Starting a Business
The Legal Basics

Dan Leer and John Marlow are partners in the Entrepreneur’s Law Group. “ELG” has been guiding small businesses including medical related business since 2003. Their practice is based in San Francisco, California.

Starting a business can be a challenging undertaking and there are many things to consider. Some of the very important considerations that are often ignored have to do with the legal issues involved. These issues can range from the deciding on the most appropriate form of legal structure to making sure you have obtained a federal tax identification number to opening a bank account.

Selecting a Business Structure

Probably the first legal decision that you will need to make when organizing your new business is to decide on the type of legal structure for your business. There are several factors that may influence your decision to choose one business structure over another, including (1) legal restrictions which may prevent you from organizing as a certain type of legal entity, (2) a desire to limit personal liability, (3) the type of business operation, (4) how earnings are distributed, (5) the number of persons who will be owners of the business, (6) the number of employees that you expect to have, and (7) tax considerations. For most orthopedic surgical practices, it is most likely that you will choose to be a (1) sole proprietorship, (2) partnership, (3) corporation, or (4) limited liability company.



Sole Proprietorship

A sole proprietorship is the easiest and least costly way of starting a business. A sole proprietorship is a business owned by one person and is essentially formed when you open your door for business. It is very likely that you will need to obtain a business license and register your trade name with the city or county government, but you will not need to file any documents to form the sole proprietorship. As the owner of a sole proprietorship, you will be personally liable for all debts and liabilities of the business. You will be taxed directly, at your ordinary income tax rates, on all business income that you earn. Attorney's fees for starting a sole proprietorship will very likely be less than the other business forms because less preparation of documents is required and you, as the sole owner, have authority over all business decisions.

Partnership

A partnership is a legal association of two or more persons. There are several types of partnerships. The two most common types of partnerships are a general partnership and limited partnership.

In a general partnership, each partner is a general partner, has the right to make decisions on behalf of the partnership (and bind the other partners) and is personally liable for all of the debts and liabilities of the partnership. The partnership does not pay taxes on partnership income, and instead each partner is taxed on his or her allocable share of partnership income. A general partnership can be formed simply by an oral agreement between two or more persons, but in some states you may be required to file a certificate of partnership with the secretary of state or other officer of the state to form a partnership. It is also advisable that a written legal partnership agreement be drawn up and signed by all partners, preferably with the assistance of an attorney. A partnership agreement could be particularly helpful in resolving disputes between the partners. Partnership agreements often address the following issues: (1) type of business, (2) amount of equity invested by each partner, (3) division of profits or losses, (4) partners’ compensation, (5) distribution of assets on dissolution, (6) duration of the partnership, (7) provisions for changing or dissolving the partnership, (8) procedures for resolving partner disputes, (9) restrictions on sale or transfer of partners’ interests, and (10) restrictions of authority and expenditures.

In a limited partnership, there is a general partner, who is responsible for the day-to-day operation of the partnership, and one or more limited partners, who are passive partners without any management rights. In a limited partnership, the general partner is liable for all of the partnership debts and liabilities, while the limited partners are only liable for up to his or her capital investment in the partnership. To form a limited partnership, a certificate of limited partnership generally is required to be filed with the secretary of state or other officer of the state where the limited partnership is formed. Limited partnerships are commonly used as investment vehicles, and it is unlikely that you will form a limited partnership to operate your orthopedic surgical practice.

Corporation

A corporation is a separate legal entity. A corporation is formed by filing articles of incorporation with the secretary of state in the state where the corporation is incorporated. The corporate structure is usually the most complex and costly to organize. You may incorporate without an attorney, but it is highly recommended that you seek legal advice. The owners of a corporation are called shareholders and their ownership interests in a corporation are represented by shares of stock. However, the shareholders do not manage the corporation. A board of directors elected by the shareholders is responsible for corporate management. The board of directors is required to meet regularly and keep written records of their board actions. The board of directors may appoint officers to handle day-to-day corporate activities and most corporations have a CEO/President, Treasurer and Secretary. One of the advantages of a corporation is that the liability of corporate shareholders is limited to the amount of their investment in the corporation, except where fraud is involved. One of the disadvantages of a corporation is that a corporation is taxed separately from its shareholders, which is often referred to as “double-taxation.” The effect is that a corporation pays taxes directly on corporate taxable income before any monies are available to distribute to the shareholders. Shareholders then must also pay taxes on the corporate distributions they receive. In some instances, it may be possible for a corporation to elect to be taxed as an "S" corporation, in which case the corporation will not be taxed directly and the shareholders will be taxed on their allocable share of taxable income (similar to the tax treatment of partners in a partnership).

