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The Different Ways of Doing Business

There are several legal structures or forms under which a business can operate, including the sole proprietorship, partnership, limited liability company and corporation. In addition, two of these structures have important variants. The partnership form has spawned the limited partnership and the registered limited liability partnership. And the corporation can be recognized, for tax purposes, as either the standard C corporation, in which the corporation and its owners are treated as separate taxpaying entities, or as an S corporation, in which business income is passed through the corporate entity and taxed only to its owners on their individual tax returns.

Often, business owners start with the simplest legal form, the sole proprietorship, then move on to a more complicated business structure as their business grows. Other business people pick the legal structure they like best from the start, and let their business grow into it. Either way, choosing the legal structure for your business is one of your important decisions when starting a business.

1. Sole Proprietorship.

A sole proprietorship is the legal name for a one-owner business (spouses can co-own and help run a sole proprietorship, too). When people think of a “mom and pop” or a home-based business, they are usually thinking of a sole proprietorship. A sole proprietorship has the following general characteristics:

Ease of Formation. The sole proprietorship is the easiest to establish legally. Just hang out your shingle or “Open for Business” sign, and you have established a sole proprietorship. Sure, there are other legal steps you may wish to take — such as registering a fictitious business name different from your own individual name by filing a “dba statement” with the county clerk — but these steps are not necessary to establish your business legally.

Personal Liability for Business Debts, Liabilities and Taxes. In this simplest form of small business legal structures, the owner, who usually runs the business, is personally liable for its debts, taxes and other liabilities. Also, if the owner hires employees, she is personally responsible for claims made against these employees acting within the course and scope of their employment.

Simple Tax Treatment. All business profits (and losses) are reported on the owner’s personal income tax return each year (using Schedule C, Profit or Loss From Business, filed with the owner’s 1040 federal income tax return). And this remains true even if a portion of this money is invested back in the business — that is, even if the owner doesn’t “pocket” business profits for personal use.

Legal Life Same as Owner’s. On the death of its owner, a sole proprietorship simply ends. The assets of the business normally pass under the terms of the deceased owner’s will or trust, or by intestate succession (under the state’s inheritance statutes) if there is no formal estate plan.


The court process necessary to probate a will can take more than a year. In the meantime, it may be difficult for the inheritors to operate or sell the business or its assets. Often, the best way to avoid having a probate court involved in business operations is for the owner to transfer the assets of the business into a living trust during his lifetime; this permits business assets to be transferred to inheritors promptly on the death of the business owner, free of probate.

Sole Proprietorships in Action Many small, one-owner or spouse-owned businesses start small with very little advance planning or procedural red tape. Celia Wong is a good example — Celia is a graphics artist with a full-time salaried job for a local book publishing company. In her spare time she takes on extra work using her home computer to produce audio cassette and CD jacket cover art for musicians. These jobs are usually commissioned on a handshake or phone call. Without thinking much about it, Celia has started her own sole proprietorship business. Celia should include a Schedule C in her yearly federal 1040 individual tax return, showing the net profits (profits minus expenses) or losses of her sole proprietorship. Celia is responsible for paying income taxes on profits, plus self-employment (Social Security) taxes based on her sole proprietorship income (IRS Form SE is used to compute self-employment taxes; Celia attaches it to her 1040 income tax return).

2. Partnership.

A partnership is simply an enterprise in which two or more co-owners agree to share in the profits. No written partnership agreement is necessary. If two people go into business together, and do not incorporate or form a limited liability company, they automatically establish a legal partnership.

Partnerships are governed by each state’s partnership law. But since all states have adopted a version of the Uniform Partnership Act (for example, the California Uniform Partnership Act, beginning with Section 15001 of the California Corporations Code), laws are very similar throughout the U.S. Mostly, these laws contain basic rules that provide for an equal division of profits and losses among partners and establish the partners’ legal relationship with one another. These rules are not mandatory in most cases, and you can (and should) spell out your own rules for dividing profits and losses and operating your partnership in a written partnership agreement. If you don’t prepare your own partnership agreement, all provisions of California’s Partnership Law apply to your partnership.


