Don’t be Fooled by Solicitations from Companies that Will “File” Your Annual Corporate Minutes (for a fee, of course)

After receiving a suspicious-looking solicitation on “official” letterhead bearing a Sacramento address, clients often ask:

“I got a form in the mail entitled “Disclosure Statement: Department of Annual Business Minutes (DOBM)” or “Annual Disclosure Statement” (or something similar), from a Sacramento address. It says I must fill it out and return it with a check for $125. Is this a scam? Do I need to do anything with my minutes on a yearly basis?”

Generally speaking, these are scams. I, myself, receive these solicitations several times a year. There are many companies out there that get an address somewhere in Sacramento (sometimes it’s just a mailbox store), and send envelopes with logos that somewhat resemble the official seal of the State of California, or they may look like they are from the Secretary of State’s office or the Department of Corporations. They generally tell you of some ill that will befall you and your business of you do not immediately sign the form and send it back with anywhere from $115 to $150 for annual minutes. You may receive such a solicitation within a few of weeks of filing your Articles of Incorporation.

Articles of Incorporation are public records, and these companies simply purchase lists of newly formed corporations. With so many small businesses incorporating every day, it’s like shooting fish in a barrel for them, and unfortunately their scare tactics work on a lot of people.

Here’s the real deal: Your corporation must have an annual meeting of the shareholders and an annual meeting of the directors. Meeting requirements are set forth in the Corporations Code and also in your corporation’s bylaws. These “meetings” do not have to be at a fancy conference location, and if your board of directors consists of just one person, you won’t exactly be “meeting” with yourself. But the meetings do have to be documented with minutes in your corporate record book. The bylaws further specify the requirements for the date and time of both the annual meeting of shareholders and the annual meeting of directors. In small corporations, these are usually handled as “paper meetings,” that is, minutes are generated documenting major decisions made that affect the corporation, but there is no actual “meeting” where folks sit down and conduct a discussion, etc. Failure to maintain an up to date corporate binder with all of the documents required in the Corporations Code and your bylaws (including minutes of these annual meetings) could potentially cause you to lose your corporate liability protection, and you may also be required to produce such documentation in the event you are ever audited by the tax authorities.

You can find an attorney or legal document assistant to prepare the necessary documents. However, these are all things you can do yourself, too. There are some easy-to-understand self-help books out there, like Nolo’s book on corporate resolutions. The Secretary of State will mail you a blank SOI form you can fill out and send back. But if you don’t want to hassle with it, we’re here to help.

Above all else, please understand that any solicitation you receive is likely a scam. Minutes do not get filed with the Secretary of State’s office; the only thing filed with the Secretary is the annual Statement of Information. Odds are, you will receive these bulk-mailed solicitations at various times of the year, often when you are nowhere near the annual meeting date established in your bylaws. Whatever services they are trying to sell you most likely won’t include the SOI, may not include the necessary notice waivers, and may not include the minutes of both meetings (shareholders and directors) as required in your bylaws.

Bottom line…buyer beware!

FAQ: Should I Incorporate My Business?

The primary advantages of operating as a corporation are liability protection and potential tax savings. Like any important decision, choosing whether to incorporate involves weighing the pros and cons, and should only be done after careful research and consultation with a legal or tax professional.

Once incorporated, the business assets of the corporation are separated from the owner’s personal finances. As a result, the owner’s personal assets generally can be shielded from creditors of the business.

To maintain this legal separation (and avoid “piercing the corporate veil”), the corporation must observe certain formalities, including:

• Keeping corporate assets and personal assets separate (no commingling of funds)


• Holding shareholder and director meetings at least annually


• Maintaining a corporate record book including bylaws, minutes of shareholder and director meetings, and shareholder records


• Filing annual information statements with the Secretary of State


• Filing a separate tax return for the corporation

Many people are concerned about “double taxation” of income, but you should do your own research, and compare the features of the C-corporation and S-corporation. The double taxation results when a C-corporation has profit at the end of the year, and that profit is then distributed to the shareholders. That profit is taxed to the corporation, at the corporate tax rate, and then the dividends are taxable income to the shareholders on their personal tax returns. However, the corporate tax rate is typically much lower than the individual tax rate that a sole-proprietor will pay on a 1040 Schedule C, and a competent accountant can help the corporation minimize double-taxation (or eliminate it completely).

For example, a small C-corporation will likely have a shareholder who is also an employee. Paychecks to the shareholder/employee are, of course, tax deductible to the business. To the shareholder/employee, they are taxable income (as would be the case with a paycheck from any employer). A bonus could be paid to the shareholder/employee in order to lower the corporation’s taxable profit, eliminating the double-taxation. These calculations should be performed by your accountant or tax advisor, but shifting income from the corporation to the shareholder/employee (or vice versa, depending on which has the lower tax rate) can be a great way to lower your overall tax liability. In addition, there are certain advantages that are only available with a C-Corporation, such as full tax-deductibility of medical benefits for a shareholder/employee.

