In my 15 years of practice, I’ve never seen reports go out like this. Companies with one or more missing annual reports are getting letters warning them that their companies will be administratively dissolved if they don’t file the missing reports and fees within sixty 60 days. While this is indeed the law of the state, typically the Secretary of State didn’t send notices until the company was five years late.

Apparently the Secretary of State has conducted an internal audit, and has contacted every company that is in violation of the statute. The notices are not always right, so you need to check your company’s situation directly with the Secretary of State’s web site.

Here are some guidelines to help you in determining if your entity owes an annual report for certain situations.

• LLCs that are formed between January 1 and April 15th of a given year will owe an annual report (and fee) on April 15 of their first year. Many LLCs believe they don’t owe an annual report at all for the first year, so when they file in their second year of operation, the report is counted for the first year, putting the company one behind.
• We have noticed that accountants routinely file annual reports for their corporate clients, but sometimes do not prepare them for LLCs. It is important to ask your CPA what is going on.
• Business Corporations are required to file an annual report at the end of their first fiscal year, even if it is a short year. Many corporations do not file until the end of their second year. This report is counted toward the first year by the Secretary of State, and the company is behind on its annual reports.
• Often a company will file its report, but forget a piece of information or a signature. The filing fee will be kept, but the document will be rejected and sent back with an explanatory letter. If these reports are not corrected and re-submitted, the company will be behind on its annual report.

These notices have been sent to the company’s registered agent. If your registered agent is your attorney, you will receive the notice and instructions on how to fix the problem. If you serve as your own registered agent, make sure you file your missing reports and fees within 60 days, or you will not have a valid entity and could lose your limitation of liability.

How do I close my business? If you formed an entity, you must vote to dissolve the company, pursuant to your bylaws, operating agreement, operating documents or appropriate statute.

Then you can either: 1) file Articles of Dissolution with the Secretary of State yourself, 2) have an attorney prepare and file these for you or 3) just stop filing your annual reports with the Secretary of State. After 5 years, the company will be administratively dissolved.

Is there something I need to do with the Department of Revenue? Some states require a tax certificate or tax clearance document indicating that the entity is current on its state taxes before it is allowed to be dissolved, but North Carolina does not require this. If you are a sole proprietor or a general partnership, you can simply stop doing business. Either way, the company or the owner may still be liable for the debts of the business.

Do I need an attorney? If you have signed any contracts (and especially if you have given personal guarantees), it is wise to work with an attorney to dissolve the business to protect the owners from personal liability and to assess the liabilities. There are some additional steps we can take to protect the company and its owners from the creditors of the business by shortening the time in which creditors must file a claim for payment. We can also negotiate to get you out of contracts early.

It also may be beneficial to review whether a bankruptcy filing would be a good idea. It is possible to close down the business operations, but keep the entity active so that it is available for a future activity. This does require some risk/benefit analysis from your accountant and attorney, and would be most appropriate for a fledgling business than one with business activities.

I never generated any revenues. Do I still have to file a tax return? This will depend on your individual situation, but the conservative view is that if you obtained an EIN, the IRS will be looking for a return. Some accountants advise not filing a return, and if the IRS notices sometimes a mere conversation will suffice and sometimes a “zero return” is needed.

Otherwise, the S-Corp must file (both federal and state) tax returns. The LLC or partnership would only file a federal tax return if the entity receives income or incurs expenditures treated as deductions or credits for federal income tax purposes. If the entity is required to file a federal tax return, it will be required to file a North Carolina tax return as well.

Individuals (sole proprietors) may still be able to deduct the start-up expenses. Check with an accountant.

What about losses? Check with your accountant, but owners of eligible small businesses may be able to amend their personal or company tax returns for the previous 5 years to apply certain losses against income earned during those years.

What else should I do?

• Cancel all services.
• Cancel all licenses, registrations and permits.
• Cancel insurance policies, but make sure of coverages first.
• Pay all taxes and debts.
• Notify creditors, employees and customers.
• Sell your inventory, equipment or other assets.
• Close all bank accounts in the business name.
• Keep your records in an organized manner for at least seven years.

While these steps may sound simple, the process will be very emotional, and a mis-step can make it that much worse. If there are significant assets and liabilities, money on professional advisors will be well spent.

