When starting your own business, you must carefully choose the appropriate legal structure for your venture. You should examine the characteristics of each structure along with the needs and desires you have for your business. All legal structures are set up at the Secretary of State online at sos.state.co.us. For more information and registration, visit mybiz.colorado.gov.
There are several issues that you should consider when determining the legal structure of your business. First, to what extent will you personally be at financial and legal risk? Second, who will have the controlling interest in the business? Third, how will the business be financed? There are advantages and disadvantages to each legal structure. As a new business entrepreneur, you should examine all the characteristics and deter- mine which is best suited to your needs.
As you decide upon your legal structure, you should carefully evaluate both your present and future needs for operating your business. To avoid duplication of legal expenses, licensing and paperwork, analyze your various options and choose the business structure that will meet your long-term needs, rather than choosing a business structure solely for its short-term convenience. While it is not a requirement, it may be valuable to consult an attorney. See the section on Choosing Advisors for suggestions on how to select an attorney and other professional advisors.
A sole proprietorship is a business owned and operated by a single individual. There are few legal requirements to be met to establish a sole proprietorship. If an individual is operating the business under a name other than his/her own full first and last legal names, the business name must be registered as a trade name online with the Secretary of State at sos.state.co.us. This is the most common form of legal structure for new small businesses.
A sole proprietorship is the least complicated form of legal structure. All profits and losses of the business are reported directly on the owner’s personal income tax return. All decision making and control remains in the hands of the single owner. As a result, the owner is able to respond quickly to business challenges and opportunities.
The primary disadvantage of a sole proprietorship is that the proprietor is personally responsible for all the business liabilities and debts. If the business is unable to meet its financial obligations, creditors may pursue the personal assets of the owner. The sole proprietor is generally limited to financing the business by using his/her own assets and/or borrowing money.
Borrowing money will require periodic loan payments, regardless of whether the business is making money. Therefore, the fact that the owner’s personal assets are at risk is an important factor. If you and your spouse run your business together and share in the profits, your business may be considered a partnership. You should record your respective shares of partnership income or loss separately for self-employment taxes. Doing this may or may not increase your total tax. It will ensure that each spouse receives credit for social security earnings on which retirement benefits are based. IRS Publication #541, “Partnerships,” is a useful guide regarding partnership filing requirements and the allocation of income to the partners. Married couples are encouraged to consult a competent tax professional to determine the exact tax implications of their business. The Colorado Department of Revenue will require that a husband and wife register the trade name as a general partnership if both are listed as owners of the business.
NOTE: The transfer of a business between spouses is considered a change in ownership and is treated in the same manner as the transfer or sale of a business between two unrelated individuals.
For more information, visit mybiz.colorado.gov.
A general partnership is a business owned by two or more individuals or other business entities. Although it is not required, it is strongly recommended that a general partnership prepare a written partnership agreement that outlines the business’ structure and each partner’s responsibilities. If the partnership owns real property, the partnership agreement should be filed in the county where the property is located with the office that keeps real estate records. Otherwise, there is no requirement to file the agreement with any state or federal agency. If the partners are operating the business under a name other than their own legal names, the business name must be registered as a trade name with the Colorado Secretary of State at sos.state.co.us.
Partnerships have few legal requirements for formation. Partnerships are able to pool the financial, professional and managerial talents and resources of two or more individuals. A partnership is financed through the capital contributions of the partners and by borrowing money. The profits and losses of the business are reported annually on federal and state partnership returns. However, there are no partnership taxes. The partners are individually responsible for the taxes on their personal income tax returns. Profits and losses may be divided among the partners in whatever manner determined by the partners.
The partners in a general partnership are personally liable for all business debts. Even if the partnership agreement specifies a defined split in profits, each partner is 100 percent responsible for all liabilities and debts. The personal assets of any one or all of the partners may be attached to cover the partnership’s liabilities, regardless of which partner incurred the liability or debt.
For more information, visit mybiz.colorado.gov.
