Posted on July 21st, 2012 by bunilaw
Are you starting your own business? Congratulations. A world of possibilities awaits. But there is a lot for a new business owner to be aware of. The first step is crucial. You need to decide how to organize your business, whether as an LLC, a corporation (C or S), a sole proprietorship, or as a partnership (common law or statutory).
First, many legal and tax consequences follow from the choice of how to organize your business, so you should not make this decision without legal advice. Here?s an overview of some of the common questions.
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I?ve heard I should form my LLC or corporation in Delaware or another state, and use that entity to do business in New York state.
For the vast majority of new businesses, there is no advantage to doing that. When you do business in New York state, you become subject to the jurisdiction of the state and are liable for complying with all New York state laws and regulations regardless of where you formed your entity.
A possible advantage to forming an entity in Delaware is that litigation over business governance or shareholder issues will occur in the courts of the State of Delaware. The Delaware Chancery court has a good reputation for consistent adjudication of these types of issues. For that reason, some potential shareholders will insist on organization in the State of Delaware, because they feel the outcome of any governance issues will be most predictable there. If you are starting a small business, the likelihood that your company will ever be involved in litigation of over governance or shareholder issues is very small. Moreover, New York courts are well-equipped to handle such disputes, and, while they may not have the same depth of experience in the area as Delaware courts have, New York has a well-developed body of law on governance and shareholder issues, and its judges are capable of adjudicating these types of disputes if they ever arise.
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I am a sole proprietor. Should I have an entity like an LLC or corporation to do business?
Let?s talk about the main reason for using an LLC or corporation: limited liability. Limited liability means that an owner can lose no more than his investment in the business. Limited liability is what makes people willing to invest in businesses even when they have no control over how it?s run. Suppose there was no limited liability. If you invested in a mutual fund and one of the companies in the portfolio was sued and lost the lawsuit, it would mean the plaintiffs in the lawsuit might be able to take your personal assets to satisfy the judgment, because you are an investor in the business. With limited liability, all you lose is what you put into the business. Your personal assets are not available to creditors of the business.
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Limited liability sounds great. Shouldn?t every business owner take advantage of it?
Limited liability does sound great, but most small businesses, especially those with a single owner, will enjoy little or no advantage from limited liability for two reasons:
1. You never have limited liability from your own acts of negligence. If you are the only owner and have no employees, it likely means that any negligent acts committed by the business are committed by you personally. ?That makes you personally liable regardless of how your business is organized.
2. In significant contractual matters a small business owner is usually required to provide a personal guarantee. Let?s say you borrow money to start your business. The bank will of course hold your business liable for repaying the loan. But it will also insist on a personal guarantee from you. That means if your business doesn?t repay the loan the bank will have recourse to your non-business assets regardless of how your business is organized.
For these reasons, a single-owner business rarely enjoys any benefit from limited liability. You should still discuss limited liability with your lawyer, because even a single owner may have circumstances that justify using an entity, but you will want to weigh the costs against the benefits of limited liability. As you?ll see, starting an LLC in New York state can be expensive, depending on what county you are in. And using a corporation means preparing another set of tax returns every year, as well as additional compliance.
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Don?t I need an LLC or corporation to use a business name other than my own?
If you?re the only owner of your business and, after speaking with an attorney, decide you?d rather not pay for an LLC or file extra tax returns every year, you may still want a business name you can use on checks, letterhead, business cards, etc. You don?t need an LLC or corporation to do that. You can register a name for your business and lawfully do all your business under that name.
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Can I obtain a federal EIN if I don?t have an LLC or corporation?
Yes, you do not need any form of entity to obtain a federal employer identification number. However, if you have employees, that is one indicator you may benefit from limited liability. If you will have employees, speak to an attorney about the potential benefits of limited liability in your situation.
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If I decide to use an entity to do business, how do I choose between a corporation, LLC, or some form of partnership?
There are tax and business differences between these types of entities. Let?s talk about tax first. An LLC and a partnership are normally ?flow-through? entities. That means they are not taxed separately for most purposes. A corporations is taxed separately, unless it has made a valid S election, in which case it is taxed similarly to other flow-through entities.
Warning: New York City taxes every business separately from its owners regardless of how the business is organized? even if it?s a sole proprietorship. Corporations are taxed under New York City?s General Corporation Tax, and sole-proprietorships, partnerships, and most LLC?s are taxed under the Unincorporated Business Tax (UBT). Because there is no statute of limitations on assessing tax if you don?t file a return, I?ve seen clients doing business in New York City taxed for as much as 20 years of past due taxes for failure to file UBT returns.
Most single member LLC?s are ignored for tax purposes. That means their owners report business income and expenses on schedule C of their individual income tax returns. Some accountants will advise you to use a corporation because schedules C are audited more often than corporate returns, which may be true. However, it?s not clear that your overall audit risk is reduced when you consider the additive risks of being audited on both individual and corporate returns. For example, having an S corporation increases your audit risk by almost half a percent, and more for a C corporation. Moreover, the best defense against being audited is to maintain good records and and report all income and expenses accurately. That way you don?t have to worry so much about being audited.
It?s also possible for partnerships and LLC?s to be taxed as corporations if their owners elect to be taxed that way. Why would anyone ever want to do that? The reasons are beyond the scope of this article, but do not apply to most business that plan to do business only within the United States. If you plan to do business outside of the United States, or if it?s possible you?ll have foreign investors or partners, be sure to speak to an attorney before you decide how to organize your business.
There are also important business differences between Corporations, LLC?s and partnerships because the state laws that create these types of entities work differently. Corporations use shares to keep track of their owner?s investments. Shareholders get back their investments on a pro rata basis depending on how many shares they own. Voting control is also pro rata in a S corporation. The same is true of a C corporation, unless there are different classes of shares. Partnerships and LLC?s are much more flexible. Partners or LLC members can make almost any deal they want about how much investment they will get back, who gets paid first, and how to distribute control.
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Why does it cost so much to start an LLC in New york state?
The law requires new LLC?s publish their existence in newspapers. In many counties it doesn?t cost much, but in New York City, the cost can be as high as $1000 or so, just for publication. The law requiring publication has been criticized as unnecessary and costly, but so far legislators in Albany have not moved to repeal it.
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Source: http://www.bunilaw.com/blog/tax-advice/business-formation/llc-how-to-business-formation-nys/
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