By Attorney Kelly Rains Jesson and Associate Attorney Danielle Nodar
Forming a corporation in the state of North Carolina is pretty easy to do yourself, but that may get business owners into trouble. Numerous corporations exist without any bylaws and without issuing any shares (especially those who do-it-themselves). Failing to complete all the steps can have negative consequences.
A corporation is owned by its shareholders. Shortly after a business is incorporated, it should issue shares to the owner(s). If there are no shares issued, there are no shareholders, and thus no owners. Why do so many business owners fail to complete this step? Probably for two reasons: (1) they don’t know this is the way it works and (2) in order to incorporate, all the Secretary of State’s office requires is that Articles of Incorporation be filed with its office. It does not require proof of bylaws or shares.
Shareholders do not manage the business just because they are shareholders. The Board of Directors manages the business. For small, family businesses, the shareholders and the directors are often the same people. However, these are still two distinct roles. Most business owners that have not issued themselves shares are simply acting like directors of the corporation.
To incorporate, the incorporator (could be a future director, shareholder, or third party, like an attorney) files Articles of Incorporation. North Carolina law states that if no directors are named in the Articles of Incorporation, the incorporator shall hold a “meeting” (can be informal) to name the initial directors. “The incorporators or board of directors of a corporation shall adopt initial bylaws for the corporation.” N.C.G.S. § 55-2-06 (emphasis added). The law states that there SHALL be bylaws, not that there MAY be bylaws. The bylaws govern the management and affairs of the corporation. The bylaws state how shares will be issued, how directors will be named/replaced, and how the company is managed.
So why should you care?
First, the liability protection corporation owners enjoy is at risk if you do not follow the corporate formalities required by North Carolina law. You risk having a creditor ask a court to “pierce the corporate veil,” making you personally liable for debts and judgments of the corporation. When a court “pierces the corporate veil,” it determines that the corporation and owner are basically the same, with the corporation serving as merely a shell for the owner to act. If this finding occurs, your personal assets can be used to satisfy corporate debts, which defeats one of main purposes of owning a corporation in the first place.
Second, you will probably not be able to obtain an SBA loan if you do not have bylaws. These loans are backed by government guarantees. The government wants to make sure it is not lending to an entity that has not been set up properly. The SBA wants to make sure the bylaws do not contain provisions that make the loan risky.
Finally, another reason why we talk to our clients about shares and bylaws is for estate planning purposes. When a person passes away, they leave their property to beneficiaries. Shares of corporations are personal property. If a business owner has not issued himself or herself shares of the corporation, what is there to pass to their beneficiaries?
Further, as we explained above, corporations are managed by the board of directors and not the shareholders. Therefore, even if a shareholder owner passes their shares to their beneficiaries, that does not mean that the beneficiary now suddenly starts managing the company as a new director. If you are the sole director of your corporation, who will take over management when you pass away or are sick? The bylaws of a corporation will govern what happens when a director passes away or otherwise becomes unable to act.
We can do some pretty creative estate planning with owners of corporations. We can help them restrict management or ownership of shares to family members. We can ensure that their shares stay out of probate through using trusts, saving their families money.
For assistance with drafting bylaws, issuing shares, and implementing an estate plan, give Jesson & Rains a call!
The privilege license tax is a tax levied on the privilege of conducting a particular trade or business. If you are a professional that is licensed by a board, you most likely should be paying state privilege license tax every year (for example, accounts, attorneys, general contractors, realtors). There are some exceptions to this requirement, like professionals working for the government or non-practicing physicians, to name a couple.
However, there are some surprising professions on this list; most notably, photographers.
A list of applicable professions can be found here:
And the license application can be found here:
The license is issued to the individual and not the business. While the individual can go ahead and form his/her business, the license should be applied for before beginning business. It is unlawful to engage in business without obtaining a required privilege license. The penalty for failure to obtain a license is the greater of five dollars ($5) or five percent (5%) of the amount prescribed for the license per month or fraction thereof from the time the amount is due until the amount is paid, up to a maximum not to exceed twenty-five percent (25%).
The privilege license tax is annual and is due by July 1 of each year. The penalty for failure to pay any tax when due is ten percent (10%) of the tax due.
Because the license is issued to the individual and not the business, if an individual is engaged in more than one business, he/she will have to obtain a privilege license for each business. If you are a licensed psychologist who has a photography business on the side, you must obtain two privilege licenses and pay two taxes, for example. The license must be displayed conspicuously at the location of the licensed business, trade, or profession.
If you have questions about the privilege tax, please give us a call!
