There are several ways to acquire and hold property and/or operate a business.
Sole Ownership and Proprietorship
The simplest way to hold property is in your own name. Customarily, the ownership document, such as a grant deed for real estate, might indicate your marital status, such as single or married. If you are married, you might hold property as community property or as joint tenants. If individuals who are not married to each other own property jointly, they may hold it as “tenants in common,” which means each ownership has its own unique rights and responsibilities, and may be transferable separate and apart from the other ownership interests.
Other Ownership Forms
Each type of ownership has its own features, advantages, disadvantages, briefly summarized as follows.
|Entity||Liability Protection?||Pass Through?||Separate Owner Compensation||California Minimum Tax||Separate Tax Reporting?|
|Limited Partnership||Yes (LPs only)||Yes||Yes||$800/year||Yes|
|S Corporation||Yes||Yes (Note 1)||Yes||$800/year||Yes|
|Limited Liability Company||Yes||Yes (Note 2)||No||$800/year||Only if Joint Ownership (Partnership)|
Note 1: California assesses a 1.5% income tax on S corporations
Note 2: California requires an additional “LLC fee” based on LLC revenues
The above chart is an overview, intended to facilitate more detailed discussion. Please contact us for additional details concerning each form of ownership and its tax and other implications.
Forming a Business Entity
Each of these kinds of business entities can be formed in nearly any state of the U.S. There are many ways of forming such an entity. Since the formation of entities is governed and regulated by statutes in each state, you should consider engaging an attorney to form your entity, especially if it involves complex matters or professional practices such as medical practice, as some states will have specific statutes regulating the practice of those professionals in an entity form, such as a corporation. Accounting and legal practices are often required to form as limited liability partnerships (LLPs) instead of limited liability companies (LLCs).
There are some discount services that can be used to form entities and produce related documents like those described below. If you are so inclined, you might even want to form the entity yourself. If you choose to use a discount formation service or form the organization yourself, you should consider consulting with an experienced and licensed professional, such as an attorney or accounting firm like Tarlson & Associates, to make sure the entity will fit your goals and match your expectations relating to income tax implications.
We can assist you in forming your entity, especially if it is part of an engagement which involves other professional services, as long as you understand that we are not engaged in the practice of law or trained to provide legal advice.
Selecting a State in Which to Form Your Entity
Each state is a little different in terms of costs of formation and maintenance of an entity. Some states have income, franchise, sales or gross receipts taxes which apply to businesses formed or doing business in their state. California’s LLC fees, for example, are based on gross receipts, and are often overlooked in the early days of formation of a business entity. As the entity grows, however, they can become quite substantial, as follows:
|If the Total Income rounded to the nearest whole dollar is:||The fee amount for 1994 and 1995 is:||The fee amount fot 1996 to 1998 is:||The fee amount for 1999 is:||The fee amount for 2000 is:||The fee amount for 2001 and after is:|
|$250,000 – $499,999||$500||$500||$865||$1,042||$900|
|$500,000 – $999,999||$1,000||$1,500||$2,595||$3,126||$2,500|
|$1,000,000 – $4,999,999||$2,000||$3,000||$5,190||$6,251||$6,000|
|$5,000,000 or more||$4,000||$4,500||$7,785||$9,377||$11,790|
If you form an entity in one state, and do business in another state, you will probably need to register the entity in the state in which you are doing business. For this reason, it often makes sense to form the entity in the same state in which you plan to do business.
There is a common misconception that Delaware is the best choice for forming an entity. It may be that Delaware has developed laws which are somewhat more favorable for large, publicly held corporations, but our experience has been that Delaware is generally over-rated as a state for the purpose of entity formation. If you do form a corporation in Delaware, you should pay careful attention to the fee structure in determining your authorized and outstanding shares and balance sheet reporting practices.
We can assist you in making your decision concerning the best state of formation. Since the fees and tax implications change regularly, we would need to research the current fees and taxes based on your specific business plans.
When you form an entity, you will begin by filing articles of incorporation or articles of formation with the Secretary of State for the state in which you are forming the entity. When you file these documents, you have the option of obtaining a certified copy of the filed document.
Each state has requirements that you file some sort of Statement of Information (SOI) on a regular basis, disclosing information about the ownership and/or management of the entity. In California, for example, the statement of information is required biennially. Although you may receive a postcard or email reminder about the need for filing the SOI, you should be familiar with the filing schedule and make sure your SOI is up to date.
Each entity should consider having some kind of agreement to specify the way in which its investors and management relate to each other. These agreements are generally identified as follows:
|Tenancy in Common||Tenancy in Common Agreement|
|Limited Liability Company||Operating Agreement|
These agreements will govern the rights and responsibilities of investors and managers, conditions for transfer of interests, and other important matters. In most cases, you should consider engaging an attorney to prepare the entity’s agreements.
Tax or Employer’s Identification Number (EIN)
Many entities will need a tax identification number to identify the entity’s business transactions, whether or not they actually have employees. This number will need to be provided to your bank when you open the business bank account, and it will be used to identify the entity on its (or your) income tax returns. We can assist you in applying for your EIN.
Some states require corporations to have regular, i.e., annual meetings of their shareholders or directors. Even if you are not required to have meetings, it may be advisable to document any significant action with a consent to action, documenting the involvement of investors and management in the decision. The form of the meetings varies depending on the entity. We can assist you in documenting your actions or meetings in an appropriate form.
Local Business Registration
In addition to state and federal requirements, many local cities and counties register and regulate businesses which operate within their jurisdictions. You should look into obtaining a simple business license in your city or town. If you use a business name other than your name, or the entity’s name, you should consider filing a fictitious business name, also known as a a “doing business as” or DBA, with your local county.
If you form an entity, you may need to file notices with the Securities & Exchange Commission (SEC) and California Department of Business Oversight in order to claim exemption from securities registration requirements.
The offer and sale of stock in a corporation or ownership interests in limited liability companies are considered “securities” under Section 2(a)(1) and Section 3(a)(3) of the Securities Act of 1933. The interests you issue when you form a small entity for your yacht charter activity should qualify for exemption from registration under Regulation D of the Securities Act, but you should file a Form D Notice with the SEC to claim the exemption. You can file the form online at: https://www.sec.gov/smallbusiness/exemptofferings/formd or contact us for assistance.
Similarly, California Corporations Law requires you to file a notice of the exemption of the issuance of your business interests from registration. This notice is also available for filing online. See http://www.dbo.ca.gov/Licensees/Corporate_Securities_Law/faqs.asp or let us know and we can assist with the filing.
For more information, see our Fact Sheet on Securities Registration.
Tarlson & Associates is an independent public accounting firm which provides a wide range of services to individuals, businesses, estates, trusts, and nonprofits worldwide. We are not attorneys and nothing in this Fact Sheet should be construed as legal advice. Rather, it represents our considered opinion as accountants with considerable business experience over many years of professional practice. Feel free to contact us for additional information concerning these matters.