The Legal Aid Society Community Development Project 230 East 106th Street New York, NY

Transcription

1 The information in this document is provided for informational purposes only and does not constitute legal advice. Please consult a qualified attorney prior to acting upon the information contained in this document. CHOOSING THE BEST LEGAL FORM FOR YOUR SMALL BUSINESS The Legal Aid Society Community Development Project 230 East 106th Street New York, NY Copyright 2009

2 GETTING OFF ON THE RIGHT FOOT: PRELIMINARY CONSIDERATIONS IN STARTING YOUR FOR-PROFIT OR NOT-FOR-PROFIT BUSINESS 1. CONSULT THE NECESSARY PROFESSIONALS: A. Lawyer Consult your lawyer before you create your business legal structure, enter into a commercial lease, when taking out a loan, or entering into any important contracts. New York City Bar Association Referral Line (212) Get referrals from family, friends or through similar businesses in your community, local business associations, and chambers of commerce Arrange for an initial consultation where you can interview the lawyer and discuss your needs. Some lawyers will do this free of charge. Make sure your lawyer has expertise in the relevant field, and has worked with businesses like yours. Consider asking your lawyer for references from prior clients. Develop a written agreement with your lawyer concerning what services she will provide and how much she will charge Make sure your lawyer is registered to practice in the State of New York, at B. Accountant/Bookkeeper An accountant is a must for filing your business tax returns, developing a payroll system, and implementing a bookkeeping system that will enable you to accurately track the income and expenses of your business. Get referrals from family, friends or through similar businesses in your community, local business associations, and chambers of commerce. Also, consult the National Association of Small Business Accountants, at Make sure they have worked with businesses of similar type, size, and stage of development as yours. Ask for references Check their qualifications. Certified Public Accountants (CPAs) will be more expensive, and may not be necessary for your purposes Develop a clear written agreement concerning fees and services C. Insurance Broker You will have to work with an insurance broker to protect your business assets. Your broker will help you evaluate your insurance needs. Small businesses generally maintain property insurance, to cover any damage to goods; liability insurance, to cover legal liabilities from accidents and other injuries; and crime insurance, to cover burglaries and employee theft. Many small businesses also maintain business interruption insurance, which covers situations in which fire, flood or some other condition prevents the business from operating. If the business has employees, it is required by law to maintain Workers Compensation insurance and Disability Insurance, which cover on and off the job injuries.

3 The business is also required to maintain Unemployment Insurance. If the business operates an automobile of any type, then it will have to acquire an auto insurance policy. Helpful resources include: New York State Insurance Department, and the New York State Insurance Fund, for Workers Compensation and Disability Insurance. 2. COMPLY WITH INITIAL TAX REQUIREMENTS A. Federal Employer Identification Number Required if you will have employees or independent contractors, or if your business will be other than a sole proprietorship Recommended in all cases as an effective way to maintain your business affairs separate from your personal affairs. Must complete IRS Form SS4, available at also, may be filed over the telephone at (800) B. Sales Tax Identification Number Required for all businesses that will be making sales subject to sales tax, Most tangible personal property is subject to sales tax, including: art, furniture, clothing, machinery and equipment, books, computers, boats, candy, cosmetics, cigarettes and tobacco, jewelry, collectibles, animals and plants, and building materials. Most services are not subject to sales tax. See Publication 750, A Guide to Sales Tax in New York State, for more information. Complete New York State Form DTF-17, Application for Registration as a Sales Tax Vendor, available at The form must be submitted to the New York State Department of Taxation and Finance at least 20 days before you begin to operate your business You will be required to collect and remit, on at least a quarterly basis, sales tax to New York State for all taxable transactions. Your accountant can help you with setting up a system to comply with this requirement. C. Self Employment Tax Some or all of your earnings from your business may be subject to federal selfemployment tax. The extent of your self-employment tax obligations will depend in part on the legal structure of your business. Consult with your accountant concerning your self-employment tax obligations. D. Employer Obligations: federal, state and local If your business has employees, you must comply with a number of additional obligations, including: Comply with the requirements of immigration law by completing an Employment Eligibility Verification Form I-9 for each employee. Withhold and pay federal, state, and local income tax; federal social security tax (FICA), and federal unemployment tax (FUTA).

