FREQUENTLY ASKED QUESTIONS
BUSINESS ORGANIZATIONS
SOLE PROPRIETORSHIPS
What exactly is a sole proprietorship?
Simply put, a sole proprietorship is a business venture with a single owner and no liability protection. A sole proprietorship does not require registration with the state, unlike a limited liability company (LLC) or a corporation (Corp). Starting a sole proprietorship requires no paperwork - all you do to create a sole proprietorship is simply go into business.
Although paperwork is not required, you will need business licenses and permits just like any other form of business. Most sole proprietorships use the term “doing business as” or “DBA” to market themselves as any other form of business. While South Carolina does not register DBAs, businesses may still choose to use a DBA, so long as business transactions are processed in the proper and legal name of the business.
How is a sole proprietorship different from other forms of organizations?
The following are some of the ways a sole proprietorship differs from other forms of organizations:
How are sole proprietorships treated for tax purposes?
Unlike corporations, sole proprietorships are treated as pass-through, and not separate, entities by the IRS. This means that any profit derived from a sole proprietorship is treated as personal income and is accounted for on individual tax returns.
Am I shielded from personal liability under a sole proprietorship?
No. Unlike other forms of organization, the sole proprietor is personally liable for any debt or claims arising out of the sole proprietorship's business. Significantly, this places the owner's personal assets at risk to satisfy debts owed by the business. This includes homes, cars, etc. This makes a sole proprietorship the simplest, the least expensive and the riskiest.
PARTNERSHIPS
What is a partnership?
A partnership is an association of two or more persons who carry on as co-owners and share profits proportionately. Partners can contribute capital or services in return for a share of the profits.
What are the different types of partnerships?
While there are four types of partnerships (general partnerships (GPs), limited partnerships (LPs), limited liability limited partnerships (LLLPs) and joint ventures (JVs)) the most common are general and limited.
In a general partnership, the partners divide management responsibilities as well as profits equally.
A joint venture is a general partnership in which the partners agree to "co-venture" for a limited period of time or for a specific project.
Limited partnerships have two types of partners, general and limited. General partners maintain an active role in the management of the business. Whereas limited partners merely invest money and have a very limited role in management, if any at all. Limited partners are in essence passive investors whose liability is limited to their initial investment. Typically, given their unique nature, limited partnerships have more formal requirements for formation than the other two types of partnerships.
Limited liability limited partnerships have the character of a limited partnership but are registered with the state in order to establish the foundation for the limitation on liability, and the operations of an LLLP are typically reduced to a formal writing in the form of a partnership agreement.
How is a partnership formed?
Generally, the formalities of registration are not required for the creation of a general partnership business relationship. Therefore, even if there is nothing in writing, a partnership may exist between individuals who have agreed to share in a business venture.
If two or more individuals have agreed to share in the profits of a business venture and each individual acts as a partner, even if no partnership is intended, the relationship will likely be deemed a partnership - each partner will then be liable for the obligations of the partnership.
Even though a written partnership agreement is not required, it is always a good idea to reduce the agreement between and among the partners to a written instrument – which should prevent undue conflict as the partnership develops.
Limited partnerships must be reduced to a writing and must expressly state that the limited partners have invested money into the partnership and retain little or no control over the partnership's operations.
In order for the limitation on liability to be effective in a limited liability limited partnership, the entity must be registered with the state and must be expressed in writing.
What determines the terms of a partnership?
The most effective means of determining the relationships between the partners is to prepare a partnership agreement. However, if there is no written agreement, partners must share profits and losses equally. A duty of loyalty between and among the partners is implied in every partnership and none of the partners are allowed to enrich themselves at the expense of the partnership. Each partner, limited or general, has a right to an accounting of the businesses finances.
Do all partnership agreements need to be written?
Since partnerships may be created without a written agreement, certain terms may be set verbally. Unfortunately, verbal agreements require the intervention of a court in order to determine their details, which is costly and time consuming. Therefore, it is always best to have an attorney prepare a written instrument setting forth the details of the partnership.