Most smaller partnerships are general partnerships — this means that all owners agree to manage the partnership together, and each partner is personally liable for debts of the partnership. However, there are two other fairly common types of partnerships: limited partnerships and registered limited liability partnerships (RLLPs). Each of these is quite different from a general partnership

THE LIMITED PARTNERSHIP The limited partnership structure is used when one or more of the partners are passive investors (called “limited partners”) and another partner (called a “general partner”) runs the partnership. A Certificate of Limited Partnership is filed with the Secretary of State to form a limited partnership, and a filing fee must be paid. The advantage of a limited partnership is that unlike a general partnership, where all partners are personally liable for business debts and liabilities, a limited partner is allowed to invest in a partner ship without the risk of incurring personal liability for the debts of the business. If the business fails, all that the limited partner can lose is her capital investment — the amount of money or the property she paid for an interest in the business. However, in exchange for this big advantage, the limited partner normally is not allowed to participate in the management or control of the partnership. If she does, she can lose her limited liability status and can be held personally liable for partnership debts, claims and other obligations.

Typically, a limited partnership has a number of limited partner investors and one general partner (there can be more, but there must be at least one) who is responsible for partnership management and is personally liable for its debts and other liabilities.

THE REGISTERED LIMITED LIABILITY PARTNERSHIP The registered limited liability partnership (RLLP) is a special legal structure designed for persons who form a partnership in California to perform the licensed professional services of attorneys, accountants or architects. An RLLP is formed by filing a Registration of Limited Liability Partnership form with the California Secretary of State.

The point of an RLLP is to relieve professional partners from personal liability for debts, contracts and claims against the partnership, including claims against another partner for professional malpractice. However, a professional in an RLLP remains personally liable for his own professional malpractice.

A general partnership has the following characteristics:

Each Partner Has Personal Liability. Like the owner of a sole proprietorship, each partner is personally liable for the debts and taxes of the partnership. In other words, if the partnership assets and insurance are insufficient to satisfy a creditor’s claim or legal judgment, the partners’ personal assets can be attached and sold to pay the debt.

The Act or Signature of Each Partner Can Bind the Partnership. Each partner is an agent for the partnership and can individually hire employees, borrow money, sign contracts and perform any act necessary to the operation of the business. All partners are personally liable for these debts and obligations. This rule makes it essential that the partners trust each other to act in the best interests of the partnership and each of the other partners.

Partners Report and Pay Individual Income Taxes on Profits. A partnership files a yearly IRS Form 1065, U.S. Partnership Return of Income, which includes a schedule showing the allocation of profits, losses and other tax items to all partners (Schedule K). The partnership must mail individual schedules (Schedule K-1s) to each partner at the end of each year, showing the items of income, loss, credits and deductions allocated to each partner. When a partner files an individual income tax return, she reports her allocated share of partnership profits (taken from the partner’s Schedule K-1), and pays individual income taxes on these profits. As with the sole proprietorship, partners owe tax on business profits even if they are plowed back into the business, unless the partners decide to elect to have the partnership taxed as a corporation.


Unincorporated co-owned businesses, including partnerships and limited liability companies (discussed below), can choose to be taxed as a corporation by filing IRS Form 8832, Entity Classification Election. Most smaller partnerships will not wish to make this election, preferring instead to have profits divided among the partners and then taxed on their individual tax returns. But this is not always true. For example, some partnerships — especially those that want to reinvest profits in expanding the business — may prefer to keep profits in the business, and have them taxed to the business at the lower initial corporate tax rates. Your tax advisor can tell you if this tax strategy makes sense for your business.

 Partnership Dissolves When a Partner Leaves. Legally, when a partner ceases to be associated with carrying on the business of the partnership (when he withdraws or dies), the partnership is dissolved. However, a properly written partnership agreement provides in advance for these eventualities, and allows for the continuation of the partnership by permitting the remaining partners to buy out the interest of the departing or deceased partner. Of course, if one person in a two-partner business leaves or dies, the partnership is legally dissolved — you need at least two people to have a partnership.