4 Detailed information about federal employment and business tax issues is available on the IRS Small Business and Self-Employed Tax Center. The website has an on-line classroom consisting of self-directed workshops for small business owners: The New York State Tax Guide for New Businesses may be accessed at Register as an employer with the New York State Department of Labor Unemployment Insurance Division, and withhold and remit contributions for New York State Unemployment Insurance. If the business has employees, it is required by law to maintain Workers Compensation insurance and Disability Insurance, which cover on and off the job injuries. E. Employees vs. Independent Contractors Many business owners try to minimize their tax obligations by classifying their employees as independent contractors, because employers have no withholding or contribution obligations for independent contractors. This misclassification may give rise to substantial penalties, back taxes, and interest if an employee in misclassified as an independent contractor. In the eyes of the government, it does not matter whether the worker is termed an independent contractor or an employee. The actual nature of the relationship counts. Generally, the most important consideration in the employee/independent contractor classification is the degree of control exercised by the employer over the worker. If the employer controls how the worker is to accomplish the task, where and when to do the work, what supplies or implements to use, then the worker is an employee. A worker supervised only with respect to the finished product, is likely an independent contractor. 3. OPEN A BUSINESS BANK ACCOUNT Prior to beginning to operate your business, open a bank account for your business. It is critically important to effectively separate personal finances and business finances. Failure to do so may have severe tax consequences and subject the owners, directors and officers to personal liability. Always use checks from your business account to pay for business expenses. Do not use cash. This will facilitate good record keeping, and make it easier to keep track of your business deductions come tax time. 4. PROPERLY REGISTER YOUR BUSINESS To legally create your business you will have to register it with New York State, or with the county in which it is located, depending upon the legal structure you have chosen. See the attached summary of small business legal structures for a description of the registration requirements for each business type. 5. SECURE REQUIRED LICENSES AND PERMITS

5 Restaurants, bars, beauty salons, grocery stores, delis, and street vendors are common examples of businesses that require permits and/or licenses. There are many other business types that also require permits and/or licenses. Before investing any money in your business idea, make sure you know what permits are required, and that you are eligible to secure those permits. You should apply for the requisite permits well before you plan on opening, because permits often take many months to be processed. To find out what licenses and permits you need go to the New York State Online License and Permit Assistance Center ( and the New York City Business Express service (

6 1. Sole Proprietorship Formation, Income Tax and Liability Issues For Small Businesses In NYC Formation/Formalities The business and the owner are one and the same. If the business will operate under a name other than that of the owner, must file an Assumed Name Certificate (also known as a DBA or Doing Business As ) with the county clerk of the borough where the business is located. The filing fee is $125 in New York City. Tax No federal or state entity level taxes. Income is reported on individual income tax return. Federal tax: owner reports income from the business on Schedule C of Form State tax: owner reports income from business on individual income tax return, Form IT-201 May have to file estimated quarterly tax payments. NYS Form IT NYC tax: unincorporated business tax is assessed at a rate of 4% on earnings of $80,000 or more; sliding-scale tax on earnings less than $80,000 and over $45,000; no tax on earnings of $45,000 or less. Form NYC-202. May have to file estimated quarterly tax payments. NYS Form IT Liability Unlimited personal liability for business debts, obligations, and judgments. Owners personal assets are at risk - i.e. house, car, personal bank accts. Advantages 1. Simple - absence of formalities and fees upon organization. 2. No separate federal or state tax on business; the double tax of corporate earnings when paid to shareholders as dividends (in a corporation) is avoided. Disadvantages 3. No limited liability - unlimited liability for all obligations of the business..

7 2. General Partnership Formation/Formalities Formation of general partnership is same as sole proprietorship. A partnership certificate is filed with the County Clerk in the borough were the business will be located. It is advisable to adopt a partnership agreement, which establishes the rights and responsibilities of each partner with respect to the business. Formation of limited partnership is similar to formation of LLC (see LLC section below), with filing fees in $2,000 range. Tax As with a sole proprietorship, the partners declare their profits or losses from the partnership on their individual federal (Form 1040) and state (Form IT-201) income tax returns. Partnership must file an informational return if it has gross income of more than $25,000 or taxable income of more than $15,000. Federal tax: Form State tax: Form IT-204. NYC tax: As with sole proprietorship, pay NYC unincorporated business tax. If annual estimated tax liability is $1,800 or more, then quarterly tax payments are required. Liability Unlimited personal liability for each partner for business debts obligations and judgments. Also, personal liability for all partners for the acts of the other partners, in business context, even if the partner acted without authorization. Exception is a limited partnership. A limited partner is liable only up to the amount of capital contributed by that partner, provided that s/he does not participate in running the business. Advantages 1. No federal or state tax on partnership income; partners are taxed directly on their share of the profits (the double tax on corporate dividends and individual income is avoided). 2. Flexibility - contributions may be cash, other property or labor. Disadvantages 2. In the absence of a written partnership agreement, the entity is dissolved upon death, bankruptcy, or withdrawal of a partner, or transfer of a partnership interest. 1. Each partner is an agent of the partnership. One partner can bind partnership without other partners approval (if a partner enters into unauthorized contracts, this will create liability for the partnership and the other co-partners).

