Kenneth Carroll: Utah Business Entity

Business entities are organizations formed by one or more persons. Since they are formed at the state level, they must comply with state laws. In most states, a business owner is required to file documents with a particular state agency, like the office of the Secretary of State, in order to legally set up their business. Business entity and legal entity are used interchangeably. A legal entity is distinct from a natural person. A legal entity is recognized by a government. It can enter contracts in its own name. A legal entity can sue and be sued. It can maintain bank accounts and buy insurance. In short, a legal entity can usually conduct all the commercial activity that an individual can.

Sole Proprietorship

This is a business run by one individual for his or her own benefit. It is the simplest form of business organization. Proprietorships have no existence apart from the owners. The liabilities associated with the business are the personal liabilities of the owner, and the business terminates upon the proprietor’s death. The proprietor undertakes the risks of the business to the extent of his/her assets, whether used in the business or personally owned. Single proprietors include professional people, service providers, and retailers who are “in business for themselves.” Although a sole proprietorship is not a separate legal entity from its owner, it is a separate entity for accounting purposes. Financial activities of the business (e.g., receipt of fees) are maintained separately from the person’s personal financial activities (e.g., house payment).

Partnerships-General and Limited

A general partnership is an agreement, expressed or implied, between two or more persons who join together to carry on a business venture for profit. Each partner contributes money, property, labor, or skill; each shares in the profits and losses of the business; and each has unlimited personal liability for the debts of the business. Limited partnerships limit the personal liability of individual partners for the debts of the business according to the amount they have invested. Partners must file a certificate of limited partnership with state authorities.

Limited Liability Company (LLC)

An LLC is a hybrid between a partnership and a corporation. Members of an LLC have operational flexibility and income benefits similar to a partnership but also have limited liability exposure. While this seems very similar to a limited partnership, there are significant legal and statutory differences. Consultation with an attorney to determine the best entity is recommended.

Corporation

A corporation is a legal entity, operating under state law, whose scope of activity and name are restricted by its charter. Articles of incorporation must be filed with the state to establish a corporation. Stockholders’ are protected from liability and those stockholders who are also employees may be able to take advantage of some tax-free benefits, such as health insurance. There is double taxation with a C corporation, first through taxes on profits and second on taxes on stockholder dividends (as capital gains).

Small Business Corporation (S-Corporation)

Subchapter S-corporations are special closed corporations (limits exist on the number of members) created to provide small corporations with a tax advantage, if IRS Code requirements are met. Corporate taxes are waived and reported by the owners on their individual federal income tax returns, avoiding the “double taxation” of regular corporations.

What Are ‘Disregarded’ Business Entities?

Business entities are often subject to taxation, so the business owners must file a tax return for those businesses. Often, the owner of a single-member limited liability company or a sole proprietorship only needs to file a single tax return. In this case, the business entity and the count as one and the same. Also, the IRS “disregards” those business entities because the owner only needs to report their personal income and deductions. When the business owner files their taxes, they will report their business expenses and income on a Schedule C form along with their personal Form 1040. Alternatively, a one-member business could be treated as a separate entity. If the owner of the business chooses to go that route, they will have to fill out a Form 8832 to declare an Entity Classification Election and file the form with the IRS. Unless the owner of the sole proprietorship or single-person LLC files the Form 8832 for their business, that business entity will fall into the default classification of a disregarded entity.

How to Choose Business Entities

Once you know where you want to register your business, you must choose your type of legal entity. While legal entities are not quite like ordering food off a menu after you choose the restaurant, you do have options.

Cost of Incorporation

Registering a legal entity costs money: sometimes a little; sometimes a lot. Costs include the filing fee, renewal fees, professional fees, and franchise taxes. These are direct cost.

• Filing fees: Every jurisdiction imposes a filing fee. Fees change frequently. There are often fees for particular kinds of filings. Fees might also vary by type of entity. Review the fees for your jurisdiction and entity type carefully.

• Renewal fees: Registering a company is not a onetime event. You must renew the registration to keep it current. Not all registration renewals are annual. Some jurisdictions do not require renewal for several years. Simply do the math to annualize registration fees to compare them from jurisdiction to jurisdiction or entity type to entity type.

• Professional fees: There are three types of professionals you may need to pay: lawyer, accountant, and registered agent. Legal fees for incorporation can be modest or breathtaking. Business lawyers should be able to tell you about the costs for incorporation in your jurisdiction before starting any work. Legal fees can rise quickly to cover complexities beyond the registration. Fees for accountants follow a similar pattern.

Providing initial tax advice and setting up your accounting might be one cost, but getting help with complex asset transfers, foreign accounts, and the like, can quickly raise the costs. Good legal and accounting advice early in the process is money well spent. Registered agents, sometimes called “local agents”, are people or companies that are empowered to accept legal notices on behalf of the business. The registered agent address is published to the world. While you can often be your own registered agent in your own jurisdiction, you might choose to use a registered agent so that any legal notices do not get mishandled.

• Franchise tax: Not all jurisdictions impose a franchise tax, but many do. A franchise tax is basically a tax on the business’ balance sheet. It might be tied to assets or to net worth. The idea is that your registration and renewal fees are determined in part by the assets of the business. If the entity operates an “asset light” business, like consulting, then the franchise tax might be low for a long time. However, for an asset intensive business with equipment, real estate, or large cash balances, the franchise tax will be a material consideration. This is an area where good accounting advice about recording the value of your assets is helpful.

