Legal Entities and Business

Although in essence this is really a very simple concept, it does make for some interesting discussion points, especially noting that an understanding of how this all fits together, will also help you better understand the legal framework of the various types of businesses you could start.

In essence there are two types of legal entities in the business world. One is a natural person, and the other is a legal person (also known as an artificial person). And if you have heard these terms before, chances are you already have a fairly good understanding of the mechanics of all this, however for clarification I would offer the following descriptions:

Natural Person

A natural person is simply a human of legal age. You are by your very definition a natural person. From a business perspective this would be defined as a human, who is old enough to legally transact (is of age). Usually, depending on the country you live in, older than 18 years going up to 21 years in some countries.

In either case within the framework of this definition you are able to sign a contract on your own behalf, and be bound by it. You do not need to have a parent or legal guardian sign for you, and if you get sued, they can take your house if you lose.

Legal Person (artificial person)

This type of entity has been created to allow for the separation of personal assets from business assets, amongst other things. The key point to consider here is that a legal person is not alive. So a corporation like IBM or Microsoft would be legal person. Even though they clearly exist and can trade they are simply not alive.

A legal person can trade, transact and contract using the registered name as if a natural person, however, since it is not alive, it requires someone (a natural person) to do so on it’s behalf. Essentially since the legal person cannot physically sign the papers, someone living needs to do so. So the manager, CEO or any person with authority to do so, can sign a contract on behalf of the corporation or business, binding it (not the authorised natural person) to the terms of the contract.

Authority for a natural person to act on behalf of a business, is also given by a natural person or persons that own the business (often called shareholders). To explain this more clearly the shareholders hire a CEO to run their business. This gives the CEO the right to sign contracts and do transactions on behalf of the company, and in the name of the company. It also means that if you are the only shareholder, you can give yourself authority to sign contracts for the legal person you own (your business).

A legal person can also own things, just like a natural person, and when the legal person (company) gets sued, they can only take the property of the legal entity, not the shareholders (or business owners).

One key thing to remember is that a legal person can only exist as long as there is a natural person in control of it. So if a company does not have any shareholders, there is nobody that can give authority, to anyone, to transact in the name of the legal person. In this case it also means that there is no one that can actually sign a document in the name of the legal person, making it completely valueless and pointless.

Since a legal person is also not a living thing, you are able to sell it, or give it away like a car. As long as there are shareholders (owners), it can continue to exist.

In conclusion when applying these two simple concepts to your intended business activities, one of the decisions you will have to make, is whether to trade as a natural person (in your own name) or as a legal person (a registered business).

And though often the cost of operating a legal person may prove prohibitive, there are also some inherent protections built into this type of business, which may make it worth biting the bullet for. With this in mind I would recommend that you seek proper legal advice to make sure that you trade in a business form that meets your specific needs.

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Financial Privacy Using Legal Entities

When I speak at workshops, I’m often approached by audience members who want to know how to use legal entities for more than just the tax planning, business development and lawsuit protection benefits. They also want to use them for privacy protection. In this article, we’ll explore their use solely for that purpose.

A Separate Legal Person

By their nature, wide recognition under the law, and tax treatment, legal entities are excellent vehicles to use in protecting your privacy and holding ownership of assets in a way that provides a lower profile and helps enhance protection of your personal and financial privacy.

In my first book on privacy we examined the growing threat of Identity Theft and the frightening trend of fraud and theft taking place in America and examined many strategies for preventing it. A few years later, my second book on privacy we looked deeply into the subject of using legal entities as a tactical means to hold ownership of assets in a way that would deflect attention away from you personal, lower the risk of loss due to personal liability, and help manage and enhance your personal financial privacy. In this article, I’d like to pick out three specific legal entities for their privacy considerations:

Corporations
Limited Liability Companies
Triple LPs

What they each have in common is that they are legal entities recognized by states that use statutory protection. Each of them is considered a separate legal person from their owners. Each of them can have a separate identity and tax life apart from their owners. Each of them have been recognized not only by statutory law but tax law as well and have been the subject matter of court examination.

While the corporation, the limited liability company and the limited liability limited partnership have each respectively been separately examined in terms of their business use and asset protection utility, this article will examine each of them solely in terms of privacy.

Using a Low-Profile Corporation

Corporations have been with us a long time. They arise from the tradition of English common law, and are used extensively in the USA. A corporation is defined as an artificial legal person that is considered a separate legal entity from its owners. Similar to a natural person, a corporation can own property, enter into contracts, hire and fire employees, open and maintain bank accounts, use the courts to pursue remedies and defend itself, and is legally authorized to do whatever is necessary to carry on a business.

