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San Diego Business Entity Formation AttorneysSan Diego Business Entity Formation Attorneys

As a business owner, one of the first decisions to make is how the company should be structured. A San Diego business entity attorney at McCarthy Law can help you choose and form the best legal structure for your business.

The business entity you choose will influence your personal liability, partners’ willingness to invest into your business, the amount of bureaucratic paperwork, and the taxes you must pay. Many sole proprietors who upgraded into a new, properly-selected business entity are stunned that their annual taxes are sometimes cut by as much as half!

How to turn my business idea into a reality?

Maybe you’re a photographer. Maybe you’re a café owner. Maybe you’re a technology consultant. You probably don’t have an MBA. You might not have taken a business class. But, you have an idea for a business. So, you jot down some notes, you sketch out a business plan, and you wonder whether it will ever fly. Most people, never try to start their own business. But, you’re here. So, you’re probably different.

Take the leap! But do it right…

Should I Go Legit with My Business?

You’re probably wondering, “Do I need to make my business ‘official’?” The answer is almost always “Yes!” If you’re operating a tiny, hobby-type business, or you’re holding an occasional junk sale in your garage, you can probably do without formal business registration… at least for a while. But, just because you can doesn’t mean you should. Plus, that’s not what you want. You want your own business. And that means the formation of a business entity.

Generally, anyone with a good-sized, or visible business should complete all the necessary registration tasks to become official. Operating under the table is easy to expose, and super risky. The government can come after you for fines, penalties, and it might even shut you down simply for operating without the necessary paperwork. If you’re making any money, the IRS wants to know about it. Besides fines and back taxes, you could even face criminal charges and jail time.

SO MANY Relevant STORIES we could SHARE! Here’s one: Paul and Danny own a nursery. They’ve been in business for 10 years. They share everything 50/50. Paul has the green thumb. Danny has the sales skills. They have a solid clientele. They make decent money. They each own a house. They each own two cars. Paul decked out his mancave in autographed Chargers gear. Danny traveled the world.

Danny went to China. He thought he bought California poppy seedlings. But, instead he bought exotic poppy seedlings (the kind you make opium with…unbeknownst to him). When Danny landed at LAX, customs asked if he was planning on selling the plants. Danny said, “Of course!”. So, customs detained him until the DEA could arrest him. Meanwhile, in San Diego, Paul was carefully shaping some bonsai trees when the DEA burst in, startling Paul, causing him to cut a tree in half, before arresting him.

News of Danny’s and Paul’s arrest soon hit the news: “Local Nursery Smuggling Illegal Plants”. There mug shots were plastered all over the place. Now, the partners were ultimately cleared, but not after they paid lawyers $50,000, and lost several high rolling customers, and racked up serious business debt. Paul had nothing to do with any of it…but he is still personally liable for the debts even though Danny bought the stupid plants.

What Business Structure / Business Entity is Best?

Image of a business entity chartYou might already have an idea of the legal business structure of your business whether you know it or not. The ownership structure — and proper business entity — that’s right for your business normally depends on: 1) how many people will own the business; and 2) what type of services or products it will provide.

For example, if you know you will be the only owner, then partnerships are obviously out. If your business will be engaged in risky activities you want to business structure that provides personal liability protection.

California has four basic types of business structures

Business entity structures to choose amongst are:

  1. Sole proprietorships;
  2. Partnerships;
  3. Limited liability companies (LLCs); and
  4. Corporations.

California Business Entity Choices

A business entity attorney at McCarthy Law can help you choose the right business entiy and organizational structure for your business.

(1) – What is a Sole Proprietorship?

Sole proprietorships are one owner businesses, that haven’t filed papers to become a corporation or an LLC.

Sole proprietorships are easy to set up and maintain. If you do for-profit work, on your own (or sometimes with a spouse), and you haven’t filed paperwork to become a corporation, or an LLC, you are a sole proprietor.

Unlike corporations, or LLCs, sole proprietorships are not legally separate from the people who own them. This has two major effects. First, sole proprietorships offer “pass-through” taxation. When tax time rolls around, a sole proprietor reports business income or losses on his or her individual tax return. You report income from the business just like wages from a job, but you also include a Schedule C, where you can provide profit and loss information. So, if your business loses money, you can use the business losses to offset any taxable income you have earned from other sources.

You’d logically conclude that a sole proprietorship would be the best structure for saving on total annual taxes. You could be wrong. Significant tax savings can be had for someone (even a husband and wife team) working from home or a small office earning a good income, but operating as a sole proprietor!

In addition to possible tax savings there are serious liability concerns. As the owner of a sole proprietorship, you can be held personally liable for business debts. So, if your business defaults on a debt, or loses a civil lawsuit, you, personally, could be forced to pay up. This is pretty sobering for most people who own, or hope to own, a house, car, or other assets. Many sole proprietors who get their “first lawsuit,” are the first to call a business entity attorney to shore up their defenses – IF they survive the legal action and remain in business.

How many of us, or a friend or relative, have purchased a home alarm system AFTER being burglarized? Lawsuits — even silly ones — are real, more common than you can imagine, sobering, and work as an unfortunate business owner “teaching moment.”

(2) – What is a Partnership?

You have a partnership when you have two or more entrepreneurs in a business venture. A partnership is a business that has more than one owner and that has not filed papers with the state to become a corporation or an LLC, or an LP, or an LLP. That is what we call a “general partnership.”

General partners are personally liable for all business debts (just like sole-proprietors). But, any individual partner can also bind the whole business to a contract or business deal.

A limited partnership (LP) requires at least one general partner and at least one limited partner. The general partner has the same role as in a general partnership. He or she controls the company’s operations and has personal liable for business debts. The limited partner contributes financially, but has minimal control over business decisions, and normally can’t bind the partnership. In return for giving up management power, the limited partner gets the benefit of protection from personal liability.

