Below you will find some of the most frequently asked questions dealing with Maryland Business Formations and Succession Planning. Please contact our office with any additional questions or concerns you may have.

Maryland Business Entities

(Starting a Business in Maryland)

What type of Business is best for you?

One of the first and most important decisions you'll make for your new Maryland business is deciding what organization is best for you. There are four different ways to organize your business in Maryland. Listed from the simplest to the more sophisticated the are:

Maryland Sole Proprietorship

Maryland Partnership

Maryland Corporation

Maryland Limited Liability Company

(also known as the Maryland LLC)

Maryland Sole Proprietorship

A sole proprietorship is, as the name suggests, a business with one owner. Of the four types of organization, a sole proprietorship is the most common for the Maryland Small Business. A business organized as a sole proprietorship is not separate from its owner, but merely a different name with which the owner represents him/herself to the public. The owner is the business and the business is the owner.

Because of this relationship, a sole proprietorship is known as a pass-through entity. This means that all income and expenses pass-through to the owner and are filed as part of the owner's personal return. If there is a business loss, the owner will enjoy a deduction to offset personal (paycheck) income. However, if the business makes a profit, the owner is responsible for any taxes due.

Since they have few legal requirements, sole proprietorships in Maryland are easy to form and operate. They can also be more affordable since no legal documents need to be filed in most cases. Basically, all one has to do to form a Maryland sole proprietorship is get a business license and begin operations.

Although the sole proprietorship does have the advantage of simplicity, the negatives can steer entrepreneurs away from this form of a business organization. The disadvantages of a sole proprietorship stem from its very nature - the business and the business owner are inseparable. This leads to three potential problems.

First, owners can lose some lucrative tax-free fringe benefits because they cannot participate in company funded employee benefit plans like medical insurance and retirement plans. Second, since the owner and the business are inseparable, whoever sues the business actually sues the owner. The owner's personal exposure is unlimited. Finally, the business owner is personally liable for the debts of the company and unfortunately, personal assets can be taken to pay company obligations.

Maryland Partnership

A partnership is similar to a sole proprietorship but has two or more owners. Like the sole proprietorship, the partnership is not a separate legal entity from its owners. Unlike the proprietorship however, the partnership can hold property an incur debt in its name.

In general, the partnership shares the same advantages and disadvantages as the sole proprietorship. However, the partnership has an additional drawback. A partner can be held liable for the acts of the other partners, increasing personal liability.

Tax treatment of the partnership is also slightly different. Although it is a pass-through entity and does not pay its own income tax, the partnership does file an informational tax return with the IRS. The pro-rata share of its income and expenses are shown on each partner's personal return, and any taxes due are paid by the partners.

Maryland Corporation

(Maryland Incorporation)

The Maryland Corporation was conceived to solve the typical problems of the partnership. Incorporating allows a group of entrepreneurs to act as one, much the way a partnership does, with one important advantage. Since the corporation is a separate legal entity capable of being sued, it can protect its owners by absorbing the liability if something goes wrong.

In recent years, the corporation has developed as a tax reduction/planning tool.

A corporation is essentially an "artificial person" created and operated with the permission of the state where it is incorporated. It's a person like you, but only "on paper." A corporation is brought to life when a person, the incorporator, files a form with a state known as the articles of incorporation. The owner of a corporation is known as a shareholder.

Since a corporation is a separate legal entity, the corporation actually owns and operates the business on behalf of the shareholder, under the shareholder's total control. This separation provides a legal distinction between the owner and the business and provides three important benefits:

It allows you, the owner, to hire yourself as an employee (typically as president) and then participate in company funded employee benefit plans like medical insurance and retirement plans.

Since you and you company are now two separate legal entities, lawsuits can be brought against your company instead of you personally.

When debt is incurred in the company name, as a separate legal entity, you are not personally liable and your assets cannot be taken to settle company obligations.

