Business

Part 3: Legal Entities For The Business Person

We've reached the final part of our 3-part blog series: Intellectual Property + Legal Entities: Common Questions + Answers. Here, we'll cover (almost) everything you need to know about legal entities as a business owner and answer the following questions: 

  1. What are the differences between an LLC and a Corporation (or other entity type), and why might someone choose one type over another?

  2. How do I stay in my entity, and how do I stay protected?

  3. What do I need to know about my taxes as a business owner?

What Are the Common Legal Entities for Business Owners?

First, we'll cover the most common legal entities for business owners. Then, we'll discuss why they're important. It is important to understand the differences; I see that people choose an entity type for their business because they're told to do so by a business blog or article they read or from a fellow business owner. They think, "Well, this protects me somehow." Unfortunately, many business owners choose a specific type of legal entity without knowing why or realizing they aren't doing the necessary things to protect themselves while in one.

Here’s what you need to know:

1.The Sole Proprietorship

One type of legal entity that's legally recognized is the sole proprietorship. One of the great things about business in America is that you do not need any governmental grant or permission to be in business. You don't need a license; you can just wake up in the morning, have a paint bucket, and start painting houses. You may, however, be at risk for many things. But you can be in business without any permission from the state. That's a big deal. (And when I say the state, I mean government.)

"Wait a minute, I thought sole proprietors had to register their name?" 

No, they do not. You can register your name so it's protected from being used by others, but you do not have to. And when you're taxed, you're taxed through your social security number on your tax forms. You can also create an EIN and use that for taxes as a sole proprietor. 

A DBA is Not a Legal Entity

The next common thing I often hear people say is, "Oh, I'm a DBA." Or, "I have a DBA trade name." A DBA or Trade Name, for that matter, is not a legal entity. The legal entity is still the sole proprietorship; it just operates using a "doing business as" name, or it has a trade name.

So if I'm Raef Granger, and I'm painting, and instead, I want to be called "Super Plus Painting Company." Then I am Raef Granger, Sole Proprietor, DBA (Doing Business As) Super Plus Painting Company. Also, just because my business name says "Company" in the name doesn't mean I'm a corporation; I'm still a sole proprietor. I can go to the Secretary of State for my state and say I want to register my trade name and that I'm calling it "Super Plus Painting." I simply pay a fee and can use that DBA name to operate under that name.

2.The Partnership

Let's say I decided to go into the painting business with my friend, Jamie; Jamie and I are painters. We are – poof – de facto, a partnership; that's the legal entity. There doesn't need to be any paperwork between us; there does not need to be a partnership agreement. Our business doesn't have to be registered. When you get two people in business together, they are a partnership, and the law defaults into a 50-50 partnership. It is not a wise or sound business decision to be in a partnership without any documentation, but you do not have to.

What if we don't want the default 50-50 partnership or to default into what the State Laws are that govern partnerships? We can create a partnership agreement between us that outlines the ownership and profits or other items we want in our partnership. We'll go to an attorney, who'll write up the agreement; it does not get filed with the secretary of state. It's just a private agreement between the two of us that says Jamie's 90% owner and I'm a 10% owner, for example, on how the profits are split and other partnership details that are important to us. 

Introducing the Limited Liability Partnership (LLP)

Since partnership entities began in the law, the law has evolved because there's a potential problem with this type of entity. Let's say Jamie goes out and does a really bad painting job. The homeowner decides to sue Super Plus Painting, which is made up of partners Jamie and Raef. Jamie claims she doesn't have any money, but Raef is rich, so the homeowner goes after Raef for the money, who says, "I didn't paint your house; my partner did." The homeowner says, "Sorry. I want my money, and that's that. It's what we call joint and severable liability; I am liable for the acts of my partner, even if I didn't do them. 

Here is a very simplistic view, and I took some liberties with the timeline, but it gets the message across. As a result of this fact, many partners said, “Wait a minute, I do want to be in business with my partner, but I do not want to be liable for his/her acts.” The law evolved, and an entity called the Limited Liability Partnership (LLP) was born. You might have seen many of these entities back in the day; many law firms, accounting firms, and doctors were LLPs. They are slightly better (protection-wise) than partnerships but can still be messy. The law evolved again and created the Corporation and the Limited Liability Company.

