This is the simplest and the most widely used structure for business. It is the least regulated type of the various business structures. For tax and legal purposes the business is the owner. The unlimited liability factor is probably the greatest disadvantage. The liabilities of the business are personal to the owner and the business ceases to exist when the owner dies.
- All of the personal and business assets of the sole owner are at risk in the sole proprietorship
- A judgment against the sole proprietorship could reach into the personal assets of the sole owner
- Liability insurance premiums are very high. Perhaps too costly for the resources of the sole owner
- Due to the structure it may be difficult to obtain a loan. If there is insufficient collateral a sole proprietor may have to mortgage a loan or place another piece of personal property as collateral
- When the sole owner dies often the business ceases to exist due to the lack of structure in this business form
- Sole owner has total control over the operations of this business
- Least regulated form of business
- Other than records for tax purposes there are no legal requirements as to how the business must be operated
- Usually one only needs to obtain a license or pay a fee to a local registry authority.
The Limited Partnership
The limited partnership is a hybrid type of business structure. It contains elements of both a traditional partnership and a corporation. The limited partnership form of business structure may be used when some interested parties want to invest in a partnership but want only limited liability and do not wish to exercise any control over the business activities of the partnership.
The Limited partnership is subject to much more regulation on the state level than either the sole proprietorship or regular partnership. Each state in the Union has adopted strict regulations according to the Uniform Limited Partnership Act governing the formation and operation of the Limited Partnership.
A limited partnership consists of two types of partners; the general partner; one or more people who actively manage the partnership; and the limited partner; one or more people who invest in the partnership but take no active role in the management of the partnership. The general partners are at personal risk for their conduct of the partnership whereas the limited partner risks only that which he has invested in the partnership.
- There is always a chance for a lack of continuity and clear cut guidelines amongst the partners concerning who does what and how to conduct business.
- Due to the state regulations, limited partnerships are subject to more paperwork than the general partnership.
- General partners maintain full personal risk. The limited partner risks losing the benefits of the limited partner status if they take any active role in the conduct of the activities of the partnership.
- The limited partner, as long as he remains passive, has no personal liability and risks only that which he invests.
- This low risk for the limited partner and the fact that the limited partner shares in the profits and tax deductions with no duties regarding the active conduct of business may make it easier for the partnership to find investors.
A corporation is an artificial entity created by filing Articles of Incorporation with the Secretary of State. This gives the corporation existence and a legal right to conduct business in the state of incorporation. Corporations are more complex than either a partnership or sole proprietorship and are subject to more regulation by the state.
The internal rules of the corporation which outline the mechanics of the operation and management are called the by-laws.
Corporate Structure: A Concise Explanation
Shareholders: They own share in the business but do not engage in the direct management of the operation except by electing the directors of the corporation and by voting on major corporate issues.
Directors: They may be shareholders, but as Directors they do not own any of the business. As group known as the Board of Directors, they are jointly responsible for making the major business decision for the corporation as well as appointing the officers of the corporation.
Officers: they may be shareholders and/or directors, but, as officers, they do not own any of the business. They are responsible for the day-to-day operations of the corporate business. Usual titles for the different corporate officers are: President, vice-president, Secretary and treasurer.
Disadvantages of Incorporation
- Due to the organizational structure in a corporation, a certain degree of individual control is necessarily lost by incorporation
- The technical formalities of corporation formation and operation must be strictly observed in order for a business to reap the benefits of corporate existence.
- The initial state fees that must be paid for registration of a corporation can be very high.
- Corporations are also subject to a greater level of governmental regulation than any other type of business entity.
- Profits are subject to double taxation when distributed to shareholders in the form of dividends.
Advantages of Incorporation
- Potential for limited liability is one of the most important advantages of the corporate form of business structure. The liability of corporate debt is generally limited to the amount of money each investor has invested.
- A corporation can theoretically have perpetual existence.
- A shareholder may freely sell, trade or give away his stock unless this right is formally restricted by corporate decision.
- Taxation can be both an advantage and a disadvantage.
