Entity Structuring involves setting up multiple businesses and trusts, and can involve having each perform different duties, hold different assets, offer different benefits and hire different employees, although you hold interests in each. Income, expenditures, profits, losses, assets, liabilities, and other business related categories are legally and strategically spread out among the entities in a way that is beneficial to the owner or owners, shareholders, members, and/or other involved parties.
3. What is a Sole Proprietorship?
A sole proprietorship is the simplest and least expensive form of business. If you currently operate a small business on your own and report your business income on Schedule C, then you are a sole proprietorship – it’s that easy. Because of this simplicity, most businesses are sole proprietorships. However, even with low start-up costs and ease of operation, other factors can make this the most expensive business structure in the long run. First, your liability for business debts is unlimited. This entity cannot shield you, as the owner, from liabilities that could literally cost you and your family everything. For instance, if you have significant business losses or an adverse legal judgment, creditors can force you to sell your home and personal property to cover the claim. Second, you may be hurting yourself tax-wise since corporations have a variety of tax advantages, such as the ability to reduce self-employment taxes. Furthermore, there are no business entities more highly scrutinized by the IRS than sole proprietorships. Finally, when it comes time to selling or passing on your sole proprietorship, it can be tedious.
4. What is a Corporation?
The most dynamic and flexible business entity is a corporation. The primary advantage of a corporation is that its owners, known as stockholders or shareholders, are not personally liable for the debts and liabilities of the corporation. Once brought to life by filing Articles of Incorporation with the state, a corporation can act much like a person. It can own and operate a business, hire employees, buy and sell goods and services, enter into contracts, lease or buy real estate, maintain its own checking and savings accounts, and sue and be sued. A corporation is not affected by the death or bankruptcy of any shareholder, officer or director. Instead, it continues to exist as long as it complies with the state requirements and corporate formalities. “S-corporations” and “C-corporations” are actually both the same type business entity, but an S-corporation has simply made a special IRS election to be treated as a pass-through entity for tax purposes, much like a sole proprietorship. In other words, corporate profits “pass through” to the owners, who pay taxes on the profits at their individual tax rates. C-corporations, on the other hand, are traditional corporations with two potential levels of tax. A C-corporation pays tax on its corporate income (the first tax). Then, if a C-corporation distributes profits to its stockholders, the stockholders pay personal income tax on those dividends (the second tax). Although this may seem like a significant disadvantage, C-corporations actually have greater tax flexibility than S-corporations and can easily minimize any “double taxation” problems.
5. What are some advantages of incorporating your business?
Liability and Asset Protection
Sole proprietors risk everything they personally own when they operate a business. If a judgment is awarded against the business, the owner’s personal assets can be used to satisfy payment. Your home, car, savings and investments could all be taken from you should your business be sued or go into debt. Unlike a sole proprietorship, a corporation is a separate legal entity apart from the individuals who own or operate it. Because of this, the personal assets of the shareholders, directors and officers of a corporation are generally not at risk when the corporation is sued or goes bankrupt. If you own property or other significant assets, forming a corporation is one of the easiest ways to protect them. If you plan to hire employees, a corporate entity will protect you personally from employee lawsuits. The only way an individual can be liable for corporate debts is through a legal action commonly referred to as “piercing the corporate veil.” This occurs when a court looks at the corporation not as a separate entity, but as an extension of the individual. Piercing the corporate veil is rare. Generally, it only occurs through fraud or failure to treat the corporation as a separate entity, such as not having a separate corporate bank account. Properly maintaining your corporation usually prevents a piercing of the corporate veil.
7. What is the best state for Incorporation?
Many people choose to incorporate in their home state. However, if your home state has a high corporate income tax or high state fee, and your corporation will not "do business" in the home state, it may be wise to incorporate elsewhere. "Doing business" means more than just selling products or making passive investments in that state. It usually requires occupying an office or otherwise having an active business presence.
Delaware is a popular choice for incorporating because of its history, experience, recognition and pro-business climate. Also, Delaware does not tax out-of-state income. In fact, over half of the companies listed on the New York Stock Exchange are incorporated in Delaware.
Recently, Nevada has also gained popularity due to its pro-business environment and lack of a formal information-sharing agreement with the IRS. Nevada does not have corporate income taxes. Business filings in Delaware and Nevada can typically be performed more quickly than in other states.
Wyoming has also started to gain popularity after passing strong pro-business laws. It also lacks state income tax, and formal information sharing with the IRS.
Keep in mind, if you do incorporate somewhere other than your home state, you may have to pay additional fees and meet additional requirements. For more details on this subject, contact an account representative at CT Strategies, and we'll be happy to assist you in choosing a state for incorporating your business.