In a limited liability partnership (LLP) all owners have limited personal liability. These partnerships are only available to licensed professionals like lawyers, accountants, and architects.

Just like sole proprietorships, partnerships provide for a pass-through taxation. Partners can structure their relationships with one another by drafting partnership agreements. But, it doesn’t take much to form a partnership.

(3) – Is a Limited Liability Company Right for My Business?

If you’re like most business owners, you don’t want to risk personal liability, and you’d rather not have the hassle of setting up, and maintaining, a corporation. If so, an LLC might be perfect for you. LLCs combine pass-through taxation (like sole proprietorships) and protection against personal liability (like corporations). But, they can’t be used for professional services like lawyers, or accountants.

Generally, owners of an LLC (called “members”) are not personally liable for the LLC his debts. This protects members from legal and financial liability in case their business fails, or loses a lawsuit, and can’t pay its debts. In those situations, creditors can take all the LLC’s assets. But, they generally can’t take the members’ personal assets.

Some LLCs opt to be run by specially designated managers. But, if all the LLC owners intend to actively manage the company LLC’s usually opt for the member-managed structure. Most LLC’s are member managed.

LLCs don’t eliminate all liability. Any manager can bind a member-managed LLC to a deal. LLC owners can even be personally liable for:

  • Personal guarantees;
  • Taxes;
  • Negligent or intentional acts;
  • Breach of fiduciary duty; or
  • When the LLC as blurred the boundaries of its owners.

Like sole proprietorships, or partnerships, an LLC is not a separate tax entity from its owners. An LLC is a “pass-through” entity. Income passes through the business to each LLC owner. LLCs give members the flexibility to choose to have the company taxed like a corporation too. Because of the income splitting strategy of corporations, LLC members can sometimes come out ahead by having their business taxed as a separate entity at corporate tax rates. For example, if the owners of an LLC become successful enough to keep some profits in the business at the end of the year, paying tax at corporate rates can save money. Federal income tax rates for corporation start at lower rates then they start for individuals.

Forming an LLC you can be trickier than a partnership or sole proprietorship. To form an LLC, you must file Articles of Organization with the California Secretary of State. You should also have an operating agreement governing the internal workings of the LLC. The filing fee is fairly cheap. But, the California Franchise Tax Board requires you pay a minimum annual LLC tax when you start your LLC.

(4) – Should My California Business be a Corporation?

Most people think of huge, industrial empires when they think of corporations. But, most aren’t. A corporation is simply a specific legal structure imposing certain legal and tax rolls on its owners (“shareholders”).

A corporation is a separate legal entity from its owners. Corporate shareholders are normally protected from personal liability for business debts. Finally, a corporation itself, not just its shareholders, is subject to income tax.

Just like LLCs, shareholders can still face person liability for personal guarantees, taxes, negligence or intentional acts, breaching fiduciary duty, or blurring the boundaries between the corporation and its owners.

Corporations are treated differently for tax purposes depending on whether they operate as a regular Corporation (also called a C corporation), or as an S corporation. S corporations are the same as C corporations in most respects, except taxes. C corporations must pay taxes, while S corporations are pass-through entities.

A C corporation must file and pay income taxes on its own tax return, much like individuals. Corporations that keep some profits in the business from year to year, rather than paying out all profits can take advantage of lower corporate tax rates.

Larger corporations, with shareholders who aren’t active employees, often face the problem of double taxation. Unlike salaries and bonuses, dividends paid to shareholders cannot be deducted as business expenses for corporate earnings. So, any amount paid as dividends are included in the total corporate profit and taxed. When shareholders receive the dividends, they are their taxed. So, there’s double taxation. You can avoid double taxation simply by not paying dividends. This is usually easy when shareholders are employees. But probably more difficult if shareholders or passive investors.

Unlike a C corporation, an S corporation does not pay taxes itself. Any profits pass-through to the owners, who pay taxes on individual income. But, the business is still a corporation. So, the owners are still protected from personal liability. Most people choose LLCs over Corporations. Corporations require more time and expense. California reduced the upfront fees for incorporating. But, most the expenses involve legal or other professional fees.

To incorporate you must file Articles of Incorporation with California Secretary of State, along with the filing fee, and a minimum annual tax. Additionally, you must file a Statement by Domestic Stock Corporation every year, beginning within 90 days of filing your Articles of Incorporation. If you decide to sell shares of the corporation to the public you must comply with lots of complex federal and state securities laws. Finally, to protect your limited personal liability you need to act like a corporation. That means you must adopt bylaws, issue stock to shareholders, maintain records of various meetings of directors and shareholders, and keep records and transactions of the business separate from those of the owners.

What Are Non-Profit Corporations?

Nonprofit corporations are tax-exempt corporations. Nonprofit corporations operate as public charities. There are several steps one must take to create a nonprofit corporation. The first is filing Articles of Incorporation. After you file Articles of Incorporation you must apply for state and federal income tax exemption. Operating a nonprofit can be both rewarding and challenging. McCarthy Law is here to help.

Public Benefit Corporations – Social Purpose Corporations

There are two other corporation options available in California since 2012. These are the Public Benefit Corporation and the Social Purpose Corporation. These entities were approved because some business owners find Non-Profits too constraining on important issues like being able to make a profit and needing to manage the business with a Board of Directors.

READ MORE: Public Benefit & Social Purpose Corps

For many new and small business owners, incorporating, or organizing as an LLC, seems like renting really expensive office space. But, really, it’s like building the foundation to a home. Picking the wrong entity or improperly forming the entity could leave you open to personal liability and make it more difficult to do the things you want to do later on.

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