Everything Starts

With Business Entity Formation

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The idea for a business is there, the motivation to start the business is there. So, what’s missing? What’s the first step in creating a successful business? Choosing the legal business entity, of course! And not only that, but choosing the right one for your business. If the business isn’t formed correctly from the get-go, a lot of problems might happen in the future, whether from a legal perspective, liability, tax issues, to other problems that your business could do without. Why worry about the future when you can set up your business correctly right from the start?

If you’re new to business, you might be wondering:

What is a business entity?

A business entity is the legal structure of your business. It’s the backbone, let’s just say. You can create one by yourself, or with a group of your buddies, who are called your business partners. Both of you would be considered business owners. Without a business entity, your business does not have an identity.

Business entities are usually formed by filing paperwork with some sort of state agency, like the Secretary of State, and they are, like everything else in life, subject to tax. But more on tax later! Let’s stick with business entities and business types for now!

Business entities are virtually the foundation of every business, regardless of business entity types. Yes, there are different types of businesses and business structures can be different from one another. The rules and regulations differ based on the type of entity for business purposes, and many are not really aware on how they should choose a business entity type, how the legal side of things work, how they’re supposed to file tax returns, and many other facets of a business and its formation process.

How Can I Create My Own Business Entity?"

It all starts with business formation. What that means, is that you need to file formation paperwork with the state you wish you start your business in. And of course, there’s paperwork involved, which we’ll talk about later down the line. After you’re done with your business formation paperwork process, congratulations! Your business officially exists, and it’s no longer an idea!

Whenever we want to start anything in life, we always like to figure out the alternatives. Business is not different. That’s exactly why this next question is super familiar to us, because we’ve been asked this many times!

Business Formation

Businesses are prone to damage during their stages of infancy. If the first steps are not taken with care, the path to success will become crooked. Prestige Auditors presents its clients with consultation on how to form a business from the ground up in a way that it grows in a firm and resolute manner and you can hit the ground running.

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Do I have any entity options to choose from when forming my business?"

Absolutely! There are various corporation types and entity types which you can choose from. Let’s discuss two different business entity types you can pick for your business right here!

  • Partnership: If you’re a business owner, and you want to have someone else on board as your business partner, then this is the entity of business you should opt for. As the same suggests, a partnership is an entity consisting of more than one owner. The upside to this form of business is that it is pass-through. What that means is that if the partnership suffers losses, those losses will pass through to the partners who will report it on their individual income tax returns. The downside to this type is that both partners are exposed to personal liability. You also need to keep in mind that things get tricky when more than one person is involved, because you need to assign roles and responsibilities to each member or manager. And don’t forget about scheduling meetings. Either way, none of these should discourage you from considering this entity, because it might just be the right fit.
  • Corporation: If only you had a dollar for every time you heard the word corporation in your life! Corporations are everywhere, at every turn. But what exactly are they? A corporation is a legal structure formed to conduct business. It is exposed to tax just like a regular person is, and the owner of a corporation is safe from personal liability. There are two types of corporations: S Corporation and C Corporation. We will discuss these in detail later on. One downside that exists when it comes to corporations, is that they are costly to form, which could be a problem if the business is a small business.
  • Sole Proprietorship: If business entities were organisms, then a Sole Proprietorship would be the simplest, single-cell type of entity. Keep in mind, that this type of entity is not a legal entity. It simply refers to anyone who owns a business, and unlike an LLC, the owner is personally liable for any debts the business might get hit with. Since it is a very simple entity to form, we see a lot of small businesses choose this business entity as their starting point. If you’re a business owner, you’ve likely come across sole proprietorships a lot in your career. There is one big downside though. Sole proprietorships are problematic in the sense that your personal assets are not protected under them, and this personal liability may prove to be an issue later on in the business, when it comes to tax and the legal side of things. Especially if you have a small business.

Then there’s the LLC, which is a very popular business entity.

