An individual or a group of people operating a business enterprise have choices in terms of how to structure their business. The default business form is that of a sole proprietorship or partnership, where the law presumes such structure unless the owners affirmatively create a corporation, limited liability company (LLC), or partnership (LLP).
Understanding Your Business
Persons starting a new business need to be aware of the available options to make an informed decision as to which business form they should operate under. Likewise, persons who have operated initially as sole proprietors or partners may wish to form a corporation, an LLC, or a partnership.
Common reasons for forming a business entity, including LLCs and partnerships, are to limit liability to the investment in the entity or company, and to gain certain tax advantages in the operation of the enterprise.
Owning and operating a business carries an inherent risk. Businesses fail every day for any number of reasons. It is important to structure the business in such a way as to limit the risk and mitigate potential loss in the event of failure. If possible, the owners should limit their liability to their investment in the business and not expose their personal assets, i.e., homes, savings, retirement, etc.
There may also be a number of tax benefits to operating a business in corporate, limited liability company, or partnership structures.
Business Entity Selection
The following corporate, LLC, and partnership structures should be considered:
- C corporation — All for-profit corporations are C corporations unless the owners elect to be treated as an S corporation. A C corporation files a tax return and pays taxes at the corporate rate. Any distributions made out of the C corporation’s earnings are taxed as dividends to the shareholders. If the C corporation is a domestic corporation based out of the United States, the dividends are considered qualified dividends, and are taxed at the more favorable capital gains rate.
- S corporation — By making an S-election, the owners are electing to treat the corporation as an S Corporation, which is a pass-through tax entity. While the corporation does file a tax return, no income tax is paid by the corporation in most instances. Instead, the profits and losses of the corporation are passed through the business and reported on the owner’s personal tax returns. Both C and S corporations have common characteristics, including limited liability protection, status as separate entities, governing structures, and the need to adhere to certain corporate formalities unique to all corporations. Our knowledgeable and experienced attorneys have the tax law expertise to inform and educate business owners as to the advantages and disadvantages of a C corp. versus an S corp., with respect to tax issues.
- Limited Liability Companies (LLCs)—LLCs are hybrid structures that combine several features of corporations and partnerships. Some of the advantages include less formal or structured rules for governance, i.e., no need for minutes or resolutions. LLCs are considered disregarded entities for tax purposes, and are treated as sole proprietors or partnerships by default. However, LLCs may elect to be treated as a C Corporation or an S Corporation, or retain their default status for tax purposes. The most significant aspect is perhaps the ability to be treated in the most advantageous way possible for tax purposes. LLCs are commonly used for real estate investments. Disadvantages may include issues of termination if an owner dies or leaves, and the inability to sell stock if there is a desire or need to go public.
- Limited partnerships — Limited partnerships are vehicles for passive investors to realize profits in a business without exposure to liabilities. Disadvantages can involve difficulty in selling the investment.
- Limited liability partnerships (LLPs) — An LLP is another hybrid entity which is similar to the LLC, but is limited to specific professions like law practices, accounting firms and engineering businesses. An LLP is a partnership, but unlike a general partnership, liability is limited, for partners are typically not liable for the negligence or wrongful acts of the other partners.
Let Us Help You Through the Process
If you are seeking guidance with the formation of your business and in decisions regarding its operation, please contact NewPoint Law Group, LLP, at 800-358-0305 or message us online to schedule a free consultation.