Ease of Incorporation

It is not difficult or time consuming to incorporate many entities in jurisdictions that encourage incorporation. The time and effort, however, can vary. Your local lawyer will have the most accurate estimate, but there several factors to consider: total time, number of steps, incorporator requirements, minimum capital required, and the number and type of investors.You can use the World Bank data on business entity formation to get benchmarks to help you estimate. While the World Bank data includes some sub national jurisdictions, like states in India, it does not include any data for individual states in the United States. You cannot compare Delaware to California and New York, for example.

Management Requirements

Some jurisdictions and entity types require named officers or certain board structures. You can often satisfy those compliance requirements without interfering with your management plan for operating the business. For example, if you must name a President and Secretary as authorized signers and you have a co-founder, then one of you can serve one role while the other serves the other function. This choice does not necessarily have any effect on the management team you put in place. Some jurisdictions also impose a dual board structure where one board is charged with governance matters and the other is the operational management board. Before chasing a dual board structure, make sure that it is required in your jurisdiction for your size and type of business.

Tax and Financial Objectives

One of the most important factors when choosing a legal entity is the tax treatment of that entity’s income. The place to start is the financial objective for the business: current income or growth. Of course, everyone wants both income and growth, but it is a question of priority and scale.

Types of taxes

Jurisdictions may impose one or more of the following taxes: personal income, business income, franchise, property, consumption, and capital gains. Incorporating a business will probably affect your personal income. It might go up or go down, depending on the choices you make and your objectives. The place of incorporation may also impose a tax on the business’ assets or net worth in the form of a franchise tax. A franchise tax is typically imposed at the time of registration and renewal by the jurisdiction where the business is registered. Jurisdiction also strongly influences property taxes. Any layer of government might impose taxes on property the business owns or acquires. If the business is asset intensive, then property taxes can influence where you decide to incorporate and operate. Consumption taxes come in two flavors: sales and use taxes (“Sales tax”) or value-added taxes (“VAT”). End consumers pay sales tax that is collected by a retailer who sends it to the taxing authority. VAT, on the other hand, is paid at each step of the supply chain. Sales and VAT regimes impose different administrative burdens on your business. Sales tax is the consumption tax used by states in the US. Finally, capital gains taxes warrant consideration. A business might generate capital gains, which are profits on the sales of things not in the ordinary course of your business, such as selling a building. But the most significant capital gains event is the sale of the business after it is wildly successful. How will the jurisdiction tax that event? As a practical matter, there might not be much choice about where to live and run the business.

International taxes

A quick word about a long, complex subject: international income taxes. If a business sells products and services across national boundaries, tax advice from a tax professional is critical. Countries tend to take either a territorial or residence approach to taxation of income earned outside the business’ home countries. The territorial system only taxes income earned within the country. The residence system taxes income earned globally for every company residing in the territory.

So knowing where your customers are and how you will reach them can affect your income tax bill and therefore the financial success of your business, and ultimately where you decide to incorporate your business.

Business Entity Compliance and Maintenance

Forming a business is a onetime event that creates a long string of maintenance tasks for as long as the entity is a going concern. Limiting liability and asset protection are primary objectives for forming a business entity. Maintenance preserves those benefits. Without careful maintenance of the legal entity, it might not provide protection when it is needed most.

Over time things change for every business entity. Those changes are easily filed and forgotten. To keep in compliance and reduce risk from legal entity management, there are five buckets of information to track: entity summary data, company documents, filing requirements, officers and directors, and owners.

Considerations for deciding the most suitable business entity

• Sole Proprietorship: In this situation, one owns the business oneself and can reap whatever financial benefits come from it. One can make decisions on one’s own and guide the growth of the business without having to consult with any other entity. This also means that no other employee will ever have the chance to have own stocks. This may sound pretty good. But be aware that with a sole proprietorship, there is no distinction between one’s business life and one’s personal life as far as taxes and other financial obligations are concerned. As far as the government is concerned, proprietor and the firm are one and the same. This could have negative repercussions on the proprietor. Moreover, as a sole proprietor, one’s business will exist only as long as one continues to own it.

• Partnership: In the same way as a sole proprietorship, a partnership draws no financial distinction between a partner’s personal and business finances. There are also inherent risks in partnerships. It is important to draft a “partnership agreement” to outline what happens if there is a disagreement among partners, if one wants to end the partnership, if one of the partners dies, etc.

• Limited Liability Company : LLC’s are extremely flexible, and can be used for a very wide range of businesses. The members (equivalent to shareholders or partners) can, but need not, have limited liability; can, but need not have, managers (equivalent to directors and officers) and can elect to be taxed either as corporations, or as partners (if they have two or more members) or be disregarded for tax purposes like a sole proprietorship.

• Business Corporation: Becoming “incorporated” brings with it many advantages. Your business becomes a separated entity (from you) and is chartered by the state in which it is located. This means that your business can enter into contracts, it pays taxes of its own, it can be sued. The owner becomes a shareholder and has the option to sell the business if things don’t work out for continued ownership. The negative piece of this option is that it is more expensive than the others and takes a bit more time. It is subject to much more compliance as compared to a Sole Proprietorship or Partnership or Limited Liability Company.