When starting a business, determining the business structure is one of the first and most important decisions an entrepreneur will make.
- Sole Proprietorship
- Limited Liability Company (LLC)
- Corporation or S-Corporation
There are a variety of legal, accounting, administrative and personal liability concerns that help determine what is the best structure for each business owner. This article will discuss some of the factors to consider but is by no means exhaustive.
- Sole Proprietor
A sole proprietor is an individual who owns, operates and has complete control over a business. The owner and the business are one in the same. There is no separation between the individual and the business for the debts and obligations of the business. Business income and expenses are reported on schedule C with the owner’s personal Federal 1040 tax return.
Some of the advantages of the sole proprietor business structure is the low cost and ease of creation and reporting. Before the tax law changes taking affect for the 2018 tax year, another advantage was the tax rate for an individual was usually lower than the corporate tax rate.
The biggest downside for a sole proprietor is being personally liability for business obligations. If anyone claims to be harmed in anyway as the result of business operations, the individual sole proprietor will be personally liable if the claimant prevails. The sole proprietor’s home, vehicles, bank accounts and most personal assets will be at risk. A good insurance policy can help protect personal assets, but only to the limit of the policy.
There are other factors and regulations to consider. A consultation with an experienced attorney will assure that your business avoids pitfalls that be difficult, if not impossible, to overcome.
There are generally 3 types of partnerships: General Partnership, Limited Partnership and Limited Liability Partnership.
A limited partnership subjects the general partners to unlimited liability for partnership debts and obligations. The limited partners’ personal assets are generally safe from partnership debts and obligations. Limited partners are only at risk for their investment in the partnership.
Limited liability partnerships can only be created by professional service businesses such as accountants, attorneys, doctors, architects and other fields treated as professionals.
A partnership is a legal business arrangement between 2 or more people to own a business or property and personally share in its profits, losses and risks. Like a sole proprietorship, all partners in a general partnership would be personally liable for all business debts, obligations and claims, putting personal assets at risk.
Creating a general partnership is easier and less costly than creating a corporation or limited liability company. A separate partnership tax return will need to be prepared on Federal Tax Form 1065. The partnership will issue a K-1 form to all partners, reporting each partners’ share of business income and expenses. The income or loss will pass through to schedule E of the partners’ personal Form 1040.
- Limited Liability Corporation
Limited liability Companies (LLC) are a hybrid of the corporate structure and either the partnership or sole proprietor structure. For most it is the best of all worlds. LLCs provide the owner(s) with the same protection from personal liability for business debts, obligations and claims as a C corporation, with the flexibility to chose how to be taxed. Like a corporation, an LLC is a separate entity from its owner(s). An individual who chooses to create an LLC will be protected from personal liability as if a corporation, while being allowed to report income as a sole proprietor. Partners in a general partnership will also be personally protected while being allowed to be taxed as a partnership.
It is important to follow required legal and accounting practices when creating an LLC. If the owner(s) break the corporate veil (discussed in a different article), a business or judgment creditor may be able to reach the owners’ personal assets.
An LLC is easier to set up than a corporation with the same protection. It is also more flexible to manage once created.
- Corporation / S-Corporation
A corporation is an entity that is separate and distinct from its owners. The owners hold an interest in the business determined by their percentage of shares in the corporation. The owners’ personal assets are protected from claims against the corporation, assuming the owners do not cosign or guarantee corporate debt. The corporation is taxed under a separate tax structure than its owners, unless the owners elect to be treated as a subchapter s corporation.
Since the costs and administration requirements to create and maintain a corporation is significantly greater than the other entities discussed in this article, few small business owners elect this as their entity of choice.
There is much more to know about creating and maintain a business regardless of the structure chosen. More than 29 years of experience qualify the attorneys at Bellenot & Boufford, LLC to help you get off on the right foot, making sure you have the greatest chance of succeeding in beginning and in growing your business. We make sure you are safe and know how to stay out of trouble. Remember, the cost of doing things correctly is nothing compared to the cost of doing things incorrectly, because you just didn’t know.