3.The Corporation

Think of the corporation's legal entity type as a bubble. Let's say my partner, Jamie, and I call our business Super Plus Painting Corporation. We go to the Secretary of State, file formation papers, pay a fee, and get our corporation granted. So is Super Plus Painting Corp. Raef, or is it Jamie? Nope, as individuals, we exist outside of that bubble, which provides liability shielding for us. In most instances, what Jamie or Raef does outside the business can't impact the corporation. It is its own separate legal entity known as the Corporation. 

I often would tell my clients to think of their corporation as a person; it has a birth certificate (The Certificate of Existence), a social security number (The Tax EIN Number), a birth date (the day it was legally formed), and it can sue and be sued in a Court of Law.

The Corporate “Bubble” Explained

Let's say that Jamie goes out and gets some experimental surgery and owes $100,000 to the hospital. Her insurance won't cover it, and Jamie, as an individual, is broke. However, even if Super Plus Painting Corp. has some money in it, the hospital can't sue the Corporation for the money Jamie owes, even though Jamie is 50% owner of that corporation. Jamie and Raef's business is protected from potential liabilities like this one.

Core Requirements for a Corporation

To be in a corporation, you need several things. There must be a board of directors, which usually consists of between one and seven people. It also has to have an officership and shareholders. These three things make up a corporation, no matter how big or small the business may be. Often, in a solo Corporation, you hold all of these positions. You are the Board of Directors. You are all of the officers, and you are the 100% Shareholder.

Your corporate requirements are to hold yearly meetings and draft minutes. The board meets with the officers to report to the shareholders what the company did over the last year. Even in a single-owner corporation, you must keep annual meetings and minutes. If you don't, you could risk losing your corporate shielding. Why? Because you're not doing the things that people do when they're in corporations. 

It's also important to note that the annual fee you pay the Secretary of State for your annual report differs from your annual meeting and minutes. You must hold the meeting, record minutes, and file your annual report (or whatever they are called in your state). There are additional requirements, but we won't get into all the details here. If you don't think you've been keeping up with meetings and minutes as you should, contact a local attorney who can get you up-to-date on your annual meetings and minutes. I highly recommend contacting an attorney with any additional questions about corporation law.

Because of the strangeness of being one person owning the corporation and holding all of the roles listed above, the law evolved again and created the Limited Liability Company. NOTE: This is not a Limited Liability Corporation (which I hear people say sometimes); that is a confounding of terms.

4. The Limited Liability Company or “LLC”

A large majority of all the corporations in the entire United States are singly owned corporations. As stated above, in this case, the owner would need to hold an annual meeting with themselves and sign the record of this meeting and minutes as the board director, the president, and the secretary.

The owner would also make up 100% of the shareholders. Because one person would fill all these roles, and it was confusing to the solo owners (and it is confusing), the law evolved, and the Limited Liability Company (LLC) was introduced.

Adding corporate protection for single-owner companies

Limited Liability Company laws were introduced to provide individual company owners the same corporate shielding or protection. These laws make it so that single owners of companies don't have to have an annual meeting or annual minutes and don't have to operate with a board and officers. Instead, the company is operated by a manager. The manager of the single-owner LLC is the president, the CEO, the Chief Operating Officer, or whatever corporate term that person wants to give themselves. A single-owner LLC also has certificates or members instead of shareholders. They don't have shares; they have certificates. An LLC can also be member-owned.

NOTE: You don’t have to have an Annual Meeting; you do have to file your Annual Report.

The IRS doesn't recognize LLCs

However, the IRS recognizes sole proprietorships, partnerships, corporations, and estates. You're taxed as a sole proprietor in a single-owner LLC. When you're in a dual or multiple-member LLC, you're taxed as a partnership would be taxed. And so your accountant will do your books as if you're in a partnership. I'm explaining this in detail because it's important to understand how to talk to your accountant about your specific entity.

