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Business Law
Advantages of Incorporating
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Anyone who operates a business, alone or with others, may incorporate. Under the right circumstances, the owner of any size business can benefit!
- Reduces Personal Liability
Incorporating helps separate your personal identity from that of your business. Sole proprietors and partners are subject to unlimited personal liability for business debt or law suits against their company. Creditors of the sole proprietorship or partnership can bring suit against the owners of the business and can move to seize the owners? homes, cars, savings or other personal assets. Once incorporated, the shareholders of a corporation have only the money they put into the company to lose, and usually no more.
- Adds Credibility
A corporate structure communicates permanence, credibility and stature. Even if you are the only stockholder or employee, your incorporated business may be perceived as a much larger and more credible company. Seeing ?,inc.? or ?corp.? at the end of your business name can send a powerful message to your customers, suppliers, and other business associates about your commitment to the ongoing success of your venture.
- Tax Advantages ? Deductible Employee Benefits
Incorporating usually provides tax-deductible benefits for you and your employees. Even if you are the only shareholder and employee of your business, benefits such as health insurance, life insurance, travel and entertainment expenses may now be deductible. Best of all, corporations usually provide an increased tax shelter for qualified pensions plans or retirement plans (e.g. 401K?s).
- Easier Access to Capital Funding
Capital can be more easily raised with a corporation through the sale of stock. With sole proprietorships and partnerships, investors are much harder to attract because of the personal liability. Investors are more likely to purchase shares in a corporation where there usually is a separation between personal and business assets. Also, some banks prefer to lend money to corporations.
- An Enduring Structure
A corporation is the most enduring legal business structure. Corporations may continue on regardless of what happens to its individual directors, officers, managers or shareholders. If a sole proprietor or partner dies, the business may automatically end or it may become involved in various legal entanglements. Corporations can have unlimited life, extending beyond the illness or death of the owners.
- Easier Transfer of Ownership
Ownership of a corporation may be transferred, without substantially disrupting operations or the need for complex legal documentation, through the sale of stock.
- Anonymity
Corporations can offer anonymity to its owners. For example, if you want to open an independent small business of any kind and do not want your involvement to be public knowledge, your best choice may be to incorporate. If you open as a sole proprietorship, it is hard to hide the fact that you are the owner. And as a partnership, you will most likely be required to register your name and the names of your partners with the state and/or county officials in which you are doing business.
- Centralized Management
With a corporation?s centralized management, all decisions are made by your board of directors. Your shareholders cannot unilaterally bind your company by their acts simply because of their investment. With partnerships, each individual general partner may make binding agreements on behalf of the business that may result in serious financial difficulty to you or the partnership as a whole.
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TYPES OF CORPORATION
General Corporation
A general corporation, also known as a ¿C¿ corporation, is the most common corporate structure. A general corporation may have an unlimited number of stockholders. Consequently, it is usually chosen by those companies planning to have more than 30 stockholders or large public stock offerings. Since a corporation is a separate legal entity, a stockholder's personal liability is usually limited to the amount of investment in the corporation and no more.
Close Corporation
A close corporation is most appropriate for the individual starting a company alone or with a small number of people. There are a few significant differences between a general corporation and a close corporation. A close corporation limits stockholders to a maximum of 30. In addition, many close corporation statutes require that the directors of a close corporation must first offer the shares to existing stockholders before selling to new stockholders. Not all states recognize close corporations.
Subchapter S Corporation
A Subchapter S Corporation is a general corporation that has elected a special tax status with the IRS after the corporation has been formed. Subchapter S corporations are most appropriate for small business owners and entrepreneurs who prefer to be taxed as if they were still sole proprietors or partners. When a general corporation makes a profit, it pays a federal corporate income tax on the profit. If the company also declares a dividend, the stockholders must report the dividend as personal income and pay more taxes. S Corporations avoid this "double taxation" (once at the corporate level and again at the personal level) because all income or loss is reported only once on the personal tax returns of the stockholders. For many small businesses, the S Corporation offers the best of both worlds, combining the tax advantages of a sole proprietorship or partnership with the limited liability and enduring life of a corporate structure.
