The Law (in Plain English) for Small Business (Fifth Edition)

Leonard D. DuBoff, Amanda Bryan

• Publisher: Allworth
• Year: 2019
• ISBN:
  9781621537113
• Edition: 5
• Topic: Commerce
• Subtopic: Droit des affaires

"Well written and logically organized." — Booklist. This handbook makes planning and problem-solving easy with its clear explanations of complex issues. In The Law (in Plain English)® for Small Business, Fifth Edition, Leonard DuBoff and Amanda Bryan guide entrepreneurs and small business owners through the maze of legal obligations and protections they need to understand. Chapters cover important topics such as:

• Licenses
• Trademarks
• Insurance plans
• Franchising
• Incorporating
• Advertising
• eBusiness considerations
• Taxes
• Succession planning

Whether one is just about to open a small business, reassessing an existing business, or simply have a few questions, The Law (in Plain English)® for Small Business, Fifth Edition, is the go-to resource for small business owners and entrepreneurs.

CHAPTER 1

Organizing Your Business

Everyone in business knows that survival requires careful financial planning, yet few fully realize the importance of selecting the best legal form for the business. Small businesses have little need for the sophisticated organizational structures utilized in large, publicly traded corporations, but since all entrepreneurs must pay taxes, obtain loans, and expose themselves to potential liability with every sale they make, it only makes sense to structure one’s business so as to address these issues.

Every business has an organizational form best suited to it. When we counsel people on organizing their businesses, we usually adopt a two-step approach. First, we discuss various aspects of taxes and liability in order to decide which of the basic legal structures is best. There are only a handful of basic forms—the sole proprietorship, the partnership, the corporation, the limited liability company, the limited liability partnership, and a few hybrids. Once we have decided which of these is most appropriate, we go into the organizational documents such as partnership agreements, corporate bylaws, or operating agreements. These documents define the day-to-day operations of a business and must be tailored to individual situations.

What we offer here is an explanation of the features of each of these kinds of organizations, including their advantages and disadvantages. This should give you an idea of which form might be best for your business. We will discuss potential problems, but, since we cannot go into a full discussion of the more intricate details, you should consult an experienced business attorney before deciding to adopt any particular structure. Our purpose is to facilitate your communication with your lawyer and to enable you to better understand the choices available.

SOLE PROPRIETORSHIPS

The technical name sole proprietorship may be unfamiliar to you, but chances are you are operating under this form now. The sole proprietorship is an unincorporated business owned by one person. As a form of business, it is elegant in its simplicity. All it requires is a little money and work. Legal requirements are few and simple. Generally, all you need is a business license and to register the name of the business, if you operate it under a name other than your own.

Disadvantages

There are many financial risks involved in operating your business as a sole proprietor. If you recognize any of these dangers as a real threat, you probably should consider an alternative form of organization.

If you are the sole proprietor of a business venture, you are personally liable for the debts of the business. This means that the property you personally own is at risk. If, for any reason, your sole proprietorship owes more than the dollar value of your business, your creditors can force a sale of some or all of your personally owned property to satisfy the debt.

For many risks, sometimes called liabilities, insurance is available that shifts the loss from you to an insurance company, but there are some risks for which insurance is simply not available. For instance, insurance is generally not available to protect against a large rise in the cost or sudden unavailability of supplies, inventory, or raw materials. In addition, the cost of product liability insurance has become so high that, as a practical matter, it is unavailable to most small businesses. Even when procured, every insurance policy has a limited, strictly defined scope of coverage. These liability risks, as well as many other uncertain economic factors, can drive a small business and its sole proprietor into bankruptcy.

Taxes

The sole proprietor is personally taxed on all profits of the business and may deduct losses. Of course, the rate of taxation will change with increases in income. Fortunately, there are ways to ease this tax burden.

IN PLAIN ENGLISH

Maximize your tax savings by establishing an approved individual retirement account (IRA) or contributing to a pension fund. By deducting a specified amount of your net income for placement into an interest-bearing account, approved government securities, mutual funds, or company pension plan, you can withdraw the funds at a later date—when you may be in a lower tax bracket. There may, however, be severe restrictions if you withdraw the money prior to retirement age. (See Chapter 23: Pension Plans, for a more complete discussion of this subject.)

For further information on tax planning devices, contact your local Internal Revenue Service (IRS) office either by phone or online to obtain free information, or use the services of an accountant experienced in dealing with business tax planning.

PARTNERSHIPS AND JOINT VENTURES

A partnership is defined by most state laws as an association of two or more persons to conduct, as co-owners, a business for profit. No formalities are required. In fact, in some cases, people have been held to be partners even though they never had any intention of forming a partnership. For example, if you lend a friend some money to start a business and the friend agrees to pay you a certain percentage of whatever profit is made, you may be your friend’s partner in the eyes of the law even though you take no part in running the business. This is important because each partner is subject to unlimited personal liability for the debts of the partnership. Each partner is also liable for the negligence of another partner and of the partnership’s employees when a negligent act occurs in the usual course of business.

