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Forming a Limited Liability Company or Corporation
for Small Business Start ups
and
QuickBooks users.
Books that will guide you
through new business set up, incorporating, LLC formation and liability
issues |
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An important step to learning how to start a
new small business is understanding the differences between incorporating or
forming an LLC (limited liability company). If you form a
corporation, take a look at S corporations which allow the owner to
avoid double taxation. If you begin operations and choose to put off
the decision to form a corporation or form an limited liability
company, the business defaults to operating as a sole
proprietor (one owner) or partnership (if you have multiple owners)
without liability protection.
If you are currently operating a business as a sole proprietorship
or a partnership, you are personally responsible for the total
liability of your business. This article offers definitions, benefits and detriments, pros and
cons of each type of new business entity and what you should
consider when making the choice between a corporation or a limited
liability company (LLC) for your company.
Another step in getting your business off to a profitable start is
finding the right tools to monitor business performance and
cash flow. This website offers many suggestions on how to make
QuickBooks accounting software produce the reports you need and how
to use these reports as a tool to manage your business. But first
lets see if you are
ready to open your own small business.
What are the key
advantages of each type of company?
Links to more information
Books that will guide you
through new business set up, incorporating, LLC formation and
liability issues
Liability Protection
By choosing a corporation (and S
corporation) or a limited liability company as the legal formation
of your business, you will be personally protected from the debts
and claims of the business. That means you cannot loose your
personal assets such as your car, home, retirement accounts or other
businesses.
Take a look at how your business operates and assess where the risk
from lawsuits come from. Do you need personal protection from
liability claims created by your new business? Risk protection
is expensive. Compare the additional costs of operating as a
limited liability company / corporation to the costs of
purchasing adequate liability insurance. Both insurance and
forming a limited liability entity may be necessary. Find out
what the legal fees would be to protect your business from one
lawsuit. In most cases, an insurance policy would cover the
cost of legal counsel and pay for itself with one lawsuit.
Research the costs in your area for:
- the licensing cost of incorporation or
forming an LLC
- legal and accounting fees to set up the
company as an LLC or a corporation
- legal and accounting fees to set up the S
corporation if applicable
- Annual filing fees for the corporation or
LLC to the state and
local government
- Cost of tax preparation for the additional
tax returns (corporate or partnership -if applicable)
- Cost of liability insurance for the
business
- Cost of time and money to conduct business
in a way that demonstrates intent to clearly separate the
business conduct from personal conduct or in other words - tell
the court system that your business is totally independent from
your personal assets.
- Corporate Documents and Records
-maintain complete records of Bylaws or Operating Agreement,
written minutes of all meetings, accounting and bookkeeping
records, and all statements and receipts.
- Financing - Undercapitalize the business-
starting the business with $1? It is unreasonable to assume that
the creditors of the business should accept all the risk of
running your business. The courts will think so. In a new
company, invest enough for down payments on new equipment,
some inventory and a bit for operating costs, for ongoing
business, don't pay yourself 100% of the earnings. Keep some
earnings within the company for growth.
- Related Party Transactions - are you
selling for a profit to related parties? Loaning money at fair
market value interest rates?
- Keeping personal expenses out of the
business?
- Protecting business assets with a
proper set of Internal Controls also
see more
- Employing competent managers
- Dropping the word "Inc.", "Ltd.", or
"Corp.", LLC from the company name is an improper use of
the company business name because it does inform the other party
that it is dealing with an entity that is limiting the liability
to the assets of the business. Be sure to include
company's full name on all business documents ( checks,
business cards, letterhead, fax cover pages, web site, e-mail,
purchase orders, business contracts and other external
communications)
- Fraudulent Representations by
Shareholders, Directors, Members or Managers - employees, agents
and owners can be sued if there was an indent to deceive.
Liability risk comes not only from customers who use your service
and products but also from the acts of your employees or agents working for
the business. Look at what risk may also exist
from using certain vendors, selling to customers who do not use your
products or services as intended, safety hazards existing on your
property, risks that exist during bad weather, injuries that could
occur on your premises due to no negligence on your part, but folly
by others. And what are the risks of your new business incurring
expenses and loan debt that it cannot pay (can your business become
insolvent- go bankrupt)?
