Legal Concerns of Starting a
What type of business organization should
Choosing an organization for your business is similar
to buying a new car. You have to know what models are
available and which of those models has the features and
options that fit your needs. For a business, there are
basically four "models" or types of organizations to choose
from: the sole proprietorship, the partnership, the
corporation and the limited liability company.
What is a sole
It's a business with one owner who makes the
management decisions. The owner and the business are one and
the same, with a common identity. Sole proprietorship is the
simplest business organization.
How is a sole proprietorship formed and
There almost are no legal formalities to forming a
sole proprietorship, so it's relatively easy. The main step is
obtaining a federal employer identification number from the
IRS by filing Federal Form SS-4.
If you have employees,
you must withhold income tax and FICA (Social Security) from
their checks and deposit it with the government. You (the
business) also have to pay FUTA (unemployment) and a matching
amount of Social Security for them. As the owner, you pay
Social Security through the self-employment tax rather than
FICA, and you have to make periodic estimated tax payments on
income from the sole proprietorship.
What's a partnership?
A partnership is simply an association of two or more
persons, as co-owners, who carry on a business for
How is a partnership formed and
A partnership can be either a general partnership or
a limited partnership. In addition, a general partnership may
be registered as a limited liability partnership (LLP), which
provides certain limits on a partner's personal liability for
the LLP's debts. No expense or legal formality is required to
organize a general partnership, except, to register a general
partnership as an LLP, a registration statement must be filed
with the state, and filing fees and expenses must be paid. To
form a limited partnership, a certificate of limited
partnership must be filed with the state, and filing fees and
expenses must be paid. It's a good idea to have a written
partnership agreement, even though one isn't required. In a
general partnership, each partner has an equal voice in
managing the business of the partnership unless a written
partnership agreement gives management authority to a certain
partner or partners. In a limited partnership, the management
of the partnership is reserved to a certain partner or
partners who are called general partners, whereas the
remaining partners, who are called limited partners, do not
participate in the management of the partnership.
responsibilities of both a general and limited partnership are
the same as those of a sole proprietorship. The partnership
must apply for a federal employer ID number and withhold
income taxes and FICA from its employees' wages. The
partnership must pay FUTA and its share of Social Security for
its employees. The partners themselves may have to pay
self-employment taxes and make periodic estimated tax payments
on their share of partnership income.
What's a limited liability
A limited liability company (LLC) is a hybrid
organization with attributes of both a partnership and a
corporation. Members receive "interests" in the LLC in
exchange for property, money or services. An LLC offers the
corporate advantage of limited liability to its members
together with the partnership tax advantage of direct
attribution of the
LLC's income or loss to its members.
However, to be eligible for partnership tax treatment an LLC
must comply with certain IRS requirements to be taxed as a
partnership or it will be taxed as a corporation.
How is a limited liability company formed
To form an LLC, articles of organization must be
filed with the state, and filing fees and expenses must be
paid. Although not required, the members also should enter
into an operating agreement that defines their obligations and
duties to each other and the company. An LLC also must apply
for a federal employer ID number, withhold income taxes and
FICA from its employees' wages, and pay FUTA and its share of
Social Security for its employees. The members may have to pay
self-employment taxes and make periodic estimated tax payments
on their share of the LLC's income.
An LLC may be
organized to be managed by its members or by one or more
managers. If an LLC is managed by its members, the members
have the same broad managing authority as a partner in a
general partnership. On the other hand, if the LLC is managed
by one or more managers, the manager's authority resembles the
managing authority of a partner in a general partnership,
while the members are merely investors in the company.
What's a corporation?
A corporation is an artificial entity that receives
its legal existence from a charter granted by the state. There
is a complete legal separation between the stockholders
(owners) of a corporation and the business of the corporation.
Stockholders receive their stock from the corporation in
exchange for money, property or services.
How is a corporation formed and
To form a corporation, articles of incorporation must
be filed with the state, bylaws and minutes of preliminary
meetings must be drafted, and filing fees and expenses paid. A
corporation faces the same requirements for obtaining a
federal employer ID number, withholding income tax and FICA
from its employees' wages and paying FUTA and its share of
The stockholders usually elect a small group of
directors to set the corporation's policies. The directors
then elect officers such as president, secretary and treasurer
to carry out the normal business functions.
Is the owner personally responsible for
all the debts of a business?
