Legal services for small businesses in the Florida Keys
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Choose the right structure

Your business starts with choosing the best structure

Most business owners know that survival requires careful financial planning, yet few fully realize the importance of selecting the best form for their business.  Most smaller businesses have little need for the sophisticated organizational structures utilized in large, publicly traded operations, but since all entrepreneurs must pay taxes, obtain loans, and expose themselves to potential liability with every sale they make, it only makes sense to structure one’s business so as to address these important issues.

Every business has an organizational form best suited to it.  Various aspects of taxes and personal liability must be discussed and evaluated with an experienced Florida business lawyer in order to decide which of the basic forms is most appropriate. There are only a handful of legal structures for your business:

  1. Sole proprietorship
  2. Partnership
  3. Limited liability company
  4. Corporation (including C corporations and S corporations)

Sole Proprietorships

A sole proprietorship is an unincorporated business owned exclusively by one person.  Any business with two or more owners cannot, by definition, be a sole proprietorship.   Sole proprietorships are easy to establish and maintain, often simply requiring a business license and/or registering the name of the business if you operate it under a name other than your own.

One of the biggest drawbacks of operating your Florida Keys business as a sole proprietor is that you, as owner of the business, can be held personally liable for business-related obligations.  This means that if your business does not pay a supplier, defaults on a debt, loses a lawsuit, or otherwise finds itself in financial hot water, you, personally, can be forced to pay those obligations.  This can be a sobering reality, especially if you own significant personal assets that may be subject to forfeiture.  For this reason alone, many businesses elect to organize as a limited liability company or corporation (discussed below) to prevent, in most instances,  personal liability for debts or obligations of the business.

Because a sole proprietorship is not, under the law, legally distinct from the person who owns it, a sole proprietor simply reports all business income or losses on his or her individual income tax return through a form known as a Schedule C.  The business itself is not taxed.  This is referred to as “ pass-through”  taxation because business profits pass through the business to be taxed on the business owner’s tax return.  One helpful aspect of this arrangement is that if your business loses money, as most do in the first year or two, you can use the business losses to offset any taxable income you have earned from other sources.

Partnerships

A partnership is an association of two or more individuals to conduct, as co-owners, a business for profit.  By definition, no formalities are necessary or required for a business to be considered a partnership under the Florida law.  In fact, in some instances, individuals have been held to be partners even though they never had any intention of forming a partnership.  For example, if you loan a friend money to start a business and agree to accept a percentage of any profits in exchange for the loan, you may be considered your friend’s partner in the eyes of the law even though you took no part in running the business.

We strongly advisable that partners have a formal partnership agreement defining the terms of the partnership, such as control and management of the partnership and the distribution of profits and losses.   If no such partnership agreement is formalized, Florida law generally dictates the terms of the partnership by default.  Like sole proprietorships, partnerships are generally required to procure a Key West and/or Monroe County, Florida business license and register the partnership with the appropriate state and local authorities.

Also like sole proprietorships, each partner in a partnership is subject to personal liability for the debts, obligations, and liabilities of the partnership, even if the partner is not personally involved in incurring those debts.  Each partner is also generally liable for the negligence of another partner and of the partnership’s employees when a negligent act occurs in the normal course of business. Therefore, you should be extremely cautious to select responsible partners and to adequately insure the assets of the partnership and the personal assets of each partner.

Partnerships also enjoy “pass-through” taxation, similar to sole proprietorships, wherein each partner pays taxes on his or her share of the profits.   The partnership itself does not pay taxes or file individual tax returns.

Limited Liability Companies (LLCs)

A limited liability company (LLC) is a relatively new form of business entity recognized in most states, including Florida.  LLCs can consist of either one or multiple owners who each own a  membership interest in the company.  Limited liability companies combine the pass-through taxation of the sole proprietorship or partnership with the same protection against personal liability that corporations offer (i.e., the individual owner is not generally liable for the debts and obligations of the business).   Because LLCs combine the best of both worlds, they have quickly become the most popular form of business entity for small, mid-size, and even larger organizations.

Because LLC owners enjoy limited personal liability, the owners are protected, with some exceptions, from legal and financial liability in case their business fails, loses a lawsuit, or cannot pay its debts.  In those situations, creditors can seize the LLC’s assets, but they generally cannot seize the personal assets of the LLC’s owners. However, like a partnership, any member of a limited liability company can legally bind the entire LLC to a contract or business transaction.  In other words, each member can act as agent of the LLC.

