Business formation is the most important legal aspect for anyone considering creating a new business. One may have even created a business without ever knowing it (sole proprietorship or partnership). The choices a party makes when initiating their business will carry liability and tax consequences for the duration the business exists.

 

When starting a business, the person or persons forming the business must consider one of a multiple of forms for your entity: Sole Proprietor, Partnership, Corporation, Limited Liability Company, Limited Partnership, Limited Liability Partnership, or Business Trust. Each one of these business entities has an individual personality and reacts differently in the world of law and tax. Each state has its own laws regarding each form of business entity.

 

Following is a brief review of some of the most common forms of business entities:

 

A Sole Proprietor can open a business without any formal declaration to the state. Just by selling handcrafts out of your basement or starting a lawn mowing service, a person has become a sole proprietor and has opened their door to personal liability and will be taxed as an individual for whatever income is made from the business. Personal liability means that if the business is responsible for any injuries or damages, the owners' personal assets will be in danger.

 

A Partnership is similar to a Sole Proprietor, in the fact that if two people begin doing business together they have created a partnership. However, partnerships are usually slightly more formal and usually a partnership agreement has been signed between the two partners explaining how profits and losses will be shared. A partnership is taxed at the individual partners for whatever income they make from the business. There is still no liability protection in a partnership. Most states have adopted the Uniform Partnership Act or the Revised Uniform Partnership Act.

 

A Corporation is the main entity form for those seeking to protect their personal assets from liability. However, a corporation is governed strictly by state law and has a very formal aspect to its management and control. The corporation is a multi-tiered entity where the owners own shares of the company (making them shareholders). They then elect a board of directors to oversee the company. The board then places officers (often board members) in the company to run the business day to day. The officers then higher employees to run the business. In small corporations a shareholder may also be a director, officer, and essentially an employee of the company. As long as the corporation is operated according to the law and in good faith, the directors and officers and employees of the corporation will be protected from liability. This liability protection is often called the corporate veil.

 

The biggest negative about the corporation form is that the Corporation itself gets taxed for the income the Corporation brings in. Then whenever that income is distributed as a dividend to the shareholders, they too will have to pay an individual tax on that income. This is known as double taxation.

 

The Limited Liability Company (LLC)is the best of both worlds. Often compared to as a hybrid between Partnerships and Corporations, the LLC offers the ability to be taxed either as a corporation or as a partnership. If neither is chosen when filing the initial tax form, the LLC automatically has chosen the pass through taxation of the partnership. Thus, only the members, not the entity pay any income tax.

 

The LLC also offers the same limited liability protection of the corporation. Like the corporation, an LLC is governed by state law. However, an LLC is often seen as a more flexible and usable entity than a corporation. Typically states do not have many regulations controlling or limiting an LLC like they do for corporations. In the state of Kansas, you can form an LLC simply by filing Articles of Organization to the Secretary of State's office. The Articles need not contain anything more than the address of the LLC, the name of the LLC, the name of the founding member(s), and the name and address of the registering member. After that, an LLC in Kansas can structure its formal structure any way it wants with an Operating Agreement signed by all the members.

 

 

The following annotated bibliography is designed to help an attorney or entrepreneur find the information necessary for business formation and choosing an entity. Several of the articles explain in detail the various forms of entities available for businesses to use. Most of the bibliography also will help an entrepreneur understand how to judge their priorities when planning and filing for their business.

 

I conducted my research by going first to the legal encyclopedia American Jurisprudence. From there I did some research on Westlaw, where I found the Practising Law Institute Article. After finding the institute article I proceeded with online research at Heinonline.com and washlaw.edu where I came across several great articles. I then utilized Google to conduct several searches looking for free and good information on business formation. I finally came across The Wall Street Journal's Entrepreneur Center Online. At that point I searched the Wall Street Journal and MSN for any more useful information.

 

I finalized my research by looking for what information I could find on the Washburn Law Library website, there I found three or four great books. I boiled it down to what appeared to be the two most useful books and I reviewed them for quite awhile. The Library has a great deal of physical material on the subject matter of business law and I wandered through the stacks for awhile looking through some of the manuals, journals, and books available. I actually wished I had started my search in the Library as opposed to online.

 

 

 

Publications by Institutes and A.B.A. Section Report

 

1) Leslie H. Loffman & Sanford C. Presant, Choice of Entity, Business and Tax Considerations, 743 Practising L. Inst. Tax 575 (2007).