Although it’s possible to start a partnership with a verbal agreement — or even with no stated agreement at all — there are drawbacks to taking this casual approach. The most obvious problem is that a verbal agreement can be remembered and interpreted differently by different partners. And having no stated agreement at all almost always means trouble. Also, if you don’t write out how you want your partnership to be operated, you lose a great deal of flexibility. Instead of being able to make your own rules in a number of key areas — for example, how partnership profits and losses are divided among the partners — California state partnership law will automatically come into play. These state-based rules may not be to your liking (for example, state law generally calls for an equal division of profits and losses regardless of partners’ capital contributions).

Another reason why you should prepare and sign a written partnership agreement is to avoid disputes over what happens when a partner wants to leave the business. Here are just a few of the difficult questions that can arise if a partner wants to leave the partnership:

·       If the remaining partners want to buy the departing partner out, how will the interest be valued?

·       If you agree on value, how will the departing partner be paid for her interest — in a lump sum or installments? If in installments, how big will the down payment be; how many years will it take for the balance to be paid; and how much interest will be charged?

·       What happens if none of the remaining partners wants to buy the departing partner’s interest? Will your partnership dissolve? If so, can some of the partners form a new partnership to continue the partnership business? Who gets to use the dissolved partnership’s name and client or customer list?

California law does not necessarily provide helpful answers to these questions, which means that if you don’t have a written partnership agreement, you may face a long legal battle with a partner who decides to call it quits. To avoid these and other problems, a basic partnership agreement should, at a minimum, spell out how much interest each partner has in the partnership, how profits and losses will be split up between or among the partners and how any buyout or transfer of a partner’s interest will be valued and handled. The aftermath of the dissolution of the partnership also should be considered, and rules set out for a continuance of the partnership’s business by ex-partners if desired.

3. The Limited Liability Company.

The limited liability company (LLC) is the new kid on the block of business organizations. It has become popular with many small business owners, in part because it was custom-designed by state legislatures to overcome particular limitations of each of the other business forms, including the corporation. Essentially, the LLC is a legal ownership structure that allows owners to pay business taxes on their individual income tax returns like partners (or, for a one-person LLC, like a sole proprietorship), but also gives the owners the legal protection of personal limited liability for business debts and judgments as if they had formed a corporation. Or, put another way, with an LLC you can simultaneously achieve the twin goals of one-level taxation of business profits and limited personal liability for business debts.


The California LLC Act prohibits certain professionals (the same professionals — such as doctors, lawyers and accountants — who must form a professional corporation if they want to incorporate) from forming an LLC. If you are a licensed professional and you want to form an LLC, contact your state licensing board (most are in Sacramento) and ask whether the law allows you to form one. If not, you’ll have to incorporate your professional practice to protect yourself from personal liability for the debts of your business. Accountants, architects and lawyers have another option: They can register their general partnership practices as registered limited liability partnerships (RLLPs) to protect themselves from personal liability in many situations. (RLLPs are discussed in Section A2, above).

Here are some of the most important LLC characteristics:

Limited Liability. The owners of an LLC are not personally responsible for its debts and other liabilities. Specifically, Section 17101 of the California Beverley-Killea Limited Liability Company Act says that members are not personally liable for any debt, obligation or liability of the LLC, whether that liability or obligation comes from a contract dispute, tort (injury to other persons or damage to their property) or any other type of claim. This type of sweeping personal legal liability protection is the same as that enjoyed by shareholders of a California corporation. In short, the LLC and the corporation offer the same level of limited personal liability protection.

Pass-Through Taxation. Federal tax law normally treats an LLC like a partnership, unless the LLC elects to be taxed as a corporation (by filing IRS Form 8832 — see Section A2, above). The California Franchise Tax Board treats a California LLC for state income tax purposes as it is treated for federal income tax purposes. An LLC with an annual gross income of $250,000 or more must pay an additional annual fee, based upon a graduated fee schedule that is adjusted from year to year.

