Tuesday, June 30, 2015

#TodayInHistory June 30, 1957: The U.S. Federal Government pulls the plug permanently on the Reconstruction Finance Corporation (RFC), one of the remaining vestiges of the Great Depression. The RFC was formed in 1931, the brainchild of President Hoover, who felt that a revived private sector could best lead America back to prosperity, and it was charged with propping up the nation's struggling banks and businesses.


#TodayInHistory June 30, 1957: The U.S. Federal Government pulls the plug permanently on the Reconstruction Finance Corporation (RFC), one of the remaining vestiges of the Great Depression. The RFC was formed in 1931, the brainchild of President Hoover, who felt that a revived private sector could best lead America back to prosperity, and it was charged with propping up the nation's struggling banks and businesses.

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Monday, June 15, 2015

Ethics and Accountability for Nonprofits

America’s charitable nonprofits rely on the public trust to do their work. That is why it is so important that charitable nonprofits continuously earn the public’s trust through their commitment to ethical principles. If only one donor loses confidence in a charitable nonprofit because the nonprofit behaves unethically, that’s one too many. That’s why the National Council of Nonprofits is taking this opportunity to showcase excellent resources that charitable nonprofits can use to demonstrate the core values of accountability and transparency.

What practices demonstrate accountability and transparency?

LAWS AFFECTING ETHICAL CONDUCT

IRS regulations require that charitable nonprofits may not be “operated for the benefit of private interests.” This prohibition is the foundation of the “public benefit” requirement, and the legal, as well as ethical, guiding principal for all charitable nonprofits.
The Sarbanes-Oxley Act of 2002 includes two provisions that apply to nonprofits: (1) a prohibition against destruction of documents that are tied to a criminal investigation, and (2) a prohibition of retaliation against whistleblowers. As a result of the Act (and questions posed on the IRS Form 990) most nonprofits are now aware of the "best practices" of having a board-approved whistleblower protection policy, and a document retention/destruction policy.  

IRS GUIDANCE

The IRS Form 990, Part VI, includes several questions focusing attention and governance practices on accountability and transparency. These questions are specifically designed to elicit whether the organization has a written conflict of interest policy, procedures for managing conflicts and reviewing executive compensation as well as the IRS Form 990 prior to filing, an approved whistleblower protection policy, and a document retention policy.  For more background on nonprofit governance and the revised Form 990, visit the Council of Nonprofits’ website resources on governance.

STATE LAW

State laws also address accountability and transparency practices of charitable nonprofits: for example, some state nonprofit corporation laws dictate the procedures a board of directors must follow to address conflicts of interest, and several states’ laws prohibit loans to board members. State laws and regulations also typically dictate a threshold level of financial transparency through annual filing and charitable registration requirements. We are unaware of any state law that requires a nonprofit to adopt a code of ethics.