8. What is involved in operating a Corporation?
When running a corporation, always keep records of important business activities. Below are some of the most common issues to consider in maintaining your corporation.
- Keep corporate affairs separate from personal affairs
It's important to keep business affairs separate from the personal affairs of the stockholders, directors and officers. This means setting up a separate bank account and maintaining separate records, including books for accounting purposes.
- Carry out all corporate meetings as required
Directors need to hold periodic meetings, and shareholders must meet once a year to elect directors. Meetings can take place in person or by phone. Either way, you need to make a written record of the items discussed and actions approved at the meetings. Alternatively, you can just get all the directors (or a majority of the stockholders) to sign a statement approving corporate actions. This is known as "written consent."
- Manage the transfer of corporate ownership interests
Generally, as long as all applicable laws are followed, a stockholder is free to sell or transfer shares to anyone. However, with small corporations in which the stockholders act more like partners and each is integral to the success of the company, you may wish to consider placing restrictions on the transfer of shares.
Stockholders sometimes enter into a buy-sell agreement, which sets the terms for when shares can be transferred or sold. A typical buy-sell agreement would state that if one stockholder seeks to sell shares to any third party, the other stockholders have a right of first refusal; that is, the other stockholders may purchase those shares at the same price. Only if the other stockholders do not purchase those shares can a stockholder sell to a third party.
Additionally, certain professional corporations can only have shareholders who are licensed professionals, which limits the transfer of shares.
- Process all corporate tax forms and licenses in a timely manner
Every corporation must obtain a federal tax identification number, which is similar to an individual's Social Security number. Some states also require a separate state tax number. In addition, certain business licenses may be required. Please check with your city, county and state to see which types of licenses you need.
9. What is an LLC?
Like a corporation, a limited liability company, or LLC, is a separate business entity. They have become quite popular because they combine the personal liability protection of a corporation with the tax simplicity of a sole proprietorship. In other words, the owners (or “members”) of an LLC are not personally liable for its debts and liabilities, and there is only one level of taxation. Moreover, LLCs are more flexible and require less ongoing paperwork than an S-corporation.
LLCs Compared to S-Corporations:
• Fewer corporate formalities. Corporations must hold regular meetings of the board of directors and shareholders and keep written corporate minutes. On the other hand, the members and managers of an LLC need not hold regular meetings, which reduces complications and paperwork.
• Simpler management structure. LLCs are not required to have a formal Board of Directors (known as “Managers” in an LLC). The owners and officers of an LLC can make all important company decisions directly.
• No ownership restrictions. S-corporations cannot have more than 100 stockholders, and each stockholder must be a resident or citizen of the United States. There are no such restrictions placed on an LLC.
• Potential Tax Disadvantage. By default, LLCs are treated as a pass-through entity for tax purposes, like a sole proprietorship or partnership. Unfortunately, an LLC does not enjoy the same self-employment tax savings as an S-corporation. Instead, single-member LLCs must pay self-employment tax on both salary and profit. An LLC can, however, make an election with the IRS to be treated like a corporation for tax purposes, whether as a C-corporation or an S-corporation.
• Greater Acceptance of Corporations. Since limited liability companies are still relatively new, not everyone is familiar with them. In some cases, banks or vendors may be reluctant to extend credit to LLCs. In addition, some states restrict the types of business an LLC may conduct.
10. What legal formalities are required to run a corporation?
First, the corporation is required to file Articles of Incorporation with the state it is registering in. After the company has been incorporated, the company must adopt a set of By-laws. Temporary officers and directors do this during the initial meeting of officers and directors. After the By-Laws have been created and accepted, stock must be issued with stock-subscription agreements. After the stock has been issued, a meeting of shareholders must take place where the shareholders vote on who will be accepted as the officers and directors of the corporation. To the average person, these procedures seem foreign and complicated, however they are very easy and we give you the tools you need to perform these functions efficiently.
11. Do I have to have a certain income before it makes sense to incorporate?
No. This is a common misconception among small-business owners, usually fostered by advice from an inexperienced accountant. Any seasoned advisor will tell you that incorporating is the first and foremost thing you should do when starting a business. Incorporating (or forming an LLC) will not only save you taxes (no matter what your income) but it will also limit your exposure to IRS audits by separating your personal and business expenses.
12. I am in a business where I am unlikely to be sued. Should I still incorporate?
Unfortunately, no business is safe anymore from lawsuits. The United States is the most litigious country in the world. In 1992 over 19 million civil lawsuits where filed in this country alone. This trend has been continuing and increasing since then. With the low costs of incorporating, it doesn't make sense not to do so considering the great risks one takes by being unprotected and exposed to litigation.
