In part 2, we explored some methods to limit liability for your business with limited partnerships and limited liability companies. In Part 3, we will explore Corporations and tax considerations in business formation.
The Corporation, according to Black’s Law Dictionary, is an entity having authority under law to act as a single person distinct from shareholders who own it and having rights to issue stock and exist indefinitely; a group or succession of persons established in accordance with legal rules into a legal or juristic person that has a legal personality distinct from the natural persons who make it up, exists indefinitely apart from them, and has the legal powers that its constitution gives it. A corporation is an artificial being, invisible, intangible, and existing only in contemplation of the law…[I]t possesses only those properties which the charter of its creation confers upon it.
The Corporation is an entity that works well to protect personal assets, if it is formed and operated correctly. The drawback to the corporation is that it has more formal procedures than a Limited Liability Company (LLC), but it is also often better for the business owner, depending on their individual needs. Sometimes it is required where the Limited Liability Company is not permitted, and sometimes it is better for tax purposes or even marketing purposes, or maybe it is as simple as the business owner likes the name better (Acme, LLC vs Acme, Inc.).
If we revisit Bert & Ernie with Disney’s fall caused by Ernie negligently spilling the butter and failing to clean it, both Bert and Ernie’s personal property would be safe from a lawsuit unless Disney was able to pierce the corporate veil. If the corporation were formed and operated properly, it would be unlikely that Disney could get to the personal assets of Bert or Ernie.
This information applies to forming either a Corporation or a Limited Liability Company.
I see a lot of advertising for “Incorporate here, not there” primarily encouraging people to incorporate in Nevada, Wyoming, or Delaware. Often the advertising pushes that Nevada and Wyoming do not have state income taxes. Please note, that where you conduct your business, you will be liable for those state’s income taxes. If you live in Missouri (or any other state that has a state income tax), and you incorporate in Wyoming, and all (or most) of your business is conducted in Missouri (or any other state that has a state income tax), guess what, you still have to pay those state income taxes and despite your formation in a tax-free state, it does not change your tax liability.
In addition to not really saving on income taxes, you will also be required to pay annual fees to the state you incorporate in (i.e. Wyoming) in addition to the state(s) you do business in. This means that it will cost you the additional $100 per year to the Wyoming Secretary of State (or more in Nevada and Delaware) plus the fee for a Registered Agent in Wyoming (or whatever state you form your corporation) PLUS the fee to the Secretary of State (or equivalent in your state) that will cost you an additional $300-500 per year. In total, you will pay approximately $400-1,000 per year in additional costs than if you incorporate in your home state. Some states also have additional minimum tax fees for a Limited Liability Company and a Corporation, that would be required to be paid, even if you did not make any money, nor do any business in that state.
These states (Nevada, Wyoming, and Delaware) may offer a little more protections (and privacy) that rarely come into play, but I would guess if it did, you would be thankful that you incorporated in one of those states. For most people, they do not find the additional expenses necessary and they choose to simply incorporate in their home state.
I have recently expanded my law firm into new states and incorporated into a Wyoming Professional Corporation. I have chosen to incorporate in Wyoming because of the protections afforded by Incorporating in Wyoming because I will also be doing business in Wyoming. If I was not going to be doing business in Wyoming, I likely would not have opted to spend the additional $350 it will cost per year.
Most of us have to pay a state income tax, and all of us are responsible for a federal income tax. The two most common questions when it comes to business corporations is the difference between a C-Corporation and an S-Corporation.
I want to be clear, both Corporations are formed, operated, and appear exactly the same with minor differences. That biggest difference is the limit on shares of the S-Corporation (or Limited Liability Company). There is a maximum of 100,000 single-class shares (or units for a Limited Liability Company) and a maximum of 100 shareholders (or members for a Limited Liability Company). This means that all of the shares (or units) are exactly the same with the same ownership interest, same dividends, and same voting rights. This can be true of a C-Corporation as well, but with the S-Corporation it is required by the IRS to qualify as an S-Corporation.
So if a C-Corporation and an S-Corporation both have 100,000 of a single class of stock, and less than 100 shareholders, what is the difference? The only difference is an additional form filed with the IRS to change how the Corporation (or Company) is taxed.
The Subchapter S within the IRS allows the income of the Corporation to flow through to the shareholders on an individual basis. This avoids what is commonly referred to as double-taxation where a corporation pays income taxes, then issues dividends to shareholders causing the shareholder to also pay an income tax on the dividends. With an S-Corporation the income of the corporation flows to the shareholders automatically to avoid the double-taxation.
I would always advise speaking to a licensed attorney to ensure you properly form your business and to ensure you meet the continued requirements of operating your business.