If an LLC is treated as a partnership at the federal and state levels, it files standard partnership tax returns (IRS Form 1065, Schedules K and K-1) with the IRS and state, and the LLC members (owners) pay taxes on their share of LLC profits on their individual income tax returns. An LLC that elects corporate tax treatment files federal and state corporate income tax returns.

Ownership Requirements. California allows one owner (member) to form an LLC. Members need not be residents of California, or even the U.S. for that matter. Other business entities, such as a corporation or another LLC, can be LLC owners.

Management Flexibility. LLCs are normally managed by all the owners (members) — this is known as “member-management.” But state law also allows for management by one or more specially appointed managers (who may be members or nonmembers). Not surprisingly, this arrangement is known as “manager-management.” In other words, an LLC can appoint one or more of its members, one of its CEOs or even a person contracted from outside the LLC to manage its affairs. This setup makes sense if one person wishes to assume full-time control of the LLC while the other owners act as “passive” investors in the enterprise.

Formation Requirements. Like a corporation, LLCs require paperwork to get going. Articles of Organization must be filed with the California Secretary of State. And if the LLC is to maintain a business presence in another state, such as a branch office, it also must file registration or qualification papers with the other state’s Secretary or Department of State. California’s LLC formation fee is $70. California LLCs, like California corporations and limited partnerships, must pay an annual minimum $800 tax to the Franchise Tax Board. There is an additional LLC annual tax, with a tiered rate structure, for LLCs with annual gross incomes of $250,000 or more (the additional tax may be anywhere from $900 to $11,000).

Like a partnership, an LLC should prepare an operating agreement to spell out how the LLC will be owned, how profits and losses will be divided, how departing or deceased members will be bought out and other essential ownership details. However, preparation of an LLC operating agreement is not legally required. If it is not prepared, the default provisions of California’s LLC Act will apply to the operation of the LLC. Since LLC owners will want to control exactly how profits and losses are apportioned among the members rather than following the default rules set out in the LLC Act, preparing an LLC operating agreement is a practical necessity.

4. The Corporation.

Now, let’s look at the basic attributes of the corporation, the type of business organization this book shows you how to organize.

A corporation is a statutory creature, created and regulated by state law. In short, if you want the “privilege” — as the courts call it — of turning your business enterprise into a California corporation, you must follow the requirements of the California Business Corporation Law.

What sets the corporation apart from all other types of businesses is that it is a legal entity separate from any of the people who own, control, manage or operate it. The state corporation and federal and state tax laws view the corporation as a legal “person” — it can enter into contracts, incur debts and pay taxes separately from its owners.

a. Limited Personal Liability.

Like the owners (members) of an LLC, the owners (shareholders) of a corporation are not personally liable for the corporation’s business debts, claims or other liabilities. This means that a person who invests in a corporation (a shareholder) normally only stands to lose the amount of money or the value of the property which he has paid for its stock. As a result, if the corporation does not succeed and cannot pay its debts or other financial obligations, creditors cannot seize or sell the corporate investor’s home, car or other personal assets.


In some situations, corporate directors, officers and shareholders of a corporation can be held responsible for debts owed by their corporation. Here are a few of the most common exceptions to the rule of limited personal liability (these exceptions also apply to other limited liability business structures, such as the LLC):

Personal Guarantees. When a bank or other lender makes a loan to a small corporation, particularly a newly formed one, it often requires that the people who own the corporation agree to repay it from their personal assets should the corporation default on the loan. Shareholders may even have to pledge equity in a house or other personal assets as security for repayment of the debt. Of course, shareholders can just say no — but if they do, their corporation may not qualify for the loan.

Federal and State Taxes. If a corporation fails to pay income, payroll or other taxes, the IRS and the California Franchise Tax Board are likely to attempt to recover the unpaid taxes from “responsible employees” — a category that often includes the principal directors, officers and shareholders of a small corporation.

