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A GUIDE TO CREATING A BUSINESS ENTITY IN NEW YORK
BASIC CHARACTERISTICS OF
VARIOUS TYPES OF BUSINESS ORGANIZATIONS
The Limited Liability Company
The Corporation
The Partnership
The Limited Partnership
IMPORTANT POINTS
TO REMEMBER:
Obtaining an EIN
Number
Special Consideration:
Using an Assumed Name
Keeping Good Corporate
Records
Hiring a good Tax
Advisor
Information Checklist
If you plan to invest
in or operate a business in the United States, you should be aware of
the possible forms the business can assume. Each of these forms has
distinctive benefits and drawbacks, which require careful consideration. Even if you do not intend
to operate any business in the United States yourself, you may find
yourself dealing with American business entities. Your rights as a creditor
of an American firm depend to some extent on the nature of the entity.
In addition, if you at any time need to bring a lawsuit in the United
States against an American business, you may find that the venue of
your suit, and the mechanics of serving process on the Defendants, may
be governed in part by the type of entity involved. This guide has been prepared
for the foreign or domestic businessman that seeks to set up a business
in the State of New York. However some of the information here provided
may be also somewhat relevant to those seeking to set–up a business
outside New York, as many US states’ laws provide for the same or
comparable forms of corporate/business entities.
BASIC
CHARACTERISTICS OF BUSINESS ORGANIZATIONS
| |
No Formalities of Formation |
Single Level of Taxation |
No Personal Liability |
| Limited Liability Company |
|
X |
X |
| C–Corporation. |
|
|
X |
| S–Corporation. |
|
X |
X |
| Partnership |
X |
X |
|
| Limited
Partnership |
|
X |
X* |
* For limited partners
only.
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THE LIMITED LIABILITY
COMPANY
A newer form of entity
that has attracted much interest is the limited liability company ("LLC").
In New York, LLCs have been around since 1994. Today LLCs can be formed
in any US state. The LLC's popularity greatly increased following the
IRS's 1997 "check the box" option on LLC Tax Returns, allowing
them to elect to be taxed as a partnership. The owners of an LLC, called
the Members, receive the tax benefits of the partnership as well as
the shield from personal liability that Corporations provide. For this
reason, the LLC is of all available entities, the one (1) that we generally
recommend to our Clients.
The organization of the
LLC is in some respects similar to that of the Corporation. The basic
structure of the LLC is set forth in the Articles of Organization. The
Operating Agreement, a contract signed by the LLC's Members, sets forth
in greater detail, the workings of the LLC, and their respective rights
and obligations.
The Members of an LLC
can operate the company themselves; or they can by the terms of the
Articles of Organization, delegate the powers of management to one or
more members, called Managers. The New York Limited Liability Company
Law (“LLC Law”) provides that unless otherwise provided in its Articles
of Organization, management of the LLC is vested in its members who
shall manage it in accordance with the LLC Law subject to any provisions
in the Articles of Organization or in the Operating Agreement.
The LLC Law also provides
that each member of a member-managed LLC -as well as managers
clothed with management authority in the Articles of Organization- may
bind the LLC in its everyday business operations. We therefore carefully
restrict the scope of their respective authority in the Operating Agreement,
and we note the fact of any such restrictions in the Articles of Organization.
As it is a publicly filed document, any third party is by operation
of law deemed to have notice of any restrictions on the members’ or
managers’ authority to bind the LLC, noted in the Articles of Organization.
Depending on the client’s
objectives, we sometimes set up the LLC as a manager managed -as opposed
to member managed, the default set up- but with the core members being
the initial managers. Since the LLC will not be member managed, this
prevents additional members of the LLC from having the management and
agency powers of members automatically vested in them by virtue of the
LLC Law.
Advantages:
1. Limited liability–the owners and managers of a limited liability
company are generally not personally liable for the debts of the LLC.
2. One level of taxation–unlike Corporations, the profits and
losses of the LLC are like those of partnerships, passed along tax–free
to the members.
3. Personal tax advantages for the members and managers-unlike
Corporations, if the LLC incurs losses, and assuming they have a capital
basis, paid–in capital, or retained earnings, members of an LLC may
like partners in a partnership and to the extent allowed by the tax
law, deduct the LLC’s losses from their personal income taxes.
