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Why and when and where to form an entity. Reasons and benefits to incorporate by Roman R. Fichman Esq.
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Roman R. Fichman Esq
TheLegalist.com
DISCLAIMER: The following presentation is meant for educational purposes only and is not intended to be legal advice and should not be construed as such. No representation is made as to the accuracy or validity of information contained herein. Roman Fichman is admitted to practice in New York and Connecticut and is not making any representations as
to laws in other states.
Circular 230 Disclosure: Pursuant to U.S. Treasury Department Regulations, unless otherwise expressly indicated, any federal tax advice contained in this communication, is not intended to be used, and may not be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to
another party any tax-related matters addressed herein. Please consult a qualified professional for any specific tax advise.
all images are under a creative commons license with attribution
forming a business entity is not just forming a business entity is not just forming a business entity is not just forming a business entity is not just a set of papersa set of papersa set of papersa set of papers
it's a mind setit's a mind setit's a mind setit's a mind set
Roman Fichman Esq
TheLegalist.com
This presentation will address:This presentation will address:This presentation will address:This presentation will address:
* why incorporate?* why incorporate?* why incorporate?* why incorporate?
* when to incorporate?* when to incorporate?* when to incorporate?* when to incorporate?
* the different entities to choose from* the different entities to choose from* the different entities to choose from* the different entities to choose from
* new york or delaware?* new york or delaware?* new york or delaware?* new york or delaware?
* detailed summary charts* detailed summary charts* detailed summary charts* detailed summary charts
Forming an entity creates aprotective wall between theentrepreneur and theoutside world and helpsanchor the relationshipbetween the foundingpartners of the enterprise
by wupperhippowupperhippowupperhippowupperhippo
Roman Fichman Esq
TheLegalist.com
LIABILITYLIABILITYLIABILITYLIABILITYLars Hammar
TAXESTAXESTAXESTAXES
BUSINESSBUSINESSBUSINESSBUSINESSNEEDSNEEDSNEEDSNEEDS
cayusa
by Mr Tickle - Wachoo Wachoo Tribe Congressman
Roman Fichman Esq
TheLegalist.com
BBBBusinessusinessusinessusiness LiabilityLiabilityLiabilityLiability
Liability resulting from breach of a duty, anobligation arising from an action or a failureto take action, in the normal course of abusiness.
as a business you are liable for:
� CONTRACTS
� DEBTS
� TORTS
Roman Fichman Esq
TheLegalist.com
Incorporating gives the ability to take advantage of:� Business deductions� Lower tax rates� Tax planning
Roman Fichman Esq
TheLegalist.comby by by by SlightlynorthSlightlynorthSlightlynorthSlightlynorth
Incorporating allows you to:
� Safely enter into contracts
� Open bank account, get credit
� Get investors
� Have employees
� Formalize the relationship with your partners
� Secure intellectual property
� Instill confidence with your customers
� Sell the Business
Roman Fichman Esq
TheLegalist.com
By Roman Fichman
Generally, incorporation should occur sooner rather than later. You should incorporate if:
� Your business is already up and running� You are about to sign a contract or enter into some sort of an obligation� You are exposing yourself through your business activities to the world� You are creating intellectual property� You are actively cooperating with partners / future co-founders� You need to hire employees� You need to raise capital
Roman Fichman Esq
TheLegalist.com
The alphabet soup of formation: “C” vs. “S” vs. “LLC” vs. “LLP”The alphabet soup of formation: “C” vs. “S” vs. “LLC” vs. “LLP”The alphabet soup of formation: “C” vs. “S” vs. “LLC” vs. “LLP”The alphabet soup of formation: “C” vs. “S” vs. “LLC” vs. “LLP”
� Sole proprietorship
� Partnership
� Corporation
� Limited Liability Company
Roman Fichman Esq
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� YOU are the businesstherefore, you are personally liable
� Can operate under a name other your own name but need to file an assumed name certificate
� The business income is recorded on your personal income tax return
� You pay unincorporated business tax (UBT)
� need to probate upon death
OK for hobbies or for innocuous endeavors that yield insignificant yearly income.
