SELECTING A BUSINESS STRUCTURE OR ENTITY

What is a sole proprietorship?

A sole proprietorship is a business entity that is not incorporated with the state. The owner is entitled to all profits earned in the business, but they are also personally liable for all liabilities and debts.  This business structure is generally better for smaller businesses. As your business grows, you may want to switch to another entity type for better liability protection.

Owners “pass-through” all profits and losses from a sole proprietorship and claim them on their own individual tax returns only. Compare business entity types further.

What is a partnership?

Partnerships are entities that are owned by two or more people, and no documentation is required to start one. If no written partnership is created, a partnership is by default a general partnership, where all partners have equal authority over the business, and share the business’s liability and profit equally. If one partner cannot cover their share of the business’s debts, the other partner will be required to pay it.

If a partnership agreement is filed with a local state agency, the partnership will contain limited and general partners. Limited partners cannot operate the business, and they also only have a limited responsibility for the debts of the business. General partners operate the business and are personally responsible for all the debts of the business.

Partnerships are taxed on profits and losses at the individual level, and not at the business level.

What is a corporation?

Corporations are liable for their actions and debts, separately from their owners, providing significant liability protection. Owners of corporations can sell shares of their business to raise funding.

It is relatively expensive and time-consuming to form a corporation and maintain ongoing administrative requirements, such as electing a board of directors, conducting annual shareholder and director meetings, developing and maintaining bylaws, and more.

Businesses can incorporate as either an S corporation or a C corporation. The two entities differ mostly in how they are taxed. C corporations are taxed at the corporate and shareholder level, while S corporations only pay taxes on profits and losses at the shareholder level.

Additionally, S corporations can only have a limited number of shareholders, and they cannot offer all classes of stock. C corporations do not face these restrictions.

What is a limited liability company (LLC)?

LLCs offer personal liability protection for owners, Additionally, LLCs can be taxed like S corporations, with pass-through taxation at the shareholder level only.

Formation and maintenance requirements are simpler for an LLC compared to a corporation. Owners must file articles of organization with their state of incorporation, and they must also create an operating agreement. However, the corporation structure may be preferable for accepting outside investment.

Does the immigration status of a director or shareholder impact which entity type I should choose?

Foreign nationals can own US businesses, even if they are not green card holders or US citizens. However, certain foreign nationals cannot be company officers with active duties, such as H-1B visa holders. Additionally, foreign nationals who are not permanent residents or US citizens cannot be shareholders in S corporations. Therefore, LLCs and C corporations tend to be popular business structures for many foreign nationals.

WHERE TO INCORPORATE YOUR BUSINESS

Is it beneficial to incorporate outside of your home state?

Businesses that incorporate in a state outside of where they are based will face compliance requirements and taxes in both their home state and their state of incorporation. For this reason, most entrepreneurs will not benefit from incorporating outside of their home state. Companies seeking venture capital funding and those expecting to face complex litigation may benefit from incorporating outside of their home state. Read more about selecting a state for incorporation.

What are foreign qualifications, and when are they required?

Businesses must apply for foreign qualification any time that they conduct business in a state outside of their state of incorporation. While the definition of “doing business” varies by state, some common activities which may require foreign qualification include:

• Hiring an employee.
• Transacting business in the state above a certain dollar threshold.
• Purchasing property.
• Opening an office or facility.
• Offering services, contract bidding, or selling products.
• And more.

You must register with the state’s local agency to qualify to do business there. You will also need to pay qualification fees, submit written information about your company’s leadership, and provide a certificate of good standing from your state of incorporation.

Your company will also be subject to the following compliance requirements in the states where you operate:

• Reporting and paying state income and sales taxes.
• Complying with employment tax filings in the state.
• Designating a registered agent in the state to handle your legal documentation.

Businesses that incorporate outside of their home state will need to register for foreign qualifications in their home state. They will be subject to taxes and annual compliance requirements in both states.

Which states do not charge a corporate income tax?

Nevada, Ohio, South Dakota, Texas, Washington, and Wyoming all do not charge a corporate income tax. Additionally, Ohio, Texas, and Washington do not charge gross receipts taxes based on your company’s gross revenue. Further, Nevada, South Dakota, and Wyoming do not charge personal income tax.

However, it is important to note that businesses must pay taxes and fees in the states where they operate, regardless of their state of incorporation.

Should I incorporate my business in Delaware?

Certain companies are more likely to benefit from incorporating in Delaware, including:

• Businesses at the highest risk of litigation, due to Delaware’s specialized business courts.
• Companies seeking venture capital (VC) funding. VC firms tend to prefer investing in companies incorporated in Delaware because they are familiar with the state’s court system.
• Those seeking flexibility in leadership staffing.

Read more reasons to incorporate in Delaware.