The economy is topsy turvy, the job unrewarding, the grass always greener . . . . . so why not start a business. America runs on . . . small business (and the coffee), so let’s consider the basics. While insurance will protect your assets sometimes, starting a separate entity helps to shield yourself from liabilities.
A Name to Call Thyself. Not all names are created equal. Take a name, say, “The Chocolate Library,” creative, descriptive, perfect. Turns out that under the New York State Business Corporation Law, “Libraries” are generally known as a collection of books and other materials for reading and study. So, New York bans the use of school-related words such as ‘library,’ ‘school,’ academy,’ ‘institute,’ and ‘kindergarten,’ in a certificate of incorporation by any New York business is barred unless there is prior consent from the education commissioner.
A Form to Fill. Now that we have a name, what “type” of entity for liability and tax purposes. New York State recognizes various corporate structures, but why choose one over another. While your attorney and accountant are best prepared to advise you for your particular situation, but here are some of the more identifiable structures:
Sole Proprietorship. The simplest form of ownership, where all liability passes through to you personally. Generally, this is used by very small businesses without a physical location and other significant liabilities.
Limited Liability Company. This entity enjoys “passthrough taxation” which allows the “member(s)” to pass the income or losses through their personal returns (i.e., no double taxation), but owners may owe “self-employment” tax on income. Members are protected from liability for acts and debts of the LLC, and can elect to be taxed as a sole proprietor, partnership, S-corp or corporation, providing much flexibility, with even just one natural person (not partnership). These are enduring legal business entities, which, with proper planning, may avoid business termination issues, including those caused by death. An LLC is considered a “partnership” for Federal income tax purposes, so (a) if more than fifty (50%) percent of the capital or profit interests are sold or exchanged within a 12-month period, the LLC may terminate for federal tax purposes; (b) there may be no ability to offer incentive stock options, and no tax free reorganizations. If more than thirty (35%) of losses can be allocated to non-managers, the limited liability company may lose its ability to use the cash method of accounting. Overall a very flexible entity. The business files income through Schedule C of the personal income tax return as a sole proprietor unless it elects to file as a corporation.
“S” Corporation. After paying a salary to the shareholders working, income can be passed through as “distributions of profits,” and may not be subject to self-employment taxes. As the company grows, if it needs to restructure, there are none of the issues that arise in an LLC. S corporations can have one shareholder. The tax ramifications of an “S” Corporation are varied and complex as to what gain or loss or tax basis may be used on death, transfer or termination. If the company plans to own real estate, consult with an accountant and a lawyer if choosing this form of ownership.
“C” Corporation. This is the father of the “S” Corporation, where there are more formalized accounting procedures and paperwork, double taxation at the corporate and individual level, however, no restrictions on the number of shareholders, the types of investments available; or the nature of the entity to add or subtract shareholders. Generally, these are managed by a Board of Directors, which may have too much power over the day to day operations.
Other Types. The remaining types include Limited Partnerships, where some partners are responsible for the acts of the Partnership only to the level of their investment; General Partnerships where all partners are fully liable for all debts; Limited Liability Partnerships where professionals agree to work together under this umbrella.
Organize or Die (Lose the Protection of the Entity). I say this with tongue in cheek, but if you go through the process of setting up an organization to run your business, use it to run your business. Do not, under any circumstance, be disorganized with your books and records, especially the money and checks. Pay yourself as recommended by the accountant, do not mingle your personal funds (assets) with the business, get a bookkeeper or a program to track your finances, and hold meetings for large decisions, so that you can avoid the appearance that this new corporate entity is really just you in disguise.
The Bottom Line– lawyers and accountants can help you to avoid some pitfalls by incorporating properly. Then, it’s up to you to run the business as a business.