Kathleen R "Billie" Lovett CPA AC
P. O. Box 642   Reedsville, WV  26547
Tel: 304-864-6618 Fax: 304-864-3744
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NEW BUSINESS FAQs

WHAT IS A SOLE PROPRIETORSHIP?

WHAT IS AN LLC?

WHAT IS A PARTNERSHIP?

WHAT IS A CORPORATION?

WHAT IS AN S-CORPORATION?

WHAT ARE THE BASIC DIFFERENCES BETWEEN FORMS OF BUSINESS?

WHAT IS A FEDERAL IDENTIFICATION NUMBER?

WHAT ARE ARTICLES OF INCORPORATION?

WHAT ARE BYLAWS?

IS IT A BUSINESS OR A HOBBY?

	Q. WHAT IS A SOLE PROPRIETORSHIP?
	In General: This is the simplest form of business. A sole proprietorship is not a separate entity itself. Rather, a sole proprietor directly owns the business and is directly responsible for its debts. Unlimited Personal Liability for Loss: In a sole proprietorship, the owner is personally liable for the company, thus placing his or her entire personal assets and wealth at risk. If an owner is married, that owner puts the community property at risk as well. Management and Control: The owner (sole proprietor) has total management and control over the company. However, the price for total management and control is that the owner is at risk for personal liability incurred through the acts of the owner’s agents or employees. No Formalities: With the exception of complying with any applicable licensing requirements, there are no formalities required of a sole proprietorship. Note, however, where the business is conducted under a name which does not show the owner’s surname or implies the existence of additional owners, California, for example, requires that the owner file a fictitious business name statement and publish notice. Transferability: The owner can sell the business as he or she pleases. Duration: The sole proprietorship remains in existence for as long as the owner is willing or able to stay in business. A  sole proprietorship is an unincorporated business that is owned by one individual. It is the simplest form of business organization to start and maintain. The business has no existence apart from you, the owner. Its liabilities are your personal liabilities and you undertake the risks of the business for all assets owned, whether used in the business or personally owned. You include the income and expenses of the business on your own tax return. TIP:   Use a separate Form 1040, Schedule C,  Profit or Loss From Business to report the profit or loss from each business (except farming) you operate as a sole proprietorship. If you have only one business, you may be able to use Schedule C-EZ,  Net Profit From Business. TIP:  If you are the sole proprietor of a farming business, use Schedule F (Form 1040),  Profit or Loss From Farming, to report your profit or loss. TIP:   For more information on sole proprietorships, refer to Publication 334,   Tax Guide for Small Business. If you are a farmer, refer to Publication 225, Farmer's Tax Guide. TIP:  If you and your spouse both participate in a business, refer to our information for a husband and wife business .   TOP
	Q. WHAT IS AN LLC (LIMITED LIABILITY COMPANY)?
	In general: An LLC is a hybrid between a partnership and a Corporation in that it combines the "pass-through" treatment of a partnership with the limited liability accorded to corporate shareholders. Two members required: Unlike a corporation which can have as few as one shareholder, most states require that an LLC consist of two or more members (owners). Recently, however, more states are allowing single-member LLCs. (WV is one of them) Please note, however, that the IRS may treat a single person LLC differently than an LLC with more than one member.   Separate Legal Entity: Like limited partnerships and corporations, an LLC is recognized as a separate legal entity from its "members."   Limited Liability: Ordinarily, only the LLC is responsible for the company's debts thus shielding the members from individual liability. However, there are some exceptions where individual members may be held liable:   Guarantor Liability: Where an LLC member has personally guaranteed the obligations of the LLC, he or she will be liable. For example, where an LLC is relatively new and has no credit history, a prospective landlord about to lease office space to the LLC will most likely require a personal guarantee from the LLC members before executing such a lease.   Alter Ego Liability: Very similar to the judicial doctrine applied to corporations where a court may hold the individual shareholders liable where the business entity is merely the "Alter Ego" of its shareholders, a member of an LLC may also be held liable for the LLCs debts if the court imposes its "alter ego liability" doctrine. Please note, however, that although a corporation's failure to hold shareholder or director meetings may subject the corporation to alter ego liability, this is not the case for LLCs in California. An LLC's failure to hold meetings of members or managers is not usually considered grounds for imposing the alter ego doctrine where the LLC's Articles of Organization or Operating Agreement do not expressly require such meetings.   Management and control: Management and control of an LLC is vested with its members unless the articles of organization provide otherwise.   Voting Interest: Ordinarily, voting interest directly corresponds to interest in profits, unless the articles of organization or operating agreement provide otherwise   Transferability:  No one can become a member of an LLC (either by transfer of an existing membership or the issuance of a new one) without the consent of members having a majority in interest (excluding the person acquiring the membership interest) unless the articles of organization provide otherwise.   