What is my personal liability under a partnership?
Partners are personally liable for the business obligations of the partnership, both debts and judgments. Therefore, if the partnership has unpaid debts, or the business fails, or there are judgments against the business, then the partners are individually liable for those obligations. This means that creditors can pursue personal assets such as bank accounts, cars, and homes.
What are the differences between partnerships and corporations?
The primary differences are: 1) creditors are able to pursue the personal assets of each partner (regardless of whether liability is based on intentional malfeasance); and 2) each partnership profit is taxed as individual income.
How are taxes paid by partnerships?
Partnership taxes are paid through the personal income tax filings of each individual partner.
How do partnerships terminate?
Without a written agreement, partnerships terminate upon a notice of severance from the terminating partner to the non-terminating partner. If there is no written agreement, then the terms of separation may require legal action to finalize.
What are the benefits of a partnership?
What are the disadvantages of forming a partnership?
LIMITED LIABILITY COMPANIES
What is a limited liability company?
A limited liability company (an “LLC”) is an organization that many entrepreneurs choose since it combines the simplicity of pass-through taxation (as is found in a partnership) with the limitation on liability found in corporations.
Pass-through taxation allows profits and losses of the LLC to pass directly through to the members (owners) of the LLC as ordinary income and expenses/losses.
Members of an LLC enjoy the benefit of limited personal liability, meaning the owners are not generally held personally liable for debts, judgments and lawsuits against the LLC - although they will be held liable for torts they commit as a member of the LLC.
Do LLCs require a minimum or maximum number of members?
No. An LLC may be a single member entity or a multi-member entity.
Which businesses benefit most from being formed as an LLC?
The main reason to organize as an LLC is to shield the members from any personal liability that may arise from the business dealings of the company itself.
There are three primary situations in which an LLC (or perhaps a corporation) makes the most sense. First, if the company is engaged in activity that carries a higher than average level of risk, and therefore a greater likelihood of being sued. Second, if the enterprise is likely to carry a great deal of debt. Third, if the entity is going to require the infusion of capital in the form of money or sweat equity. Additionally, if the owner has a great deal of personal wealth which they wish to protect, an LLC is a good choice.
However, businesses engaged in banking, trust and insurance are generally prohibited from forming as an LLC.
How do I form an LLC?
In South Carolina, an LLC may be formed in person or online. At their most basic, articles will include the name of the LLC, the location of the main office, the name of the organizer (who does not need to be a member) and the name of the LLC's registered agent.
Must I use a lawyer to form an LLC?
In general no, you will not need a lawyer to form an LLC in South Carolina. Business owners are allowed to form LLCs simply by filing the articles of organization with the South Carolina Secretary of State. However, if you are not sure which entity to form, you should consult an experienced business attorney. Additionally, if the LLC is a multi-member LLC, the members will need an operating agreement before starting operations and consulting a lawyer before entering into such agreement is advisable.
Do I need an operating agreement?
An operating agreement is not required, and in the case of a single member LLC it would likely be superfluous. However, in the case of a multi-member LLC an operating agreement is strongly advised.
The following are reasons why an operating agreement is necessary:
How is an LLC taxed?
Unless its members choose to be taxed as a corporation, an LLC is not considered a separate tax entity. Therefore, the taxes pass-through to the owners of the business (much the same as sole proprietorships and partnerships). The members/owners of an LLC will pay taxes on their share of the profits on their personal tax returns.
However, LLCs may elect to be taxed like corporations. You should consult with your CPA before taking any such tax election.
What are there differences between a limited liability company and a partnership?
An LLC, unlike a partnership, provides limited liability to the owners/members of the LLC for the business' liabilities (including debts and judgments). Therefore, if there is a judgment against the LLC, or if a creditor is seeking payment from the LLC, then the creditors cannot satisfy their claims with the personal assets of the members.
Additionally, LLCs must be formed through registration with the state. Whereas, a partnership exists the moment its partners enter into a co-venture with shared profits.
Can an organization convert from one type to another?