Unlawful or Unauthorized Transactions. If you use the corporation as a device to defraud third parties, or if you deliberately make a decision (or fail to make one) that results in physical harm to others or their property (such as failing to maintain premises or a work site properly, manufacturing unsafe products or causing environmental pollution), a court may “pierce the corporate veil” and hold the shareholders of a small corporation individually liable for damages (monetary losses) caused to others.

Fortunately, most of the problem areas where you might be held personally liable for corporate obligations can be avoided by following a few commonsense rules (rules you’ll probably adhere to anyway): First, don’t do anything which is dishonest or illegal. Second, make sure your corporation does the same, by having it obtain necessary permits, licenses or clearances for its business operations. Third, pay employee wages and withhold and pay corporate income and payroll taxes on time. Fourth, don’t personally obligate yourself to repay corporate debts or obligations unless you fully understand and accept the consequences.

b. Corporate Tax Treatment  

Let’s now look at a few of the most important tax characteristics of the corporation. We’ll start with the dual level of taxation built into the corporate business structure.

1. Dual Taxation and Income Splitting

The corporation is a taxpayer, with its own income tax rates and tax returns separate from the tax rates and tax returns of its owners. This double layer of taxation allows corporate profits to be kept in the business and taxed at the initial corporate tax rates, which are generally lower than those of the corporation’s owners. The result of this type of business income splitting between the corporation and its owners can result in an overall tax savings for the owners (compared to pass-through taxation of all business profits to the owners, which is the standard tax treatment of sole proprietorships, partnerships and LLCs).

Even though corporate tax rates can go up to 39%, all corporate net income below $10 million is subject to an effective flat tax rate of 34%. (See Chapter 4, Section B.)


Dual taxation and income splitting are no longer unique to corporations. Partnerships and LLCs can elect to be taxed as corporations if they wish to keep money in the business and have it taxed at corporate rates. (See the sidebar in Section A2, above.)


What about the old bugaboo of corporate double taxation? Most people have heard that corporate income is taxed twice: once at the corporate level and again when it is paid out to shareholders in the form of dividends. In theory, the Internal Revenue Code says that most corporations are treated this way (except S corporations, whose profits automatically pass to shareholders each year — see below). In practice, however, double taxation seldom occurs in the context of the small business corporation. The reason is simple: Employee-owners don’t pay themselves dividends, which are taxed at the corporate rate when earned and at the individual shareholder level when paid to them. Instead, the shareholders, who usually work for their corporation, pay themselves salaries and bonuses, which are deducted from the profits of the corporate business as ordinary and necessary business expenses. The result is that profits paid out in salary and other forms of employee compensation to the owner-employees of a small corporation are taxed only once, at the individual level. In other words, as long as you work for your corporation, even in a part-time or consulting capacity, you can pay out business profits to yourself as reasonable compensation. Your corporation won’t have to pay taxes on these profits.

2. Corporations Can Elect Pass-Through Taxation of Profits

Just as partnerships and LLCs have the ability to request corporate tax treatment, corporations can change their built-in dual income tax treatment to the type of pass-through taxation of business profits which normally applies to partnerships and LLCs. A corporation accomplishes this by making an S corporation tax election with the IRS.


An LLC, like an S corporation, gives its owners pass-through taxation of business profits plus limited personal liability for business debts. It also is more flexible than an S corporation for technical reasons (see below). Therefore, it usually makes more sense to form an LLC when you are just starting to organize your business. If you are already doing business as a corporation, switching over to S corporation tax status — by making an S corporation tax election — makes sense if you wish to keep your corporation intact, but decide that pass-through taxation of profits will save you tax dollars. This might be true, for example, for a corporation that no longer wishes to keep profits in the business, but can’t pay all of them out to shareholders as salaries (if some shareholders don’t work for the corporation or if the payout of all profits as salaries would render them “excessive” and subject to IRS attack, for example). The only other way an existing corporation can get the limited liability protection and pass-through tax treatment of the S corporation is to dissolve, then reorganize as an LLC. This can be costly from a tax


