Business Entities – Which one is right for your Business ?
Which one is right for your Business ?
Are you in business for yourself? Good for you. It’s part of the American dream. Or perhaps you are planning to start your own business. In either case, one of the most important steps you can take is ensuring that you choose the proper legal entity for your business. It will affect your taxes, your management authority, the transferability of your interests and your exposure to liability. The following are the various business formation options which will give you a starting point as to which form will work best for you. Once you are familiar with the formation options, it’s best to consult with an accountant and attorney. before making a final decision.
A sole proprietorship is owned by the individual and exists without any formal registration. In other words, if you open a lemonade stand on the comer, you are a sole proprietor. As with some other forms of business, profits and losses are treated as personal income or loss and taxed accordingly. However, as the sole owner you are personally responsible for all debts and liabilities. Due to the exposure to liability, it is rarely advisable for anyone to operate a business as a sole proprietor.
A general partnership exists whenever two or more people are operating a business for profit. Each partner is personally responsible for all debts and liabilities of the firm. Even though the partnership legally exists even without a formal agreement, smart business people prepare a partnership agreement. Such agreements will avoid future conflicts by addressing issues such as each partner’s management authority; how profits or losses will be allocated; and how the partnership will be dissolved when disputes occur or upon the death of one or more partners. As with sole proprietorships, a general partnership is rarely advisable due to the high exposure to personal liability. There are, however, other forms of partnerships that are acceptable, including the limited partnership and limited liability partnership.
The limited partnership (LP) is similar to the general partnership with several major differences. In an LP at least one person must be identified as a general partner and be responsible for the operation of the organization; the general partner(s) will be liable for the organization’s debts. The limited partners are not active managers of the business and are not liable for the organization’s debts, etc. A typical arrangement would be for an investor to be a limited partner and the hands on entrepreneur to be the general partner.
LIMITED LIABILITY PARTNERSHIP (LLP)
The Limited Liability Partnership (LLP) is a relatively new form of business entity in Arizona. There are no general partners in an LLP, only limited partners, all of whom receive the protection of limited liability. These are very similar to the Limited Liability Company, which is usually preferable as a business entity for many reasons, which are addressed below.
The Limited Liability Company (LLC) has become one of the most popular forms of business structure in recent years and nearly all states now have laws providing for LLC creation and regulation. LLCs have become popular because they offer the liability protection of a corporation and the ease of operation of a partnership.
An LLC can be formed with minimal state filing requirements and no advance IRS filings. The filing fees are less than for corporations and there are no requirements for public disclosure by the owners and finances of an LLC.
Some of the attractive features of an LLC include the ability to build in buy/sell provisions and ownership compensation provisions. This can avoid disputes down the road. There can be different classes of ownership (called members) and the management of the LLC can be assigned to a non-member.
A traditional corporation, sometimes referred to as a “C Corporation,” is the most complex type of business organization. It is a completely distinct legal entity from its owners and has its own rights and responsibilities.
In forming a corporation, potential shareholders offer money and/or property in exchange for capital stock. The stockholders are the owners of the corporation and the directors of the firm may or may not be stockholders.
While both an LLC and a corporation offer liability protection for the owners, a corporation is usually more suited to a company with a significant number of owners. This is because a corporation issues stock, which allows for greater flexibility of ownership among many owners.
A corporation will result in taxation on both the corporate profits and again on dividends, known as double-taxation. In addition, the spectrum of a corporation’s business activities can be limited by its corporate charter. These factors, combined with greater record-keeping and reporting requirements, will usually make the LLC a preferred business structure for the small business.
A Subchapter S Corporation is simpler to create and manage that a traditional C Corporation. An S Corp is one where the shareholders agree to include their proportional share of the corporation’s income, loss, deductions and credits as part of their personal income.
To qualify for S Corporation status, a corporation has a limit on the number of shareholders; must be headquartered in the United States; and must have only one class of stock. Aside from this issue, an S- Corp is identical to a C-Corp.