Forming a corporation (s corporation) or
limited liability company (LLC) provides "personal protection" from
financial risk. This only occurs if the business has been
operated with the proper management and supervision of a prudent
business owner. And if the owners have kept their personal finances
independent from the
business assets. If you do not want a debtor or claimant
attaching your house or car, run a business with ethics and
professional care and incorporate or form a limited liability
company. Run a business with negligence and deceit your personal assets
are at risk no matter what type of organization you form.
If the pockets of the corporation or liability company are not deep
enough for the attorney and plaintiff, rest assured they will
attempt to bring you (and your assets) into the suit as a defendant.
The easier you can establish support for item 7 above, the more
likely the opposing attorney will cease the chase.
There are some instances where your legal form of business will not
protect you from personal liability.
Find out more
Visit the sites listed at the
bottom of this article for a more in depth discussion of the
legal and tax issues to be considered..
At a minimum, if there are two owners, consider
the LLC (or a sole owner for the many states that now recognize the
single ownership
LLCs) for protection against legal claims. It is fairly inexpensive
to set-up and it is possible to do without an attorney. Make
sure to produce an operating agreement which includes all the key
characteristics of an LLC to avoid the pitfalls of being taxed as a
corporation.
Keeping costs to a minimum:
- learn all you can,
- make preliminary decisions
- then sit with an attorney and a CPA to make
sure you are on the right track then.
- complete forms and have your advisor review
before filing
- mistakes are costly and the knowledge of
professionals generate years of savings
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How to's for the "do it yourself route"
1 Set up set up an LLC or
an S Corporation without an attorney
2. Apply for a Federal EIN number
https://sa2.www4.irs.gov/
3.
If you incorporate, Elect S Status with Form 2553
download at
www.irs.ustreas.gov
Many states require you to elect S Status with the State too.
http://taxsites.com/state.html
4 Register your LLC or Corporation with
your state
http://taxsites.com/state.html. This same
registration will permit you to register as an employer and to
collect sales tax.
5. If you are an employer, you may need to
register with the department of labor for remitting unemployment tax
http://www.payrollnw.com/
You will also need a workers compensation policy
(even if it is just one employee and that employee is the
owner of the corporation)
6. If you are an employer you may want to sign up
for EFTPS direct deposit of payroll taxes: https://www.eftpsnorth.com/
7. Set up a set up books using
QuickBooks. Call us for help selecting which product is best
for your business
Buy
QuickBooks
8. Get the training you need to
use QuickBooks
QuickBooksTrainingUSA.htm
9. Have any questions with these
procedures? Help setting up and learning payroll? Economical
training on QuickBooks?
We offer support to help you get started
on the right foot. Call
800-216-0763. We work via the telephone, fax, e-mail, high speed
internet remote access, computer desktop training and more!
$30 for ten minutes, or purchase
a four hour annual support contract. All support provided by CPAs
and Certified QuickBooks Advisors. |
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Nolo's Quick LLC:
All You Need to Know About Limited Liability
Companies
by Anthony Mancuso
$20.99
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The
Partnership Book: How to Write a Partnership Agreement
by
Attorneys Ralph Warner & Denis Clifford
$27.99
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The Successful Business Plan: Secrets and
Strategies
by Rhonda Abrams, Eugene Kleiner
$20.97 |
 Small Business Kit For Dummies®
by Richard D. Harroch
$20.99
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Characteristics |
Sole
Proprietorship |
General
Partnership |
Limited
Liability Company |
S-Corporation
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Corporation
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Formation |
No permission required
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Agreement of parties
involved. No permission required |
File with state for
permission |
File with state for
permission |
File with state for
permission |
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Number of owners |
1 |
2 or more |
1
(Mass.
requires 2) |
1-100
(Family members treated as 1) |
Unlimited |
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Who can be an owner |
Individual |
No restrictions |
No restrictions
(some states, incl CA, prohibit professionals such as architects,
accountants, doctors and other licensed healthcare workers |
Individuals
estates, 401(a) and 501c(3)
certain trusts
No nonresident alien shareholders!