LLC owners and partners can split profits disproportionately to their ownership interests in the business (these are called “special allocations” of profits and losses under the tax code); S corporation shareholders can’t. Also, the amount of corporate losses that may be passed through to S corporation shareholders is limited to the total of each shareholder’s “basis” in his stock (the basis is the amount paid for stock plus and minus adjustments during the life of the corporation) plus amounts loaned personally by each shareholder to the corporation. Losses allocated to a shareholder that exceed these limits can be carried forward and deducted in future tax years if the shareholder then qualifies to deduct the losses. In contrast, LLC owners and partners may be able to personally deduct more business losses on their tax returns in a given year than S corporation shareholders. The reason is that an LLC member and partner gets to count her pro-rata share of all money borrowed by the business, not just loans personally made by the member or partner, in computing how much of any loss allocated to her by the business she can deduct in a given year on her individual income tax return.

U.S. corporations that have 75 or fewer shareholders who are U.S. citizens or residents can elect federal S corporation tax treatment (by filing IRS Form 2553). Once an S corporation election is made with the IRS, the corporation can make the same election with the California Franchise Tax Board. A corporation that files an S corporation tax election has all its profits, losses, credits and deductions passed through to its shareholders, who report these items on their individual tax returns. In effect, this allows the corporation to sidestep corporate taxes on business profits, passing the profits (and the taxes that go with them) along to the shareholders. Each S corporation shareholder is allocated a portion of the corporation’s profits and losses according to her percentage of stock ownership in the corporation (a 50% shareholder reports and pays individual income taxes on 50% of the corporation’s annual profits, for example).

Note that these profits are allocated to the shareholders whether the profits are actually paid to them or kept in the corporation.

3. Tax Consequences of Corporate Dissolution

You should consider an additional tax aspect of forming a corporation before deciding to incorporate — the tax consequences of ending the corporation when it is dissolved or sold. The general rule is that when a corporation is sold or dissolved, both the corporation and its shareholders have to pay capital gain taxes. However, there are ways to minimize this double tax, if you plan in advance. Check with your tax person on the eventual tax ramifications of dissolving your corporation right from the start. One of the most important pre-incorporation services your tax advisor can provide is to make sure that the future dissolution or sale of your corporation will not result in an unexpectedly hefty tax bill for your corporation and its owners.

c. Owners Who Work in the Business Are Treated as Employees  

A key tax characteristic of the corporate structure is that business owners who also work in the business become employees. This means that you, in your role as an employee, become eligible for tax-deductible corporate fringe benefits, some of which you would not qualify for as a sole proprietor, partner or LLC member.

d. Built-In Organizational Structure

Perhaps the most unique benefit of forming a corporation is the ability to divide management, executive decision making and ownership into separate areas of corporate activity. This separation is achieved automatically because of the separate legal roles which reside in the corporate form: the roles of directors (managers), executives (officers) and owners (shareholders). Unlike partnerships and LLCs, the corporate structure comes ready-made with a built-in separation of these three roles, each with its own legal authority, rules and ability to participate in corporate income and profits.

Board of Directors: The management team, which meets once each quarter to analyze and project financial performance and review store operations, consists of the three founders, Myra, Danielle and Rocco, and one of the other three investors. The investor board position is a one-year rotating seat. This year Tony has the investor board seat; next year, Collette; the third year, Aunt Kate. This pattern repeats every three years. Directors have one vote apiece, regardless of share ownership — this means the founders can always outvote the investor vote on the board, but this also guarantees that each of the investors will have an opportunity to hear board discussions and give input on major management decisions.

Executive Team: The officers or executive team charged with overseeing day-to-day business; supervising employees; keeping track of ordering, inventory and sales activities; and generally putting into practice the goals set by the board are Myra (President) and Danielle (Vice President). Rocco fills the remaining officer positions of Secretary/Treasurer of the corporation, but this is a part-time administrative task only.

