FAQ: Advantages & Disadvantages of Online Business Incorporation Services

On a legal message board on which I respond to user's questions with user name Calif Business Lawyer from time to time, a question concerning online business incorporation was posted, to which I responded, and which I'm reprinting here, because I get frequent questions about the advantages and disadvantages of online incorporation services:

I am using an online service to create the S-corporation, and one question asked by the website is to check off a box if it is a "personal service corporation". Examples of such corporations are health and attorney industries, etc. I don't know if a beauty salon is classified as such.

It's probably not critical to classify the corporation as a personal service corporation except when filing taxes, right?

My reply:

Unfortunately, this illustrates one of the problems of using online incorporation services - if you don't know the answers to the question being asked (which in this case doesn't make a lot of sense anyway - only a C corporation need be concerned with personal service corporation [PSC] classification), you need to obtain legal and/or tax (accounting) advice prior to or in conjunction with - or instead of - incorporating online. Of course, by the time you pay to consult an attorney and/or accountant, then pay the document preparation services, most or all savings will have evaporated. Also, such services don't usually start from square one, and ask you, Are you forming in the right state? Have you considered an LLC instead of a corporation (or vice versa)? Why or why not?

Most of the online incorporation services include disclaimers like this one I found in small print at the bottom of one popular site:

"[Company] is not a law firm and is not a substitute for the advice of an attorney."

And this on another leading site: "[We] cannot provide information as to whether a person should incorporate or form a limited liability company or a partnership. If you are contemplating forming any of these entities you should consult with private counsel regarding your individual fact situation."

For those who know exactly what they want, and can explain it to someone else in plain English in a few sentences, the disadvantages of online incorporation services may be overcome by the one big advantage of cost savings. In my experience, however, this is a minority of those who are using such services. And savings up-front sometimes ends up in more expenses later, when I am hired to resolve business disputes the corporation bylaws and LLC operating agreements should have covered, or would have covered, had they ever been adopted, or to dissolve or merge entities, and replace them with better-suited ones.

You are correct that the personal service classification is largely tax-related. Some regulated professions are prohibited from forming certain types of business entities in some states (e.g., California does not permit professional LLCs - to test out your favorite online incorporation service, try starting the process of forming a California professional LLC online, and see if the system warns you or rejects it before you get to the submit order stage).

Don't forget state and local licensing and registration requirements.

Personal service corporation defined:

"A type of C-Corporation that is owned and operated by individuals performing personal services in such fields as health, law, engineering, architecture, accounting, actuarial science, performing arts and consulting.

The requirements for a PSC are:

The corporation is a C-Corporation.
The corporation's principal activity during the year is the performance of personal services.
The personal services are primarily performed by the employee-owners of the corporation.
Employee-owners own at least 10% of the corporation's stock.

PSC's must generally use a calendar year as their fiscal year and are taxed at a flat rate of 35% on all of their taxable income."

See also:

Zoom Past Legal Zoom and
LegalZoom - Why We Love It

Beverly Hills Lawyer

I recently received an emailed new client inquiry. She indicated that she was seeking a book contract to write on some new information regarding a celebrity trial, which would thus in her opinion (which I did not disagree with) be quite marketable. Specifically, she wanted to know if I had connections to get the book sold. I indicated to her that New York rather than Los Angeles was the locus of attorneys servicing book authors, because that is still where the vast majority of book publishers are located, but that with a book such as the one she had in mind, any ethical, honest, and hardworking attorney ought to be able to assist her in making the sale. (I also should have noted that book sales are usually and probably best done by book agents where one can be obtained, and that negotiating and documenting the finer points of the contract would best be done by an attorney regularly dealing with literary agreements, and working in conjunction with the author's agent, rather than by a Los Angeles film/TV entertainment attorney such as myself.)

Ignorning at least the portion of my email indicating to her that I was not well connected in the book publishing world, her reply email began by again asking whether I had the necessary connections to make the sale for her. But in the more interesting portion of her reply, she stated that she indeed already had a "Beverly Hills lawyer - right on Wilshire" that was not getting the job done for her due to his apparent lack of connections. The implication was that a Beverly Hills attorney would be a very good attorney, the best of the best in Los Angeles, and thus if a Beverly Hills attorney without connections was not going to get the job done for her, no connection-less attorney would. Putting aside the issue of whether Beverly Hills lawyers are all ethical, honest, and hardworking - I'm sure most are and some are not - the comment reminded me of something an attorney friend of mine who does indeed have a Beverly Hills office - right on Wilshire(!) - had told me:

He noted that clients seemed more willing to pay for his small law firm's services ever since the firm relocated from a Los Angeles to a Beverly Hills address. He was a bit amused and a bit perplexed by the phenomenon, shrugging his shoulders as he pointed out to me that he was the same lawyer, and his colleagues the same attorneys, that they were before they moved into their Beverly Hills office building; nonetheless, his clients were now willing to pay more for the same legal services (part of which was no doubt needed to cover the firm's increased rent, the balance representing extra profit for the firm).

Nothing against Beverly Hills lawyers, on Wilshire Boulevard or off, but the city or street of a prospective lawyer is, in my arguably biased opinion, at best one of many factors a client should consider when choosing an attorney, and perhaps one best disregarded altogether.

FAQ: When can I obtain an EIN number for the corporation or LLC I'm forming?

Another frequently asked question:

When can I obtain an EIN number for the corporation or limited liability company I'm forming?

The definition of "EIN" is Employer Identification Number. An EIN, sometimes also called a Taxpayer Identification Number (TIN), Taxpayer ID number, or Federal Identification Number (FIN) is in essence the business entity equivalent of a social security number. Individuals have social security numbers, while corporations, LLCs, and some sole proprietorships, partnerships, and trusts, may obtain an EIN.

