Forming a Business Entity

Forming a Business Entity

by Jane Haskins, Esq., February 2017

Forming a business entity is an important way to protect yourself from liability and save money on taxes. A business entity such as a corporation or limited liability company (LLC) is legally a separate "person" from its owners. Here are some key things to keep in mind when you go about forming a business.

Filing Formation Paperwork

To form most business entities, you must file a form with the state agency that handles business filings (usually the secretary of state) along with a filing fee, which varies from state to state. After the state receives and processes your formation paperwork, you'll receive a certificate confirming that your new company officially exists.

In addition, every business entity should have documents that describe the rights and responsibilities of the people who own and operate the company. Although these documents are not filed with the state, they are important guidelines for running your business and can prevent costly conflicts later.

Setting Up Financial and Tax Accounts

It's important to keep business and personal expenses separate. Here are some ways to do that:

  • Get a federal Employer Identification Number (EIN). Most businesses must have an EIN, the business equivalent of a Social Security number.
  • Open a business bank account. Take your business formation certificate and EIN to a bank or credit union to open a business account. Consider getting a business credit card as well.
  • Register with state and local taxing and licensing agencies. You must register with your state taxing authority to pay state taxes, including income and sales tax. Businesses with employees must also pay various employment-related taxes.

Getting Business Insurance

Business entity formation can protect your personal assets if your business is sued, but it can't protect the business itself from potentially devastating losses due to a personal injury lawsuit, fire, theft, flood or data breach. For that kind of protection, you need business insurance. There are several types of business insurance for different kinds of risk. An insurance agent who specializes in small business insurance can help you get the coverage you need.

Using Contracts to Protect Yourself

Most small businesses need a basic set of contracts to cover their most common transactions. These might include:

  • Nondisclosure agreement (NDA). Protects the business's confidential information by requiring that people keep information about your business private.
  • Employment contracts. Provides written employment terms.
  • Intellectual property assignment. Allows the transfer of property rights while protecting the rights of all parties.
  • Terms and conditions. Specifies the rules governing the use of a website.

Written contracts are important because they help avoid misunderstandings and make it easier to enforce an agreement in court.

Staying Up-to-Date with State Agencies

Your state's laws may require business entities to keep certain records. These might include meeting minutes, resolutions and ownership records. You may also need to file an annual report and pay an annual fee. The rules vary based upon the type of entity, and from state to state, so consult your state's laws or a business lawyer to learn more about your obligations.

If you will do business in a state other than the one you formed your business in, you must register to do business in that state. The procedure is similar to the one you followed when forming your business, and it may require additional tax and reporting obligations in the other state.

To maximize your protection and avoid tax penalties, always keep personal and business finances separate, observe proper procedures and keep complete and accurate records, maintain adequate insurance, and file and pay taxes on time.