Roman Fichman Esq
TheLegalist.com
�No formalities required. Can come into existence merely by cooperating with someone.�Can operate under a name but need to register�Need to obtain a tax ID�No liability protection, pass-through tax and subject to UBT tax�Exists only while the original set of partners are together.
Roman Fichman Esq
TheLegalist.com
The Good� Separate legal entity� Limited liability� Perpetual� Separation of ownership from management� Fringe benefits (incentive stock options, business deductions)
The Bad� Corporate formalities must be observed� Risk of undercapitalization� May present challenging tax issues
Roman Fichman Esq
TheLegalist.com
The good
� Pass through taxation
� Simple capital structure – only one class of shares
� Simple management structure – shareholders vote according to their % of ownership
The bad
� Can't have more than 100 shareholders.
� Can't have a nonresident alien as a shareholder.
� Can't have more than one class of shares.
� Can't have a shareholder who is not an individual (except an estate, certain trusts or a “S” corp that wholly owns another “S” corp).
� Must be careful not to co-mingle personal assets with corporate assets
� In NYC “S” corps are subject to the General Corporation Tax.� Investors shy away from “S” corps.
Note: Subchapter “S” needs to be elected, otherwise the default is a “C” Corporation
Roman Fichman Esq
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The Good� Flexible capital structure – many classes of shares� Flexible management structure – can be run by a board, officers and/or the shareholders
� Easiest and most familiar form to investors� Clear rules on corporate veil piercing� Can easily get acquired or go public
The Bad� Double Taxation: The Corporation is taxed on profits before dividend distribution to the shareholders which is also taxed
� Sarbane-Oxley and director liability� Formalities must be observed.
Roman Fichman Esq
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Very flexible entity but with flexibility comes complexity
� Hybrid form of Partnership / Corporation
� Members own a “member interest” not shares
� Pass-through tax treatment
� Members share profits and losses
� Profit and loss are allocated by agreement and can be different than membership interest
� Members and Managers have limited liability. (investors can participate in
management without losing their liability protection)
� Flexible capital structure – can have preferred classes of “membership interests”
� Flexible management structure - managers can operate like a corporation’s board of
directors and have different classes of managers
� Under new IRS rules a LLC can elect to be taxed either as a partnership or as a
corporation
� LLC can own 100% of the shares of a corporation
� In NY LLCs have to publish their formation
� In NYC LLCs are subject to the UBT
� Members who are also managers may be subject to self employment taxes on profits
� A one member LLC is taxed as a sole proprietorship
Roman Fichman Esq
TheLegalist.com
P.C. – Professional Corporation
PLLC – Professional Limited Liability Company
� Doctors, chiropractors, lawyers, accountants, architects, engineers etc.
� In New York and some other states all the shareholders / directors / members must have a license and the same type of license
� Generally, the state licensing department must approve the entity before formation documents can be filed with the secretary of state.
Roman Fichman Esq
TheLegalist.com
Why choose Delaware?
� Very well developed body of corporate law and no jury decisions.
� Often the annual franchise tax is lower (yearly tax on the shares the corporation issued)
� One person can be the sole officer, director and shareholder of a company
� No corporate taxes for non-resident companies
� Privacy – shareholder information is kept private
� Any attorney can represent a Delaware company (no need to be admitted in Delaware)
Why not choose Delaware
� You still need to file a foreign entity certificate in New York
� You still need to pay corporate taxes in the state where you are conducting business
� Any legal disputes might lead you to court in Delaware which could be geographically inconvenient
Why choose New York
� Because that’s the state where you conduct your business
� New York also allows one person to act as the sole shareholder, director and officer
� Privacy – shareholder information is kept private
Why not choose New York
� Ten largest shareholders of a private corporation are personally liable for wages of any of its
employees
Roman Fichman Esq
TheLegalist.com
TypeTypeTypeType AreAreAreAre shareholders and shareholders and shareholders and shareholders and investors personally liable?investors personally liable?investors personally liable?investors personally liable? How are taxes paid?How are taxes paid?How are taxes paid?How are taxes paid?
Sole Proprietorship Yes. Business income/profits / losses "pass through" to the “owner “and are reported on the sole proprietor's personal income tax return.