How do I obtain an EIN? EINs are issued by the IRS; apply with Form SS-4 by mail, fax, phone, or online. The name EIN is somewhat misleading, since an EIN is often needed regardless of whether a corp. or LLC will have any employees. For example, an EIN is generally required to open a business bank account in a corporate name, or to file corporate taxes.

Because they want to open a bank account as soon as possible, clients and potential clients often want to know how they can get an EIN as soon as possible. While it is not time-consuming to have an EIN issued once the corporation or LLC is formed (I obtain them same-day for clients), it is not possible to issue an EIN for an entity that does not yet exist. Anyone who claims they can get you one today is lying, misguided, or filing fraudulent paperwork on your behalf with the IRS - and probably with your name and social security number on it.

So if an EIN is needed yesterday, then the corporation or LLC itself is also needed yesterday, and the options that should be considered include expedited filing procedures to form the entity as soon as possible, or the purchase of an already-formed, ready-to-use shelf corporation or shelf LLC.

Incorporation Service Pursued by State Bar

The State Bar of Michigan has successfully obtained a permanent injunction from the Kent County Circuit Court against the "We the People USA, Inc.," and its franchises in the state from engaging in the unauthorized practice of law.

The consent judgment was a result of action taken in response to a complaint received by the State Bar of Michigan that "We the People of West Michigan LLC," drafted a special needs trust for an individual and that the trust did not meet statutory requirements. Had the elderly individual funded the trust, she would have suffered serious financial harm. The defendants were ordered to pay the State Bar $150 in costs and to reimburse the victim $356.

"The State Bar is committed to protecting Michigan residents from entities and individuals not licensed to provide legal services or advice," said SBM President, Kimberly M. Cahill. She added that the Bar usually receives 100-150 complaints each year about persons or organizations that are practicing law or giving legal advice without a license. Most of these complaints are usually resolved through correspondence with the offender. In rare cases, litigation becomes necessary.

State Bar of Michigan Press Release 1/27/2007

FAQ: California Corporate Seal

In this post, I will address the first of many frequently asked questions (FAQs) I receive from client and potential clients regarding California business law:

Do I need a corporate seal for my California corporation or LLC? Where do I get one?

Historically, a company's official seal was applied to documents to indicate that the contract was a corporate act. Wax and a stamp was used. In modern times, the wax was replaced by a stamp that made only an impression on the paper.

California Civil Code Section 1628 states:

"A corporate or official seal may be affixed to an instrument by a mere impression upon the paper or other material on which such instrument is written."

The term "may" in the statute indicates that the use of a seal is permissive, rather than mandatory. Lest anyone interpret this code section to mean only that a modern seal must be used, instead of an old-world wax seal, Section 1629 makes it clear:

"All distinctions between sealed and unsealed instruments are abolished."

This is consistent with the laws of most if not all U.S. states which have abolished the use of seals as a requirement for corporate contracts.

Thus, while a corporate seal may be applied to a document, its legal signifigance is zilch. If your company still desires to have one, or in the rare circumstance that a third party will not complete a transaction without one (occasionally encountered in lending situations), custom seals can be purchased at most office supply stores and from many online outlets. For our clients that prefer to have one, we can also arrange to have one made as part of a corporate kit at the time of incorporation or LLC formation.

2007: Time to Incorporate Your Sole Proprietorship?

IRS to Target Schedule C Filers:

In a recent telephone conference, IRS commissioner Mark Everson said that they will be conducting more audits on individuals running unincorporated businesses (i.e. self-employed individuals).

While Schedule C filers have long been audit targets for the IRS, they are now stepping up their audit efforts because they believe that self-employed individuals represent a large portion of those individual taxpayers underreporting their income.

IRS to Target Schedule C Filers, About.com U.S. Business Law / Taxes, 25 December 2006

Incorporating, while not a panacea by any means, nor appropriate for all small businesses, entrepreneurs, and those with side businesses in addition to W-2 income, can help reduce exposure to a time-consuming audit, as well as potentially offering tax, asset protection, and other benefits to business owners.

See also: January 2009 update

Minimum Wage Increase

The Los Angeles Times reports today:

House OKs rise in minimum wage

82 REPUBLICANS JOIN DEMOCRATIC MAJORITY

By Richard Simon / Los Angeles Times

WASHINGTON - The House Democratic majority, exercising its new political clout, Wednesday approved the first increase in the federal minimum wage in a decade -- from $5.15 to $7.25 an hour over two years.

The measure heads to the Senate, where it is likely to be coupled with tax breaks for small businesses to win Republican votes in the narrowly divided chamber and to secure President Bush's signature.

The minimum wage has been unchanged since 1997, the longest period without a raise since the first minimum wage was enacted in 1938.

California employers are also reminded that the state's minimum wage has risen to $7.50 per hour, effective January 1, 2007, and will rise again to $8.00 per hour on January 1, 2008.  California is amongst 29 states with a minimum hourly wage rate higher than the federal rate.  Certain localities have an even higher minimum wage, such as San Francisco ($9.14 [PDF]).

Updated 2007 mandatory California workplace postings can be found here.

Update 1/25/07: As noted in a blog concerning California employee rights, the recent minimum wage increase may also affect the eligibility of certain employees to be paid on an exempt basis:

"An employee MUST receive twice the minimum wage to be exempt from overtime pay. Commissioned salespeople MUST receive 1.5 times minimum wage to be exempt. If this criteria is not met, these employees are automatically entitled to overtime pay.

Under prior law, employees had to receive $28,080 per year to be exempt (twice the minimum wage ($13.50) X 40 hours X 52 weeks), but now that number has risen to $31,200."