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Make Your
Business Legal

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Dun & Bradstreet estimates that there are over eleven million businesses in the United States. The overwhelming majority of these companies are small, privately held concerns.

Before charging off to join the ranks of this army of small enterprises you will need to give some serious thought to the legal structure that is most suitable for your particular business. Consideration should be given not only to your current circumstances but also to your future plans and objectives as you determine the legal structure under which you will operate.

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Numerous factors will influence your ultimate decision, including:

  • Cost and complexity of the various alternatives
  • Control issues
  • Legal reporting requirements
  • Tax considerations
  • Flexibility
  • Liability concerns

Let's examine some of the alternatives and discuss the advantages and disadvantages of each of these. There are significant differences between alternative business structures, particularly with respect to taxation and liability. As always, it is advisable to obtain legal and tax advice before proceeding.

Legal Business Entities

Sole Proprietorship

By far the most common and simple of the business structures is the sole proprietorship. A sole proprietorship is the de facto structure of choice for many would-be entrepreneurs who are eager to "hang out their shingle" and get on with business without the burden and expense of filing for corporate status.

From a legal as well as a tax perspective, no distinction is made between the owner of the business and the business itself. In short, they are one and the same. This is a concept which has important implications. In essence, as the owner of a sole proprietorship you personally assume all the liabilities and responsibilities of the business.


  • Start-up costs are low.
  • Registration is simple and quick.
  • Taxation occurs at your personal tax rate, which may be lower than the corporate rate.
  • It may be possible to shield non-related personal income from taxes through the deduction of legitimate business expenses.
  • You are in total control of your business.
  • The business can be discontinued at will.


  • As the owner of a sole proprietorship, you are personally liable for any and all liabilities which are incurred by the business.
  • Because you are the sole shareholder, access to capital may be limited.
  • In order to allow the entry of other stockholders or partners, the legal structure of the business must be changed.

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A partnership is essentially a pooling of resources of two or more individuals or businesses to form a new legal business entity. The partners become co-owners of the jointly formed enterprise.

A partnership agreement is necessary to spell out the details of the partnership arrangement, including ownership interests, capital requirements, profit distributions and general responsibilities of each of the partners. This document is critical to the smooth operation of the partnership as well as the protection of the involved parties. If possible it should be drafted under the guidance of a qualified attorney.

General vs. Limited Partnerships:

There is an important distinction between general and limited partnerships which should not be overlooked. An active partner in a business is normally considered to be a general partner. Each partnership must have at least one general partner. The general partners manage and operate the business. They also assume complete and unlimited personal liability for all debts of the partnership.

Limited partners, by contrast are really just passive investors. They are inactive in the management and operation of the partnership and their liability for the debts of the partnership is limited to the amount of their investment. If the partnership fails, they stand to lose their entire investment. Other personal assets (like their homes) however, are generally protected from creditors of the partnership. The same cannot be said of the general partners.


  • Allows for a pooling of capital and resources.
  • Distributes liability and exposure over more individuals or business entities.
  • Allows for a variety of perspectives that may facilitate prudent decision-making.
  • Partnerships are not taxable entities. All profits pass through to the partners and are taxed at their respective tax rates.
  • Losses incurred by the partnership may be allocated to each of the partners according to their share of ownership in the business and used to offset other ordinary income.


  • The general partners in a business assume unlimited personal liability for all debts incurred by the partnership.
  • Certain tax forms and profit distribution schedules must be filed each year with the IRS.
  • Overall control of the business is distributed among the various partners according to their level of ownership. If you have a minority position in the firm, you may find that the strategic direction of the business is not always consistent with your expectations.

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After the sole proprietorship, the corporation is the most common business entity. The corporation is a versatile business structure with special characteristics that make it appealing to owners and investors.

To begin with, the corporation is considered to be a separate legal entity with an indefinite life span. As a separate entity it is liable for its own debts. Owners or stockholders are liable for the debts of the corporation only to the extent of their investment in the firm. An additional advantage of the corporation is its facility for raising capital through the sale of stock to numerous potential investors.

Because the corporation is a more formal organization than the sole proprietorship, it has special reporting requirements and is more complex and expensive to establish. It is also subject to a potentially expensive double taxation. This occurs because the dividends, which are paid out to shareholders from corporate profits, are not tax deductible to the corporation. In other words, they are recognized and taxed as income to the corporation and then paid out to shareholders in after-tax dollars. Once these dividends are distributed, they become subject to a second round of taxes as they are recognized as income by each individual shareholder.


  • Owners and investors have limited liability for the debts of the corporation.
  • Corporations can have numerous stockholders providing important access to capital.
  • Corporations can endure indefinitely.
  • Ownership is easily transferred through the sale of stock.


  • Corporations are relatively costly and time consuming to establish.
  • Corporations have special ongoing reporting requirements.
  • Double taxation of income may occur in a corporation.
Subchapter S Corporation

The Subchapter S Corporation or S Corporation, as it is commonly called, is a relatively new alternative to the traditional corporation. Designed for small businesses, it allows business owners to enjoy limited liability benefits while avoiding the onerous double taxation of corporate earnings.

