Written by: Jasmine Arooni

 

Determining the type of ownership structure for your business is crucial to its formation. However, a challenge exists in what comes after making the choice of ownership structure. Issues arise over specifics of ownership type, taxes, bank accounts, agreements, identifications and restrictions within the business structure. Selecting your business type must be determined FIRST before you can take
the next steps.

Entity Types

1. Sole Proprietorship: A sole proprietorship is a business that is operated by a single person. The sole proprietor is responsible for all of the profits or losses of the business and his/her personal
assets are involved with full liability.
2. Partnership: A general partnership is two or more people operating a business together. There is shared responsibility, so personal liability of each partner exists.
3. Limited Liability Corporation (LLC): In a LLC, the characteristics of a sole proprietorship are combined with that of the limited liabilities of a corporation in order to protect against personal liability. A LLC does not have to distribute profits to all its members, but profits are reported on the
individual member’s personal taxes. The LLC does not file it’s own taxes like a corporation does.
An LLC can be member-managed or manager-managed, and the company can be owned in different percentages by its members.
4. Corporation: A corporation is owned through the ownership of stock. The owners are described
as “shareholders.” Thus, a corporation is separate from its owners, functioning as an entity with its
own legal rights and tax filings.

Next Steps

After determining which entity type is right for your business, confusion may exist about the
different steps that need to be taken in order to start the official process. Here, the specifics are broken down based on entity type.
Sole Proprietorship:
Step 1: Identify that the sole proprietorship model best fits your business needs.

Step 2: Identify business name, business address, and state of principle business activities.

Step 3: File a DBA with your county, if you do not want to operate under your legal name.

Step 4: Secure separate bank account for clear business expenses and income reporting for taxes. You may need to present a business license or DBA license in order to open a bank account.

Step 5: A sole proprietor’s personal social security number must be used for the business reporting. For privacy, security, and accounting reasons, a sole proprietor should consider establishing a separate EIN for the purposes of the business. Obtain EIN by submitting Form SS-4 to the IRS.

Step 6: Draft supplemental agreements like business plan, promissory notes and secure a CPA or bookkeeper for reporting income and filing taxes.
Partnership:
Step 1: Identify that the partnership model best fits your business needs.

Step 2: Identify the business name, business address, and state of principle business activities.

Step 3: File a DBA with your county, if you do not want to operate under your legal name.

Step 4: Secure separate bank account for clear business expenses and income reporting for taxes. You may need present a business license or DBA license in order to open a bank account.

Step 5: One of the member’s to the partnership must use their personal social security number for the business reporting. For privacy, security, and accounting reasons, a sole proprietor should consider establishing a separate EIN for the purposes of the business. Obtain EIN by submitting Form SS-4 to the IRS.

Step 6: Set forth an oral partnership agreement, subject to the laws of the state of principle business activities.

Step 7: A formal written partnership agreement is necessary to set forth roles, responsibilities, and purpose of the partnership. This written partnership agreement should be constructed based on specific provisions.

Step 8: Put a Buy-Sell Agreement in place to your business if something were to happen to one of the business owners (i.e. if a business is owned equally by four people, and one of them dies, with a Buy-Sell Agreement in place, the dead owner’s share will pass on to his or her heirs).

Step 9: Draft supplemental agreements like business plan, promissory notes and secure a CPA or bookkeeper for reporting income and filing taxes.
Limited Liability Corporations (LLC) and Corporations:
Step 1: Identify that the LLC or corporation model best fits your business needs.

Step 2: Identify the business name, business address, state of principle business activities, and desired incorporation state.*

Step 3: Identify agent for service of process. The agent must accept lawsuits, claims, legal demands, or tax notices on behalf of the corporation or LLC.

Step 4: Include registered agent in your Articles of Incorporation, Articles of Organization and/or Statement of Information. File your Articles with the Secretary of State office in your desired incorporation state.

Step 5: Obtain EIN by submitting Form SS-4to the IRS. For corporations, determine if the entity should be classified as a “S” or C” corporation for tax purposes. For LLC, determine if the entity should be classified as a sole proprietorship, partnership or corporation for tax purposes.**

Step 6: Secure separate bank account for clear business expenses and income in taxes. A LLC or corporation must show proof that it was established under the Articles of Incorporation or Articles of Organization in order to start a bank account.

Step 7: Most banks require a corporate resolution, which expressly authorizes the opening of an account. It also specifies which individuals can sign checks and/or make withdrawals from the account.

Step 8: Prepare to pay a minimum state income tax per year, regardless if the LLC or corporation earns money. California requires a minimum of $800, and Wyoming does not have a corporate income tax. To find a 50 state survey of 2015 tax rates, click here.

Step 9: Be prepared to be responsible for taxes with the federal government and local county or city entities, as well as employee, merchandise, sales, use or local taxes.

Step 10: Draft supplemental agreements like a LLC operation agreement, shareholder agreement, bylaws, corporate minutes, business plan, or promissory notes and secure a CPA or bookkeeper for reporting income and filing taxes.
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* Consult with an attorney or do your due diligence in research the advantages of incorporating in other popular incorporation states, such as Delaware, Wyoming or Nevada.

** A“S” corporation may be chosen as a starting point because it allows “pass through” tax
treatment to shareholders. Any income earned or losses sustained will not be taxed at the corporate level. Any income earned will not be subject to double taxation. However, a Corporation has to be eligible to be a “S” corporation” under certain provisions and file an election (Form 2553 Election)with the IRS. A “S” corporation should be ready to become a “C” corporation if it is no longer eligible under the provisions.

**A “C” corporation is able to provide certain tax-deductible employee benefits, since it is subject to taxation. A “C” corporation is subject to taxation on income earned and losses sustained and double taxation may apply. If a “S” corporation no longer fits under the provisions, it will transition to a “C” corporation.