8 3. Corporation Formation/Formalities In contrast to partnership and sole proprietorship, corporation is a separate legal entity from its owners. To create, must file a certificate of incorporation with the state of NY, which costs $135. Also, must issue shares to the owners of the corporation, and adopt bylaws. Substantial ongoing formalities required, including annual meetings, elections, written resolutions, following bylaws, and minutes. Tax C-Corp - incurs tax at both the entity level and the level of the owners. Federal Corp Tax: 15-35% NYS Corporate Tax: 7.5%, with minimum of $100 NYC Corp. Tax: 8.85%, with minimum of $350. Owners also pay personal income tax on their income derived from the business Federal Tax: Form State Tax : Form CT-3. S-Corp - a pass through entity. Must file S-election with State and Federal Gov. No more than 100 shareholders. Federal Tax: Form 1120S (an informational tax return no federal tax).- No federal entity level tax. State Tax: Form CT-3-S -NYS Corp Tax:.65%, with minimum of $100 - NYC Corp. Tax: 8.85% with minimum of $350. The shareholders declare their profits or losses from the S-Corp on their individual federal (Form 1040) and state (Form IT-201) income tax returns. Liability Limited personal liability for business debts and obligation s. Owners only risk losing the amount of money they invested in the company, rather than all of their personal assets. Advantages Disadvantages Form of business enterprise that combines the elements of limited liability, perpetual existence and free transferability of interests. S-Corp.: Offers the tax advantages of a partnership in that members are taxed directly on their share of the profits ( Pass-through tax model). State corporate tax is at lower rate than for C corps. Certain tax disadvantages (franchise and corporate tax, and possible federal and state tax on corporate income). S-Corp: limited to 100 shareholders (individuals); only one class of stock; no nonresident alien shareholders. NYC does not recognize S Corps. Therefore, there is NYC Annual Franchise Tax.

9 4. Not-for-Profit Corporation Formation/Formalities To create, must file a certificate of incorporation with the state of NY, which costs $75 Must hold an initial organizational meeting and elect at least three directors and officers. Substantial ongoing formalities required, including annual meetings, elections, written resolutions, following bylaws, and minutes. Tax No federal or state tax on revenues derived from activities that are directly related to the charitable purposes of the corporation. File informational tax return Form 990 with the IRS and annual report Form CHAR500 with the A.G. s office Unrelated business taxable income (from revenues not directly related to the charitable mission) must be reported on IRS Form 990-T and on a corresponding state form. Liability Limited personal liability for business debts, May be individually liable for tax, employment and other obligations. Register with the Charities Bureau of the New York A.G. s Office (Form CHAR410). Advantages May obtain tax exempt status from the IRS, including 501(c)(3) status which makes most donations to the entity tax deductible. The Not-for-Profit Corporation Law provides clear rules for the entity to follow. Disadvantages Complex form of organization with numerous federal and state regulatory requirements. Continuous monitoring by the IRS and the NYS Charities Bureau.

