Main Index : Writings of Marie A. D'Amico, Esq.

Business FAQ

Q: What Type of Business Structure Should I Have?

  Before you start selling your title, referring to yourself as "The Prez," or even conjuring cool t-shirts, you need a form of business structure. You may select sole proprietorship, partnership, or corporation. Most states also have variations on these themes, such as limited partnerships and limited liability corporations. There is no one element which is determinative of the business arrangement you should select. We present pros and cons for each configuration to help you evaluate which is appropriate for you given your present professional and personal situation.

Sole Proprietorship

The simplest sort of business structure is a sole proprietorship, or as it's commonly referred to, Doing Business As (DBA). In the eyes of everyone, you and your company are one and the same. You can conduct business under your own name or under an alias. If you want to operate via a nom de plume , you must generally file a fictitious business name statement. Call the county clerk of the county where your principal place of business is located and request one. Your proposed pseudonym will be published in a local paper, usually for one month, to permit other people to object. Filing fees for the form and for publication (typically less than $50 total) are required. You should also acquire a business license. Call the tax collector's office at your county's city hall and request a form; annual fees vary but can be less than $100 for a small business.

Pros? Simplicity. Other than the documents described above, you need not file any legal documents nor fulfill any particular Internal Revenue Service (IRS) regulations to operate your company as a sole proprietorship. You report and pay taxes on the business’ profits and losses on your individual income tax return. You can hire employees, rent office space, purchase equipment, and engage in normal business activities. If you require funds to expand your venture, normally you simply borrow money, because a sole proprietorship has no stock which may be issued to raise capital.

Cons? Personal liability, no employee or third party ownership, unadjustable tax planning. You, as the sole proprietor, are personally liable for all the debts, taxes, and liabilities of the business. In addition, you are liable for any claims made against one of your employees for acts committed within the scope of his employment, e.g. , accidents caused by an employee while careening in the company car. This means your house in the hills, Miata, and Beastie Boys CD collection can all be confiscated and sold to pay company debts. You cannot grant either employees or outside investors a portion of your business because you, and you alone, own the entire company. You can, however, pay employees or third parties a percentage of the profits in exchange for wages or a loan via an employment agreement or royalty agreement between yourself and that employee. Because your company's profits and losses must be reported in full on your personal income tax return, a sole proprietorship permits no flexibility in tax planning.

What happens to your sole proprietorship if you die? On your death, your sole proprietorship terminates. Your company's assets will become owned by whomever you've designated in your will or to your direct descendants if you have no will. Your will, however, must wind its way slowly but surely through probate court. This can be a many-month process. If you've watched Court TV , you have some understanding of the snail's pace speed of the legal process. Your heirs may be unable to continue properly your company during this wait. For this reason, you might consider placing your business assets in a living trust. A living trust is a legal document which avoids probate court and permits your beneficiaries or co-trustees to obtain title to your business’ assets immediately.

If you're afraid to plunge headfirst into one of the more convoluted business structures, partnership or corporation, your might start out as a sole proprietor. Ensure you have carefully crafted documents between yourself, your partners, investors, and employees. When your fear disappears and you're ready to pole-vault to the next level, you can then form a partnership or corporation.

Living Trust Maker and WillMaker

 To easily write a will or trust, you can use WillMaker or Living Trust Maker, excellent software packages by Nolo Press . These titles are not only easy to use but contain lengthy legal descriptions of the interpretation and ramifications of each provision. Living Trust Maker 2.0 recommends you make a backup will with WillMaker 5 to ensure any assets accidentally left out of your trust are properly inherited. WillMaker 5 is based upon the best-selling book and contains health care documents, wills, final arrangements, and employs a simple, interview-based user interface.

Living Trust Maker 2.0, $79.95 (Macintosh, Windows), Nolo Press , 950 Parker Street, Berkeley, CA 94710, (800) 992-6656 or (510) 549-1976.

WillMaker 5, $69.95 (DOS, Macintosh, Windows), Nolo Press , 950 Parker Street, Berkeley, CA 94710, (800) 992-6656 or (510) 549-1976.

