Establish Legal Structure
The legal structure of your business carries great importance. Sole Proprietorships, Limited Liability Companies, General and Limited Partnerships, etc., all offer different situations which affect tax and liability issues. There are many types of business organizations, and some of the most popular types are:
Sole Proprietorship
The most common form of business organization, a sole proprietorship is a business that is operated by a single individual. Profits under a sole proprietorship are taxed as personal income to the owner. While an advantage is that the owner has complete control of all aspects of the business, a disadvantage is that he or she faces complete and sole liability for any debts the business incurs.
General Partnership
A general partnership exists when multiple individuals join together to form a legal entity (the partnership) that operates and manages a business. Generally, partners are advised to write a formal partnership agreement to address any potential disputes or conflicts before they arise. Profits in a general partnership are taxed to all partners according to their percentage share. All partners are therefore jointly reliable for any debts the business incurs.
Limited Partnership
A sub-form of a general partnership, a limited partnership exists when an agreement is established in which there are two types of partners: a general partner, who has greater control over the management aspects of the business, and a limited partner, who receives a share of any profits made based on the amount of his or her investment into the business. Accordingly, the general partners are liable for all debt and there are no limitations on their dividends from profits. Limited partners, on the other hand, have liability limited in proportion to their investment.
“C” Corporation
A “C” corporation is a legal entity with its own rights, liabilities, privileges, etc. The corporation is comprised of persons who have received a charter that legally recognizes the corporation as such. The corporation may therefore own assets, sue or be sued, borrow money, etc., just as an individual. Due to its greater power, a corporation is generally under greater government regulation than the aforementioned types. Shareholders, directors, and officers comprise the corporation, therefore leading to “double taxation,” in which the corporation is first taxed for its profits, and then individual stockholders are again taxed for dividends. The advantage of the “C” corporation, however, is limited liability.
“S” Corporation
An “S” corporation is created through employing a section of the tax code that allows a corporation to be taxed as a sole proprietorship or partnership at the individual rather than the corporate rate. There are a number of requirements, however, to qualify for Subchapter “S”. Those interested should contact the Internal Revenue Service.
Limited Liability Company (LLC)
A LLC is a combination of partnership and corporation. The LLC is a separate entity that can acquire assets, incur liabilities, etc. However, a LLC offers the advantage of providing limited liability for the owners, as LLC owners only risk their investment. Again, there are specific requirements that must be met to qualify as a LLC; thus, professional consultation is recommended.