Signing documents for protection

Remember, I said the LLC or the Corporation is a separate bubble from you? One way you create and maintain your liability shielding is with how you sign your documents. If a single business owner, Sally, has a new vendor, and this vendor is sending her a contract, she wants to sign it using her LLC name vs. her personal name. If Sally signs the contract with her personal name, she has bound herself personally liable as an individual to that contract and not in her “corporate” capacity, even though it is for company purposes. This means she would owe that money personally. 

Instead, she's binding the company if she signs the document with her name and company title. It often happens that LLC owners will receive agreements made out to them as individuals. It's important to request the sender to make the agreement out to your LLC instead of you personally for liability purposes or edit the signature line so you can sign in your corporate capacity. 

Tax Treatment Basics: S Corporations, C Corporations, and LLCs

Now, let’s talk about tax treatment as an S-Corp vs. a C-Corp vs. an LLC, so you have the basics when talking to your accountant.

In the eyes of the federal government, a C-Corp gets taxed at its corporate capacity, and the corporation's owners get taxed in their personal capacity, which leads to being taxed twice. Some people decide they don't want to be in a C-Corp because they don't want to be doubly taxed. This is the case for big companies like Microsoft, Oracle, etc. However, the government decided they didn't need to double tax everyone and created the S-Corp. The S and the C are tax code designations. 

According to the IRS, "S corporations are those that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes." You're not doubly taxed in an S corporation because you're a "pass-through taxation entity."

Why Choose an S-Corp VS. an LLC?

In some cases, the change in tax treatment is worth switching from an LLC to an S-Corp and adhering to the more restrictive regulations and additional fees. As a lawyer, I would just want to file everybody as LLCs due to their legal ease of operation. There's no need to have all that corporate formality; you get all the protections that you would ever want from an LLC.

However, I used to advise that when forming entities, you should talk to your accountant or bookkeeper, as they may want to make you a corporation for tax reasons. There are certain businesses that, for tax reasons, may result in better tax treatment as a corporation. 

Is it Worth it to Be in an LLC or S-Corp?

At the end of the day, it's important to determine how much money can be saved by choosing one entity type over the other. If your accountant says they can save you $10,000, then it might make sense to pay the attorney $500 to $2500 annually or go through all the extra paperwork to ensure you're in an S-Corp. 

Have More Questions About Legal Entities? Ask Your Attorney!

Those are the basics of legal entities, how they were formed, and why they were created by law. It can be confusing. That’s where a business attorney comes in. Schedule a meeting with yours; they will guide you through this. A lot of times, in business, it is not a “what challenge” you have; it’s a “who challenge.”

So, if you’re facing many questions about legal entities or something involving the law, rather than think you need to know what all that means or what to do, ask yourself, who do I need to talk to that can help and educate me on what to do? The answer is an attorney.

Need Help Taking Your Business to the Next Level?

Regardless of which entity type your business falls under, ensuring that you and your business continue to thrive is no easy feat. If you need help moving from thought to action and making things happen in your business, reach out for a discovery call today.

Part 2: Rules Around Using Learned Intellectual Property

As promised, we’re diving into part 2 of the 3-part blog series: Intellectual Property + Legal Entities: Common Questions + Answers. The two main questions we’ll answer here are as follows:

  1. What can I use that I have learned or read without stealing someone else’s IP (Intellectual Property)?

  2. What can I advertise, share, or teach that I have learned elsewhere, legally?

Using Copyrighted Material to Educate Others

“I can use copyrighted material if it is for ‘educational purposes’ or if I make no money, right?”

No. Using someone else’s work without permission is a violation of their copyright. Using someone else’s work for educational purposes or if you make no money without permission is still a violation of that person’s copyright.

You may often see this specific permission inside written works that educators use. For example, let’s say you’re reading a book that's copyrighted, and you flip through the front pages, and it says, “This material may only be shared for educational purposes.”

In many cases, educational texts will put this specific permission in their material to enable educators to use their content for educational purposes without seeking or having to ask permission. This does not, however, apply to all copyrighted material.

What I sometimes get asked or see, is someone saying, “Well, I’m not making any money or seeking to make any money from it, so I can use that person’s material, right?”

