Here are the answers to commonly asked questions of small business owners

What is limited liability?

What forms of businesses provide potentially limited liability?

What are the advantages of incorporating my business?

What are the disadvantages to incorporating my business?

Will my personal assets automatically be protected if I incorporate?

How can I minimize my personal liability?

Should I consider a Limited Liability Company (LLC)?

 
1. What is limited liability?
Limited liability is the concept that business owners may limit their personal liability for the debts and liabilities of their businesses. For example, typically an director, officer, or shareholder is not personally liable for the debts of the corporation. In this way, if a business fails, the owners may only lose the capital they invested in the business, and creditors cannot usually seize or sell the owner's home, car or other personal assets.

 
2. What forms of businesses provide potentially limited liability?
Limited liability companies (LLCs), limited partnerships, limited liability partnerships, and corporations potentially limit the personal liability of certain individuals involved with their businesses. LLCs have been recognized in California since 1994, and provide limited liability to its members. In California, an LLC must have two or more members. Limited partnerships limit the liability of its limited partners, but must have at least one general partner who is actively engaged in the partnership; that general partner does not have limited liability. Subject to certain exceptions, a limited partner is not allowed to participate in the management of the partnership. Limited liability partnerships are partnerships that engage in the practice of public accountancy, the practice of law or related activities.
For-profit corporations recognized by the IRS include C-Corporations and S-Corporations. C-Corporations are corporations subject to double taxation by its owners, i.e. the corporation pays income tax and the owners pay taxes on any dividends they enjoy. In contrast, the S-Corporation is not subject to double taxation. The S-Corporation pays no income taxes to the IRS (although in California it must pay the minimum Franchise Tax Board annual tax, currently set at $800); instead, the owners are taxed directly for any corporate earnings which are said to "flow through" to the owners. In addition, in California, certain types of professions (e.g. attorneys, physicians) may only incorporate as professional corporations. Always check with your accountant or attorney to determine which type of corporation, if any, is appropriate for your business.

 
3. What are the advantages of incorporating my business?
For many business owners, there are numerous advantages to incorporation. Those advantages include limited liability protection for its owners (but see below for important exceptions!). In addition, corporations, unlike sole proprietorships and partnerships have perpetual existence and can survive after the death of its owners. Corporations are more easily sold or transferred and can also offer financial advantages, since they are more likely to be able to raise capital than other business forms.
There may be important tax advantages as well. A business owners who elect to operate their businesses as S-Corporations, for example, may be able to lower their social security tax burdens by drawing a smaller salary as an employee. In addition, those business owners are eligible to deduct certain employee benefits. As always, check with your accountant if you are considering the potential tax costs and benefits to
incorporation.

 
4. What are the disadvantages to incorporating my business?
Some of the potential disadvantages of incorporation include the following: Incorporation can sometimes result in increased accounting and bookkeeping costs and in time lost in preparing corporate reports required by governmental entities. In addition, corporations must maintain certain formalities such as holding regular meetings. Also, there is a fee charged by the California Secretary of State for filing the corporation (currently $415.00) and all active corporations in California must pay at least the annual minimum Franchise Tax Board tax (currently $800.00). Note that said fees are subject to change at any time. Note also that incorporating your business may have negative tax consequences and that you should check with your accountant first before incorporating.

 
5. Will my personal assets automatically be protected if I incorporate?
Not necessarily. Always check with your attorney since, in cases where corporate formalities are not adhered to and/or the corporation is undercapitalized, creditors may "pierce the corporate veil" and sue shareholders personally for the corporation's debts. Corporate formalities that should be adhered to include: holding and documenting formal meetings of the Board of Directors and shareholders at least annually, and whenever you wish to make a significant change in the business, legal, or tax affairs of the corporation. Also, the corporation should issue its stock, keep accurate records of who holds the stock, and keep corporate funds separate from the personal funds of the shareholders. In addition, the corporation should be adequately capitalized relative to the level of business it generates.

 
6. How can I minimize my personal liability?
First, you should choose the appropriate business entities which provide limited liability as enumerated above. Second, make certain that your business is paying its taxes and complying with all state and federal tax withholding and reporting requirements, and that you are timely filing the appropriate documents with the California Secretary of State and other governmental entities. Third, if you own a corporation, make sure that you are holding and documenting regular (and at least annual) meetings and follow other corporate formalities. Fourth, make clear to creditors, vendors and customers that they are dealing with a corporation, not an individual. Fifth, make sure your company is capitalized adequately, relative to the amount of business you are doing. Sixth, always carry the appropriate type and amount of insurance for your business.

 
7. Should I consider a Limited Liability Company (LLC)?
For many business owners, the answer is yes. LLC's, authorized in California since 1994, have many advantages and some disadvantages. Bear in mind that LLC's, unlike corporations which can be owned and run by one person, must have at least two members. The filing fee with the California Secretary of State is cheaper (currently $70.00 to file the Articles of Organization), but it typically takes longer for the Secretary of State to process than with incorporation's. LLC's, subject to certain restrictions, can choose to be treated as either a corporation or a partnership for tax purposes. Case law regarding the duties and liabilities of LLC's and its members is not as well-settled as the case law in connection with corporations, however, it is advisable that LLC's, like corporations, should also adhere to operational formalities and maintain adequate capitalization. In this way, LLC's can maintain the limited liability of its members. For a more detailed analysis of the benefits and disadvantages of LLC's check with an experienced attorney and accountant.

If you need legal assistance in starting your business, sorting through complicated legal documents or protecting your assets call Darren Gordon Smith, a Professional Law Corporation today at (714) 505-2700. Our office can also help you and your business draft and review joint venture agreements, employment and independent contractor agreements, shareholder agreements, noncompetition clauses, licensing agreements and leases.

DISCLAIMER: THE ABOVE IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE CONSTRUED AS LEGAL ADVICE. LAWS CAN BE COMPLEX AND ARE CONSTANTLY CHANGING. FILING FEES ARE ALSO CONSTANTLY CHANGING. AS ALWAYS, YOU SHOULD FIRST SEEK THE ADVICE OF AN ATTORNEY TO FIND OUT HOW CERTAIN LAWS MAY AFFECT YOUR PARTICULAR SITUATION.