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Choosing a Business Entity

Common business entities include Sole Proprietorship, Partnership, Corporation (S-Corp and C-Corp), and LLC (Limited liability Company).  Some business entities help you shield yourself from liability and protect your personal assets (but you should still look into having good insurance as well). Depending on your situation, one entity form may be more desirable because of the tax consequences.  It is very important to discuss your options with a legal and/or tax advisor before making a decision on what entity for will be best for you!

Sole Proprietorship

Many new small businesses start out as a sole proprietorship. The business consists of one owner, the sole proprietor. Legally, the sole proprietor and the business are the same. Establishing a sole proprietorship can be as simple as filing a DBA (doing business as) at your town or city hall.

 

Advantages of a Sole Proprietorship

  • Setting up a sole proprietorship is easy and other than applicable licensing fees, may cost nothing.
  • Sole proprietors receive all income generated by the business to keep or reinvest.
  • Profits from the business flow directly to the sole proprietor’s personal tax return.
  • It’s easy to dissolve a sole proprietorship.

 

Disadvantages of a Sole Proprietorship

  • Sole proprietors are not personally protected from any debts or liabilities of the business.
  • Sole proprietorships have a hard time raising money from investors as there is no structure to invest in.

 

Partnership

A Partenership is when two or more people share ownership of a single business. The law does not distinguish between the business and its owners. There should be a clear partnership agreement that spells out things like who will contribute what money, how decisions will be made or disputes handled, how profits and losses will be shared, how partners can sell their interest or buy out another partner, and how the partnership could be dissolved.

 

Advantages of a Partnership

  • Partnerships can be established easily.
  • The profits and losses of the business flow directly to the partners’ personal tax returns.

 

Disadvantages of a Partnership

  • Partners are jointly and individually liable for what the other partners do.
  • Partners are personally liable for the debts and obligations of the partnership.
  • You need a well-drafted partnership agreement (see an attorney).

 

Corporation

A Corporation is formed by filing articles of organization (or your state’s equivalent) with the secretary of state’s office.  A Corporation can have one or more owners (shareholders). If there are multiple owners, you really should have a well-drafted shareholder’s agreement. Whether you elect to be a “C” or “S” corporation should be decided by your tax advisor as the distinction relates to tax treatment of your business.  If you decide to be an S-corp (the term commonly used) which many small businesses do, you will need to file an election form with the IRS. An S-corp can have a maximum of 100 shareholders (make sure to discuss the specifics of this rule with your CPA or attorney). None of the shareholders can be C corporations or LLCs.  The S corporation status enables the shareholders to treat the earnings and profits as distributions and have them pass through directly to their personal tax return (avoiding double taxation).

 

Advantages of a Corporation

  • Owners’ personal assets are usually protected from the liabilities, debts and obligations of the corporation.
  • In most cases, the largest amount a shareholder can be liable for in a judgment against the corporation is his or her stock (but there can be personal liability for fraud, failure to withhold/ pay employment taxes,etc).
  • Corporations can raise money by selling stock.

 

Disadvantages of a Corporation

  • Filing and Annual fees /reports.
  • Formalities must be prepared and kept up (such as corporate bylaws, minutes, resolutions, etc….).
  • Less flexibility in dividing profits.

 

Limited Liability Company (LLC)

An LLC is sometimes thought of as a “hybrid” of a corporation and a sole proprietorship or partnership. It is becoming an increasingly popular choice.  There can be one or more owners (called “members”).  An LLC is formed by filing a certificate of organization with your secretary of state’s office.

 

Advantages of an LLC

  • Owners are generally not liable for the debts and obligations of the LLC.
  • Income and losses of the LLC are accounted for on the owner’s individual tax returns.
  • Can be owned by individuals, corporations, other LLC’s and foreign entities (subject to state law).
  • Can have an unlimited number of members.
  • More flexibility in distribution of profits.
  • Less formal than a corporation (minutes, corporate resolutions, etc. are not necessarily required).

 

Disadvantages of an LLC

  • Filing and annual fees with the secretary of state’s office are typically greater than those for a corporation.
  • Should have a well-drafted operating agreement (similar to a partnership or shareholder’s agreement) that includes specifics as to how the LLC can be or will be dissolved.
  • self-employment and other tax considerations.

 

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