An S corp can own shares of a Qualified
S Corp Trust (which must distribute 100% income each year) |
No restrictions like in S
Corp |
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Duration
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Dependent on sole proprietor
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Dissolved by death of
partner or bankruptcy |
Typically limited to a fixed
amount of time
Ends when a partner leaves the LLC, unless operating agreement states
differently |
Perpetual |
Perpetual |
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Regulations
by State for LLCs |
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Liability
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No Protection
Sole proprietor has
unlimited liability |
No Protection
Partners have unlimited
liability |
Protected
Members not typically liable
for the debts of the LLC |
Protected
Shareholders are typically
not personally liable for the debts of the corporation |
Protected
Shareholders are typically
not personably liable for the debts of the corporation |
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Simplicity of Operation
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Relatively few legal
requirements |
Relatively few legal
requirements |
Some formal requirements but
less formal than corporations
Operating agreement |
Formality of board of
directors, officers, annual meetings and annual reporting |
Formality of board of
directors, officers, annual meetings and annual reporting |
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Management
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Full control of management and operations |
Typically each partner has
an equal voice unless otherwise arranged |
Members have operating
agreement that outlines management |
The corporation is managed
by the board of directors who are elected by the shareholders
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The corporation is managed
by the board of directors who are elected by the shareholders
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Taxation
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No separate business tax return. Owner reports
business and pays all taxes
on personal tax return |
Partnership tax return is needed but
each partner pays the tax on
his/her share of the income through his/her personal return Losses can
be deducted against other sources of
income |
If 1owner Report
business income and pay tax on personal return.
If 2 or more, choice of preparing and paying tax as partnership (no payroll taxes issues) |
No tax at entity level.
Income/loss is passed through to the shareholders.
Pensions provide
additional savings from Fica/Medicare Taxes.
See chart below for a more detail on S Corporation
tax benefits |
Corporation is a taxable
entity. See our chart on
Corporate
Tax rates
Pensions provide
additional savings from Fica/Medicare Taxes.
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Pass Through Income/Loss |
Yes |
Yes |
Yes |
Yes |
No, corporate losses can't
be deducted by shareholder |
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Double Taxation
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No |
No |
No |
No |
Yes |
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Payroll Prep and Taxes |
No |
No |
No
Except if electing to be taxed as a corporation |
Yes |
Yes |
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Cost of Creation
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None |
None |
Filing fee with the state
Create an operating agreement |
Filing fee with the
secretary of state
Promptly file form 2553 with the IRS and with
the state |
Filing fee with the state
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Raising Capital
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Difficult, unless individual
puts in money |
Contributions from partners
or an addition of more partners |
Possible to sell interests.
Subject to operating agreement restrictions |
Sell shares of stock to
raise capital |
Sell shares of stock to
raise capital.
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Transferability of Interest |
No |
No |
Possibly |
Yes, subject to consent
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Shares of stock in a
corporation are easily transferable |
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Ownership |
No more than 1 owner |
No restrictions like in S
Corp |
No restrictions like in S
Corp
Some States may require at
least 2 members |
Only 1 class of stock. No
more than 100 owners . All must be citizens or residents of the USA
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No restrictions like in S
Corp |
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Set up an LLC, Corporation, S Corporation
online for a small fraction of the cost of
having your attorney create the documents.
Don't exclude your attorney/CPA when making these important
decisions, but
certainly, do the paperwork yourself with the help of this online
incorporating/LLC formation service. They provide you with the
templates you need and they will guide you through the process.
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Set up an LLC, Corporation, S Corporation
online for a small fraction of the cost of
having your attorney create the documents.
Don't exclude your attorney/CPA when making these important
decisions, but
certainly, do the paperwork yourself with the help of this online
incorporating/LLC formation service. They provide you with the
templates you need and they will guide you through the process.
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Set up an LLC, Corporation, S Corporation
online for a small fraction of the cost of
having your attorney create the documents.
Don't exclude your attorney/CPA when making these important
decisions, but
certainly, do the paperwork yourself with the help of this online
incorporating/LLC formation service. They provide you with the
templates you need and they will guide you through the process.
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What we recommend:
In prior years, S Corporations, LLC's and Sole Proprietors and Partners were
not entitled to the full 100% deduction for health insurance premiums on the
owners. But this has changed and for 2003, 100% becomes
deductible on the personal returns of the business owner.
