Summary of Information regarding Business Organizations
The first is an understanding of the available business entities and their advantages and pitfalls. The second is an understanding of their needs given their current circumstances and long-term business objectives. An entrepreneur’s decision regarding the form in which to conduct his or her business should involve a balancing of both tax and non-tax characteristics. The following is a summary of the commonly used business organizations in Washington.
Sole Proprietorship
A sole proprietorship is the simplest form of doing business from both a tax and non-tax standpoint because it does not require the creation of a new entity. However, sole proprietorships expose an owner’s unrelated assets to the obligations of the business and are simply unavailable where more than one person owns an interest in the business.
Partnership
Partnerships and limited partnerships are not subject to double taxation, but require that one or more general partners be fully liable for the entity’s obligations.
Corporation
A corporation is a separate legal entity, which is created by state law and subject to specific statutes. A corporation is fundamentally different from partnerships and sole proprietorships,which are legally indistinguishable from their owners. For example, a corporation is a separate entity for virtually all federal, state, and local tax purposes.
Profit corporations formed in Washington are governed by Title 23B of the Revised Code of Washington, the Washington Business Corporation Act (the “Act”). Subject to the Act, a corporation is formed and governed by its Articles of Incorporation (the “Articles”) and its Bylaws, which give the corporation its basic structure and form, and by the will of its shareholders and directors, as expressed in formal corporate actions. The Articles and Bylaws may both be amended to change the governing rules, within certain prescribed limits.
Formal corporate actions of the shareholders and directors may be taken at formal meetings, or by unanimous written consent. Shareholders are responsible for election of the board of directors,and have the right to control certain major actions of the corporation. Directors are responsible for the appointment of officers and the governance of the corporation, including setting policies and authorizing certain important or extraordinary transactions. Day-to-day control of the corporation is exercised by its officers. To some extent, the degree of authority granted to shareholders vis-à-vis the officers, is determined by state law. However to a great extent, the degree of authority is determined by the Articles, the Bylaws, the policies established by the corporation’s board of directors and by custom and practice.
A corporation is formed when its Articles are filed with the Washington Secretary of State. The State charges a one-time fee of $175.00 to file the Articles, plus a $20.00 handling fee if the Articles are filed in person or through a messenger service. In most cases, we recommend filing the Articles with a messenger service so that filing occurs immediately and we then receive a copy of the Articles stamped as “filed” within a couple of days after filing. If the Articles are filed through the mail, it may take several weeks to receive a stamped copy from the State. However, a number of other matters must be completed before the corporation’s organization is finalized, including but not limited to an Consent in Lieu of Organizational Meeting of Board of Directors (the “Organizational Consent”); Bylaws; Subscription Agreements; and a Master Business Application.
- Organizational Consent
Within 120 days after the date that a corporation’s Articles are filed, the corporation’s initial board of directors must either hold an organizational meeting or execute a unanimous written consent for the purpose of appointing officers, adopting bylaws, and conducting any other business the board may deem appropriate. The simplest and most cost-effective means to satisfy this requirement is for the shareholders to execute the Organizational Consent. The Organizational Consent includes resolutions that approve and adopt the corporation’s Bylaws; elect the corporation’s President for the coming year and designate the person to perform the duties normally performed by a secretary; accept stock subscription; approve the corporation’s form of stock certificate; and give the corporation’s President blanket authority to perform a wide variety of activities necessary to operate the business. - Bylaws
The Bylaws regulate the management and internal affairs of the corporation. They are subordinate to the Articles. The Bylaws contain provisions affecting the rights of the corporation’s shareholders and directors, as well as the authority of corporate officers. They also establish the basic administrative rules for the day-to-day legal operation of the corporation, including the procedures for:- altering the number of directors;
- calling, convening, conducting, and voting at shareholder’s meetings;
- electing officers and directors;
- the issuance of certificates representing shares of the corporation’s stock; and
- the amending of the Bylaws.
As a practical matter, the Bylaws do not impose any significant operational burdens so long as the directors, officers, and shareholders are in basic agreement on corporate directions.
- Subscription Agreement
The Subscription Agreement evidences the shareholders’ commitment to acquire a certain number of shares of the corporation’s common stock in exchange for a payment to the corporation of the consideration for such shares. Also, the Subscription Agreement usually contains language necessary to effectuate compliance with certain securities law requirements. - Master Business Application
Although a business will be applying for a Federal Employer Identification Number with the Internal Revenue Service, the corporation also must file a Washington State Master Business License Application and may also need to file other forms that are related to requirements for tax, payroll, and financial records.
Limited Liability Company
As compared to a corporation, a limited liability company (“LLC”) can be a simpler, more direct and more flexible way to achieve not only beneficial federal income tax treatment of a partnership (i.e., no federal income tax at the entity level), but also the immunity from personal liability for company obligations enjoyed by corporate shareholders. An LLC can be a very attractive alternative to a general partnership, limited partnership, or proprietorship.
Similar to a corporation, an LLC is created by filing a Certificate of Formation (the “Certificate”) with the Washington Secretary of State’s office. The LLC will become a valid, independent legal entity immediately upon filing of the Certificate. The State charges a one-time fee of $175.00 to file the Certificate, plus a $20.00 handling fee if the Certificate is filed in person or through a messenger service. In most cases, we recommend filing the Certificate with a messenger service so that filing occurs immediately and we then receive a copy of the certificate stamped as “filed” within a couple of days after filing. If the Certificate is filed through the mail, it may take several weeks to receive a stamped copy of the Certificate.
In addition to filing the Certificate, the owners of the LLC, or “Members,” as they are defined in the Limited Liability Company Act, should enter into an Operating Agreement (the “Agreement”). Although the Agreement operates much the same as a Shareholders Agreement among shareholders of a corporation, the Agreement generally is significantly more detailed because its provisions also must address many other important issues, including, but not limited to:
- management;
- rights and obligations of the Members;
- contributions to the capital of the LLC and capital accounts;
- allocations of net profits and losses, and distributions;
- taxes;
- accounting, books and records;
- transferability of interests;
- admission of additional members;
- dissolution and termination; and
- the independent activities of managers and the Members.
The Agreement should be completed before the LLC begins its operations.
While many of the benefits of LLCs can be achieved using more traditional business structures like Sub-S corporations and limited partnerships with corporate general partners, doing so may be more complicated, cumbersome and expensive than using LLCs.
Needless to say, there are a large number of considerations that go into the choice of an appropriate business entity that cannot be fully summarized here. However, we hope that this summary has provided you with basic information regarding business organization choices available in Washington.
