Forming a New Entity for your Business

Ready, set, GO! Now which entity shall you choose? An excellent question!  Here we give you some considerations and basics. When you are ultimately ready, give us a call and ask us how we can help?

How should my business be structured?  All businesses need to form some legal structure that defines the rights and liabilities of participants within the business. This includes defining ownership, control, personal liability, duration, and financial structure.  In choosing, you will want to take into consideration the following:

  • How big do you want your biz to grow?
    •How much control do you want to have?
    •How much governance do you want to provide/deal with?
    •What level of exposure do you want?
  • What does your accountant advise?
    •Expected profit (or loss) of the business.
    •Do you need to reinvest in the business?
    •Do you need to be able to liquidate the business?

Sole proprietorship’s own all the assets of the business and all of the profits.  However, on the other side of the coin they assume all responsibility for any of its liabilities or debts.  For a minimal investment and minimal organization an LLC is much more advisable.

Benefits of a Sole Proprietorship

  • Inexpensive to put together.
    • Sole proprietors are in complete control.
  • Profits from the business flow-through directly to the owner’s personal tax return.
    • Easy to dissolve.

Negatives of a Sole Proprietorship

  • Sole proprietors are exposed to unlimited liability of the business and both personal and business assets are at risk.
    • Raising funds typically limited to personal loans and personal savings.
    • Employee benefits are not deductible.

Partnerships

In a Partnership, two or more people share ownership of a single business.  The partners are similar to a sole proprietor in their level of exposure.  The Partners should have a partnership agreement that provided how decisions will be made, profits will be shared, disputes will be resolved, how future partners will be admitted to the partnership, how partners can be bought out, or what steps will be taken to dissolve the partnership when needed

Benefits of a Partnership

  • Easy to establish.
    • With more owners, the ability to raise funds may be increased.
    • The profits from the business flow directly through to the partners.
    • Future partnership can be attractive to potential employees.
    • Partners bring different skill sets to the table.

Negatives of a Partnership

  • Partners are jointly and individually liable for the actions of the other partners.
    • Profits must be shared.
    • Potential for disputes among partners.
    • Some employee benefits are not deductible.
    • The partnership may have a limited duration.

Types of Partnerships that should be considered:

  1. General Partnership
    Partners divide responsibility for management and liability, as well as the shares of profit or loss according to their internal agreement.  Equal shares are assumed unless there is a written agreement that states differently.
  2. Limited Partnership and Partnership with limited liability
    The partners have limited liability which is usually capped at their investment level. Limited decision-making ability, regarding management decision. Good for short term projects, or for groups looking to invest in capital assets.
  3. Joint Venture
    Used for a limited period of time or a single project.  If the partners in a joint venture repeat the activity, they will be recognized as an ongoing partnership and will have to file as such, and distribute accumulated partnership assets upon dissolution of the entity.

Corporations

A Corporation is considered by law to be a unique entity, which has a separate and existence from those who own it.  A Corporation can be taxed, prosecuted, sued. It can enter into contracts. The owners of a corporation are its shareholders.  The shareholders elect a board of directors to run the company. The corporation has a life of its own and does not dissolve when ownership changes.

Benefits of a Corporation

  • Shareholders have limited liability for the corporation’s debts or judgments against the corporation.
    • Generally, shareholders can only be held accountable for their investment in stock of the company.
    • Corporations can raise capital with the sale of stock.
    • A Corporation may deduct the cost of benefits it provides to officers and employees.
    • Can elect S Corporation status if certain requirements are met.  This election enables company to be taxed similar to a partnership.

Negatives of a Corporation

  • Capital outlay to form a corporation is more intensive.
    • Corporations are monitored by federal, state and some local agencies, and as a result may have more paperwork to comply with regulations.
    • Incorporating may result in higher overall taxes.  Dividends paid to shareholders are not deductible from business income (double taxation).

Subchapter S Corporation

A tax election only; this election enables the shareholder to treat the earnings and profits as distributions, and have them pass through directly to their personal tax return.  A shareholder working for the company must pay his/herself wages (if there is profit), and it must meet standards of “reasonable compensation”. If you do not do this, the IRS can reclassify all of the earnings and profit as wages, and you will be liable for all of the payroll taxes on the total amount.

Limited Liability Company (LLC)

An LLC is designed to be a hybrid of a corporation and a partnership.  It provides the benefits of limited liability of its members and functionality like in kind to a partnership.

The owners are members and the governance is provided by an operating agreement or by statute should an agreement not exist.  A very common business in today’s business environment.

Not sure what to choose? No problem that is what we are here for, give us a call.