A few differences between an S corporation and a C
corporation
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S corporation |
C
Corporation |
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Double taxation |
None, income is taxed only
at personal rates |
Corporate tax rates as of 1/1/2005 for small
corporations can be as low as 15% and as high as 39% for federal
and add on another 3-10% for state taxes. Don't forget to add in
city taxes, if any. Any income paid out
of the corporation to the owners as wages are taxed at personal
rates, not Corporate.
Any income paid out of the corporation as
dividends are first taxed at the corporate rates, then taxed as
dividends, with a top rate of 15%. |
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Medical Fringe Benefits paid on behalf of the
owner |
Generally, not deductible by the corporation
unless
included in wages. But, the 100% of the health and
dental premiums are deductible on the front page of the
business owner's
1040 ( personal return) . |
Fully deductible to the
corporation. Medical expenses fully deductible if same plan
offered to all employees. |
C Corporations - Now that S Corp owners can deduct
their health premiums on their personal returns, the C corporation is generally
avoided. Consider incorporating and remaining a C Corporation if :
- the company expects to go public.
- a possible good choice for a company that plans to
reinvest earnings for years to come. Whenever a C Corporation is a
consideration, engage a Certified Public Accountant to calculate the tax on projected income
based on the different ownership types
- a possible good choice for a company that projects
a business loss
for several years and the owners do not have other earnings to offset on
their tax return
-
Dividends are now taxed at a top rate of 15%
through year 2008.
How can that save tax dollars today?
An Example would be a new business earning $200,000 before wages. If
the owner takes the net of $200,000 as wages
the owner, the business and business owner will pay a combined tax:
- 15.3% for Fica and Medicare up to $90,000
(2005 limit) ($94,200 2005 limit)
- 2.9% Medicare tax on the remainder $110,000
- ordinary income rates on the entire $200,000 less
deductions (approximately 25% effective rate).
What if the allocation of wage and dividends changed?
Before arbitrarily determining what the gross wages are for the
owner read our article on
Reasonable Compensation
To see how the taxes will change if a salary of $90,000 was drawn
and the remainder paid as dividends
- dividends are not subject to the Medicare tax of
2.9%
- owner will save 10% in income taxes on the on the dividends of $112,100
(Based on an average income tax rate of 25% on wages versus a 15% dividend rate)
What does that savings total ?
make the calculations - they can be significant
The down side? Will need to think about
what must be done in year 2009 when the tax law may change again.
Also, if you plan on selling the business the corporation will pay
tax on the profit first then the distributions from the sale are
taxed to the owner creating double taxation. The double tax
rate adds up to as 60% of the selling price of the business
leaving the owner with only 40%
How can you avoid this? Convert to an S corporation in year
2009 and hold onto the company an additional 10 years. At that
point, the sale is only taxed on the individuals tax return.
LLC - A limited liability company is a good choice for the small new business.
Protection of personal assets from liabilities created by the business, lower
cost to set up, if one owner, no additional tax returns needed. For a company
with multiple
owners, there is flexibility in splitting income differently among owners.
No double taxation. If the company generates a business loss the owner can deduct losses against other income.
If the owner has no other income to offset the losses he may carry
forward the loss to the next year (after adjustment - see a CPA for
assistance on this).
Should you choose S Corp or LLC?
New tax deduction provides a case to choose the corporation ( with S
Election) rather than an LLC if the owner wants to include his/her wages
as qualifying wages. This new law provides a 9% additional
deduction (beginning in the year 2010). S Corporations are more
rigid in the way earnings are distributed among the shareholders. Also
when its time to offer ownership to colleagues/affiliates or capital
contributors, flexibility as to ownership & share in profits &
losses are strictly in accordance of % of shares held. LLC's allow
for flexibility in ownership/management/profit & loss sharing- areas
that will allow the current owner to transfer earnings/ownership at a
pace he/she is comfortable with. An LLC has less regulatory issues
and is easier to set-up. New start-up LLCs can avoid payroll tax
filings if all the employees are owners. BUT, with the new
Section 199 deduction, an S Corporation may provide significant tax
savings over the life of the entity.