The Limited Liability Company (LLC)
A Limited Liability Company (LLC) is a hybrid business entity, designed to combine the advantages of a corporation with the tax advantages of a partnership. Like a corporation, the owners of an LLC are not personally liable for the LLC's debts and obligations. Like a partnership, an LLC can be treated as a pass-through entity for tax purposes. Beginning in 1997 the IRS no longer taxes these entities as corporations. They permit the LLC to elect whether taxation as a partnership, sole-proprietorship or corporation best fits the needs of its business and its Members. This may be advantageous for those who cannot meet the IRS requirements for an "S" corporation and desire the tax pass-through treatment.
Once organized, the corporation must maintain a continuous record of all authorized actions - approved by its stockholders or directors.
A complete and detailed record of stockholders’ and directors’ meetings - “minutes” as they are called - is important for many reasons:
- Parties dealing with the corporation may want evidence that the corporate action was approved.
- Officers and employees within the corporation are entitled to the protection if their acts were approved.
- Accurate minutes are frequently necessary to preserve certain tax benefits or to avoid tax liabilities and penalties.
- Minutes are oftentimes necessary to prove the corporation is operated as a separate entity independent of its principals.
The forms in this kit will help you maintain a well-documented written record of stockholders’ and directors’ actions, in a format that meets legal standards.
By using these forms you can create a complete corporate biography, detailing the important events during the life of the corporation.
Generally, you need only complete the resolution that conforms to the corporate action voted. Occasionally you may need to modify the form to suit your particular needs. Always be certain the resolution accurately states the corporate action approved. In some cases - particularly the more important transactions - you may find it necessary to have an attorney decide what the resolution should contain. While these prepared forms can greatly simplify your recordkeeping requirements, they are not a substitute for your good judgment in deciding how you should document the actions of your corporations.
Records of Stockholder Actions
Stockholders can usually vote on the broadest issues relating to the corporation. These typically include change of corporate name, address, purpose, the amount of authorized or type shares and other matters involving the corporate structure. Stockholders action may also be needed on major legal or financial issues such as whether to mortgage, encumber, pledge or lease all or substantially all of the corporate assets or to file bankruptcy, merge or consolidate. There are, of course, many other actions that can be taken by stockholders. The primary function of the stockholders, however, is to elect the Board of Directors, through whose governance the corporation is actually managed.
Stockholders can act officially only as a group. This means that a formal meeting is needed before they can legally bind the corporation. There are some exceptions where the stockholders can consent in writing to a particular action without having to hold a meeting. These instances, however, are rare.
Certain rules and procedures have to be followed for stockholders to properly conduct an official stockholder meeting.
- Every stockholder has to be properly notified about the time and place of the meeting, who is calling the meeting and any matters that will be considered at the meeting. It is common in small corporations for the stockholders to do without a formal notice, especially where the by-laws set out the time and place of the regular annual meeting of stockholders. This can be done by having all the stockholders sign a waiver of notice at the meeting. Unscheduled or special meetings of stockholders may require notice, although a signed waiver of notice can be used at these meetings. For an unscheduled meeting to be legally convened, it is essential that the records show that proper notice was given, or that the stockholders signed a waiver of notice requirement. Your articles of incorporation or by-laws will specify where and when a stockholder meeting can legally be held and the book of minutes should show the time and place of each meeting. In this way, you can prove the meeting complied with legal requirements.
- No business can be transacted at stockholders meeting unless a quorum is present. Therefore, it is essential that the book of minutes reflect a quorum of stockholders attended the meeting. The articles of incorporation or by-laws will usually state the size of the quorum, either in terms of the number of stockholders, or the number of shares that must be represented at the meeting. If there is no rule on a quorum, then whatever number of stockholders shows up for the meeting will constitute a quorum.
- Stockholder meetings must have a chairperson to preside over the meeting. It must also have a secretary to record what happened at the meeting. The by-laws will ordinarily designate these officials, such as by specifying that the president serve as chairperson, and the secretary act as secretary, however, substitutes are usually allowable.