The S-Corporation avoids the double-taxation by offering a tax structure similar to the Limited Liability Company (LLC, which is not an option for businesses that are required to hold a license, certification or registration). A corporation with 100 or fewer shareholders can elect to be treated as an S-Corporation. If the corporation is profitable, the shareholder/employee must draw a reasonable salary (and pay employment tax on it), but then all remaining corporate profits flow through to the shareholder’s personal tax return (thereby avoiding the FICA tax on the portion of profits that is taken as a dividend).

Before deciding to incorporate, you should seek legal and tax advice on what type of ownership best suits your business. An experienced attorney and tax advisor can help you decide which form of ownership is best for your business. For the do-it-yourselfers, we highly recommend “Own Your Own Corporation” by Garrett Sutton, Esq. (part of the Rich Dad series).

C-Corporation vs. S-Corporation

The difference between a C-Corporation and an S-Corporation is in the way each is taxed. Under the law, a corporation is considered to be an artificial person. Shareholders who work for the corporation are employees; they are not “self-employed” as far as the tax authorities are concerned.

The C-Corporation

In theory, before a C-corporation distributes profits to shareholders, it must pay tax on the income, at the corporate rate. Then, leftover profits are distributed to the shareholders as dividends, which are then treated as investment income and taxed to the shareholder. This is the “double taxation” you may have heard about. In reality, most (if not all) of a small C-Corporation’s earnings are paid out to its employees as wages, bonuses, fringe benefits, etc. Often, there is no “income” for the small C-Corporation to owe tax on, unless the shareholders choose to keep taxable earnings in the company to reinvest for future growth. Should you choose to keep profits in the corporation and pay tax on that income, it will be taxed at the corporate tax rate, which is typically lower than the individual tax rate the shareholders are subject to.

C-Corporations enjoy many tax-related advantages :

• Income splitting is the division of income between the corporation and its shareholders in a way that lowers overall taxes. By working with an experienced tax advisor, you can determine exactly how much money the corporation should pay you, as an employee, to ensure the lowest tax bill at the end of the year.


• C-Corporations enjoy the greatest variety of tax-favored fringe benefits of any business entity. Fringe benefits may include things like health insurance, retirement accounts, and medical reimbursement plans.


• With a C-Corporation, medical costs, including health insurance premiums, are 100% tax-deductible to the corporation and tax-free to the recipient.


• C-Corporations can also pay for an employee’s education expenses (if they are directly related to the job), and these expenses are also deductible to the company and tax-free to the employee. The company can also contribute – and deduct – up to $5,250 per year for an employee’s non-job-related education expenses.


• A C-corporation can provide tax-free financial and tax planning to help employees, provided this benefit is part of a written employee benefit plan.


• C-Corporations can deduct insurance disability insurance premiums for employees, and can provide employees and/or former employees with $50,000 in tax-free life insurance. Premiums paid for these policies are tax-deductible to the corporation.


• A shareholder can borrow up to $10,000 from a C-Corporation, interest-free. Tax-free loans are not available to sole proprietors, partners, LLC members, or S-Corporation shareholders.

S-Corporation

S-Corporations pass income through to their shareholders, who pay tax on it according to their individual income tax rates. To qualify for S-Corporation status, the corporation must have less than 100 shareholders; all shareholders must be individual U.S. citizens, resident aliens, other S-Corporations, or an electing small business trust; the corporation may have only one class of stock; and all shareholders must consent in writing to the S-Corporation status.

Electing S-Corporation tax treatment eliminates any possibility of the “double taxation” referenced above. S-Corporations pay no federal corporate income tax, but must file annual tax returns. Because losses also flow through, shareholders who are active in the business can take most business operating losses on their individual tax returns.

S-Corporations must still file and pay employment taxes on employees, as with a C-Corporation. An S-Corporation may not retain earnings for future growth without the shareholders paying tax on them. The taxable profits of an S-Corporation pass through to the shareholders in the year they are earned.

S-Corporations cannot provide the full range of fringe benefits that a C-Corporation can.

Further Reading:
Own Your Own Corporation, by Garrett Sutton, Esq.
Tax Savvy for Small Business, by Frederick W. Daily
Publication 15B, Employer’s Tax Guide to Fringe Benefits, Internal Revenue Service

Corporations: An Overview

Corporations are the most commonly used business entity. Corporations are, generally, a more complex form of business operation than either a sole proprietorship or partnership, and are subject to more state regulations regarding both their formation and operation.

