The Benefits of "limited liability"
Many people come to me wanting limited liability. Limiting the liability of the owner is important. Every state allows an owner of a business to create an entity and to do business in the name of that entity. Most businesses choose a "corporation", but some owners choose an Limited Liability Company (LLC), Limited Liability Corporation (LLC), or, in the case of certain professionals, a Professional Corporation (PC). One can also act as a sole proprietorship. There are other kinds of similar entities. All of these choices offer a common benefit: Limited Liability. If you enter into contracts in the sole name of the business and do business in the name of that business, other parties can only look to that business for liability under those contracts and/or tortious conduct. This is meant to protect the business owner. A sole proprietorship does not have the benefit of limited libaility.
What are the differences between the entities?
The choice depends on the circumstances. Many people will choose a Corporation. A Corporation must have a Board of Directors, Officers, and at least one shareholder. One person can serve in all capacities at the same time. Many small business have corporations with only one person acting in all capacities. A corporation must have articles of incorporation that are filed with a state in order to be created. Additionally, they should have bylaws to govern the board of directors, as well as minutes to keep track of the activities of the board and officers. One makes an election with the IRS to determine whether income is taxed at the Corporate or Shareholder level (A subchapter S or Subchaper C corporation) An LLC is also filed with the state, but it is simpler. It has "members" and an operating agreement. There are no shares issued, but there are "membership interests". Generally, income is taxed at the member level. Professional Corporations are the same as Corps.
What should I choose?
One should usually choose based on the complexity of the business. Most small businesses should choose LLC's if they have only one or several members and wish to be taxed at the individual level. While this article is not meant to give tax advise, most small businesses choose to do this. LLC's are easy to govern. They are easy to draft by attorneys and do not require much housekeeping. The operating agreement acts as a partnership agreement and can be drafted for many different circumstances. If there are more individuals and it is imagined that more people may become part of the business, a corporation may be better. A corporation is governed by a Board of Directors and Officers. Additionally, stock is issued. This may be a better way to allow management for a small company as well as to transfer interests in the event of a sale. Additionally, more tax flexibility may be achieved in this manner.
What is the importance of keeping up with my paperwork and filings?
It is critical, once you set up your business entity, to keep up with filings and paperwork. The minutebook must be kept up, regular board meetings must be done, and filings with the state must be maintained (As well as yearly corporation fees paid). Additionally, personal funds must not be commingled with the business funds. Failure to pay fees to the state may result in an administrative dissolution of the corporation. Failure to keep up with the formalities of the business may result in a "disregard of the entity" in the event of a lawsuit. While this is rare, it is prudent to do regular housekeeping. Keep in mind that any thing that is signed in your personal capacity as well as the business capacity will still be your personal responsibility. Many credit agreements require a personal gauruntee of the business owner. But, everything should be signed by you in the name of your business to avoid headaches down the road.