Partnership

A partnership is a business structure owned and operated by two or more individuals. You can form a partnership by executing a written partnership agreement specifying the rights and liabilities of each partner. An oral agreement, believe it or not, is sufficient to create a partnership. I don't recommend reliance upon oral agreements, however, because money makes everyone's memory a bit buggy. Generally, each partner in a partnership has an equal vote in management and control, shares equally in the profits and loses, and is personally liable for all the partnership's debts, taxes, and liabilities. In your partnership agreement, however, you may custom-tailor every facet of your business to suit your needs and desires. Most states have a Uniform Partnership Act which governs your partnership if you either foolhardily rely upon an oral agreement or fail to include a provision in your partnership agreement. You might want to review your state's Partnership Act to determine which areas you need to address. For example, if a partner dies, is disabled, or withdraws, the partnership legally ends but most partnership agreements provide the remaining partners purchase that partner's share.

Pros? Simplicity and ownership. As with a sole proprietorship, you need not file any legal documents nor fulfill any particular IRS regulations to operate your company as a partnership. Each partner declares his share, as specified in the partnership agreement, of the business's profits and losses on his individual income tax return and pays taxes on it at his own particular federal and state personal income tax level. The partnership may hire employees, purchase assets, and operate a business in the same manner as a sole proprietorship or a corporation.

Cons? Personal liability and legal expenses. You, and each partner, are personally liable for all the debts, taxes, and liabilities of the company, not simply for your particular part of those liabilities. In addition, you are responsible for all the acts of your partners, regardless of whether you were cognizant of those acts. For example, any partner, unless specifically prohibited in the partnership agreement, can hire, fire, borrow, and sell, without another partner’s pre-approval. Remember, partners are like spouses, their actions will either help or haunt you. Finally, you are liable for any claims made against one of the partnership's employees for acts committed within the scope of his employment. Legal start-up expenses for a well written partnership agreement can be costly; they commonly commence at $1,000 and continue upward.

About 45 states now permit a modified form of partnership, called a limited partnership. A limited partnership consists of general partners, as described above, and limited partners. Limited partners are passive investors; they contribute capital to but have no control over, the management of the business. If the business falters and fails, limited partners remain liable only for their initial capital contribution. Limited partnerships are governed generally by the Limited Partnership Act in participating states. The Act contains statutory filings and other legal requirements for a limited partnership; in some situations, these filings are very similar to those required of corporations. A limited partnership is the same in the IRS’ eyes as a general partnership; each partner's share of the company's profits and losses must be reported and paid on his individual income tax return.

Partnership Maker by Nolo Press

This product contains the basic documents for setting up and operating your business as a partnership. The original copyright date is 1988 and unfortunately, its DOS and text-based user interface is dated, and requires each response be confirmed with a "yes" or "no." The real value is in the legal guide which also can be bought as a book from Nolo Press for $24.95.

Partnership Maker, $129.95 (DOS), Nolo Press , 950 Parker Street, Berkeley, CA 94710, (800) 992-6656 or (510) 549-1976.

Corporation

A corporation is a legal entity which is created, maintained, and regulated by the corporations law of the state in which you incorporate. The shareholders of a corporation own it but only play a cameo role in managing it. Rather, the shareholders elect a Board of Directors. The Board then elects officers, such as a President, Vice President, Treasurer, and Secretary who, along with Board, manage and operate the daily activities of the corporation. In many states, a corporation may be owned and operated by only one person who is both the sole shareholder and director.

The first incorporation step is to select a name for your corporation. You must pick a name which is neither identical nor substantially similar to a pre-existing corporate name in the state in which you wish to incorporate. Most states no longer require you to use the words Corporation, Corp., or Inc. To ensure your proposed moniker is available, generally you write a letter to the Secretary of State, requesting a search and reservation of the name, in exchange for a nominal fee, probably less than $20. You may also employ a corporate name reservation service, who for a fee of between $20-$50 per name, will check and reserve numerous names for you in any state. Names are reserved for between 30 and 60 days.

