Why Are So Many Legal Entities Turning to Consulting Firms to Outsource Their IT?

A legal entity is one in which an organization is permitted to legally enter into a contract with a different party and be subject to lawsuits if they do not keep their contractual obligations. Every legal entity has IT, or information technology, needs. IT involves the use of computers and telecommunications to receive, store and transmit information. An interesting fact is that recently the question has come up as to why more and more legal entities are turning to external sources for legal IT needs. We will explore those reasons here.

After the new creation of any business, legal entity or otherwise, the owner will usually be able to maintain every part of the business at first, including information technology needs. As the business begins to grow, however, and more employees hop on board, it becomes apparent just how unmanageable everything is to one person or group of people. This is when it becomes necessary to understand the benefits and reasons why more and more legal entities are turning to external sources for legal IT needs. A legal entity needs time, money and manpower to manage every money-making part of the business. Wasting such valuable resources on something that can easily be outsourced is an unwise business move.

Today, businesses in general are struggling to make more out of less, and legal entities are no exception. Money is tighter than ever and in an effort to save cash, legal entities in the past attempted to complete all their legal IT needs by themselves. As time has gone by and more experience has been had by these companies, they are coming to a realization that outsourcing can actually be less expensive. By outsourcing technology needs, a business can benefit from having a separate full-time staff of professional IT workers at a fraction of the cost of attempting to do it all yourself. External sources that specialize in IT services can offer such benefits as website hosting, computer networking and overall IT support. This crucial part of any business simply cannot be overlooked, and it is becoming apparent why more and more legal entities are turning to external sources for legal IT needs.

Apart from saving money, a legal entity can also save valuable time by outsourcing technology needs. This gives the owners and employees alike the freedom of more time to focus their efforts on advantageous daily procedures. The only large, very developed companies that should not be outsourcing their information technology needs to an outside service provider should be the IT service providers themselves. You created the legal entity you own to deliver contractual services to your customers, not to focus on keeping the technology up and running! The simple truth is that most companies will save significantly valuable time, money and energy by seeking an external source to take care of these issues, another reason why more and more legal entities are turning to external sources for legal IT needs. What a legal entity and any other business should be focusing their time, money and other resources on are things that will increase company income.

Marketing products is an essential part of any legal entity. Marketing is what draws leads and allows a company to succeed. Another reason why more and more legal entities are turning to external sources for legal IT needs is because they want to focus on marketing and generating leads. Along those lines, establishing customer-employee relationships and being able to provide outstanding customer service and support is an important focus. Obviously legal entities hope to stay out of legal baffles as much as possible, and if the main focus is on IT needs and not on the specific needs of the company, such goals may not be achieved.

It has been discussed that once a company becomes large and established enough it may become time to outsource the IT needs. How do you know when that time has come? You be the judge. When it seems to you like the demands of the internal information technology department are negatively impacting the more business related activities, then that is a sign that it may be time to go to an external source for help. A legal entity should never feel crippled by its IT department. If it becomes apparent that progress is slowing down due to the need to purchase more computers and other supplies for the IT workers, this is another sign. When the resources you currently have for completing IT tasks becomes insufficient, instead of spending more on supplies and expanding the internal department, seriously consider the reasons why more and more legal entities are turning to external sources for legal IT needs.

The obvious disadvantages of ignoring the need to outsource IT needs are many. Apart from the other points already mentioned including waste of time, money and resources when done internally, IT staff require benefits. When you have an internal department, you will have to provide those benefits, as well as time and resources to get new staff trained. You also can easily end up overpaying an internal IT staff member because the agreed upon salary is usually not based on the actual amount of work they will be completing. The disadvantages of internally hiring IT staff greatly outweigh the benefits, making it obvious why more and more legal entities are turning to external sources for legal IT needs.

Legal entities can become severely stuck in a rut of no progression if they refuse to outsource to an external information technology service provider. This is why more and more legal entities are turning to external sources for legal IT needs. They recognize the need to grow their company and understand that turning to the option of outsourcing is a very useful way to attain the desired growth.

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Legal Entities and Business

Although in essence this is really a very simple concept, it does make for some interesting discussion points, especially noting that an understanding of how this all fits together, will also help you better understand the legal framework of the various types of businesses you could start.

In essence there are two types of legal entities in the business world. One is a natural person, and the other is a legal person (also known as an artificial person). And if you have heard these terms before, chances are you already have a fairly good understanding of the mechanics of all this, however for clarification I would offer the following descriptions:

Natural Person

A natural person is simply a human of legal age. You are by your very definition a natural person. From a business perspective this would be defined as a human, who is old enough to legally transact (is of age). Usually, depending on the country you live in, older than 18 years going up to 21 years in some countries.

In either case within the framework of this definition you are able to sign a contract on your own behalf, and be bound by it. You do not need to have a parent or legal guardian sign for you, and if you get sued, they can take your house if you lose.

