How to Succeed in Business: Why Incorporation is Important for Your Business?
As a business consultant, my main area of expertise is assisting small business owners with properly incorporating their businesses in their particular state. In the State of Maryland, one has to ensure that their business is properly registered with the Maryland State Department of Assessment and Taxation (SDAT). In Maryland, the average yearly fee of incorporating one’s business is from $150 to $300. It is normally advisable to incorporate your business with the appropriate state agency, in your particular state, within the first three years of being in business.
Incorporating your small business will provide you with the following protection and benefits:
- Tax Breaks;
- Assurance that one’s personal assets are protected from the business debts;
- The ability to be able to do business with various government agencies; and
- Business being recognized by customers as a legitimate and legal entity.
The different forms of incorporation for a business are:
- Sole proprietorship: simplest business form and not a legal entity. The business is not legally separate from the owner. The owner’s personal assets and obligations of the business are not distinguished. They are considered one in the same. The owner’s personal assets can be used to pay off the debts, obligations, and liabilities of the business. This form of incorporation is good for business owners first starting out due to lack of income, but when start making money it is good to incorporate one’s business into another legal entity form. For tax purposes, do not need to file separate taxes because profits or losses are reported on the owner’s tax return.
- General Partnership: This is the simplest form of partnership and is created when two or more individuals engage in business together for profit. A general partnership can begin with just a verbal agreement and handshake. All partners involved in the business shares in the day to day operation and management of the business. Also, all partners split the profits and proceeds of the business equally. There is no liability protection in this form of business and every partner is equally liable for all debts and obligations of the business. Also, the personal assets of each partner can be used to pay such debts. Do not have to file paperwork to create a general partnership, but is advisable to do so. Also, it is good to write out a partnership agreement that will spell out the rights and responsibilities of each partner.
- Limited Partnership (LP): There are two classes of partners (general and limited). The general partners normally handle the day to day operations of the business and are held personally liable for the business debts and obligations. Limited partners only contribute money and capital to the business. The limited partners are not involved in the daily operation of the business. The limited partner’s personal liability does not go beyond their capital contributions to the business. In a limited partnership, one partner must be the general partner with unlimited personal liability, and one must be the limited partner with limited personal liability based on their monetary contribution to the business. One tax advantage for a LP is that it allows for pass-through taxation, as income is not taxed at the business level.
- Limited Liability Partnership (LLP): This business entity is a hybrid and similar to a Limited Liability Company (LLC). All partners in the business handles the daily operation and management of the business. Unlike the Limited Partnership, Limited Liability Partnerships ensures that all partners’ personal assets cannot be used to satisfy the business debts and liabilities like an LLC. LLP partners are ensured that they will not be held accountable for the acts of other partners (have personal liability protection). Each partner is still liable for their own actions. Many LLPs are set up by professionals like accountants, doctors, architects, and lawyers. LLP for taxation purposes has pass-through taxation because its income is not taxed at the entity level. With a LLP, one has to file formation papers with their state’s chartering agency and pay a filing fee.
- Limited Liability Company (LLC): It is an unincorporated business that can be formed by one or more individuals with no personal liability for debts of the LLC. An LLC is unique because for statutory purposes it is treated like a corporation regarding limited liability of partners and partnership status for tax purposes. In Maryland, this business entity has to be registered with SDAT by filing Articles of Organization. LLC based in Maryland are authorized and regulated by the Limited Liability Act. When forming a LLC, it is advisable to draft an Operating Agreement that provides greater detail regarding the operation of the LLC and the relationship of the members to each other.
- Corporation: Corporation is an independent entity. The corporation is separate from the owners of the business because can contract in the corporate name, sue and be sued as the corporation, and buy, sell, and own property in the corporate name. There is no personal liability for owners of the business because the corporation is responsible for its own debts and liabilities. The business entity outlasts the death or disability of all stockholders. It is good to have estate planning with a corporation to deal with the death or disability of a stockholder. A buy-sell agreement properly funded by life insurance and disability insurance can provide a disabled stockholder or the estate of a deceased stockholder with the means to sell stock at a fair price, and at the same time the buy-sell agreement can control the ownership of stock in the corporation. A corporation is formed by filing Articles of Incorporation with SDAT and it has to be accepted by SDAT.
- S-Corp and C-Corp: Have the general guidelines as a corporation. Must be registered with SDAT similar to a corporation. There is no difference between S-Corp and C-Corp for purposes of Maryland Corporate Law. S-Corp does not have double taxation like a C-Corp. C-Corp has double taxation because it is treated as a separate taxable entity and distributions to stockholders are generally treated as dividends. S-Corp is the best avenue over C-Corp because it provides liability protection of a corporation while allowing tax treatment similar to a partnership.
Whatever legal entity one decides to create for their business, you must do the following before doing so:
- Do your research on which one will be the best fit for you and your business?
- Get advice on the tax advantages and tax disadvantages of forming a particular legal entity.
- Talk with a tax expert and accountant.
- Talk with an attorney to figure out the best legal entity to form for your business.
Donya Zimmerman is a business consultant, mediator, and legal professional with over ten years of experience. She is owner of Family & Community Mediation and Business Consulting (FACMBC) based in Baltimore, Maryland and has been in business since 2013. Services provided by FACMBC: Mediation and Conflict Resolution Services; Business Registration Assistance (Limited Liability Company, Corporation, S-Corp, Limited Liability Partnership, etc.); Business Plan Drafting Assistance; Business Certification Assistance (MBE, WOSB, 8A, 501(c) (3), Hub Zone, etc.); and Business Organization Assistance. She is also a contributing writer to the Maryland Daily Examiner Newspaper. Contact information: firstname.lastname@example.org; www.facebook.com/FACMBC; www.twitter.com/FACMBC; https://dzimmerman36.wordpress.com; http://www.linkedin.com/in/dzbusconsultantandmediator