In California, a corporation is created by filing Articles of Incorporation with the Secretary of State. The Articles of Incorporation serve as a public record of certain formalities of corporate existence. Adoption of corporate bylaws, or internal rules of operation, is often the first business of the corporation. The bylaws of the corporation outline the actual mechanics of the operation and management of the corporation.

There are two basic types of corporations: C-corporations and S-corporations. These prefixes refer to the particular chapter in the U.S. Tax Code that specifies the tax consequences of either type of corporate organization. There are significant differences in the tax treatment of these two types of corporations, however, they are both generally organized and operated in a similar manner.

In its simplest form, the corporate organizational structure consists of the following levels:

• Shareholders: who own shares of the business but do not contribute to the direct management of the corporation, other than by electing the directors of the corporation and voting on major corporate issues.


• Directors: who may be shareholders, but as directors do not own any of the business. They are responsible, jointly as members of the board of directors of the corporation, for making the major business decisions of the corporation, including appointing the officers of the corporation.


• Officers: who may be shareholders and/or directors, but, as officers, do not own any of the business. Officers (generally the president, vice president, secretary, and treasurer) are responsible for day-to-day operation of the corporate business.

Disadvantages

Due to the nature of the organizational structure in a corporation, a certain degree of individual control is necessarily lost by incorporation. The officers, as appointees of the board of directors, are answerable to the board of management decisions. The board of directors, on the other hand, is not entirely free from restraint, since it is responsible to the shareholders for the prudent business management of the corporation.

However, in most small, family-owned incorporated businesses, only one or two people may occupy all roles, from shareholder to director to officer to employee. In this type of situation, the shareholder/directors continue to exercise full control over the operation of the business.

The technical formalities of corporation formation and operation must be strictly observed in order for a business to reap the benefits of corporate existence. For this reason, there is an additional burden of detailed recordkeeping. Corporate decisions must be reflected in the corporate records. Corporate meetings, both at the shareholder and director levels, must be formally documented.

Advantages

One of the most important advantages to the corporate form of business structure is that it limits the liability of the founders of and investors in the corporation. Liability for corporate debts is generally limited, to the amount of money each owner has contributed to the corporation. Certain requirements must be met, however, to assure that the limitation on liability remains in effect. Courts may be able to pierce the corporate veil, that is, hold shareholders personally liable, for the following reasons:

• Failure to observe corporate formalities. The corporation must hold the required shareholders’ and directors’ meetings (or sign consents), keep a corporate minute book, comply with all state filing requirements, etc. Even a corporation with just one shareholder/director must still comply with these formalities. In addition, corporate officers must always sign all documents with the corporate title (e.g. John Doe, President).


• Commingling of assets. Shareholders must take care to avoid mixing their personal assets with those of the corporation. Corporate assets should not be used to pay personal debts. Corporate and personal funds should be kept in separate accounts. Transfers between the corporation and the shareholder, whether a loan, reimbursement, paycheck, etc., must be appropriate and clearly documented.


• Inadequate capitalization. If corporate founders fail to raise or contribute enough operating capital, the courts may require the shareholders to pay the corporate obligations. If the shareholders do not have sufficient capital to fund the corporation, they should purchase adequate liability insurance.


• Fraud. A corporation may not be used to shelter fraud. Even if the fraud is committed in the name of the corporation, the shareholders may be held personally liable.

Depending on your personal situation, there may be significant tax advantages to incorporating.

Every corporation should have an experienced accountant or tax attorney on its team, to help determine whether tax treatment C-Corporation or an S-Corporation provides the most benefit, and to help with tax planning strategies before the close of each fiscal year.

In many cases, it is possible to reduce taxable profit to the point that the corporation pays only the corporate minimum tax. If the corporation stands to show a substantial profit at the end of the year, that tax is paid at the corporate tax rate (often much lower than individual tax rates), and that income can be reinvested in the corporation to further grow the business. Hiring a qualified tax advisor will pay for itself many times over.

Partnerships: An Overview

The General Partnership

A partnership is a relationship existing between two or more persons who agree to share profits and losses. A partnership is usually based on a partnership agreement of some type. No formal, written document is required in order to create a partnership. If a formal agreement is not signed, the partnership will be subject to the applicable state laws governing partnerships.

Disadvantages

Like the sole proprietorship, owners of a partnership have no asset protection. Each partner’s personal assets are at risk. However, with a partnership, the owners face twice the liability exposure of a sole proprietorship. Any partner may obligate the partnership, and each individual partner is liable for all of the debts of the partnership, regardless of which partner may have been responsible for their accumulation.

In addition to the risk of personal financial liability, general partners also face potential personal legal liability for the negligence of another partner. Furthermore, each partner may also be liable for the negligence of an employee of the partnership if such negligence takes place during the usual course of business of the partnership.