S Corporation Restrictions
To elect S Corporation status, your corporation must meet specific guidelines.
1. All stockholders must be citizens or permanent residents of the United States.
2. The maximum number of stockholders for an S Corporation is 75.
3. If an S Corporation is held by an "electing small business trust," then all beneficiaries of the trust must be individuals, estates or charitable organizations. Interests in the trust cannot be purchased.
4. S Corporations may only issue one class of stock.
5. No more than 25 percent of the gross corporate income may be derived from passive income.
6. Not all domestic general business corporations are eligible for S Corporation Status.
Exclusions:
o a financial institution that is a bank
o an insurance company taxed under Subchapter L
o a Domestic International Sales Corporation (DISC)
o certain affiliated groups of corporations
For more detailed information about these changes and other aspects regarding S Corporation status, contact your accountant, attorney or local IRS office.
How to File as a Subchapter S Corporation
1. Form a general or close corporation in the state of your choice.
2. Obtain the formal consent of the corporation's stockholders and note this consent in your corporation's minutes.
3. Complete Form 2553, Election by a Small Business Corporation. The Company Corporation¿ can provide you with the IRS Form 2553 as part of your incorporation process. See our online order form to receive your IRS Form 2553 as part of the Complete package, or order it a la carte if you prefer.
Limited Liability Company (LLC)
The LLC is not a corporation, but it offers many of the same advantages. Many small business owners and entrepreneurs prefer LLC¿s because they combine the limited liability protection of a corporation with the "pass through"" taxation of a sole proprietorship or partnership.
· General Corporation
A general corporation, also known as a ¿C¿ corporation, is the most common corporate structure. A general corporation may have an unlimited number of stockholders. Consequently, it is usually chosen by those companies planning to have more than 30 stockholders or large public stock offerings. Since a corporation is a separate legal entity, a stockholder's personal liability is usually limited to the amount of investment in the corporation and no more.
Close Corporation
A close corporation is most appropriate for the individual starting a company alone or with a small number of people. There are a few significant differences between a general corporation and a close corporation. A close corporation limits stockholders to a maximum of 30. In addition, many close corporation statutes require that the directors of a close corporation must first offer the shares to existing stockholders before selling to new stockholders. Not all states recognize close corporations.
Subchapter S Corporation
A Subchapter S Corporation is a general corporation that has elected a special tax status with the IRS after the corporation has been formed. Subchapter S corporations are most appropriate for small business owners and entrepreneurs who prefer to be taxed as if they were still sole proprietors or partners. When a general corporation makes a profit, it pays a federal corporate income tax on the profit. If the company also declares a dividend, the stockholders must report the dividend as personal income and pay more taxes. S Corporations avoid this "double taxation" (once at the corporate level and again at the personal level) because all income or loss is reported only once on the personal tax returns of the stockholders. For many small businesses, the S Corporation offers the best of both worlds, combining the tax advantages of a sole proprietorship or partnership with the limited liability and enduring life of a corporate structure.
S Corporation Restrictions
To elect S Corporation status, your corporation must meet specific guidelines.
1. All stockholders must be citizens or permanent residents of the United States.
2. The maximum number of stockholders for an S Corporation is 75.
3. If an S Corporation is held by an "electing small business trust," then all beneficiaries of the trust must be individuals, estates or charitable organizations. Interests in the trust cannot be purchased.
4. S Corporations may only issue one class of stock.
5. No more than 25 percent of the gross corporate income may be derived from passive income.
6. Not all domestic general business corporations are eligible for S Corporation Status.
Exclusions:
§ a financial institution that is a bank
§ an insurance company taxed under Subchapter L
§ a Domestic International Sales Corporation (DISC)
§ certain affiliated groups of corporations
For more detailed information about these changes and other aspects regarding S Corporation status, contact your accountant, attorney or local IRS office.