A limited partnership is a business owned by two or more individuals or other business entities in which at least one of the partners has limited liability protection. There must be at least one general partner who remains personally responsible for all the partnership’s liabilities. Limited partnerships are created by filing a “Certificate of Limited Partnership” with the Secretary of State.
A limited partner’s risk is limited to his/her financial (cash or property) investment in the business. The general partner(s) can retain personal control of the business while increasing the financial resources available to the businesses without incurring long-term debt. A limited partnership may raise capital by selling additional limited partnership interests in the business.
The general partner(s) remain(s) personally responsible for all the liabilities and debts of the business. The limited partner(s) may not work in the business or participate in management without risking loss of limited liability status. For more information, visit mybiz.colorado.gov.
A corporation is a legal entity that exists separately from the people who create it. A corporation is owned by its shareholders and run by a board of directors elected by the shareholders. In a large corporation, the directors hire corporate officers to manage the day-to-day operations of the business. In a small corporation, the directors and the corporate officers are usually the same individual(s).
Corporations are created by filing “Articles of Incorporation” with the Secretary of State and by adopting bylaws. There are certain formalities a corporation must adhere to, including:
Although many of the requirements may seem unnecessary for a small corporation, they are important to preserve the corporate form.
A corporation is a legal entity separate from the owners. It is like a person with a life of its own. This creates a wall of separation which normally limits a stockholder’s liability to the amount of investment in the corporation. If an owner dies or wishes to sell his/her interest, the corporation continues to exist and do business. This adds stability to its existence. Once a corporation has been established through the Secretary of State, no other business may register with the Secretary of State using the same name.
While a corporation limits an owner’s liability, the owner(s) and/or the corporate officers may still be held responsible if the “corporate veil” has been pierced. The “corporate veil” can be pierced in a number of ways, primarily by the personal actions or guarantee of an owner. Corporate profits may be subject to double taxation. A corporation must pay tax on income as a separate legal entity. If profits are distributed to shareholders, they are also subject to taxation as part of the individual shareholder’s income. For more information, visit mybiz.colorado.gov.
An S Corporation is not a separate form of legal structure, but rather a special tax status granted by federal tax law to a corporation to tax the business’ income like a partnership or a sole proprietorship. A corporation elects S Corporation status by filing with the IRS on Form 2553, “Election by a Small Business Corporation.” Generally, the election must be filed within 75 days of incorporating. Otherwise, a corporation may not change its status until the beginning of each new calendar year. Form 2553 must to be filed by March 15 to be effective for the new tax year. Once elected, S Corporation status will continue until the shareholders revoke the choice or a corporation no longer meets the qualifications.
An S Corporation has all the general advantages of “regular” corporations except it does not pay corporate income taxes. It divides the expenses and income among its shareholders. Individual shareholders report profits and losses on their personal income tax returns.
To apply for S Corporation status, the business must comply with the following restrictions:
While an S Corporation is not subject to double taxation as a regular corporation, it loses the ability to deduct the full cost of medical insurance as a business expense under current tax law. Corporate officers are still treated as employees. There are also differences in how business losses are carried forward, which may be positive or negative depending upon the individual situation. A competent tax advisor should be consulted before applying for S Corporation tax status. It is important to note that the corporation must file the “Articles of Incorporation” with the Secretary of State before it can apply to the IRS for S Corporation status. For more specific information about qualifying and applying as an “S” Corporation, visit mybiz.colorado.gov.
The Colorado Limited Liability Company Act was adopted in 1990. A Limited Liability Company (LLC) combines the concepts of partnerships for tax purposes and corporations for liability purposes. LLCs are created by filing “Articles of Organization” with the Secretary of State. While similar, LLCs are NOT corporations. In an LLC, the owners are called members. The members may elect or hire a manager(s) to run the business. As in a corporation, the owner(s)/member(s) may elect themselves to be the manager(s).