Continuity is also an issue for the partnership. A partnership terminates when one partner dies, leaves, or goes bankrupt. In addition, it often very difficult to sell an interest in a partnership. Most sophisticated buyers do not want the risk associated with a general partnership.

Finally, certain benefits of corporate organization are not available to a partnership. Since a partnership cannot obtain financing through public stock offerings, large infusions of capital are more difficult for a partnership to raise than for a corporation. In addition, many of the fringe benefit programs that are available to corporations (such as certain pension and profit-sharing arrangements) are not available to partnerships.

Advantages

For a business in which two or more people desire to share in the work and in the profits, a partnership is often the structure chosen. It is, potentially, a much simpler form of business organization than the corporate form. There are fewer start-up costs and regulation of partnerships is limited. However, this simplicity can be deceiving. A sole proprietor knows that his or her actions will determine how the business will prosper, and that he or she is, ultimately, personally responsible for the success or failure of the company. In a partnership, however, the duties, obligations, and commitments of each partner are often ill-defined. This lack of definition of the status of each partner can lead to serious difficulties and disagreements. In order to clarify the rights and responsibilities of each partner and to be certain of the tax status of the partnership, it is good business procedure to have a written partnership agreement.

The Limited Partnership

A limited partnership is similar to a general partnership, except that it has two types of partners: general partners and limited partners.

General partners have broad powers to obligate the partnership (as they do with a general partnership). General partners are also personally liable for the debts and claims against the partnership. If there is more than one general partner, each of them is liable for the acts and omissions of the remaining general partners.

Limited partners are “limited” to their contribution of capital to the business, and may not become actively involved in running the company.

As with a general partnership, limited partnerships are flow-through tax entities.

Disadvantages

General partners are personally liable for all partnership debts. However, a corporation or an LLC may be formed to serve as the general partner, thereby limiting the limiting the potential for personal liability.

Because limited partners are prohibited from participating in the management activities of the enterprise, the general partners maintain complete control of the partnership’s business affairs. Limited partners have no control of their investment.

Advantages

Limited partners are not liable for the partnership’s debts beyond the value of their capital contribution into the business. Creditors of a limited partnership can only reach the partnership assets and those of the general partner (which is further limited by utilizing a corporation or LLC as a general partner).

Creditors of the individual partners can only reach the partner’s ownership interest in the partnership, but not the partnership assets themselves.

With proper estate planning, family assets can be transferred from one generation to the next at discounted rates. By using a family limited partnership, gifting can be accelerated with an IRS-approved discount. If you are considering this option, you should consult with an attorney.

Limited partnerships afford a great deal of flexibility to the partners. A written partnership agreement can be tailored to the business, family and estate planning needs of any situation.

The Sole Proprietorship: An Overview

The sole proprietorship is the simplest and least regulated of all business entity structures (e.g. corporation, LLC, general partnership, etc.). For legal and tax purposes, the sole proprietorship’s owner is the business. The liabilities of the business are personal to the owner and the business ends when the owner dies. On the other hand, all of the profits are also personal to the owner and the sole owner has full control of the business.

Disadvantages

The primary consideration in choosing this type of business structure is liability. With a sole proprietorship, you have no asset protection. With just one lawsuit against the business, your house, savings and personal assets can be lost. If the demands of the business’ creditors exceed those assets which were formally placed in the name of the business, the creditors can tap the owner’s personal assets. This unlimited liability is a significant drawback to the sole proprietorship.

Depending on the profitability of the business, a sole proprietorship may incur a larger tax liability than other business structures. Profit from a sole proprietorship is reported on Schedule C of the owner’s personal income tax return, and is subject to self-employment tax (the “employer’s match” of Social Security and Medicare taxes). You are taxed on all profits in the year they are earned, whether or not you actually take money out of the business. When you reinvest in your sole proprietorship business, you must do so with “after tax” money. Additionally, certain fringe benefit plans are not tax-deductible to the sole proprietor.

Sole proprietorships also face potential difficulty in obtaining business loans. Often in starting a small business, there is insufficient collateral to obtain a loan and the sole owner must use his own personal assets as collateral to obtain the loan. This, of course, puts the owner’s personal assets in a direct position of risk should the business fail.

The sole proprietorship suffers from the lack of continuity that is inherent in the business form. It is difficult to sell a sole proprietorship, since its value is based on the owner and not the business. Upon the owner’s death, the assets of the sole proprietorship become part of the estate, and may face estate tax and probate consequences.

Advantages

The sole proprietorship is the simplest of all business structures. Aside from the maintenance of records for tax purposes, this type of business is not subject to legal requirements for how it must be operated (e.g. annual documentation and filings with the Secretary of State).