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BUSINESS FORMATION CHOICES de la Riva & Associates Legal Team de la Riva & Associates Legal Team - Business Formation Choices 1.

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Presentation on theme: "BUSINESS FORMATION CHOICES de la Riva & Associates Legal Team de la Riva & Associates Legal Team - Business Formation Choices 1."— Presentation transcript:

1 BUSINESS FORMATION CHOICES de la Riva & Associates Legal Team de la Riva & Associates Legal Team - Business Formation Choices 1

2 Basic Startup Issues to Discuss 1. Name of Entity: name protection. 2. Organization: LLC, type of partnership, corporation. 3. Costs and Fees: Filing fees, attorney fees, title company expenses, miscellaneous. 4. Term: Indefinite or limited. 5. Principal Business Office: Local or Foreign 6. Registered Agent: Who and Duties. 7. Purpose of the Business Entity: Limited or broad. 8. Initial Members or Owners: Who? How many? 9. Who will research, write and produce the Business Plan? de la Riva & Associates Legal Team - Business Formation Choices 2

3 Issues Regarding Initial Contributions Beginning Capital: Who and how much financial contribution? Property Contributions: Tax issues. Changing title. Costs. Title insurance addendum. Interest or Return. Time of distribution? Capital Accounts: Necessity. CPA. de la Riva & Associates Legal Team - Business Formation Choices 3

4 Management Issues Member Managed. Manager Managed. Identity. Elected or appointed. Scope of Responsibility. Powers. Accountability. To whom and when? Limitations. Extraordinary transactions. Indemnification. Removal or Resignation. de la Riva & Associates Legal Team - Business Formation Choices 4

5 Issues Regarding Operations Meetings: schedule and location. Necessary Books and Records: Follow up letter. Bank Accounts: Set up and EIN. Annual Tax Accounting Period. Reports: Annual report to the state; reporting to members; report to IRS; accounting. Tax Matters Member: Elections. Notices. Changes to Agreement. Disputes. Alternate dispute resolution procedures to stay out of court. de la Riva & Associates Legal Team - Business Formation Choices 5

6 Exit or Ending The Business Exit Strategies and identified personnel. Liquidation and Dissolution. Limitation of Liability. Restoration of capital accounts: Tax issues. Transfers of Interests: To family, third parties, voluntary v. involuntary transfers. Events of Dissolution: Planned or unplanned. Winding Up. de la Riva & Associates Legal Team - Business Formation Choices 6

7 Advantages / Disadvantages The advantages and disadvantages of each legal business formation depend upon the objectives of the business owners and the assets that the owners contributed to the business, past and present. With each choice of a legal formation, there are various qualifying requirements, degrees of liability, tax consequences, and possibilities for exiting and ending of the business. de la Riva & Associates Legal Team - Business Formation Choices 7

8 Issues with forming a business A common misconception by the business community is that a business owner must cumulatively be a 1. Banker 2. Accountant, 3. Lawyer, 4. Manager, 5. Marketing person 6. Salesperson While familiarity with all these areas is invaluable to the entrepreneur, it is unnecessary and unwise to attempt to establish a business alone. Acquiring professional assistance from legal, accounting and marketing services will save the start up business person time and money. One of the first major considerations a new business person investigate is the type of business organization to use for his/her enterprise. The choices are (1) sole proprietorship, (2) partnership, (3) Limited Liability Company or (4) corporation. Once this Business Plan has been established and implemented, the owner should periodically review the options and adapt the business organization to the current needs. de la Riva & Associates Legal Team - Business Formation Choices 8

9 3 choices The simplest and least expensive form is the sole proprietorship. The formation is as the name implies; the entrepreneur is the sole owner who receives all the profits along with all the responsibilities and liabilities. A partnership is a business enterprise which is owned jointly by two or more persons. With the partnership form, the profits, debts and liabilities are shared amongst the partners. This business form can be either a general partnership or a limited partnership. The third form of business is the business corporation. This form is a legal entity that can own a business, sue or be sued and must pay taxes. The corporation operates the business according to a written charter which is issued by the state for a specific business purpose or purposes. de la Riva & Associates Legal Team - Business Formation Choices 9

10 Sole Proprietorship and Partnerships The sole proprietorship contains the most risk because there is no limited liability protection inherent in this legal business form. The business owner is personally liable for any claims against his company that are not covered by some form of business insurance. The business owner's personal assets are not protected. de la Riva & Associates Legal Team - Business Formation Choices 10