In some cases, yes. Risk is a fundamental aspect of
every business. So an owner must be aware of possible
liabilities arising out of business operations. A sole
proprietor, a partner of a general partnership and a general
partner of a limited partnership are personally liable for all
the debts of the business, including loans, accounts payable,
defective products and employee accidents.
the liability of limited partners, stockholders, and the
members of an LLC is limited to what they have invested or
committed to invest. Unlike corporate stockholders or members
of LLCs, limited partners can lose their limited liability if
they actively participate in the limited partnership's
business. In addition, corporate stockholders and LLC members
who have responsibility for managing compliance with certain
types of laws, such as tax and environmental, can have
personal liability if such laws are violated.
closely-held entities, limited liability may exist more in
theory than in reality because owners often are required to
personally guarantee their entity's loans and, in some
instances, accounts payable. In Wisconsin, stockholders also
may be liable for the unpaid wages of corporate
How is a business owner taxed on the
profits of his or her business?
The answer depends upon how the business is
All income and deductions (expenses)
generated by a sole proprietorship belong to the owner. He or
she reports these items on Schedule C of the federal income
tax return (Form 1040). The net income of the business is
added to any other income the owner may have (wages, interest
or rent) and taxed at the owner's individual tax
A partnership has to file an annual federal
income tax return (Form 1065) but the business itself isn't
taxed. Instead, its net income or loss is attributed directly
to the partners. Each then reports his or her share on his or
her individual tax return (Schedule E, Form 1040).
LLC that is taxed as a partnership must file a federal income
tax return (Form 1065), but the LLC itself is not taxed. The
LLC's net income or loss is attributed directly to its
members. Each member then reports his or her share of the
LLC's income or loss on his or her individual tax return
(Schedule E, Form 1040).
A corporation must file its
own state and annual federal income tax returns (Form 1120)
and pay taxes on its income. Stockholders also are taxed on
any profits they receive in the form of dividends. Since the
corporation can't deduct dividends, a corporation's income is,
in effect, taxed twice.
Owners of small corporations
can avoid this second tax by distributing the corporation's
earnings in the form of salaries, fringe benefits and rent,
which are deductible. However, such distributions must be
Another way to avoid the double-taxation
inherent in the corporate structure is to elect to be taxed as
an "S Corporation." You do this by filing Form 2553 with the
IRS. An S Corporation doesn't pay income taxes directly. As in
a partnership, any income or loss from an S Corporation is
passed directly to the owners (shareholders), who pay personal
income tax on it. So the income is taxed only once. However, a
corporation must meet several tests in order to make an S
Corporation election. Those tests can be found in the
instructions to Form 2553.
Where can I get more help on starting a
We can help! Call now for assistance in
incorporation and other start-up legal issues!
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There are a variety of state and federal agencies that
can help you over the hurdles of starting a new
The Wisconsin Department of Development
maintains information and offers free consulting services.
Write to the DOD office at 123 W. Washington Ave., P.O. Box
7970, Madison, WI 53707, or call (608) 266-1018 or (800) HELP
The Wisconsin Job Service, a
division of the State Department of Industry, Labor and Human
Relations (DILHR), provides a variety of free services to
employers. Write to DILHR, Job Service Division (Main Office),
at 201 E. Washington Ave., Room 201, P.O. Box 7903, Madison,
WI 53707, or call (608) 242-4900.
The federal Small
Business Administration (SBA) can provide financial and other
assistance. Contact the SBA at: 212 E. Washington Ave., Room
213, Madison, WI 53703, (608) 264-5261, or 310 W. Wisconsin
Ave., Room 400, Milwaukee, WI 53203, (414) 297-3941. The
Milwaukee SBA also sponsors the Service Corps of Retired
Executives (SCORE), (414) 297-3942.
The Wisconsin Small
Business Development Center (SBDC) provides noncredit
management courses for small business owners, managers and
entrepreneurs. SBDC counselors offer free one-on-one advice
for those businesses in need of specific management
assistance. The center also conducts research, distributes
information, and works with other state agencies offering
specialized assistance. The SBDC State Office is located at
432 N. Lake St., Madison, WI 53706-1498. Call (608) 263-7794
to find the SBDC office in your area.
If you plan to
incorporate your business and need information about Wisconsin
laws, contact the Secretary of State, P.O. Box 7846, Madison,
WI 53707, or call (608) 266-3590.
The Internal Revenue
Service can provide you with several useful, free publications
to help you comply with the various federal tax laws and help
you acquire a federal employer ID number. Contact the IRS at
212 E. Washington Ave., Madison, WI 53707, or call (800)
829-1040. In Milwaukee, call (414) 271-3780.
Wisconsin Department of Revenue also can provide you with free
publications, and help you comply with state tax laws and
acquire any necessary tax permits and identification numbers.
Contact the DOR at 4638 University Ave., P.O. Box 8902,
Madison, WI 53708, or call (608) 266-2776.
Wisconsin Institute of Certified Public Accountants (WICPA)
has a program that offers Wisconsin small businesses two hours
of free service from a certified public accountant. For more
information contact WICPA at (414) 785-0445 or P.O. Box 1010,