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Business Planning

Basic Business Types

BUSINESS PLANNING

Frequently Asked Questions

Business Plan


A business plan is essential to successful growth and tax strategies as well as proper succession planning.

What is a “D/B/A” name?

A “d/b/a” name, also known as a “fictitious name” or “doing business as” name, is name under which a company or individual conducts business as an alternative to the proper or legal name. Back to Top

Is There A Difference Between An Employee And An Independent Contractor?

There is a big difference between and employee and an independent contractor. These are legally defined terms. Merely classifying or placing a label on a worker is insufficient. The amount of control that one exerts over a worker is a key factor in determining whether a worker is an employee or an independent contractor. The consequences of classifying a worker can be enormous, including whether payroll taxes and benefits must be paid and whether an employer can be held liable for the actions or representations of the worker.

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How do I Transfer My Business to My Children?

There are many different ways to transfer business interests to family members. First, one can sell the business outright for its full fair market value, which creates immediate liquidity and provides some estate transfer tax avoidance but has potential income and capital gains tax consequences. Second, the business owners can enter into a “buy-sell” agreement which provides that sale of an owner’s business interest will be triggered by certain specified events (e.g., retirement, divorce, disability, or death). A buy-sell agreement can provide that owners buy out each other’s interests or the interests of their successors (often with treasury shares or the proceeds of insurance policies). Third, family limited partnerships also are a very powerful business-succession tool that often fit nicely within a larger estate plan. Fourth, the ALP attorney can set up a grantor retained annuity trust (“GRAT”) or a grantor retained unitary trust (“GRUT”), which are more complex devices that utilize irrevocable trusts that take ownership of the business while providing an income stream to the grantor for a specified time period. The income payments reduce the value of the business for estate and gift tax purposes.

There also are some lesser-used options. Private annuities can be powerful tools because the business interest can be sold in exchange for an unsecured promise to make set payments to the seller over his or her lifetime. There can be significant capital gains and income tax ramifications, however. Finally, a self-cancelling installment note (“SCIN”) is similar to a private annuity in that the business is sold in exchange for a promissory note, except that it is a promise secured by the business and the terms of the SCIN state that upon death, the outstanding payments will be cancelled. Back to Top

BASIC BUSINESS TYPES

Starting a Business

Introduction

Starting a business requires initiative, courage, and savvy. It also takes careful and proper planning in order to avoid many pitfalls related to licensing, taxes, payroll, employee benefits, labor law, liability of owners, officers, and directors, and ownership succession. In many cases, an owner may want to position
Entrepreneur
a small business for sale, which raises a number of related issues. The type of business structure chosen can impact each of these issues. In addition, laws and licensing regulations vary from state to state, which add a layer of complexity, especially for companies that will operate across state lines. Back to Top

How To Pick a Name

There is much more is involved in naming a business than simply imagining a name that you like. There are numerous legal requirements and serious potential for liability for infringement of intellectual property rights. (click here for more on intellectual property rights). The type of business form also can impact the name that you choose. There are also may be prohibitions against misleading business names.

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Choosing a Business Structure

One of the initial questions an entrepreneur faces is whether to incorporate his business. As with most things, there are important factors to weigh when decided whether and how to incorporate a business.

It is important to understand just what ‘incorporation’ means. It means more than just creating a corporation. A corporation is just one type of incorporated entity. Incorporation literally means to create a new person that is recognized by law. It means taking a business and transforming it into a new person. Of course, we are not talking about a real, human being. In fact, it really isn’t real at all. It is a fiction. But it is a fiction that the law recognizes. The law recognizes a properly incorporated entity as a legal person that has all the rights and duties of a citizen. Significantly, the law recognizes that many incorporated entities are completely separate from their owners. It is this last aspect of incorporation that can allow business owners to realize many big benefits: limited liability and potential reductions in income taxes or payroll taxes.

It also is helpful to understand how incorporation occurs and some key issues related to incorporation. Incorporating a business requires certification by the state and re-certification on an annual basis. Most states also require incorporated businesses to designate a person or corporation to serve as a resident agent to receive all notices or legal process. In addition, counties and towns have licensing requirements for businesses that usually are tied to the level of business revenue.

Incorporating sometimes can entail new costs and paperwork associated with employee payroll. Required paperwork
Schedule C
can include regular payroll checks and deposits, quarterly payroll reports for state unemployment and workers compensation insurance, Social Security, Medicare and annual payroll reports like W-2s and the annual federal unemployment tax return.

