. Professionals can organize LLCs and provide services as LLCs. LLCs are formed by filing paperwork with the state and paying the appropriate filing fee.
LLCs are not taxed at the entity level; instead, income is passed through to members, who are taxed at the individual level.
Limited Liability Partnership
Limited Liability Partnership (LLP) is a partnership in which some or all partners (depending on the jurisdiction) have limited liability. In an LLP, one partner is not responsible or liable for another partner’s misconduct or negligence.
Limited Liability Limited Partnership
Limited Liability Limited Partnership (LLLP) is a limited partnership in which the partners have chosen to be a limited liability partnership, so that the general partner is not personally liable for the debts and obligations of the partnership.
Corporate Business Entities
Forms of corporate business entities include C Corporations, S Corporations, Statutory Close Corporations, Professional Corporations; Societas Europaea, and Not-For-Profit Corporations.
Main features of C Corporations include:
– Power to act, hold property, sue and be sued in its own name;
– Legal existence, which is separate from the corporation’s shareholders;
– Centralized management in a board of directors and officers;
– Free transferability of shares;
– Limited liability of shareholders;
– Perpetual duration;
– Responsibility to comply with corporate requirements (holding shareholder meetings, election of directors, etc.);
– Failure to maintain corporate requirements may result in termination of the corporate status, so that the limited liability shield does not exist anymore;
– Possible double taxation: the corporation is taxed at the corporate level and then again at the individual level if dividends are distributed to shareholders.
A C corporation is formed by filing necessary paperwork with the state and paying the appropriate fee. A C corporation can be a public corporation, in which most of the shares are held by the public, although public shareholders usually do not participate in management.
An S Corporation is a corporation with the same features of a C Corporation, but which has made a valid election to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code (IRC). The way an S corporation is taxed is similar to the way a partnership is taxed for federal income tax purposes. S corporations generally do not pay any federal income taxes. Instead, the corporation’s income or losses are divided among and passed through to its shareholders. The shareholders must then report the income or loss on their own individual income tax returns. As such, S corporations avoid double taxation that C corporations are subjected to.
Like C corporations, S corporations are formed by filing the necessary paperwork with the state and paying the appropriate fee. In order to qualify for the S election, a corporation must satisfy certain requirements, including:
– The corporation must be a “small business corporation”, organized under the United States laws, with no more than 100 shareholders, all of whom must be individual U.S. citizens or permanent residents (green-card holders); or a small business or certain tax-exempt organizations.
– If the corporation had conducted business before making the S election, there is a limit on the amount of income it can earn from rents, royalties, dividends, and other passive income.
Financial institutions, insurance companies, domestic international sales corporations and corporations eligible for tax credit election for Puerto Rican operations are not eligible to make the S election. Not all U.S. states recognize the S election for state tax purposes. The District of Columbia (Washington, DC) does not recognize S corporations. Additionally, a corporation’s S election will automatically terminate if the corporation fails to satisfy or maintain one or more conditions that define a small business.
Professional Corporation (PC) is similar to C Corporation, but with the only business purpose of providing professional services through the company’s shareholders, directors, or officers who hold valid licenses to provide that service.
Societas Europaea (SE) is an entity formed under the European Union (EU) law. An SE can operate and conduct business activities throughout the EU without having to establish subsidiaries or re-registering in every EU member state where it does business.
An SE can be formed in several ways:
– Merger of two or more existing companies from two or more EU member states;
– Formation of a holding company, where shareholders are two or more companies from two or more EU member states;
– Formation of a subsidiary by two or more companies from two or more member states;
– Conversion of a company that has had a subsidiary in another EU member state for at least two years.
SE is taxed by each EU member state.
Not-For-Profit Corporate Entities
A not-for-profit corporation is an entity where no part of the income can be distributed to its members, directors or officers, although the entity can reasonably compensate those individuals for their services. A not-for-profit corporation does not have any shareholders or shares; individuals participate in the corporation’s management by becoming members or serving as directors of officers. Traditionally, not-for-profit corporations are involved in education, religion, trade or charity activities, but they are not limited to those areas and can engage in any lawful activities. A not-for-profit corporation is not the same as tax exempt corporation; in order to obtain tax exempt status, a not-for-profit corporation has to qualify for it.
Place of Incorporation
Usually, a corporation chooses to incorporate in the state where it is doing business. “Doing business” in a particular state means that the corporation is transacting systematic business within that state. A corporation is not considered “doing business” in a particular state just because it is involved in interstate commerce, a single transaction, a lawsuit, debt collection, or has resident agent, owns property or has a bank account in that state. Every state requires corporations to license their intrastate business (business within the state), but no state can require corporations to license their interstate business (business between two or more states), which is a power reserved for Congress.
If a business incorporates in a different state from where it primarily operates, the business is subjected to regulation and taxation not only in the state of incorporation, but also in the states where it is doing business as a “foreign corporation”. However, if a corporation wants to take advantage of a particular provision of another state’s corporate law, then incorporating in another jurisdiction can be beneficial despite the additional expense. In most cases, the alternative state a business might choose for incorporation would be Delaware.
Benefits of Incorporating in Delaware
Benefits of incorporating a business in Delaware include:
– Low organizational tax rates;
– Any partnership, association, corporation, or individual can act as incorporator;
– Corporations can issue stock options upon approval of the board of directors;
– Dividends can be paid out of surplus or net profits for the fiscal year;
– Majority vote of shareholders is enough to approve a merger, dissolution, sale or lease of the corporation’s assets;
– A shareholder’s proxy is valid for three years or longer, as stated in the proxy;
– Shareholders are not liable for wage claims.
However, most advantages of the Delaware law are not particularly helpful to small corporations. For that reason, it may be more beneficial for you to incorporate your business in the state where you live and/or expect to do business rather than Delaware.
Attorneys at I.S. Law Firm have helped many entrepreneurs start their own businesses. For information about our services and to schedule your detailed consultation, please contact us: (703) 527-1779,
or via e-mail: [email protected].