Members of an LLC are protected from personal liability in the same way as corporation shareholders, while the entity itself can have the flexibility of a partnership. The IRS has determined that LLCs may elect to be treated as partnerships or corporations for income tax purposes. A Colorado LLC will be treated as a partnership if there are two or more owners, unless the LLC elects to be taxed as a corporation. However, state law allows the formation of an LLC by a single individual. In that case, the IRS will treat the LLC as a sole proprietorship. Because LLCs are a new form of legal structure and various questions remain unanswered, it is recommended that you consult a knowledgeable attorney if considering the formation of an LLC.
LLCs are a recognized legal structure in all states. However, tax and liability treatment of an LLC is not uniform across state lines. There may also be limitations on the transferability of ownership in certain situations. In that case, the IRS may treat the LLC as a sole proprietorship or partnership. For more information, visit mybiz.colorado.gov.
Registered Limited Liability Partnerships (LLP) and Registered Limited Liability Limited Partnerships (LLLP) limit a partner’s personal liability in the business to their personal investment in the business, except in areas related to their personal professional conduct. LLPs and LLLPs will usually be taxed as partnerships but may elect to be taxed as corporations. Both entities are created by filing a “Registration Statement” with the Colorado Secretary of State. The partners in LLPs and LLLPs are directly considered the operators of the business. There is usually no election of officers or managers as in corporations or LLCs.
New businesses and existing general partnerships (currently registered with the Colorado Department of Revenue) may register as a Registered Limited Liability Partnership. Existing limited partnerships (currently registered with the Colorado Secretary of State) may register as a Registered Limited Liability Limited Partnership and gain liability protection for all partners without a complete reorganization of the business. The liability protection is similar to the protection provided to the owners of a corporation. Once an LLP or LLLP has been registered with the Colorado Secretary of State, no other business may register with the Colorado Secretary of State using the same name. The intent of the law is to gain the benefits of the partnership form of business while limiting the personal liability of the owners.
LLPs are primarily for businesses where all the owners belong to a single licensed profession (e.g. CPAs, attorneys, doctors, etc.) It is a new form of legal structure and it is not a recognized form of legal structure in all states. Anyone considering the formation of a LLP or a LLLP should consult a knowledgeable attorney. For more information, visit mybiz.colorado.gov.
Limited Partnership Associations (LPAs) are created by filing “Articles of Association” with the Colorado Secretary of State.
The main difference between a limited partnership association and a partnership or limited liability partnership is that the association has an indefinite life. Its existence terminates upon the affirmative vote of all of its members or as otherwise provided in the bylaws and by filing articles of dissolution with the Colorado Secretary of State. The association’s existence does not terminate upon the disassociation, death or bankruptcy of a partner. LLCs may convert to LPAs in the same fashion that they could convert to partnerships or limited partnerships under the Limited Liability Company Act.
Nonprofit is a term that refers to an organization which uses all profits to further organizational goals instead of distributing the profits to shareholders, organizers or owners. (NOTE: Distribution of wages includes the payment of wages.) In Colorado, an organization may choose to be an Unincorporated Nonprofit Association or a Nonprofit Corporation.
Nonprofit associations are normally formed by clubs or other less formal groups that do not intend to seek any special tax-exempt status or to exist beyond the current members. If organized as an unincorporated nonprofit association, a constitution, articles of association or a written declaration of organization must be adopted by two or more persons and the name must be registered with the Colorado Secretary of State at sos.state.co.us.
To further clarify an association’s nonprofit status, additional optional documentation may be filed with the Secretary of State. However, organizations that want to become tax-exempt or exist beyond the current organizers should consider organizing as a Nonprofit Corporation. While not explicitly required, it will be easier to obtain tax-exempt status if organized as a corporation rather than as an association. A Nonprofit Corporation must file articles of incorporation with the Secretary of State in accordance with the Colorado Nonprofit Corporation Act. For the necessary forms to become a Nonprofit Corporation, contact the Secretary of State at sos.state.co.us.
After organizing, submit Form SS-4, Application for Employer Identification Number, to have the Internal Revenue Service (IRS) assign a Federal Employer Identification Number (FEIN), whether there are any employees or not. The FEIN is the basic federal tax ID number for the organization.