Legal Person (artificial person)

This type of entity has been created to allow for the separation of personal assets from business assets, amongst other things. The key point to consider here is that a legal person is not alive. So a corporation like IBM or Microsoft would be legal person. Even though they clearly exist and can trade they are simply not alive.

A legal person can trade, transact and contract using the registered name as if a natural person, however, since it is not alive, it requires someone (a natural person) to do so on it’s behalf. Essentially since the legal person cannot physically sign the papers, someone living needs to do so. So the manager, CEO or any person with authority to do so, can sign a contract on behalf of the corporation or business, binding it (not the authorised natural person) to the terms of the contract.

Authority for a natural person to act on behalf of a business, is also given by a natural person or persons that own the business (often called shareholders). To explain this more clearly the shareholders hire a CEO to run their business. This gives the CEO the right to sign contracts and do transactions on behalf of the company, and in the name of the company. It also means that if you are the only shareholder, you can give yourself authority to sign contracts for the legal person you own (your business).

A legal person can also own things, just like a natural person, and when the legal person (company) gets sued, they can only take the property of the legal entity, not the shareholders (or business owners).

One key thing to remember is that a legal person can only exist as long as there is a natural person in control of it. So if a company does not have any shareholders, there is nobody that can give authority, to anyone, to transact in the name of the legal person. In this case it also means that there is no one that can actually sign a document in the name of the legal person, making it completely valueless and pointless.

Since a legal person is also not a living thing, you are able to sell it, or give it away like a car. As long as there are shareholders (owners), it can continue to exist.

In conclusion when applying these two simple concepts to your intended business activities, one of the decisions you will have to make, is whether to trade as a natural person (in your own name) or as a legal person (a registered business).

And though often the cost of operating a legal person may prove prohibitive, there are also some inherent protections built into this type of business, which may make it worth biting the bullet for. With this in mind I would recommend that you seek proper legal advice to make sure that you trade in a business form that meets your specific needs.

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Which Legal Entity Is Right for My Business?

Many small business owners start with a sole proprietorship to avoid the costs of forming a corporation or LLC. This is a wise decision as statistics show that most small businesses lose money for the first several years.

What about when the business starts to make a profit? There are several decisions that can be made about the type of legal entity one can form, and the tax ramifications differ as well. A general rule of thumb is to determine which entity will save the most money in taxes.

Suppose you are self-employed and your business makes a $20,000 profit for the year. The tax rate for this type of business is 15.3% in addition to the regular income tax calculated on the tax return. Once the profit is determined for the year, there are no further deductions that can be taken to reduce the tax due. Using the scenario listed above, 15.3% of $20,000 is $3,060. That amount can only be reduced if estimated tax payments are made. Let’s say we have a single taxpayer with no children, no mortgage interest and other itemized deductions. So far the tax due is $3,060.

Now we calculate if there is any income tax due. Assuming for the moment that no other income exists, we calculate taxable income by taking the profit from the business ($20,000) and subtract the standard deduction (which is $5,950 for 2012) less the exemption deduction (which is $3,800 for 2012). The taxable income would then be $20,000 – $5,950 – $3,800 which equals $10,250. Based on tax law the additional income tax due for this person would be $1,099. So, the total tax bill for this taxpayer would be $1,099 + $3,060 for a total of $4,159.

Making estimated tax payments while a wise decision, can also take money from your pocket and give it to the government unnecessarily. Suppose you were to take that $3,060 and divide it equally amongst the 4 estimated payments required to be made annually. That comes to $765 each quarter. We are not considering State estimated taxes as the rates vary widely. Many accountants and tax preparers would have you make estimated tax payments this year based on your profit and tax bill from last year. As was already stated, that is a good idea which has a downside. Suppose you have a year that is not nearly as profitable as last year and by the end of September you have actually lost money. If you have paid the three payments of $765 each in April, June and September, you have given the government a loan of $2,295. However, your business has run a loss for the year, so you won’t have a tax bill which means that the $2,295 is an overpayment. You can get that money refunded during tax season, but meanwhile that’s money you don’t have to take care of expenses. My preference is to review the profit or loss of each client business quarterly and then determine if any estimated tax payment is due.

Getting back to the decision of which legal entity to choose, let’s take each one separately. The most common form of legal entity is the corporation. There are two basic forms, C Corp and S Corp. A C Corp pays tax based on its profit for the year and then any dividends paid to shareholders is also taxed. Hence the term double-taxation. An S Corp however works differently. The S Corp pays no tax on profits. The profit flows through to the shareholders who then pay tax on that money. The big difference here is that the 15.3% self-employment tax does not apply. So, by forming an S Corporation, your business saves $3,060 for the year on a profit of $20,000. The income tax still applies, but I am sure someone would rather pay $1,099 than $4,159. That is a huge savings.