One advantage is that a corporation’s owners (who are referred to as shareholders or stockholders) are generally not personally liable for the corporation’s liabilities and debts (except that the IRS can pursue the shareholders for a corporation’s unpaid taxes). Every for-profit corporation begins life as what is known as a ‘C’ corporation and is taxed separately from its owners. Some of them subsequently elect to be taxed under subchapter ‘S’ of the Internal Revenue Code and are then taxed as pass-through tax entities, meaning that their profits are taxed federally and reported on the personal income tax returns of the corporation’s owners. For many years in the late 20th Century, using ‘S’ corporations was the knee-jerk default approach taken by many advisors. However, see my article ‘The S Corporation is a Dinosaur’ and examine it in comparison to the LLC.

From a privacy perspective, a privately-held corporation (one that has not ‘gone public’) can certainly be used for creating a lower profile. For example, if the corporation does not have your personal name attached to it (i.e. ‘The John Alfred Jones Corporation’) but instead uses a commercial trade name (i.e. ‘Green River Lending, Inc.’), your personal identity is not a neon sign attracting attention to your personal identity and raising awareness of your relationship to the company.

The corporation can have bank accounts, vehicles, investment accounts, trademarks, copyrights, patents and other assets in its name without your specific identity and financial status being associated with it.

LLCs and Financial Privacy

By its legal nature, a Limited Liability Company (or ‘LLC’) is an ownership structure that allows its owners (which are called ‘Members’) the advantage of limited their personal risk of liability and at the same time offer them the advantages of taxation more similar to a partnership, in which the profits of the enterprise are passed through to the owners and taxed on the income tax returns of the owners rather than the LLC itself.

An LLC is a separate artificial legal ‘person’ and like a corporation it can own bank accounts, investment holdings, land, office buildings, residential property, mutual funds, stock trading accounts, option accounts, commodity trading accounts, and intellectual property as well, such as copyrights, trademarks and patents.

Held in the name of the LLC, assets are more private. It is less likely than an Identity Thief will have access to assets or accounts held in the name of the LLC. This allows you to have a lower profile and enhances your personal financial privacy since the entity’s ownership of an asset does not necessarily in and of itself reveal your personal identity. This is why many celebrities, investors and others who wish to protect their privacy use the LLC.

Private Triple LPs

All 50 states now have Limited Partnerships within their statutes. A limited partnership is defined as a structure that allows its owners (called limited partners) to benefit from limited personal liability for the debts and liabilities of the partnership. In the majority of the states, the general partners have unlimited personal liability. But in a growing minority of states, the trend is for general partners to also enjoy liability protection under a more advanced version of this entity form called the Limited Liability Limited Partnership.

The key distinction between the general partner and the limited partners’ role has to do with day to day management and decision making authority. The general partners operates the partnership and makes the daily operational and investment decisions. The limited partners on the other hand are passive investors, are not allowed to make business decisions.

The more advanced version – the Limited Liability Limited Partnership (also called the ‘LLLP’ or as I refer to it as the ‘Triple LP’) – provides the enjoyment of limited liability to the general partner, and it can own property in the same private way that corporations and LLCs do. With the partnership’s name on assets, your personal name is not. With the partnership being the owner of investment accounts such as a stock or option trading account for example, it’s far less likely that an identity thief could even know about the account much less have access to it.

The point of course is that by not even knowing about the existence of the account – held in a name other than yours – the likelihood of access by an unauthorized person who somehow manages to steal your personal identity is far less realistic and you are much better protected than you would otherwise be.

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What’s In a Name? Important Entity Name Considerations in New York State

Choosing a name can be one of the most important decisions a company can make. After considering the business and marketing implications of a given name, a company also needs to ensure the desired name has not been trademarked through use or by registration with the U.S. Patent and Trademark Office. Finally, when registering the entity to do business in a state, there are a number of legal requirements that vary depending on where the entity registers.

The legal requirements for company names in New York can present many difficulties. Some things that have the potential to create problems or delays include:

the large number of active registered companies (This increases the chance that the name you want will not be available for use.)
a somewhat nebulous procedure for determining whether a name is different enough from the names of existing entities in the state
the inability to obtain consent for the use of a similar name
the need to obtain another state agency’s approval for the use of many words and phrases

Decreased Pool of Available Names Due to Number of Registered Entities

New York state’s history as one of the most populous states and the fact that it is a major financial center have likely played a major role in the large number of business entities that are registered in the state. New York has over 1.7 million active registered companies, which is more than highly popular filing states like California, Florida, Delaware and Nevada. In fact, as of the end of 2010, New York holds the title for most active companies on record.

A contributing factor to the large number of active entities on record is New York’s somewhat lax policy regarding dissolving existing corporations. Many Secretary of State offices administratively dissolve companies that have not filed their annual reports after a specified number of years. In New York, the primary reason for administrative dissolution (dissolution by proclamation) is notification from the Department of Taxation and Finance that the company is delinquent in paying franchise tax. These notifications, however, do not always occur within a predictable time frame, so there are many companies that have not paid taxes for years, but are still listed as active on the Secretary of State’s records.