4. Financing options–The
LLC can sell membership interests, in smaller or larger portions, to
prospective investors. In addition, banks and other financial institutions
are more willing to extend loans to LLCs with a track–record, because
of the permanence of existence, and the formality of organization of
these entities.
Drawbacks:
1. Organizational formalities–the LLC cannot begin to operate
until its Articles of Organization have been filed with the New York
Secretary of State, or the appropriate authority in its home state.
2. Expenses–There are fees for filing the LLC’s Articles
of Organization at the office of the Secretary of State in Albany, as
well as to satisfy the publication requirement.
3. Publication Requirement–like the Limited Partnership, all
LLCs except certain theatrical production companies, must within 120
days of their formation, publish in two (2) local newspapers designated
by the County Clerk in which the office of the LLC is located, each
week for six (6) consecutive weeks, a copy of their Articles of Organization,
or a notice containing the substance of the information thereof. By
reason of Amendments to the LLC Law effective June 1, 2006, failure
to so comply with the publication requirements results in the automatic
suspension of the LLC’s right to carry on, conduct or transact any
business in the State of New York.
4. Time needed to complete formalities–This office can complete
the filing needed for creating an LLC in about five (5) days. If there
is urgent need, we can complete the incorporation process in a single
day, assuming the client is willing to assume additional costs of expedited
service with hand delivery of the Articles of Organisation to Albany/NY.
The publication of the required notice and the filing of the required
Certificate of Publication will take six (6) to eight (8) weeks. However
satisfaction of the publication requirement is not necessary prior to
commencement of the LLC's operations.
5. Lack of portability–The LLC must separately file for authority
to do business in each additional state, beyond its home state.
When one of our clients
requests our help in forming a LLC, we normally request certain information
concerning the proposed business, please see the Information Checklist
below.
THE
CORPORATION
Until the LLC dethroned
it, the Corporation was the preferred entity
for most businesses in the United States, from the smallest to the largest.
The corporate form of
business organization is based on the separation of ownership and management.
It is true that a single individual can incorporate a business, and
act as its sole shareholder, director, and officer. However, many if
not most Corporations have multiple owners, the shareholders. At their
annual meeting, the shareholders elect a board of directors, which is
the policy–making body for the Corporation. The directors in turn
choose a president, secretary, treasurer, and other officers to implement
their decisions and run the day–to–day operations of the Corporation.
The basic organizational
structure of the Corporation and its stock capitalization, are set forth
in the Certificate of Incorporation, or Charter, a document that is
filed with the state authorities. In addition, a Corporation's inner
workings is set forth in its Bylaws, which detail the mechanics of its
operation.
In small Corporations,
sometimes referred to as "Closely held Corporations", the shareholders
can agree to customize the operation of their Corporation to suit their
needs. This is done by a Shareholders' Agreement, a formal document
which governs both the ownership and the management of the Close Corporation.
For instance, the Shareholders' Agreement will frequently name the persons
who are to act permanently as directors, or as officers. It will also
typically define how the shareholders can sell their shares, to whom,
and under what circumstances. In Close Corporations, the shareholders
usually prefer to buy back the stock of a departing shareholder rather
than allow it to be sold to an outsider.
The basic type of Corporation
is known as the C–Corporation, because it is governed for federal
tax purposes by Subchapter C of the Internal Revenue Code ("IRC").
A Corporation that meets the requirements of IRC's Subchapter S can
file to be treated as a S–Corporation. The following discussion of
benefits and drawbacks applies to both C–Corporations and S–Corporations.
Advantages:
1. Lack of personal liability–The owners and managers of a
Corporation will generally not be personally liable for the debts of
the Corporation.
2. Financing options–The Corporation can sell its own stock,
in smaller or larger portions, to prospective investors. In addition,
banks and other financial institutions are more willing to extend loans
to Corporations with a track–record, because of the permanence of
existence, and the formality of organization of these entities.
3. Unlike Limited Liability Companies, and Limited Partnerships, see below,
there is no publication requirement for Corporations, which results
in cost-savings.
Drawbacks:
1. Organizational Formalities–The Corporation must file its
certificate of incorporation, or Charter, with the appropriate state
officials (in New York, the Secretary of State in Albany).
2. Time for Incorporation–A Corporation cannot operate as such
until its Certificate has been filed; to do so may result in personal
liability for the officers who so acted. The time needed to incorporate
is generally the same as that for LLCs.