Tax-exempt status requires an additional set of forms and paperwork. Tax-exempt status is granted by the IRS to nonprofit organizations to determine their status for paying federal income taxes. Forming a nonprofit association or even a nonprofit corporation does NOT automatically establish tax-exempt status. For more information, visit irs.gov.
After a 501(c)(3) Letter of Determination is received from the IRS, apply to the Colorado Department of Revenue for a sales tax-exemption. A copy of the Letter of Determination, financial statements and documents confirming your organizational structure and function must accompany application Form DR0715. If the Colorado Department of Revenue determines the organization qualifies for Colorado tax-exempt status, a Certification of Exemption authorizing purchases for the organization without state or state collected local sales taxes will be granted. A Letter of Determination from the IRS does not guarantee Colorado tax-exempt status.
Some religious, charitable and educational nonprofit tax-exempt organizations may qualify for property tax exemption. An organization must own real property to take advantage of this exemption. Federal tax-exempt status is not used to determine whether an organization qualifies for the property tax exemption. Organizations that would like more information should contact the Colorado Department of Local Affairs, Division of Property Taxation at cdola.colorado.gov/property-taxation.
Although nonprofit tax-exempt organizations may not pay income tax, they must still file tax returns. IRS Form 990 is used for federal income tax returns and DR 112 for state returns. While there are a few exceptions, tax-exempt organizations are still responsible for all payroll taxes and all other employer responsibilities on employees and must collect appropriate sales tax when selling personal tangible products to the public. See the Employer Responsibilities and Sales Tax sections of this book for more information.
A cooperative is a legal organization that is formed by a group of individuals and/or businesses that desire to work together for their “cooperative” benefit. A cooperative has two unique characteristics. It allows a group of separate individuals or individual businesses to join together for a common purpose, such as the bulk purchase of materials, to share office space or to sell common products. While a cooperative has to cover its costs to stay in business, it can focus its resources on meeting the needs of its user-owners, called members. Business decisions are made on the basis of what is in the overall best interests of the members. Each member maintains his/ her status as an individual or individual business and the cooperative becomes a means to realize common business and personal goals.
NOTE: A cooperative is not a form of legal structure used to operate a single independent business. In a cooperative, each member generally has only one vote regardless of the amount of equity owned. This one-member, one-vote approach makes cooperatives very democratic, which can be viewed as an advantage or a disadvantage. Wealthy members can’t buy control and all members have equal say in how the business is conducted. However, it does not take into account the amount of financial and/or time commitments made to the organization. In a non-cooperative business, people usually have voting power that is based solely on their equity investment.
A cooperative may organize as an unincorporated association. This is the least formal method for organizing a cooperative. The only government requirement is the registration of a trade name with the Secretary of State at sos.state.co.us. However, you must also adopt and have available for members a constitution, articles of association or a written declaration of organization.
Most groups organize as a corporation. Organizing as a corporation has three advantages. First, the personal liability of each member for losses suffered by the cooperative is limited to the member’s equity in the cooperative. Second, the cooperative exists independently of the original organizers. Transfer of ownership and control is simple. New members purchase a membership or a share of voting stock. When a person is no longer eligible to be a member, the cooperative repurchases that person’s membership interest. Finally, organizing as a corporation conveys the image of a solid, long-lasting venture to members and outsiders. For more information, visit mybiz.colorado.gov.
Any out of state business that will have ongoing business in the State of Colorado must register with the Colorado Secretary of State. Doing business in Colorado is NOT defined by statute but commonly refers to any business with a physical location in Colorado and/or operation that will extend beyond 30 days.
NOTE: All wages and income earned from work and operations conducted in the State of Colorado are subject to Colorado income tax regardless of the residency of the individual or the business. Employers must withhold Colorado income tax from employee wages and make the required estimated income tax payments for the business. Refer to the Employer Responsibilities and the Income and Property Tax sections of this book for more information on filing requirements. For more information, visit mybiz.colorado.gov.
