Debra A. Simmons, CPA

Which Form of Business Should I Use?

In Business Info on September 8, 2009 at 5:42 pm

Choosing the form of entity of your business, whether it be corporation, “S” corporation, sole proprietor or limited liability company, is a crucial decision that can have significant tax implications. Before you start the business, you should evaluate the advantages and disadvantages of each entity type to help you determine the most beneficial form of business for your company.

Sole Proprietor
Sole proprietors are owned by one person (or husband and wife) and are the most common type of ownership. Sole proprietors are personally liable for business debts. This means if your business fails and you have unpaid business debts, you must use your personal assets to pay the debt. When you fill out contracts, the legal name of a sole proprietorship is the owner’s personal name. By identifying yourself as a sole proprietorship, others may think that your business is small. Despite these drawbacks, forming a sole proprietorship is the simplest and least expensive business type.

Corporation
Corporations provide limited liability protection to the business owners. This means that if the business fails, the business owners do not have to use their personal assets for unpaid business debt. This limited liability protection does not apply to taxes. There is an $800 minimum annual tax for all corporations (including corporations formed out-of-state) In practice, incorporating does not protect owners from acts that they do themselves. That is because people can sue both the corporation and the person individually. Also, incorporating does not protect owners if they guarantee debt. Most lenders require the major shareholders to personally guarantee debt. By incorporating, the smaller shareholders are protected, but not the larger ones. So overall, incorporation makes sense if other people (employees or partners) will be doing some of the work or you have smaller shareholders that you want to protect from debt.

There are S corporations and C corporations. This is a tax designation only. Normal corporations (C corps) have their earnings double taxed. First the corporation is taxed. Then profit is distributed to shareholders and shareholders pay tax on those dividends. S corporations were developed so that earnings are only taxed once.
However, S corporations cannot offer incentive stock options to employees.

Limited Liability Company
LLCs were developed to give people the flexibility of partnerships with the liability protection of corporations. Corporations have strict rules regarding annual meetings and minutes, which can be a nuisance to small corporations. LLCs do not have any of the corporate “formalities”. Yet they have the same liability protection that corporations do. Because of that, they have become a very popular business entity choice. Like corporations, forming an LLC costs $800 per year. However you must pay the $800 earlier with LLCs – four months after forming your business. Like corporations, forming an LLC will not protect business owners from actions that they do themselves, from tax debt, or from personally guaranteed debt. LLCs are popular entities if your business has more than one person doing the work or you want to protect smaller stakeholders from business debt.

Partnership
Partnerships are owned by more than one person. Each of the partners is personally liable for the business’ debts. Much like a marriage, each partner is responsible for the others’ actions, even if they did not know what their partner was doing. This works if both partners are equally responsible and have equal ideas about risk. If this is not the case, a partnership can be disastrous. For this reason, partnerships are less desirable business entities. Partnerships are inexpensive to form and unlike corporations or LLCs, there is no minimum tax.

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