Business Formation F.A.Q.

Q: Why should I consider incorporating?

A: There are a number of advantages to being incorporated. Marketing image is one. A sole proprietor or partnership usually ends on the death of the owner or owners. Corporations may survive the death of their owners. There is also flexibility in dividing your business. Corporate stock provides an ease of transfer of interest in the business. In addition, use of the corporation may make estate planning easier in making gifts of stock in the business to family members. The corporate form may simplify the sale of the business to others if at some point a sale is contemplated.

Q: Are their disadvantages to incorporating?

A: You will incur additional expenses, particularly legal and accounting fees and administrative costs. A corporation needs annual meeting votes, a minute book, financial records, separate income tax forms, and an annual report with a filing fee to the Secretary of State. Double taxation on a C corporation's income occurs with income taxed to the corporation and again to the owners when distributed to them as dividends. To avoid it, the sub S election, available for most small businesses, allows the sub S corporation owner to be treated like an individual. There are numerous factors to consider in making this election, and they may vary with changes in your priorities and number and tenure of employees. Deciding whether to be taxed as a C corporation or making a sub S election is an important decision. We work with your accountant to ensure that you make the right decision for your particular situation.

Q: What does it mean to “pierce the corporate veil”?

A: There are dangers in failing to properly maintain the corporation. If you do not treat your personal assets and your corporate funds and property as totally separate, you may face a "piercing of the corporate veil." In other words, a judgment creditor may be able to reach through the corporation to your personal assets if you do not properly set up or maintain the corporation. If you neglect to sign contracts and agreements in your corporate capacity as president or other officer of the corporation rather than just with your own name, you may find yourself personally liable. You need to have separate corporate stationery, signs, and a checking account with the company name, including "Inc." or "Incorporated."

Q: Will I avoid or lessen my personal liability by incorporating?

A: Unlike a sole proprietorship or general partnership, all of your personal assets (your house, car, savings accounts) are no longer at risk, if you should be sued. This is called “limited liability.” The corporate form of business has many benefits, but primary among them is protection of your personal assets from most claims if your corporation is properly maintained. Without this protection, if an injury or wrong occurs at your business, the injured person may seek money damages in a court action against you. Examples include someone slipping and falling, an employee who claims unfair treatment, or a customer alleging some negligent act. Some of these risks can be covered by liability insurance, but it may be inadequate or may be subject to exclusion. However, you are always personally liable for your own conduct. Limited liability protection mainly extends to acts or omissions of employees.

Q: What is a limited liability company and how is it established?

A: Limited liability companies (“LLC's”) have the flexibility of a partnership and the legal protection of a corporation. Because of its dual character of corporation protection against personal liability and partnership tax treatment, the LLC has largely replaced general partnerships and limited partnerships as the entity of choice. The LLC uses an operating agreement, similar to a partnership agreement, to control business, financial and tax provisions. Management of an LLC may be by either in the members or by designated "managers." Through its provisions, the operating agreement determines whether the LLC is taxed as a partnership or corporation.

Q: What are the advantages of limited liability companies?

A: LLC members are protected from personal liability just like corporate shareholders. They have “limited liability.” However, the LLC will be treated as a partnership as to tax treatment: it will be a flow-through entity for which income and losses are reported directly by its members. Unlike an S corporation, special allocations of income, expenses, deductions and losses can be made among its members, and an individual member's losses are not limited by the amount of a member’s investment in the LLC. It differs from a partnership in that management may be by nonmembers. It differs from a limited partnership in that members may be actively involved in the LLC's management, without the danger of personal liability faced by an active limited partner.

Q: Generally speaking, when should an LLC be used?

A: An LLC is best used when two or more people are considering a business or investment venture. The LLC provides significant advantages over both general partnership and limited partnership structures. Similar to an S corporation, it does not have its restrictions on the way distributions are allocated to members.

Q: How does a corporate or LLC's buy-sell agreement provide for ownership changes necessitated by the death, disability, or withdrawal of a shareholder or member?

A: Your business may be the primary asset that provides income and security for you and your family. The shareholders, of many closely held corporations understandably find it hard to plan for the risk of the death, disability, or voluntary or involuntary termination of employment of the company owner(s). Buy-sell agreements include provisions governing those situations and legally enforceable restriction on the transfer of stock. They provide for the redemption of stock by the corporation or purchase by one or more of the remaining shareholders. For the selling shareholder, the agreement assures a buyer for his stock at an agreed formula to determine a fair price. If a minority shareholder’s interest is being sold, the provision for a buyer at fair market value is peace of mind in situations where minority positions in closely-held businesses might not sell at all or for a very low price. It often prevents strain or even litigation between the selling shareholder or his or her estate and the remaining shareholders.