  • Limited Liability Company: You’ve probably heard this business entity type being mentioned a lot in the business sphere. It’s also called an LLC, or a limited liability company LLC. You’ve probably seen business billboards or advertisements in every state which have LLC at the end of their name. By itself, limited liability is a legal status. When that legal status is actualized as a business, it becomes a limited liability company LLC. This is the business type we usually see small business owners go for when they start their business entity formation process. Why is it so popular among small businesses and large business alike? Basically, by choosing a limited liability company, the owners of the company will not be held personally liable in the event that they are sued or take a loss. This makes limited liability companies the perfect candidate for protecting personal assets.

Many are sometimes confused when it comes to LLCs. Are they corporations? Are they partnerships? Questions of the century!

Let’s clear that up.

An LLC is basically the best of both worlds. It’s a mix of a corporation and a partnership, in the sense that an LLC is a pass-through business, meaning that any profit or loss that the business will see, will pass through to the owners. The business itself will not be hit with tax, and the owners will not be personally held liable. On top of that, there’s much less paperwork involved with LLCs, which is great, because who likes paperwork? We’ll talk more about this annoying part of the process later on.

Now that we’ve talked about business structuring, let’s address a question we know you’re dying to ask:

How do I know which entity is the best fit for my business?"

Obviously, every business has its own criteria when it comes to choosing entities. But there are some matters that all business owners need to keep in mind, since they are very common, and even integral. Let’s go over these real quick and discuss them.

  • Tax: Ah, yes. Tax plays a pretty integral role even before the business is formed. Double taxation, for example, is an issue that might occur in the long run. It’s always best to consult with tax professionals to know how your entity is going to be taxed. Obviously, you should be trying to minimize tax as much as possible, especially if your business is located in a state which has high tax rates. Tax, whether sales tax or income tax, is also something which changes from state to state and the amount of taxes is higher and lower compared to what state you’re located in. You can, for example, form your business in a state like Delaware, which has no sales tax, meaning double taxation won’t be much of a headache. Either way, they are ways of dealing with tax per state even after your business is formed. We’ll discuss this elsewhere.
  • Finances: Businesses require paperwork, and for certain type of business, like corporations, paperwork can prove to be quite costly. If you want to minimize paperwork cost, and on top it, paperwork headache, maybe you could shoot for an LLC or a Sole Proprietorship. In either case, you need to follow through with your paperwork correctly to make sure everything is set up right. On top of the paperwork, there’s also the cost of maintaining what you create. Looking after specific types of companies, especially those that have a lot of employees, can mean a lot of financial resources. So keep this in mind as well.
  • Legal Side of Things: Obviously, you want to protect yourself when you’re forming a business. Different business entities require different type of protection. The entity you choose should preferably be in line with the nature of your business, and what security measures you are looking to have in your business operation. If it’s just you and it’s a sole proprietorship, the security measures you take will be different compared to, let’s say, a partnership. The more people are involved, the more intricate. What if there is disagreement between members and there’s a falling out? You need to keep that in mind.

It’s very important for you not to follow trends when it comes to choosing your business entity. You might hear people say: “Oh, an LLC is the best for a small business!” or “Just pick sole proprietorship! I did, and it worked out great!”

Indeed, it might have worked out great for them, and that’s, well, great! But it might be the same in your case. Generally, all of the business entities which we have mentioned so far are extremely popular with business owners. There’s corporations of different types everywhere. Many are opting for sole proprietorships. You’ve definitely seen a lot of LLCs. But what matters is choosing the entity which is a good fit for your business and your needs! We suggest you spend a lot of time perfecting the thought-process of how you wish you to move forward and operate.

Let’s say you’ve decided on the type of business you want to form. Congrats! Next comes another familiar question from someone who wants to file a business entity:

Which State Should I Form In?

Good question, and again a very common one!

There’s 50 or 52 states in the U.S., depending on which source you’re following. If you’re planning on forming your business outside of the state you’re living in, there’s a wide variety of options. Obviously, every state has its own legal system, and its own regulations when it comes to businesses. So, which one is the best option for you?

That depends. Let’s say you are located in California and your target audience is in California. If your suppliers are also located in this state, then it would make sense for you to form your business or corporation in this state. But if your supplier are located in a state outside of where you live, you can try forming your business in that state.

The state your business is formed in is called your home state. But that does not make your operations limited to that state. If you form your business in California, there’s no reason why you shouldn’t be active in other states. The only thing you need to be careful about is taxation. Because each state has a different regulation when it comes to tax. If you’re an online seller, then every state is at your disposal for your business!