Yes. Organizations can convert from one type to another with relative ease. However, the conversions require planning and will often require an attorney. The owners should plan for the implications the conversion will have on taxes, licenses and permits. Most entities should take several weeks to prepare and implement their conversion plan.
Do the state and/or federal securities laws effect LLCs?
If the LLC is a single member LLC, then the state and federal securities laws will have no effect. However, if the LLC is a multi-member LLC, then there will need to be an understanding of how, when and where new members can be solicited. The best choice is to use an experienced attorney to form and advise the members with respect to expansion of the company and acquiring new investment.
The majority of small businesses that form as LLCs qualify for the securities law exemption, even if they sell ownership interests to non-managing members as investors.
You can learn more about SEC exemptions by visiting: http://www.sec.gov
CORPORATIONS
What is a corporation?
Unlike a partnership, and in most cases an LLC, a corporation stands by itself as its own legal entity. Therefore, a corporation is legally separate from its owners, as well as from those who make decisions about the business. Corporations are treated as “persons” that can form and enter into contracts, incur debt and pay its own taxes.
Some other differences between corporations and other entities are: a corporation survives the death or divestment of its owners or shareholders; the owners enjoy limited liability; the owners are not taxed on their profits as if they are ordinary income.
Why is a limitation on liability important?
Investors seek “limited liability” so they can take a risk on a new venture without the fear of being held accountable for the liabilities which may result therefrom. However, to maintain this limited liability the owners of the corporation must ensure that the business complies with certain corporate formalities, and maintains adequate funding for the maintenance of corporate liabilities (insurance, payroll, etc.)
The limitation on liability is often the number one concern of entrepreneurs who are starting a business, and as significant as that limitation may be, it is important to review the pros and cons of incorporation vs. the other forms of organization before making any decisions.
How are corporations different from sole proprietorships, partnerships and LLCs?
Naturally, with respect to sole proprietorships and partnerships generally, the limitation on liability is the corporations most obvious distinguishing feature (see above). However, ownership is what truly distinguishes corporations from all other forms of organization. A corporation is held in units called shares. Said shares are issued by the corporation in various denominations, and may be increased in volume by the corporation.
Small businesses need to understanding how a corporation is taxed in order to determine which entity is best suited to the needs of the owners. A corporation's taxable income is calculated by as profits left once salaries, bonuses, overhead and other expenses are paid out. In contrast, the profits of LLCs, partnerships and sole proprietorships are passed through to the owners of those businesses, making the profits taxable as personal income to the owners.
What are the benefits of forming a corporation?
The up-front costs and efforts of forming a corporation are higher than those for the other forms of organizations. However, there are a number of reasons why forming a corporation may benefit small business owners:
How do I form a corporation?
In South Carolina you will need an attorney for the filing. A simple filing may be handled by mail. However, if the business is going to have more than one owner, employees, more than one class of shares, then a more comprehensive filing, likely online, will be necessary.
The South Carolina state filing fee for articles of incorporation is $125.00 (includes online filing fee), plus $25.00 for the CL-1. The articles of incorporation must generally include:
Do corporations require more paperwork than registration with the state?
Yes. Since corporations have a more complex structure than other forms or organization, the corporation will need a set of by-laws to set forth the requirements of the directors, officers, shareholders, etc. Additionally, the state code requires a corporation to meet and provide shareholders with notice and to keep them informed of significant developments effecting the business. These meetings will need to be announced and minutes will need to be kept. This will require detailed documentation and record keeping.
Is corporate income taxed differently than other types of income?
Yes. The owners of a corporation only pay taxes on salaries, bonuses and/or dividends that the owners are paid in return for their services to the business. The corporation itself will owe taxes on any profits in the corporation from year to year.
In an s-type corporation the owners of the corporation elect to be taxed as if the business was a partnership. Under an s-type corporation all of the business profits pass-through to the business owners. Each owner will then report these profits as income on their personal tax returns.
Does the income to owners of a corporation get taxed twice?
