Business Formation

You could feel confused and overwhelmed when establishing a business. You are likely to have many questions. Many people quickly search the internet to find answers regarding business formation. However, while you can find some information online, you must determine whether the information you have obtained is accurate. The data could have expired since business laws keep changing. The information could also lack important specifics for the business you are starting.

The only way to set up your business on a firm foundation is to seek the services of a local business formation attorney. An attorney will not only know how to protect your company for years and decades to come but will also have the correct information that is up-to-date, accurate, and complete. At the Los Angeles Business & Real Estate Law Firm, we have experienced attorneys who will guide you on the best business entity, tax implications, and the formation that will protect your assets best.

Business Formation Explained

Business formation is one of the most important decisions you must make while creating your business structure. Business structures like nonprofits, corporations, limited liability companies (LLCs), partnerships, and sole proprietorships will influence the business decisions you make for your business.

It is crucial to choose the correct business formation from the beginning. This will assist you in determining your restrictions, privileges, liabilities, and responsibilities. Some of the elements you should consider while choosing a business formation that will work for you include:

Permits And Documents

Gathering necessary permits and filing with entities like the IRS will differ depending on the business formation. As a result, the documents needed and the annual reporting will also vary.

Hierarchies

Corporate ladders vary in responsibility and the required size based on your chosen business formation.

Liability

In case of default, some business formations risk their owner’s assets.

Taxes

Most business formations differ in several aspects, including:

• What tax exemptions apply
• Who meets the cost of taxes
• The amount of taxes to be met

Types Of Business Formations

Some of the business formations you could adopt include:

1. Corporations

The first step in starting the business is deciding on the business formation to adopt. You could establish your business as a corporation if you want it to remain valid in the long run. A corporation is distinct and independent from its owner. If you fail to check and keep your corporate status well, you could be shocked, especially if you face a lawsuit. For example, if you fail to hold director or shareholder annual meetings, the corporation status of your business could be questioned. If a person sues you, he/she could succeed at “piercing the corporate veil” that puts you in danger of being responsible for the company’s debts.

C Corporation and S Corporation

A C corporation, also known as a standard corporation, is the shareholders’ separate legal entity. A C corporation is formed by paying fees and filing incorporation documents with the state. The corporate formation restricts your liability for the corporation’s business debts to the money you invested in the company.

An S corporation is a pass-through taxation system. Its formation requirements are similar to those for C corporations. You must pay the required filing fees and file incorporation documents with the state. The special tax status under an S corporation removes the double taxation, which can arise with the income of a C corporation. You will not incur any tax at the corporate level, but you must file a corporate income tax return. The business profits and losses “pass through” to shareholders, and then they reflect on each shareholder’s tax returns. You are required to pay any due tax at your tax rates.

You could choose S Corporation as your appropriate business type if:

• For example, you need the flexibility to set owners’ or employees’ salaries to reduce Medicare and social security taxes.
• You want to take advantage of “pass-through” taxation but also take advantage of the corporate business type’s benefits.
• Reducing the risk of exposure to IRS audit is desired since S Corporations file Form 1120 S U.S. In addition, a higher audit rate for business income is reported on Schedule C of Form 1040 (U.S. Individual Income Tax Return). There is also an Income Tax Return for an S corporation.
• Accounting flexibility is desired since corporations must adopt the accrual accounting approach unless they are regarded as small corporations, having gross receipts of $5 million or less. The S Corporation does not have to employ the accrual approach unless they have inventory.