A corporation may raise capital to begin the business by two different means: equity financing and borrowing money. Equity financing involves the issuance of shares of stock, which represent ownership in the business. Stock may be issued in exchange for cash, property, labor or services rendered. The primary advantage of equity financing is that the corporation is not required to repay the principal or interest. Instead, the shareholder acquires an interest in the business and may share in its future profits. When issuing stock, a corporation should be aware that there are various types or classes of stock. Different classes of stock grant the shareholder different rights when profits are distributed. A corporation may also acquire capital by borrowing money. Debt financing is attractive to the investor because the corporation is legally obligated to repay the principal and interest. Interest payments are deductible to the corporation. However, debt financing may be difficult or impossible for a new corporation which has little or no current earnings. A loan may require the personal guarantee of the corporate officer(s) who may then be held personally responsible for the repayment of the loan. A shareholder who is a working officer in the corporation is considered to be an employee and must be paid a “reasonable wage” subject to state and federal payroll taxes. If dividends are paid in lieu of wages, the entire dividend is subject to payroll taxes.
If you are a sole proprietor or general partnership and will be doing business under a name other than your own legal name(s), you must register your trade name(s) with the Colorado Secretary of State at sos.state.co.us. Registration of the trade name does not grant exclusive rights to the use of the name. Sole proprietors and general partnerships gain exclusive rights to their name through the use of the name over a period of time or by filing a trademark in addition to registering with the Secretary of State. If you want to find out if a name is already being used, visit the Secretary of State’s website at sos.state.co.us. Click “Businesses, trademarks, trade names” then “Search business database.” By searching this database, you can find out whether or not a name is currently in use. If your business will be a Limited Partnership, Limited Liability Company, Corporation, Registered Limited Liability Partnership, Registered Limited Liability Limited Partnership or a Limited Partnership Association, you must file with the Secretary of State at sos.state.co.us. If you do business under an additional name, you must file a “Statement of Trade Name” with the Secretary of State. Corporations, limited partnerships, limited liability companies and limited liability partnerships organized outside Colorado must file for authority to do business in Colorado as a foreign entity.
All forms of legal structure, except sole proprietors with no employees, must obtain a Federal Employer Identification Number (FEIN). The FEIN is your federal tax ID number. You can obtain your FEIN by:
Sole proprietorship owners with no employees may use their social security number as a federal tax ID number or may file Form SS-4 to receive a FEIN. The SS-4 and many other federal tax forms may be obtained from the IRS website located at irs.gov.
The Colorado Non-Profit Association is a statewide “trade association” for nonprofits in Colorado, composed of a diverse group of more than 1,100 members. It provides information programs, publications and group purchasing services. The association helps charitable and philanthropic nonprofits manage their organizations and resources, represents the non-profit sector and serves as a bridge between the public and private sectors. Its bookstore sells a number of useful publications including “How to Form Your Own Nonprofit Corporation” and “Fiscal Sponsorship: 6 Ways to Do It Right.”
Colorado Non-Profit Association
789 Sherman Street #240
Denver, CO 80203
The Community Resource Center (CRC) helps take start-up groups through the process of forming a nonprofit. CRC provides direct training, consultation and empowerment services to nonprofits, including leadership training for directors. CRC also publishes the “Colorado Grants Guide” and the “Colorado Funding Report.”
Community Resource Center
789 Sherman #210
Denver, CO 80203-0426
An attorney is not required to file Articles of Incorporation. However, if you decide not to use an attorney, you should educate yourself thoroughly regarding all aspects of a corporation. The following are basic definitions related to filing Articles of Incorporation and should not be considered comprehensive legal advice. For example, common stock and preferred stock are the two classes of stock that a corporation may issue. In addition, stock may have other attributes and combinations of attributes that define a stockholder’s rights. Articles of Incorporation may include additional information regarding the management, structure, purpose and goals of the corporation that are not outlined here.