Double taxation only applies to income that is paid out to owners in the form of dividends. A dividend is a corporate profit that is paid by the corporation to its shareholders in return for their investment in the business. Double taxation generally only occurs when a corporation pays out money to people that do not work for the business.
Salaries and bonuses can be deducted from the corporate tax as reasonable and necessary business expenses and the corporation does not have to pay taxes on them. However, if money is paid out to people that do not work for the business, it can really only be classified as a dividend, which is then double taxed.
SALE OF OWNERSHIP (i.e., SALE OF SECURITIES)
Will the securities laws effect the decision to issue stock in a corporation or membership interests in an LLC?
Generally, securities laws provide requirements that corporations/companies must follow before accepting investment capital in exchange for shares/membership interests in the corporation/company. Typically, a corporation/company must register the sale of securities with the Securities Exchange Commission ("SEC") and the relevant state securities agency before issuing shares of stock or membership interests to the initial owners of the corporation/company.
However, if the corporation/company is a small business, and if the sale of securities is made as part of a "private placement", then the sale of corporate stock/company membership interests may be exempt from the registration process. The SEC does not ordinarily require a corporation/company to register a “private offering” (a non-advertised sale of securities to accredited/sophisticated investors) to a small number of individuals (normally fewer than 35), or to those who are accredited/sophisticated investors.
If the owners are setting up a small business with you and a few associates, you will most likely qualify for an exemption and will you not have to file paperwork for your first sale of shares/membership interests.
Further, if all of the shareholders/members will be directors/managers of the corporation/company, then no SEC filing is required at all.
NON-PROFIT CORPORATIONS
What is a non-profit corporation?
A non-profit corporation is an organization formed for a charitable, educational, religious, literary, or scientific purpose. Unlike “s” and “c” corporations, a non-profit corporation does not pay income taxes (state and federal) on profits it makes from engaging in activities related to the corporation's purpose. This tax exemption is meant to support the broad objective of serving the public.
Can I convert my for-profit corporation into a non-profit?
Since a non-profit corporation is not taxed on surplus revenue raised from activities related to the corporation's stated purpose (i.e., profits), conversion looks like a very attractive option. Unfortunately, while it would be nice to avoid paying taxes, this is an option only afforded to organizations formed for a charitable, educational, religious, literary, or scientific purpose. Additionally, non-profit organizations cannot be owned by private individuals. Therefore, while it may be possible to convert from a for-profit to a non-profit corporation in theory, this process is both risky and impracticable.
How is a non-profit corporation formed?
While the initial formation of a non-profit corporation is much the same as a conventional, for profit corporation, the similarities stop there. The articles of incorporation will require special provisions setting forth the purpose and the disposition of the corporation assets should the entity be liquidated. The IRS will then require the corporation's board of directors to file form 1023. The process is information intensive and should not be embarked upon without the counsel of an experienced attorney.
Is running a non-profit more complicated than a for-profit corporation?
Running a non-profit corporation is much the same as running a for-profit corporation. With that said, the IRS filing requirements are far more burdensome, and that demands an eye for details and accurate record keeping.
What exactly is a sole proprietorship?
Simply put, a sole proprietorship is a business venture with a single owner and no liability protection. A sole proprietorship does not require registration with the state, unlike a limited liability company (LLC) or a corporation (Corp). Starting a sole proprietorship requires no paperwork - all you do to create a sole proprietorship is simply go into business.
Although paperwork is not required, you will need business licenses and permits just like any other form of business. Most sole proprietorships use the term “doing business as” or “DBA” to market themselves as any other form of business. While South Carolina does not register DBAs, businesses may still choose to use a DBA, so long as business transactions are processed in the proper and legal name of the business.
How is a sole proprietorship different from other forms of organizations?
The following are some of the ways a sole proprietorship differs from other forms of organizations:
- Sole proprietorships are the least complex and least expensive form of business;
- Sole proprietorships are not required to file formal paperwork nor to register with the state;
- Sole proprietorships do not shield individuals from personal liability;
- Sole proprietorships are treated as individuals for tax purposes, and do not need to have separate taxes prepared
How are sole proprietorships treated for tax purposes?