We encourage business owners to form formal business structures like Limited Liability Companies and Corporations in order to protect their personal assets from business debts and creditors. However, simply filing the Articles of Organization or Articles of Incorporation with the Secretary of State’s office is not enough. If you do not keep your business and personal finances and operations separate, a court could potentially find that, while there was an apparent separation of the two, in reality, the individual was using his or her business for their own personal affairs and order that the two are not really separate. If this happens, a court could satisfy a business debt or judgment with your own personal assets.
What can you do to avoid this? First, the easiest thing to do is to keep your finances separate. Open a business bank account and only use that account for business income and expenses. Do not pay for personal items out of this account, even if you’re going to reimburse yourself. Keep good records. Do not take liberties with categorizing something as a business expense when it’s really a personal expense. Use a trustworthy business accountant. It is not worth the risk of stretching your deductions to pay less taxes (if it’s not really a business expense) because you’re opening yourself up to personal liability. Second, sign all of your contracts as member of your LLC. Don’t sign them as you personally.
Third, if you own a corporation, you have to comply with the North Carolina Business Corporation Act. You are required to have bylaws, even if you are the sole owner. You are required to vote and install a Board of Directors. If you want to own your corporation, the board (which may just be comprised of you) needs to issue you shares so that there’s a record that you own the business and that you’re not simply just a director or the president of the business. Directors need to keep thorough records of annual meetings and need to vote on business decisions (even if it is just yourself voting). If you do not have robust corporate records, you risk having a creditor ask a court to “pierce the corporate veil” … meaning that a court may find you and your corporation one of the same, and you may be ordered to satisfy corporate debts and judgments with your personal assets, defeating one of the main purposes of owning a corporation. If you or someone you know on a business and you believe that the books and records need to be improved, please give us a call.
In North Carolina, you do not have to “form” a business to start a business! However, the disadvantages outweigh the advantages. Here is a brief overview of a business owner’s options in North Carolina:
Sole Proprietor – This is the easiest type of business to form because there are no forms to submit to the Secretary of State’s Office. You may need to complete a “certificate of assumed name” with the County if you do business with a different name other than your own. You will have to pay self-employment taxes with the state.
You are your business. Therefore, your business debts are your personal debts. If your business is sued, you are sued, meaning that a judgment can be recovered out of your personal assets. This is the main reason why this is not the best type of business to form. The paperwork to the Secretary of State’s Office and the IRS is very simple and it is not expensive, so that should not be a deterrent to formalizing your business.
Partnership – This is similar to the sole proprietor except for number of people. You are your business . . . well, you and your partner(s) together are the business. This means that if one of your partners does something wrong, your personal assets may be used to pay the liability. If the wrongdoing partner has sufficient assets to cover the liability, you can sue for contribution and force the wrongdoing partner to pay. Otherwise, you are on the hook personally.
No formation paperwork is required to be filed with the Secretary of State’s Office. The partners individually pay income tax every year (regardless of whether you “pay yourselves” or not . . . partnership income is your income). Finally, you should draft a partnership agreement. This will outline how the partnership is run, how the partners are paid, and the ownership interests of each partner (if not owned equally, which is the default unless otherwise stated).
There can also be a limited partnership, which means that one (or more) of the partners has no management control but is there for investment purposes only. The limited partner is entitled to income from the partnership and enjoys limited liability in the event the partnership is sued. General partners participate in the management of the partnership and are personally liable for partnership debts. A limited partnership must file paperwork with the Secretary of State’s Office.
Limited Liability Partnership - This type of partnership has only general partners, but the partners still enjoy protection from personal liability. This is certainly the way to go when it comes to partnerships. The only thing that is additionally required is registering the LLP with the Secretary of State’s Office.
Corporation – A corporation (“C-Corp”) is the most formal type of business. A corporation has a board of directors, who make management decisions, and shareholders, who invest and receive income back in the form of dividends. In order to form a corporation, Articles of Incorporation must be filed with the Secretary of State’s Office. An EIN must be obtained from the IRS. If securities are offered, federal securities regulations will need to be followed. North Carolina has statutes that govern board meetings and shareholder meetings. By-laws must be created.
The main drawback of a corporation is the double taxation structure. When the corporation makes money, the corporation has to pay income tax. When the shareholders are paid a dividend, they have to pay income tax as well. Because the corporation is its own entity, the shareholders have no personal liability for the corporation’s liabilities.
An “S Corp” is a special type of taxation structure that is not taxed at the corporate level. See below (LLC) for more discussion. An S-corp is not a form of corporate entity created with the NC Secretary of State. It is an IRS designation.
Limited Liability Company (LLC) – This is a popular option because there are not as many formalities as a corporation, but the company/individual is typically only taxed once, and the owners enjoy limited personal liability. The LLC is its own separate entity for debt/liability purposes.