11 Sole Proprietorship The sole proprietor enjoys complete control over his/her business. While this type of business owner receives all the profits, he/she also has sole responsibility for all debts and liabilities. Income tax returns combine business income and personal income. Advantages: Least amount of red tape to complete in establishing business. Little or no expense in forming or dissolving the business. Simplicity of operation. Certain reporting requirements are not necessary. Income is taxed only once. Social Security is the lowest allowed by law. de la Riva & Associates Legal Team - Business Formation Choices 11

12 Sole Proprietorships Disadvantages: Unlimited liability for business debts. Income tax rate may be higher than the corporate form of business organization. Tax saving or retirement plans are complicated. If the business is to operate as a sole proprietorship or partnership, the entrepreneur should consider recording a declaration of business name. de la Riva & Associates Legal Team - Business Formation Choices 12

13 Partnership There are several kinds of partnerships: general partnership, limited partnership, and limited-liability partnership The partnership form of business is necessary when there are several owners involved in a business. Income tax returns are information returns that allocate income or losses to the partners. The partnership or business must file this return, but it pays no tax. The partners must claim their share of the profits or losses on their personal returns. The general partnership, which is the most common partnership used, has all partners sharing equally: equal ownership, equal management decisions equal responsibility for partnership debts. de la Riva & Associates Legal Team - Business Formation Choices 13

14 Limited Partnership The limited partnership must include at least one or more general partners who participate in management decisions and who have personal responsibility for the partnership debts. There will also be one or more limited partners who do not participate in management and whose liability for partnership debts is limited to the amount they have contributed to the business. Advantages: Allows persons with insufficient net worth to pool funds to purchase a business. Provides opportunity to split management duties, unless the partner is a limited partner. Income is taxed only once. Social Security tax rate is the lowest allowed by law. de la Riva & Associates Legal Team - Business Formation Choices 14

15 Limited Partnership Disadvantages: Must share the decision making with other general partners. Compatibility and cooperation of the partners is essential. Each general partner has unlimited liability for the debts of the partnership. If all but one of the general partners are financially unsound and unable to pay debts, the one financially secure partner can be required to pay the total amount owed. Income tax rate may be higher than for the corporate form of business organization. Tax saving, retirement or pension plans for partners are limited. de la Riva & Associates Legal Team - Business Formation Choices 15

16 Corporations The corporate form is the most permanent form of business. It continues for the life of its charter regardless of what happens to the original organizer or stockholders. The corporation is owned by stockholders in proportion to the number of shares owned by each stockholder. A corporation can be a one person operation with only one stockholder holding all of the stock and being the only officer. "S Corporation" versus a "C Corporation" or regular corporation. For federal income tax purposes, the S Corporation is taxed the same as a partnership. The income of the S Corporation passes directly to the stockholders who pay taxes on their shares without any federal income tax being paid by the corporation itself. The C Corporation pays corporate income tax on its earnings while the stockholders only pay income tax if and when they receive dividends on their stock. de la Riva & Associates Legal Team - Business Formation Choices 16

17 Corporation Advantages Advantages: A corporation pays 15% federal income tax on taxable income up to $50,000; 25% tax on income from $50,001 - $75,000; 34% tax on income from $75,001 - $100,000; 39% tax on income from $100,001 - $335,000; and 34% tax on income over $335,000. Profits made by the corporation are subject to double taxation since the corporation must pay tax on its profits and the stockholders must pay tax on any declared dividends and any sale of stock that realize capital gains from the increased value of the stock. It is easy to sell part of the business. Bank financing may be obtained more easily for the business, but stockholders will probably be required to sign personal guarantees. A corporation has some legal immunity available. With legal assistance, a person can protect their personal assets. de la Riva & Associates Legal Team - Business Formation Choices 17

18 Corporation Disadvantages Disadvantages: Corporations must withhold Social Security taxes from the salaries of stockholders who are employees of the corporation. The corporation is then required to match the tax. Earnings or income that are withdrawn from a corporation must be in the form of dividends or bonuses. These are then taxable to both the corporation and the person receiving the dividends or bonus. It is more difficult to transfer cash in and out of a corporation than a partnership or sole proprietorship. Funds contributed to the corporation by stockholders must be recorded as payables and the corporation must pay interest. The corporate form requires the most paperwork. It is necessary to have annual meetings, maintain a minute book and records of stock and stockholders. There is an annual report and fee payable to the Secretary of State and an attorney is required to prepare the minutes annually. The corporation requires the drafting of By-Laws and Articles of Incorporation and the issuance of stock by an attorney. Approval by the Secretary of State is also necessary. de la Riva & Associates Legal Team - Business Formation Choices 18