Unlike corporations, sole proprietorships are treated as pass-through, and not separate, entities by the IRS. This means that any profit derived from a sole proprietorship is treated as personal income and is accounted for on individual tax returns.
Am I shielded from personal liability under a sole proprietorship?
No. Unlike other forms of organization, the sole proprietor is personally liable for any debt or claims arising out of the sole proprietorship's business. Significantly, this places the owner's personal assets at risk to satisfy debts owed by the business. This includes homes, cars, etc. This makes a sole proprietorship the simplest, the least expensive and the riskiest.
PARTNERSHIPS
What is a partnership?
A partnership is an association of two or more persons who carry on as co-owners and share profits proportionately. Partners can contribute capital or services in return for a share of the profits.
What are the different types of partnerships?
While there are four types of partnerships (general partnerships (GPs), limited partnerships (LPs), limited liability limited partnerships (LLLPs) and joint ventures (JVs)) the most common are general and limited.
In a general partnership, the partners divide management responsibilities as well as profits equally.
A joint venture is a general partnership in which the partners agree to "co-venture" for a limited period of time or for a specific project.
Limited partnerships have two types of partners, general and limited. General partners maintain an active role in the management of the business. Whereas limited partners merely invest money and have a very limited role in management, if any at all. Limited partners are in essence passive investors whose liability is limited to their initial investment. Typically, given their unique nature, limited partnerships have more formal requirements for formation than the other two types of partnerships.
Limited liability limited partnerships have the character of a limited partnership but are registered with the state in order to establish the foundation for the limitation on liability, and the operations of an LLLP are typically reduced to a formal writing in the form of a partnership agreement.
How is a partnership formed?
Generally, the formalities of registration are not required for the creation of a general partnership business relationship. Therefore, even if there is nothing in writing, a partnership may exist between individuals who have agreed to share in a business venture.
If two or more individuals have agreed to share in the profits of a business venture and each individual acts as a partner, even if no partnership is intended, the relationship will likely be deemed a partnership - each partner will then be liable for the obligations of the partnership.
Even though a written partnership agreement is not required, it is always a good idea to reduce the agreement between and among the partners to a written instrument – which should prevent undue conflict as the partnership develops.
Limited partnerships must be reduced to a writing and must expressly state that the limited partners have invested money into the partnership and retain little or no control over the partnership's operations.
In order for the limitation on liability to be effective in a limited liability limited partnership, the entity must be registered with the state and must be expressed in writing.
What determines the terms of a partnership?
The most effective means of determining the relationships between the partners is to prepare a partnership agreement. However, if there is no written agreement, partners must share profits and losses equally. A duty of loyalty between and among the partners is implied in every partnership and none of the partners are allowed to enrich themselves at the expense of the partnership. Each partner, limited or general, has a right to an accounting of the businesses finances.
Do all partnership agreements need to be written?
Since partnerships may be created without a written agreement, certain terms may be set verbally. Unfortunately, verbal agreements require the intervention of a court in order to determine their details, which is costly and time consuming. Therefore, it is always best to have an attorney prepare a written instrument setting forth the details of the partnership.
What is my personal liability under a partnership?
Partners are personally liable for the business obligations of the partnership, both debts and judgments. Therefore, if the partnership has unpaid debts, or the business fails, or there are judgments against the business, then the partners are individually liable for those obligations. This means that creditors can pursue personal assets such as bank accounts, cars, and homes.
What are the differences between partnerships and corporations?
The primary differences are: 1) creditors are able to pursue the personal assets of each partner (regardless of whether liability is based on intentional malfeasance); and 2) each partnership profit is taxed as individual income.
How are taxes paid by partnerships?
Partnership taxes are paid through the personal income tax filings of each individual partner.
How do partnerships terminate?
Without a written agreement, partnerships terminate upon a notice of severance from the terminating partner to the non-terminating partner. If there is no written agreement, then the terms of separation may require legal action to finalize.
What are the benefits of a partnership?
- They are easy to establish.
- Raising capital may be less complicated.