10 5. Limited Liability Company (LLC) Formation/Formalities File Articles of Organization with the State of New York, $200. Adopt Operating Agreement, which establishes the rights and responsibilities of the owners, internal rules of the organization. Must publish basic information about the company in local newspapers, which can cost $2000-$3000. Effective June 1, 2006 If the LLC fails to publish within 120 days of formation, it will be suspended from transacting any business in New York. LLCs formed prior to June 1, 2006 have 18 months from June 1, 2006 to comply with the publication requirement. Tax Most favorable tax treatment. - no federal entity level taxation - no state level entity taxation - NYC unincorporated business tax of 4% - Annual NYS filing fee of $100 per owner, with minimum of $500, except for single member LLC, with $100 annual fee. Federal tax: informational return Form However, a single member LLC is treated like a sole proprietorship for federal tax purposes and files Form 1040 together with Schedule C. State tax: informational return: IT-204- LL. The LLC members declare their profits or losses on their individual federal (Form 1040) and state (Form IT-201) income tax returns. Liability Limited personal liability for business debts and obligations. Owners only risk losing the amount of money they invested in the company, rather than all of their personal assets, provided that they maintain separation between entity and owners, and follow procedural formalities similar to Corps. Advantages: Disadvantages: 3. Limited liability for the owners (who may participate in management and still maintain their limited liability status). 4. Offers the tax advantages of a partnership in that members are taxed directly on their share of the profits; there is no federal or state tax on LLC income. 5. Costly to set up because of publication requirement. 6. High annual fees on New York State level ($100 per member, with a minimum of $500 annually, except for single member LLCs, which incur only $100 annual filing fee.)

11 Employers Federal Payroll Tax Obligations 1 Type of Employee Social Security & Medicare ( FICA ) Federal Unemployment Taxes ( FUTA ) Federal Income Tax Withholding For ordinary employees Employer withholds from employee s paycheck 6.2% for Social Security and 1.45% for Medicare. The employer is required to make matching contributions of 6.2% and 1.45% on behalf of each employee. Total contribution is 12.4% for Social Security and 2.9% for Medicare. The obligation to pay Social Security tax ends once an employee has been paid $94,200 ($97,500 in 2007). The employer pays FUTA in an amount equal to 6.2% of the first $7,000 paid to each employee. The employer receives a tax credit of 5.4% for state unemployment taxes paid the FUTA tax rate after the credit is.8% of the first $7,000 paid to each employee. FUTA taxes are deposited quarterly but if FUTA tax liability for the quarter is less than $500, then taxes owed may be carried over to the next quarter. A 501(c)(3) organization is exempt from the payment of FUTA. IRS Pub Amount withheld with every paycheck is based on an approximation of employee s year-end tax liability and is calculated using tax tables. IRS Pub provides the tables and an explanation of how to calculate the amount of tax to withhold. Child of a sole proprietor Not subject to FICA until the child turns 18. Not subject to FUTA until a child turns 21. Subject to income tax withholding. A spouse Subject to FICA. Not subject to FUTA. Subject to income tax withholding. A parent employed by his or her child Subject to FICA Not subject to FUTA Subject to income tax withholding. 1 2 Although no tax need be withheld on payments to independent contractors, the business is required to report to the federal government (on Form 1099-MISC) payments of $600 or more that are made to any independent contractor. Available online at

12 Employers NYS & NYC Payroll Tax & Other Obligations Type of Employee NYS Income Tax Withholding Registration with NYS Department of Labor Unemployment Insurance (UI) Contributions NYC & NYS Sales Tax Ordinary Employer withholds from employee s paycheck appropriate amount of NYS & NYC taxes, calculated using NYS DTF tax tables (Form NYS- 50-T). Employer registers with Dept of Labor and keeps records for each employee that show: (i) employees name and SS number; (ii) for each payroll period: the start and ending dates; days the employee worked and daily earnings; all other payments to the employee. Employee must file quarterly returns even if no wages are paid. The filing is also an Unemployment Insurance Return. Form NYS-45. Employer is liable for UI contributions starting the first day of the quarter in which the employer pays wages of $300 or more. The tax is paid on the first $8,500 of wages paid to each employee in a tax year. The standard rate of UI contribution is 5.4%, but may vary from zero to 8.9%. UI contributions are reported quarterly on Form NYS-45. Unrelated to employees. Sellers of taxable goods and services must register as sales tax vendors with both NYC and NYS before they do business. NYS Form DT-17 Retails sales of most tangible property, and of some services, are taxed. Seller is personally liable for payment of the tax, which is usually paid by the customer. Sales tax returns: (i) an informational return must be filed even if the business had no taxable sales during the reporting period; (ii) file on Form ST-101 if sales tax is under $3,000 for a 12 month period; (iii) file on Form ST-100 if over $3,000 and under $300,000; (iv) file on a monthly schedule if amount is over $300,000. Spouse or child under 21 Same as above Same as above Not subject to UI contributions.