NEW for Manufacturers/Producers/Construction/Engineer/Architect -
Section 199 is a Manufacturer's deduction limited to 50% of gross wages
(W2 wages in the USA only). LLC owners do not
get payroll checks reported on form W2, instead they receive
distributions so for start-up manufacturers, talk to your accountant to
determine if an S Corporation might be a better choice so you can take
advantage of this new deduction. Section 199 deduction is phased
in through the year 2010 when it will reach 9% of qualified "production"
activities income Who might get this deduction? Very
simplified explanation: If you
- produce tangible personal property, computer software, sound
recordings, that is manufactured, produced, grown, or extracted by
you in whole or significant part within the USA . (Computer software
receipts exclude sales from internet access services, online services,
customer support, telephone services, games played on the internet,
provider-controlled software on-line access services.) Does not
include food processing at a retail establishment.
- produce a qualified film 9motion picture, video tape, or live or
delayed tv programming if NOT less than 50% of total compensation
is fro services performed in the USA by actors, production personnel,
directors and producers.
- produce electricity, natural gas, potable water in the USA
- perform construction or erection of real property (and its
components) including buildings, inherently permanent land
improvements and infrastructure in the USA. Activities include the
erection of new or substantially renovate real property (but do not
include tangential services such as hauling trash and debris, and
delivering materials.
- engineer or provide architectural services for construction or
erection of real property (and its components) in the USA.
Only one taxpayer may claim the deduction under 199 with respect to
the same function performed to the same property, In other words, if you
subcontract out the manufacturing, producing, growing, or extracting,
then the 199 deduction is available to your subcontractor.
S Corporations- Are you a professional, now offering consulting
services?
Read our article on
reasonable compensation and the S Corporation. Make a calculation
of tax savings from social security taxes vs additional costs needed for payroll
and payroll tax preparation. Consider your pension funding requirements (lower
wages mean lower pension contributions). It is always good to get a
knowledgeable tax and business advisor. The Medicare savings may pay for the
services of a top notch CPA that will advise you wisely on finance and business
decisions. See discussion about C Corporations above. Consider
becoming a corporation and converting to an S corporation in year 2009.
It is time to higher a CPA to get you through these calculations.
See more
about starting a
business
See more
small business tips offering help on all aspects of running a business
|
Use the service CPA firms use
to incorporate or form LLCs for their clients
save money
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Pros
and cons of each entity type |
Small Business administration document discusses each
entity type from a tax, liability and cost point of view. You need
Adobe Acrobat Reader software view and download this document. If
you do not have Acrobat Reader installed, click
here to access the software from Adobe. |
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An attorney's point of view |
Discussion of each entity type |
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A comprehensive discussion of entity types |
Find Law resources |
Disregarding entity choice for tax purposes
Form 8832 |
Want the legal characteristics of one entity and the tax
characteristics of another? There are some options open to
noncorporate entities to be taxed differently. Frankly, the only
time we have seen this implemented is with the LLC. If you are a
sole owner of an LLC, the regulations default to being taxed as a sole
proprietor (schedule C on form 1040), you may instead choose to be taxed
as a corporation and with file form 2553 to be taxed as an S Corporation.
Any savings with this election may be entirely offset with the additional
payroll taxes and tax preparation fees. Before going this route, speak to
a tax professional and get it in writing what the advantages are. For the
most part, selecting a form of taxation that is different from what is
standard will probably convert into high professional tax preparation
fees. |
State and
federal contact numbers, websites, for forms and applications.
Liability considerations:
Are you seeking liability protection from creditors? Before you choose an
entity form because of liability considerations:
-
Business owners of new businesses are generally
required to sign a personal guarantee for bank loans and large vendors.
- The IRS may seek payment of unpaid payroll taxes
from the owners of a business or anyone signing the payroll tax returns.
- Businesses including corporations that have its
books commingled with personal payments/transactions of the
owners/officers can have a problem if it is ever necessary to defend
itself in court. The court may decide that both entities
(individual and business) are behaving as one, therefore, exposing the
owners assets to plaintiffs. Corporations should follow the legal
requirements for running the corporation (keeping the corporate book
with meeting minutes and keeping the corporation's money and
accounts strictly separated from personal assets).
- Involve an attorney if your industry has a
tendency to be sued.
- Periodically consult with your CPA to make sure
you are complying with federal state & local tax regulations and are
implementing sound business policies.
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