Deciding how to structure a small business is a vital step for an entrepreneur because the proper business structure can determine eligibility for small business financing and business credit. It is very common for new entrepreneurs to set up their business as a sole proprietor.
As your business grows and expands, you may find the need to restructure your business to ensure optimal chances for financing, obtaining large contracts or tax purposes.
Even after a decision is made, the nature of your business may change and the structure may need to change again. Fortunately there are several options to choose from. Some research and perhaps the advice of an attorney may be necessary when determining how to set up a business but below are the most common business structures.
A sole proprietorship is set up to allow an individual to own and operate a business by him/herself. A sole proprietor has total control, receives all profits from and is responsible for taxes and liabilities of the business.
If a sole proprietorship is formed with a name other than the individual’s name, a Fictitious Business Name Statement must be filed with the county where the principal place of business is located. It is a very common, simple business structure which is easy to start-up and maintain. However, you are the business and any liabilities belong to you.
A partnership exists between two or more persons who join together to carry on a trade or business. Each person contributes to the partnership and the partners share in the profits as well as losses. There are also incorporating services that will incorporate your business and provide the necessary documentation online.
The C-Corporation acts as a separate legal entity which is distinct from shareholders. There is no limit to the number of shareholders and shares can be held by non residents and citizens who do not reside in the United States. The corporation must pay federal and state income taxes on earnings. The earnings are distributed to shareholders and the shareholders are also taxed. Double taxation occurs. The benefits of the C-Corporation:
- Limited liability for the directors, officers, shareholder and employees of the corporation.
- C-Corporations can attract potential investors through the sale of shares of stocks.
- More than one type of stock can be issued.
- The C-Corporation exists whether or not the owners leave the business.
- Standard business expenses can be deducted as well as benefits to employees.
- Fringe benefits may be deducted such as group term life insurance, health and disability insurance, death benefits and employee medical expenses not paid by insurance as a business expense.
- Shareholders who are also employees are exempt from paying taxes on fringe benefits.
- Profit and loss can be split between the owners and the business to lower the overall tax rate.
- Corporate losses can be carried over to future tax years.
The S-Corporation is generally exempt from corporate income taxes on its profits. The shareholders pay income taxes on their proportionate share of the profits. Shareholders report the income and pay taxes, if any. One of the issues associated with the (C) corporation is that the corporation along with its owners are taxable. This is where the term “double taxation” comes into play because the corporate income is often taxed twice. The benefits of the S-Corporation:
- Limited liability like C-Corporations. S-Corporations are also considered to be to be separate entities apart from their owners.
- Debts incurred by the corporation are the responsibility of the corporation, not its shareholders, who can only be held accountable up to the amount they invested in the corporation.
- No double taxation as in the C-Corporations. According to the Internal Revenue Service, an S corporation is not a separate taxable entity, the corporation’s profits are considered to be the shareholders’ .
- Losses appear on the shareholders’ personal income tax returns just as profits do so at the end of the year if the corporation experiences losses shareholders end up owing less or even no taxes after they deduct their share of the corporation’s losses.
Limited Liability Partnership
The Limited Liability Corporation is similar to the S-Corporation. The profits of the LLC go to the shareholders/employees rather than to the business. Owners have limited personal liability for the debts and actions of the LLC. Owners of an LLC are called members. Members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states permit “single member” LLCs, those having only one owner. The benefits of the LLC:
- Limited liability of the members for acts and debts of the LLC.
- No requirement of an annual general meeting for shareholders.
- Limited paperwork and record keeping as compared to the C-Corporation and S-Corporations.
- No double taxation unless the LLC elects to be taxed as a C-Corporation.
- Profits are taxed personally at the member level, not at the LLC level.
- In most States, not all, LLCs are treated as separate entities from their members.
Shelf or Aged Corporations
You can also purchase a “shelf” or “aged” corporation in the State where you want to do business. A shelf or aged corporation is one which has no activity and is created and put on the “shelf” to age and use at a later date. There are companies which sell shelf corporations.