The S Corporation is essentially identical to a normal corporation with several significant exceptions:

  • The S Corporation is considered a pass-through entity for tax purposes. That is, profits are not taxed to the corporation but are passed directly to the shareholders. They are taxed only once.
  • The S Corporation can have only a limited number of stockholders (currently 75 - up from 35 under a previous law). This precludes large and very widely held public corporations from taking advantage of subchapter S status.
  • There are restrictions on stock ownership and subsidiary ownership designed to maintain the integrity and intent of this popular alternative - although these have been relaxed significantly in recent years.
  • There are restrictions pertaining to the conversion of a normal corporation to an S Corporation and vice versa. Generally a period of time is required before a company is able to change its election.
Limited Liability Company

The limited liability company (LLC) is a relatively new alternative that is now being offered in many states. The LLC operates very much like a partnership but offers investors the additional benefit of limited liability for company debts.

Like the partnership, the LLC passes profits and losses directly on to investors according to their level of ownership in the firm.


  • LLC's can offer multiple classes of stock
  • LLC's can have an unlimited number of shareholders
  • Equity ownership can be held by corporations and partnerships as well as individuals
  • Owners assume no personal liability for debts of the LLC
  • Profits and losses can be passed directly to owners


  • Certain restrictions apply to the transfer of equity ownership
  • States differ with respect to taxation of LLC's
  • LLC's have no continuity of life. If an owner dies or leaves, the LLC is dissolved.
Complying with Legal and Regulatory Requirements

In addition to defining the legal structure of your new business, you must ensure that you are complying with all local, regional and national regulations relating to the establishment and operation of your business.

Business Licenses

It is important that you properly license and register your business with the appropriate local, county and state authorities. While this is generally neither expensive nor time-consuming it is a critical step in properly establishing your business.

Licensing requirements will vary by city and state. A good place to start would be to contact your local licensing authority and inquire about the requirements for starting a new business. Look in the city or county government pages of your local telephone directory for a listing entitled Business Licenses, Business Taxes or City Clerk.

Zoning Restrictions

Local zoning requirements are designed to safeguard the community from the hazards and nuisance of heavy traffic flows, parking problems, unsightly premises, noisy operations, and other potential problems arising from your business activities.

If you decide to lease commercial office space, the building owner or manager will be able to inform you of any specific restrictions relating to the site. If you choose to operate from your home you will need to call the planning or zoning office in your town or city to inquire about possible restrictions. If you intend to operate a service business you will generally not experience problems but it is always a good idea to receive the blessing of the city before beginning your operations.

Employer Identification Number

The employee identification number (EID) is an extremely important but often overlooked requirement for running a business. The EID works very much like a social security number. It is the means whereby the federal government monitors and verifies employee related tax payments from business organizations. Employer identification numbers are required by law for all businesses that employ one or more individuals. There are quarterly payroll tax payment and reporting requirements that carry stiff penalties if ignored. You would be well advised to make this a matter of considerable priority both at the outset of your business and on an ongoing basis thereafter.

Neglecting payroll tax payments is a very serious matter. Falling behind on payroll taxes has caused more than one business failure. In the long run it is far more expensive to ignore or postpone payroll tax payments than virtually any other payment obligation I can think of.

An application for an EID is available from the IRS.

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Developing a Credit Rating

If you are interested in building a credit rating, it is advisable to register with Dun & Bradstreet, or other national business credit reporting agencies. Dun & Bradstreet will assign your business a DUNS number - a business identification number. Your DUNS number will become a permanent part of your business identity and will be widely used by government and industry to identify your organization.

There is no cost to register with D&B and it is strictly voluntary. However, you should be aware that a DUNS number will eventually be assigned automatically and a credit file compiled on your business. You should also be aware that the Federal Government requires that all of their contractors have a DUNS number.

It is often in your best interest to cooperate with credit agencies to ensure that your credit report contains as much positive information as you are able to legitimately provide.


Trademarking allows a business to register a name or symbol for its sole use in identifying its specific products or services. Most recognizable brand names are trademarked. Trademarks can become very valuable over time. For example, if I could go out and develop a new soft drink and label it Coca-Cola, I might stand to make a lot of money. The Coca-Cola trademark is extraordinarily valuable. Unfortunately for me, it is already registered to the Coca-Cola Company. This prevents me from using it.

Trademarks can be obtained for business names, logos, product names and even key phrases used to market or identify a business, product or service. A trademark provides for the exclusive use of the trademarked identifier for a period of ten years. Trademarks are generally renewable for subsequent ten-year periods until the trademark is allowed to lapse without being renewed. At that point it is up for grabs. A smart company will never allow a valuable trademark to lapse.

For a fee you can have a trademark attorney conduct a national search to ensure that your preferred name has not already been trademarked by another firm. If it is available, the attorney will have it registered - for an additional fee. There is also a fee assessed by the U.S. Department of Commerce to register the name. Total fees for attorney services and registration fees can quickly approach $1,000 or more.

A growing number of on-line services are available to assist you in conducting trademark searches and name registrations. Trademark Express can be contacted at 1-800-340-2010 or visited at www.tmexpress.com on the Internet.

Of course, many people opt to save money by conducting their own searches and registration on the U.S. Department of Commerce website. The U.S. Department of Commerce maintains an interactive public domain database which is updated every few months. Most searches can be completed in a matter of seconds.

Current as well as pending trademark information is available through this on-line database. Trademark requests can also be processed on-line for the normal filing fee. The U.S. Department of Commerce Patent and Trademark Office web page can be found at www.uspto.gov on the Internet.

The Patent and Trademark office can also be contacted at 1-800-786-9199. Trademark applications and information can also be requested in writing from the U.S. Department of Commerce, Patent and Trademark Office, Washington, DC 20231.

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