19 Corporations The C Corporation: The C Corporation is the "default corporation." All corporations are automatically C Corporations, unless they are set up to be S Corporations. The C Corporation is so named because it is governed under subchapter "C" of the Internal Revenue Code of The S Corporation: The S Corporation, known as "the Small Business Corporation," derives its name from the fact that it is governed by subchapter "S" of the IRS Code of To qualify, a business must meet certain strict eligibility requirements with regards to the number and type of shareholders. A shareholder cannot generally be anything but an individual or a certain kind of trust, and the "single class of stock" rule applies; the business can only deal with one kind of stock. The application submitted to the IRS must contain the signatures of the shareholders and meet all requirements prior to the S-Corporation status being granted. de la Riva & Associates Legal Team - Business Formation Choices 19

20 Limited Liability Company The Limited-Liability Company, or LLC, is the most flexible of the business legal forms, and it provides a considerable amount of liability protection. The number and type of owners is not restricted in an LLC. Legally, the LLC is an entity onto itself, and it provides liability protection to its owners, so long as there is no fraudulent activity. The rules for administering an LLC are not as strict as those for administering a C or an S Corporation. The single-member LLC: An individual in business by himself, with no employees, can make his company an LLC. It is treated as a disregarded entity for tax purposes, so there's one less tax return that needs to be filed. In addition, as a single-member LLC, a business person can treat the business like a sole proprietorship and only needs to file a Schedule C. de la Riva & Associates Legal Team - Business Formation Choices 20

21 Limited Liability Company The LLC is identical in some respects to the limited partnership and the corporation, but also very different. In fact, the LLC is a powerful tool. In many cases, it is the solution. The attractiveness and power of the LLC derive from its principal attributes: a single level of income tax and limited liability for investors. An LLC ordinarily is classified as a partnership for tax purposes and not taxed at the entity level. Its members face only one level of income tax. Items of income, gain, loss, deduction, and credit flow through to the members of the LLC. Unlike the tax treatment of an S corporation, this favorable tax treatment for LLCs is not dependent on the identity of its members, and there is no upper limit on the number of members an LLC may have. Like corporations and limited partnerships, LLCs provide holders of their ownership interests with broad limits on liability. The limits on liability are independent of other relationships such holders may have to the LLC. Participation in the management of the LLC does not subject a member to general liability. A member of an LLC who is also a manager may still benefit from protection against contract and tort liability in circumstances where a limited partner would have general liability. de la Riva & Associates Legal Team - Business Formation Choices 21

22 LLC Advantages: -Has the same liability protection against third parties as a corporation. -Can be taxed as partnership, with single level, flow-through taxation, as opposed to the double taxation of a corporation. -Flexibility of business deals and sharing of profits, losses, capital; as opposed to strict proration under an S corporation. -Losses, which are common to a start-up business venture, can pass through the entity and be deducted directly by the owners of the business, as opposed to losses in a corporation which accumulate and are limited in how they may be used. -All members/owners of the LLC can be protected from liability, as opposed to a limited partnership where one partner has to be a general partner and thus exposed to liability for all partnership actions. -LLC's are easy to form and easy to dissolve compared to issues arising in corporations where appreciated assets can cause difficulties when a successful corporation is liquidated. de la Riva & Associates Legal Team - Business Formation Choices 22

23 Issues regarding LLC A disadvantage to forming an LLC: Upon sale, the LLC would likely have some ordinary income component that would be taxed at a higher rate than if a business were to end up selling its stock in an S or a C Corporation, where it would receive capital gains treatment. Losses from single-member LLC's flow through automatically when filed on the Schedule C. In fact, from a tax perspective, there's no difference between a sole proprietorship and a single-member LLC. You get the benefit of limited liability protection without having the additional administrative burden of filing an additional tax return. It can't hurt you from a tax perspective to form a limited liability company. de la Riva & Associates Legal Team - Business Formation Choices 23