Six Mobile Marketing Tips for Small Businesses

Mobile phones are essential to shopping these days, and a majority of cell phone owners say they’re willing to share personal data with merchants in exchange for such things as coupons and discounts.
But navigating mobile marketing can be confusing for small business owners, who must avoid bombarding people with unwanted texts while they’re slogging through crowds of holiday shoppers. So how can local merchants use mobile marketing effectively? Here are six tips.
Focus on customers. Consider how consumers already interact with their mobile devices and take advantage of that behavior. Eliminate anything that makes buying more difficult, such as a website that doesn’t load correctly on a mobile device or hard-to-find contact information. Optimize your customers’ mobile Web experiences by adding “click to call” and “click for directions” features, suggests Jeff Fagel, chief marketing officer at G/O Digital. Make sure all your marketing messages look great on the small screens where people are increasingly opening them, says Jessica Stephens, chief marketing officer at marketing technology company SmartFocus. She says 30 percent of mobile shoppers abandon transactions that aren’t optimized for mobile and 57 percent abandon sites that take more than three seconds to load.
Don’t get too pushy. Most Internet shopping activity involves consumers actively searching out information on services or products. But mobile marketing is what’s called “push” technology, which involves sending unsolicited messages to would-be customers. “It’s all done with the idea of engaging customers and getting them to spread your offers on social media,” says Betsy Page Sigman, who teaches operations and information management at Georgetown University’s McDonough School of Business. “If people buy something every time you send a discount, keep sending them. But pay attention to when they stop, because that data tells you a lot, too.”
Respect privacy. The discovery of a series of ad beacons used to track phones in New York City recently caused a ruckus over privacy concerns. You won’t catch people by surprise if you direct your marketing messages to customers who have agreed to receive texted discounts or coupons or who have downloaded an app such as Shopkick. The application, and others like it, allows merchants to send messages to users’ devices when their location service is turned on, showing they are nearby.
Give something away. Most people don’t mind that their supermarket tracks their purchases—as long as they get discounts when they swipe their reward cards. The same idea applies to mobile marketing: You need to sweeten the deal, not just text annoying ads. Send customers special offers, reminders about sales, and discount coupons. Imagine the response to a “free coffee with purchase” offer you send to shoppers a block away from your bakery at 4 p.m., for instance.
Integrate. Mobile marketing should be part of your overall marketing plan, along with e-mail, direct mail, and other advertising, says John McGee, chief executive of OptifiNow, a Los Angeles sales and marketing company. “Track the results you get from each channel and see which one is working. There’s no silver bullet—you need to do a little bit of everything. And remember, it doesn’t matter what you want to do—it’s what your customers like,” he says.
Be concise. Unlike e-mail, text messages have a high open rate. But you have to get your point across in few words, which is easier to do the better you know your customers. “Text messages work better for local marketing, which lends itself to small business,” McGee says. “If a local restaurant is having a slow night and sends text to people nearby to get them in for a special, that’s more effective than a retail chain sending out messages to people 20 miles down the freeway.”

Are You an Ethical Leader?

If you're really honest with yourself for a moment how ethical are your leadership behaviors? Are you trustworthy? Do you always show others respect? Are you willing to forgo potential profits if it means looking after the needs of your employees better?
Given British historian Lord Acton famously declared in the 19th-century that "power tends to corrupt" - an observation since supported by numerous studies - it appears that balancing the needs and interests of different stakeholders can challenge even the most ethical among us.
So when you're being pressured to continually deliver better results, can you afford to hold onto your morals?
"In the past decade over 100 studies with more than 30,000 employees have consistently found that employees who believe their leader is ethical are happier, more committed, perform better, are more likely to be helpful to others and less likely to behave unethically," explained Professor David Mayer from the University of Michigan when I interviewed him recently.
And while the business outcomes are impressive, perhaps more heartening is David's observation that many executives embrace the practices of ethical leadership because of the kind of leaders they hope to be and the legacies they want to leave.
"Ethical leaders are moral people and moral managers", explained David. "They don't just act ethically on their own, but try to create the right type of environment to influence others' behaviors by creating an ethical culture, talking about ethics and really following that up with policies and practices that encourage the employees in the organization to do the right thing."
But is ethical leadership something that can be taught?

While researchers agree that our biology and upbringing impacts the values we hold, David and his colleagues have found the workplace environment plays a significant role in helping people overcome biases that might distort the way their values emerge and creating an ethical culture to help positively influence their behavior.
So what can you start doing to be a more ethical leader?
In a chapter David recently contributed to "How To Be A Positive Leader: Small Actions, Big Impact" three approaches he recommends are:
  • Build Your Ethical Muscles - In other areas of our work, we think if we're not that good at something - like writing, public speaking or coaching - we could practice and get better. But traditionally we haven't thought about ethics in that way. Aristotle proposed that ethics were a skill and researchers are finding that ethics can be viewed as an area of expertise. So what goals can you set for your own development to actually grow and be better at being the type of leader you really want to be?
  • Create Ethical Support Tools - Given all the different elements competing for your attention each day at work, it helps to develop some simple tools to keep your ethical compass on track. For example developing an ethical mantra - like "What would my children/parents think if they saw me engage in this behavior?", "Would I be comfortable if this was on the front page of the Wall Street Journal?" or "Do only what you're prepared to tell" - can keep your values top of mind. Some studies have found arranging your workspace, with photos of family and friends can actually increase your ethical behavior as it reminds you of the types of your core values.
  • Walk The Talk - It's not enough to just talk about your values or your code of ethics. While most companies have these tools, it seems they're generally not a good predictor of ethical behavior unless there is some type of action that demonstrates you're living in line with the words you're espousing. This is why it's critical for you to raise awareness about how the decisions you're making fit with the organization's ethics and values. It's also important to remember that employees will have their antennas up for hypocrisy so if you're going to advocate for values like "respect", but then promote individuals who are disrespectful or dishonest high performers, it will damage people's levels of trust.
As a leader what can you do to build your ethical muscles?
For more tested, practical examples you can be more a moral manager who brings out the best in yourself and others grab a copy of "How To Be A Positive Leader: Small Actions, Big Impact."