Incorporating can result in more complicated taxes and accounting, but not always.

Some incorporated entities are considered “pass through” entitles that are not taxed separately from their owners. The income is “passed through” to the owners and is reported on Schedule C of the form 1040 tax return. Examples of these kinds of entities include sole proprietorships, single-member limited liability companies, or corporations formed under subchapter S of the Internal Revenue Code (“S Corporations”).

Other incorporated entities are taxed separately from the owners and must file separate federal and state tax returns. Completing a corporate tax return can involve some sophisticated issues of tax law. Retaining and certified public accountant, therefore, often is advisable. Examples of these kinds of entities include certain partnerships and corporations formed under subchapter C of the Internal Revenue Code (“C Corporations”).

In some cases, the mere reclassification from sole proprietor or partner to owner-employee can increase the payroll taxes (i.e., Social Security and Medicare taxes). Back to Top

Incorporated Forms of Ownership

There are many incorporated forms of ownership, but there are four core types of business ownership:

The business owner who wishes to incorporate must choose the most beneficial form of ownership. This fundamental decision is very important because it has long-term implications for tax, employment, and business succession planning, among other things. It is essential, therefore, to consult with an attorney to identify the correct type of corporate structure.

Factors that any business owner should consider when choosing a corporate form include: the business plan for the size and nature of the business; the amount of control that one or more owners will have; tolerances for corporate formalities and paperwork; susceptibility to lawsuits and the desire for liability protection; federal and state tax treatment of different corporate entities; expected profits or losses; treatment of corporate earnings; whether the entity will have employees; whether the entity will engage in more than one line of business; and owners’ needs to access cash of the business. It is important to recognize that some businesses are prohibited from operating as traditional corporations and other businesses are required to be corporations. Back to Top

Sole Proprietorships

Most small businesses begin as sole proprietorships. Usually one person owns the business and exercises daily management of the company. Sole proprietors own all the business assets and the profits and are responsible for all liabilities and debts of the company. The law views the business and its owner as identical.

The sole proprietorship form of doing business offers many advantages. It involves little paperwork and is the least expensive form of ownership to initiate and maintain. The sole proprietor is in complete control of the organization and may make all decisions according to his preferences, consistent with law. All income that the business generates flows directly to the owner, for saving, reinvestment, or spending as he deems appropriate. There is no need to file a separate tax return because all income is directly attributed to the owner personally. It is easier to dissolve a sole proprietorship than other forms of businesses.

The disadvantages of the sole proprietorship drive most people to avoid this form of ownership. The sole proprietor is personally liable for any actions or debts of the business. This liability is unlimited. Thus, if the company breaches a contract or an agent of the company injures an individual, the owner’s personal assets could be placed in jeopardy. It also is harder for sole proprietorships to raise funds. Frequently, sole proprietors rely on personal savings or consumer loans to fund the business. It may prove more difficult for a sole proprietor to attract employees that desire profit sharing programs or employee stock ownership programs offered by many other corporate entities. Some types of employee benefits might not be deductible from business income, including, for example, medical insurance premiums. Instead, various types of employee benefits may be only partially deductible as adjustments to gross income. Back to Top

Partnerships

A partnership exists whenever two or more people own a business. As with sole proprietorships, there is no legal distinction between the partnership and its owners, which are called members or partners. It is an excellent idea for the partnership to have a legal agreement establishing processes for decision-making, division and distribution of profits, sale or purchase of ownership interests, admission of new members, and dispute resolution. In addition, as counter as it may seem to the dream of success, it is essential to set out how the partnership can be terminated because the time of stress and conflict is not the time to decide what events will trigger dissolution and how ownership interests will be allocated and distributed.

There are several sub-categories of partnerships that one should consider. The general partnership is a partnership where all members are assumed to have equal shares, unless an agreement states differently. In the general partnership, the partners divide the management responsibility, liability for debts and obligations, and shares of profits or losses according to a private agreement.

Second, a limited partnership is a structure that, as the name suggests, limits each partner’s liability to the amount of each partner’s investment. The management decisions and most liability rest with one general partner and the other partners are considered limited partners or investors. This arrangement often is used where a class of partners wants to be only passive investors or to be insulated from liability that can be associated with management and operational aspects of the business. This is a complex structure that, not surprisingly, involves greater formalities than in a general partnership.

Finally, the joint venture is similar to a general partnership, but it typically exists only for a limited time or for the purpose of achieving a well-defined objective.