- Profits are paid directly to the partners, making it easier to report taxes.
- Partnerships are more agile and capable of adjusting to sudden changes in circumstances.
- Enabling employees to earn an interest in the partnership is simpler than in most forms of organization.
What are the disadvantages of forming a partnership?
- Partners face individual liability for debts and judgments.
- Partners are subject to the actions of other partners, even if consent is not obtained.
- If a partner leaves the partnership, the partnership may be terminated.
- Collective decision making may lead to disagreements or paralysis of the partnership.
LIMITED LIABILITY COMPANIES
What is a limited liability company?
A limited liability company (an “LLC”) is an organization that many entrepreneurs choose since it combines the simplicity of pass-through taxation (as is found in a partnership) with the limitation on liability found in corporations.
Pass-through taxation allows profits and losses of the LLC to pass directly through to the members (owners) of the LLC as ordinary income and expenses/losses.
Members of an LLC enjoy the benefit of limited personal liability, meaning the owners are not generally held personally liable for debts, judgments and lawsuits against the LLC - although they will be held liable for torts they commit as a member of the LLC.
Do LLCs require a minimum or maximum number of members?
No. An LLC may be a single member entity or a multi-member entity.
Which businesses benefit most from being formed as an LLC?
The main reason to organize as an LLC is to shield the members from any personal liability that may arise from the business dealings of the company itself.
There are three primary situations in which an LLC (or perhaps a corporation) makes the most sense. First, if the company is engaged in activity that carries a higher than average level of risk, and therefore a greater likelihood of being sued. Second, if the enterprise is likely to carry a great deal of debt. Third, if the entity is going to require the infusion of capital in the form of money or sweat equity. Additionally, if the owner has a great deal of personal wealth which they wish to protect, an LLC is a good choice.
However, businesses engaged in banking, trust and insurance are generally prohibited from forming as an LLC.
How do I form an LLC?
In South Carolina, an LLC may be formed in person or online. At their most basic, articles will include the name of the LLC, the location of the main office, the name of the organizer (who does not need to be a member) and the name of the LLC's registered agent.
Must I use a lawyer to form an LLC?
In general no, you will not need a lawyer to form an LLC in South Carolina. Business owners are allowed to form LLCs simply by filing the articles of organization with the South Carolina Secretary of State. However, if you are not sure which entity to form, you should consult an experienced business attorney. Additionally, if the LLC is a multi-member LLC, the members will need an operating agreement before starting operations and consulting a lawyer before entering into such agreement is advisable.
Do I need an operating agreement?
An operating agreement is not required, and in the case of a single member LLC it would likely be superfluous. However, in the case of a multi-member LLC an operating agreement is strongly advised.
The following are reasons why an operating agreement is necessary:
- It establishes parameters for profit and loss sharing among the owners.
- It will set forth meeting times and voting rights of all members.
- It will help establish the limitation on personal liability.
- It will enable members to resolve conflicts before they arise and without the need for protracted litigation.
- It avoids the default provisions imposed by the state statute applicable to LLCs absent an operating agreement.
How is an LLC taxed?
Unless its members choose to be taxed as a corporation, an LLC is not considered a separate tax entity. Therefore, the taxes pass-through to the owners of the business (much the same as sole proprietorships and partnerships). The members/owners of an LLC will pay taxes on their share of the profits on their personal tax returns.
However, LLCs may elect to be taxed like corporations. You should consult with your CPA before taking any such tax election.
What are there differences between a limited liability company and a partnership?
An LLC, unlike a partnership, provides limited liability to the owners/members of the LLC for the business' liabilities (including debts and judgments). Therefore, if there is a judgment against the LLC, or if a creditor is seeking payment from the LLC, then the creditors cannot satisfy their claims with the personal assets of the members.
Additionally, LLCs must be formed through registration with the state. Whereas, a partnership exists the moment its partners enter into a co-venture with shared profits.
Can an organization convert from one type to another?
