Important Thoughts, Financial and Economic Advice
Posted by alex in Financial Column, George Lenz at 1:04 pm | Permanent Link
By George Lenz
Today’s post will deal with incorporation – an opportunity many WN small businessmen and tradesmen encounter sooner or later as their business grows and becomes more stable. Few manage to incorporate without incurring huge and often unnecessary costs, charged by lawyers. This post will explain the basics of incorporation as well as way of incorporating a small business.
What is incorporation? Incorporation is the creation of a new legal person, a corporation, that has definite obligations and rights under the law. A corporation is legally independent from its owners, so the owners are generally not responsible for the debts of the corporation, incurred in the process of doing business. The income of the corporation is taxed separately from the income of its owner, under different tax rates, and there are many tax incentives available to corporations, including, but not limited to, investment incentives. At the same time, part of profit paid to owners is taxed doubly: the first time as profit under corporate tax rates; the second time as income under income tax rates.
What main types of corporations are available to the small business owner or tradesman? The two most suitable are limited liability company (LLC) and S-corporation. A LLC provides for limited liability of owners, and at the same time profit paid to owners is taxed only as individual income, so double taxation is not applicable. Income/loss from LLC is put on schedule C or K-1 in income tax return, depending on the number of owners. An S-corporation provides for limited liability of its owners, and at the same time owners can elect by filing a declaration with the IRS and state tax office, so that profit paid to individuals would be taxed only as individual income, so double taxation is not applicable as well, yet there is limit to the loss that can be passed to each S-corporation owner. There are other restrictions: no more than 75 owners who are U. S. citizens or permanent residents, and only one class of stock paying the same dividend (differences in voting rights are allowed). Generally, a tradesman is advised to form a LLC first, unless he is located in one of the (few) states where self-employed tax is high. In that case, it is often better to form an S-corporation and elect taxation of income at corporate tax rates. If a business is well established and relatively large (e.g. a few shops, or business conducted in more than one state) it is advisabel to form an S-corporation.
What is necessary to form a corporation? First it is necessary to choose the name. It should include designation of a corporation (Corp., Inc., Ltd depending on the state), be easily memorable and explain the business one is involved in. After the name is chosen, it should be reserved to your corporation by filing a notice with the state corporate filing office. Second, it is necessary to prepare and file with the state corporate filing office articles of incorporation, the include the name of corporation, number of authorized shares, their nominal value (that usually equals to the share of the paid up equity of corporation) and voting rights, the name of the incorporator (the director of the corporation), effective date of authorization of articles of incorporation, liability of directors of the corporation, anti-dilution provision and other necessary articles. Detailed recommendations on how to prepare articles of incorporation are usually available at state corporate filing office. Third, it is necessary to set up a corporate records book, order corporate seal and stock certificates. The fourth step is to prepare corporate bylaws or statutes – the specific rules and procedures followed by your corporation. Bylaws are very important as a corporate management tool. The fifth step is to appoint corporate directors, if their names are not stated in articles of incorporation. The sixth step is to prepare minutes of the first meeting of the board of directors of the corporation. Here the following points should be included: formal approval of officers of corporation, its principal location, seal, stock certificates and authorization of issuance of shares and bank account. And the last step is issuance of shares.
The legal forms for each corporate document are available from multiple sources: corporate filing office, local library, some are even on the Internet – so there is no reason to pay 200 USD an hour to a lawyer. You can also contact me at VNN forum for a particular legal form, or advice concerning the incorporation in particular state.
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