Participation in Profits: Corporate net profits are used to stock inventory, pay rent on the West End storefront and pay all the other usual and customary expenses of doing business. The two full-time executives, Myra and Danielle, get a corporate salary, plus a year-end bonus when profits are good. Rocco gets a small stipend (hourly pay) for his part-time work.

 To duplicate this structure as a partnership or LLC would require a specially drafted partnership or LLC operating agreement with custom language and plenty of review by the founders and investment group (and, no doubt, their lawyers). The corporate form is designed to handle this division of management, day-to-day responsibilities and investment with little extra time, trouble or expense.

e. Raising Money — Corporate Access to Private, Venture and Public Capital  

Corporations offer a terrific structure for raising money from friends, family and business associates. There is something special about stock ownership, even in a small business, that attracts others. The corporate structure is designed to accommodate various capital interests — for example, you can issue common, voting shares to the initial owner-employees, set up a special nonvoting class of shares to distribute to key employees as an incentive to remain loyal to the business and issue yet another preferred class of stock (one that gives investors a preference if dividends are declared or the corporation is sold) to venture capitalists willing to help fund future expansion of your corporation.

And owners of a small corporation can set their sights someday on making a public offering of shares. Even if your corporation never grows large enough to interest a conventional stock underwriting company in selling your shares as part of a large public offering, you may be able to market your shares to your customers or to individual investors by placing your company’s small offering prospectus on the Internet — something that has now been approved by the SEC (the federal Securities and Exchange Commission). And the good news is that no matter how you market your shares, handling your own small direct public offering (DPO) is much more feasible than it was even a few years ago. The reason is that federal and state securities laws designed to help smaller corporations raise from $1 million to $10 million annually by making a limited public offering of shares have been liberalized.

f. Perpetual Existence

A corporation is, in some senses, immortal. Unlike a sole proprietorship, partnership or LLC, which can terminate upon the death or withdrawal of the owner or owners, a corporation has an independent legal existence that continues despite changeovers in management or ownership. Of course, like any business, a corporation can be terminated by the mutual consent of the owners for personal or economic reasons and, in some cases, involuntarily, as in corporate bankruptcy proceedings. Nonetheless, the fact that a corporation does not depend for its legal existence on the life or continual ownership interest of a particular individual does influence creditors, employees and others to participate in the operations of the business. This is particularly true as the business grows.

g. Downsides of Incorporating

Just about everything, including the advantage of incorporating, comes at a price. And, of course, the answer to the question “How much does it cost?” is an important factor to weigh when considering whether to incorporate your business. For starters, a corporation, unlike a sole proprietorship or general partnership, requires the filing of formation papers — Articles of Incorporation — with the California Secretary of State. The filing cost is $100. Corporations must pay an annual franchise tax, as explained in Chapter 4, Section B1. Ongoing paperwork is generally not burdensome, but you will have to hold and document annual meetings of shareholders and directors and keep minutes of important corporate meetings.


As an active California business, the answer is no — it is usually a very poor idea to incorporate out of state.

The big reason is that you will have to qualify to do business in California even if you don’t incorporate here, and this process takes about as much time and costs as much money as filing incorporation papers in California in the first place. You’ll also need to appoint a corporate agent to receive official corporate notices in the state where you incorporate — another expensive pain in the neck.

Incorporating in another state with a lower corporate income tax isn’t likely to save you any money. If your business makes money from operations in California, even if it is incorporated in another state, you still must pay California taxes on this income.

Unless you plan to open up a business with offices and operations in more than one state and, therefore, have a real reason to compare corporate domiciles, you should incorporate in your home state — California.

One final thought. When your clients complain about your prices, remind them of this. The rich get everything and the poor get nothing when it comes to taxes. Sound familiar? I hear it everyday. What one doesn’t realize is that the tax code applies to everyone, not just the rich with a exclusion for the poor. So why does the rich get everything and the poor gets nothing? The rich will pay for advice and the poor do not need advice. If you are not willing to pay or work for this advice, then you truly don’t deserve it. You become whom we call, ‘the cheap and cheesy’. We try not to do ‘cheap and cheesy’ in this office.