The thought behind this typically comes from someone who, when a student, saw a “special copyright rule” in an educational publication that said something to that effect, as referenced above. To be clear, there is no special copyright rule that applies to all material that says, “If I use this for educational purposes and make no money, I can use it.”

Every piece of written material is subject to copyright unless it specifically says it is not.

Earning Money From Sharing Learned Material 

Now, let’s say you’re a coach, physical therapist, or other professional with valuable knowledge, and you want to share that learned material in a paid workshop or webinar in exchange for money or as part of your sales process.

Here’s what you need to know:

1.You Can Use Learned Information in Your Business Offerings

When you learn information and put that knowledge into your brain, that is your knowledge. What you’ve read and learned from it is yours to use. I often reference Byron Katie's work and methodology, which I’ve learned; it’s now in my brain. I read her book, Loving What Is, and I learned from it. I share the principles I learned with my MasterClass (which is of my own creation) and earn money from teaching and facilitating MasterClass. I am allowed to teach concepts from things I’ve learned from others. 

Now, when I am using her words or her methodology, I cite her. I also do not advertise that I am teaching The Work, (the name of her process), nor list it on my website that I teach it. This is not to hide it from her, but because I am not authorized to advertise that nor promote a workshop saying I am teaching The Work. I do not have her permission. I am not an authorized vendor. 

However, if during a MasterClass, someone is struggling with what is their reality or how they feel, I might say, “Oh, here is a set of tools that may help you with that,” and then give the tools. I then often say, “If you want to go to the source, read Byron Katie’s book: Loving What Is.” Similarly, a golf coach may give their student a set of tips they learned in some golf book to help the golfer they are helping.

2.You Cannot Claim Learned Information as Your Own

As I stated above, what I can't do is try to pretend that I created someone else’s material. I can’t put the principles I’ve learned from this material on my website and somehow make it look like I came up with them, because I didn't. Even after doing your best to cite the person who created the material, just be aware that there’s still a chance they may send a cease and desist letter stating that they are not authorized to use or display their material. If this happens, you have two options.

Option 1: You can ask how to become authorized or request permission to reference the material in a certain way. And they may say yes, or they may say no, and that’s their right. Or, they may indicate certain procedures to become authorized to use the material. In some cases, they may even charge a fee for you to become an authorized user of their material, and there may even be a required course to ensure you are using it correctly.

Option 2: If they say no, or you don’t want to ask for permission, your other option is to decide to use the material in a way that matches your brand and your offerings and teach the subject matter but make it your own. Now, in this case, you may still decide you want to give credit to the person or entity that created and taught you the material simply out of integrity. 

When in doubt, acknowledging that you’ve taken learned material and modified it for your program or offering and giving credit to the source is always a good idea. However, remember that it does not make you immune if you are using someone else’s work without permission.

3.Fun Facts Regarding Game Rules  

Fun fact: the rules of games are not copyrightable. For example, the rules of Monopoly are not copyrighted and protected. The layout, font, and branding aspects of the game are protectable, however. For example, “Move your piece five spaces by rolling the dice and adding the sum” – not copyrightable. Move your Monopoly tophat(™), Monopoly shoe(™), or Monopoly dog(™) 5 spaces by rolling the dice and adding the sum is partially protected. You can probably guess which parts. 

If your goal is to teach rules (or underlying concepts) you’ve learned from reading, listening, or watching another person teach something, you can do this without infringing on someone’s intellectual property. You’re simply applying what you’ve learned to material that you are creating a new and different version of.

**Legal Disclaimer**

Dealing with intellectual property law can be very nuanced and very fact-specific to your case. Don’t fret, because you can reach out to an intellectual property lawyer, and they can help you with this. Also, this advice is general in nature and not meant to nor should be taken as legal advice specific to your needs. Seek out the counsel of an attorney, and they can properly guide you for your specific needs and goals.

Stay Tuned for Part 3: Legal Entities 101!

In Part 3 of this article series, we’ll cover the main types of business entities, how they differ, why someone might choose one type over another, how this all relates to taxes, and more.

Can’t wait for the article? Check out podcast Episode 16: Legal Entities for the Business Person!

Need help taking the right actions to get the results you want in your business and life? Schedule a discovery call today!