Corporation Name is the name you wish to call your corporation. The name must include the word corporation, company, incorporated or limited or an abbreviation of one of these words. The name may not be the same as any existing corporation. You may check on the name availability at sos.state.co.us. If it is not being used, go to “File a Document” and create a new record. Fill out the form for a profit corporation. When you complete the form online, you will be able to submit online with a credit card.
Cumulative Voting is the ability of a shareholder to vote the number of shares owned multiplied by the number of directors to be voted on. For example, if shareholder “A” owns 100 shares and three directors are being elected, shareholder “A” has 300 votes to
cast for any one director or he can split up the votes and cast any desired number for any one or more of the candidates.
Preemptive Rights entitle each shareholder the right to maintain the same proportion of ownership if additional stock is issued. If a stockholder owns 25 percent of current outstanding stock, she/he would have the option to purchase 25 percent of new issues before the stock is offered to anyone else.
Common Stock normally has the following characteristics: 1) The right to vote for the board of directors, 2) The right to receive dividends when declared by the board of directors, and 3) The right to share in the distribution of assets, after creditors and preferred stock, if the corporation is liquidated.
Preferred Stock is normally associated with the following characteristics: 1) Very limited voting rights, 2) Preference over common stockholders for receiving dividends, 3) A preference over common stockholders, after creditors, in the distribution of assets if the corporation is liquidated, and 4) The stock may be repurchased by the corporation at the option of the corporation.
Authorized Shares are the total number of shares that the corporation has the authority to issue. If there is more than one class, record the number of shares in each class. The number of authorized shares may only be changed at a later date by a vote of the stockholders as provided in the bylaws.
Par Value stock must have a stated value in the Articles of Incorporation. The stock cannot be issued unless par value is paid to the corporation.
No Par Value (NPV) stock is issued at a value determined by the board of directors at the time of issue. Generally, the value is determined by whatever price the market will bear when the stock is issued.
A Registered Agent may be an individual or another corporation who represents the corporation. Although a post office box may be included, the registered agent must have a physical address in Colorado on record at all times with the Secretary of State. The address may or may not be the corporation’s place of business.
A Board of Directors must have one or more members and the number or method of determining the number must be specified in the bylaws. Directors must be at least 18 years of age.
Incorporators are the individuals who perform the initial steps of incorporation. They may or may not be involved in the corporation’s activities after the formation of the corporation. Incorporators must be at least 18 years of age.
Bylaws are the rules by which a corporation is managed and regulated. The bylaws are adopted and amended by the board of directors.
A Sole Proprietorship is a business owned and operated by a single individual.
A General Partnership is a business owned by two or more individuals or other business entities.
A Limited Partnership is a business owned by two or more individuals or other business entities in which at least one of the partners has limited liability protection.
A Corporation is a legal entity that exists separately from the people who create it.
An S Corporation is not a separate form of legal structure, but rather a special tax status granted by federal tax law to a corporation to tax the business’ income like a partnership or a sole proprietorship.
An LLC combines the concepts of partnerships for tax purposes and corporations for liability purposes.
Registered Limited Liability Partnerships (LLP) and Registered Limited Liability Limited Partnerships (LLLP) limit a partner’s personal liability in the business to their personal investment in the business, except in areas related to their personal professional conduct.
Limited Partnership Associations are created by filing “Articles of Association” with the Colorado Secretary of State.
Nonprofit is a term that refers to an organization which uses all profits to further organizational goals instead of distributing the profits to shareholders, organizers or owners.
A cooperative is a legal organization that is formed by a group of individuals and/or businesses that desire to work together for their “cooperative” benefit.
Any out of state business that will have ongoing business in the State of Colorado must register with the Colorado Secretary of State.
If you are a sole proprietor or general partnership and will be doing business under a name other than your own legal name(s), you must register your trade name(s) with the Colorado Secretary of State online.
An attorney is not required to file Articles of Incorporation. However, if you decide not to use an attorney, you should educate yourself thoroughly regarding all aspects of a corporation.
A corporation may raise capital to begin the business by two different means: equity financing and borrowing money.