Organizing a New Business

Organizing a New Business

You are starting up a new business. What legal form should your business take? That legal form will depend somewhat on the nature of your business and the number and profiles of the owners. The following are general considerations for which you should consult your attorney and your accountant.

Sole Proprietorship

If you are the only owner, without more you would be operating your business as a sole proprietor. You can operate it as your real name or in an assumed name. Say your name is John Brown and you want to do business as "JB Plumbing"; for a $22 fee, you can register online with an assumed name (DBA) with the Utah Division of Corporations and Commercial Code. First, you need to search on their website to see if that name is available.

Corporation

A corporation is a separate legal entity chartered by your state. The shareholders own the equity and distributable profits. It is managed by directors elected by the shareholders and managers appointed by the directors.

A corporation is governed by Articles of Incorporation filed with the Utah Secretary of State. It may, but is not required, to be further governed by the corporation's by-laws. Actions by the corporation are taken by the Board of Directors.

A singular advantage of incorporation is "limited liability". That is, in general, the shareholders are not personally liable for the actions of the corporation. However, this corporate shield can be 'pierced' in certain cases with the result that shareholders can be held liable. To maintain the shield the corporation must faithfully follow all formalities including holding at least annual shareholder meetings and regular directors meetings, filing required annual reports, and conduct the operations in compliance with the Articles of Incorporation and by-laws.

One of the disadvantages of the corporate form of doing business is potential "double taxation". A corporation is a taxable entity under federal and state tax laws. The profits of a corporation are taxable. When those profits are distributed to the owners they are again taxed to the shareholders. However, where the profits are paid out as salaries they are deductible by the corporation and therefore not double-taxed.

Subchapter S Corporation

Subchapter S Corporations are mentioned in passing here because they were once used as a legal way to avoid the corporate double tax problem. However, they were cumbersome and are mostly obsolete now.

Partnership

A partnership is a separate legal entity – sort of. It has long been the subject of debate among legal scholars. Is it a separate entity (entity theory) or an aggregate of its principals and owners (aggregate theory)?

A partnership necessarily consists of more than one member. It is formed by a written or oral agreement among the members. The better course is to have a written partnership agreement that governs the sharing of profits, management, and operations of the business.

While the entity theory might prevail, a normal partnership is not a taxable entity. Therefore, they have no double-taxation issue that a corporation has.

The partners of a partnership do not enjoy the limited liability that corporate shareholders have. They are jointly and severally liable for partnership debts and obligations.

Limited Partnership

A limited partnership consists of one or more General Partners and Limited Partners. As long as the General Partners are adequately capitalized and liable for the partnership obligations, the Limited Partners enjoy the limited liability like a corporate shareholder.

However, the Limited Partners cannot participate in the management of the partnership or they lose their limited liability.

Provided the limited partnership complies with all requirements and formalities, it is treated as a non-taxable partnership. All tax attributes flow through to the partners.

Limited Liability Corporation

For years the IRS and the courts struggled with the classification of businesses for tax purposes – taxable entities or non-taxable aggregations of individuals. The Subchapter S corporation was a cumbersome compromise not available to many organizations.

A few states, followed eventually by all states, adopted limited liability company (LLC) laws. They are entities chartered by the state that affords the shareholders limited liability. But they are organized to comply with IRS regulations treating them as non-taxable partnerships.

Like a regular corporation, an LLC must be diligent about maintaining its limited liability. It must follow the management and operating procedures in compliance with the articles of incorporation (called "Certificate of Organization''). Like regular corporations, it may but is not required to adopt bi-laws (called the "Operating Agreements''). The Certificate of Organization is filed with the Utah Secretary of State.

Summary

As this article shows, there are many options and complex considerations for tailoring the proper organization when it comes to conducting your business. Your best advice is to consult an experienced business lawyer.

They can advise you with your choice of entity and prepare and file all necessary documents for launching your new enterprise. They can also counsel you with respect to your continuing operations in compliance with the requirements of the legal form that you adopt.

Spencer & Associates has attorneys with decades of experience in business matters in their offices in Sandy and Syracuse, Utah. We invite you to give us a call to discuss the best legal organization for your business.

Tags: start-up, business law