After you've successfully reserved your name of choice, you must file Articles of Incorporation with the state. These Articles should be simple; the detailed provisions of your corporation should be contained within resolutions of the Board and within other documents such as your Bylaws. The filing fee varies per state, in California it is $100. Many states require you pay your annual corporate franchise tax upon incorporation; this tax is usually less than $1,000. After the Articles are filed and accepted, the initial incorporator resigns and elects the Board. The Board then elects officers and commences corporate activity. Each state contains a myriad of statutes which your corporation must adhere to in its day-to-day actions.

About 46 states and the District of Columbia have now enacted laws to permit limited liability corporations (LLCs). An LLC, which must have a minimum of two members, is formed by filing Articles of Incorporation, like a regular corporation. An operating agreement, similar to a partnership agreement, specifies the rights and duties of each LLC member. An LLC generally is taxed by the IRS as a partnership, not an S or C corporation. If you're interested in this legal vehicle, you should consult both the LLC statutes in your state and a lawyer competent in these corporate matters.

Pros? No personal liability. A corporation is a separate entity and is liable for its own debts, taxes, and liabilities. The shareholders are not personally liable except to the extent of their capital contribution in the form of their stock ownership which, like any stock, can become simply scrip. If your corporation is not properly organized and maintained, a court could "pierce the corporate veil" and shareholders can become personally liable. You should retain and regularly consult with a counselor to ensure your corporation follows all the rules and regulations of your state's corporation code.

Cons? Legal expenses and efforts. The initial incorporation filing and legal expenses can cost you $2,500 or more. In addition, your corporation needs to continually file documents with the state. The Board needs to regularly meet and enact resolutions to approve your company's activities; these resolutions are typically kept in a corporate minute book. Someone in your company, presumably the Secretary, should be appointed to confer with counsel and keep track of the different documents required by your state's corporation law. If well-organized, these efforts can consume a scant few hours each month, hardly the time-consuming process many dread.

Sidebar: The Delaware Fable

You may incorporate your company in any of the 50 states. Do not fall for the fable that you should incorporate in the State of Delaware, regardless of the principal place of your business. Organizations incorporated in Delaware will pay lower initial and ongoing filing fees than those incorporated in some other states, most notably California. In addition, Delaware companies sometimes have stronger corporate freedom, e.g. , in combating corporate raiders. Your corporation, however, will not and cannot avoid paying state taxes or becoming subject to a state's corporate law if it operates in that state and if many of its shareholders reside in that state. For example, if your corporation actually operates business in California and more than 50% of its shareholders reside in California, your corporation will be subject to California’s corporate rules and regulations. If your corporation transacts business within any state, it must usually qualify to do so with the Secretary of State; the fee is about $1,000 per state. If you fail to so qualify, your corporation can be fined hundreds of dollars, can be unable to use the state's courts to assert claims against third parties, and can be in a morass of sticky red tape. I recommend you incorporate your business in the state in which you intend to principally transact business, or in which the majority of your shareholders reside, and also qualify to do business in every state in which you transact business.

Sidebar: S Corporation or C Corporation

A corporation can be an S corporation or a C corporation. These are not special types of corporations; they are federal tax designations for the IRS. In a C corporation, the company's income is taxed twice, once at the corporate level and again at the shareholder level if any shareholder distributions are made. The maximum federal corporate rate is currently 35%. In an S corporation, the business' profits and losses are passed through to the shareholders and income is taxed only once, at the personal income level of the different shareholders. All income, however, is taxed regardless of whether it is distributed to shareholders. You may select S corporation status if: (a) your company is a U.S. domestic corporation, (b) your company has no more than 35 shareholders, (c) no shareholder is a resident alien, (d) your company doesn't have any 80% or more owned subsidiaries, and (e) your company has only one class of outstanding stock, e.g. , either common stock or preferred stock, but not both. Any company who wishes to issue both common and preferred stock cannot choose S status.

Sidebar: Name Reservation Service

CT Corporation, Main Office: 1633 Broadway, New York, NY 10019, (800) 327-5202.