3 Basic Financial Statements You Need to Keep Track of Your Money

Who keeps track of your business numbers? It’s easy to just say, “I’m a craftsperson and I know my craft and that’s all I need to know. I’ll just hire someone to take care of the numbers for me.” The truth is, if you are in charge of making decisions about your business, then you need to understand the basics of accounting and what each of the financial reporting statements you receive as a small business owner means. In other words, even if you let someone else keep the books for you, you need to understand the meaning behind the math.

Here are a few reasons why you have to keep accurate books; and you'll notice that tax reporting is at the bottom of the list.

Keeping accurate books will help you:
  • Price your products accurately.
  • Know if you're making or losing money—in general and on specific jobs.
  • Know your cash flow—both in the short and long term—and work with bankers and investors.
  • Let the tax agencies know how you're doing.
The important thing in accounting is to not let the terms and formatting of the financial information intimidate you. All you need to remember is that you need three basic financial statements to keep track of your money:
  1. The balance sheet shows your business at a particular point in time and outlines the assets you have and who owns them. Information on cash and earnings included in the balance sheet is drawn from the other two statements.
  2. An income statement shows your earnings over a period of time.
  3. The cash flow statement shows cash coming in and going out and what the net result is over a period of time.
Let’s take a look at this, broken-down in simple terms.

1. The Balance Sheet

As mentioned above, your balance sheet outlines your business assets, both current and fixed. Current assets are cash or other assets that can be converted into cash within one year (things like accounts receivable, inventory, prepaid expenses, etc.). Fixed assets are property and equipment owned by your business—things that you don’t intend to sell (furniture, manufacturing equipment, real estate, etc.). As you create your balance, remember that the left side will always equal the right side. If they do not equal, then you have made a mistake. It is that simple. This is called the “accounting equation.” It’s what makes your balance sheet always equal on both sides. The equation is this: Assets = Liabilities + Owner’s Equity Here’s a sample balance sheet:
balancesheet
Owner’s Equity covers the share of the business that you or other partners own.

2. The Income Statement

The second piece of essential accounting information you need is an income statement (or profit and loss statement), which is used to track sales and expenses. The difference between these two is your net profit. The formula for calculating this is: income minus cost of sales equals gross margin, and gross margin minus fixed operating expenses equals net profit. Remember, larger assets may be depreciated so that those bigger expenses don’t skew your profitability numbers. It is important to remember that your income statement presents sales and expense activities over a period of time as opposed to your balance sheet which shows your financial condition at a point in time.

3. The Cash Flow Statement

cash flow statement is the financial document that presents income actually received and expenses actually paid. This statement (usually modified for a small business) generally shows beginning cash balances, cash inflows, cash outflows and ending cash balances. In its simplest form, a cash flow statement is presented in the following format:
  • Beginning cash balance
  • Plus cash inflows
  • Minus cash outflows
  • Equals ending cash balance.
Sample cash flow statement for a new business (beginning cash balance is $0):cashflowstatementThere are many free resources available to help you prepare your financial statements and understand the basics of business accounting. For a deeper dive into this topic, SBA offers a free online course: Introduction to Accounting through its Small Business Learning Center. The course also includes automated financial statement templates. You can also discuss your financial statements and any accounting questions you have with a business mentor (such as those available through SCORE) or get assistance from your local Small Business Development Center.