Comparing C Corporation And S Corporation

There are significant differences between C and S corporations, even though they are deemed the same. They differ in the following ways:

• Corporate ownership — There are unlimited shareholders under C corporations, while the number under S corporations is limited to 100 or less. Non-U. S citizens/residents can be shareholders under C corporations, but under S Corporations, they cannot. C corporations, partnerships, limited liability companies, other S Corporations, and trusts cannot own S corporations. S corporations, limited liability companies, other C Corporations, and partnerships can own C Corporations. C Corporations can have several classes. In contrast, S Corporations can have only one class of stock, disregarding voting rights.
• Election under S Corporation — A corporation must go through an election to become a valid S Corporation by filing Form 2553 with the IRS on time. In addition, all the corporation’s shareholders must accept the S Corporation election in writing.
• Taxation-C corporations report profits and losses, file a corporate tax return, and they are separately taxable entities. Losses do not pass through for use by shareholders to meet other taxable income, and any profits are taxed at the corporate level. When corporate income is distributed to shareholders as dividends, the earnings of C corporations face possible double taxation. The corporation pays tax on its corporate income, and then the shareholders pay personal income tax on the same income once they receive it as dividends. On the other hand, no tax is paid at the corporate level under S corporations since they are pass-through tax entities. Profits and losses go through the corporation and reflect on the shareholders’ individual tax returns. Shareholders pay any due tax at their tax rates.

2. Limited Liability Company (LLC)

An LLC is a hybrid business company that treats its members like shareholders of a corporation. It offers its members limited liability but treats members as partners for tax purposes. The items of deduction, profit, and loss pass through the members. The LLC as a company is not subject to income tax. The limited liability company combines partnership forms of conducting business with the best elements of the corporation without some of the drawbacks of either form.

Like a corporation, an LLC’s operating managers and members are not liable for the company’s liabilities, obligations, and debts. Unlike a limited partnership, a general partner with unlimited liability is unnecessary. Restrictions on the owners do not exist regarding the limited liability company. A corporation could own an LLC, and an LLC could own a controlling interest in a corporation.

There are limitations on the member’s right to transfer an interest in the LLC, just like in a partnership. However, members have a say in the company’s management, which is not valid with limited partnership partners.

The Operating Formalities Of An Limited Liability Company

Generally, limited liability companies offer untoward flexibility regarding operation and management. They also provide substantial tax benefits through pass-through taxation and protection from liability. However, specific organizational and operational steps called “LLC formalities” must be followed for the members to enjoy all tax benefits and limited liability.

Piercing The Corporate Veil

The courts often use this equitable solution to disregard corporate formation, and this means piercing the “LLC veil.” The jury or judge can pierce the corporate veil and order the owners to take up the responsibility for the company’s debts or obligations if:

• The corporation is suspected to be operating in a way that causes harm to another corporation or entity
• There is a gross misappropriation of finances to benefit the owner
• The company’s owner is exercising too much control
• The corporation’s operations do not adhere to the formalities

Traditionally, judges have considered several circumstances to determine if a controlling member behaved improperly. One among these circumstances is a poorly written agreement or lack of an operating agreement. The judge could also disregard the company and hold the controlling member personally responsible for the following reasons:

• Failure to keep proper records of minutes of meetings
• Failure to keep appropriate records of membership transfer ledgers
• Failure to maintain accurate records of business transactions
• Failure to keep proper records of acquisitions

Unlike a corporation, there are no strict rules for an LLC. However, you are still required to put these formalities in place to avoid piercing the limited company’s veil:

• Create a separate bank account for the LLC and avoid commingling personal funds with LLC funds
• Maintain adequate operating capital and ensure sufficient capitalization for the company
• Keep proper records on the operating agreement with well-defined duties for members and highlight distribution, operational, and taxation rules.
• Keep proper records for all business engagements and transactions, as well as appropriate documentation of the minutes of meetings. In addition, you must have accurate records indicating a list of members, present and past, bank statements, and tax returns for the past three years. You also need a copy of the filed articles of organization and a decision authorizing activities that, by law or under the conditions of the operating agreement, require members to vote.

You should not treat an LLC as an extended personal account of your own or its members. The tax regulatory boards and the courts always evaluate an LLC’s workings and financial dealings to ascertain if it is an independent profit center or a working business for its members or owners. The court could pierce the company’s veil if it is deemed a separate profit center. In this case, the court could impose liabilities and penalties against you or your family members personally.

