Business Formation

A business can be set up in various ways, such as sole proprietorship, partnership, limited liability company (LLC), corporation. When starting a new business, selecting the right business entity type is important. Below are the three most common and popular forms of business, all provide limited liability for its owners.

Corporation:

Generally, corporation is a legal entity which exists separately and distinctly from its owners. Corporation normally shields the owners from personal liability.

In the U.S., corporations are formed under state laws, therefore, the procedures of setting a business vary by state. Most corporations form in the state where the business will be primarily operated or in the state of Delaware because of its business-friendly laws. Here are some general steps to form a corporation:

• Choose and register an available business name.
• Draft and file Articles of Incorporation (also called “certificate of incorporation” or “charter” in some states) with Secretary of State according to the laws of that state and pay a filing fee.
• Appoint the initial directors of the corporation.
• Issue stock certificates to the initial shareholders of the corporation.
• Apply for a Federal Employer Identification Number (FEIN) for taxing filing and reporting purpose.
• Obtain a business license, permit, or any other certificates specific to the business (if necessary).

A Corporation can be set up as a C Corporation or an S Corporation.

C Corporation:

A C corporation is a corporation that is taxed separately from its owners or shareholders.

Advantages of a C corporation:

• Limited liability: The directors, shareholders, officers, and employees of a C corporation have limited liability towards business debts, and their personal assets will not be used to satisfy the liabilities of the C corporation.
• Perpetual existence: Death, leave, or bankruptcy of an owner has no institutional effect on the C corporation. Unlimited ownership: In a C corporation, there can be an unlimited number of shareholders.
• Unlimited growth potential: The C corporation can raise additional funds by selling stocks if the corporation need finances for expansion.
• Ease of transferability: The owners and the shareholders can transfer their shares to other individuals.
• Flexible capital structure: The owner of a C corporation can issue multiple classes of stocks to different shareholders. Different classes of the stocks have their own advantages to attract different groups of investors.
• No residency requirement: Foreign nationals can own or invest in a C corporation. This lets diverse investors participate in the business, and allows foreign money to flow in for investment.

Disadvantages of a C corporation:

• Double taxation: The C corporation pays income tax on its earnings; when the corporation issues dividends to the shareholders, the shareholder dividends are subject to income tax.
• Costs: There are several types of fees to incorporating a C corporation, such as a fee to file the articles of incorporation with the Secretary of State, fees for various governmental filings, a first-year franchise tax prepayment, and legal fees. After the corporation set up, there are costs for filing of annual report and payments of annual fees.
• Formalities and regulations: To form a C corporation, the Article of Incorporation needs to be drafted in accordance with statutory requirements. If the corporation intend to operate in any state other than where it incorporated, the qualification to do business there is required too. A C corporation usually has more government oversight than other companies due to the complex tax rules and the protection provided to owners and shareholders from being personally responsible for debts and other financial obligations.
• Complicated maintenance: A C corporation is required to have at least one meeting each year for both shareholders and directors, or has taken action by formal written consent in lieu of meetings. Minutes and records must be maintained for transparency in business operations.

S Corporation:

S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.

Advantages of an S corporation:

• Limited liability: The directors, shareholders, officers, and employees of a S corporation have a limited liability towards business debts, and their personal assets will not be used to satisfy the liabilities of the S corporation.
• Elimination of double taxation of income: S corporations are pass-through tax entities. The income tax is not paid at the corporate level but at the individual level. Income is not taxed twice as in a C corporation.
• Perpetual existence: Death, leave, or bankruptcy of an owner has no institutional effect on the S corporation.
• Deduction of corporate losses: The owners of a S corporation can deduct their business losses on their personal tax returns.

Disadvantages of an S corporation:

• Residency requirement: S corporation shareholders must be either U.S. citizens or lawful permanent residents.
• Limited ownership: An S corporation may not have more than 100 shareholders, and all shareholders must agree to type S corporation.
• Limited stock flexibility: In an S corporation, only one class of stock can be issued, which may make it harder to attract investors and incentivize early owners.
• Tax qualification obligations: In general, an S corporation experience more close IRS scrutiny. Any mistakes regarding the various filing requirements can result in the termination of S corporation status and be taxed as a C corporation.

Limited Liability Company (LLC):

A limited liability company is a legal entity whereby the members of the company are prevented from personal liability for the company’s debts and liabilities. This business structure allowed by state statute and may use different state regulations.

Advantages of a LLC:

• Limited liability: Forming an LLC gives managers and members limited liability for business debts and liabilities.
• Tax flexibility: The LLC can determine the way to be taxed. It can pass through taxation like a partnership or be taxed like a corporation.
• Less paperwork and requirement for compliance: Compared with C corporations or S Corporations, LLCs are very flexible and easier to form and keep in good legal standing.
• No residency requirement: Those who creating an LLC need not be U.S. citizens or lawful permanent residents.

Disadvantages of a LLC:

• Limited growth potential: LLC owners cannot issue shares of stock to attract investors.
• Fees: In some states, including California, an extra fee is charged for operating an LLC.
• Restricted transferability: Unless the articles of organization or operating agreement provide otherwise, a member cannot transfer membership rights freely without the consent of all members. However, the member may assign or transfer financial rights.
• Complicated departure process: the process of departing from an LLC is much more complicated than leaving a corporation. The remaining members have to adjust the business ownership percentages, assign the value of the departing member’s share, and document the departure in writing.
• Lack of uniformity: An LLC can be treated differently pursuant to applicable state laws.
• Personal liability for payroll taxes: The owners of an LLC that is taxed as a single-member LLC or as a partnership can be personally liable for payroll taxes that are not paid by the company.
• Self-employment tax (social security and medicare tax): Unless you choose to be taxed like a corporation, a LLC is usually subject to self-employment taxes. The earnings of the LLC will not be taxed at the corporate level, but will pass through to individual level. Oftentimes, these taxes are higher than they would be at the corporate level.

Comparison Table:

DISSOLVING A BUSINESS

Before you can dissolve your corporation or LLC, you will need to finish up your corporation by liquidating assets, collecting accounts receivables, and using these proceeds to pay off your corporation’s tax liabilities and corporate debts.

Serve all of your creditors and shareholders with a Notice of Dissolution to give them the notice. Publication of the notice of dissolution in a local newspaper may also be required.

Assuming that your corporation had employees, the final payroll tax and employment tax must be filed in a reasonable amount of time. If your corporation fails to pay its payroll taxes, the IRS can hold your shareholders personally liable and satisfy the corporation’s tax liability.

Your corporation must then file a final income tax return with the IRS and the state indicating that it will be the final return filed by your corporation. It is recommended that you keep all of your corporation’s tax documents for at least 7 years.

After the DISSOLUTION is filed with the State, all of your corporation’s legal rights and privileges are terminated, and your business’ name will then be available for others to claim.

Call Law Office of Tricia Wang at 510-791-0232 or send us an email at tricia@wangslaw.com to schedule an initial consultation with our lawyer if you are thinking about starting a C-corp, S-corp or LLC in California, or if you need help to properly close your California business.

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