New York state’s voluntary dissolution requirements also help to create a situation where inactive corporations remain on record. New York does not allow a corporation which never engaged in business to quickly and easily dissolve as many other states do. Instead, the company must apply for tax clearance and file a tax return, even if shares have not been issued and the corporation never engaged in business. Because of this, some New York corporations, especially those formed carelessly or in error, ignore their obligations and let inactive companies remain on record.

With well over 100,000 companies getting filed each year and the policies described above that contribute to keeping inactive or delinquent companies on record, it is a fairly common occurrence in New York that the name a company wants to use is not available.

Strict Requirements Regarding Distinctiveness of Entity Names

New York’s rules regarding the uniqueness of an entity name also contribute to desired names not being available for use. Every state requires that a registered entity be either “distinguishable” or “distinguishable on record” from other registered entity names, or not “deceptively similar” to them. Usually, it is easier to find an available name in states like Delaware with “distinguishable on record” statutes. For example, making one word plural in Delaware is enough to distinguish one name from another. “Deceptively similar” states, such as California or Texas, tend to take a stricter approach and not allow names which vary in spelling, or form of the word.

New Yorkuses the term “distinguishable” in the Business Corporation Law and, through the New York Codes, Rules and Regulations, operates like a “deceptively similar” state. Section 156.2 of Title 19 states that a name is not considered distinguishable if the only difference between the proposed name and an existing name is a change in tense or form of the word (including abbreviations, alternate spellings, or alternate numeral systems, such as Roman and Arabic), punctuation differences or the addition of the word “company.” Whether a word is considered to be a form of another word is often decided by the individual reviewer at the Secretary of State’s office and procedures change over time. For example, the terms “real estate” and “realty” have at times, in the past, been considered to be indistinguishable, but at other times have not.

In some ways, Texas is tougher than New York when it comes to entity names. Besides “deceptively similar” rules that are very similar to New York’s, it has a further, broader category of “similar name requiring consent.” Under section 79.40 of Title 1 of the Texas Administrative Code, names that contain “similarities which may tend to be misleading as to the identity or affiliation of the entity” will require the consent of the existing entity to be accepted. Under this rule, a company wishing to use the name “United Phase Two” or “United Productions” would need to provide a letter of consent from an existing “United Company,” because they share the word “united.” This is a much broader interpretation of similar names than New York. A key difference is that Texas, like many other states, allows an existing company to grant consent to the forming company. In New York, this is never allowed; the new company must provide a distinguishable name.

Use of Assumed Name When Desired Name Not Available

New York offers an alternative that allows a company to use the business name they want even though it is not available. A Certificate of Assumed Name can be filed, pursuant to Section 130 of the General Business Law, after registering as a corporation, limited liability company or limited partnership under a unique, but less desirable, name. Note that in New York, an assumed name cannot contain an entity indicator such as Inc., Ltd., LLC, etc.

An assumed name filing only registers the name with the state, meaning that in the state’s eyes, it can conduct business using that name. It does not protect the name in any way, since assumed names in New York are not required to be unique. A company should also bear in mind that registering an entity name, either as an assumed name or as a true entity name with the Department of State does not in any way ensure that the chosen name could not be considered a trademark infringement and subject to legal proceedings. Whether choosing an assumed name or an entity name, a company should first ensure that the name it wishes to have will not be confusingly similar either because of a registered trademark or prior usage that would constitute a common law trademark.

Finally, when choosing an assumed name in New York, note that Section 130(2)(3)(c) of the General Business Law indicates that corporations, limited partnerships and limited liability companies can’t use a name “which consists of or includes a word or words the use of which is prohibited or restricted…” by the laws governing the formation of those entities.

Prohibited or Restricted Names in New York

The list of words that are prohibited or restricted is quite long in New York and extends well beyond the list of 31 words and phrases listed separately in Sections 301(5)(a) and (b) of the Business Corporation Law. My company has found that there are at least 90 words and phrases that are either listed in the statutes or have been determined through experience to require additional consents and approvals from other agencies. Often, this consent or approval will be required even when the meaning of the word as it is used in the name makes it clear that the company is not engaging in an activity that the approving agency governs. For example, let’s say an independent bookstore decides it wants to use the name “The Title Page Book Store, L.L.C.” Even though it is clear from the name that this company is not involved in the title insurance business in any way, it will still be required to obtain consent or waiver of consent from the Insurance Division of the New York Department of Financial Services to use that name. Consents and approvals can be obtained, but the process is often a lengthy one, so it is wise to verify whether the name contains a restricted word well before the company wishes to form.