Duration:  Although many states now allow an LLC to have a perpetual existence, LLC's traditionally were required to specify the date on which the LLC's existence will terminate. In most cases, unless otherwise provided in the articles of organization or a written operating agreement, an LLC is dissolved at the death, withdrawal, resignation, expulsion, or bankruptcy of a member (unless within 90 days a majority in both the profits and capital interests vote to continue the LLC).   Formalities: The existence of an LLC begins upon the filing of the Articles of Organization with the Secretary of State. The articles must be on the form prescribed by the Secretary of State. Among the required information on the form is the latest date at which the LLC is to dissolve and a statement as to whether the LLC will be managed by one manager, more than one manager, or the members. To validly complete the formation of the LLC, members must enter into an Operating Agreement. This Operating Agreement may come into existence either before or after the filing of the Articles of Organization and may be either oral or in writing. An  LLC and/or LLP  makes an entity election with Form 8832, Entity Classification Election. An LLC may be a sole proprietorship, a corporation, or a partnership. (A minimum of two members is required for federal tax purposes to operate an LLC as a partnership.) Consequently, the applicable tax forms, estimated tax payment requirements, and related tax publications depend upon whether the LLC operates as a sole proprietorship, corporation, or partnership. The default entity for federal tax treatment of an LLC with two or more members is a partnership. The default entity of an LLP is a partnership and the partnership tax forms, estimated tax payment requirements, and partnership publications apply. TOP
	Q. WHAT IS A PARTNERSHIP?
	In General: A form of business entity in which 2 or more co-owners engage in business for profit. For the most part, the partners own the business assets together and are personally liable for business debts. Sharing Profits: In the absence of a partnership agreement, profits are shared equally amongst the partners. A partnership agreement, however, will usually provide for the manner in which profits and losses are to be shared. Unlimited Personal Liability for Losses: Each Partner is, jointly and severally, personally liable for debts and taxes of the partnership. For example, if the partnership assets are insufficient to satisfy a creditor's claims, the partners' personal assets are subject to attachment and liquidation to pay the business debts. Liability for a Co-partner's debts: Each general partner is deemed the agent of the partnership. Therefore, if that partner was apparently carrying on partnership business, all general partners can he held liable for his dealings with third persons. Liability for a co-partner's wrongdoing: Each partner may be held jointly and severally liable for a co-partner's wrongdoing or tortious act (e.g. the misapplication of another person's money or property. Duration: Technically, a partnership terminates upon the death, disability, or withdrawal of any one partner. However, most partnership agreements provide for these types of events with the share of the departed partner being purchased by the remaining partners in the partnership. Management and Control: In the absence of a partnership agreement, each general partner has an equal right to participate in the management and control of the business. Disagreements in the ordinary course of partnership business are decided by a majority of the partners. Disagreements of extraordinary matters and amendments to the partnership agreement require the consent of all partners Transferability: Unless otherwise provided in the partnership agreement, no one can become a member of the partnership without the consent of all partners. However, a partner may assign his share of the profits and losses and right to receive distributions ("transferable interest"). Further a partner's judgment creditor may obtain an order charging the partner's "transferable interest" to satisfy a judgment. TOP
	Q. WHAT IS A CORPORATION?
	Generally : The "C-Corporation" designation merely refers to a standard, general-for-profit, state-formed corporation.  To be formed, an Incorporator must file Articles of Incorporation and pay the requisite state fees and prepaid taxes with the appropriate state agency (usually, the Secretary of State -- Corporations Division). Separate Legal and Tax Life: A corporation which is properly formed and operated as a corporation assumes a separate legal and tax life distinct from its shareholders.  A corporation pays taxes at its own corporate income tax rates and files its own corporate tax forms each year (IRS Form 1120). Management and Control in Corporations: Normally, a corporation's management and control is vested in the board of directors who are elected by the shareholders of the corporation. Directors generally make policy and major decisions regarding the corporation but do not individually represent the corporation in dealing with third persons. Rather, dealings with third persons are conducted through officers and employees of the corporation to whom authority is delegated by the directors of the corporation. Shareholders: Shareholders are the owners of a corporation. Board of Directors: The Board of Directors is responsible for the Management and policy decisions of the corporation.  There are, however, a few instances when the shareholders are required to approve of the Actions of the Board of Directors (e.g. amendment to the Articles of incorporation, sale of substantially all of the corporate assets, the merger or dissolution of the corporation, etc...). Corporate Officers: Corporate officers are elected by the Board of Directors and are responsible for conducting the day-to-day operational activities of the corporation.  