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Entrepreneurs have new business ideas all the time for a new product or service. It is their business to focus on how to bring new ideas to market quickly and efficiently. Worrying about liability, taxes, and staying in business after the product is on the market is often the province of lawyers. That is probably no surprise, as the consumer injured by a new product or stiffed by a business venture gone bad often comes to us lawyers to help them recover for their injuries.
Incorporating a business entity helps entrepreneurs plan for getting a product off the ground, can limit the personal liability of the entrepreneur in the event that things don’t work out, and can help to ensure that revenues earned result in appropriate taxes and fees paid to all the government entities that are owed something from the business. Thinking about starting a new business? Here are a few thoughts for you folks with great ideas.
When it comes to liability, the general rule is that it is easy to enter into a partnership and have personal liability. A partnership by definition is any profit making activity engaged in by two or more persons. Profits that are enjoyed by a partnership are taxable as income. In addition, partners are personally liable for acts or omissions of the partnership. So, for example, you and a friend might have decided to start providing a computer repair service, and started to work for your friends and family in the evenings or weekends. Your customers that paid you for services rendered were providing you with profit, which is taxable, and if you broke someone’s computer while trying to repair it, you and your friend are personally liable for the computer (and perhaps its contents, depending on whether you effectively disclaimed damages, had a written contract, or disclaimed implied warranties, as the circumstances might merit).
The reason why it is harder to limit your liability is that you have to think ahead of time of doing so through successfully incorporating a business entity in a particular state. In Maryland, this means drawing up the appropriate papers for incorporation (such as Articles of Organization for a corporation or limited liability company, or certificate of limited partnership for an LP, for example), making sure that your proposed corporate name is not already in use and will not be confusingly similar to another entity, filing the appropriate papers with Maryland’s SDAT, paying the fees, and waiting for SDAT to accept your papers. The Corporations and Associations Article of Maryland contains the starting point for the various business forms allowed under Maryland law.
In Maryland, there are several business forms that you can create, depending on the goals of your business. The business forms that provide some kind of limit to your personal liability are: limited partnerships, corporations, and limited liability companies. Limited partnerships are designed with the investor in mind who wishes to only passively invest and leave the liability for the general partner (there must be at least one general partner for a valid limited partnership in Maryland). Corporations allow for all the owners (stockholders) of the entity to have limited liability, but require that both the corporation and the stockholders to pay taxes on net profit and earnings, respectively. Limited liability companies allow for all the owners (members) of the entity to have limited liability, and allow profits and losses to be passed to the individual members as though they were general partners.
Beyond that, depending on the business form, the incorporators of the business may have to draw up corporate bylaws or draft an operating agreement. These documents describe how a business entity will operate, including how new business owners may join the business after incorporation, how owners may exit the company, how major business decisions are made, who has delegated authority to act as an agent for the company and the extent of that delegated authority, along with a host of other operational issues that are critical to a new business.
After you have created an appropriate business entity, an incoporator then should treat the business entity as separate from his personal finances. An entity needs to apply for a federal employer identification number (FEIN) or tax identification number from the IRS, and must file the appropriate documents with the IRS to establish federal tax accounts. These can be used to open a new bank account in the name of the corporate entity to help maintain separate financial accounting for the business. In Maryland, a business entity also needs to establish various accounts with the State for sales tax liability, income tax liability, unemployment tax if the entity is an employer, and the like.
Maryland requires that business entities file various tax filing documents annually (or more frequently for payroll, depending on how much the entity pays its workers), including a personal property tax filing, payroll reconciliation MW508, and some version of the corporate tax report (which may be a pass through entity such as a limited liability company on form 510, or a corporate tax form on form 500). The federal government also requires the filing of business tax forms and the payment of business taxes (or pass through to personal income if the business form is appropriate) on net profit.
If you are contemplating setting up a new business entity, you should talk with a good accountant or experienced tax attorney that can help you to start out right.
Business planning is the process of developing a plan for financing and marketing a product. The plan includes a roadmap for who will do what to help bring the product to market, who will have an ownership interest in the business entity, who will be responsible for handling the finances, and how much each owner will need to invest in the entity to get started. Management and authority are also important aspects of a business plan (in defining who will have final say in what areas of the management of the business, who can sign checks, who can bind the company to a contract, and so on) Business plans should also include some research on the market and potential competitors, and some sense of the time it will take to realize a return on an investment in a particular product or service. The more detailed and thoughtful the business plan, the more likely that the business will succeed.
Complying with these many rules is necessary (and this is just the surface at a high level) to maintain your business entity in good standing. Which entity is right for you depends on your circumstances and the kind of business activity that you are considering engaging in. An experienced attorney can help you to select an appropriate business entity, and help you to file the appropriate papers to incorporate. Need help incorporating? Contact us for further information.