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If you have questions about how to incorporating your business, our
guest blogger, Julie Henningfield, offers some pointers to help you
figure out the details. Remember to consult with our small business
experts at ShopTalk if you have any additional questions!
You’ve
started your business and decided on business structure type to protect
your hard-earned assets. It seems the hard part is over.
Wrong.
The
demands placed on corporations and Limited Liability Corporations
(LLCs) do not stop once the formation documents have been approved by
the state of incorporation. Corporations and LLCs face internal and
external state-imposed requirements on an ongoing basis. Because the
benefits that corporations and LLCs afford their owners are advantages
specific to these incorporation types, the business owners must carry
out certain responsibilities to maintain these benefits. Falling short
of these imposed requirements can result in serious consequences,
including the potential loss of the limited liability.
Internal demands
Corporations
and LLCs must be accountable for certain formalities when it comes to
their internal governing system. The ongoing formalities imposed upon
corporations are the strictest. Corporations are required to hold and
properly document initial and annual meetings of the directors and
shareholders. The importance of consistently undertaking and properly
documenting each cannot be repeated enough. There are a number of tools
available today, many specifically geared toward small business owners,
to help make the process of complying with internal formalities as easy
and convenient as possible for business owners.
Internal corporate demands
Ownership
interest in a corporation is measured in shares of stock. At the
organizational meeting, which is the initial meeting of the directors,
the directors issue shares of stock to the initial shareholders to
formally document their ownership of the corporation. The issuance of
shares should be formally recorded in a stock transfer ledger, which is
updated any time shares are issued to or bought back from shareholders.
The
officers are responsible for managing the corporation’s day-to-day
operations. A corporation’s officers are appointed by the directors, and
the initial officers are typically officially appointed during the
organizational meeting.
Corporations should also conduct an
initial meeting of the shareholders. While the directors undertake the
first major corporate actions, the shareholders typically formally
approve the incorporation of the company, approve the initial board of
directors and also approve all steps undertaken by the directors at the
organizational meeting.
Directors and shareholders must conduct
annual meetings. At an annual meeting of directors, directors typically
approve or reject major business decisions, renew the officers’ terms,
and/or appoint new officers. At an annual meeting of shareholders,
shareholders typically renew directors’ terms and/or appoint new
directors. Management should always document all director and
shareholder meetings and actions. Also, all director or shareholder
resolutions approving certain corporate actions should be documented and
kept with the minutes of the meeting during which those resolutions
were approved.
Internal LLC recommendations
LLCs are
not required to hold an initial meeting or annual meetings of the
members or managers; however, doing so is strongly recommended. It could
be advantageous for the LLC to have formal records and documentation of
all business decisions, particularly if a management or ownership
dispute should ever arise.
Ownership of an LLC is measured by
membership interest, much in the manner of a partnership. Having the LLC
issue membership interest certificates to all members and recording all
transactions in a membership interest ledger is also advisable.
Providing certificates to members offers a formal record of their LLC
ownership status. It also helps the LLC keep accurate records. Other
items of business such as authorizing the opening of a bank account for
the LLC can be completed during an initial meeting.
BizFilings,
an online incorporation service provider, recommends that LLCs hold
annual meetings of the members or managers. As with corporations, major
business decisions can be addressed during these meetings. Properly
documenting any business decisions made during member and manager
meetings is important, and minutes and resolutions from all meetings
should be kept with the LLC’s records.
External demands
External
requirements are requirements imposed by the states upon corporations
and LLCs. These requirements include an annual or biennial state filing
and payment of a corresponding state fee.
Nearly all states
require corporations and LLCs to file periodic reports with the
Secretary of State’s office or its equivalent department. Periodic
statements allow states to maintain current information on corporations
and LLCs formed or qualified to transact business there. Annual
statements are the status quo – but some states have relaxed their rules
and require only a biennial statement. In either case, the states
typically impose a filing fee along with the periodic statement. The
fees vary by state and by entity type, from $1 to more than $200.
Some
states also impose a franchise tax. A franchise tax is a tax levied in
consideration for the privilege of either forming or qualifying to do
business in a state. A franchise tax may be based upon income, assets,
outstanding shares or a combination. Put another way, a franchise tax is
a tax one pays for “just being there.”
The due dates for annual
statements and franchise taxes vary by state. Some states connect these
due dates to the anniversary of the corporation’s or LLC’s formation or
qualification. Other states set a specific due date for all corporation
annual statements and another for all LLCs. Because the periodic filing
requirement and annual franchise tax can represent a significant burden
and expense, you should research these requirements prior to organizing.
Additional external requirements
What follows is a list of other potential state and federally imposed requirements that may apply to a company:
- Filing a federal income tax return and paying necessary taxes
- Filing a state income tax return and paying necessary taxes
- State franchise taxes
- State annual statements
- Payroll tax obligations (such as Social Security, Medicare and unemployment)
- Property tax obligations
- State sales and use tax obligations
- County, city or municipality tax obligations
- Obtaining and renewing any necessary business permits and/or licenses
Non-compliance consequences
Small
business owners often mistakenly believe that ongoing corporate and LLC
requirements do not apply to them, or perhaps they feel too busy to
properly satisfy these requirements. Failing to observe internal and
external requirements can yield dire consequences, such as losing the
corporate or LLC entity status recognized by the state and subsequent
loss of the limited liability protection afforded to the owners.
If
a corporation or LLC is sued and is unable to show that is faithfully
followed all corporate or LLC formalities, a judge might rule that the
company was operating more in the manner of a sole proprietorship or
general partnership. In such a case, the court might sidestep the
corporate or LLC status and extend full liability to the entity’s
owners.
There are also consequences on the state level that can happen prior to piercing the corporate veil
– which refers to the legal theory by which a court will sidestep the
liability protection normally afforded by a corporation or LLC and
impose full liability upon the owners. When a corporation or LLC does
not comply with a state’s annual or ongoing requirements, that company
is no longer in “good standing” with the state. Each state has different
parameters for what is required before a company falls out of good
standing and also how the states handle it. For example, many states
impose late fees and interest payments on the outstanding annual
statement and/or franchise tax fees. Being out of good standing long
enough may lead to administrative dissolution of the company by the
state. When the state administratively dissolves a corporation or LLC,
all of the benefits of being a corporation or LLC are lost.
It’s imperative to keep the “corporate veil” intact by meeting all ongoing external and internal compliance requirements.