Registering a Company: Choosing a Business
Structure
Forms of Business Ownership
One of the first decisions that you will have to make as a business
owner is how the company should be structured. Below
are the most common forms of business structure:
• Sole Proprietorships
• Partnerships
• Corporations
• S-Corporation
• Limited Liability Company (LLC)
Sole Proprietorships
The vast majority of small businesses start out
as sole proprietorships. These firms are owned by one person, usually
the individual who has day-to-day responsibilities for running the
business. Sole proprietors own all the assets of the business and
the profits generated by it. They also assume complete responsibility
for any of its liabilities or debts. In the eyes of the law and
the public, you are one in the same with the business.
Advantages of a Sole Proprietorship
• Easiest and least expensive form of ownership
to organize.
• Sole proprietors are in complete control, and within the
parameters of the law, may make decisions as they see fit.
• Sole proprietors receive all income generated by the business
to keep or reinvest.
• Profits from the business flow directly to the owner's personal
tax return.
• The business is easy to dissolve, if desired.
Disadvantages of a Sole Proprietorship
• Sole proprietors have unlimited liability
and are legally responsible for all debts against the business.
Their business and personal assets are at risk.
• May be at a disadvantage in raising funds and are often
limited to using funds from personal savings or consumer loans.
• May have a hard time attracting high-caliber employees or
those that are motivated by the opportunity to own a part of the
business.
• Some employee benefits such as owner's medical insurance
premiums are not directly deductible from business income (only
partially deductible as an adjustment to income).
Partnerships
In a Partnership, two or more people share ownership
of a single business. Like proprietorships, the law does not distinguish
between the business and its owners. The partners should have a
legal agreement that sets forth how decisions will be made, profits
will be shared, disputes will be resolved, how future partners will
be admitted to the partnership, how partners can be bought out,
and what steps will be taken to dissolve the partnership when needed.
Yes, it's hard to think about a breakup when the business is just
getting started, but many partnerships split up at crisis times,
and unless there is a defined process, there will be even greater
problems. They also must decide up-front how much time and capital
each will contribute, etc.
Advantages of a Partnership
• Partnerships are relatively easy to establish;
however time should be invested in developing the partnership agreement.
• With more than one owner, the ability to raise funds may
be increased.
• The profits from the business flow directly through to the
partners' personal tax returns.
• Prospective employees may be attracted to the business if
given the incentive to become a partner.
• The business usually will benefit from partners who have
complementary skills.
• Disadvantages of a Partnership
• Partners are jointly and individually liable for the actions
of the other partners.
• Profits must be shared with others.
• Since decisions are shared, disagreements can occur.
• Some employee benefits are not deductible from business
income on tax returns.
• The partnership may have a limited life; it may end upon
the withdrawal or death of a partner.
Types of Partnerships that should be considered:
1. General Partnership. Partners divide responsibility
for management and liability as well as the shares of profit or
loss according to their internal agreement. Equal shares are assumed
unless there is a written agreement that states differently.
2. Limited Partnership and Partnership with limited liability. Limited
means that most of the partners have limited liability (to the extent
of their investment) as well as limited input regarding management
decisions, which generally encourages investors for short-term projects
or for investing in capital assets. This form of ownership is not
often used for operating retail or service businesses. Forming a
limited partnership is more complex and formal than that of a general
partnership.
3. Joint Venture. Acts like a general partnership, but is clearly
for a limited period of time or a single project. If the partners
in a joint venture repeat the activity, they will be recognized
as an ongoing partnership and will have to file as such as well
as distribute accumulated partnership assets upon dissolution of
the entity.
Corporations
A corporation chartered by the state in which it
is headquartered is considered by law to be a unique entity, separate
and apart from those who own it. A corporation can be taxed, it
can be sued, and it can enter into contractual agreements. The owners
of a corporation are its shareholders. The shareholders elect a
board of directors to oversee the major policies and decisions.
The corporation has a life of its own and does not dissolve when
ownership changes.
Advantages of a Corporation
• Shareholders have limited liability for
the corporation's debts or judgments against the corporations.
• Generally, shareholders can only be held accountable for
their investment in stock of the company. (Note however, that officers
can be held personally liable for their actions, such as the failure
to withhold and pay employment taxes.)
• Corporations can raise additional funds through the sale
of stock.
• A corporation may deduct the cost of benefits it provides
to officers and employees.
• Can elect S corporation status if certain requirements are
met. This election enables company to be taxed similar to a partnership.
Disadvantages of a Corporation
• The process of incorporation requires more
time and money than other forms of organization.
• Corporations are monitored by federal, state and some local
agencies, and as a result may have more paperwork to comply with
regulations.
• Incorporating may result in higher overall taxes. Dividends
paid to shareholders are not deductible from business income; thus
it can be taxed twice.
Subchapter S Corporations
A tax election only; this election enables the shareholder
to treat the earnings and profits as distributions and have them
pass through directly to their personal tax return. The catch here
is that the shareholder, if working for the company, and if there
is a profit, must pay him/herself wages, and must meet standards
of "reasonable compensation". This can vary by geographical
region as well as occupation, but the basic rule is to pay yourself
what you would have to pay someone to do your job, as long as there
is enough profit. If you do not do this, the IRS can reclassify
all of the earnings and profit as wages, and you will be liable
for all of the payroll taxes on the total amount.
Limited Liability Company (LLC)
The LLC is a relatively new type of hybrid business
structure that is now permissible in most states. It is designed
to provide the limited liability features of a corporation and the
tax efficiencies and operational flexibility of a partnership. Formation
is more complex and formal than that of a general partnership.
The owners are members, and the duration of the
LLC is usually determined when the organization papers are filed.
The time limit can be continued, if desired, by a vote of the members
at the time of expiration. LLCs must not have more than two of the
four characteristics that define corporations: Limited liability
to the extent of assets, continuity of life, centralization of management,
and free transferability of ownership interests.
Taxed as partnership in most cases; corporation forms must be used
if there are more than 2 of the 4 corporate characteristics, as
described above.
In summary, deciding the form of ownership that
best suits your business venture should be given careful consideration.
This decision will have long-term implications, so consult with
an accountant and a business law attorney to help you select the
form of ownership that is right for you.
THE INFORMATION ON THIS WEBSITE IS NOT TO BE
CONSIDERED LEGAL ADVICE. SUCH INFORMATION IS INTENDED TO EDUCATE
MEMBERS OF THE PUBLIC GENERALLY AND IS NOT INTENDED TO PROVIDE SOLUTIONS
TO INDIVIDUAL PROBLEMS. READERS ARE CAUTIONED NOT TO ATTEMPT TO
SOLVE INDIVIDUAL PROBLEMS ON THE BASIS OF INFORMATION CONTAINED
HEREIN AND ARE STRONGLY ADVISED TO SEEK ADVICE FROM A QUALIFIED
ATTORNEY REGARDING SPECIFIC CASE SITUATIONS.
|