Ask The CPA: 5 Facts About Business Formation That Could Destroy Your Business
I’m often asked by entrepreneurs about the things that I’ve seen with small businesses that cause me to lose sleep at night. My answer is always the same: Business Formation Issues! Business formation is the one area that many entrepreneurs know little to nothing about but could have a serious impact on the survival of their business. I decided to dedicate a blog posting to this topic in order to educate entrepreneurs in the hopes that they avoid the many potential pit falls associated with the formation of a business entity.
What exactly is business formation?
Business formation is the process of forming “a business entity that is administered as per corporate law in order to engage in business activities, charitable work, or other activities allowable. Most often, business entities are formed to sell a product or a service. There are many types of business entities defined in the legal systems of various countries. These include corporations, cooperatives, partnerships, sole traders, limited liability companies and other specifically permitted and labelled types of entities. The specific rules vary by country and by state or province”. The primary reasons why business entities are formed is to limit personal liability and potentially save on income tax obligations.
There are many factors to consider before selecting an entity. The process of selecting an entity is so important that the very survival of your business may be impacted if you don’t handle the process with the utmost of care.
Be sure to obtain the proper advice
The first pitfall that many entrepreneurs fall prey to is failure to obtain the proper advice before deciding to form an entity. There are so many providers online that offer entity formation services that it gives the average entrepreneur the false impression that entity formation is a simple process. The truth is that there is much more to selecting the proper entity beyond the preparation of the paper work. You should always meet with an attorney, CPA or other qualified professional before attempting to navigate the process on your own. The advice that you receive on the front end can not only save you money but can also be instrumental in the survival of your business.
Research your options… Then research them again
Research shows that the fastest growing entity type in the United States is the Limited Liability Company. LLCs are hybrid business entities which possess a unique combination of favorable legal, business and tax attributes that do not exist in any other single entity. Properly structured, LLCs provide the benefits of limited liability protection, operational flexibility, and pass through taxation without the restrictions generally applied to other entity types.
But did you know that there are other entities that you can choose from? Each entity has its advantages and disadvantages. As part of your research you should ensure that you’re choosing the best entity for your business type. It is never a good idea to simply select an entity because it’s popular or easy to form. The entity types are:
The entity you choose will also impact the way in which you can elect to be taxed at the federal level. In addition, the state where you choose to form your entity will dictate the types of tax filings required at the state level. So as you can see entity formation is no laughing matter. In other words research, research, research!
Maintain a set of separate books and records
It is of utmost importance to maintain a set of separate books and records for your business. A set of separate books and records will allow you to keep track of your business income and expenses. It will also provide financial reporting so that you can make decisions regarding your business. However, the most important thing to remember about maintaining a set of separate books and records is that it’s required by law. In general, business owners are not permitted to commingle personal and business assets. If you commingle funds, you could lose the limited liability protection afforded by your business entity due to what is known as “piercing the corporate veil”. There are several factors that courts look at when deciding whether to pierce your company’s veil and hold you personally liable for company debts and lawsuits. One important factor is the presence of commingled funds. If you treat your business’s money the same as your own, then you risk the exposure of your personal assets.
Examples of commingling include:
Establishing and maintaining your books and records is not that difficult. In fact there are many software options that will do most of the work for you assuming you avoid the behaviors noted above. By having these simple procedures in place you will save yourself a headache at tax time, be in a position to evaluate the health of your business through timely and accurate reporting, reduce risk as well as be in a position to share your financial records with potential investors.
Hopefully you’ve gotten a lot out of our blog post. Please share with your networks and on your social media feeds.
If you have any comments or would like to contact us regarding this or any of our blog postings please feel free to send an email to firstname.lastname@example.org.
Also, if you’d like to schedule a consultation to discuss your options for entity formation please feel free to visit our website at www.pcsllcsolutions.com
Melantha K. Paige CPA, MBA
"The Finance Fixer"
CEO & Founder
Paige Consulting Services, LLC
Melantha K. Paige, CPA | 04/21/2018