What Type Of Company Should I Form?


By Steven Goldberg, Esquire
Theisen, Lank, Mulford &Goldberg, P.A.

Once you have reached the decision to go into business for yourself, the first question to be answered is the nature of the entity which will conduct the business. Should you conduct your business as a sole proprietorship, a corporation, and if a corporation, what kind of corporation or should it be a limited liability company. Each form of business has its own benifits and disadvantages.

The most simple form of business is the sole proprietorship. A sole proprietorship is just you operating your business under your own name or under a "trade name" such as "Mary’s Antiques". The major drawback of a sole proprietorship is you are placing all of your personal assets, future assets and future earnings at risk to creditor or other claims if the business fails or experiences a loss for which you do not have adequate insurance. (No matter what type of entity you choose, you will always be personally liable to your bank or anyone else who requires your personal guarantee of your company’s debts or obligations). Creditors or others suing your business are really suing you personally and if they obtain a judgment, the judgment is against you personally. A judgment against you is a lien against all of your property. Once the creditor has obtained a judgment, the creditor can cause your personal assets to be sold to satisfy the judgment. A judgment is enforceable in Delaware for ten years and can be renewed. An aggressive judgment creditor can keep coming back and sell assets which you acquire at a later time and can also attach your wages to satisfy the judgment.

To obtain protection for you and your assets from creditor claims you must choose a from of business which has "limited liability". Limited liability means that the owner or owners of the business are not personally liable for the obligations of the business except to the extent they have guaranteed the obligation and to the extent of their investment in the business. Generally, in Delaware, owners of corporations and limited liability companies are not personally liable for its debts if it is adequately capitalized, is not used to defraud its creditors, company assets are not commingle with the owner’s assets and the fundamentals of corporate governance are observed. The company needs to have enough capital to conduct it business, that is enough money is invested and not just loaned to the company. The question of what is "adequate" is always fact dependant. Not commingling assets is very important. Do not use the company accounts to pay personal bill and do not pay company obligations with personal checks. The company must annually have a meeting to elect at least one director and officers (one person may hold all offices). Minutes must be kept of that meeting and minutes must reflect significant business actions.

Corporation or limited liability company? A limited liability company is a statutory mixture of partnership and corporate law. For tax purposes and operating purposes an LLC is treated as a partnership. For liability to creditors and other third parties, an LLC is treated as though it were a corporation as it has "limited liability." Delaware permits single member limited liability companies which are disregarded for tax purposes, which means that the IRS will consider it as a sole proprietorship which has limited liability. An LLC seems as the ideal business vehicle, however, and there is always a however, a member (owners of LLC’s are called members and the owners of a corporation are called shareholders) of an LLC who actively participates in management is subject to federal self employment tax, the same as a sole proprietorship. Salary paid to a corporations’s owner/employee are subject to FICA and earnings of a subchapter S corporation are not subject to either self employment tax or FICA.

Business corporations come in two flavors, general corporations and close corporations. Close corporation were created in the 1970's to give small businesses flexibility. The business of a close corporation is conducted by its shareholders and not by its officers and directors. Close corporation never met their full potential and have never become generally accepted as the state placed many and unnecessary limitations on them.

A general corporation is the same from of corporation whether it is a multi national company listed on a stock exchange or Bob’ Burgers, Inc. The multi national’s certificate of incorporation may be more complicated than Bob’s, however they both have the same effect and create in the State of Delaware’s eyes the same type of corporation. Many people speak about Subchapter S corporations as though they were a separate specie of corporation. In truth they are general corporations which have filed with the IRS a special election form which taxes the company’s income to its shareholders and allocates it loss to its shareholders. An electing Subchapter S corporation does not file an income tax return with the IRS, it does file an "informational return," Form 1120S. A corporation which intends to elect Subchapter S status often inclines in its certificate of incorporation language which protects the corporation from inadvertently losing the election. Congress has placed significant limitations on Subchapter S corporations and the rules dealing with the timing of the election are very technical.

The decision as to what form of business you should select is both a legal and accounting decision. Going into business for yourself is a momentous decision. No amount of information from the Internet can substitute for competent advice from an attorney or accountant.


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Title: What Type Of Company Should I Form?
Author: Steven Goldberg, Esquire
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