Keeping it Legal - Small Biz Entity Compliance

Maintaining Legal Compliance in S-Corporations and Limited Liability Companies

Understanding the Basics

This is a frequent topic with our small business owners. "How do I make sure I do things the right way from a legal perspective?" If you get sued or audited, need to borrow money, want an investor or partner, or decide to sell all or a portion of the business, you MUST pay attention to these issues. If important documents are missing or outdated, it will cause harm, diminish value, or expose you to liability.

Before diving into compliance matters, let's clarify the distinctions between S-Corporations and Limited Liability Companies (LLCs).

• S-Corporation: A type of corporation that passes its profits and losses directly to its shareholders, avoiding double taxation. To qualify, an S-Corporation must meet specific criteria, including having no more than 100 shareholders and only one class of stock.

• Limited Liability Company (LLC): A hybrid business structure that combines elements of a corporation and a partnership. LLCs offer limited liability protection to their members, meaning their personal assets are generally shielded from business debts.

Key Compliance Considerations

Regardless of whether you're operating an S-Corporation or an LLC, adhering to legal compliance is crucial. Here are some essential factors to consider:

1. Organizational Documents (keep on-hand and up-to-date):

   • Articles of Incorporation (S-Corp): Ensure these documents accurately reflect your business structure, name, purpose, and initial shareholders.

   • Articles of Organization (LLC): Similar to an S-Corporation, these documents outline the basic structure, name, and purpose of your LLC.

   • Operating Agreement (LLC): A contract that governs the internal operations of your LLC, including ownership interests, management structure, and dispute resolution procedures.

   • Bylaws (S-Corp): A contract that governs the internal operations of your S-Corp, including ownership shares, director and officer structure, and dispute resolution procedures.

2. Tax Compliance:

   • EIN: The entity needs to acquire a tax ID number from the IRS. This is essential for the entity to report taxes, pay employees, open a bank account, and more.

   • S-Corporation Taxes: S-Corporations pass profits and losses to shareholders, who report them on their individual tax returns. However, the corporation still needs to file a corporate tax return.

   • LLC Taxes: LLCs can be taxed as sole proprietorships, partnerships, or corporations. The choice of tax status depends on the number of members and the desired tax treatment.

   • Other Tax: The entity may be required to obtain a sales tax number if it sells a product. It may need to report taxes to other states if it sells across state lines.

3. Perpetual Existence:

   • S-Corporations: Have perpetual existence, meaning they can continue to operate indefinitely unless dissolved.

   • LLCs: Generally have perpetual existence, but this can vary depending on state laws.

4. Shareholder or Member Meetings:

   • S-Corporations: Regular shareholder meetings are required to approve important decisions, such as electing directors and approving dividends.

   • LLCs: Member meetings are not always mandatory, but they can be beneficial for making important decisions and maintaining transparency.

   • Even though LLCs are less formal, it is a best practice to hold regular member meetings. And always document them!

5. Recordkeeping:

   • S-Corporations and LLCs: Both entities must maintain accurate records of financial transactions, minutes of meetings, and other relevant documents. This is probably the most important thing you as a business owner can do to protect your company and yourself from liability.

   • Bookkeeping: Keep separate your personal and business accounts. Commingling these will expose an attack point for a lawsuit. Maintain good financial records. Consider outsourcing this service.

   • Licensing: Remember that the entity will probably need a business license of some sort from your locale, especially if it is "brick and mortar." It or you might also need a professional or occupational license.

     
     

Additional Considerations for S-Corporations

• Shareholder Eligibility: Only U.S. citizens or residents can be shareholders of an S-Corporation.

• Number of Shareholders: An S-Corporation cannot have more than 100 shareholders.

• One Class of Stock: There can only be one class of stock issued by an S-Corporation.

Conclusion

Maintaining legal compliance is essential for the long-term success of your S-Corporation or LLC. By understanding the key requirements and seeking professional advice when needed, you can ensure that your business operates within the boundaries of the law.