The LLC is still considered a relatively new business structure, although it’s been around for more than 30 years. The LLC, like a corporation, is a separate legal entity from its owners. It is formed by filing articles of organization with the Secretary of State. An operating agreement is recommended, but not required. So long as it is properly formed, properly capitalized and properly maintained, it should limit the owner’s personal liability for debts and actions of the LLC to the amount invested in the company. LLCs are owned by members and can be managed either by the members or managers. Neither members nor managers must live in North Carolina. It is

LLCs are desirable because they are flexible as to management participation and allocation of profits and losses, yet they provide limited liability. It is also possible to make an S-election for an LLC so that it is taxed the same way as an S-corporation. This is valuable when the owner wants to treat some profits as dividends to minimize income tax. LLCs and S-corporations (which we will discuss in detail in another post) are similar in that they both pass-through income directly to the owners, but they have vastly different rules on deductions, salary and self-employment taxes.

LLCs do require an annual report to be filed with the Secretary of State.

LLCs are classified as either single-member or multiple-member, and the designation has a big impact on how taxes are reported. Single-member LLCs owned by an individual report all income and expenses on a schedule to Form 1040. Multiple-member LLCs report all income and expenses on a partnership tax return Form 1065. LLCs are responsible for all employment-related taxes and must issue W-2s and 1099s as required. Members of the LLC are subject to self-employment taxes on all earnings or shares of the profits.

When people are starting a business, they are often very confused and overwhelmed as to how to choose an entity, or even whether they need one. Many entrepreneurs look at limiting their legal liability but never consider the tax implications of their business entity. The only entities which provide limited liability to owners (with respect to both tort and contract liability) are S corporations, C corporations, and limited liability companies. Before selecting the entity, it is essential to review the tax implications as well as the legal ones.

In a series of blog posts, I will discuss the various available entities (sole proprietorship, partnership, limited liability company, C-corporation and S-corporation) and some tax issues associated with each.

Sole Proprietorship:
Many entrepreneurs start their businesses as sole proprietorships, where the owner and the business are one and the same (sometimes known as “hanging out a shingle”). This is certainly the simplest way to begin. There are no formalities required. But, if the business is sued or has a hefty tax debt, you are financially responsible. Many risks of having a sole proprietorship can be addressed with insurance.

From a tax perspective, the business profits are reported on the owner’s personal income tax filings under his/her Social Security number, and the income will be taxed at the owner’s standard personal income rate. The owner must file form 1040, and 1040 ES Declaration of Estimated Tax For Individuals. The owner is responsible for paying self-employment taxes. There are many deductions available as well.

Once you hire employees, you should consider forming a limited liability entity to protect yourself from the acts of the employee.

As with any service provider, word-of-mouth referrals are the most powerful. Ask other business owners, friends, church members and colleagues who they use and why. If you already have a trusted insurance agent or accountant, ask them for referrals for the other professionals. You can also meet many professionals at Chambers of Commerce and similar business networking groups. This is nice because you will be able to observe their personalities and learn a little about them in an informal setting.

Then do some research.

Each of these professionals is licensed by a state regulatory board, such as the State Bar for attorneys, a Board of CPA Examiners or the Insurance Commission. Financial planners can be merely brokers who sell various financial products and are licensed by the Financial Industry Regulatory Authority (FINRA) or they can obtain a voluntary additional credential known as a Certified Financial Planner, which means the certificant’s first duty is to the client as a fiduciary, ensuring that recommendations are in the client’s best interests. The broker’s first duty is simply to make sure that the client’s situation can reasonably handle the recommendation, and the further duty of the broker is to sell a product.

It is wise to make sure your advisor is currently licensed.

Many professionals will have a web site listing their area of expertise, practice philosophy, education, etc., although insurance agents tend to have fairly generic sites featuring one of the companies they represent. Look through the site and see if their philosophy and geography mesh with yours. I also conduct an online search to see if the professional has been in the news, has been published, is active in the community, etc. They may have a blog with interesting information that helps you know them better.

Call and set up an introductory meeting with your potential professional. Ask ahead of time if there is a fee for this. At that meeting, you will want to ask about what services are offered, how they are priced, what payment terms are offered, and who will actually be doing your work.

BioTech0296 wrote: if the owner/franchisee hired these morons, then he is responsible for their actions..NO EXCUSES!!!!

After two renegade Domino’s pizza employees posted viral “joke” videos on YouTube of them defiling sandwiches, Domino’s President Patrick Doyle announced the franchise will re-examine all of the corporate hiring practices to “make sure people like this don’t make it into our stores.”

What he’s getting at is avoiding negligent hiring and retention.

North Carolina courts typically recognize a tort claim for an employer’s negligent hiring or retention of employees where a plaintiff (victim) can establish: (1) a specific bad act by the employee in question; (2) the employee’s inherent unfitness or previous specified acts of negligence from which incompetence can be inferred; (3) the employer’s actual or constructive notice of the employee’s unfitness; and (4) injury resulting from such incompetence.

