I N CO R P O R AT I O N I N S I D E R
To Incorporate or Not to Incorporate?
Protect Yourself and Your Business By Selecting the Right “Entity”
By DeAnn Flores Chase, Attorney at Law
f you are thinking about starting a business, no doubt you have pondered the question, “Do I need to form a business entity?” The answer is a resounding, “Yes!” Unfortunately, we live in a very litigious society. Statistics tell us that an estimated 50,000 lawsuits are filed daily in the U.S., with nearly 1.4 million filed in the State of California annually. You should take steps to protect your wealth before you ever get served with a lawsuit against your business. A business entity provides personal liability protection from the debts and obligations of the business because it has its own legal identity separate and apart from its officers, directors, shareholders, managers or members – even if the entity consists of only one person. If you are sued based upon an occurrence arising during your business operations, a properly formed and maintained business entity can limit exposure to a judgment solely to the assets of the business-and not your family. It is imperative to form a business entity before you sign a lease, contract, franchise agreement, or otherwise start to do business. Once the entity is properly formed, every agreement must be signed in the name of your business entity. Forming a business entity before you start conducting business can not only provide personal liability protection, but can also allow your entity to develop corporate credit. Many business owners defer the formation of a business entity until after they have done business for some time. By that time, however, they have incurred start-up costs and debt that will unfortunately be reflected on the individual owner’s personal credit. At that point, it is not possible to simply “roll over” the individual debt to a “limited liability” company. And it is quite difficult to unravel the business assets and obligations from the personal ones. Waiting to form the entity until after you have been in business for a year or more means that you must in essence “start over” when forming the entity at a later point. Now that we’ve established that it’s best to protect your personal and family assets and build credit, the next step is to determine which type of business entity is right for you. Whether you are going it alone or with another person, the choice of a proper business entity should be made in close consultation with a business law at20 S o u t h B a y B u S i n e S S i n S i d e r M a g a z i n e
torney and your tax advisor. Business entities include: General Corporation (“C-Corp” or “S-Corp”): If properly formed and maintained, a corporation provides protection from personal liability for the debts and obligations of the corporation for its officers, directors and shareholders. “C” Corporation: A traditional “C” corporation involves the issue of “double taxation.” The corporation is taxed on its income at the corporate level, and its shareholders are taxed on distributions of income in the form of dividends on their personal income tax. In order to maintain a corporation, corporate formalities must be maintained, such as annual meetings and the keeping of minutes. A “C” corporation has some tax benefits, such as deductibility of health insurance premiums. “S” Corporation: A corporation that has made an election to be an “S” corporation for federal income tax purposes is treated as a sole proprietor or partnership for tax purposes, known as “pass through” taxation; thereby, avoiding “double taxation.” “S” corporations have many limitations in their structure, such as limits on the number of shareholders, citizenship requirements for shareholders, and issuance of only one class of stock. Limited Liability Company (LLC): As with a corporation, a limited liability company (LLC) provides personal liability protection for the debts and obligations of the business. LLCs also have “pass through” taxation where the income and losses pass through to the individual members’ tax returns. An LLC may elect to be taxed as a corporation. It can be managed by all of the members or can have centralized management in one or more of the members, known as “managers.” If properly formed, an LLC does not need to maintain corporate formalities, such as holding meetings and keeping minutes. In California, an LLC may not render professional services, which include services lawfully rendered only pursuant to a license, certification or registration under the Business and Professions Code, the Chiropractic Act, the Osteopathic Act or the Yacht and Ship Brokers Act. However, the California Attorney General has opined that such services do not include services rendered pursuant to a nonprofessional occupational license under the Business and Pro2nd iSSue 2009
fessions Code. Notably, neither the Contractor’s State Licensing Board nor the Department of Real Estate will issue a corporate license to an LLC. Professional Corporation: A professional corporation is appropriate for medical and therapeutic practices, accounting and finance, and legal professions. The requirements for professional corporations vary according to the governing body regulating the practice of a particular profession. Some professions require corporate registration with the governing body; others do not. Many professional corporations are limited with respect to who can be officers, directors or shareholders in the corporation. Careful analysis is necessary to ensure that a professional corporation complies with the requirements for its particular profession. And now a word or two about DBAs. DBA stands for “Doing Business As.” A DBA is formed by filing a Fictitious Business Name (FBN) statement with your clerk in the county (or counties) where business transactions will occur. A DBA is not a business entity, and provides absolutely no personal liability protection for the individual or individuals conducting business. After a business entity is formed, it may be appropriate to file an FBN for the entity if it is anticipated that the business entity will transact business under a fictitious name that differs from the name reflected on its registration documents. What else is NOT a business entity? Sole Proprietorship: A sole proprietorship is one person alone. He or she will have unlimited liability for all debts of the business, and the income or loss from the business will be reported on his or her personal income tax return along with all other income and expense he or she normally reports. A sole proprietor often does business under a fictitious business name as a “DBA.” General Partnership: In a general partnership, each of the two or more partners will have unlimited liability for the debts of the business. The income and expense is reported on a separate return for tax purposes, but each partner then reports his or her pro rata share of the profit or loss from the business as one line on his or her personal tax return. Limited Partnership: With a limited partnership, each of the general partners has unlimited liability for the debts of the partnership, but the limited partner’s exposure to the debts of the partnership is limited to the contribution each has made to the partnership. However, a limited partner may be deemed a general partner if it determined that he or she actively participated in the management of the entity; and therefore, he or she may then have the same unlimited liability for the debts of the partnership. Ultimately, liability protection depends not only upon proper for2nd iSSue 2009
mation, but proper maintenance to provide the personal liability protection provided by law. Failure to do so will allow a creditor to “pierce” the veil of liability protection in order to collect against the personal assets of the individual owners of the entity. In recent years, many companies have come into the marketplace telling you that you do not need a lawyer to form a business entity, make a contract, or get a trademark. But the truth of the matter is that the money you “save” by doing it yourself can cost you thousands more dollars in the future. Why take the risk?n DeAnn Flores Chase has spent the last 12 years counseling and defending individuals and businesses of all sizes. She has successfully defended her business clients against a broad range of claims, including contract and lease disputes, trademark and copyright infringement, and catastrophic injury and wrongful death claims. Ms. Chase’s focus on liability protection comes from the successful handling of all aspects of litigation for individuals and businesses of all sizes. To obtain a FREE copy of Ms. Chase’s report on “The Four Common Mistakes Business Owners Make,” visit her website www.sbblmb.com and enter the promo code, “BIM.” DeAnn Flores Chase A Law Corporation – South Bay Business Lawyers 310-546-8111. Email: deann@dfclawcorpcom.
A business entity provides personal liability protection from the debts and obligations of the business because it has its own legal identity separate and apart from its officers, directors, shareholders, managers or members – even if the entity consists of only one person.
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