How to File as a Subchapter S Corporation
7. Form a general or close corporation in the state of your choice.
8. Obtain the formal consent of the corporation's stockholders and note this consent in your corporation's minutes.
9. Complete Form 2553, Election by a Small Business Corporation. The Company Corporation¿ can provide you with the IRS Form 2553 as part of your incorporation process. See our online order form to receive your IRS Form 2553 as part of the Complete package, or order it a la carte if you prefer.
Limited Liability Company (LLC)
The LLC is not a corporation, but it offers many of the same advantages. Many small business owners and entrepreneurs prefer LLC¿s because they combine the limited liability protection of a corporation with the "pass through"" taxation of a sole proprietorship or partnership.
o LLC¿s have additional advantages over corporations:
o LLC¿s allow greater flexibility in management and business organization.
o LLC¿s do not have the ownership restrictions of S Corporations, making them ideal business structures for foreign investors.
o LLC¿s accomplish these aims without the IRS' restrictions of an S Corporation.
LLC¿s are now available in all 50 states and Washington, D.C. If you have other questions regarding LLC¿s, be sure to speak with a qualified legal and/or financial advisor.
LLC¿s have additional advantages over corporations:
· LLC¿s allow greater flexibility in management and business organization.
· LLC¿s do not have the ownership restrictions of S Corporations, making them ideal business structures for foreign investors.
· LLC¿s accomplish these aims without the IRS' restrictions of an S Corporation.
LLC¿s are now available in all 50 states and Washington, D.C. If you have other questions regarding LLC¿s, be sure to speak with a qualified legal and/or financial advisor.
Although it has been in existence for 10 years in the USA, the LLC is the newest entity available.. One of the main advantages of the LLC is that it is taxed according to partnership law. LLC's do not pay taxes. LLC's file an information return (Form 1065) and all profits are reported on each member's own personal 1040 Form, according to ownership percentage. Another advantage of LLC's is they can be owned by other entities. Under most circumstances the members involved in the day-to-day running operations must recognize the income as earned income and pay the 15.3% self-employment tax.
The S-Corporation, like the LLC, is taxed like a partnership. S-Corporations file an information return (Form 1120S) and profits are reported on each shareholder's own 1040 Form, based on ownership. The main advantage of the S-Corporation is that a business owner can draw income from the company. Business owners may take a "reasonable " salary and distribute the rest of the profits as stock dividends. Usually, the dividend distribution is exempt from the 15.3% self-employment tax. One major disadvantage of the S-Corporations is that only individuals {not other entities} or certain types of grantor trusts may own stock in the company.
The C-Corporation is the only entity that actually pays taxes. This entity files Form 1120 and is taxed according to a different tax table than individual members. The primary advantage of C-Corporations is their ability to provide tax-deductible benefits. These benefits are usually not entirely deductible in the other entities, but dividends are from 2003.
Another main advantage of the C-Corporation is its lower tax bracket. The first $50,000 that a C-Corporation earns pays only 15 percent in federal income taxes. This can be extremely beneficial to a business owner that has expenses that are not deductible.
The primary disadvantage of the C-Corporation is how dividend distributions are taxed. Because dividends are paid after the corporation has paid taxes on its profits, double taxation occurs since the owner of the stock also pays taxes on the distribution. (This falls away during the 2003 tax year) Another disadvantage of the C-Corporation is that there are few ways to access retained earnings without incurring the double taxations discussed above.
The Limited Partnership, like the LLC and S-Corporation is also taxed like a partnership. It files an information return {Form1065) and all profits are reported by each owner on their individual 1040 Form.
The main advantage of the Limited Partnership is it has two types of owners. The general partners have voting rights and control, while the limited partners do not. This allows the general partners to control the distribution of profits, even though they may have been taxed at the limited partner's tax bracket
A business owner with children over the age of 14 can utilize his/her children's tax brackets as limited partners and not lose control over the entity, even though the children may own a majority.
One disadvantage of the Limited Partnership could be the business owner's ability to access money within the partnership for his or her own purposes.