 

This is one of the best, most comprehensive articles available on choice of entity and business formation. The article begins by breaking down all the available entities available to those desiring to go into business. It takes into consideration how the choice of entity question is approached by an investor to balance their tax objectives, personal liability, and management. The article focuses on the most common methods of business investment: sole proprietorships; tenants in common; partnerships, general and limited; C and S corporations; limited liability companies and the business trust.

 

The Article reviews taxation under each form of entity discussed, including how income and losses are typically calculated for the IRS. The article discusses personal liability and ways to limit liability in a sole proprietorship or partnership. Also covers risk management from an investors perspective and how each entity effects risk in the investment.

 

One of the unique forms of business that has slowly become more popular over the last century is the business trust. This article examines the business trust and compares its operation to that of a corporation or partnership.

 

One of the most useful parts of this article is a spreadsheet list indicating statutes for each of the fifty states regarding choice of entity and formation issues.

 

 

Allan G. Donn, Is the Liability of Limited Liability Entities Really Limited?, 2002 A.B.A. Sec. Bus. L.

 

An excellent job of answering anyone’s questions to who, what, where, and how does it fail, of limited liability. The article’s caption is “Is The Liability of Limited Liability Companies Really Limited?” The article then proceeds to state yes, why, and how anticipated liability protection may not be available.

 

The article continues to discuss the general principles of limited liability, distinguishing the principal’s liability from that of the organization. This area explains how an owner is distinct and separate from the limited liability entity. The article then goes in depth of how to maintain, protect, and lose limited liability for each form of organization that is granted some status of limited liability. The article examines corporations, limited liability companies, Limited Partnerships, Limited Liability Partnerships, Limited Liability Limited Partnerships, Professional Corporations, Professional Limited Liability Companies, Professional Limited Liability Partnerships, and Business Trusts.

 

The most useful information conveyed in this article is likely how to pierce the limited liability shield. This information allows an investor to know when he may be able to sue a parent company, limited partner or the management’s personal assets, as well as informing the managers and directors how they can keep themselves protected by following certain steps.

 

 

Magazine

 

2) Michael F. Schaff & Robert J. Chalfin, Basic Factors to Consider When Advising Clients in Choosing an LLC or a Corporation, New Jersey Lawyer Magazine, Apr., 2006, at 55.

 

This article covers all the basic information for choosing an entity in the business formation. This article reminds the reader to consider both tax and non-tax related issues as well as liability related issues when forming their business. It asks the investor to consider ownership control, transferability of ownership interest, and management structure. Although all these considerations are important, the article recognizes that tax and liability considerations are usually the biggest motivating factors for choosing a certain business form.

 

The article also seems to suggest that an LLL has the greatest flexibility in both tax consequences and liability, as well as the most freedom to determine its particular management structure, control and transferability. However, the downside of the LLC that the article acknowledges, is the fact that because so few statutes and court decisions have limited them in their discretion, they may be prone to be veil pierced rather easily.

 

 

Legal Encyclopedia

3) 63 Am. Jur. 2d Products Liability § 117 (2006).

 

This American Jurisprudence section describes the liability of a successor organization regarding its business form. It goes into depth on product liability and which organization, predecessor, successor, or partner to either, is liable for a defective product. Typically, successor liability is held by the successor and not the originating business form, if following a business form that resembles a corporate structure. However, there is a rule of nonliability of a successor business when: (1) a successor limited partnership acquired the assets of a predecessor corporation in a forced bulk sale transfer, although the limited partnership was comprised of the former stockholders of the corporation; (2) the predecessor manufacturer was a sole proprietorship the assets of which had been purchased by a corporation; (3) the predecessor was a partnership and the successor corporation was formed by a surviving partner; and (4) the successor was a proprietorship employing only one person and the predecessor was a corporation. This section is useful for understanding limited liability, especially if your creating a business with a successor, predecessor, or partnering organization.

 

 

Books

 

4) Richard D. Harroch, Corp. Sec. Series, Start Up Companies, Planning, Financing and Operating the Successful Business, (Law Journal Press 2002) (1985). Corporate Security

 

The book begins with the typical initial choice of entity concerns previously discussed. Chapters two through five focus on corporations, limited liability companies, general partnerships, and limited partnerships and the methods of raising capital. These ways also include common stock and preferred stock sales as well as debentures and other interest or security sales from non-corporation businesses. These chapters discuss the federal and state securities law affecting these capital raising activities, which should definitely be taken into consideration during the formation process prior to financing the business.

 

The next several chapters are dedicated to financing and the legal risks related to that. Chapter 12 discusses the tax treatment of several of the various entities. The book goes into some depth on the tax consequences to each organization and for the owners of the company.

