Corporate Formalities Checklist
Corporations must maintain proper formalities to safeguard limited liability and proper tax treatment. A corporation needs to be treated as a separate entity in order for the shareholders to avoid potential business liabilities and tax problems. Many of the important “arm’s length” indicia that are evaluated by courts and the IRS include the 14 items discussed in this three-part series. Items one through five were discussed in the Spring 1999 issue and items six through ten were discussed in the Summer 1999 issue.
- Maintain the existence of the corporation by filing biannual reports with the Secretary of State.
- Operate the corporation under the proper name and under one or more duly filed fictitious names.
- Make sure that third parties who deal with the corporation are aware that it is a corporation and are dealing with the corporate name or a properly registered fictitious name.
- Make sure that fictitious names are duly registered both with the Secretary of State and locally in the county where the primary office is located.
- Do not give personal guarantees or have personal involvement in situations that would result in personal liability. Any document signed on behalf of the company should clearly indicate that the person signing is doing so in his capacity as an officer, without a personal guaranty. Read the agreement carefully to be sure that there is no “small print” that would make the signing officer liable. The proper way to sign on behalf of a company is as follows:
- Treating the corporation as a separate financial entity is important. The corporate checkbook should not be your individual checkbook. Payments to and from the corporation need to be properly documented as loans, capital contributions, compensation or dividend distributions. These items should be specified in the annual corporate minutes.
- Invoices for items purchased by the corporation should have the invoice show the corporation as the purchaser to avoid potential personal product liability claims.
- Think twice before permitting employees to drive personally-owned vehicles. If an individual’s name is on the title of a car, he has potential liability for accidents while someone else drives it. Make sure that your commercial insurance package includes “non-owned automobile” coverage to cover potential liability from errands that one runs in an employee or contractor’s own automobile.
- If the company owes money to a shareholder or related parties, document this with a promissory note, file a security interest lien or mortgage on corporate assets so that the individual will be paid before any third-party creditors.
- Corporate pension plans require periodic updates and IRS filings to maintain creditor-proof status and income tax advantages.
- On an annual basis, the corporation’s CPA should advise its attorneys what needs to be documented in the corporate minute book for tax purposes. This includes salary payments made to shareholders, shareholder loans, capital contributions and any significant capital transactions. The IRS and creditors may ask to inspect the corporate minute book when tax or liability issues arise.
- If a corporation is not an “S” corporation, employee shareholders should draft an employment agreement entitling their estates or successors to be paid compensation in the event of death or disability. Otherwise, the IRS can deny deductibility of payments made after death or disability.
- The assets of a corporation can be protected by giving the related landlord a lien to enforce future rent on a long-term lease. Rental payments must comply with the terms of the lease to be deductible.
- Avoid confusion among multiple corporations. Clients owning more than one corporation should be sure that applicable formalities and documentation do not inadvertently make these corporations “parents” that would be jointly and severally liable. Inter-company transfers or financial arrangements may cause tax problems.
IAN FUNNY, President