Helping You Pursue Your Business Venture
If you are in the process of forming a business, you will need to determine the most advantageous entity format for your business. When considering the entity type, there are several factors to consider, including cost, tax benefits, legal documentation requirements and the liability protection offered by the entity type.
When structuring your business, there are many types of entities that can be formed. A few options include:
- A sole proprietorship
- A limited liability company (LLC)
- A limited liability partnership (LLP)
- A limited partnership
- A corporation
Arnold and Associates, LLC, can differentiate the most popular types of entities and provide the pros and cons of each option.
Being A Sole Proprietor
This is the easy type of entity to set up because you are a sole proprietor just by performing business operations. There are no formal filings to set up the business, except for state or local licenses or fictitious name filings. It has a sole owner who is the manager and operator of the business.
The sole proprietor can have employees, debts and assets in the name of the business, but the business and the individual are, in essence, the same. This means creditors can reach all your assets, including your personal assets like your home and retirement funds. The sole proprietor’s profits and losses pass-through to the individual through the owner’s personal tax return. Usually, this is on the Schedule C of the owner’s Form 1040 – Individual Income Tax Return.
A pitfall of being a sole proprietor is that the owner must pay self-employment tax. This means the owner must pay not only the portion of Social Security and Medicare an employee would pay but also the portion that is typically paid by the employer. You are allowed to deduct the employer-equivalent portion of your self-employment tax when calculating your adjusted gross income. However, this deduction only affects your income tax. The deduction does not affect your net earnings from self-employment or your self-employment tax.
Working As A Partnership
As with a sole proprietorship, a general partnership does not have to register or pay a fee to the state to be in business. Truthfully, a partnership can be formed without even a written agreement between the partners. All it takes to form a partnership is two or more people intending to share profits or losses. In addition, a general partnership is not a taxable entity. All partnership profits and losses are passed through to the partners, which makes filing income tax returns relatively easy. A disadvantage of a general partnership is that the business-related acts of another partner implicate all partners. This means that under state agency law principles, partners are personally liable for the torts committed by another partner. Thus, it is essential that business partners completely trust one another before they enter into a partnership with each other.
Creating A Limited Liability Company
The limited liability company (LLC) is a business entity that allows for the flexibility of sole proprietorship but adds the limited liability and tax aspect of a corporation. LLC formation is a bit more complex than a sole proprietorship or partnership because it requires formation filing with the Office of the Secretary of State.
The owners of an LLC are called members, and the duration of the business can be limited when the formation filings are filled out. The tax forms are similar to that of the sole proprietorship because the profits and losses flow through to the members on their personal tax return. However, these tax forms can be a bit more complicated than filing a Schedule C.
The best benefit of an LLC is its limited liability protection. Like a corporation, the LLC limits the liability of its members to the capital contribution of each member. This means that, unlike the sole proprietorship, the members’ personal assets are not at risk if the business gets sued.
Forming A Corporation
Like an LLC, a corporation gives limited liability protection to its shareholders, who are the owners. This means that creditors cannot pursue the shareholders’ personal assets to pay for the debts and liabilities of the business. Therefore, a major benefit of a corporation over a sole proprietorship or partnership is that a corporation protects the owners’ houses, cars, and other personal assets from being used to pay debts of the business.
There are some tax advantages and disadvantages of being a corporation. Some of the tax advantages of being a corporation are that health insurance is deductible for premiums paid on behalf of the corporation, savings on self-employment taxes, corporate income is not subject to Social Security, and the benefit of being able to pay the shareholder dividends.
A tax disadvantage of being a corporation is double taxation: The corporation ends up paying taxes twice because the corporation is taxed on its profits and the shareholders are taxed on their dividends. This is why many incorporated businesses choose to file their taxes as an S corporation. This is accomplished by filing Form 2553 with the IRS.
Being an S corporation provides all the protections of a C corporation but avoids the double taxation problem by allowing the income, losses, deductions and credits to pass directly to the shareholders for federal tax purposes. Another disadvantage of a corporation is the maintenance of documentation that it is required to file and keep. The corporation must file annual reports and tax returns, maintain minutes of the shareholder meetings, organize the board of director’s records and keep all corporate money separate from personal money. This can be burdensome for a beginning business with minimum shareholders and capital.
Form Your Business With A Legal Perspective
At Arnold and Associates, LLC, you can partner with experienced business law attorneys throughout the development of your business and beyond. Call 601-345-4355 or complete our intake form to contact our Mississippi law firm today.