Reserving Names: Beware of Limitations

Name reservations can be requested to help protect a desired name, but it is important to understand their limitations in New York State. A name with a restricted word can be reserved without obtaining the required approval from the appropriate state agency, but consent will be required when filing the documents. The name reservation itself does not guarantee that the name can be used. When reserving the name, it is important that the company reserves exactly the name it wishes to use. If the name on the filing differs from the reserved name in any way, even if it is only the omission of a comma, the state will require that the existing name reservation be canceled for an additional fee before the document can be filed.

Finally, it is important to be aware of certain delays that occur when reserving a name. A name reservation filing receipt, which is issued late in the afternoon after the actual reservation, must accompany the filing. Accustomed to procedures in other states, people often wish to reserve the name one day and form the company the next. In New York, due to the filing receipt requirement, this cannot be done unless the company pays expensive two hour expedite fees when filing the reservation.

Importance of Registration Confirmation; Registration Does Not Protect the Name

When registering an entity, keep in mind that the final determination is always in the hands of the filing officer. Even if every precaution has been taken to ensure the availability and acceptability of a name, it is important to wait until the document has been accepted and filed before obtaining bank accounts or taking other actions that assume there will be no problem with the registration. Understand that registering an entity name with the Secretary of State does not necessarily mean the company is legally allowed to use it. The desired name should be checked against trademarked names and names already in use to ensure that it will not be subject to trademark infringement legal proceedings. Similarly, registering a name as an entity in New York or in any state also does not protect it from anything other than having another entity register the same or very similar name based on the particular state’s rules. Trademark filings are needed to protect a name nationwide.

In summary, understanding the legal requirements for company names in the state or states where a company is registering is critically important. New York is one state where those requirements can create unexpected issues. A knowledgeable and experienced service provider can alert you to potential problems and pitfalls of the chosen name and help you avoid the additional costs and delays involved when filings are rejected.

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How to Transition From a Sole Proprietorship to a Separate Legal Entity

You started your business with one approach in your own name and now you have made the important step to form a separate legal entity. That is a huge step. The key is to complete the transition so your business will actually benefit from the advantages you gain by forming a separate legal entity.

Over the years, we have seen several mistakes in this transition and many times where someone is still operating their sole proprietorship at the same time as their new entity without knowing about it. We wanted to clear up the steps you must complete to make the transition.

Here are the steps:

Form the separate legal entity (an LLC or corporation). NCP can help you do that (we form corporation and LLCs in all 50 states).

Obtain a NEW TAX ID Number. Even if you had a Tax ID number as a sole proprietorship you need a NEW ONE!

Open a NEW bank account in the name of the entity. Yes, even if you already have a bank account and you went from “Marketing Solutions” to “Marketing Solutions, Inc.” that is a new name and a separate legal entity and you need a NEW bank account. Yes, new checks too!

Connect the DBA (doing business as) to the new entity. When you filed the DBA in your local county you were the applicant. That is what make that business in your name. Now you need to “reconnect” the DBA to the NEW legal entity. That means you need to dissolve the DBA name linked to you and refile (the same day) the DBA name to the new entity. That means the new entity is the applicant. This is what connects it to the new entity. Now, for both tax and liability issues any business in the DBA from this point forward is under the new entity name.

Obtain a new business license in the name of the new entity. Yes, a new one. Typically, you can NOT transfer a business license from your sole proprietorship name to your new LLC. Reason? It is a separate legal entity.

Obtain a business credit card in the name of the new entity. Stop using your personal credit card cards to finance your business. Ask the bank how long does the new entity have to be in business before they would recommend you apply for a business credit card.

Update all your sources of income with the new Tax ID number of the new entity. You goal is to avoid receiving unnecessary 1099s (meaning you want the money, just not to yourself individually anymore) for affiliate or referral fees by the end of next year. Make sure all your affiliates are updated with the new entity information.

Update any contracts in the name of the new entity.

Update vendors with your new entity name and information.

Get new business cards. Don’t be cheap even if the only difference of the name of your company is “LLC”.

Set up a new chart of accounts in the new entity name.

Update your merchant account provider with the new entity information. You may have to complete new forms.

Update your insurance provider with the new entity information.

Comply and update any state related issues in the name of the new entity.

Check with your attorney or CPA for any steps missed.

This is a good list to help you get started. The biggest mistake we see is not completing updating the DBA name from your name to the new entity and using the new bank account. The goal is to get off the sole proprietorship track as fast as possible. If you add new businesses in the future you can add a new DBA name with the entity as the applicant. The key part is to be aware of the type of asset class. Safe assets like gold, investments should be owned by a separate legal entity from your operating business. Real estate should be in a separate legal entity also. If you have several properties each with a lot of equity it may make sense to split those into separate legal entities.

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