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CHOOSING A STATE
- Forming a Corporation or LLC in Your Home State
Many small businesses prefer to incorporate or form an LLC in their home state. Typically, it is least complicated and most cost effective to incorporate in the state where you are planning to operate your business. If you incorporate outside your home state, you still may be required to qualify to do business in your home state. The cost of a local incorporation will usually be less than incorporating in another state and then qualifying to do business in your home state as a "foreign" (out of state) corporation. Plus, you will avoid paying franchise taxes and filing annual reports in two different states.
- Advantages of a Delaware Corporation or LLC
Over 50% of all companies on the NY Stock Exchange are Delaware corporations. Delaware has a long heritage as a business-friendly state and may be a good choice if you intend to take your company public and offer publicly traded stock. Delaware has many other advantages, including low incorporation fees, low annual franchise taxes, and no state corporate income tax for corporations that operate outside of Delaware. Furthermore, Delaware maintains a separate court system for business, called the "Court of Chancery." This Court is known for its well-established record of decisions and speed at which it handles disputes. So instead of spending your valuable time in court, you can spend it running your business. Be aware, however, that if you incorporate in Delaware while your business is located outside of Delaware, you may need to qualify to do business in your home jurisdiction. This may require an extra step and an additional fee to your home state.
- Advantages of a Nevada Corporation or LLC
Nevada has become increasingly friendly to corporations with its privacy and liability protection status as well as certain tax advantages. Nevada has no state tax on corporate profits, no state annual franchise tax, or no state personal income tax. Stockholders of a Nevada corporation are not public record, allowing complete anonymity. Be aware, however, that if you incorporate in Nevada while your business is located outside of Nevada, you may need to qualify to do business in your home jurisdiction. This may require an extra step and an additional fee to your home state.
- Can a Delaware or Nevada Corporation or LLC Do Business in Other States?
Yes. Nearly half of the corporations listed on the New York Stock Exchange are Delaware corporations and numerous large businesses are relocating to Nevada. These large companies conduct business throughout the U.S. and abroad. They must, of course, conform to the laws of any jurisdiction they enter. Many states require that any foreign (out of state) corporation qualify to do business in their state prior to actually conducting business there.
- Doing Business in More Than One State
Many companies conduct business throughout the U.S. and abroad. A corporation having business locations in multiple states will typically incorporate or form an LLC in a single state, then "qualify to do business" in the other states. This means they formally register in these other states, paying additional franchise taxes and filing annual reports, as required. The Company Corporation¿ can assist you in qualifying your corporation or LLC in any state you choose.
CHECKLIST FOR BUSINESSES CORPORATE BOARD AND SHAREHOLDER MEETINGS FOR CORPORATIONS.
Have an annual shareholder meeting to elect directors--and keep minutes of that meeting. With respect to the board of directors, have minutes for board meetings or have unanimous written consents for major decisions regarding the company. These can be written up later if everyone on the board concurs, but it is better to do them at the time the resolutions are needed.
REGISTRATIONS IN OTHER STATES. If you have offices in other states, make sure you register your business in those states.
SECURITIES LAWS. Before offering or giving stock, stock options or promissory notes with stock-conversion rights, contact an attorney to make sure you obtain the proper securities-laws exemptions. BUY-OUT AGREEMENT AMONG OWNERS. The shareholders generally should have an agreement where, before a shareholder can sell or transfer shares, the company and the other shareholders have a right to buy them first. The shareholders may also want an agreement that provides buy-out provisions if a shareholder leaves the company or is terminated from it.
LOANS TO AND FROM PRINCIPALS. With loans between the company and a principal: *the interest rate and other terms should be commercially reasonable. *each loan should be documented in writing. *with corporations, the board of directors should approve the loans.
STOCK-OPTION PLANS. If you are choosing a stock-option plan, consider: *whether it should be a statutorily approved plan to minimize tax consequences for the employees. *whether you ought to use a shadow-stock (phantom-stock) plan instead, so that while employees share in the success of the company they do not own stock or options (which can be problematic with potential investors).