24 Reasons for a single member LLC in a service business Asset Protection. A limited liability company ("LLC") offers the same asset protection as a corporation. If you sign agreements in the name of the LLC, then the LLC is the responsible party on the agreement, not you as an individual owner. If the business is not successful, or if it incurs a large unexpected debt (which you did not personally guarantee or sign for), then your other personal assets are protected from the LLC creditors. de la Riva & Associates Legal Team - Business Formation Choices 24

25 Operating as an LLC In order to have the asset protection benefits of an LLC, especially a sole member LLC, the owner must observe the formalities and operate the business as an LLC. There should be adequate capitalization depending on the nature and extent of the business. The owner should have annual meetings and produce statements about the past business year and expectations for the future. The owner must be careful to enter into contracts through the LLC, and not personally. The owner should use checks and stationery to give notice to third parties that they are dealing with an LLC. de la Riva & Associates Legal Team - Business Formation Choices 25

26 Ease of Operation of LLC The single member LLC should be operated as a separate business. The owner needs a separate business checking account, and set of books. The bookkeeping can be on QuickBooks or a similar software program. The end of year tax work can be done by an accountant quickly and efficiently if you have a separate set of books for your business. The sole member LLC will not require a separate federal income tax filing. The income tax can be reported on schedule C of your personal tax return. For federal income tax purposes the single member/owner LLC is disregarded. de la Riva & Associates Legal Team - Business Formation Choices 26

27 LLC v. Corporation A limited liability company (LLC) has natural asset protection features. It can be used to shield investors and active participants of a business in the same way they are shielded by a corporation. An LLC has a definite advantage over a corporation when it comes to creditor's claims against the owner of the business. If a creditor of an LLC owner obtains a judgment against that owner, the creditor may go to court and ask for a "charging order" against the owner's interest in the LLC. The creditor will have limited rights to the profits and/or losses of that owner. The creditor will have no right to become an actual voting member of the LLC or to interfere with the management. If an LLC owner is in bankruptcy, a bankruptcy trustee would have more powers than a third party creditor, but the ownership interest in the LLC would likely be purchased by other owners at a substantially reduced value. de la Riva & Associates Legal Team - Business Formation Choices 27

28 LLC v. LLP An LLC has an asset protection advantage over a limited partnership: Limited partners are fully responsible for all claims against the partnership. A limited partnership will likely have a corporation for a general partner to limit the liability of the general partner, however you will need assistance in setting up a business arrangement by requiring a corporate entity within a partnership entity. de la Riva & Associates Legal Team - Business Formation Choices 28

29 LLC Agreement The LLC agreement by which the owners govern themselves can have additional asset protection features written into the business arrangement, depending on the circumstances of the owners. Both the agreement and concerns, will be different depending on whether the owners are family, strangers, wealthy, cash tight, or a mixture of all and more of these circumstances. Discuss asset protection with your attorney. de la Riva & Associates Legal Team - Business Formation Choices 29

30 Basic LLC Asset Protection. Many people are creating limited liability companies (LLC) for protection of their personal assets from creditors and lawsuits related to their businesses The basic LLC is an effective asset protection device, provided that the operations of the LLC include the following essential features: 1. A comprehensive LLC operating agreement which is followed by the member (owner). 2. Accounting procedures to keep the owner's personal assets separate from the business assets, with clear, timely, and accurate documentation of funds going into and out of the LLC. 3. Operating procedures consistent with the LLC being a separate valid business entity, such as signing contracts in the name of the LLC (rather than personally), and using a personal guarantee of the LLC's obligation only as a last resort. The above methods of operation for a LLC will extend protection to the owners of the LLC from the creditors of the LLC. de la Riva & Associates Legal Team - Business Formation Choices 30

31 INC. - Issues With the already formed corporation Make sure it is an S corporation under IRS Company who owns property Company who owns business Company who owns business name / trademark de la Riva & Associates Legal Team - Business Formation Choices 31

32 Management of business LiabilityOwnership de la Riva & Associates Legal Team - Business Formation Choices 32 Operating Agreement can delineate duties, roles, responsibilities, etc. OPERATING AGREEMENT can answer all the HOW, WHEN, WHO, WHAT questions of your business.

33 de la Riva & Associates Legal Team - Business Formation Choices 33 Offices in San Antonio, Houston, and McAllen The Acropolis Building Two Post Oak Central McAllen Office NW Military Hwy 1980 Post Oak Blvd, Ste West Pecan Blvd, Ste G San Antonio, TX Houston, TX McAllen, TX (210) (281) (956)


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