Yes. Organizations can convert from one type to another with relative ease. However, the conversions require planning and will often require an attorney. The owners should plan for the implications the conversion will have on taxes, licenses and permits. Most entities should take several weeks to prepare and implement their conversion plan.
Do the state and/or federal securities laws effect LLCs?
If the LLC is a single member LLC, then the state and federal securities laws will have no effect. However, if the LLC is a multi-member LLC, then there will need to be an understanding of how, when and where new members can be solicited. The best choice is to use an experienced attorney to form and advise the members with respect to expansion of the company and acquiring new investment.
The majority of small businesses that form as LLCs qualify for the securities law exemption, even if they sell ownership interests to non-managing members as investors.
You can learn more about SEC exemptions by visiting: http://www.sec.gov
CORPORATIONS
What is a corporation?
Unlike a partnership, and in most cases an LLC, a corporation stands by itself as its own legal entity. Therefore, a corporation is legally separate from its owners, as well as from those who make decisions about the business. Corporations are treated as “persons” that can form and enter into contracts, incur debt and pay its own taxes.
Some other differences between corporations and other entities are: a corporation survives the death or divestment of its owners or shareholders; the owners enjoy limited liability; the owners are not taxed on their profits as if they are ordinary income.
Why is a limitation on liability important?
Investors seek “limited liability” so they can take a risk on a new venture without the fear of being held accountable for the liabilities which may result therefrom. However, to maintain this limited liability the owners of the corporation must ensure that the business complies with certain corporate formalities, and maintains adequate funding for the maintenance of corporate liabilities (insurance, payroll, etc.)
The limitation on liability is often the number one concern of entrepreneurs who are starting a business, and as significant as that limitation may be, it is important to review the pros and cons of incorporation vs. the other forms of organization before making any decisions.
How are corporations different from sole proprietorships, partnerships and LLCs?
Naturally, with respect to sole proprietorships and partnerships generally, the limitation on liability is the corporations most obvious distinguishing feature (see above). However, ownership is what truly distinguishes corporations from all other forms of organization. A corporation is held in units called shares. Said shares are issued by the corporation in various denominations, and may be increased in volume by the corporation.
Small businesses need to understanding how a corporation is taxed in order to determine which entity is best suited to the needs of the owners. A corporation's taxable income is calculated by as profits left once salaries, bonuses, overhead and other expenses are paid out. In contrast, the profits of LLCs, partnerships and sole proprietorships are passed through to the owners of those businesses, making the profits taxable as personal income to the owners.
What are the benefits of forming a corporation?
The up-front costs and efforts of forming a corporation are higher than those for the other forms of organizations. However, there are a number of reasons why forming a corporation may benefit small business owners:
- The option of raising capital by issuing stock shares.
- The ability to incentivize employees with stock ownership.
- The owners wish to leave a substantial portion of the business' profits in the company – for growth, research, etc.
- Corporate taxes may be lower than personal income taxes.
- This is a family business and the owners wish to make gifts of shares as part of an estate plan.
- The business relationships with employees, subcontractors, lenders, etc. is better suited to a corporation than other forms of business.
How do I form a corporation?
In South Carolina you will need an attorney for the filing. A simple filing may be handled by mail. However, if the business is going to have more than one owner, employees, more than one class of shares, then a more comprehensive filing, likely online, will be necessary.
The South Carolina state filing fee for articles of incorporation is $125.00 (includes online filing fee), plus $25.00 for the CL-1. The articles of incorporation must generally include:
- The name of your corporation,
- The legal address of the corporation,
- The name and address of the corporation's “registered agent.” This will be the person or law firm that will be given notice regarding law suits involving the corporation, and
- The names of the corporation's owners and organizer.
Do corporations require more paperwork than registration with the state?
Yes. Since corporations have a more complex structure than other forms or organization, the corporation will need a set of by-laws to set forth the requirements of the directors, officers, shareholders, etc. Additionally, the state code requires a corporation to meet and provide shareholders with notice and to keep them informed of significant developments effecting the business. These meetings will need to be announced and minutes will need to be kept. This will require detailed documentation and record keeping.
Is corporate income taxed differently than other types of income?