S Corporations

An "S" corporation is the same as any other business corporation with one important difference - IRS allows it to be taxed like a partnership, a pass-through entity.

When business corporations are created, they are all regular "C" corporations. This special filing status is elected by filing IRS Form 2553. Many people begin corporate life as an S corporation when there are losses to offset their "paycheck" income and then revert to a C corporation status when the corporation begins to make taxable profits. It is important to remember that being an S corporation is a tax matter only.

Maryland Limited Liability Companies (Maryland LLC)

A Maryland limited liability company is the newest form of business organization. Available in 49 states, it's a hybrid entity that has favorable aspects of both the corporation and partnership structures. The LLC features pass-through taxation of the partnership, and limited liability of the corporation. You may choose to see it like this - the LLC is a partnership that offers the limited liability protection of a corporation. Or conversely, it's a corporation that's taxed like a partnership. Yes, it is much like an S corporation without the 35-shareholder limitation.

The limited liability company is a promising type of business entity, but it does have a couple of disadvantages. First, its newness means that law regarding LLC is still evolving and some issues regarding operation remain unsettled. Also, if the LLC is taxed as a partnership, business owners will lose some company funded benefits.

Non-Profit Organization (501(c) 3)

To be tax-exempt as an organization described in IRC Section 501(c)(3) of the Code, an organization must be organized and operated exclusively for one or more of the purposes set forth in IRC Section 501(c)(3) and none of the earnings of the organization may inure to any private shareholder or individual. In addition, it may not attempt to influence legislation as a substantial part of its activities and it may not participate at all in campaign activity for or against political candidates.

The organizations described in IRC Section 501(c)(3) are commonly referred to under the general heading of "charitable organizations." Organizations described in IRC Section 501(c) (3), other than testing for public safety organizations, are eligible to receive tax-deductible contributions in accordance with IRC Section 170.

The exempt purposes set forth in IRC Section 501(c)(3) are charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and the prevention of cruelty to children or animals. The term charitable is used in its generally accepted legal sense and includes relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erection or maintenance of public buildings, monuments, or works; lessening the burdens of government; lessening of neighborhood tensions; elimination of prejudice and discrimination; defense of human and civil rights secured by law; and combating community deterioration and juvenile delinquency.

To be organized exclusively for a charitable purpose, the organization must be a corporation, community chest, fund, or foundation. A charitable trust is a fund or foundation and will qualify. However, an individual or a partnership will not qualify. The articles of organization must limit the organization's purposes to one or more of the exempt purposes set forth in IRC Section 501(c)(3) and must not expressly empower it to engage, other than as an insubstantial part of its activities, in activities that are not in furtherance of one or more of those purposes. This requirement may be met if the purposes stated in the articles of organization are limited in some way by reference to IRC Section 501(c)(3). In addition, assets of an organization must be permanently dedicated to an exempt purpose. This means that should an organization dissolve, its assets must be distributed for an exempt purpose described in this chapter, or to the federal government or to a state or local government for a public purpose. To establish that an organization's assets will be permanently dedicated to an exempt purpose, the articles of organization should contain a provision insuring their distribution for an exempt purpose in the event of dissolution. Although reliance may be placed upon state law to establish permanent dedication of assets for exempt purposes, an organization's application can be processed by the IRS more rapidly if its articles of organization include a provision insuring permanent dedication of assets for exempt purposes.

An organization will be regarded as "operated exclusively" for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of the exempt purposes specified in IRC Section 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.

The organization must not be organized or operated for the benefit of private interests, such as the creator or the creator's family, shareholders of the organization, other designated individuals, or persons controlled directly or indirectly by such private interests. No part of the net earnings of an IRC Section 501(c)(3) organization may inure to the benefit of any private shareholder or individual. A private shareholder or individual is a person having a personal and private interest in the activities of the organization. If the organization engages in an excess benefit transaction with a person having substantial influence over the organization, an excise tax may be imposed on the person and any managers agreeing to the transaction.