Corporate officers usually consist of the following: (President, Vice-President, Secretary, Treasurer). Number of Persons Required: In most states, one or more persons may form and operate a corporation.  Some states, however, require that the number of persons required to manage a corporation be at least equal to the number of owners.  For example, if there are two shareholders, there must also be a minimum of two directors. Fringe Benefits: Corporations may often offer their employees unique fringe benefits.  For example, owner-employees may often deduct health insurance premiums paid by the corporation from corporate income.  In addition, Corporate-defined benefit plans often afford better retirement options and benefits than those offered by non-corporate plans. Corporate Formalities: To retain the corporate existence and thus the benefits of limited liability and special tax treatment, those who run the corporation must observe corporate formalities.  Thus, even a one-person corporation must wear different hats depending on the occasion.  For example, one person may be responsible for being the sole shareholder, Director, and Officer of the corporation; however, depending on the action taken, that person must observe certain formalities:  Annual meetings must be held, corporate minutes of the meetings must be taken, Officers must be appointed, and shares must be issued to shareholders.  Most importantly, however, the corporation should issue stock to its shareholders and keep adequate capitalization on hand to cover any "foreseeable" business debts. Shareholder Liability for Corporate Debts: Where corporate formalities are not observed, shareholders may be held personally liable for corporate debts.  thus, if a thinly capitalized corporation is created, funds are commingled with employees and officers, stock is never issued, meetings are never held, or other corporate formalities required by your state of incorporation are not followed, a court or the IRS may "pierce the corporate veil" and hold the shareholders personally liable for corporate debts. Avoiding Double Taxation: Generally, the corporation is taxed for its own profits; then, any profits paid out in the form of dividends are taxed again to the recipient as dividend income and the individual shareholder's tax rate.  However, most small corporations rarely pay dividends.  Rather, owner-employees are paid salaries and fringe benefits that are deductible to the corporation.  The result is that only the employee-owners end up paying any income taxes on this business income and double taxation rarely occurs. S-Corporation Election: Another alternative is to elect the S-Corporation Status as discussed later. Please consult an accountant or CPA who knows and understands the intimate details of your business along with federal and local tax rules so that you can make the best decision regarding which form of business entity (S-Corporation or C-Corporation) will best suit your needs. Duration of a Corporation: As a separate legal entity, a corporation is capable of continuing indefinitely. Its existence is not affected by death or incapacity of its shareholders, officers , or directors or by transfer of its shares from one person to another. Constitutional Protections for Corporations: Although a corporation is not a "citizen" under the privileges and immunities clause of the Fourteenth Amendment to the U.S. Constitution, a corporation may exercise some of the constitutional protections granted to natural persons: Right to Due Process and Equal Protection: Corporations enjoy the right to equal protection and due process of law under the Fourteenth and Fifth Amendments to the U.S. Constitution and under similar provisions of the California Constitution.   Freedom of Speech: Absent some narrowly drawn restrictions serving compelling state interests, corporations have the right to express themselves on matters of public importance whether or not those issues "materially affect" corporate business.   Right to Counsel: While a corporation cannot be imprisoned, a criminal action can result in fines and other penalties that could harm shareholders, officers, and other persons. Thus, a corporate criminal defendant has a Sixth Amendment to a Right to Counsel. But note, because a corporation faces no risk of incarceration, it has no right to appointed counsel if it cannot afford to retain private counsel No Privilege Against Self-Incrimination: Corporations have no privilege against self-incrimination (e.g. to prevent disclosure of incriminating corporate records). TOP
	Q. WHAT IS AN S-CORPORATION?
	Generally: An S Corporation begins its existence as a general, for-profit corporation upon filing the Articles of Incorporation at the state level.  A general for-profit corporation (also known as a 'C corporation') is required to pay income tax on taxable income generated by the corporation.  However, after the corporation has been formed, it may elect "S Corporation Status" by submitting IRS form 2553 to the Internal Revenue Service (in some cases a state filing is required as well).  Once this filing is complete, the corporation is taxed like a partnership or sole proprietorship rather than as a separate entity.  