Also, keep in mind that states have different tax rates. A lot of new businesses go for Delaware, for example, because it has virtually zero sales tax. This makes it the perfect state for purchasing and reselling products. In general, Delaware, Montana, New Hampshire and Oregon have the lowest collective sales tax. On the other hand, states like Louisiana, Washington, and Alabama have extremely high collective sales tax rates. Good thing is, you can always handle taxes with tax exemption, but that’s a whole other topic for a whole other day!

OK, I've decided on the entity, and the state. Now what?

Now comes the part that everyone loves: paperwork!

Yep, we’re happy to report that you need to get some paperwork done in order to start your business. We’ll clear that up for you:

You’re going to need an EIN, an Operational Agreement, and Articles of Organization, among other things.

Let’s go over these:

  • EIN: EIN is short for Employee Identification Number and it’s used for, you guessed it, identification purposes. Sometimes, it’s also called a Federal Tax Identification Number. Basically, it’s a number used for identifying your business. Whenever somebody looks up your EIN, they can get info on what type of business you’re running, where your located, and other tidbits. You can apply for an EIN in every state, but you need to make sure whether you need a state number for the state you’re located in. This little nine digit number has been around since the 70’s, and is a must-have for forming your company or corporation. Just a tip: if you are a non-U.S. citizen and need to get an EIN for your company, you need to have an ITIN first to proceed with your business formation process. Which is something that we also help our clients with. See more here.
  • Operating Agreement: This is an important piece of document when you’re forming an LLC. It’s basically a document which outlines all the goings-on and who’s-who of your business. Each owner decides how to run their business, and who will be responsible for what duty during its operation. All of this is outlined in the operating agreement of a business. Basically, all the rules of your LLC can be found in this document. This includes the percentage each member owns, who has what rights and what they can do internally, how profits and losses are distributed, when and how meetings are held, and what will be done in the event of a death or a transfer of interest. Again, the requirements for this document vary in each state, and some might not even require operating agreements. But, trust us, it’s a pretty handy document!
  • Articles of Incorporation: This document has been around since the 1800’s! That alone showcases how important it is. Articles of Incorporation is a document which validates that your company or corporation officially exists within the U.S. or Canada. Usually, you’ll find the name of your entity, the type of corporation, the registered agent, and other pieces of information in this document. Filing for this document requires fees, and as usual, they vary from state to state.
  • Articles of Organization: This is the LLC counterpart to Articles of Incorporation. It’s basically the same thing, but for LLCs. It includes the name of your LLC, the legal structure, members or managers list, signatures, and the whole nine yards. This is the document which shows who can do what and when in your LLC.

Did we tell you everything there is to know? Hmm, something seems to be missing…

Oh, right! The name of your business! How could we forget?

Let’s say you’ve decided what entity type you need, and you know the state you’ll be operating from. Time to start the filing process! But, you can’t really do that if you haven’t decided on a name! Your name is your identifier, and how people will recognize your business. And just like with everything else, there are regulations for choosing names for your company or corporation.

You obviously can’t use names that are trademarked, like Nike, Disney, etc. It’s also generally advised not to use names that exist in other states, because it might lead to legal issues and complications. Do you really want to carry that liability? Probably not! Make sure whatever name you choose, is unique, simple, and memorable. It should stick with people after they hear it. How you choose one is completely up to you!

Also, don’t forget about tax exemption either, if you’re planning to be a reseller! That’s a very important part of your business. After you’re done with forming your business, we can help you take care of this side of things as well. More info here.

As you can see, there are many layers to forming a business or corporation. From choosing the entity type you think fits you best (could be a corporation, sole proprietorship, or limited liability, or a partnership), to picking a name, to filing the right paperwork. It might seem like a ton of work, but if you set everything up correctly, and you should, your business will have extremely strong groundwork, making it ready for a successful take-off!

If you have a general idea of how you want your business to be shaped, go to the next page so we can discuss what we, Prestige Auditors, can do for your business, from helping you choose the perfect entity, to handling all the formation processes, sparing you the headache of paperwork!