3. Lack of Portability–Like the LLC, in order to operate in
states other than its state of incorporation, the Corporation must file
for permission to do business in each additional state, and pay a fee.
4. Expense–The expense of filing a Corporation’s Certificate
depends in part on the number and par value of its shares of stock.
In addition there is an annual tax, called the franchise tax, imposed
each year of continued corporate existence.
5. Double taxation–Unless the Corporation is organized as an
S–Corporation (see below), the income of the Corporation is taxed
twice: Once as corporate income, and a second time as dividends, salaries,
distributions etc… to the shareholders, officers, and directors.
Special Consideration:
The S–Corporation and taxation
The major difference between C–Corporations and S–Corporations is
their tax treatment. The income of the C–Corporation is taxed at the
corporate level. Subsequently, when transferred to the stockholders
as dividends or to the officers as salary, this income is taxed again at the individual level.
By comparison, the income
of the S–Corporation is taxed only once. The S Corporation is a pass–through
tax entity– this means that the income or loss generated by the business
is reflected pro-rata on the personal income tax return of its owners.
Shareholders in S–Corporations are treated essentially as partners,
for tax purposes.
However in order to gain
the benefits of Subchapter S, the Corporation must meet certain requirements.
The most important of these are that:
1. It must have fewer than 100
shareholders;
2. All shareholders must be individuals;
3. No shareholder may be a non–resident
alien for purposes of the IRC;
4. It must make a timely election
of S–Corporation status; and
5. It must not have more than one (1) class of stock.
When our clients request
our help in forming a Corporation, we normally request certain information
and certain documents concerning the proposed business; please see the
Information Checklist at the last section of this Guide.
THE PARTNERSHIP
Thirdly, if more than
one owner will be involved, the business may operate as a partnership.
If the partnership will use an assumed name, a "Business Certificate
for Partners" must be filed in the County Clerk’s Office,
in the county where the business will be located[1].
Whenever the ownership
of a business is to be shared by more than one (1) individual, the partnership
is a possible choice of entity. The ordinary partnership (not to be
confused with the limited partnership discussed separately below) is
made up of individuals who contribute assets or services to a commonly–owned
business, act as general partners with full personal liability for the
business's debts, and share the profits and losses of the business.
An important tax consideration
for some partners is that they can under certain circumstances deduct
from their personal income tax returns, their share of the business
losses of the partnership.
The partnership does
not have the formal organizational hierarchy of the Corporation, and
all partners are entitled to a share in the management of the partnership.
Under New York law, each partner is an agent of the partnership, authorized
to bind the partnership by contract. This fact illustrates the importance
of choosing partners with great care.
Advantages:
1. Limited formalities of commencement–Under New York law,
a partnership can be created simply by agreement between the partners,
without filing or notice to governmental agencies of any kind, except
if it will use an assumed name, see previous page. However, it is unwise
for partners to commence operation without a written Agreement of Co–Partnership,
which should be drafted by a lawyer. This agreement will set forth the
division of ownership, responsibilities, profits and losses between
the parties.
2. Immediate operation–There is no required waiting period
before the partnership can commence operations.
3. No required fees for commencing operation– but note comment,
above, about the advisability of a partnership agreement.
4. One Level of Taxation–The partnership must file a tax return
but its profits or losses are passed on to the partners without taxation
at the partnership level.
5. Portability-The partnerhsip does not have to file for authority to do business in another state.
Drawbacks:
1. Personal Liability–All the partners are personally liable
for the debts of the partnership.
2. Deadlock–Partnerships are peculiarly subject to problems
of deadlock, when there is disagreement as to fundamental, or even trivial
questions of operation. A partnership usually cannot oust a dissatisfied
partner, and may be forced by the courts to dissolve at the petition
of the minority partners.
A less commonly–used
form of business operation is the limited partnership ("LP"),
which offers some of the benefits of corporate existence without all
its drawbacks.
In order to create a
LP, the members are required to file with the New York Department of
State2, a Certificate of Limited Partnership, containing
inter–alia the name of the partnership, the character of the business,
the name and place of residence of each member, general and limited
partners being respectively designated, the property, money or other,
contributed to the partnership by each limited partner, etc.
Being strictly a creature
of statute, a LP resembles a Corporation more closely than it does an
ordinary partnership.
The membership of a LP
consists of at least one (1) general partner, and any number of limited
partners. A limited partner is only allowed to contribute cash or other property,
but not services, to the partnership.