CONTRACTS INTEGRATION AND MODIFICATION. Each of your agreements should have provisions stating that: *it constitutes the entire agreement between the parties for this subject matter. *it cannot be modified except in a writing signed by both parties.
DISCLAIMERS OF WARRANTY AND LIMITATIONS OF LIABILITY. If you provide goods or services, your agreements should: *restrict warranties which can arise by implication to reasonable terms. *limit your potential liability (which could otherwise be far larger than the value of the deal to you).
ASSIGNMENT. If you do not want the other party to be able to assign its rights (for example to a competitor or to a company which may not be financially sound), your agreement should expressly say so. INTERNET. If you sell on the Internet or out of state, your agreements should: *limit jurisdiction of disputes so that any litigation or arbitration occurs where you are located (as opposed to the other side of the country). *say which state's laws will be used to interpret the agreement.
TERMS AND CONDITIONS. If you use terms and conditions with purchase orders or order acknowledgments, have an attorney review the provisions so that, if there is a conflict between your terms and the other party's terms, yours are more likely to prevail. Alternatively, it may be more practical to use signed written contracts instead (which are much less likely to result in a "battle of the forms").
LETTERS OF INTENT. If you use letters of intent, they should expressly state whether they are binding or not.
INTERNATIONAL AGREEMENTS. Unless you are sure you want it, your international agreements should expressly exclude application of the United Nations Convention on Contracts for the International Sale of Goods. It applies automatically otherwise. If you are dealing with people or businesses with no assets in the United States, your agreements should include an international arbitration provision. It is much easier to get a foreign court to enforce those than judgments obtained in the U.S. court system.
FORM CONTRACTS. If you use form agreements, be sure they are reviewed and updated periodically to meet changes in business needs and law.
EMPLOYEES
AT-WILL EMPLOYMENT.
Make certain your employment agreements and any employee handbooks specify
employment is "at will". If they do not, fired employees may file lawsuits on the basis that they
were not fired for proper cause.
NON-COMPETE CLAUSES.
Avoid non-competition clauses with employees (and with your customers) stating that
your employees cannot compete with you or work for your competitors or customers after they
leave your company. In California these restrictions on employees are generally invalid and can
lead to lawsuits by employees alleging restraint of trade. Confidentiality agreements, on the other
hand, are generally upheld and may cover customer preferences and sometimes customer lists.
INDEPENDENT CONTRACTORS.
If you use independent contractors, be sure you can justify your decision not to make them
employees if the government enquires. One rule of thumb: an independent contractor must earn
at least one-third of his/her income from sources other than your company OR be incorporated.
Have a written agreement with each independent contractor stating that he/she is an
independent contractor and is responsible for his/her own taxes etc..
CONSISTENCY IN POLICIES.
Apply your company policies consistently to all employees. If you don't have one already,
consider creating an employee handbook to make it clear what the exact rules are and to ensure
consistency.
If you have an employee handbook, follow its provisions and have it reviewed periodically
for changes in the law and in business conditions. The handbook should state that it may be
amended by the company at any time.
Have each employee sign an acknowledgment of receipt of any employee handbook and
any major amendments to it.
Consider having employees sign a separate agreement to arbitrate (rather than litigate) all
disputes regarding employment. If you do this, either have them sign it at the time when they first
start work or give them additional consideration (small amounts of stock or money) as
consideration for signing. If existing employees are not given additional compensation to sign, the
agreement may not be enforceable.
DISCIPLINARY PROCEDURES.
Follow disciplinary procedures consistently with each employee.
Before terminating any employee, give repeated oral and written warnings over time if at
all possible. Write up your conversations and place them and the written warnings in the
employee's personnel file.
SEXUAL HARASSMENT POLICIES.
Have a written policy prohibiting sexual harassment as well as discrimination concerning
race, gender, age and, in California, sexual orientation. Expressly give the employees several
different people in the company to contact if they believe there has been a violation.
Distribute all of these policies to your employees and have each employee sign an
acknowledgment of receipt for them.
