Just in time for tax season I would like to discuss Forms of Business. Once an entrepreneur decides to start a business one of the first things she should think about is choosing a form of business ownership.
This can seem like a scary step because many entrepreneurs are not savvy in tax law or business law. So I have designed this post to help you decide which form of ownership is best for you. Of course there is no particular form that is better than the other it is simply a matter of which form offers the best features for you and your company.
Here are the 8 (eight) criteria you should consider when choosing a form of ownership:
Tax considerations: The amount of net income an entrepreneur expects the business to make and the tax the owner has to pay are important. New tax codes, add to that the company’s fluctuating revenue from year to year, and graduated tax rates that apply to each form of ownership makes some more attractive than others.
Liability Exposure: Some forms of ownership offer entrepreneurs better protection against personal liability. You must be able to decide to what extent you’re willing to assume personal responsibility for your company’s financial obligations.
Start-up and Venture Capital needs: Depending on how much you need and where you plan to get, some forms again are more attractive than others.
Control: As entrepreneurs you must decide early on, how much control you are willing to give up in return for venture capital.
Managerial skills: You will need to assess your own skills and abilities. Ask yourself “Will I be able to manage my business effectively?” If you don’t have certain skills you may need to choose a form of ownership that allows you to bring in more owners who can fill in the skill gaps.
Business Goal: How big do you want your business to be? You’re not stuck if you grow you can change the form of ownership as you grow however it can be rather expensive depending on the form. So it is best to decide on the form that offers the most flexibility.
Management succession plan: No one likes to think of the negative but when choosing a form of ownership entrepreneurs should be looking ahead to the day they will pass on their legacy. Depending on the form of business you choose this transition can be relatively easy.
Cost of formation: Some forms of ownership take more thought, time, and money. The cost depends on the form you choose.
When it comes to forms of business entrepreneurs have a variety of forms to choose from, including a sole proprietorship, a general partnership, a limited partnership, a corporation, an S corporation, and a limited liability company.
Sole Proprietorship: a business owned and managed by one individual; the business and the owner are one and the same in the eyes of the law. Income and expenses of the company are reported on the proprietor’s individual income tax return, and profits are taxed at the proprietor’s individual income tax rate.
General Partnership: an association of two or more people who co-own a business for the purpose of making a profit. In a partnership, the co-owners share the business’s assets as well as its liabilities. All partners share equally in the obligations and responsibilities associated with the business. The distribution of profits, responsibilities of each partner and anything affecting the partnership should be expressed in a Partnership agreement.
The income and expenses of the partnership are reported on federal and state “information” tax returns, which should be filed by the partnership. The partners are taxed on their respective share of the partnership’s profits but at their individual tax rates.
Limited Partnership: a partnership composed of at least one general partner and at least one limited partner. In the limited partnership the general partner is treated—by the law—as a member of a general partnership. However limited partners are treated-by the law-as investors and they have limited liability for the debt of the partnership. Due to the complex nature of this form it is best to seek legal advice before attempting to set up this form of business. Remember if you chose this form to take care in naming your business it should contain the words “limited partnership, limited liability partnership” or the abbreviation “L.P., L.L.P.”
Limited Liability Partnership: a special type of limited partnership in which all partners—who in many states must be professionals—are limited partners. A general partnership can register as a LLP by filing a limited liability partnership registration. In limited liability Partnership the personal assets of the partners is protected against liabilities incurred by the partnership. An LLP must file an annual report with the Secretary of State in their community.
I should say that although they are a popular form LLP’s are fairly new and the tax aspects and other entities are not fully developed or even understood by most.
Corporation: a separate legal entity apart from its owners that receives the right to exist from the state in which it is incorporated. Corporations are owned by one or more shareholders and must be established in compliance with the statutory laws of the state of incorporation. This means the life of the corporation is independent of the owners; the shareholders can sell their interest in the company without impacting its continuation. The corporation may be taxed under Subchapter C of the internal revenue Code. A C-Corporation reports its income and expenses on a corporation income tax return and is taxed on its profits at a corporation income tax rate.
S-Corporation: a corporation that retains the legal characteristics of a regular (C) corporation but has the advantage of being taxed as a partnership if it meets certain criteria. An S Corporation is merely a term that is used for federal income tax purposes and as a way to describe its legal characteristics. Other than that an S-Corporation is no different from any other corporation.
Limited Liability Company: a new form of ownership that is a cross between a partnership and a corporation. Limited liability companies with more than one member—like partnerships and limited partnerships—may choose to be taxed as partnerships or corporations. Either way the limited liability company must obtain both federal and state tax identification numbers, even if it has no employees.
Now that you know what your choices are the decision is up to you. Regardless as to the form of owner you decide to choose you should do your research and find out the pros and cons. Seeking the advice of a qualified lawyer and or accountant will also help your chances of getting it right.
If you’re not sure where to start I have included the New business checklist
|Date business started:|
|Number of owners:|
|Choose type of business entity.Business entity type:|
|Select end of fiscal year.Fiscal year-end:|
| Apply for IRS Employer Identification
Number (EIN), if applicable.
|To obtain Form SS-4 to apply for an EIN, call
|Register with state as a business.|
|Obtain county and city business licenses.|
| If corporation, file letters of incorporation. Yes or NoIf partnership, create and sign partnership agreement.
Yes or No
|Purchase insurance plan(s).|
|Create company Web site. Web site address:|
|Choose an accounting method:|
|Select and purchase accounting software.|
|Install and set up accounting software.|
|Open a business banking account.|
|Obtain a business credit card.|
|Consider contracting with payroll processing firm and/or record-keeping firm.|
|Establish a salary agreement for each owner.|
|Establish a retirement plan.|