Small business owners are especially at risk of stumbling into this particular pitfall. Since they are often overwhelmed with the multiple facets of their business’ day-to-day operating needs, they may not know how to avoid noncompliance and the resulting crippling or fatal business consequences. IncFile.com can help.

Corporations and LLCs have both internal and external ongoing requirements. The internal requirements must be met by the directors of the corporation or the members of the LLC, and then documented in company records. External requirements are those imposed by the state in which the LLC or corporation was formed; these often include, at a minimum, an annual (every year) or biennial (every two years) filing with the state, as well as some kind of fee.

Internal Requirements

Internal requirements are frequently overlooked, but are vitally necessary to effective decision-making and communication within the organization. A corporation has more internal requirements than an LLC; these include holding and properly documenting director and shareholder meetings, adopting and updating bylaws, issuing stock to shareholders, and recording stock transfers. While these actions are not specifically required for an LLC, it’s still a good idea to adopt an operating agreement (and keep it up to date with amendments as needed), issue membership shares, record interest transfers, and hold annual meetings.

Owners use a consolidated corporate records book to organize and maintain important corporate documents such as articles, bylaws, meeting minutes, resolutions, stock certificates, deeds, and so on. Many business owners use a Corporate Kit or LLC Kit for organizing and maintaining these vital records. Many businesses also use a metal or rubber corporate seal—the kind that leaves the company name in raised letters on a document—to signify that the document is an authorized, official transaction of the corporation. These can be obtained as part of a corporate kit or from a stationery store.

Bylaws lay out the corporation’s basic operating principles; they should be planned for and drawn up as part of the incorporation process. It is not required to file the bylaws with any government agency, but a corporation is required to have at least an initial and annual meetings, adopt bylaws, and keep minutes of the meetings, and keep these on file with the corporate records. Bylaws are important because they set down formal rules for such things as: when and how meetings can be held; notice, quorum, and voting rules for meetings; how decisions can be reached and recorded outside of meetings; basic titles and responsibilities of corporate officers; and the requirements for providing periodic (usually at least annual) information to shareholders.

In short, bylaws are the corporation’s major decision-making and operating procedures set down on paper. This can help owners refine and improve their common practices, and can also serve as a “referee” when uncertainty or disagreements arise on what the official solution is to a given situation or need. Bylaws also give your firm credibility in the eyes of shareholders, creditors, potential investors, other businesses, and even the IRS. Owners should take care, though, to make sure their bylaws do not conflict with their state’s Business Corporation Act or its equivalent.

If the board of directors is not already appointed in the articles of incorporation—a requirement in some states—the initial board’s names and addresses will need to be listed in a separate document. These directors will serve on the board until the first annual shareholders’ meeting, when a new board will be elected.

One of the new corporation’s most important tasks is to prepare minutes for the first board of directors meeting. This first meeting is where several key company actions should be approved, such as electing officers, adopting bylaws, selecting the main office or headquarters location, choosing a bank for corporate accounts, the accounting period or fiscal year, initial tax elections, and issuance of initial shares of corporate stock. Normally the groundwork and supporting research is done before the actual meeting, although the board can change or amend the minutes as prepared if they vote to do so. Any of the initial directors can prepare the minutes, but the entire board must sign them at the meeting, incorporating any amendments or changes as needed.

Thereafter, at a minimum, the corporation must hold a shareholders’ meeting and a board of directors meeting at least annually; accurate, complete minutes for both are essential, because these documents will be used as reference materials for future decisions. Remember: “If it’s not written down, it didn’t happen.”

A limited liability company, on the other hand, comes officially into being when its articles of organization are filed with the state’s LLC office. The articles contain basic organizational information about the LLC, such as its name; whether it’s managed by its members or by selected members called managers; the name and address of its members; and where its office is.

Next to its articles of organization, the most important document for an LLC is its operating agreement. This isn’t required by the state (except for New York)—but it’s a key internal document that officially records how the LLC will run. It is very much the same as a partnership agreement; except for an LLC it is called an operating agreement. It lists the members, how much each member has invested, how profits will be divided, and how much weight each member has when matters come to a vote. It may also specify requirements for meetings (notice, quorum, voting rules, etc.) and the like, but it doesn’t have to. Normally, however, the operating agreement does include state-mandated requirements.

 External Requirements

External requirements usually consist of a periodic report to the state and some kind of fee. Most states require corporations and LLCs to file an annual or biennial statement or report, along with an associated filing fee of some kind. LLCs may also be liable for payroll tax, property taxes, sales and use taxes or “seller’s permits,” or business license renewals. Other state or local filings, such as business licensing or state or municipal tax registrations, may also be required. Owners will also still file their individual state and federal income tax returns.

Some states also impose a franchise tax—basically a fee paid by the company for the state’s permission to operate there. Different states use different methods to calculate the franchise tax; it may be based on revenue, or on some measure such as a corporation’s total number of authorized shares and their value.