Where an employee alleges harassment or discrimination, investigate and take appropriate
disciplinary action if warranted. If you fail to adequately investigate, your company may be held
liable for acts by its employees.
COMPUTER-USE POLICIES. Have an express computer-use policy which states that:
*employees may only use your computer systems for purposes related to your business.
*employees may not use the e-mail or on-line access for objectionable materials or
messages of any kind.
*employees may not use the e-mail or on-line access for any material protected by
copyright law, trademark law etc. without the permission of the owner.
*e-mails and materials sent or received with the company's equipment may be subject to
review by the company.
REQUIRED POSTINGS.
You must post all required federal and state employment notices. If you are in California,
the California Chamber of Commerce has all the employment posters that must be posted, plus
required Unemployment Insurance and State Disability Insurance pamphlets and required Sexual
Harassment pamphlets. To order, go to http://www.calchamberstore.com/calchamber/, click on
Required Notices and then on Required Notices Kit. Prices are currently $35 to $55 dollars per
kit, less expensive than many other vendors.
INTELLECTUAL PROPERTY
NON-DISCLOSURE AGREEMENTS.
Have signed non-disclosure (confidentiality) agreements with the employees and principals
of your company as well as with independent contractors and other businesses where appropriate.
Be certain that your definition of what constitutes confidential material is specific enough
to identify the confidential information without disclosing it. Vague or overly broad definitions of
what constitutes proprietary material may nullify non-disclosure agreements. Have your
confidentiality agreements with employees signed at the time when they first start work and give
existing employees additional consideration small amounts of stock or money as consideration for
signing the agreement. If existing employees are not given additional compensation to sign, the
agreement may not be enforceable.
INDEPENDENT CONTRACTORS.
Ascertain that your "work for hire" agreements with independent contractors (such as
programmers and Web designers) also include an assignment of ownership rights in the resulting
product to your company. "Work for hire" clauses alone may not be sufficient.
EMPLOYEE INVENTIONS.
If you are in California, your agreements with employees regarding inventions must
comply with California Labor Code Section 2870. This means that inventions developed entirely
on an employee's own time without using the company's equipment, supplies, facilities, or trade
secret information must NOT be assigned to your company unless they relate to your business.
Making invention-assignment clauses too broad will nullify the agreement.
DOMAIN NAMES.
Registered the domain names (for example, www.yourcompany.com) for your company
name and consider doing so for your important trademarks. Mere use of the names or trademark
registrations may not be sufficient to prevent others from acquiring the corresponding domain
names.
Have a Web site however simple--up and running for each domain name you have. A
recent case says that a Web site must be established in order to generate trademark rights in the
domain name. An "Under Construction" notice on the site is not sufficient.
TRADEMARKS.
Register your important trademarks with the federal government for nationwide
protection, or at the very least register them with the state for state-wide protection.
Register your trademarks with each foreign country where you do (or plan to do) a
substantial amount of business.
For trademarks and service marks registered with the federal government, use an "R" in a
circle after the name to show it has been registered.
For other trademarks (names for goods) and service marks (names for services), use a
superscript "TM" for trademarks and a superscript "SM" for service marks to show you are
claiming rights in that name.
Check periodically to see whether any of your trademark or service mark registrations are
coming up for renewal.
NAMES. Before investing significant time and money in a new product, service or company
name, do the following:
*have a trademark search conducted.
*check the availability of the domain name for the .com version of the name.
*perform an Internet search on the name.
*and, where appropriate, check with the State for availability as a corporate or limited
liability company name.
COPYRIGHTS.
If your business uses copyrights, register them with the Copyright Office. Registration
PRIOR to infringement allows attorneys' fees and statutory damages.
PATENTS.
With potentially patentable ideas, be sure to contact an attorney early enough so that a
patent application can be filed within one year of the earlier of a) the publication of the invention
in any patent or printed publication anywhere in the world by anyone and b) anyone placing the
invention in public use or on sale. Otherwise patent rights are lost.
Areas Of Practice
- Art Law
- Child Custody
- Child Support
- Commercial Law
- Contracts
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