General Partnership Yes. Business income/profits / losses "pass through" to the partners and are reported on the general partners' personal income tax returns. Note that a partnership will need to file an informational tax return with the IRS.
Limited Partnership A limited partner is not personally liable unless the limited partner is active in the management of the partnership.Note that a limited partnership must have at least one general partner who is personally liable for the business debts and obligations of the partnership.
Business income/profits "pass through" to the partners and are reported on the general and limited partners' personal income tax returns. The limited partnership will need to file an informational tax return with the IRS.
Corporation No.
Note that the shareholders must confirm to proper corporate practices, not to comingle assets & affairs, properly capitalize to maintain the “corporate veil”
A "C" corporation is taxed on its profits before dividends are distributed to the shareholders. The shareholders are then taxed on their dividends (this is known as double taxation).An "S" corporation is not subject to double taxation. The profits or losses "pass through" to the shareholders who report them on their individual tax returns.
Limited Liability Company No . In some states members may be personally liable up to the extent of their capital investment in the Company.
Members must confirm to proper corporate practices, not to comingle assets & affairs, properly capitalize to maintain the “corporate veil”
Business income/profits / losses "pass through" to the members of the limited liability company and are reported on their individual income tax returns. A LLC will need to file an informational tax return with the IRS. Also note that a LLC can elect to be taxed as a corporation.
SUMMARY: LIABILITY & TAXES
Roman Fichman Esq
TheLegalist.com
Type of EntityType of EntityType of EntityType of Entity AdvantagesAdvantagesAdvantagesAdvantages DisadvantagesDisadvantagesDisadvantagesDisadvantages
Sole Proprietorship SimpleSole Proprietor reports profit or loss on his/her personal tax return.
Sole Proprietor personally liable.No tax benefits.
General Partnership Simple and inexpensive to createPartners report their share of profit or loss on their personal tax returns
Partners personally liable for business debtsCan be created merely by cooperating with others
Limited Partnership Limited partners have limited personal liability for business debts as long as they don't participate in the management of thepartnership.
General partners personally liable for business debts.Suitable mainly for investment companies such as venture capital firms, private equity etc.
Limited Liability Partnership Mostly of interest to licensed professions such as lawyers, doctors, accountants etc.Partners aren't personally liable for the malpractice of other partnersPartners report their share of profit or loss on their personal tax returns
Partners remain personally liable for many types of business obligationsOften limited to licensed professions.
“S” Corporation Owners/shareholders have limited personal liability for business affairs.Simple capital and management structures.Owners report their share of corporate profit or loss on their personal tax returns and can use losses to offset other income.
Limited number of shareholders. Non-resident aliens cannot be shareholders.Only one class of shares.Income must be allocated to shareholders according to their ownership interests
“C” Corporation Shareholders have limited personal liability for business affairs.Very flexible capital, corporate and management structuresFringe benefits can be deducted as business expense.Owners can split corporate profit among the owners and the corporation to lower taxes.
Can be expensive to maintain (each outstanding share costs money)Paperwork can be burdensomeDouble Taxation
Professional Corporation Shareholders do not have personal liability for malpractice of other shareholders.All the other benefits of a corporation
Generally, all shareholders must belong to the same profession.Could be subject to the “qualified personal service corporations" flat federal income tax rate of 35%.
Nonprofit Corporation Contributions to charitable corporation are tax-deductibleThe corporation does not pay taxesFringe benefits can be deducted as business expense
Full tax advantages available only to groups organized for charitable, scientific, educational, literary or religious purposesProperty transferred to a non-profit corporation must remain there andupon dissolution must be transferred to another non-profit.
Limited Liability Company Very flexible.Members have limited personal liability for business affairsProfit and loss can be allocated differently than ownership interests.LLCs can elect to be taxed as a partnership or corporation
Flexibility can result in a very complicated entity.Members are personally liable to the extent of their capital investmentSubject to the UBT.
Professional Limited Liability Company
Similar advantages as a regular limited liability company but for licensed professionals.
Generally, all members must belong to the same profession.Similar caveats to a regular LLC.
The pros and cons of sole proprietorships, Corporations, Partnerships and LLCs
Roman Fichman Esq
TheLegalist.com
