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| Starting a Business? Which Entity Type Should You Choose? |
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Starting your own business can be an immensely rewarding undertaking. One of the first decisions that you will face will concern the type of business entity who choose. There are four; each is briefly described below, and some advantages and disadvantages of each are pointed out.
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Starting your own business can be an immensely rewarding undertaking. One of the first decisions that you will face will concern the type of business entity who choose. There are four; each is briefly described below, and some advantages and disadvantages of each are pointed out.
1. Corporations – The generally accepted legal definition of a corporation is, “an organization formed with state governmental approval to act as an artificial person to carry on business (or other activities), which can sue or be sued, and (unless it is non-profit) can issue shares of stock to raise funds with which to start a business or increase its capital.” A corporation is a separate and distinct entity from its owners – the shareholders.
There are both advantages and disadvantages to the corporation:
• Probably the most important advantage is that the shareholders of the company have a limited liability for debts of the corporation, and in the event of lawsuits brought against the corporation.
• Another important advantage is that the ownership of the corporation – represented by shares – can be transferred readily (think about the stock market)and lawsuits incurred by the corporation and its activities.
• Corporations can have an easier time of raising capital via the sale of stock – a recognized instrument of ownership.
Now, the bad news:
• Corporate income is subject to “double taxation.” The corporation has to pay taxes on its income, and then when that income is distributed – as dividends – to shareholders, THEY pay taxes on it.
• Generally, corporations are more costly to set-up. They also are required to keep more extensive records, and to make regular tax and/or informational filings.
A variant of the corporate form is called a “Sub-Chapter S Corporation” (also known as a Sub-S Corp or simply, an S-Corp). An S-Corp is a regular corporation (sometimes called a “C-Corp”) that has filed for special tax treatment with the IRS, by submitting IRS Form 2553. Its owners enjoy liability and debt protection like those of a C-Corp…but the corporate profits are not taxed at the corporate level…they “pass through” to the owners on Form K1 (part of the corporation’s tax return). Losses will also pass-through and influence the owners’ personal tax returns – losses offset income, and income is taxed at the owners’ tax rate. On the downside, S-Corps are size-limited…no more than 75 shareholders (not usually a concern however for small business owners).
2. LLC - Limited Liability Company - An LLC is sort of a hybrid. LLCs combine the limited liability protection of a corporation with the tax advantages of a partnership or an S-Corporation.
The good and bad:
• The LLC owners have limited liability, and the liability is limited to the amount of each owner's investment in the LLC.
• Like an S-Corp, income and losses pass-through to the owners' personal tax
Disadvantages include:
• Generally more expensive than a partnership to set-up, and they have record-keeping requirements that are somewhat similar to corporations.
• Since there aren’t shares of ownership, you can’t sell shares for capital.
3. Partnerships – A partnership is a business entity in which at least 2 people are involved. Both profits and liability are shared. The main difference between a partnership and a corporation is liability. They are fairly easy to form, and to dissolve.
Some advantages of partnerships are:
• Income and loss flow through to the partners' individual tax returns. There is no double taxation and the profits and losses can be distributed unevenly.
• Less expensive to start and operate compared to corporations and LLC's
But partnerships are not without disadvantages, the chief one being unlimited liability for each (unlike corporations and LLC’s). Generally, each partner is jointly liable with the partnership for the obligations of the partnership. In many states each partner is jointly and severally liable for the wrongful acts or omissions of a copartner.
4. Sole Proprietorship –A sole proprietorship is an unincorporated business, having a single owner paying personal income tax on income from the business activity. Losses offset other tax return income. There isn’t much government (Federal or State) here, and they are the simplest business form to start-up. The majority of sole proprietors conduct business under their own names; it is not necessary to create a separate or assumed name to operate. Since there is no separate and distinct legal entity, the proprietor is not shielded from liability – the proprietorship’s debts and obligations belong to the owner – there isn’t a “firewall.”
The sole proprietorship’s advantages include
• Tax – income and losses are reported on a separate schedule (Schedule C) of your personal tax return. Income is taxed at your personal tax rate.
• Ease of formation and dissolution.
The ugly can be that:
• YOU are responsible for all of the debts and obligations and other liability. No “corporate veil” to shield you.
• Your liability in unlimited.
• See the first two.
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Posted on Feb 20, 2009 11:28am by amjr
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