The LLC is expected to pay and guarantee its debts unless the operating agreement states otherwise for specific requirements like the rental or leasing of real assets. Sometimes, if you or a member regularly pays or guarantees debts, you must be shown how to act as an alter ego of the LLC. This will lead to the LLC losing its status as a separate entity. You are not supposed to pay or guarantee the debts of your own LLC. You can only do so if it is specifically highlighted in the operating agreement for specified purposes.

3. Nonprofit Formation

Typically, a nonprofit organization is started and managed like a traditional business. However, some business requirements and other issues are specific to nonprofit organizations. Usually, two types of nonprofit organizations are available, including an LLC and a corporation. In this case, you require a nonprofit formation attorney to walk you on the road to starting your business. A nonprofit formation attorney knows the specialized requirements and forms for charitable and nonprofit organizations. For example, your attorney could help you in the following ways:

• Assist you in avoiding costly mistakes and legal pitfalls.
• Help you file the right business formation papers.
• He/she will guide you on the types of nonprofit organizations and assist you in making the right choice for business.
• Assist you in filing formation papers and solidifying the tax-exempt status of your business.
• Help you to ensure you meet the requirements of being a 501(c)(3) organization.
• Assist you in coming up with a business plan.
• Offer you guidance on compliance issues and record keeping.
• Guide you on employment statute issues, which are specific to nonprofit businesses, as well as review contracts.
• Help you form your board of directors and guide you on appointing officers.

Additionally, nonprofit tax requirements differ from those of traditional businesses; your attorney will assist you in navigating those requirements.

Dissolving a Nonprofit Business

If you want to stop doing nonprofit business, you do not just hang a “closed” sign on the door. Instead, the Attorney General’s office demands that you follow specific procedures to dissolve the business and distribute your remaining property. You must follow the process after the nonprofit corporation’s board of directors or its members vote to dissolve the business. Dissolving a nonprofit business involves the California Franchise Tax Board, the Secretary of State, and the Attorney General’s Office. First, however, you must do the following for your nonprofit business to be dissolved:

• The nonprofit board or most of the corporation’s members must vote to dissolve and prepare a certificate of dissolution or a certificate of election.
• You must take the final federal tax procedure toward dissolving the business. You must file IRS Form 990-EZ or IRS Form 990 and a completed Schedule N (Dissolution, liquidation, termination, or substantial disposition of property). You must also submit copies of the certificate dissolution and resolution to dissolve the business.
• Submit the final notice of submission to the Attorney General’s Office
• Submit the final notice of submission to the Secretary of State’s Office
• Obtain a dissolution waiver from the AG’s Office before disposing of any remaining property.
• File the final state tax return, and the current tax status must be verified with the Franchise Tax Board.

4. Partnership

You do not need to file any documents with your state as part of a partnership. However, partners always draw up a partnership agreement between themselves. The agreement often outlines how profits and losses should be shared. It also outlines how the partnership should operate. Many states maintain that every partner has unlimited liability for lawsuits, the actions of the other partners, and business debts. The profits and losses move through the partners and are reported on every partner’s income tax return. The partners are required to file partnership information with the IRS every year.

5. Sole Proprietorship

This is the cheapest and simplest type of business to start. Only one person operates a sole proprietorship business. You do not need to file incorporation documents or business notices to run in the newspaper. You only require a local or state business license based on your occupation. You can apply for a “doing-business-as” name to give your business a unique name, or you can do business under your name. However, the proprietor and business remain one entity.

Under a sole proprietorship, you are not protected from creditor claims or lawsuits. You can use your property to satisfy a legal judgment or a business debt. You are required to report your business expenses and income to the Internal Revenue Service on Schedule C. In addition, you are required to file your individual income tax return.

Find a Business and Real Estate Attorney Near Me

A skilled business formation attorney is essential, no matter the type of business you intend to form or the establishment stage. An attorney will assist you in maneuvering through the landmines of business buildings. The Los Angeles Business & Real Estate Law Firm has experienced attorneys who will guide you through several areas, including corporate law, business law, and IRS tax matters. Contact us at 310-796-7794 and talk to one of our attorneys.