Yes. The owners of a corporation only pay taxes on salaries, bonuses and/or dividends that the owners are paid in return for their services to the business. The corporation itself will owe taxes on any profits in the corporation from year to year.
In an s-type corporation the owners of the corporation elect to be taxed as if the business was a partnership. Under an s-type corporation all of the business profits pass-through to the business owners. Each owner will then report these profits as income on their personal tax returns.
Does the income to owners of a corporation get taxed twice?
Double taxation only applies to income that is paid out to owners in the form of dividends. A dividend is a corporate profit that is paid by the corporation to its shareholders in return for their investment in the business. Double taxation generally only occurs when a corporation pays out money to people that do not work for the business.
Salaries and bonuses can be deducted from the corporate tax as reasonable and necessary business expenses and the corporation does not have to pay taxes on them. However, if money is paid out to people that do not work for the business, it can really only be classified as a dividend, which is then double taxed.
SALE OF OWNERSHIP (i.e., SALE OF SECURITIES)
Will the securities laws effect the decision to issue stock in a corporation or membership interests in an LLC?
Generally, securities laws provide requirements that corporations/companies must follow before accepting investment capital in exchange for shares/membership interests in the corporation/company. Typically, a corporation/company must register the sale of securities with the Securities Exchange Commission ("SEC") and the relevant state securities agency before issuing shares of stock or membership interests to the initial owners of the corporation/company.
However, if the corporation/company is a small business, and if the sale of securities is made as part of a "private placement", then the sale of corporate stock/company membership interests may be exempt from the registration process. The SEC does not ordinarily require a corporation/company to register a “private offering” (a non-advertised sale of securities to accredited/sophisticated investors) to a small number of individuals (normally fewer than 35), or to those who are accredited/sophisticated investors.
If the owners are setting up a small business with you and a few associates, you will most likely qualify for an exemption and will you not have to file paperwork for your first sale of shares/membership interests.
Further, if all of the shareholders/members will be directors/managers of the corporation/company, then no SEC filing is required at all.
NON-PROFIT CORPORATIONS
What is a non-profit corporation?
A non-profit corporation is an organization formed for a charitable, educational, religious, literary, or scientific purpose. Unlike “s” and “c” corporations, a non-profit corporation does not pay income taxes (state and federal) on profits it makes from engaging in activities related to the corporation's purpose. This tax exemption is meant to support the broad objective of serving the public.
Can I convert my for-profit corporation into a non-profit?
Since a non-profit corporation is not taxed on surplus revenue raised from activities related to the corporation's stated purpose (i.e., profits), conversion looks like a very attractive option. Unfortunately, while it would be nice to avoid paying taxes, this is an option only afforded to organizations formed for a charitable, educational, religious, literary, or scientific purpose. Additionally, non-profit organizations cannot be owned by private individuals. Therefore, while it may be possible to convert from a for-profit to a non-profit corporation in theory, this process is both risky and impracticable.
How is a non-profit corporation formed?
While the initial formation of a non-profit corporation is much the same as a conventional, for profit corporation, the similarities stop there. The articles of incorporation will require special provisions setting forth the purpose and the disposition of the corporation assets should the entity be liquidated. The IRS will then require the corporation's board of directors to file form 1023. The process is information intensive and should not be embarked upon without the counsel of an experienced attorney.
Is running a non-profit more complicated than a for-profit corporation?
Running a non-profit corporation is much the same as running a for-profit corporation. With that said, the IRS filing requirements are far more burdensome, and that demands an eye for details and accurate record keeping.
The Ericsson Law Firm, LLC
1501 Belle Isle Avenue, Suite 110
Mount Pleasant, SC 29464
Office: (843) 588-8478
Mobile: (843) 437-9488
Fax: (843) 350-5113
todd@ericssonlawfirm.com
1501 Belle Isle Avenue, Suite 110
Mount Pleasant, SC 29464
Office: (843) 588-8478
Mobile: (843) 437-9488
Fax: (843) 350-5113
todd@ericssonlawfirm.com
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