Legal Services of Easern Missouri’s CED PROGRAM Presents: Legal Workshop for Entrepreneurs: Choice of Entity January 26, 2011

Choice of Legal Entity: Overview Factors to consider Primary types of legal entities

Major considerations Liability Taxation Formal requirements and fees Management and control of business Ability to transfer ownership Continuation of business

Types of Legal Entities **Sole Proprietorship **General Partnership **Corporation **S Corporation Statutory Close Corporation **Limited Liability Company Limited Partnership Limited Liability Partnership

Sole Proprietorship Business owned by one person Duration limited to life of owner Tax treatment Report business income and expenses on individual tax return Taxed at ordinary income rates Business losses can offset other gains Unlimited liability

Sole Proprietorship – Unlimited Liability Owner personally liable for debts and lawsuits Possible liability for acts of agents and/or employees Liability continues after business terminated or sold General business insurance can provide some protection Homestead Exemption can give some protection for your home

Sole Proprietorship -- requirements Few formal requirements Register fictitious name with Secretary of State Pay self-employment tax on wages File gains and losses on personal tax return

Sole Proprietorship – Pro’s and Con’s Benfits Pass through taxation Easy to form and maintain Maximum flexibility and control for owner Drawbacks Unlimited liability Difficult to get investments

Sole Proprietorship – Practical Tips Sufficient for most start up companies with one owner/investor Non-retail businesses (e.g., consulting, other service businesses, home-based businesses) Obtaining adequate insurance is critical

General Partnership Business conducted by 2 or more people Includes a business owned by a husband and wife Not a distinct legal entity Partnership ends when: One partner dies, files for bankruptcy or leaves the business One partner can force dissolution by court order Transfer ownership – all partners must agree

General Partnership Tax treatment Unlimited liability Each individual partner files income and expenses on personal income tax return Losses from partnership may offset other personal gains Unlimited liability Each partner has unlimited liability for debts, obligations and wrongful acts committed by any partner Liability continues after even after leave the partnership

General Partnership -- Requirements Few formal requirements and fees Register fictitious business name with Secretary of State Pay self-employment tax on wages received File gains and losses on personal tax return

General Partnership – Pro’s and Con’s Benefits Pass through taxation Easy to create and maintain Drawbacks Easy to form Unlimited liability

Partnership -- Formation Can be formed through oral agreement or actions If share profits with someone (Paying someone wages does not create a partnership) Create public perception that business is a partnership

Partnership – Practical Tips Written partnership agreement is essential Provides flexibility Defines relationships among the partners to fit the needs of the business Minimizes risk of disputes Seek legal assistance to prepare All partners must understand their rights and responsibilities under the agreement

Corporation Independent entity, separate from owners Owned by stockholder/s Managed by a board of directors and officers MO law requires only one director Must have President and Secretary

Corporation Unlimited duration No personal liability Easy to transfer ownership interests Taxation: Pay corporate taxes on net income Stockholders taxed on profits distributed as dividends

Corporation . . . Taxation continued More items can be deducted as business expenses Can deduct fringe benefits for employees E.g., cost of health insurance For all other entities, owner/s must include as wages

Corporation -- Requirements Obtain federal EIN number File articles of corporation with MO Secretary of State Filing fee $58 if business has $30,000 or less Form 2643: MO Tax Registration Application

Corporation -- Requirements File Federal and State corporate income taxes Must file annual report $40 paper $20 online

Corporation – Pro’s and Con’s Benefits Liability protection (personal guarantee often required ) Easy to transfer ownership interests Easier to raise $ Drawbacks 2 levels of tax Formalities to create and maintain

Corporation – Drawbacks cont. Must adhere to corporate formalities Ongoing federal and state filing requirements Must hold regular meetings of board and shareholders Record keeping

Corporation – Drawbacks cont. Avoid “Piercing the Corporate Veil” No commingling funds Pay yourself and other owners a salary Transact all business in corporation’s name Sign agreements in corporation’s name Advertising, correspondence etc in corporation’s name Follow corporate formalities

S Corporation Similar to a C Corporation EXCEPT: Corporation does not pay federal income tax Pass through taxation like partnership or sole proprietorship Owners must pay self employment taxes on wages More limitations with tax allocations (e.g., no special allocations of profits and losses) Must file IRS Form 2553 to get special tax status

S Corporation -- Limitations Stockholders limited to US citizens or permanent residents All stockholders must be individuals (e.g., no corporations can invest) Only one class of stock Maximum of 100 stockholders Tax year must be calendar year

S Corporation –Practical Tips Depending on personal income tax rate, C corporation could be better option Consider how owners are paid – dividends or wages Consider need to build capital

Limited Liability Companies Combines attributes of corporation and partnership No personal liability like a corporation Pass through taxation like a partnership Owned by member/s Managed either by member/s or manager/s

Limited Liability Company Duration limited but can be perpetual Taxation: If one member, tax same as a sole proprietor If two or more, tax same as a partnership Federal self-employment tax

Limited Liability Company Management: Statutory default is member managed Articles can change to managers If managers, members cannot bind the LLC If members manage, member action binds LLC Transfer ownership: Statutory default is only economic interests transfer

LLC -- Requirements Must file articles of organization with Secretary of State $105 paper filing, $50 online Name must contain “lc”, “llc”, limited liability company, or “limited company. “ Cannot have “corporation”, “incorporation” as part of name

LLC Requirements cont. File profits and losses on personal income taxes Self-employment tax for member employees Avoid “piercing the corporate veil” Must have an operating agreement

LLC Requirements – Operating Agreement Governs conduct of business Sets forth rights, duties and obligations of members In MO can be oral (BAD IDEA!!)

Limited Liability Company Benefits Flow-through taxation Liability protection Flexible management structure Few corporate formalities and filings

Limited Liability Company Benefits cont. Allocating ownership interests flexible Can be based on services provided, not $ No limitations on types of stockholders Drawbacks Can be difficult to transfer full interests Tax filings can be complicated

Closed Corporation Similar to a C corporation EXCEPT: Stockholders generally know each other Stockholders also active in management Restrictions on sale of stock No requirement to have board of directors, hold meetings or have bylaws

Closed Corporation --Requirements Articles must state that corporation is a statutory closed corporation 50 or fewer shareholders Can only transfer ownership interest if sell back to corporation or All stockholders agree

Closed Corporation – Pro’s and Con’s Benefits Maintain more control Articles can eliminate board of directors, stockholders can manage corp. Articles can state who can be a stockholder Drawbacks Same as C corporation Can be difficult to leave the business

Limited Partnership Similar to a General Partnership EXCEPT: Comprised of at least one General Partner and at least one Limited Partner Can be individual/s or entity/ies

Limited Partnership Similar to a General Partnership EXCEPT: General Partners have unlimited liability Limited Partners have liability protection Provided they do not help manage the business File application for registration with Secretary of State

Limited Liability Partnership Similar to General Partnerships EXCEPT: Partners not liable for debts and liabilities incurred by partnership Still liable for acts of other partners Partnership does not dissolve if one partner withdraws.

Limited Liability Partnership Must file application for registration every year OR Automatically revert to General Partnership Law less settled

Useful websites Missouri Secretary of State Business Divisions: http://www.sos.mo.gov/business/corporations/ www.missouri.business.net/sbtdc/doingbusiness/legalform.pdf