Thus, the income is "passed-through" to the shareholders for purposes of computing tax liability. Therefore, a shareholder's individual tax returns will report the income or loss generated by an S corporation. Qualifying for S Corporation Status: To qualify as an S corporation, a corporation must timely file IRS Form 2553 with the IRS. This election must be made by March 15 if the corporation is a Calendar year taxpayer in order for the election to take effect for the current tax year. However, a "New" corporation may make the filing at anytime during its tax year so long as the filing is made no later than 75 days after the corporation has began conducting business as a corporation, acquired assets, or has issued stock to shareholders (whichever is earlier).  To qualify for S corporation status, the corporation must be a U.S. corporation with only one class of stock.  In addition, the corporation cannot have more than 100 shareholders. Further, shareholders must be individuals, estates or certain qualified trusts, who consent in writing to the S corporation election. No shareholder can be non-resident alien.   Corporate Formalities: An S-Corporation follows the same state formalities as does a C-corporation (i.e. filing Articles of Incorporation and paying state fees).  However, an S-Corporation must make a special tax election under sub-chapter S of the Internal Revenue Code by filing IRS Form 2553.  IRS Filing: The S-Corporation must complete and file IRS Form 1120S to report its annual income to the IRS each year. General Shareholder Requirements: ALL shareholders of the corporation must be U.S. Citizens or have U.S. Residency Status.  If, for any reason, shares are somehow sold or transferred (even if by will, divorce, or other means) to a shareholder who is a foreign national, the corporation will lose its S-Corporation status and be treated as a C-Corporation. In addition, the S-corporation may never have more than 75 Shareholders. Only One Class of Stock: S-Corporations may have only one class of stock. Losing S-Corporation Status: An S-Corporation that loses its status as such may not re-elect S-Corporation status for a minimum of five years. Who Should Elect S-Corporation Status: Owners who want the limited liability of a corporation and the "pass-through" tax-treatment of a partnership will often make the S-Corporation election. TOP
	Q. WHAT ARE THE BASIC DIFFERENCES BETWEEN FORMS OF BUSINESS?
	This table shows some of the basic differences between the available forms of business. Type of Company Liability Operations Management Raising Capital  Sole Proprietorship  Unlimited Simple Proprietor Difficult General Partnership Partners Simple Partners -- Limited Liability Company No Medium Managers/Members Possible Corporations No Difficult Board Stock S-Corporations No Difficult Board Stock TOP
	Q. WHAT IS A FEDERAL IDENTIFICATION NUMBER OR FEIN?
	A Federal Tax Identification Number (also known as a "55 Number" or "EIN Number" ) is a number assigned to a corporation, partnership, or LLC by the Federal Government for purposes of taxation. The Federal Tax ID Number is to a corporation, partnership, or LLC. as a Social Security Number is to an individual. Most banks require that a corporation, partnership, or LLC provide a Federal Tax Identification Number as a prerequisite to opening a bank account regardless of whether the company will have employees.  As a general rule, a Federal Tax Identification Number is not required for a sole proprietorship, unless it will have employees. TOP
	Q. WHAT ARE ARTICLES OF INCORPORATION?
	A Corporation's "Articles of Incorporation" is the main filing document which begins the corporation's existence under state law.  Once filed, the corporation comes into existence. The level of complexity for a corporation's Articles of Incorporation can range from very simple to extremely complex.  Generally, most jurisdictions require Articles of Incorporation to contain, at a minimum, information about the Corporate Name, the Registered Agent, and the Corporation's business address.  Requirements vary by state. TOP
	Q. WHAT ARE BY-LAWS?
	Bylaws serve as the internal operating document for the corporation.  Generally, Bylaws detail the responsibilities, rights, and duties of directors, shareholders and officers.  Currently states generally do not require that Bylaws be filed. TOP
	Q. IS IT A BUSINESS OR JUST A HOBBY?
	It is generally accepted that people prefer to make a living doing something they like. If you are thinking of starting a business but it does not provide you with "a living," or make a profit, your expenses may not be deductible. Expenses connected with your business activities may be tax deductible or limited, due to the rules for hobby expenses. The limit on not-for-profit (hobby) losses applies to individuals, partnerships, estates, trusts, and S corporations . It does not apply to corporations, other than S corporations. In determining whether you are carrying on an activity for profit, all the facts should be taken into account. No one factor alone is decisive. Among the factors to consider are whether: You carry on the activity in a business-like manner. The time and effort you put into the activity indicate you intend to make it profitable. You depend on income from the activity for your livelihood. Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business). You change your methods of operation in an attempt to improve profitability. You, or your advisors, have the knowledge needed to carry on the activity as a successful business. You were successful in making a profit in similar activities in the past. The activity makes a profit in some years (and the amount of profit it makes). You can expect to make a future profit from the appreciation of the assets used in the activity. For details about not-for-profit activities, refer to Chapter 1 in Publication 535,  Business Expenses. The chapter explains how to determine whether your activity is carried on to make a profit and how to figure the amount of loss you can deduct. TOP
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