This is important to employers because it brings liability from the wrong-doer (employee) to the employer, who typically has “deeper pockets” and is a more attractive defendant in a lawsuit.

Typical examples of negligent hiring are hiring a bus driver with numerous traffic convictions, a controller with convictions for embezzlement or day care workers who are convicted sex offenders. Negligent retention is keeping these employees in position after you know about the traffic violations, embezzlement or sex crime. In these cases, a routine background check often reveals the initial unfitness for the job.

Courts will look at the fundamental questions of what did the employer know about its employees and when did it know. They will compare the employer’s hiring and retention practices to the industry standard and will determine if the employer used reasonable care.

North Carolina courts generally defer to employers on this issue, holding that there is an initial presumption that an employer uses due care in hiring employees, but this presumption can be overcome where a court finds that an employer ignored facts that would suggest that an employee is unfit or failed to follow customary hiring practices for its industry.

At a minimum, it is important to keep up with HR/hiring/retention practices in your industry. Employers should also consider implementing procedures for verifying facts given on resumes or applications, verifying and documenting employee references, using criminal background and credit checks for final job candidates, and pre-hiring drug tests (if appropriate) regardless of industry custom.

These areas are fraught with their own perils, such as improperly considering arrests instead of convictions, not complying with the Fair Credit Reporting Act or not following state drug testing laws, but a claim for negligent hiring could carry a much higher liability. See the above comment for an example of just how much you have to lose when you hire the wrong people.

Today, I am following up that post with the view from the attorney’s perspective. Almost every corporate attorney I know has spent hours cleaning up DIY-formations. Here’s a sampling of what we fix:

• Selecting the wrong entity. Probably the number-one question I get is C-corp, S-corp or LLC? Astoundingly to me, people often embrace the recommendations of their brother-in-law, mechanic or neighbor and resist the advice of legal and tax professionals (as in “my brother-in-law has an LLC and says that’s what I need to be”). The differences between the different forms of organization in the eyes of the IRS can result in significant amounts of money. And it is very easy to make a wrong choice or check the wrong box on a confusing tax form.
• Failing to complete all steps of formation (no bylaws or operating agreement, failure to make timely IRS filings, failure to name officers, directors or managers, failure to issue stock or hold an organizational meeting).
• Not obtaining an EIN, getting an “extra” one or getting one when you don’t need it. The rules governing when you do and do not need a new EIN are more complex than any rational person would imagine, unless they work for the IRS. Sorting this out can take hours away from your core business.
• Picking a corporate name that violates a third-party’s trademark. Think about all the time and money you will have wasted in promotional materials, signage and branding if you find out downstream that your business name violates another person’s trademark. You also need to protect your company’s intellectual property (business name, trademarks, copyrights, inventions, trade secrets).
• Not addressing and minimizing other risks (appropriate insurance, good form contracts, good business practices, proper use and treatment of assets, etc.).
• Failing to have buy-out agreements. If you do not have an appropriate operating agreement, or shareholders agreement, you’re saying that you’re perfectly comfortable knowing that one morning you might wake up and find that your new partner is the pothead/slacker son of your old partner.
• Not holding annual meetings. Corporations must hold annual meetings of shareholders and directors to name directors, approve major decisions such as bonuses, benefits, leases, name changes, changes to the capital structure, etc. If you’re audited, one of the first things the IRS asks for is the Corporate Minute Book.

In addition to being able to help you select the proper entity and place of filing (Nevada, Wyoming, Florida, Delaware or the Old North State), good business attorneys will connect you to other reputable professional service providers — bankers, accountants, insurance agents, financial planners and web designers. We know where to send you for free or low-cost business services to make sure your business plan is sound, or to get assistance with Quick Books, marketing, sales or hiring employees. We will make sure your ongoing filings with the Secretary of State are current and that the corporation is holding requisite annual meetings. In short, we take an ongoing professional interest in your success.

I am really interested in the local experiences, good and bad, with attorneys and DIY formations.

If keeping up with these types of tax deadlines is a thorn in your side, difficult, stressful, or you never seem to get around to it, you may want to hire a payroll service, such as PrimePay or Paychex. I know if I ran my own business, this would be one of my first phone calls. Not only would I have more time to spend on the things I love in my core business (advising clients, drafting legal documents, blogging), but many payroll companies will indemnify your company for penalties and interest caused by their mistakes in making your tax filings and withholdings. This is a good way to minimize risk for tax issues.