Further, when owners fail to respect the separate legal existence of their limited liability company, and instead treat it as extension of their personal financials, the court may ignore the existence of the LLC and rule that the owners are personally liable for business debts and liabilities.  Therefore, it is essential that the LLC and its owners maintain separate bank accounts, accounting records, and funding to adequately meet foreseeable expenses.

Like a sole proprietorship or partnership, a limited liability company is not a separate tax entity from its owners.  Instead, it is a pass-through entity, meaning that the LLC itself does not pay any income taxes.  Income taxes pass through the business to each LLC owner, who in turn pays taxes on his or her respective share of the profits.

To form a limited liability company, the company must file articles of organization with the Florida Division of Corporations.   Most states, including Florida, charge initial filing fees in addition to annual fees to renew the LLC filing.  If the limited liability consists of more than one member, it is essential that the members execute a written operating agreement (similar to a partnership agreement) setting forth how the LLC will be operated and managed and how profits and losses will be distributed, in addition to other important terms.

LLCs are generally more expensive to form and are subject to more regulation than a sole proprietorship or partnership.  However, the benefits often outweigh the expense and regulatory hassle that may exist with LLC formation.

C Corporations

There are two basic types of corporations, C corporations and S corporations Similar to a limited liability company, the owners of a corporation are not, as a rule, subject to personal liability for the corporation’s acts and debts.  Owners of a corporation, its shareholders, own stock in the corporation that has its own independent value, which can fluctuate based on the success and health of the corporation and other market forces.

Shareholders are allowed participation in the control of the corporation through the shareholders’ voting privileges.  Typically, the higher the percentage of outstanding shares owned, the more significant the control.  However, shareholders do not participate in the day-to-day operations of the corporation.  Shareholders elect a board of directors to manage the corporation, and the board of directors appoints officers to carry out the corporation’s operations.

In most larger corporations, shareholders can generally sell all or any number of their shares to whomever and whenever they wish without prior approval of the corporation.  However, transferability may be restricted in small corporations by agreement of the shareholders.  The corporation may also raise new capital through issuance of additional stock.  The corporation may elect pay out a percentage of its profits to its shareholders, known as dividends.

Under both state and federal laws, the profits of the corporation are taxed to the corporation before they are paid out as dividends.   Then, because the dividends constitute income to the shareholders, they are taxed again as the shareholder’s personal income.  This double taxation constitutes the major disadvantage of incorporating.

The basic rules of the corporation are stated in its articles of incorporation that are filed with the Florida Division of Corporations.  The serve as the constitution for the corporation and can be amended by shareholder vote.  More detailed operational rules, known as bylaws, should also be prepared.  Due to the complexity and formalities associated with corporations, it is always advisable to engage the services of a knowledgeable Florida Keys business attorney to ensure compliance with state regulations, completion of corporate mechanics, and to obtain advice on corporate taxation.

S Corporations

Congress has created a hybrid organizational form that allows the owners of a small corporation (defined as less than 100 shareholders) to take advantage of many of the features of a C corporation, but to be taxed in a manner similar to a limited liability company or partnership (thereby avoiding most of the double-taxation problems).  In this form of organization, called an S corporation, income and losses flow directly to its shareholders, and the corporation pays no income tax.

Unfortunately, the tax rules for S corporations, although advantageous, are not as simple as those for partnerships or individuals.  Generally speaking, the owner of an S corporation is taxed on his or her pro rata share of the distributable profits and may deduct his or her share of the distributable losses.

Because S corporations have a limited number of shareholders, its shareholders may not want the shares to be openly traded and subject to outside ownership and control.  Therefore, shareholders often agree to restrict the ability to transfer shares.  Such an agreement, known as a stock restriction or buy-sell agreement, may be executed by the shareholders to determine when and under what conditions a shareholder’s stock may be sold or transferred.

Like C corporations, shareholders in S corporations are not subject to personal liability for the debts and obligations of the corporation.   S corporations are typically subject to the same filing requirements and regulatory compliance of C corporations, and it is advisable to consult with an experienced business attorney and a tax professional before deciding on the appropriate legal entity for your business.

At The Hulse Law Office, we work with businesses of all sizes in Key West and throughout the Florida Keys to structure their businesses to most effectively minimize risk and personal liability while allowing for both long and short term growth.   Contact us today to discuss the best legal structure for your business and for a thorough analysis of your business needs.

 

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