08
Feb2019

The Early Years of a Business, Part 1 of 5: Selecting a Business Entity

The foundational step in protecting your personal assets from your business risks is by forming a business entity. Here are several forms of popular business entities that you can choose from:

Corporation

  • Articles of Incorporation are required to be filed with the Secretary of State in order to form the entity.
  • A corporation is a legal entity separate from its owners, who own shares of stock in the company. They are called the shareholders.
  • Corporations can be created for profit or nonprofit purposes.
  • A special structure called a Professional Corporation may be used when the corporation provides a certain professional service (i.e. law).
  • Profits may be taxed both at the corporate level and again when distributed to shareholders. This is referred to as “double taxation.”
  • Shareholders are not personally liable for corporate obligations unless corporate formalities have not been observed; such formalities provide evidence that the corporation is a separate legal entity from its shareholders. Failure to do so may open the shareholders to liability of the corporation’s debts. Corporate formalities include: issuing stock certificates, holding annual meetings, recording the minutes of the meetings, and electing directors or ratifying the status of existing directors.
  • The shareholder’s interests are managed by an elected group, the Board of Directors. The Board of Directors is responsible for election of the officers that run the day-to-day business of the corporation.
  • The shareholders and/or Board of Directors may adopt Bylaws setting for the management and the affairs of the corporation.
  • Shareholders may adopt a Shareholder Agreement which sets the rules for how the shareholders interact.

Subchapter S Corporations

  • Identical to the Corporation, except a tax election is made that enables the shareholder(s) to treat the profits as distributions and have them pass through to their personal tax return. This avoids “double taxation.”
  • A shareholder that works for the corporation must pay him/herself reasonable wages.

Limited Liability Company (LLC)

  • Articles of Organization are required to be filed with the Secretary of State in order to form the entity.
  • The LLC is generally considered advantageous for small businesses because it combines the limited personal liability feature of a corporation with the tax advantages of a partnership and sole proprietorship.
  • Profits and losses can be passed through the company to its members or the LLC can elect to be taxed like a corporation.
  • LLCs do not have stock and are not required to observe corporate formalities.
  • Owners are called members, and the LLC is managed by these members or by appointed managers.

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