Probably one of the most confusing, but important decisions you need to make when setting up a business is choosing the right business entity. You can choose from different types of business entities. Each of them has different legal and tax compliances for owners and managers. You need to analyze the consequences of using different types of business together with their purpose and goals.
Sole Proprietorship
This is a type of business entity in which there is only one owner, with no legal difference between the owner and the company. It does not require official government requests to create and is not required to comply with operational formalities. The advantage of Sole proprietorship is the taxability of business income and the deductibility of business losses are from the Individual owner’s tax returns. The owner is responsible for all obligations and responsibilities of the enterprise, which include not only debts exceeding the amount invested in the business, including all insurance, but also the assets of the business owner.
General Partnership
This is a business entity formed by two or more partners that has not filed papers with the state to create a specific entity such as a corporation or limited liability company. In a general partnership all partners (called general partners) are personally liable for all business debts, including court judgments. Additionally, each individual partner can be sued for the full amount of any business debt (though that partner can in turn sue the other partners for their share of the debt), and finally, each partner has authority to bind the business to business deals and contracts.
Limited Liability Partnership
The limited liability partnership (LLP) is a similar business structure but it has no general partners. All of the owners of an LLP have limited personal liability for business debts. LLPs are particularly well-suited to professional groups, such as lawyers and accountants because they don’t want to be personally liable for another partner’s problems.
Limited Partnership
With a limited partnership at least one of the owners is considered a “general” partner who makes business decisions and is personally liable for business debts. But LPs also have at least one “limited” partner who invests money in the business but has minimal control over daily business decisions and operations. The advantage for these limited partners is that they are not personally liable for business debts because they do not play an active role in the business; however, they may become personally liable if they do not keep to their passive role. If a limited partner starts taking an active role in the business, that partner’s liability can become unlimited. Additionally, limited partners face slightly different tax rules.
S Corporation
S Corporation is a company that has elected S corporation tax status the Internal Tax Code and is considered a partnership for most tax purposes. The income of the corporation is transferred to its shareholders. In a regular corporation, the company itself is taxed on business profits. The owners pay individual income tax only on money they receive from the corporation as salary, bonuses, or dividends. By contrast, in an S corporation, all business profits “pass through” to the owners, who report them on their personal tax returns (as in sole proprietorships, partnerships, and LLCs). The S corporation itself does not pay any income tax, thus eliminating the double taxation, but must file an informational tax return that reports each shareholder’s corporate income.
C Corporation
These are often used by large companies. They have an unlimited number of shareholders including foreign investors and several classes of shares. One drawback is that a C corp pays corporate taxes on earnings before distributing remaining amounts to the shareholders in the form of dividends. Individual shareholders are then subject to personal income taxes on the dividends they receive. Although double taxation is an unfavorable outcome, the ability to reinvest profits in the company at a lower corporate tax rate is an advantage.
Corporate formalities must be followed such as holding at least one meeting each year for shareholders and directors. Further, the business must have company bylaws at the business location. The corporation is responsible for filing annual reports, financial disclosure reports, and financial statements. Additionally, minutes must be maintained for purposes of operation transparency. Finally, the corp. must keep voting records of the company’s directors and a list of the owner’s names and ownership percentages. Further.
Limited Liability Company
A limited liability company offers the right mix of personal asset protection and simplicity. Unlike sole proprietorships and general partnerships, LLCs can protect your personal assets if your business is subject to legal action. Unlike corporations, LLCs are relatively easy to form and maintain, and are not subject to double taxation. Typically the owners of an LLC are not personally responsible for the LLCs debts or lawsuits. Unlike a corporation, profits pass-through directly to the LLC owners, thus eliminating double taxation. Moreover, unlike corporate formalities required with a corporation, LLC’s are not required to assign formal officer roles, hold annual meetings, or record company minutes and resolutions.
Conclusion
Each business entity has its own rules and regulations. So here we are. Now you must consider the pros and cons of each and make a decision depending on your situation. Also, it is recommended that you seek the advice of a qualified lawyer and accountant before making a firm decision and moving on. Good luck.
