Structuring your company will influence your taxes, financing, compensation, and insurance. And don’t forget your exposure to lawsuits. Therefore, a business owner’s first consideration is usually: What type of company do I want to create? Here are four questions you’ll need to answer:
- What kind of liability protection do I need?
- How do I want to pay taxes?
- What are my financing needs and options?
- And, how much administrative complexity can I deal with?
A sole proprietorship is the simplest business structure, owned by an individual or a married couple.
The sole proprietorship is simple to set up because it doesn’t require you to create a controlling document. After registering or licensing your business with your state and local governments (so they can tax you appropriately), you’re free to go on your own. Federal taxes are easy, just add a Schedule C – Profit or Loss from a business – to your individual Form 1040.
Cons: As a sole proprietor, if something goes wrong, your personal assets have no legal protection. This may not be suitable for growing a business.
A general partnership is similar to a sole proprietorship, except there are two or more owners of the business (who aren’t a married couple).
Like sole proprietorships, general partnerships are very easy to build. The partners are co-owners of the business and share all rights and responsibilities equally. The partnership itself doesn’t have to pay any taxes; the profits flow through to the partners and are reported, and paid, via each owner’s individual return.
Cons: Like sole proprietorships, this structure provides no liability or professional indemnity protection. Each partner’s personal assets are at risk to pay business debts or for adverse legal judgments
Limited Liability Companies (LLC)
A Limited Liability Company or LLC is a hybrid business entity that protects owners’ personal assets from business liability, but allows the returns they earn to be taxed once, as personal income. If you have an LLC, your personal assets are protected from being seized to pay the company’s debts or to resolve any legal problems.
Cons: Compared to a sole proprietorship, running an LLC involves higher costs and greater complexity – in exchange for some level of liability protection.
For the GP, a limited partnership is much easier to set up and operate than a corporation. A limited partnership is a complex business structure with two classes of partners: limited (LP) and general (GP). Capital can be raised from LPs who essentially have no say in running the company.
Cons: Experts consider the risk exposure to lawsuits and debts of the partnership to be the major disadvantage of limited partnerships. GPs are fully exposed to all liabilities of the partnership; LPs’ liability is limited to the size of their investment – but it still can be a factor.
A C Corporation is a legal entity, with a charter granted by the state. It can sell shares of stock to raise money, and shareholders become owners with an interest based on the size of their investments. It provides the best protection against liability. It’s also attractive for equity investors, since there are no limits to the size of investments or number of investors and shareholder protections are well defined.
Cons: There is a lot of work to be done. You have to create a board of directors, hold regular meetings, and record notes of the proceedings. Other key business processes, from accounting to human resources, may also be subject to regulatory guidelines on both the state and federal levels. C corporations are subject to double taxation – once on corporate profits and a second time on dividends paid to shareholders.
An S corporation is structured like a traditional C corporation, except that a special classification from the IRS exempts earnings from double taxation. S corporation earnings flow through to your individual tax return. You’ll also be protected from personal liability by the well-defined precedents of corporate law.
Cons: No more than 100 shareholders are allowed, and they cannot be foreigners or other corporations. Also, owners can create only one class of stock. Plus, there are some fairly complex shareholder compensation requirements.
For more ideas, read our recent article “Selling your business? Here are some tips from experts”
Speak with a licensed agent at Uniamericainc.com to discuss which coverages best fit your unique situation.
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