The IRS and NCDOR treat LLCs as partnerships for tax purposes, so there is no separate entity tax unless the LLC elects to be taxed as an S-Corp. If the LLC has just one owner/member, the IRS treats it as a sole proprietorship (again, no separate entity tax), so no election is required; however, the LLC will still have to make the election (partnership vs. S-Corp) with the IRS and NCDOR. If the business makes the S-Corp election, the business profits are taxed on each shareholder’s individual tax return. Any LLC member who works for the company must pay himself “reasonable compensation.” Therefore, many start-ups are not initially taxed as S-Corps.
An LLC must be registered with the Secretary of State’s Office by filing an Articles of Organization and must file annual reports like LLPs and Corporations. If there is more than one owner/member, an operating agreement needs to be drafted governing how the LLC will be run and detailing the ownership interests of each member.
PLLCs also exist for "professionals," such as accountants, attorneys, and doctors, who are licensed by state boards. The LLC requirements are the same, but the professionals should check with the licensing board because the board will likely have additional formation and filing requirements.
This is a very basic outline of the types of business entities in North Carolina. Depending on the type of business and your goals, one might work better than another. For any of the above entities promising limited liability, it is very important that business and personal debts be kept separate. Also, some of these types of business require that the business names be unique and contain words that signify what type of business entity it is. Thus, you should consult an attorney when the time comes to formalize your business!
We have had clients contact us who are interested in forming several LLCs for liability protection but then have heard that it is a good idea to form a “holding company” to then own these LLCs under one umbrella.
Traditionally, holding companies are corporations that own stock in other corporations, and all they do is collect dividends from the stock. Berkshire Hathaway is the most famous holding company. It owns stock in many notable companies. It’s beneficial for the holding company to own a majority amount of stock, too, for control and tax purposes. Holding companies are a way for investors to buy shares of companies and make money by receiving dividends for doing nothing but investing. The owners of Berkshire Hathaway (its shareholders) don’t run any of the companies it owns. The board and officers of Berkshire Hathaway (including Warren Buffet) don’t run any of the companies Berkshire Hathaway owns. Of course, if Berkshire Hathaway owns a controlling amount of stock, it could vote to replace the board if the subsidiary wasn’t doing well.
Nowadays, people are forming “holding companies” for other purposes. Modern holding companies are really used as a tool for liability protection. If you form one LLC to own or “hold” the real estate, you can form a second LLC to operate / manage the properties. That way, if one LLC gets sued, the property of the other is not up for grabs. For example, if someone sues the property management company and it has to file bankruptcy, the building is safe because it is owned by the other LLC and its owners (also the owners of the operating LLC) can form another operating LLC immediately.
We think it is a great idea to form multiple LLCs. The more segmented and specific you can get it, the more liability protection there is. However, with each new LLC, there are additional costs: formation fees, annual report fees, and accounting fees.
Some people think that there is a benefit to having a parent LLC own multiple LLCs. So, in our example above, Real Estate Enterprises LLC would own the property holding LLC and the operating LLC. Again, creating a parent company for the purposes of simply “holding” the separate LLCs is an added expense without much of a benefit. There’s no increased liability protection forming a parent company. Each LLC has to file annual reports and tax returns each year, so consolidating isn’t making that easier. There is possibly an extra layer of management, too (management of the subsidiary and management of the parent) that may be unnecessary.
For investment purposes, though, there may be some benefit. The subsidiary LLCs are assets on the parent company’s books. There are also some estate planning benefits. Instead of having the deceased’s ownership interest pass to the heirs for 12 different companies, the parent LLC’s interest could pass to the heirs and they would automatically own all the subsidiary LLCs.
With any business formation, it is important to contact a business planning attorney and a reputable CPA.
The number one reason why we recommend individuals form businesses instead of operating as a sole proprietor or partner is for liability protection. Generally, a member of an LLC or an owner of a corporation will not be personally responsible for the debts and liabilities of the business.
1) If the member or owner signs a personal guarantee. It is very common for banks and landlords to require new business owners to sign a guarantee which “guarantees” the bank or landlord that if the business is unable to pay back the loan or pay the rent, the member/owner will pay personally.
2) If the member or owner is personally negligent. A member/owner can be held personally liable for his own careless actions if he injures someone while operating the business. Professionals can be held personally liable for their own malpractice. This is why we also recommend getting commercial liability insurance. A member/owner can also be held personally liable for conduct occurring outside the scope of employment.
3) If a court “pierces the corporate veil,” meaning the LLC or corporation was merely a shell for the member/owner to carry out his wrongdoing and served no legitimate business purpose. Three elements must be satisfied before a court will hold the member/owner personally liable:
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