13. The difference between "C" and "S" Corporations: Which one is right for me?
A "C" Corporation is just a standard corporation filed with the state that you wish to incorporate in. It is subject to the federal corporate tax structure. An "S" Corporation is the same as a standard "C" Corporation but with an "S-Election" (form 2544) filed with the IRS. This entity is known as a pass-through entity, because the income of the corporation is "passed-through" to the individual very similar to a sole-proprietorship. Determining which entity is right for you is directly contingent upon the type and size of your business and your individual situation. In one of our free consultations, we will be able to assist you in determining which entity is right for you. Contact us today to have one of our consultants speak with you right away!
14. Who should be concerned about asset protection?
The more “attachable” assets we own, the more the reward for successfully securing a legal judgment against us. Anyone with significant accumulated assets is more likely to be sued over a dispute than someone with little or no exposed assets. Even families with modest assets may have a home, savings, or personal property they expect to utilize for their family security and are at risk of attachment.
15. What is an "attachable" asset?
Assets become attachable if they are titled (registered) in the name of the defendant to a legal complaint. The judge "attaches" a lien to the title of the property to recompense the plaintiff for damages awarded by the court. If the defendant fails to remit the assessed amount of money to the plaintiff, the awarded property is court re-titled to the plaintiff.
16. Under what circumstances could a court grant a judgment to a plaintiff?
If the plaintiff successfully argues that the defendant’s action or inaction caused damages directly or indirectly by negligence over events they could have or should have taken greater precaution to oversee. This theory of liability is so broad in scope so as to enable skilled attorneys to prevail in ascribing liability to almost anyone even remotely connected to the event.
17. I have never had a major claim I didn’t settle or have insurance cover. What should I do?
We cannot control what claims may be surfaced against your family in the future. All insurance companies have numerous exclusions from all property and liability policies. All insurance policies have internal limits on claims payout. Some insurance companies are reluctant to pay any sizable claims and end up being litigated, some win, some lose. Divorce, disputes in business and family are not covered at all. Plans are not expected to render you “bulletproof”, plans are designed to give you a leveraged position in negotiations based on the removal of the judgment tool reward normally relied upon by claimants.
18. Should an affluent person own nothing in order to thwart opportunists?
A well structured program enables ownership in a legal container (entity) that has impediments to attachment. Such entities permit the family to control the asset fully until an attack emerges. The isolative qualities of such containers make it expensive and difficult to outside penetration and thereby render the asset holder unattractive to claims seeking financial rewards.
19. What is the difference between INC and LLC?
"LLC" and "Corporation" have many of the same characteristics. The most important characteristic they share is that they both offer limited liability protection to its owners. Typically, shareholders are not liable for the debts and obligations of the corporation; thus, creditors will not come knocking at the door of a shareholder to pay debts of the corporation. In a partnership or sole proprietorship the owner's personal assets may be used to pay debts of the business. With an LLC, the members are not personally liable for the debts and obligations of the corporation. There are many important differences between the corporation and LLC. The entities are taxed differently. An LLC is a pass-through tax entity. This means that the income to the entity is not taxed at the entity level; however, the entity does complete a tax return. The income or loss as shown on this return is "passed through" the business entity to the individual memers or interest holders, and is reported on their individual tax returns. With a standard corporation, the corporation is a separately taxable entity. Corporations are treated as a separate legal taxable entity for income tax purposes. Therefore, corporations pay tax on their earnings. If corporate earnings are distributed to shareholders in the form of dividends, the corporation does not receive the reasonable business expense deduction, and dividend income is taxed as regular income to the shareholders. Thus, to the extent that earnings are distributed to shareholders as dividends, there is a double tax on earnings at the corporate and shareholder level.
20. What is the difference between a "C" and an "S" corporation?
All corporations start life as "C" corporations. As a benefit to small businesses which meet certain criteria, the Internal Revenue Service allows them to apply (via form 2553) for "S" status. This means that the corporation will be taxed similarly to a partnership, with each shareholder reporting the profit or loss of the corporation on his personal tax return, in proportion to the percentage of shares he holds. This means that if there is a loss the shareholder can use it to offset his other tax obligations. If there is a profit it is taxed once, at the individual's tax rate, rather than twice (a "C" corporation will pay a tax on profits and individual shareholders will be taxed again when those profits are distributed as dividends.) Are there any drawbacks to being an "S" corporation? The main negatives are the restrictions. There cannot be more than 65 shareholders; non-resident or non- US citizens may not be shareholders; and the tax year is somewhat inflexible (it usually must end on Dec. 31). Additionally, another corporation cannot own an “S” corporation. What is the difference between an "S" corporation and a Limited Liability Company? In terms of reporting income, they are quite similar. The LLC is somewhat less restrictive than the "S" corporation. There can be any number of members, and there are few restrictions on who those members may be. They are also a relatively new entity, so there is not as great a definitive body of tax rulings on them as there is with corporations.