- The first items of business at every stockholder meeting should be to read and approve the minutes of the previous meeting. Once the minute as are approved, they legally document what occurred at the meeting. They are most nearly conclusive proof of what the corporation is authorized to do. That is why it is important to show that the minutes have been read and approved as accurate, or that necessary changes have been made.
- Parliamentary procedure governs the conduct of meetings. It is not generally necessary to identify the person making the motion or seconding a motion. Nor is it essential to record the exact tally of votes, as long as the action approved is clear.
Record of Director Actions
Most of the rules and procedures that apply to stockholder meetings apply equally to meetings of the Board of Directors with several exceptions:
- Directors will meet far more often than stockholders, and in large corporations may meet monthly. The directors can also hold special meetings for interim board action and in more active corporations they will routinely meet more often.
- The board - as with stockholders - can only function through a duly called meeting where a quorum of directors (as defined in the by-laws) is present. Directors who may be in conflict with the interests of the corporation may however, not be counted towards the quorum or be entitled to vote.
- The board must be particularly careful to document not only its actions but why the action was taken. Because the board has responsibility to stockholders - and potential liability to other constituencies - it may be called upon to show why its action was prudent - particularly in areas of dividends, loans to officers, major contracts, compensation and policy making. It is especially critical for the minutes to include or refer to reports, arguments, opinions and other documents to support the reasonableness of the board’s actions.
- Frequently the board will be called upon to issue “certified resolutions” or “certificates of vote” which conclusively show to third parties dealing with the corporation that the person acting on behalf of the corporation has the required authority.
All records, resolutions and minutes should be kept for no less than six years - although retaining records for longer is recommended considering the numerous types of claims that are possible and the varying statute of limitations.
Properly used, the forms in this kit will provide you with a simple, easy-to-use and legally sound records system for your corporation.
- Your Tax Year
- Accounting Methods
- Bookkeeping Systems
- An Example of Single Entry Bookkeeping
- Business Checking Account
- Check Disbursement Journal
- Sales Tax Records
- Employer Records
Your taxes are based on a one-year period called your tax year. Your tax year may be a calendar year or a fiscal year consisting of twelve consecutive months. It is the same as that established for federal tax and in most cases will be a calendar year beginning January 1 and ending December 31.
Your tax year is established when you file your first federal income tax returns. You must continue to use this tax year unless you get permission from the Internal Revenue Service to change it.
You may use one of two basic accounting methods to record your business transactions: cash method or accrual method. You must use the same method of accounting for determining your New York taxable income as you use for federal income tax.
Most taxpayers use the accrual method of accounting. The following must use the accrual method:
- Anyone who collects sales tax
- Corporations (other than S corporations);
- Partnerships that have a corporation (other than an S corporation) as a partner;
- Anyone subject to motor fuel or diesel motor fuel tax; and
- Tax shelters
Using the cash method, you report income when the money is actually received, and report expenses when the bills are actually paid. Using the accrual method, you report income when it is earned (whether you’ve received payment or not), and report expenses when they are incurred.
Generally, you may use either the cash or the accrual method or a combination of the two as long as you apply your accounting method consistently (However, if the production, purchase or sale of merchandise is an income-producing factor, you must keep inventory records to clearly show income, and you must use the accrual method to record your purchases and sales).
If you operate more than one business, you may use different accounting methods for each. You must keep complete records and separate books for each business.
You may also choose one of two bookkeeping systems: single-entry or double-entry. The single-entry system is easier to keep; the double-entry system, although more complex, assures better accuracy and control.
In double-entry bookkeeping you keep journals and ledgers. Transactions are entered in a journal and then, at certain times, summary totals are posted to ledger accounts showing income, expenses, assets, liabilities and net worth. The system is self-balancing because each transaction is shown as a debit entry in one account and a credit entry in another. Total debits must always equal total credits; if they don’t, it is evident an error has been made.
At the end of an accounting period, you will be able to prepare a profit and loss statement reflecting current operations and a balance sheet showing the overall financial position of your business.
An Example of Single-Entry Bookkeeping:
Single-entry bookkeeping concentrates on the profit and loss statement and not the balance sheet. It is a partial system that records the flow of income and expense using a daily summary of cash receipts, a monthly summary of receipts and a monthly check disbursements journal.
