Determining Your Legal Structure, Part 2
What you need to know about the incorporation process and the effects it will have on your day-to-day operations.
The April issue of this column examined the myriad issues that you should consider before deciding on a legal structure for your new or existing business. If you have chosen to incorporate your company, there are several ways to go about it. Each of these options comes with its own price tag and its own advantages and disadvantages.
The easiest way to go about incorporating is to hire a local attorney to file your incorporation paperwork and to advise you on how to form and operate your business in the way that best suits your goals, risk tolerance and proposed structure. When your entity involves more than one person, you should seek legal counsel to help you address issues ranging from how you account for one partner contributing more capital upon formation to what happens when a partner wishes to leave the entity.
Many corporate attorneys also hold a certified public accountant (CPA) license and/or a master’s degree in taxation (LLM), which is preferable. Consider an attorney who is part of a medium- to large-sized firm that has the specialists and manpower available to represent your interests in all areas of law as your business grows. You should hire an attorney with a rating of BV or higher; this rating is typically reserved for lawyers with extensive experience and an excellent reputation. To locate a local attorney, www.martindale.com is an excellent online resource.
You might think hiring an attorney would be the most expensive option. In fact, these professionals charge fees that are often comparable to those charged by some online companies that will perform the process for you, especially if it is a simple state filing. Attorneys may charge an additional flat fee or an hourly rate for work related to partnership and operating agreements. However, hiring an attorney may save you fees and costs later by properly insulating you from liability right from the start and by providing a process for resolving future legal disputes.
Several companies now provide incorporation services online. Their prices range from $49 to $199. The fee typically includes 1 year of support, which can include acting as your agent for service of process.
Agent for service of process means that the online provider is the designated contact point for your corporation if anyone wants to sue your corporation. You can also elect to be your own agent, or you can elect that your state’s office of the secretary of state act as your agent.
Examples of online companies that will help you incorporate include the following:
- The Company Corporation, www.in corporate.com
- Legal Zoom, www.legalzoom.com
- My Corporation, www.mycorporation .com
An alternative to using an incorporation service is to perform the process yourself. In this approach, your first step is to call or visit your local state government’s small-business helpline (search for your state government’s website online) to obtain or download the appropriate forms. The next step is to file the required incorporation documents (including your articles of incorporation or articles of organization) with your Secretary of State or Department of Corporations, as the case may be. Finally, you must complete your initial company meeting; issue your shares or membership certificates; draw up your bylaws or operating agreement; obtain your necessary local business licenses; and open up your business bank account.
Keep in mind that when you incorporate your business, it will be considered a separate entity/person from yourself (even if you are the only employee). Your business will need its own tax identification number, also known as your employer identification number (EIN). You can obtain your EIN online at www.irs.gov.
This option may save you a significant amount of money, but it will take more of your time, and obtaining your incorporation documents may take longer.
Remember that incorporating will have a substantial impact on many of your day-to-day operations, as follows:
Incorporating your business will affect every contract you sign. This includes advertising contracts, location contracts, instructor-employee agreements and any other contracts that involve your business. Be sure to sign all contracts in your capacity as an officer of your corporation, rather than as yourself as an individual. In some cases, you may be required to sign a personal guarantee on certain types of contracts (this is common with banks for any loans they issue).
If you don’t do this already, you will need to maintain a business bank account that is separate from your personal funds. Commingling of personal funds with your business monies gives the impression that your corporation is not truly a separate legal entity from yourself, and this can be grounds for what is known as “piercing the corporate veil.” Piercing the veil means that you can be found to be personally liable for the liabilities of your corporation, thus defeating one of the primary reasons for establishing your corporation in the first place.
Although not a day-to-day practice, you will need to hold annual meetings and record meeting minutes. Keep in mind that your state may allow you to document a meeting by virtue of a written consent rather than actually holding a physical gathering of the shareholders.
You will also need to make any annual corporation filings, such as paying the applicable annual franchise tax/filing fee. These fees are often due on April 15, but the filing deadlines may vary from state to state. Most states charge a reasonable nominal fee (e.g., the state of Florida is $50 per year), but California charges a minimum of $800 annually for an LLC.
Should you choose to start your business as one form of legal entity (such as a sole proprietorship) and then change your legal structure (subsequently incorporating as an S-Corp., for example), you will need to assign all agreements that you signed under the initial legal entity to the new legal entity and update your insurance.
If you plan to incorporate your business in the future (and it is always a good idea to reserve that option, even if it could be in the distant future), secure the right of assignment in any contracts that you sign, such as facilities or advertising contracts. If you plan on incorporating in the near future, you may wish to incorporate from the start so as to limit your liability.
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If you do not incorporate, you may be inviting the IRS to audit you. Common tax audit flags the IRS looks for include being self-employed and working from a home office. The IRS often focuses on sole proprietors because there is not a system of checks and balances within the business. Lower your risk of being audited by keeping paper trails for your deposits, providing clients with receipts and claiming your cash payments from clients. If your cash clients are audited, the paper trail could make its way back to you.
Although many business owners choose to incorporate in the state in which their studio is based, check with your tax adviser to see if filing in another state better suits your long-term business goals. Delaware’s flexible corporate laws and business-friendly state government have made it one of the best states in which to incorporate a business. This state also offers favorable tax treatment for companies headquartered in other states. More than half of the largest firms in America have chosen this small state as their state of incorporation. Other advantages of filing in Delaware include no requirement for an LCC business owner to reside in the state (or even in the U.S.); no annual sales tax, corporate tax or personal or property taxes for companies that do not do business in the state; and no requirement for filing an annual report or listing personal names and addresses on filing documents. Source: The Company Corporation, www.thecompanycorporation.com.
Harper, Stephen C. 2003. The McGraw-Hill Guide to Starting Your Own Business (2nd ed.). New York: McGraw-Hill. Sutton, Garrett, Esq. 2001. Own Your Own Corporation. New York: Warner Books.
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