Choose Your Business Structure

Of all the choices you make when starting a business, one of the most important is the type of legal structure you select for your company. Not only will this decision have an impact on how much you pay in taxes, it will affect the amount of paperwork your business is required to do, the personal liability you face and your ability to raise money.
Mark Kalish is co-owner and vice president of EnviroTech Coating Systems Inc. in Eau Claire, Wisconsin, a company that applies powdered paint through an electrostatic process to items ranging from motorcycles to musical instruments. Kalish has also been involved with a number of other start-up businesses, both as an owner and in various management positions. The answer to the question of "What structure makes the most sense?" depends, he says, on the individual circumstances of each business owner. "Each situation I've been involved with has been different," he says. "You can't just make an assumption that one form is better than another."
It's not a decision to be entered into lightly, either, or one that should be made without sound counsel from business experts. Kalish says it's important for business owners to seek expert advice from business professionals when considering the pros and cons of various business entities.
"I've heard horror stories from people who, in hindsight, wish they had taken the time and spent the money to get expert advice upfront," Kalish says. That advice can come from a variety of sources, ranging from the no cost/low cost, such as the SBA or the Service Corps of Retired Executives (SCORE), to pricier attorneys and accountants who can serve as valuable sources of information throughout the life of your business.
Types of Business Entities 
The type of business entity you choose will depend on three primary factors: liability, taxation and record-keeping. Here's a quick look at the differences between the most common forms of business entities:
  • sole proprietorship is the most common form of business organization. It's easy to form and offers complete managerial control to the owner. However, the owner is also personally liable for all financial obligations of the business.
     
  • partnership involves two or more people who agree to share in the profits or losses of a business. A primary advantage is that the partnership does not bear the tax burden of profits or the benefit of losses-profits or losses are "passed through" to partners to report on their individual income tax returns. A primary disadvantage is liability-each partner is personally liable for the financial obligations of the business.
     
  • corporation is a legal entity that is created to conduct business. The corporation becomes an entity-separate from those who founded it-that handles the responsibilities of the organization. Like a person, the corporation can be taxed and can be held legally liable for its actions. The corporation can also make a profit. The key benefit of corporate status is the avoidance of personal liability. The primary disadvantage is the cost to form a corporation and the extensive record-keeping that's required. While double taxation is sometimes mentioned as a drawback to incorporation, the S corporation (or Subchapter corporation, a popular variation of the regular C corporation) avoids this situation by allowing income or losses to be passed through on individual tax returns, similar to a partnership.
     
  • A hybrid form of partnership, the limited liability company (LLC) , is gaining in popularity because it allows owners to take advantage of the benefits of both the corporation and partnership forms of business. The advantages of this business format are that profits and losses can be passed through to owners without taxation of the business itself while owners are shielded from personal liability.