There are many advantages to doing business as a partnership. Aside from drafting a partnership agreement, it can be fairly easy to create a partnership. It may be easier to raise funds if there are multiple business owners. Business profits flow through to each partner’s individual tax return. It may be easier to attract employees if the business offers incentives to become a partner. Balanced abilities and skills among the partners may improve the business.

There are some significant disadvantages associated with partnerships. First, each partner is liable for the actions of the other partners. Second, all profits must be shared with the other partners, often where one partner generates a disproportionate level of income. In addition, there is a greater likelihood for disagreement because decisions must be made as a group. Some employee benefits may not be deducted as business income. Finally, the partnership may inadvertently terminate upon the withdrawal or death of a partner. Back to Top

Corporations

A corporation is a state-chartered business entity that is legally separate and distinct from its owners. The corporation creates and issues shares to its owners, who are known as shareholders. The shareholders elect a board of directors to set policies and decide major issues. The board of directors often delegates day-to-day management and operational control to a number of officers. Though it acts only through its management, it can do almost anything a person can do, including entering into contractual agreements. It also can be sued and taxed. The corporation exists perpetually and does not dissolve when ownership changes.

There are many benefits to a corporation. First, shareholders’ liability for the corporation's debts or adverse judgments generally is limited to the amount of their investments (i.e., “basis”). Corporations can generate additional capital through the sale of stock. Costs of employee benefits are deductible from the corporation’s taxes. If certain criteria are satisfied, corporations can choose to be taxed as pass-through entities by electing S corporation status. In this situation, the profits of the corporation will not be subject to corporate tax because the profit would be taxed only as individual income, similar to a partnership.

There are significant disadvantages associated with choosing to do business as a corporation. Forming a corporation is more expensive and time intensive than forming other types of business entities. There is greater regulatory oversight by federal, state and local governments. Significantly, choosing a corporation can result in double taxation – once on corporate profit and at the shareholder level on any individual income earned from the corporation (e.g., dividends). Back to Top

Subchapter S Corporations

An S Corporation really is not a business form. It is a choice for tax purposes. A tax election only; this election enables the shareholder to treat the earnings and profits as distributions and have them pass through directly to their personal tax return. Clever people think: "Great, I can just distribute profits and earnings to myself and my workers and avoid payroll taxes." Not so fast. The IRS, predictably, takes a dim view of any attempt to use the S Corporation to avoid payroll taxes. In fact, if a shareholder (i.e., owner) does work for the company, the company must pay him a "reasonable compensation." The IRS will scrutinize wages to determine whether they are unreasonably low, in which case distributions may be treated as wages subject to the payroll taxes. Where the line is appropriately drawn is a subject of Treasury Regulations and IRS private letter rulings.

The pass-through tax status of an S Corporation is a major advantage. However, because there are criteria for qualification as an S Corporation, the S Corporation status can be inadvertent destroyed by certain corporate actions. In addition, some states impose franchise taxes on S corporations, which could be triggered by the company conducting business or owning property. Back to Top

Limited Liability Company (LLC)

The LLC is a relatively new business structure, now recognized by most states, that is a hybrid of the partnership and the corporation. As the name suggests, the LLC provides limited liability, similar to a corporation. However, under the IRS’s “Check the Box” rules, the LLC also can enjoy the partnership’s pass-through taxation and operational flexibility. In fact, an LLC also can choose to be taxed as a sole proprietorship, C corporation, or an S corporation.

The key to obtaining all the benefits of this hybrid entity is how the LLC is structured. Historically, the IRS has considered an LLC a “disregarded entity” subject to pass through taxation if it does not have too many characteristics of a corporation.

The following are some federal tax forms for different forms of corporate ownership (you should not rely on these lists without consulting an attorney and a certified public accountant):

Sole Proprietor’s Federal Tax Forms

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Partnership’s Federal Tax Forms

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“C” Corporation’s Federal Tax Forms

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Subchapter S Corporation's Federal Tax Forms

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Federal Tax Forms for LLC

Limited Liability Companies are taxed as partnerships in most cases, but can be taxed as a corporation if the company acquires more than two of the four characteristics of a corporation.

In conclusion, determining the corporate form that is optimal depends on a number of factors. You should consult the ALP attorney before setting up your company. If you already have set up your company, ALP can assist you with corporate cleanup and, if necessary, reorganization. Back to Top

What is the difference between an Assignment and a Merger?

In the most basic terms, an assignment is a sale or transfer of assets, including contracts, and a merger is a sale or transfer of an entire company, including all assets and liabilities. Back to Top