Corporate Structures

Selection of your business’s corporate structure affects how you track revenue, pay employees, and complete government paperwork. Your options currently range from operating as a sole proprietorship, a partnership, a corporation, a limited liability company, a limited liability partnership, or a professional corporation.

Corporate Structures
Corporate structure
Selection of your business’s corporate structure affects how you track revenue, pay employees, and complete government paperwork. Your options currently range from operating as a sole proprietorship, a partnership, a corporation, a limited liability company, a limited liability partnership, or a professional corporation. Most importantly, a separate corporate entity shifts liability for financial obligations or lawsuits from the business owner to the business itself. This is the major reason many business owners incorporate—to shield themselves from corporate liabilities.

Bright Idea
To learn whether a company name has already been trademarked, visit www.tmcenter.com. Be aware, however, that individuals and businesses can choose to sue whomever they please, so despite the fact that you’ve incorporated, you can still be named personally in any lawsuit. Incorporating generally helps protect personal assets, such as a house or car, in such instances.

Sole proprietorship
Many companies start out as one-person operations. These solo businesses are often run as sole proprietorships, which are taxed at individual rates rather than corporate tax rates. As the IRS sees it, any income generated for the business is passed through directly to the business owner. To establish a sole proprietorship, you need to complete a Doing Business As (DBA) certificate, available at a legal stationery shop, search courthouse records to confirm that no other business has already registered the same name, and pay the requisite fee, typically under $50. If you have a partner in the business, you can also file a DBA for a partnership. The main difference with a partnership, however, is that each partner is equally responsible for the acts and omissions of the other. So if your partner chooses to buy a building for your new business, you are both responsible for the mortgage payments.

Corporation
Incorporating enables you to separate your business obligations from your personal obligations. Once your business is officially incorporated, you become an employee. Any revenue earned is paid to the company, not to you personally. Taxes are also paid monthly, not quarterly or annually as they are with sole proprietorships, on salaries and wages paid to employees—like you, the owner. Once your revenues as a sole proprietorship reach a certain level, your company has a greater chance of being audited. Statistics show that sole proprietorships with revenues above $50,000 are audited more frequently than those below that amount. Some companies elect to incorporate when their revenues approach $50,000. The major advantage is that if the company is ever sued, you may be able to shield some of your personal property. Another advantage—to your clients—is that if you operate as a freelancer or independent consultant, for example, your corporate clients do not need to issue 1099 forms at the end of each year summarizing what they paid you. It’s also clearer to the government that you are not an employee—a situation some companies are concerned about proving. Being able to tell clients that you operate a corporation, in some cases, may give you an edge when competing for business. Although the actual process of incorporating can be handled in minutes, consulting your attorney and accountant before initiating anything will also save you time and money. Doing so will ensure that you’ve selected the appropriate form of incorporation, that you’ve elected appropriate officers, and that the paperwork is all in order. Keep in mind that incorporating in a state different from your home state, such as Delaware, frequently does not eliminate the annual franchise fee that home states charge all corporations operating in their borders. This franchise fee is also payable regardless of the size of your sales. If you incorporate before you actually plan to start operating, you will still be expected to cough up the annual fee (which is generally somewhere between Watch Out! Employers are required to complete an I-9 form when an employee is hired, documenting that the individual is a U.S. citizen or resident alien with two forms of ID. Employees must also complete a W-4 form, authorizing their employer to withhold their taxes. $100 and $400). Depending on the number of shareholders involved in the company, you may elect to file as a Subchapter S corporation or as a Subchapter C. Most smaller companies are Subchapter S corporations. Operating as a Subchapter S corporation allows you to avoid being “double taxed.” Instead of reporting profits on the corporate return, shareholders (including the business owner) are taxed on amounts received from the company. Allowing profits to be distributed to shareholders without taxation at the corporate level is called “pass through” tax treatment.

Limited liability companies
Both limited liability companies (LLC) and limited liability partnerships (LLP) have a general partner, who is personally liable for the actions of the organization, and limited partners, who are not liable. LLPs are frequently used in real estate transactions, where there are several silent partners not involved in the day-to-day decision-making. LLCs are becoming very popular among law and consulting firms, where the partners are active in daily operations; and they are less expensive and less complex to set up and manage than corporations.

Professional Corporations
If you’re starting a business in order to provide professional services, such as architecture design, legal services, medical or dental services, accounting guidance, or financial planning, among others, you should consider comparing the advantages and disadvantages of a professional corporation—generally identified by a PC, PA, P. Corp., (Professional Corporation), or Inc., with those having either a Subchapter S or C. Find out first from your state whether your services are on their list of what are considered “professional services,” since that list varies by state. In some states, professional services are defined as those services that require a license.

Bright Idea
Companies frequently incorporate in Delaware rather than their own home state because of its business-friendly courts. When lawsuits are filed, Delaware will rule in favor of the corporation more often than not—although favorable rulings are never guaranteed. However, any licenses or permits required by your home state still need to be obtained. Professional corporations (PC) are taxed like a C corporation, unless the owner(s) have elected to be taxed as an S corporation. PCs do not have the advantage of graduated corporate federal income tax rates and some states require that professional corporations pay a flat tax rate regardless of income level. The advantages come into play mainly when a professional service provider, such as a doctor, operates within a larger organization and wants to set up his or her own entity. Even if a professional practice is set up as a corporation, with the accountants or doctors as employees, each member can elect to set up his or her own PC; the larger corporation then pays the doctor’s PC, and the PC pays the doctor (based on the doctor’s instructions). In addition to providing liability protection, having a professional corporation also opens tax planning avenues not available to individuals, such as being able to set up corporate retirement programs.