Selecting a Business Entity

When making a decision about the type of business to form, there are several criteria you need to evaluate. Kalish and EnviroTech co-owner John Berthold focused on the following areas when they chose the business format for their company:
1. Legal liability. To what extent does the owner need to be insulated from legal liability? This was a consideration for EnviroTech, says Kalish. He and Berthold had a hefty investment in equipment, and the contracts they work on are substantial. They didn't want to take on personal liability for potential losses associated with the business. "You need to consider whether your business lends itself to potential liability and, if so, if you can personally afford the risk of that liability," Kalish says. "If you can't, a sole proprietorship or partnership may not be the best way to go."
Carol Baker is the owner of The Company Corporation, a firm based in Wilmington, Delaware, that offers incorporation services. She points to the protection of personal assets as "the number-one reason our clients incorporate. In case of a lawsuit or judgment against your business, no one can seize your personal assets. It's the only rock-solid protection for personal assets that you can get in business."
2. Tax implications. Based on the individual situation and goals of the business owner, what are the opportunities to minimize taxation?
Baker points out that there are many more tax options available to corporations than to proprietorships or partnerships. As mentioned before, double taxation, a common disadvantage often associated with incorporation, can be avoided with S corporation status. An S corporation, according to Baker, is available to companies with less than 70 shareholder returns; business losses can help reduce personal tax liability, particularly in the early years of a company's existence.
3. Cost of formation and ongoing administration. Tax advantages, however, may not offer enough benefits to offset other costs of conducting business as a corporation.
Kalish refers to the high cost of record-keeping and paperwork, as well as the costs associated with incorporation, as one reason that business owners may decide to choose another option--such as a sole proprietorship or partnership. Taking care of administrative requirements often eats up the owner's time and therefore creates costs for the business.
It's the record-keeping requirements and the costs associated with them that led Kalish to identify the sole proprietorship as a very popular form of business entity. It's the type of entity in place at his other business, Nationwide Telemarketing.
"I would always take sole proprietorship as a first option," he says. "If you're the sole proprietor and you own 100 percent of the business, and you're not in a business where a good umbrella insurance policy couldn't take care of potential liability problems, I would recommend a sole proprietorship. There's no real reason to encumber yourself with all the reporting requirements of a corporation unless you're benefiting from tax implications or protection from liability."
4. Flexibility. Your goal is to maximize the flexibility of the ownership structure by considering the unique needs of the business as well as the personal needs of the owner or owners. Individual needs are a critical consideration. No two business situations will be the same, particularly when multiple owners are involved. No two people will have the same goals, concerns or personal financial situations.
5. Future needs. When you're first starting out in business, it's not uncommon to be "caught up in the moment." You're consumed with getting the business off the ground and usually aren't thinking of what the business might look like five or ten-let alone three-years down the road. What will happen to the business after you die? What if, after a few years, you decide to sell your part of a business partnership?
The issue of ownership was a key one for EnviroTech. "When we started EnviroTech," Kalish remembers, "our reasoning for forming it as a corporation was because of ownership; we wanted to be able to bring in stockholders as we grew."
"A corporation's capital," Baker says, "can be expanded at any time in a private offering by issuing and selling additional shares of stock. This is especially helpful when banks are being tight with money."
Another important question to ask yourself is, "What do I want to happen to the business when I'm no longer around to run it?" While a sole proprietorship or partnership may dissolve upon the death of its owner or owners, a corporation can be readily distributed to family members.
Keep in mind that the business structure you start out with may not meet your needs in years to come. Many sole proprietorships evolve into some other form of business-like a partnership or corporation-as the company grows and the needs of the owners change.
The bottom line? Don't take this very important decision lightly, and don't make a choice based on what somebody else has done. Carefully consider the unique needs of your business and its owners, and seek expert advice, before settling on a particular business format.

Sole Proprietorship

The simplest structure is the sole proprietorship, which usually involves just one individual who owns and operates the enterprise. If you intend to work alone, this may be the way to go.
The tax aspects of a sole proprietorship are especially appealing because income and expenses from the business are included on your personal income tax return (Form 1040). Your profits and losses are first recorded on a tax form called Schedule C, which is filed along with your 1040. Then the "bottom-line amount" from Schedule C is transferred to your personal tax return. This aspect is especially attractive because business losses you suffer may offset income earned from other sources. As a sole proprietor, you must also file a Schedule SE with Form 1040. You use Schedule SE to calculate how much self-employment tax you owe.
In addition to paying annual self-employment taxes, you must also make quarterly estimated tax payments on your income. Currently, self-employed individuals with net earnings of $400 or more must make estimated tax payments to cover their tax liability. If your prior year's adjusted gross income is less than $150,000, your estimated tax payments must be at least 90 percent of your current year's tax liability or 100 percent of the prior year's liability, whichever is less. The federal government permits you to pay estimated taxes in four equal amounts throughout the year on the 15th of April, June, September and January. With a sole proprietorship, your business earnings are taxed only once, unlike other business structures. Another big plus is that you have complete control of your business-you make all the decisions.
There are a few disadvantages to consider, however. Selecting the sole proprietorship business structure means you're personally liable for your company's liabilities. As a result, you're placing your own assets at risk, and they could be seized to satisfy a business debt or legal claim filed against you.
Raising money for a sole proprietorship can also be difficult. Banks and other financing sources are reluctant to make business loans to sole proprietorships. In most cases, you'll have to depend on your own financing sources, such as savings, home equity or family loans.