Each state has its own deadlines for annual statements and franchise taxes. Some states determine these based on the formation anniversary of the corporation or LLC. Other states set one deadline for annual statements for all corporations and another for all LLCs. Business owners need to know how and where to research these requirements so that they can plan for them before incorporating, and then keep up with changing requirements as their business continues to operate and progress.

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One advantage of the S Corporation is that like the LLC it receives pass through taxation. Pass through taxation simply means that federal income tax is not assessed at the entity level; profits are distributed in the form of dividends and flow through to the individual tax returns of the shareholders, and the IRS taxes the shareholders at their individual income tax rate and not at the entity or corporation level. Therefore the S Corporation, unlike the C Corporation, is not subject to double taxation. Since net losses are “passed through” as well, the individual shareholder may be able to reduce his or her tax liability by offsetting other income with any S Corporation losses. One of the most enticing advantages of the S Corporation is its ability to minimize payroll / self employment taxes which can be a significant amount of money, currently the rate is set at 15.3%. For example let’s take an S Corporation with a single shareholder, if the company was to have a net profit of $90,000.00 and the shareholder / employee assigned himself a salary of $25,000.00 he would be able to reduce payroll / self employment taxes by $9,945.00. This is because only the $25,000.00 salary portion would be classified as earned income and subject to payroll / self employment taxes, the remaining $65,000.00 would pass through as a non-qualified dividend. While taxed at the personal income tax rate of the shareholder, the $65,000.00 is exempt from the self-employment / payroll taxes.

Companies doing business as an LLC have the same advantage of pass through taxation; however a single member LLC is treated as a disregarded entity by the IRS. The business entity is disregarded as a separate entity from its owner for Federal tax purposes; essentially what this means is that the IRS classifies the single member LLC as a sole proprietorship and since all income from a sole proprietorship is treated as earned income the full $90,000.00 would be subject to the 15.3% payroll / self employment tax. For this reason, an S Corporation could be viewed as a superior entity choice for the individual owner who is looking to minimize his or her payroll and self-employment tax exposure.

A multimember LLC is treated by the IRS as a Partnership as the default status for federal tax purposes. This requires that the LLC file the Form 1065 Partnership return (informational only - the LLC does not pay federal taxes), and the net income (or loss) passes through and is accounted for on the tax returns of each individual member.

Companies doing business as S Corporation must first form a standard corporation with the state (and the default federal tax status at that point is that of a C Corporation). After the corporation is formed with the state the company must file an IRS Small Business Tax Election form 2553 stating their intention to be taxed as an S Corporation. IncFile prepares the Form 2553 and returns it to you for your signature along with your filed corporation, and after the initial shareholders have signed it can simply be faxed or mailed in to the IRS. The IRS Form 2553 must be signed and submitted to the IRS within 75 days of the date of formation of the Corporation.

There are advantages to starting an LLC. For one thing members may be individuals, other partnerships; they may be non-resident aliens or a trust. This allows for more flexibility for the company formation. Distributions need not be equal. If one member invests more or contributes more to the business, that member may reap more of the profits. The agreements of disbursement are stipulated in the LLC operating agreement. Additionally, there need be no organized meetings and minutes, often an unnecessary formality for a small business. Taxes “pass-through” the company, and the individual members are taxed at an individual levels and not the company level according to their profits or losses. While LLCs file tax returns, the company does not pay federal income tax. Consequently, administrative paperwork and accounting are simpler for an LLC. Perhaps the most important advantage to LLCs is that it provides liability protection to the business owners, since owners are considered separate entities from the LLC. Personal assets are not connected to the company if the LLC is in litigation.

You might wonder, “Can anything be simple”? Well, yes, with the proper help some things, like forming an LLC, can be made quite simple. Knowing where to look may be the hardest task. You can hire a lawyer to guide you through the process of an LLC formation, but expect this to be costly. Using an online incorporation company is another option. Online incorporation companies will guide you through the process. Look, to incfile.com for help when filing for a LLC. With their help, the process can be made quite simple. An online incorporation company such as incfile.com will process the paperwork with the state of formation as well as file any necessary IRS forms.

Generally speaking, most states will expect you to be registered with them if there is substantial ongoing business and/or a physical presence in that state. If you do form your company in a state other than the one in which your company is located, you may ultimately need to register your company as a foreign (out of state) company with your home state, which will subject you to all of the fees, taxes, and regulations of that state.

NOTE: When choosing a company keep in mind that many company names comprised of two and three letter combinations are frequently unavailable.

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NOTE: If you require us to provide a registered agent, the address cannot be used as a general business/mail forwarding address. Only official legal and tax correspondence from the state will be forwarded, and any other mailings to the registered agent may result in additional charges.

An LLC consists of one or more members which may be individuals, partnerships, limited partnerships, trusts, estates, associations, corporations, other limited liability companies or other business entities. The members of an LLC are afforded limited liability similar to shareholders of a Corporation and have pass-through taxes comparable to a partnership.

NOTE: These are general tax explanations and may not apply to everyone. You should confer with the appropriate accounting/tax specialists to make sure you understand your personal tax liability.