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:
- 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.