Partnership

If your business will be owned and operated by several individuals, you'll want to take a look at structuring your business as a partnership. Partnerships come in two varieties: general partnerships and limited partnerships. In a general partnership, the partners manage the company and assume responsibility for the partnership's debts and other obligations. A limited partnership has both general and limited partners. The general partners own and operate the business and assume liability for the partnership, while the limited partners serve as investors only; they have no control over the company and are not subject to the same liabilities as the general partners.
Unless you expect to have many passive investors, limited partnerships are generally not the best choice for a new business because of all the required filings and administrative complexities. If you have two or more partners who want to be actively involved, a general partnership would be much easier to form.
One of the major advantages of a partnership is the tax treatment it enjoys. A partnership doesn't pay tax on its income but "passes through" any profits or losses to the individual partners. At tax time, each partner files a Schedule K-1 form, which indicates his or her share of partnership income, deductions and tax credits. In addition, each partner is required to report profits from the partnership on his or her individual tax return. Even though the partnership pays no income tax, it must compute its income and report it on a separate informational return, Form 1065. Personal liability is a major concern if you use a general partnership to structure your business. Similar to a sole proprietorship, general partners are personally liable for the partnership's obligations and debt.
In addition, each general partner can act on behalf of the partnership, take out loans and make business decisions that will affect and be binding on all the partners (if the general partnership agreement permits). Keep in mind that partnerships are more expensive to establish than sole proprietorships because they require more extensive legal and accounting services.
Protect yourself and your business with a partnership agreement.
Starting a business with a partner? It may be difficult to talk about problems during your honeymoon stage, but that's exactly when you should. A written partnership agreement helps guide you when questions arise.
According to W. Thurston Debnam Jr., a partner with Smith, Debnam, Narron, Wyche, Story & Myers LLP, a law firm in Raleigh, North Carolina, a partnership agreement should answer the following questions:
  • What is each partner's investment? Is one investing cash and the other energy? Do any of the partners own equipment that you'll use in the business, and does that fact deserve consideration as part of the start-up investment?
  • What are the responsibilities and duties of each partner? Be specific about each partner's role in the day-to-day operations of the company.
  • If a partner becomes disabled, how long will he or she get a share of the profits? If a partner dies, what happens to that share? A good way to deal with this issue: life insurance on all partners.
  • Can the partners have other outside partnership interests? In particular, can interest be in similar or competitive businesses?
  • What will you do if one partner wants to withdraw? Typically, you'll set up a buyout agreement, but it's a very good idea to decide on the terms before the situation arises. You'll also want to include a noncompete covenant.
  • How will you restrict partnership-interest transfers? Can a partner transfer his or her ownership to anyone, or can you limit that transfer? This means the remaining partners won't find themselves in partnership with someone they object to. This is frequently used to protect the business in the event that one of the partners gets a divorce and his interest becomes a part of the divorce settlement.
  • Can a partner pledge his or her interest as collateral for a loan?
  • Are additional contributions mandatory? If the business needs capital in the future, are partners required to make capital contributions?
  • How will conflicts be resolved? Most often, an arbitrator is used.
Debnam recommends that every business partnership-regardless of the relationship of the individuals-begin with a written agreement. "It ensures that the partners have the same vision," he says.
But there's another reason for a partnership agreement. "Poorly drawn agreements keep litigation attorneys in business," Debnam notes. "The best reason to have a good agreement is to avoid the legal fees when you have a meltdown.