Limited Liability Company

A limited liability company (LLC) is a separate legal entity that is a hybrid of a corporation and a partnership. An LLC is formed by filing articles of organization with the secretary of state or other officer in the state where the LLC is formed. Like a corporation, the liability of the owners of an LLC, known as members, are is limited to the amount of their investment in the LLC. Although an LLC can elect to be treated as a corporation for federal income tax purposes, LLCs are generally classified as partnerships for such purposes. When an LLC is classified as a partnership, each LLC member is taxed only on his or her allocable share of LLC income. An LLC may be managed directly by the members of the LLC or a board of managers may be appointed by the members to manage the LLC’s affairs. It is also advisable that a written legal operating agreement be drawn up and signed by all members, preferably with the assistance of an attorney. The operating agreement is very similar to a partnership agreement and should address many or all of the same issues that are covered in a partnership agreement. However, several states place strict limitations on the types of business that may operate as an LLC. Therefore, your state’s law may not allow you to operate your orthopedic surgical practice as an LLC.

Federal Employer Identification Number (EIN) / Form SS-4

Federal employer identification numbers (EIN) are used to identify the tax accounts of employers, sole proprietors, corporations, partnerships, LLCs and other entities. An EIN is required if you have employees, operate your business as a corporation, LLC or partnership, or will need to file any of these tax returns. In the case of your orthopedic surgical practice, it is likely that one or more of these will be true. Therefore, it is advised that you apply for an EIN as soon as you form your legal entity. Even if you operate as a sole proprietorship, you may find it advisable – for privacy reasons – to apply for a separate EIN for such proprietorship. You can get an EIN on-line at the IRS website, https://sa.www4.irs.gov/sa_vign/newFormSS4.do, by fax at 215-516-3990 or over the telephone at 800-829-4933. To obtain an EIN, you must complete a Form SS-4 (Application for Employer Identification Number), which is available in Adobe PDF format at the IRS website.

Opening a Bank Account

It is important that you keep business and personal income and expenses separate. If there is a commingling of business and personal activities, the business entity could be deemed a sham, in which case, creditors may be able to look through the legal entity and hold you personally liable for the business’s liabilities. Therefore, it is very important that the legal entity open and maintain its own bank account and that business income be deposited directly into, and business expenses be paid directly from the business bank account.

To open a bank account, you will need to go to a bank and provide the bank officer with a copy of your organizational or incorporation documents (i.e., articles of incorporation, articles of LLC organization, certificate of partnership, LLC operating agreement, partnership agreement, etc.) and the business EIN. It is also important to consider who you want to authorize to sign checks and make deposits on behalf of the business.

Recordkeeping

Except in a few cases, the law does not require that you maintain any special kind of records. Consequently, you may choose any recordkeeping system suited to your business that clearly shows your income. The business you are in affects the type of records you need to keep for federal tax purposes. It is advised that you set up your recordkeeping system using an accounting method that clearly shows your income for your tax year. Your recordkeeping system should include a summary of your business transactions. This summary is ordinarily made in your books (for example, accounting journals and ledgers). Your books must show your gross income, as well as your deductions and credits. For most small businesses, the business checkbook is the main source for entries in the business books. In addition, you must keep supporting documents. It may be advisable to set up and maintain your business records with the assistance of an accountant or book-keeper

"The legal information in this article is of a general nature. It is not legal advice and you should not rely on. You are advised to seek your own legal counsel."


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