21. What do the terms "articles," "meeting" "bylaws" and "minutes" mean?
The Articles of Incorporation is the primary legal document of a corporation; it serves as a corporation’s constitution. The articles are filed with the proper state government to begin corporate existence. The articles contain basic information on the corporation as required by state law. Organization Meeting: The organizational meeting completes the formation of the corporation. At the organizational meeting, a number of initial tasks are completed such as: the Articles of Incorporation are ratified; the initial shares are issued; officers are elected; bylaws are approved; and a resolution authorizing the opening of bank account is passed. If the initial directors are named in the Articles of Incorporation, they can hold the organizational meeting. If they are not named, then the organizational meeting is held by the incorporator. Bylaws: Bylaws are rules and regulations adopted by a corporation for its internal governance. They usually contain provisions relating to shareholders, directors, officers and general corporate business. At the corporation’s initial meeting, the bylaws are adopted. Bylaws are a private document not filed with any state authority. Minutes: The Board of Directors and shareholders transact business at meetings, with decisions being typically made by majority vote. Certain formalities must be followed in holding Board of Directors and shareholder meetings. The meetings must be held pursuant to notice. Notice may be waived if the waiver is done in writing. The secretary or other person mailing the notice should complete an affidavit of mailing notice, and the minutes of the meeting should be recorded. The notice document, affidavit or waiver should all be attached to the minutes of the meeting.
22. Are directors' and officers' names a matter of public record?
Yes. Names and addresses are filed with the state and are therefore available to anyone. Nevada requires this filing annually. They do not require notification of intervening changes. What is the responsibility of the president, treasurer and secretary? The president is typically responsible for entering into contracts on behalf of the corporation; the treasurer is responsible for maintaining and accounting for corporate funds; and the secretary is responsible for observing corporate formalities and maintaining corporate records. In addition to these required officer positions, a corporation may also have vice presidents and/or assistant secretaries or assistant treasurers. Typically, the authority and responsibilities of each officer is described in the corporate bylaws and may be further defined by an employment contract or job description. The President: The president has the overall executive responsibility for the management of the corporation and is directly responsible for carrying out the orders of the Board of Directors. The Board of Directors usually elects him or her. The Treasurer: The treasurer is the chief financial officer of the corporation and is responsible for controlling and recording its finances and maintaining corporate bank accounts. Actual fiscal policy of the corporation may rest with the Board of Directors and be largely controlled by the president on a day-to-day basis. The Secretary: The secretary is typically responsible for maintaining the corporate records.
23. What are the directors' and officers' corporate liability?
Under normal circumstances, officers, directors, managers, etc. do not have personal liability for lawful acts of the corporation. In addition, in Nevada statutes, the owners are not the “appropriate” party to a lawsuit. The company may also indemnify any officer, director, manager, etc. from personal liability.
24. What is a Board of Directors?
The Board of Directors is essentially the management body for the corporation. Responsibilities of the Board of Directors include establishing all business policies and approving major contracts and undertakings. In addition, the board may also elect the president. The officers and employees under the directives and supervision of these directors carry out ordinary business practices of the corporation. The directors must act collectively for their votes and decisions to be valid. That's why directors may only act at a Board of Directors meeting. This, however, requires certain formalities. One such formality is that the directors all must be notified of a forthcoming meeting in a prescribed manner, although this can be waived or provided for in the corporation's Articles of Incorporation or bylaws. For a directors' meeting to be valid, there must also be a quorum of directors present. A quorum is usually a majority of the directors then serving on the board; however, the bylaws may specify another minimum number or percentage. The Board of Directors must meet on a regular basis (monthly or quarterly), but in no case less than annually. These are the regular board meetings. The board may also call special meetings for matters that may arise between regular meetings. In addition, boards may call a special shareholders' meeting by adopting a resolution stating where and when the meeting is to be held and what business is to be transacted. The first meeting of the Board of Directors is important because the bylaws, the corporate seal, stock certificates and record books are adopted. Board members, like officers, have a fiduciary duty to act in the best interests of the corporation and cannot put their own interests ahead of the corporation's. The board must also act prudently and not negligently manage the affairs of the corporation. Finally, the board must make certain that it properly exercises its authority in managing the corporation and does not abrogate its responsibilities to others. This means that the board must be very careful to document that each board action was reasonable, lawful and in the best interests of the corporation. This is particularly true with matters involving compensation, dividends and dealings involving officers, directors and stockholders. The record or corporate minutes of the meeting must include the arguments or statements to support the board's action and why must detail why the action was proper.
25. Can you change the directors or add new ones?
You can change or add new directors anytime. If you want the Secretary of State to record the change, you have to submit a new Annual List of Officers and Directors.