 

Chapter 15 discusses how to protect a company’s intellectual property. The discussion goes into the various forms of protections (patent, trademark, copyright) and when they should be used. The following chapter discusses licensing for many companies and includes useful forms of licensing agreements.

 

This two volume book has a lot of everything you could ever want to know about starting your own corporation, but seems to fall flat when it comes to consideration of LLCs. This book seems to be designed to the already business or legally savvy mind. If you have clients considering starting up a company with an initial public offering, this is definitely the book for you.

 

 

 

5) Peri H. Pakroo, The Small Business Start-Up Kit (Nolo 2003) (2000).

 

This book is filled with examples, state contacts, and legal forms. The first part of the book covers the legal formations available to choose from, but also includes remarks about when you should not choose certain forms. Every business form listed also comes with examples of that type of business with tax and liability issues that might arise. The next part of the book explains the forms (operating, tax and some state regulatory) and procedures a business should follow to keep itself protected from liability. The book provides every states’ office to contact regarding business formation within that state. There are also plenty of examples of legal forms, such as articles of incorporation, bylaws, operating agreements, stockholder agreements and tax forms.

 

This book is a great source for samples and examples of forms, procedures, and tax consequences. It seems like it would be an invaluable source of information when forming a business.

 

 

 

Websites

6) Steps to Success, A Resource Guide to Starting a Business in Kansas, Kan. Dep’t of Commerce, http://kdoch.state.ks.us/KDOCHdocs/BD/Steps_To_Success.pdf (last visited March 1, 2007).

 

This is the best website to go to if forming a business in the state of Kansas. This online guide lists all the resources available to in state entrepreneurs, from where they can get financing to where they can get free legal advice.

 

The Steps to Success begin as the rest of the information by briefly explaining the structure of the different types of entities. It next begins to explain the importance of creating a business plan, which is not just to keep an entrepreneurs eye on the prize, but also to show lenders and interested investors. The Steps to Success also explain the necessity for keeping records, choosing an appropriate location to start your business and selecting a Certified Public Accountant. The Steps to Success then explain how to register your business in the state, register as an employer, apply for a patent, trademark or copyright.

 

The next section of the Steps to Success then explains specifically what licensing procedures may apply to your specific business. Whether its retail or trucking, you will probably have to get some sort of operational approval. This guide leads you to the source of those licenses. The guide also provides plenty of information on State and Federal taxes, including credits and deductions that may be available as well as how and where to file.

 

The Steps to Success guide is one of the best tools provided to local entrepreneurs through the state.

 

 

 

7) Kansas Secretary of State, http://www.kssos.org/main.html (last visited March 1, 2007).

 

Some of the best information available out there for the entrepreneur is to look at their Secretary of State’s website for information. This website has links that will lead you to forms, that will answer your questions, and that will give you the Kansas Statutes regarding the various legal entities that are available to you in Kansas. You can also email the Secretary of State to find out whatever other information may be needed. This website will also help direct you to find out what kind of license you might need with the state, but recommends you check with whatever county or city you are in for additional information.

 

 

8) Internal Revenue Code Business, http://www.irs.gov/businesses/index.html (last visited March 1, 2007).

 

Uncle Sam has a lot of great resources located on the IRS website. You can find all the initial tax forms you will need, including the employer identification number which is basically a social security number for your business. The IRS provides lists of what can and cannot be deducted as business expenses. You can also quickly find links to forms or reference material for whatever type of entity you choose. The IRS also provides links to learning opportunities for small businesses.

 

9) The Wall Street Journal Center for Entrepreneurs, http://startup.wsj.com/ (last visited March 1, 2007).

 

This site has several incoming articles by other entrepreneurs, business professionals and Wall Street Journal reporters. The site contains columns, how-to information, ideas, franchising, financing, and e-commerce information. Some of the current business suggestions floating out there are Online Communities and web video at the local level. Inspiration and ideas are abundant on this site.

 

10) Entrepreneur.com, http://www.entrepreneur.com/ (last visited March 1, 2007).

 

Entrepreneur.com is very similar to the Wall Street Journal Center for Entrepreneurs. However, this site also has answers to management, starting a business and franchise opportunities. This site has several articles to read about being an entrepreneur and starting your own business. Two useful articles to be considered after your business has been formed are "Developing a Marketing Calendar" and "Getting Out of a Commercial Lease." This site is worth a look if you are an independent entrepreneur looking for ideas in running a business.