Another angle to consider: suppose your business takes a loss for the year. As a C Corp there is no tax on the loss, however there is also no flow-through to the shareholders as with an S Corp. The loss will not help your personal tax return at all. A loss from an S Corp will reduce taxable income, provided there is other taxable income to reduce. If not, then there is no income tax due.

The next popular business entity is the LLC. There are many advantages to the LLC. Keep in mind; if you are a single member LLC, then your business will be taxed as a sole proprietorship, meaning that 15.3% self-employment tax comes back into play. Unless you like paying higher taxes, a single member LLC is not the way to go. A husband and wife LLC is considered in community property states to be a single member LLC and is taxed the same as a regular single member LLC.

If the LLC is owned by a corporation or partnership, it is also considered to be a single member LLC. The income and expenses are added to the income and expenses of the Corporation or partnership and taxed accordingly.

Multiple member LLCs are taxed as a partnership. The profit or loss is distributed to each member according to the LLC agreement. This distribution is taxed the same as a sole-proprietorship, so here comes the 15.3% tax again. LLCs are great due to limited liability for each member, however for tax purposes, the tax benefits are not the same as for an S Corp.

The other legal entity is the partnership. This is an entity made up of two or more partners who start a business and bring a certain amount of money or other asset to the partnership. Each partner is entitled to a distribution from the partnership based on their percentage of ownership. Again, the income tax rate is 15.3% on partnership distribution plus the income tax calculated on the tax return.

Which entity is right for you? Only you can decide. You should consider all avenues before making a decision. If you wanted limited liability, the then LLC would be right. If you want to pay the least amount of taxes, the Sub S Corporation is the best. Requirements for recordkeeping for a corporation are more involved than an LLC, but they are not so overwhelming as to be a burden.

Costs involved in forming a legal entity as stated in this article varies by state. Each state has its own filing fee. You do not need an attorney to create an LLC or Corporation. You can find a variety of web sites that offer the service and their fees for handling the filing for you can also vary.

My personal choice I believe has been given herein. An S Corporation pays the least amount of taxes. In addition, forming an S Corp in Nevada avoids any state income tax as it does not exist. If you want more information, feel free to contact me via my website.

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How to Transition From a Sole Proprietorship to a Separate Legal Entity

You started your business with one approach in your own name and now you have made the important step to form a separate legal entity. That is a huge step. The key is to complete the transition so your business will actually benefit from the advantages you gain by forming a separate legal entity.

Over the years, we have seen several mistakes in this transition and many times where someone is still operating their sole proprietorship at the same time as their new entity without knowing about it. We wanted to clear up the steps you must complete to make the transition.

Here are the steps:

Form the separate legal entity (an LLC or corporation). NCP can help you do that (we form corporation and LLCs in all 50 states).

Obtain a NEW TAX ID Number. Even if you had a Tax ID number as a sole proprietorship you need a NEW ONE!

Open a NEW bank account in the name of the entity. Yes, even if you already have a bank account and you went from “Marketing Solutions” to “Marketing Solutions, Inc.” that is a new name and a separate legal entity and you need a NEW bank account. Yes, new checks too!

Connect the DBA (doing business as) to the new entity. When you filed the DBA in your local county you were the applicant. That is what make that business in your name. Now you need to “reconnect” the DBA to the NEW legal entity. That means you need to dissolve the DBA name linked to you and refile (the same day) the DBA name to the new entity. That means the new entity is the applicant. This is what connects it to the new entity. Now, for both tax and liability issues any business in the DBA from this point forward is under the new entity name.

Obtain a new business license in the name of the new entity. Yes, a new one. Typically, you can NOT transfer a business license from your sole proprietorship name to your new LLC. Reason? It is a separate legal entity.

Obtain a business credit card in the name of the new entity. Stop using your personal credit card cards to finance your business. Ask the bank how long does the new entity have to be in business before they would recommend you apply for a business credit card.

Update all your sources of income with the new Tax ID number of the new entity. You goal is to avoid receiving unnecessary 1099s (meaning you want the money, just not to yourself individually anymore) for affiliate or referral fees by the end of next year. Make sure all your affiliates are updated with the new entity information.

Update any contracts in the name of the new entity.

Update vendors with your new entity name and information.

Get new business cards. Don’t be cheap even if the only difference of the name of your company is “LLC”.

Set up a new chart of accounts in the new entity name.

Update your merchant account provider with the new entity information. You may have to complete new forms.

Update your insurance provider with the new entity information.

Comply and update any state related issues in the name of the new entity.

Check with your attorney or CPA for any steps missed.

This is a good list to help you get started. The biggest mistake we see is not completing updating the DBA name from your name to the new entity and using the new bank account. The goal is to get off the sole proprietorship track as fast as possible. If you add new businesses in the future you can add a new DBA name with the entity as the applicant. The key part is to be aware of the type of asset class. Safe assets like gold, investments should be owned by a separate legal entity from your operating business. Real estate should be in a separate legal entity also. If you have several properties each with a lot of equity it may make sense to split those into separate legal entities.

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