One of the first decisions that you will have to make as a
business owner is how the company should be structured. This
decision will have long-term implications, so you want to
make sure to review your options carefully. In making a
choice, you will want to take into account the following: -
Your vision regarding the size and nature of your
business.
- The level of control you wish to
have.
- The level of "structure" you are willing
to deal with.
- The business's vulnerability to
lawsuits.
- Tax implications of the
different ownership structures.
- Expected profit
(or loss) of the business.
- Whether or not you
need to re-invest earnings into the business.
-
Your need for access to cash out of the business for
yourself.
| |  |
An excellent tool to help you decide which business
structure (ex. Corporation, LLC) is right for you. This
worksheet also includes tax calculations. (2 Sheets) |
SOLE PROPRIETORSHIPS
The vast majority of small business start out as sole
proprietorships. These firms are owned by one person,
usually the individual who has day-to-day responsibility
for running the business. Sole proprietors own all the
assets of the business and the profits generated by it.
They also assume complete responsibility for any of its
liabilities or debts. In the eyes of the law and the
public, you are one in the same with the business. |  |
Advantages of a Sole Proprietorship -
Easiest and least expensive form of ownership to
organize.
- Sole proprietors are in complete
control, and within the parameters of the law, may make
decisions as they see fit.
- Sole proprietors
receive all income generated by the business to keep or
reinvest.
- Profits from the business
flow-through directly to the owner's personal tax
return.
- The business is easy to dissolve, if
desired.
Disadvantages of a Sole
Proprietorship -
Sole proprietors have unlimited liability and are
legally responsible for all debts against the business.
Their business and personal assets are at risk.
-
May be at a disadvantage in raising funds and are often
limited to using funds from personal savings or consumer
loans.
- May have a hard time attracting
high-caliber employees, or those that are motivated by
the opportunity to own a part of the business.
-
Some employee benefits such as owner's medical insurance
premiums are not directly deductible from
business income (only partially deductible as an
adjustment to income).
Federal Tax
Forms for Sole Proprietorship
(only a partial list
and some may not apply) -
Form 1040: Individual Income Tax Return
-
Schedule C: Profit or Loss from Business (or Schedule C-EZ)
-
Schedule SE: Self-Employment Tax
- Form 1040-ES:
Estimated Tax for Individuals
- Form 4562:
Depreciation and Amortization
- Form 8829:
Expenses for Business Use of your Home
PARTNERSHIPS
In a Partnership, two or more people share ownership of
a single business. Like proprietorships, the law does
not distinguish between the business and its owners. The
Partners should have a legal agreement that sets forth
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;. Yes, its hard to think about a
"break-up" when the business is just getting started,
but many partnerships split up at crisis times and
unless there is a defined process, there will be even
greater problems. They also must decide up front how
much time and capital each will contribute, etc. |  |
Advantages of a Partnership -
Partnerships are relatively easy to establish; however
time should be invested in developing the partnership
agreement.
- With more than one owner, the
ability to raise funds may be increased.
- The
profits from the business flow directly through to the
partners' personal tax returns.
- Prospective
employees may be attracted to the business if given the
incentive to become a partner.
- The business
usually will benefit from partners who have
complementary skills.
Disadvantages of
a Partnership -
Partners are jointly and individually liable for the
actions of the other partners.
- Profits must be
shared with others.
- Since decisions are shared,
disagreements can occur.
- Some employee benefits
are not deductible from business income on tax returns.
-
The partnership may have a limited life; it may end upon
the withdrawal or death of a partner.
Types of Partnerships that should be considered: -
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. -
Limited Partnership and Partnership with limited
liability
"Limited" means that most of the
partners have limited liability (to the extent of their
investment) as well as limited input regarding
management decisions, which generally encourages
investors for short term projects, or for investing in
capital assets. This form of ownership is not often used
for operating retail or service businesses. Forming a
limited partnership is more complex and formal than that
of a general partnership. - Joint Venture
Acts like a general partnership, but is clearly 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.
Federal Tax Forms for Partnerships
(only a partial
list and some may not apply) -
Form 1065: Partnership Return of Income
- Form
1065 K-1: Partner's Share of Income, Credit, Deductions
-
Form 4562: Depreciation
- Form 1040: Individual
Income Tax Return
- Schedule E: Supplemental
Income and Loss
- Schedule SE: Self-Employment
Tax
- Form 1040-ES: Estimated Tax for Individuals
CORPORATIONS
A corporation, chartered by the state in which it is
headquartered, is considered by law to be a unique
entity, separate and apart from those who own it. A
corporation can be taxed; it can be sued; it can enter
into contractual agreements. The owners of a corporation
are its shareholders. The shareholders elect a board of
directors to oversee the major policies and decisions.
The corporation has a life of its own and does not
dissolve when ownership changes. |  |
Advantages of a Corporation -
Shareholders have limited liability for the
corporation's debts or judgments against the
corporations.
- Generally, shareholders can only
be held accountable for their investment in stock of the
company. (Note however, that officers can be held
personally liable for their actions, such as the failure
to withhold and pay employment taxes.)
-
Corporations can raise additional funds through 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.
Disadvantages
of a Corporation -
The process of incorporation requires more time and
money than other forms of organization.
-
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 form business income,
thus this income can be taxed twice.
Federal Tax Forms for Regular or "C" Corporations
(only a partial list and some may not apply) -
Form 1120 or 1120-A: Corporation Income Tax Return
-
Form 1120-W Estimated Tax for Corporation
- Form
8109-B Deposit Coupon
- Form 4625 Depreciation
-
Other forms as needed for capital gains, sale of assets,
alternative minimum tax, etc.
Subchapter S Corporations
A tax
election only; this election enables the shareholder to
treat the earnings and profits as distributions, and have
them pass thru directly to their personal tax return. The
catch here is that the shareholder, if working for the
company, and if there is a profit, must pay herself wages,
and it must meet standards of "reasonable compensation".
This can vary by geographical region as well as occupation,
but the basic rule is to pay yourself what you would have to
pay someone to do your job, as long as there is enough
profit. 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.
Federal Tax Forms for Subchapter S Corporations
(only
a partial list and some may not apply) -
Form 1120S: Income Tax Return for S Corporation
-
1120S K-1: Shareholder's Share of Income, Credit,
Deductions
- Form 4625 Depreciation
- Form
1040: Individual Income Tax Return
- Schedule E:
Supplemental Income and Loss
- Schedule SE:
Self-Employment Tax
- Form 1040-ES: Estimated Tax
for Individuals
- Other forms as needed for
capital gains, sale of assets, alternative minimum tax,
etc.
LIMITED LIABILITY
COMPANY (LLC)
The LLC is a
relatively new type of hybrid business structure that is now
permissible in most states. It is designed to provide the
limited liability features of a corporation and the tax
efficiencies and operational flexibility of a partnership.
Formation is more complex and formal than that of a general
partnership. The owners are
members, and the duration of the LLC is usually determined
when the organization papers are filed. The time limit can
be continued if desired by a vote of the members at the time
of expiration. LLC's must not have more than two of the four
characteristics that define corporations: Limited liability
to the extent of assets; continuity of life; centralization
of management; and free transferability of ownership
interests. Federal Tax Forms
for LLC
Taxed as partnership in
most cases; corporation forms must be used if there are more
than 2 of the 4 corporate characteristics, as described
above. In summary,
deciding the form of ownership that best suits your business
venture should be given careful consideration.
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