A LP is best suited for
an entity that needs large amounts of capital, and that will be operated
by a single person or small group with special experience in a certain
industry. It is also a recognized way of capitalizing on tax loss benefits.
In Manhattan, LPs are common in the real estate and entertainment industries,
but not in ordinary commercial enterprises, where the LLC reigns supreme.
Advantages:
1. No personal liability for the limited partners–A limited
partner is not personally liable for the debts of the partnership, unless
in addition to exercise of his/her rights and powers of limited partners,
he/she takes part in control of the business, or actively participates
in the business. But the general partner is personally liable for all
the debts of the Limited Partnership.
2. One level of taxation–the partnership must file a tax return
but its losses and profits are passed on tax–free to the partners.
3. Financing opportunities–LP interests can be bought and sold
like corporate stock.
Drawbacks:
1. Organizational formalities–Like a Corporation, and a LLC,
a LP must initially file (Certificate of Limited Partnership) with the
authorities, in New York State, the New York Department of State.
2. Unlimited liability for the general partner(s).
3. Publication–like the LLC, all Limited Partnerships except
certain involved in theatrical production, must within 120 days of their
formation, publish in two (2) local newspapers designated by the County
Clerk in which the office of the LP is located, each week for six (6)
consecutive weeks, a copy of their Certificate of Limited Partnership,
or a notice containing the substance of the information thereof. By
reason of Amendments to the LP Law effective June 1, 2006, failure to
so comply with the publication requirements results in the automatic
suspension of the LP’s right to carry on, conduct or transact any
business in the State of New York.
4. Time needed to complete formalities–The time needed to complete
the organization of a LP includes not only the preparation and filing
of the necessary documents, but also the publication period, same time
periods as for LLCs. As with LLCs, satisfaction of the publication requirement
is not necessary prior to commencement of the LP's operations.
5. Lack of portability–Like the Corporation and the LLC, the
LP must separately file for authority to do business in each additional
state, beyond its home state.
When our clients request
our help in forming a LP, we normally request certain information concerning
the proposed business, please see the Information Checklist at the last
section of this Guide.
Finally
please note that you may also operate your business as a Sole Proprietorship.
It may be tempting to forgo setting-up any any of the entities described
hereof, as well as the attending costs and delays involved and immediately
start operating your business as a Sole Proprietor. However, you should
know that a Sole Proprietor is personally liable for all the debts and
liabilities of the business. Moreover, operating your business as a
Sole Proprietor will not necessarily convey the most professional image,
an important consideration particularly when starting out.
For both of those reasons,
in most instances we do not recommend that you operate your business
as a sole proprietorship.
OBTAINING
AN EIN NUMBER:
For all entities described hereof, we
will in most instances3 also need to file an SS–4, Application
for an Employer Identification Number (EIN). The EIN is required
by law, and moreover without it, US Banks will not open a bank account
for the business. To obtain an EIN, we will need the US Social Security
Number (SSN) of one (1) of the owners of the entity. If our client does
not have such a SSN, we first have to obtain an Individual Taxpayer
Identification Number (ITIN) for the foreign owner. Once we have obtained
the foreign owner's ITIN, we can then obtain the entity’s EIN.
SPECIAL CONSIDERATION:
USING AN ASSUMED NAME
All entities described in this Guide may operate under an Assumed Name, however
the filing requirements differ: Corporations, LPs and LLCs may use an
Assumed Name, by causing the New York Department of State to file the
requisite Certificate of Assumed Name setting forth:
- The name or designation under
which business is carried on or conducted or transacted,
- The Corporation's, LP's or
LLC’s name,
- The location including number
and street, if any, of its principal place of business in New York state,
- The name of each county in
New York State in which it does business or intends to do business,
- The location including number
and street, if any of each place where it carries on or conducts or
transacts business in the state.
General Partnerships and Sole Proprietorships
need to file their Certificate of Assumed Name, directly with the County
Clerk in each of the New York State Counties in which they will conduct
business.
THE IMPORTANCE OF
KEEPING GOOD CORPORATE RECORDS
For the entities described
hereof, another point that cannot be stressed too strongly is the importance
of keeping timely and accurate, formal written records (called "minutes"
and "resolutions") of the entity's decisions and activities,
and to strictly respect its separate juridical existence. Sometimes
owners, directors or even officers of small businesses neglect these
formalities. They may also treat their entity's assets like their personal
assets, and in a financial crisis for example, intermingle their personal
bank accounts with those of their entity.