Corporation

Using the corporate structure is more complex and expensive than most other business structures. A corporation is an independent legal entity, separate from its owners, and as such, it requires complying with more regulations and tax requirements.
The biggest benefit for a small-business owner who decides to incorporate is the liability protection he or she receives. A corporation's debt is not considered that of its owners, so if you organize your business as a corporation, you're not putting your personal assets at risk. A corporation also can retain some of its profits, without the owner paying tax on them. Another plus is the ability of a corporation to raise money. A corporation can sell stock, either common or preferred, to raise funds. Corporations also continue indefinitely, even if one of the shareholders dies, sells the shares or becomes disabled.
The corporate structure, however, comes with a number of downsides. A major one is higher costs. Corporations are formed under the laws of each state with their own set of regulations. You'll probably need the assistance of an attorney to guide you through the maze. In addition, because a corporation must follow more complex rules and regulations than a partnership or sole proprietorship, it requires more accounting and tax preparation services.
Another drawback: Owners of the corporation pay a double tax on the business's earnings. Not only are corporations subject to corporate income tax at both the federal and state levels, but any earnings distributed to shareholders in the form of dividends are taxed at individual tax rates on their personal income tax returns.
To avoid double taxation, you could pay the money out as salaries to you and any other corporate shareholders. A corporation is not required to pay tax on earnings paid as reasonable compensation, and it can deduct the payments as a business expense. Keep in mind, however, that the IRS has limits on what it believes to be reasonable compensation.
How to Incorporate
To start the process of incorporating, contact the secretary of state or the state office that is responsible for registering corporations in your state. Ask for instructions, forms and fee schedules on business incorporation.
It's possible to file for incorporation without the help of an attorney by using books and software to guide you along. Your expense will be the cost of these resources, the filing fees, and any other costs associated with incorporating in your state.
If you do file for incorporation yourself, you'll save the expense of using a lawyer, which can cost from $500 to $1,000. The disadvantage of going this route is that the process may take you some time to accomplish. There's also a chance you could miss some small but important detail in your state's law.
One of the first steps you must take in the incorporation process is to prepare a certificate or articles of incorporation. Some states will provide you with a printed form for this, which either you or your attorney can complete. The information requested includes the proposed name of the corporation, the purpose of the corporation, the names and addresses of the parties incorporating, and the location of the principal office of the corporation.
The corporation will also need a set of bylaws that describe in greater detail than the articles how the corporation will run, including the responsibilities of the shareholders, directors and officers; when stockholder meetings will be held; and other details important to running the company. Once your articles of incorporation are accepted, the secretary of state's office will send you a certificate of incorporation.
Once you're incorporated, be sure to follow the rules of incorporation. If you don't, a court can pierce the corporate veil and hold you and the other owners personally liable for the business's debts.
It's important to follow all the corporation rules required by state law. You should keep accurate financial records for the corporation, showing a separation between the corporation's income and expenses and that of the owners'.
The corporation should also issue stock, file annual reports and hold yearly meetings to elect officers and directors, even if they're the same people as the shareholders. Be sure to keep minutes of these meetings. On all references to your business, make certain to identify it as a corporation, using Inc. or Corp., whichever your state requires. You also want to make sure that whomever you deal with, such as your banker or clients, knows that you're an officer of a corporation.

The S Corporation

The S corporation is more attractive to small-business owners than a standard (or C) corporation. That's because an S corporation has some appealing tax benefits and still provides business owners with the liability protection of a corporation. With an S corporation, income and losses are passed through to shareholders and included on their individual tax returns. As a result, there's just one level of federal tax to pay.
In addition, owners of S corporations who don't have inventory can use the cash method of accounting, which is simpler than the accrual method. Under this method, income is taxable when received and expenses are deductible when paid. Some relatively recent tax law changes brought about by the Small Business Job Protection Act of 1996 have made S corporations even more attractive for small-business owners. In the past, S corporations were limited to 35 shareholders. The 1996 law increased the number of shareholders to 75. Expanding the shareholder number makes it possible to have more investors and thus attract more capital, tax experts maintain.
S corporations do come with some downsides. For example, they're subject to many of the same requirements corporations must follow, and that means higher legal and tax service costs. They also must file articles of incorporation, hold directors and shareholders meetings, keep corporate minutes, and allow shareholders to vote on major corporate decisions. The legal and accounting costs of setting up an S corporation are similar to those of a standard corporation.
Another major difference between a standard corporation and an S corporation is that S corporations can only issue common stock. Experts say this can hamper the company's ability to raise capital. In addition, unlike a standard corporation, S corporation stock can only be owned by individuals, estates and certain types of trusts. The 1996 Small Business Job Protection Act law also added tax-exempt organizations such as qualified pension plans to this list starting in January 1998. Tax experts believe this change should help provide S corporations with even greater access to capital because a number of pension plans are willing to invest in closely held small-business stock.

