Friday, February 23, 2007

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."

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