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Entity Incorporation

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Entity Incorporation

Business operations can be conducted in a number of different forms. Among the various possibilities are the following:

Sole Proprietorship
General Partnership
C Corporation
S Corporation
Limited Liability Company
Professional Corporation
Professional Limited Liability Company
Limited Liability Partnership
Limited Partnership
Nonprofit
For Federal income tax purposes, the distinctions among these forms of business organizations are very important. The following discussion of the tax treatment of sole proprietorships, partnerships and regular corporations highlights these distinctions.

A sole proprietorship is not a taxable entity separate from the indivdiaul who owns the proprietorship. The owner of a sole proprietorship reports all business transactions of the proprietorship on Schedule C of Form 1040. The net profit or loss from the proprietorship is then transferred from Schedule C to Form 1040, which is used by the taxpayer to report taxable income. The proprietor reports all of the net profit from the business, regardless of the amount actually withdrawn during the year.

Partnerships are not subject to the income tax. However, a partnership is required to file Form 1065, which reports the results of the partnership’s business activities. Most income and expense items are aggregated in computing the net profit of the partnership on Form 1065. Any income and expense items that are not aggregated in computing the partnership’s net income are reported separately to the partners.

Corporations are governed by Subchapter C or Subchapter S of the Internal Revenue Code. Those governed by Subchapter C are referred to as C Corporations or regular corporations. Corporations governed by Subchapter S are referred to as S corporation.S corporations which generally do not pay Federal income tax, are similar to partnerships in that net profit or loss flows through to the shareholders to be reported on their separate returns. Also like partnerships, S corporations do not aggreagate all income and expense items in computing net profit or loss. Certain items flow through to the shareholders and retain their separate character when reported on the shareholders returns.

Unlike proprietorships, partnerships, and S corporations, C corporations are taxpaying entities. This results in what is known as double tax effect. A C corporation reports its income and expenses on Form 1120. The corporation computes tax on the net income reported on the corporate tax return using the rate schedule applicable to corporations. When a corporation distributes its income, the corporation’s shareholders report dividend income on their own tax returns. Thus, income that has already been taxed at the corporate level is also taxed at the shareholder level.

The type of entity incorporated plays a very important role in determining the future profitability of the entity because of the above said difference. Other facts that play an important role in determining the type of entity to be incorporated are analyzed in the below paragraphs:-

Once you have decided to incorporate your business or form an LLC, the next step is to decide where to incorporate. You are not required to form your company in the state where it will be physically located. You can form a corporation or LLC in any state or Washington D.C.; however, there are factors you should consider when evaluating which state is best for your business.

Home State Versus Another State

Forming a corporation or LLC in the state where the business is physically located is called home state formation. Corporations and LLCs must pay filing fees to the state when the formation documents are filed. They are also subject to ongoing requirements and fees imposed by the state of formation.

Internal Requirements:

Holding initial and annual meetings of directors and shareholders,
Adopting and maintaining updated bylaws,
Issuing stock to shareholders, and recording any subsequent stock transfers.

External Requirements:

Most states require corporations and LLCs to file an annual statement or annual report.
Some states also have a franchise tax, which is essentially a fee paid to the state for the mere privilege of operating as a corporation or LLC formed or qualified in that state.
If a corporation or LLC is sued and unable to show it indeed has met all of the corporate or LLC formalities and state requirements, a judge can rule that the company has been acting more like a sole proprietorship or general partnership. This can result in what is called ‘piercing the corporate veil’.

When the corporate or LLC veil is pierced, the limited liability protection of the entity disappears and the assets of the individual owner(s) are now accessible should a lawsuit judgment be made against the company.

Common Advantages Of Forming In Delaware

External Requirements:

Delaware’s business law is one of the most flexible in the country.
The Court of Chancery focuses solely on business law and uses judges instead of juries.
For corporations, there is no state corporate income tax for companies that are formed in Delaware but do not transact business there (there is a franchise tax, however).
The taxation requirements are often favorable to companies with complex capitalization structures and/or a large number of authorized shares of stock.
There is no personal income tax in Delaware for non-residents.
Delaware does not require director or officer names (corporations) or member/manager names (LLCs) to be listed in the formation documents, thereby providing a level of anonymity.
Shareholders, directors and officers of a corporation or members or managers of an LLC need not be residents of Delaware.
Shares of stock owned by persons outside Delaware are not subject to Delaware taxes.

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