You may not realize that even if you have formed a corporation or LLC to minimize your personal risk, you may be personally liable for payroll withholdings that are not properly paid to the IRS, or business taxes not properly paid to state governments. The FICA and FUTA taxes are required to be withheld on behalf of an employee, and are considered held in trust by the employer for benefit of the United States. Shareholders, officers, directors or employees who have authority to decide the order of bill paying and/or have check-writing authority can be held personally liable for withholdings that are not properly paid to the IRS. There can be a 100% “trust fund penalty” against the “responsible person.”

If you are having trouble paying your bills, we strongly advise paying all taxes in full first. If you can’t, contact your accountant or attorney and negotiate up front with the IRS or Department of Revenue. You can typically get a payment plan to catch up without penalties if you disclose early. Once you are behind, it is more difficult to negotiate a solution.

That’s my 2 ¢. What tax advise to the small business owner readers have for their peers?

Not everyone realizes that business owners are able to file Articles with the North Carolina Secretary of State on their own without an attorney. In addition, there are many services around that can help entrepreneurs form corporations or limited liability companies (LLC). These include online services, forms from books/guides sold in office supply stores, and online forms available from the Secretary of State.

So, do you really need a lawyer to form your corporation?

Yes. Well … maybe…

Let me ask you some questions: Should you form a C-corporation, an S-corporation or an LLC? What do you do after you file your articles? What assets should be transferred into the company and how do you do it? What do you need to do to maintain your limited liability? If you don’t know, or you don’t understand the differences between the available entities, you probably shouldn’t form your own corporation.

If you don’t know, none of these cost-saving services are going to be able to tell you; that’s unauthorized practice of law. They can tell you what’s on the menu, but they can’t recommend what to order. And the problem with a bad choice is not mere indigestion. Setting up your business entity incorrectly or incompletely can lead to tax penalties, unprotected personal assets, no limited liability and lost peace of mind.

Forming an entity without legal counsel works best for single-member entities that don’t expect to bring in additional owners or outside capital, hire employees or set up multiple locations (particularly multi-state locations). It may also make sense to set up your own entity if you had an attorney set up a prior entity, and you are following a similar business model, with the same people as before, and nothing has changed in any of their lives. In reality, of course, every deal is different, people change, laws change, and the structure that you used last year may not be the best structure this year for this situation.

What an attorney adds.

While many people have used these services and are happy with the results, almost every business lawyer I know has a story (or two or three) about incomplete, incorrect or ill-conceived formations done by clients “going commando.”

If you plan to raise money from outside investors, hire employees, open multiple business locations, pay only those taxes that you really owe, or if your business is in a highly regulated field, you absolutely need the services of a competent business attorney. By the time you fill your online shopping cart with your best guesses, you are getting close to what you’d pay for an attorney…and you are getting a lot less for your money the online route.

In addition to being able to help you select the proper entity and place of filing (Nevada, Wyoming, Florida, Delaware or the Old North State), good business attorneys will connect you to other reputable professional service providers — bankers, accountants, insurance agents, financial planners and web designers. We know where to send you for free or low-cost business services to make sure your business plan is sound, or to get training on Quick Books, marketing, sales or hiring employees. We will make sure your ongoing filings with the Secretary of State are current and that the corporation is holding requisite annual meetings. In short, we take an ongoing professional interest in your success.

Bottom-line: if the initial organization is not done correctly and completely, or if you choose the wrong form of entity or state of incorporation, the costs to unravel the errors greatly exceed the savings of “doing-it-yourself.” As they said in Ghostbusters, “Who ya gonna call?!”

If you have decided to form your own entity, particularly using an online service such as Legal Zoom, The Company Corporation, BizFilings, etc., a couple caveats:

1. As with any significant online purchase, research the vendor. Find people you know who have used these services personally (ask around on Facebook, LinkedIn, or Twitter) and ask about their experience. Check with the Better Business Bureau and the NC Department of Justice for complaints on file. What are your options if things go bad? Can you get your money back?

2. This may not be the time to go with the cheapest alternative. The low rates advertised are often “teaser” rates and the companies will try to upsell you at every turn. Make sure you know what you are getting, and most importantly what you are not getting. Understand what you need to have a complete formation, and what comes in each price-point package. How long does it take and how much does it cost to get it faster? By the time you add express services and ala cart documents (shareholders agreement, DBA, tax filing documents), the price may not be that different from an attorney’s fee.

I realize that every profession has its “princes” and its “toads” and the legal profession is no different. There is no shortage of bad experiences with attorneys, and a quick internet search shows no shortage of bad experiences with do-it-yourself strategies. I’d love to hear what has worked and hasn’t worked for you.