Choosing a Business Entity

Whether you are just starting a business enterprise or you’ve been running your existing business as a sole proprietor or as a partnership, you should consider whether it makes sense to form a separate legal entity for the business. This is important for accounting purposes, as well as insulating your personal assets from the liabilities, debts and obligations of the business.

If you are operating your business as a sole proprietor, then from a legal and tax perspective, you, as the owner, are inseparable from the business. Since a sole proprietorship and its owner are considered one and the same, taxes on a sole proprietorship are determined at the personal income tax rate of the owner. In fact, a sole proprietor simply reports all business income or losses on an individual income tax return.

Similarly, because they are the same entity, a sole proprietor is personally responsible for any liabilities, obligations and debts of the business.

If you have a partner, then you have formed a general partnership, which is defined under the Maryland Code as “an association of two or more persons to carry on as co-owners a business for profit.”

Each partner is personally liable to third parties for all the liabilities, obligations and debts of the partnership, as well as the other partners. In this context, the only difference between a sole proprietorship and a partnership is that a partner could find him/herself liable for liabilities, obligations or debts created by another partner in the business. The partnership is not taxed as a separate entity. Instead, taxable income, losses, deductions, and credits are passed through on a pro-rated basis to each of the partners. Each partner is taxed directly on his/her share of the partnership’s net income, whether that income is distributed or not.

Why Form a Separate Entity?

Most of us carry casualty insurance, which protects our business from the loss of assets in the event of a casualty (e.g., a fire) and liability insurance (which, by the way, should always include contractual liability coverage), which protects your business from liabilities asserted by third parties for acts such as negligence (e.g., a fire caused by your -- or your employee’s -- negligence in your leased space which damages or destroys the landlord’s premises). But there could be situations where the insurance proceeds either don’t cover the claim being asserted or where the limits of coverage are insufficient to cover the entire amount of the claim being asserted. Also, business and economic cycles could create financial pressures on your business operations, making it necessary to negotiate with lenders, landlords and other creditors.

Unless your business is a separate legal entity, your home and other personal assets could be at risk. Establishing a separate legal entity, maintaining its separate existence and using the entity’s name on your marketing materials, invoices, etc. will help protect your personal assets.

There are also tax and accounting benefits associated with establishing a separate legal entity. Each type of entity has different tax and legal implications so it is critical that you consult with your attorney and a tax advisor before forming a separate legal business entity.

Next week I will discuss the various types of common legal entities.

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Thinking of Filing a Lawsuit to Collect Long Over-Due Fees? Some Considerations Before Suing ...

There is no dearth of advice from business pundits on what business owners should be doing during this economic downturn to shore up the bottom line. A recent Business Week article seemed to tout going for a bike ride. Another suggested canning long-term goals. In such desperate times thoughts may naturally turn to those clients, customers and patrons that owe money to your business. If we could just collect some of this bad debt, the thinking goes, everything would be fine.

At the risk of oversimplifying a fairly complex analysis, here are some considerations savvy business owners must take into account when analyzing the various legal options:

1. Start at the end. That is, consider the likelihood of collecting if you win. This may depend on a combination of factors such as the potential defendant’s ability to pay, the length of time required to obtain a final judgment, and whether an insurance policy is available. If you do not know the defendant’s ability to pay, inquiring about assets through mutual acquaintances or obtaining an asset check may be considered. Next, determine how the assets of the delinquent are owned. For instance, is the potential defendant’s only asset a personal residence owned with a spouse as tenants by the entireties? Or, does the potential defendant have many assets, but few or none in the LLC that your business signed the contract with? Is bankruptcy a factor? Such factors greatly impact your business’s ability to collect any judgment obtained in court, and thus, warrant careful thought at the outset.

2. Equally important is the cost of pursuing the action. In truth, most lawsuits end in settlement where the parties, after having exhausted their resources or their wherewithal to fight, or both, finally determine that it is in their mutual best interests to resolve the lawsuit before a judge or jury has an opportunity to fully examine the case. Given this reality, it is best to weigh the cost to the business to pursue the litigation in earnest against what you may reasonably expect the defendant to offer to rid itself of the matter. Obviously, the availability of an insurance policy, or a written contract that states that the winner of a dispute between the parties is entitled to recover their attorneys’ fees, or anything that may mitigate your costs is very positive. As my partner Daniel P. Dozier discusses more fully in his ADR Law blog, it makes sense to explore mediation and other, less expensive options for collecting the debt. In any event, as the cliché goes, do not fail to count the costs. If it costs $20K to obtain a $25K judgment—have you won? Maybe, but the point is, you need to have a base line to measure against.

3. Finally — and this is the only point some litigants wish to consider — do you have a good case? I do not place whether the business has a viable case as the preeminent factor because if the potential defendant has no assets from which to collect, or the business does not have the means to pursue the action to a satisfactory conclusion, the merits of the case may be immaterial (aside from the bluff value). But having determined it is worth it to the business to file the lawsuit or to pursue mediation before or after filing suit, the merits of your case must be fully analyzed. Doing so has several benefits:

a.) It will likely give you the upper hand in settlement negotiations because you will have already determined the strengths and weaknesses of the case;

b.)It will force the decision makers in your business to take a sober look before committing company assets to the litigation; and

c.)You will be prepared to deal with technical considerations such as the timeliness of the lawsuit, the availability of proof to support your contentions, the defendant’s ability to effectively assert a defense (such as counterclaims), and the like.

Although this blog shares some of the analyses we go through with our clients, this blog is not intended to substitute for obtaining legal counsel. Each case must be evaluated independently with the help of a professional.

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Copyright Office's Increased Fees

As of August 1, 2009, the Copyright Office is instituting new fees for registering works that are protectable under the Copyright Law of the United States. And, as with many of the federal government agencies, the Copyright Office encourages people to register on-line.

In the case of a fully electronic registration of a basic claim, the fee remains $35.00. However, because the Copyright Office is required to recover the full cost for many of the services it provides, it has now instituted a new schedule of fees.

Because copyright protection applies to more than literary writings, there are other application forms to consider. If you are registering a visual art work, performing art work, sound recording or serial, such as magazine issues, newspapers, newsletters, then you must select the proper form whether you submit your registration application electronically or via a paper format. The fees for those kinds of submissions have been increased from $45.00 to between $50.00 and $65.00.

While the Copyright Office’s registration forms are short, their apparent simplicity can be deceptive. From the applicant’s point of view, it is critical to understand what kind of work you are seeking to protect and what ownership interest you have in the work. Moreover, the electronic registration process can require submissions to be made partially on-line and partially via delivery of an actual hard copy to the Copyright Office.

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