You begin the day with a fixed amount of petty cash in the cash register ($25.00) in this example). That allows you to make change and make small payments without writing checks. Every time you make a payment from the cash register, fill out a petty cash slip and place it with the receipts in the cash register.
At the end of the day, total the amount of sales and sales tax shown on your cash register tape or sales slips. Enter these amounts ($53.75) and ($3.76) on the summary sheet and add them to get the total receipts ($57.51) for the day. Count the money in the cash register ($76.51) and add any petty cash slips ($6.00) to find the total cash ($82.51). Then subtract your initial petty cash amount ($25.00) to determine the total cash deposits for the day. This figure must be the same as the total receipts ($57.51).
Deposit your day’s receipts into your business checking account. You will begin the next day with $19.00 cash and $6.00 in petty cash slips in the cash register. When the petty cash slip total approaches your fixed amount of petty cash, write a check made out to “petty cash” for the amount of the outstanding slips, cash the check, and add the cash to the register.
Transfer total receipts, sales tax and cash sales (net sales) from each daily summary to a monthly summary and total. Net sales totals give you your monthly taxable income ($1,612.33).
Your monthly summary sheet will also provide the records necessary to prepare your New York State sales and local use tax returns.
Business Checking Account
You should deposit all receipts in a separate business checking account and , if possible, make all disbursements by check. Your canceled checks will be proof of your business expenses. Avoid making check payable to “cash” or payable to yourself (except for income withdrawals). Payments made from petty cash should be documented by petty cash slips and receipts.
Check Disbursement Journal
All checks drawn on your business account should be entered daily in your journal. This enables you to keep track of total expenses and break them down into categories for income tax purposes.
For each check you write, enter the date (June 4), the payee (First Bank) and total amount ($84.64) and extend it to the proper column. In some cases (petty cash, for example) you will make entries in several columns. At the end of the month, add each column to determine total expenses. You may want to prepare an annual summary to help in preparation of your income tax returns.
Sales Tax Records
These same records will provide the information you need to prepare your New York State and local sales and use returns. Your daily and monthly summaries indicate the amount of gross sales, taxable sales and sales tax you collected. Your cash register tapes or sales slips (with sales tax separately stated) must be available for inspection for three years.
For more information, see Publication 752, Record Keeping for Sales Tax Vendors, and FormST-150, General Instructions for State and Local Sales Use Taxes.
If you pay someone to work for you, you’re an employer and you will be required to keep additional records. All records supporting your tax returns, as well as the returns themselves, should be kept for at least three years (four years for employer information) after your return is filled.
You have been provided with a brief introduction to keeping business records. Federal Publication 334, Tax Guide for Small Business, will provide you with additional information. You must determine what kind of system will be most comfortable for you and best suited to your business needs.
Office supply stores sell a variety of complete bookkeeping systems as well as any record-keeping forms and other materials that may help you.
The “S” Corporation is a particular type of corporation that exists for certain tax purposes. It is particular to the Internal Revenue Service and “S” corporation status is not relevant to state corporate laws. It enables a small corporation to be taxed on the federal level like a partnership yet retain some of the benefits of corporation status.
To qualify as an “S” Corporation , a corporation must meet these requirements:
- It must have no more than 35 shareholders
- All of the shareholders must be individuals (no corporations or other entities as shareholders)
- It may have only one class of stock
- Each shareholder must consent to “S” corporation status; and
- An election of “S” corporation status must be filed with the IRS
The “S” corporation retains all of the advantages and disadvantages of the traditional corporation except concerning taxes. Shareholders in “S” corporations are treated like partners in a partnership. The income and losses generated by an “S” corporation go through the corporation directly to the individual. This means that there is no double taxation. Also, unlike a regular corporation, shareholders in an “S” corporation can deduct any corporate losses.
As with any legal and business matters a competent attorney should be consulted before an individual makes any decision concerning what form of business structure to choose and how to go about drawing up the documents.