One danger in such circumstances
is that New York Courts may be called upon to disregard the separate
juridical existence of the entity which even its owners, directors or
officers failed to respect, and "pierce its corporate veil."
For example aggrieved
creditors of the entity sometimes bring an action for "corporate
waste", alleging the Officers or Directors neglected or failed to perform, their respective duties
in the management and disposition of corporate assets; or that
they acquired for themselves, or transfered to others, or caused the
loss or waste of corporate assets due to their neglect of their respective
duties. If successful,
the Court will place personal liability for the entity's debts on the
shoulders of the individuals involved. Keeping clear, written, formal
corporate records helps defend against "piercing the corporate
veil."
Another danger when no
corporate records are kept, is the inability to prove the owners' agreed-to
changes to the entity's ownership or operating structure.
THE IMPORTANCE OF
RETAINING A GOOD TAX ADVISOR
The US taxes its citizens,
green-card holders, as well as those foreigners that are deemed to be
US persons, on their worldwide income. Complex tax rules e.g. US source
income, or income effectively connected with the operation of a US trade/business,
apply to foreigners' business operations. In addition your country is
likely to have a Bilateral Income Tax Treaty with the US under which
you may be entitled to certain tax benefits including the avoidance
of double-taxation. Finally the entities hereof described need to make
periodic tax filings with US, State, and Local taxing authorities, or
risk hefty penalties and interest. For all these reasons when planning
the creation of a new entity, this office strongly recommends that an
experienced tax advisor versed with the tax laws applicable to your
particular situation, be employed to assure tax compliance. Sometimes
the tax advisor will also be an accountant, and therefore he or she
will be able to actually prepare your entity's tax returns. At other
times, you may also need an international tax lawyer, who often will
not be an accountant. Working with them, we will help you structure
your business in a way that is most-tax efficient.
INFORMATION CHECKLIST:
In order to assist our
clients in setting up their business in the most expeditious way, we
request the following information of all clients. If we receive all
of this information at the first contact with our clients, we will be
able to assist you more efficiently.
1. The client’s name, and coordinates, and the name of any business the
client is presently operating.
2. If the new
business is to be a branch of a foreign business, whether and where
the foreign business is incorporated.
3. The name of
the new entity to be created, and if available, its intended address
in the United States.
4. The type of
business to be commenced, including the type of product or service to
be sold or produced, and whether the sales will be wholesale or retail.
5. How many people
will be employed at the United States address.
6. The U.S. Social
Security number, if any, of one of the owners. If the owner has no US
Social Security Number, we will obtain an Individual Taxpayer Identification
Number (ITIN), for which we will need a copy of one (1) owner's passport.
7. The date the
client wishes to commence operations in the United States.
8. If the business
is to be a partnership:
- The names,
addresses, and citizenship of all partners;
- The share
of partnership interest each is to have;
- The amount
each partner is to contribute;
- The partners’
agreement as to management of the business; and
- The partners’
agreement as to the division of profits and losses.
9. If the business
is to be a LP, all the information in paragraph 8, plus the names of
the General Partners, and those of the Limited Partners.
10. If the business
is to be a LLC or a Corporation:
- The names,
addresses, and citizenship of all the parties who will be shareholders
or members–managers;
- The share
of ownership in the Corporation or LLC of each such shareholder or member;
- If a Corporation,
the names of the persons who will be directors if a Corporation (must
be at least two (2), unless there is only one (1) shareholder);
- If a Corporation,
the names of the persons who will be president, treasurer, and secretary
(if only one shareholder, he or she may hold all these posts);
- If an LLC,
the names of the members who will be managers of the LLC.
11. If a Corporation
is desired, whether it is to be an S–Corporation or a C–Corporation.
12. If a Corporation
is desired, the number and par–value of stock the Corporation will
be authorized to issue. Unless our clients desire a different arrangement,
this office normally incorporates Corporations with 200 shares of no–par
stock. No–par stock is stock that does not have a stated (usually
nominal) value, set forth in the Charter of the Corporation.
13. Whether the
business entity is to have an accounting year beginning other than on
January 1.
14. If a Corporation
is desired, and the client wishes a shareholders’ agreement, we will
discuss various other questions, including restrictions on transfer
of stock, and control of the voting of stock for management.
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