FAQsBusiness and nonprofit law can be complicated. We hope to answer some basic questions in this section, but if not, just give us a call at 830.285.9087.
- 1. I want to start a business - why should I incorporate?
There are a hundred reasons to incorporate a small business, but let's talk about the basics - avoiding personal liability, tax flexibility, and perpetual existence. With the many business forms available, one will be right for just about any set of needs. Unless you choose another business form, by default your business will be either a sole proprietorship or, if you are in business with another person(s), a partnership. This is almost always a poor idea.
Each sole proprietor or partner is completely liable for all of the business's actions and debts. Incorporating or forming an LLP lets owners separate personal assets and liabilities from the business entity's. The business becomes a "person" in its own right for this purpose. Except under certain, limited circumstances such as fraud, an owner can not be held individually responsible. Likewise, any personal debt or liability of a sole proprietor or partner allows a creditor to pursue the assets of an unincorporated business whether or not the debt or liability has any relation to that business.
In a sole proprietorship or partnership, the business's taxable income becomes the owner's or partners' taxable income, and tax rates depend on their tax brackets. Because a corporation is a separate entity, it is taxed under corporate tax rules for that type of business. For some businesses this can be problematic because income distributions to shareholders would be taxed twice - first in corporate tax, then again as individual taxes to those who receive the income. However, in S-corporations, LLC, LLPs, the principal(s) may still elect to have taxes flow through, if that is advantageous.
A corporation exists in perpetuity until its directors or shareholders decide to dissolve it. A sole proprietorship or partnership will be affected by the owners' circumstances. For example, if an owner or partner were to decide to no longer run the business, the business is generally required to dissolve regardless of the wishes of the sole proprietor or remaining partner(s). An incorporated business can continue to be operated by others, or be sold. An LLP can reform as needed to allow the exit of a partner, or the addition of others.
- 2. What is a non-profit organization?
A nonprofit organiation is a corporation (or unincorporated association) that may not distribute any of its income to members, directors, or officers. They may be created for any lawful purpose, which must be stated in its certificate of formation when organized as a state business entity. In general, they are mission-driven, not profit-driven. The IRS defines more than 25 types of nonprofits that may qualify for tax exemption.
Nonprofits are not automatically exempt from federal or state taxes. To become exempt, the organization must meet certain requirements and apply with both the IRS and the state taxing authority.
- 3. I’d like to be able to treat my workers as independent contractors, not employees. What is the difference?
There is a lot more to deciding on whether someone who works for a business is an employee or independent contractor than how the decision-maker wants to pay the person. The nature of the person's work will determine the status, which is complicated because the rules aren't simply set in stone. There are multiple places to look when answering this question - what makes an independent contractor has been outlined by common law principles and court decisions, and the Fair Labor Standards Act.
The IRS and many states have adopted common law definitions of an independent contractor that mainly focus on how much control an employer has over a service or product. In other words, does the employer define what is being done and how it will be accomplished?
Method of compensation also is a factor. If a person is on an employer's payroll and receives a steady paycheck, the person is an employee. Independent contractors are generally paid in other ways, such as fees to complete a particular task. Other considerations that suggest that someone is an independent contractor may include:
1. If the worker supplies all equipment, materials, and tools.
2. Whether the worker could be discharged at any time, and can choose whether or not to come to work without fear of losing the job.
3. If the worker control the hours of employment.
4. Whether the work is temporary or permanent.
In general, when work is considered ongoing and integral to the business, it is more likely that the person is an employee.
Courts and federal agencies have come up with an "economic realities test" in an attempt to interpret parts of the Fair Labor Standards Act and decide when a person is an employee or independent contractor. It looks at how dependent the worker is on the business for which he works. If a large portion of his salary comes from that business, chances are that he is as an employee. The test also factors in other considerations such as level of skill, integral nature of the work, the employer's and worker's intent, and payment of social security taxes and benefits.
These courts also look to the "right to control." When a business controls the way work is carried out and a product is delivered, the relationship is employer/employee. If an employer does not have authority over how a worker does the job but provides goals and guidelines, the relationship between the parties tends to be that of a hiring party/independent contractor.
- 4. Do I need written employment contracts for my staff?
Written employment contracts are not required, but they can be a good idea in some situations. Contracts often include such terms as the employee's responsibilities, grounds for termination, notice for ending the relationship, noncompetition or confidentiality agreements, and pay and benefits.
Employment agreements are most useful when an employer wants to control how an employee leaves a business. Contracts that require a set notice period for leaving the company can help avoid problems replacing an employee with very little warning. They can provide some surety that confidential or trade secret information will not be passed on, or that a highly valued employee with deep industry contacts and intimate knowledge of the business will not immediately accept employment with a competitor.
Contracts can also help attract quality workers, when they feel they have some surety in the employment relationship. While it would be nice to operate on a "handshake," many employees have gotten the worse end of the deal in those situations and are more comfortable with some guarantees regarding pay, reviews, and benefits. The flip side is that this gives the employer less flexibility as conditions change.