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Choosing Your Business Structure

April 24, 2014 by Ed Becker

Whether you are just beginning your small business or are already established and considering your legal and tax obligations, deciding how to classify your business entity can be confusing. Knowing what your personal legality and financial risks are in each type of structure will help you decide what is best for the company and for you, as owner or a partner.

Sole Proprietorship

  • Is the most common type of business entity for unincorporated businesses run by a single owner.
  • No official action needed, no legal distinction between personal and business income, debts or losses.
  • May choose to use a DBA for business name, and be registered with your state.
  • Simplest tax preparation as it is filed on personal tax return.
  • Full personal responsibility and accountability for all financial and legal aspects.
  • Can be harder to obtain funding through investors or banks.

Limited Liability Company, LLC or LTD in Europe and Canada

  • Hybrid between a Sole Proprietorship and a fully incorporated company.
  • Shareholders/Owners liability is limited to amount invested.
  • Can be a single owner or partnership of two or more individuals.
  • Creates legally limited liability for all parties, less record-keeping, and profit sharing is less restricted.
  • Company is not taxed separately by the Federal Government, but some states recognize it as separate entity.
  • Profits and losses are passed on from the business to each members’ personal tax return as in a partnership.
  • Members are treated as self-employed and must make Medicare and Social Security contributions on the entire net worth of the LLC.
  • Slight variations by state for formation, check for regulations.
  • Can choose classification by filing Form 8832, to file as sole proprietor, corporation or partnership.
  • Can choose a special election to be treated as an S-Corp.
  • If partners choose to leave, in some states, the LLC must dissolve.

Partnerships: General, Limited (LP) & Joint Ventures

  • Two or more individuals share ownership and contribute to all aspects of the business.
  • General partnership- all aspects are equal, unless noted as percentages in partnership agreement.
  • Limited Partnership- usually limited by extent of investment.
  • Joint Venture- similar to general partnership but limited period of time or single project.
  • Usually must obtain business licenses and permits through Federal, State and local offices.
  • Most partnerships need to register with the IRS and obtain a tax ID number or permit.
  • Must file an Annual Information Return reporting income, deductions as well as gains and losses from operations. The business does not pay taxes, profits and/or losses are passed through to the partners.

Incorporation- S Corporation or C Corporation

  • The major difference between an S Corp and a C Corp is that an S Corp’s profits and losses pass through to shareholders’ personal tax returns and the business is not a taxed entity. Legally it is considered to be a unique entity separate from its owners. The shareholders must pay themselves a fair market value wage.
  • C Corp is the most complex business entity, as it is considered a completely separate legal entity owned by shareholders. The company is legally responsible for its actions.
  • There are expenses for administrative fees and complex legal and tax requirements.
  • Can be privately or publicaly held for selling shares of stock.
  • C Corp is a legal tax entity in that it files its own tax return and pays all federal, state and local taxes due. There are more legal requirements and filings that must be completed for a C Corp than any other entity.
  • The issue of double taxation is controversial with a C Corp, because the corporation pays taxes on income and the shareholders pay taxes on the same “income.”

When choosing how to classify your business evaluating liability and legal risks and protections will help guide you. Consulting with your accountant and a business attorney about the pros and cons of each type of business structure is a must for any business owner(s) before making a decision.

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