You should have a federal employer identification number (EIN) if you are a sole proprietor and you pay wages to one or more employees. To get one, you must file federal Form SS-4, Application for Employer Identification Number, with the Internal Revenue Service (IRS). If possible file four weeks before you will need the number.
If your business is a partnership or a corporation, you will need a federal EIN even if you are not an employer. You will also need one if your business requires you to file excise, alcohol, tobacco, firearms or employment tax returns. When you register in New York State to collect sales tax, the Certificate of Registration asks for it. Certain nonprofit organizations (churches, clubs, etc.), trusts and estate must also use it.
If you become the new owner of an existing business that you will operate as a sole proprietorship, you cannot use the EIN of the former owner. You must apply for and acquire a new EIN. For application forms and more information about who needs an EIN, contact your local IRS office.
If you are not required to have a federal EIN for your new business, the Tax Department will assign you an account number to be used on all of your business tax records.
Assets - Anything owned with monetary value. This includes both real property and personal property.
Authorized Shares - The number of shares a corporation is authorized to sell.
By-Laws - Rules adopted for the regulation of a corporation’s own actions, by the corporation itself; a subordinate law adopted by a corporation, association or other body for its self-government or to regulate the rights and duties of its officers and members.
Calendar Year - The accounting year beginning on January 1 and ending on December 31.
Certificate / Articles of Incorporation - The document which creates a corporation according to the laws of the state. This must be filed and approved by the state.
Consolidation - When two corporations combine creating a third.
De Facto Corporation - An entity operating as a corporation but without the benefit of a formal charter.
De Jure Corporation - A lawfully chartered corporation.
Domestic Corporation - A corporation formed in one state to do most of its business in that state.
Fiscal Year - Any twelve month period used by a business as its fiscal accounting period. Such accounting period, may for example, run from July 1 of one year through June 30 of the next year.
Foreign Corporation - A corporation formed in one state or country but conducting some or all of its business in another state or country.
Holding Company - A corporation that has no function other than to own other corporations.
Incorporate - To form a corporation or to organize and be granted status as a corporation by following procedures as proscribed by law.
Incorporator - One who signs the Certificate/Articles of Incorporation petitioning the state for a charter.
Issued Shares - The number of shares actually sold by the corporation.
Merger - The absorption of one corporation by another.
Minority Stockholder - One who owns or controls less than 50% of the stock in a corporation.
Minutes - Written records of formal proceedings of stockholders and directors meetings.
Non-Par Value Stock - Shares of stock with out a specified value.
Not-for-Profit Corporation - A corporation organized for some charitable, civil, social or other purpose that does not entail the generation of profit or the distribution of its income to members, principals, shareholders, officers or others affiliated with it. Such corporations are accorded special treatment under the law for some purposes, including taxation.
Par Value Stock - Shares of stock with a specified value.
Pre-Emptive Rights - The rights of existing stockholders granting them first option to acquire new issues of stock in proportion to their present stock ownership.
Proxy - Authorization by a stockholder allowing another to vote his shares of stock.
Publicly-Owned Corporation - One whose stock is owned by large number (over 25) stockholders and is regulated by the SEC.
Quorum - A majority of the stockholders or directors necessary for vote counting and decision making at a meeting. While a quorum is usually a majority of the total membership or the members present, a quorum may consist of a greater number than a simple majority if desired and stated in the by-laws.
Shareholder - See “Stockholder”
Statutory/Registered Agent - A lawyer, corporation or individual who has assumed the responsibility to be the legal representative for the corporation in your state. The Statutory/Registered Agent is the legal agent of the Corporation, for purposes of accepting legal service.
S Corporation (Subchapter S Corporation) - A small business corporation which elects to be taxed as a partnership or proprietorship for federal income tax purposes. Individual shareholders enjoy the benefits under state law of limited corporate liability but avoid corporate federal tax.
Stock Certificate - Written instrument evidencing a share in the ownership of a corporation.
Stockholder - A holder of one or more shares of the stock of a corporation. A stockholder may be called a “shareholder”.
Subsidiary - A corporation owned by another corporation.
Treasury Stock - Shares of the corporation owned by the corporation.