Limited Liability Companies

Limited liability companies, often referred to as "LLCs," have been around since 1977, but their popularity among small-business owners is a relatively recent phenomenon.
An LLC is a hybrid entity, bringing together some of the best features of partnerships and corporations. "An LLC is a much better entity for tax purposes than any other entity," says Ralph Anderson, a CPA and small-business tax specialist with accounting firm M. R. Weiser. LLCs were created to provide business owners with the liability protection that corporations enjoy without the double taxation. Earnings and losses pass through to the owners and are included on their personal tax returns.
Sound similar to an S corporation? It is, except an LLC offers small-business owners even more attractions than an S corporation. For example, there's no limitation on the number of shareholders an LLC can have, unlike an S corporation, which has a limit of 75. In addition, any member or owner of the LLC is allowed a full participatory role in the business's operation; in a limited partnership, on the other hand, limited partners aren't permitted any say in the operation. To set up an LLC, you must file articles of organization with the secretary of state in the state where you intend to do business. Some states also require you to file an operating agreement, which is similar to a partnership agreement.
Like partnerships, LLCs do not have perpetual life. Some state statutes stipulate that the company must dissolve after 30 or 40 years. Technically, the company dissolves when a member dies, quits or retires.
Despite the attractions, LLCs also have their disadvantages. Since an LLC is relatively new, its tax treatment varies by state. If you plan to operate in several states, you must determine how a state will treat an LLC formed in another state. If you decide on an LLC structure, be sure to use the services of an experienced accountant who is familiar with the various rules and regulations of LLCs.
Even after you settle on a business structure, remember that the circumstances that make one type of business organization favorable are always subject to changes in the laws. It makes sense to reassess your form of business from time to time to make sure you're using the one that provides the most benefits.
Why LLC?
  • Limited liability. Your only risk is capital paid into the business. Business debts and other liabilities can't be squeezed out of your personal assets. Caution: If you personally guarantee a debt, you've forfeited your "limited liability."
  • Tax simplicity. Profits and losses are reported and taxed on owners' individual returns. There's no separate business tax return, unless you have more than one member and choose to be taxed as a partnership, in which case you file Form 1065. And there's no corporate "double taxation," in which both the business and the shareholders are taxed.
  • Flexible management. A "member" (shareholder equivalent) can be a person, partnership or corporation. Members get a percentage of ownership. If your idea people can't manage their way out of a paper bag, you can hire management help. Smaller LLCs are usually member-managed, but not always.
  • Flexible distribution. Profits and losses don't have to be distributed in proportion to the money each person puts in. A regular C corporation can't allocate profits and losses. And in a subchapter S corporation (taxed as a partnership), profits and losses are in proportion to shares held.
Why Not?
And now for the downsides:
  • No stock. LLCs are tough if you have several investors or raise public money, since you don't have shares or stock certificates to offer. If you give a percentage of ownership to outside investors, you must decide whether they'll be managing members. Seidel cautions entrepreneurs: "Ask yourself if you need more flexibility in terms of corporate stock ownership, financing options, etc. If so, the LLC is probably not a good idea-try a C corporation."
  • Two's a crowd. LLCs in most states require only one member: you. But if you live in Massachusetts or the District of Columbia, you must have two members, and that could be a deal-buster.
  • Fewer incentives. LLCs aren't ideal if you want to give fringe benefits to yourself or employees. Unlike with a C corporation, you can't deduct the cost of benefits with an LLC. And since there's no stock, you can't use stock options as incentives for your employees.
  • Paperwork. LLCs file articles of organization with the State Corporation Commission or Secretary of State and must draft an operating agreement listing members' rights and responsibilities. Some paperwork that must be filed, like an application for employer ID number (IRS Form SS-4) and choice of tax status (IRS Form 8832), are one-shot; others (annual report, quarterly withholding and tax deposit coupons, and business bank account) are ongoing. While it's not an impossible burden, there's more paperwork than if you're a sole proprietor.
  • Taxes. LLC members pay self-employment taxes, the Medicare/Social Security tax paid by entrepreneurs; it's calculated on 15.3 percent of profits. Contrast this with an S corporation: Self-employment tax is due on salary only, not your entire profits. You're caught in the self-employment tax net if: 1) you participate in the business for more than 500 hours during the LLC tax year; 2) you work in a professional services LLC (health, law, engineering); or 3) you can sign contracts on behalf of the LLC.
Ultimately, the LLC decision is one you won't want to make alone. "Get advice from a specialist about the ideal corporate form to take," advises Seidel. "It can make a huge difference later on." In business, as in life, one size rarely fits all.

Secretary of State and Commerce Web Sites

Find the information you need to choose your business structure at the following state websites: