Business Structure Basics

Unlike the partnerships described above, the corporation is considered an artificially created legal entity that exists separate and apart from those individuals who created it and carry on its operations. With as little as one incorporator, a corporation can be formed by simply filing an application for a charter with the respective state. By filing this application, the incorporator will put on record facts, such as:

• The purpose of the intended corporation,
  
• The names and addresses of the incorporators,
  
• The amount and types of capital stock the corporation will be authorized to issue, and
  
• The rights and privileges of the holders of each class of stock.

It is true that operating as a corporation has its share of drawbacks in certain situations. For example, as a business owner, you would be responsible for additional record keeping requirements and administrative details. More important, in some cases, operating as a corporation can create an additional tax burden. This is the last thing a business owner needs, especially in the early stages of operation.

Remember, aside from tax reasons, the most common motivation for incurring the cost of setting up a corporation is the recognition that the shareholder is not legally liable for the actions of the corporation. This is because the corporation has its own separate existence wholly apart from those who run it. However, let's examine three other reasons why the corporation proves to be an attractive vehicle for carrying on a business.

• Unlimited life. Unlike proprietorships and partnerships, the life of the corporation is not dependent on the life of a particular individual or individuals. It can continue indefinitely until it accomplishes its objective, merges with another business, or goes bankrupt. Unless stated otherwise, it could go on indefinitely.

• Transferability of shares. It is always nice to know that the ownership interest you have in a business can be readily sold, transferred, or given away to another family member. The process of divesting yourself of ownership in proprietorships and partnerships can be cumbersome and costly. Property has to be retitled, new deeds drawn, and other administrative steps taken any time the slightest change of ownership occurs. With corporations, all of the individual owners' rights and privileges are represented by the shares of stock they hold. The key to a quick and efficient transfer of ownership of the business is found on the back of each stock certificate, where there is usually a place indicated for the shareholder to endorse and sign over any shares that are to be sold or otherwise disposed of.

• Ability to raise investment capital. It is usually much easier to attract new investors into a corporate entity because of limited liability and the easy transferability of shares. Shares of stock can be transferred directly to new investors, or when larger offerings to the public are involved, the services of brokerage firms and stock exchanges are called upon.

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There are pros and cons to operating your business as a corporation. One of the biggest tax disadvantages for the ordinary C corporation is the dreaded double taxation. Many business owners opt for electing to operate their corporations under subchapter S of the Internal Code. Also known as an S corporation, this entity allows income to pass through to the individual shareholders.

The Limited Liability Company (LLC): New Kid on the Block
In earlier editions of this Top Tax Savings Ideas, the S corporation had been referred to as the logical choice for those small businesses that need to steer away from the regular corporation and its potential tax pitfalls. Increasingly, however, the LLC has been coming to the forefront as another viable alternative. This is especially the case now that much of the air is clearing within the various state laws and professional organizations that deal with LLCs. In fact, many practitioners argue that the LLC is now the preferred choice in the following situations where:

• Legal liability protection is a primary concern
  
• A simplified "one time" tax on the owners is preferred to dealing with cumbersome corporate tax liability
  
• The entity cannot qualify for subchapter S status.

An LLC is a hybrid entity that has the legal protections of a corporation and the ability to be taxed (one time) as a partnership. In many regards, LLCs are treated much like S corporations for tax purposes. However, there are some additional advantages over S corporations, including the following examples:

• The LLC usually offers better leeway for owners who wish to write off business losses in a business that relies on entity-related debt that is incurred
  
• The LLC allows greater flexibility for the owner to take assets out of the company without incurring unplanned tax liability

Remember to check with your lawyer or accountant about the advantages of the LLC in your particular state. Ask up front what it would cost to form a corporation versus the cost of forming an LLC. You may be surprised to learn that in some states an LLC could be established by filing a simple, one-page document, which lays out the Articles of Organization of your LLC, with the secretary of state.

You can form an LLC for any lawful business as long as the nature of the business is not banking, insurance, and certain professional service operations. By simply filing articles of organization with the respective state agency, an LLC takes on a separate identity. Similar to a corporation, but without the tax problems of the corporation, it will be taxed like a partnership.

Former IRS agent Thomas J. Stemmy, CPA, MMS, is a widely respected tax specialist and consultant. An award-winning writer, he is also the author of How to Slash the Cost, Time and Aggravation of a Tax Audit.

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