Incorporating Structures

For the remainder if this series, when "incorporate" or "incorporating" is used, it will refer to forming a corporation or limited liability company. In some cases, incorporation means forming only a corporation, however what we mean is forming a distinct and separate legal business entity. This is going to be a Corporation or LLC for the remainder of the incorporation guide. We have introduced and discussed non incorporated business structures and going forward we will dive deeply into both the C and S Corporations and Limited Liability Companies.

Legal business structures have come along way in the past few decades. Previously the Corporation or the Partnership were the two directions. Bridging that gap the Sub Chapter S section of the IRS code that gave pass through taxation to corporations, however raised several restrictions, such as limiting the number and kind of shareholders. The newest form of incorporated business and a distinct legal entity is the Limited Liability Company which offers the liability protection to both owners and members and favorable pass through taxation. This guide will cover taxation issues in depth, however this is an introduction to our primary incorporating topics, the Corporation and LLC.

Limited Liability Company
An introduction to incorporating and the creation of the LLC. Corporations have always provided liability protection to business owners, however this came with a price tag. The entity paid income tax and the owners paid income tax, this is called double taxation. The only other option to reap the tax rewards was to remain a sole proprietor or partnership, which doesn't offer the protection incorporated business structures do. Even S Corporations didn't close the gap entirely. The limited liability company was started in Wyoming in 1977. This incorporated business structure is a separate legal entity offering limited liability to the owners, who are called members. You can actually choose how you would like your LLC to be taxed. Flexible taxation, liability protection and you create your own management structure. You can have a partnership style management structure where the members operate the business. You can also have a standard corporation style management structure, which is called "manager managed" and appointed managers run the operations of the business. This added flexibility is a great feature of the LLC, it can be run as a partnership or with more robust corporate structure, similar to a board of directors and corporate officers.

Now this raises the question, why would you not choose an LLC over a corporation when you are deciding what business structure to incorporate? To start off, corporations have been rigorously tested in court to provide protection from business liability and debts - for centuries corporations have proven reliability here. Secondly raising capital with a corporation is more traditional. Selling corporate stock to raise equity capital is straight forward. LLC's are the new kid on the block as far as legal entities are concerned and lack the hundreds of years of durability testing that corporations have proved in court shielding business owner's assets from corporate obligations.

Incorporating an LLC
Forming a limited liability company is much like incorporating a standard corporation. The documents drafted are called Articles of Formation, compared to the counterpart's Articles of Incorporation. These documents are essentially the same, both are filed with the Secretary of State of where you are incorporating.

LLC's have less operational formalities than corporations do. By law, all corporations are required to hold meetings of the shareholders and keep meeting minutes on, at least, an annual basis. More information on operating formalities will be covered in this guide as we progress, but for now, we'll just mention that currently, limited liability companies do not have state mandated requirements to keep meeting minutes, although it is a recommended practice so that separate status is maintained between the incorporated entity and the business owners.

This is the grandfather of all business structures. Featuring incredible liability protection, ease of transferability, simplicity of raising capital and perpetual duration. Once you incorporate, you create a separate and distinct entity, or "person". This is separate from those who own it or comprise it. The entity could have more than one "home", traditionally where the business is incorporated is its resident domicile, however if the principle place of business is another state, then this could be called a commercial domicile.

Corporations have long been favored for their liability protection over any other business structure. In the rare cases that the shareholder's assets were reached to satisfy corporate responsibilities, it is usually the result of either fraudulent activity, poorly managed formalities and alter-ego scenarios. This could be an array of issues, but the focus here is that a corporation that is properly established, organized and maintains its operating formalities is the maximum in liability protection for business owners. Proven.

There are two types of corporations, the standard and default "C" Corporation and the IRS classification "S" Corporation. The S Corp is a tax classification giving the incorporated entity, pass-through taxation. This means that the S Corporation is not a taxable entity, the income and losses are reported on the shareholder's personal tax return. The S Corporation is also limited in number of shareholders, type of shareholders and classes of stock.

There are other types of corporations, such as Professional Service Corporations and Close Corporations. Each are still an incorporated business structure and begin their life as a traditional C Corporation. Close corporations are typically smaller and owned by a few shareholders and are recognized by some states which allow these entities to have fewer operating formalities, thus reducing some of the paperwork involved with maintaining a corporation. Some states require certain types of professionals to incorporate a Professional Service Corporation, such as Doctors, for example. Please keep in mind that these two variants can be recognized differently state to state.

Every corporation is responsible to pay taxes on income. Shareholders of a corporation pay taxes on their income and dividends from the corporation, which is called "double taxation." This is why the Sub Chapter S Election was introduced by the IRS. More information on S Corporations will be covered later on in this guide.

Incorporate vs. Non Incorporated
With LLC's offering incredible flexibility, liability protection and tax classification options, this leaves at least one question, why wouldn't you incorporate? This is a fairly significant impact for entrepreneurs. Most states recognize and allow for a single member LLC, which would be the same as a sole proprietor and adding additional members mirrors a traditional partnership. In those states that do not allow single member LLC's, you could simply bring in a family member or someone else that you trust to hold minimal interest in the company and have the operating agreement empower only the proprietor to make all top down decisions and run the business. Another route is to incorporate in a state that does allow single member LLC incorporation and qualify as a foreign entity in your home state - this should be taken into careful consideration with a legal expert if you feel that this applies to you. Since the limited liability company has so few operating formalities and the protection from business liability, and full service document filing businesses, such as Abstract, who make it easy to incorporate, it could possibly render some older forms of business obsolete - those being the unincorporated structures.

Next Section: What Structures to Incorporate