This means that as with a sole proprietorship, each partner is personally liable for the debts of the business. If, for any reason, your partnership owes more than the dollar value of the business, the partnership’s creditors can force a sale of most or all of your and your partners’ personally owned property to satisfy the debt.

A joint venture is a partnership for a limited or specific purpose, rather than one that continues for an indefinite or specified time. For example, an arrangement whereby two or more persons or businesses agree to build a single house and sell it for profit is a joint venture. An agreement to develop numerous properties over a period of time is a partnership.

Advantages and Disadvantages

The economic advantages of doing business in a partnership form are:

• the pooling of capital;

• the collaboration of skills;

• easier access to credit enhanced by the collective credit rating; and

• a potentially more efficient allocation of labor and resources.

A major disadvantage is that, as noted above, each partner is fully and personally liable for all the debts of the partnership, even if not personally involved in incurring those debts.

This means that if you are getting involved in a partnership, you should be especially cautious in two areas: First, since the involvement of a partner increases your potential liability, you should choose a responsible partner. Second, the partnership should be adequately insured to protect both the assets of the partnership and the personal assets of each partner.

Formalities

No formalities are required to create a partnership. If the partners do not have a formal agreement defining the terms of the partnership, such as control of the partnership or the distribution of profits, state law will dictate the terms. State laws are based on the fundamental characteristics of the typical partnership and attempt to correspond to the reasonable expectations of the partners. The most important of these legally presumed characteristics are:

• no one can become an actual member of a partnership without the unanimous consent of all partners;

• every member has an equal vote in the management of the partnership regardless of the partner’s percentage interest in it;

• all partners share equally in the profits and losses of the partnership, no matter how much capital each has contributed;

• a simple majority vote is required for decisions in the ordinary course of business and a unanimous vote is required to change the fundamental character of the business; and

• a partnership is terminable at will by any partner—a partner can withdraw from the partnership at any time, and this withdrawal will cause a dissolution of the partnership.

Most state laws contain a provision that allows the partners to make their own agreements regarding the management structure and division of profits that best suit the needs of the individual partners.

Partnership Agreements

A comprehensive partnership agreement is no simple matter. Some major considerations in preparing a partnership agreement include the name of the partnership, a description of the business, contributions of capital by the partners, duration of the partnership, distribution of profits, management responsibilities, duties of partners, prohibited acts, and provisions for the dissolution of the partnership. (These items are detailed in Chapter 2.) It is essential for potential partners to devote time and considerable care to the preparation of an agreement.

IN PLAIN ENGLISH

Enlist the services of a competent business lawyer. The expense of a lawyer to help you put together an agreement suited to the needs of your partnership is usually well justified by the economic savings recouped in the smooth organization, operation, and, when necessary, the final dissolution of the partnership.

Taxes

A partnership does not possess any special tax advantages over a sole proprietorship. Each partner pays tax on his or her share of the profits and each is entitled to the same proportion of the partnership deductions and credits. It is important to note that each partner pays tax on the profits received whether the profits are distributed to the partners or retained by the partnership. The results of this rule can be, especially for new partnerships that reinvest profits into the business, that the partners pay taxes without receiving any, or receiving very little, distributions from the business and must pay taxes from other resources.

The partnership must prepare an annual information return for the IRS known as Schedule K-1, Form 1065. This form details each partner’s share of income, credits, and deductions that the IRS uses to check against the individual returns filed by the partners. The K-1 is used by the individual partner, much like a W-2 might be used by an employee, to prepare the individual’s state and local income tax filings.

LIMITED PARTNERSHIPS

The limited partnership is a hybrid containing elements of both partnerships and corporations. A limited partnership may be formed by parties who wish to invest in a business and share in its profits but seek to limit their risk to the amount of their investment. The law provides such limited risk for the limited partner, but only so long as the limited partner plays no active role in the day-to-day management and operation of the business. In effect, the limited partner is very much like an investor who buys a few shares of stock in a corporation but has no significant role in running the business. While the limited partner will have limited personal liability, the general partners will have full personal liability just like a sole proprietor or a partner in a standard partnership. This means that the general partner’s personal property may be sold by the limited partnership’s creditors to cover the limited partnership’s debts.

Formation

In order to establish a limited partnership, it is necessary to have one or more general partners who run the business and one or more limited partners who play a passive role. In order to form a limited partnership, the organizer must prepare and file documentation with the proper state agency. If this documentation is not filed or improperly filed, a limited partner could be treated as a general partner and lose the benefit of limited liability. In addition to filing the appropriate documents, the limited partner must refrain from becoming involved in the day-to-day operation of the partnership. Otherwise, the limited par...