- Industry-specific regulations that govern the licensing and business activities of businesses in industries like construction, healthcare, insurance, financial services, credit card processing and so forth.
- General rules that apply to all businesses such as those required to maintain your corporate status or do business legally.
- Local and state rules and zoning ordinances that apply to businesses in a specific geographic location.
Since most entrepreneurs start businesses in industries they’ve worked in before, the industry-specific regulations may be the simplest for start-up businesses to remember. Few construction contractors would start a new project without securing the required building permits, a barber, plumber, or manicurist wouldn’t forget to renew a state license, and few insurance agencies would forget the NAIC and FINRA regulations that apply to them.
Somehow, though, the more general rules and regulations can come as a surprise to some entrepreneurs. At 1-800Accountant, we often get questions from clients about basics like state franchise taxes (which usually apply to all businesses, not just those that are franchised), shareholder agreements, and annual reports. This article covers the five basic compliance areas that can get growing businesses in trouble.
Keep Your Corporate Status
Setting up your business as a corporation or LLC isn’t a “do it once and forget it” process. There are legal formalities and paperwork required for maintaining your corporate status in many states.
Here’s a sampling of the periodic paperwork required to retain your corporate or LLC status. These requirements vary from state to state, so check with your tax or legal adviser to see which apply to your business.
- Federal taxes (e.g., corporate income, Social Security, Medicare, unemployment)
- State taxes (corporate income; annual franchise; payroll, including unemployment, disability and workers’ compensation; sales; certain property)
- Federal, state and local licenses and permits (certification, operating and safety)
- Shareholder agreements
- Company records (articles of incorporation and bylaws; personal: key transactions: minutes of meetings; etc.)
- State annual reports
To keep your corporation or LLC in good legal standing, you must file all required reports on time and pay your corporate taxes on time. Failure to plan for taxes—income taxes, payroll or other withholding taxes—is one of the primary causes of small business failure. Specific statutory authority allows federal and state officials to assess liability for certain unpaid taxes against individuals responsible for the corporation. Common targets are corporate presidents and treasurers, although directors and shareholders of small businesses may also be liable. Tax debts can’t be written off in bankruptcy, so setting aside the cash to pay taxes on time is critical.
Most states require corporations to file an annual report and an annual franchise tax report; some have other forms that must be filed as well. Annual reports provide states with current information on such things as corporate address, business activity and changes in the roster of officers or directors.
Some states charge a franchise tax that must be paid when you file the franchise report. The tax is a fee assessed for doing business in the state, if you fail to file your annual report or franchise tax in a timely fashion, your corporate charter may be revoked, effectively dissolving the corporation.
Keep Proper Corporate Records
In addition to the records required by law, it’s important to document key corporate meetings and transactions. Besides the required legal documents such as articles of incorporation and bylaws, most states require corporations to hold annual shareholder meetings and maintain a record of the minutes of those meetings and any consent resolutions, and all written communications to shareholders within the last three years, including copies of any financial statements furnished to them.
The IRS and other parties with claims against the corporation may be able to compel disclosure of a much broader range of documents, including detailed financial information, tax returns, sales records, personnel records and company contracts. If you fail to keep appropriate records, a tax court could impose personal liability against individual officers, directors and shareholders of the corporation.
To maintain your corporation’s status as a separate legal entity, important activities should be documented, usually in corporate minutes, contracts or both. If you don’t hold the corporation out as a separate legal entity, you make it easier for creditors and other claimants to assert personal liability against the owners rather than the corporation.
While corporate minutes don’t have to include specific reference to day-to-day business operations, extraordinary items or matters that fall outside the category of daily activity should be expressly noted in the minutes. This would include, for example, decisions relating to the purchase or lease of expensive equipment or real estate, borrowing money or pledging corporate assets as security for a loan, or declaring a dividend or redeeming a corporate stock. Other important transactions can be documented through a bill of sale, invoice, promissory note or contact.
Avoid Commingling Assets
The first commandment of corporate compliance is: Do not commingle personal assets with business assets or make personal use of business property. Even a single instance where a check made out to the company was deposited in a personal bank account, or a company credit card was used to purchase personal items or a company check was used to pay a personal bill can “pierce the corporate veil” and result in a wide range of civil and criminal penalties.
A corporation should have its own bank account distinct from any personal account you may have. It’s much harder to demonstrate that certain expenditures were made for the benefit of the business when personal and business accounts are the same. If personal items are used by the business—tools, office supplies or computer equipment, for example—corporate minutes should document which items are personal.
Something as simple as personal use of a company-owned car can create potential legal problems. Even if you use the car just to tote the kids back and forth from school, you should document this time for the corporate records. Also, don’t try to deduct or depreciate, as business assets, property that is used almost exclusively for personal purposes.
Operate the Corporation at Arm’s Length
It’s common for the shareholders, officers and directors of small corporations to enter into business transactions with the corporation. For start-up businesses, corporate loans often come from these individuals. Any such loans should be documented with a corporate resolution or promissory note. Interest rates and repayment provisions should be comparable to those the corporation would have to meet had the lender been a bank or other unrelated party.
The same rules apply if the corporation is the lender and an officer or shareholder is the borrower, and in cases where shareholders sell or lease assets to the corporation. The temptation to offer favorable terms to individuals associated with the corporation is great, but it must be avoided. “Sweetheart” deals between an individual shareholder, officer or director and the corporation are subject to close scrutiny by the IRS, other shareholders and creditors.
Identify Your Business by Its Corporate Name
Whenever you do something on behalf of the corporation, make it clear you are not doing business in an individual capacity. If you sign a contract for the corporation, for example, be sure to include your title. Sign as “John Doe, President,” and not simply “John Doe.” By remembering to use the corporate name and referring to yourself with your corporate capacity, you help to insulate yourself from personal liability.
This rule applies to every facet of your business. Credit cards used exclusively for business should show the company name and the individual cardholder’s name – John Doe, MQZ Company. Leases, purchases of expensive equipment, and other business transactions should be made in the company’s name.