Reporting and paying taxes
The Internal Revenue Service (IRS) requires that Americans pay taxes on a wide variety of items, including:
Salary and wages
Owned property
Sales
Luxury items
Capital gains on investments

As a business owner, you are responsible for paying a number of taxes, based on your annual sales and employees’ wages, to both federal and state governments. Earnings of sole proprietorships are taxed as part of the owner’s personal income, rather than as a separate business. IRS Schedule C allows the sole proprietor to itemize all income and expenses for the year. On the other hand, partnerships, corporations, and limited liability companies (LLC) file separate business and personal tax returns. Partnerships and LLCs file a tax return, with each partner also responsible for paying personal taxes on his or her share of the business’s earnings. Corporations—Subchapter S, C, or professional—file a tax return for the organization while the owner pays taxes on any salary or dividends received from the company during the year.

Income
Employers are responsible for withholding a portion of each employee’s salary or wages, according to his or her individual tax bracket. The company then pays that withholding figure to the government, by making a payment to its bank each month. Failure to withhold and pay the required tax amounts on time each month will cost your company big bucks in fines and penalties.

Unemployment Taxes
In addition to income taxes, employees must pay a portion of their earnings to the state unemployment fund. Under the Federal Unemployment Tax Act (FUTA), employees pay 8% of their wages up to the first $7,000 earned. This means that employers must withhold this amount and pay the state accordingly. Failing to pay monthly corporate withholding amounts is extremely costly. Making the deposit even one day late can result in fines of several hundred dollars. Avoid these penalties by paying your monthly tax withholding figures by the 15th of each month.

Social Security
Employee and employer also split the social security tax, which is 12.4% of the first $68,400 earned. An additional 1.45% of the employee’s salary is paid to Medicare.

Insurance
Although some business owners decide to risk not having insurance to cover their business against loss, most successful entrepreneurs would agree that having no insurance is the most risky situation of all. Especially at the start of a business, when your financial risk is the greatest, insurance is crucial. If you are leasing work space, be sure to read your lease closely as it may specify the type and minimum amount of insurance you are required to carry. The building owner or leasing agent may require written proof from your insurance carrier annually that you have coverage in place. The whole purpose of insurance is to reduce the risk of loss and keep a company up and running following a disaster. Of course, a disaster could be anything from an earthquake, to a fire, to an owner’s serious illness, to one of your employees cleaning out your bank account and skipping town. Worker’s compensation, which provides for any employee who is injured on the job, is the only type of insurance required by law in every state. However, some states may also require additional insurance beyond worker’s compensation. In New York, for example, you are required to have disability insurance to provide for any employee who is injured off the job. Be sure you know your state’s particular requirements. “Talk to both a reputable property and casualty insurance agency and an agency whose specialty is life and health insurance. Together they can evaluate your business premises and operations and advise you of potential risks and appropriate types and levels of insurance coverage.” —William Seybold, ING Business owners can often be exempted, however, from certain types of insurance. Although it’s not necessarily smart to restrict yourself from insurance protection, you can often save money by exempting yourself from coverage. Other valuable types of insurance include
General liability: Protects against a lawsuit that may result if someone is injured at your place of business.
Home-based business rider: Many property insurance policies allow you to add a rider to protect any businessrelated equipment on-site. However, there are limitations you’ll want to investigate before relying totally on your homeowners policy for protection in case of a loss.
Errors and omissions (E&O): Protects against a lawsuit that alleges your advice was either damaging or incomplete. Lawyers and consultants typically buy this type of protection. E&O may also provide coverage for discrimination claims or negligent acts of corporate officers.
Business interruption: Provides funds to compensate the company for some event that caused business to be lost.
Key man: Enables the company to continue to operate even if one of the owners or senior managers becomes ill or dies.
Automotive: Ensures that the company isn’t penalized if an auto accident occurs at the hands of an employee while on the job.

Licenses and permits
Some service businesses require all individuals providing services to be licensed, such as hairstylists and cosmetologists, while companies are often required to have a business permit in order to operate. The list of businesses and professions that must be licensed varies by state, as does the list of businesses needing a permit in order to operate. Each state has an office that handles the processing of licenses and permits. To learn whether you are required to be licensed or have a permit, call your local SBA office or Chamber of Commerce.

Just the facts
Writing a mission statement for your company helps your employees understand the purpose and top priorities for your business, making it easier for you to reach your goals.
To protect your company’s intellectual property, such as written work, product brand name, or innovative manufacturing processes, consult an attorney and complete all the necessary forms to register a patent, copyright, or trademark. Investigate which corporate stucture makes sense for your business, based on the amount of revenue you expect to earn, whether you’ll have partners or shareholders, as well as other issues your attorney or accountant bring up. Consult a tax accountant to be sure that you are withholding all the necessary taxes from your employees’ paychecks and that you are paying the least amount required under the law. Business insurance is essential to ensure that your company continues to operate after disaster strikes.

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