Business Types
Business Forms and Their Advantages
Sole Proprietorship:
This enterprise is owned by one person and easiest to create by filing for a business license with a business name, and setting up a business checking account. The owner has full control of the business decisions and realizes all its profits and losses. His expenses include any salary he pays to his employees, but his profit is his net income after all expenses.
Company profit goes on his own personal income tax in schedule C. For both his federal and state income tax as well as too. His business is identified by his Social Security number. When he dies, there’s no automatic provision for the business to continue.
Its disadvantages are unlimited liability and lack of funds for expansion. He’s personally liable for all damage he causes through his business. So both his personal and business assets are in jeopardy. If he wants to expand his business, he has only his own earnings and savings to draw from.
General Partnership:
A partnership is constituted by a legal agreement between two or more partners although there’s often a state requirement to register it beyond that required for a sole proprietorship. Unless there’s an agreement otherwise, the partnership ends when someone dies or stops participating.
Because each partner is a general partner, each participates in all business management and decisions. It’s pretty much like a multi-sole proprietorship. Therefore all its characteristics are the same as for the sole proprietorship.
The main difference is splitting up the net income among the partners. The agreement determines this. Only an informational form is sent to the government showing which partner gets what. Each partner then adds his share onto his personal income tax just like for a sole proprietorship.
The advantage of the general partnership is that it’s as easy as a sole proprietorship to set up. The partners – often just two – have full the control and share all the profits.
The disadvantages are the same as for the sole proprietorship – unlimited liability to both partners for whatever either partner does and lack of raising funds beyond the partners. The partners must also agree how the business is run. This requirement often breaks up partnerships.
Limited Partnership:
A limited partnership is composed of at least one general partner and a number of limited partners. The agreement specifies how the net income is share among all partners. Some states require registration for limited partnerships.
The main difference from a general partnership is that the limited partners don’t participate in the management and decisions of the business. Because of this they have a limited liability – restricted to whatever they invested in the company.
All the other characteristics are the same as the general partnership. Taxation is passed through to all partners on to their own personal income tax. Only an informational form is sent to government.
Of course the advantage to this form of business is that funds can be raised by taking on more partners as limited partners whose personal liabilities are limited to their investment. Many limited partnerships have one general partner so he maintains control of business management and decisions.
The disadvantage is that the general partner must share more of the profits with the other partners, and of course his own liability is still unlimited.
All businesses that expand into another state, must pay sales taxes for what sold in that state. All employees and partners will have to have state taxes withheld according to the state they live and work in.
C-Corporation:
Forming and maintaining a corporation is complex. That’s because the corporation is a separate legal entity. In this case all the business aspects of the corporation – sales, expense, assets, and liabilities – are completely separate from the personal assets of the owners of the corporation. The owners have shares in the corporation but this alone doesn’t make them managers.
A corporation is incorporated in a specific state. It files its Articles of Incorporation there. Additionally it needs to specify its and a listing of officers and directors. Also it must . As a separate legal entity, the corporation extends its existence beyond any of its shareholders or employees.
The main owner – with the majority of shares – has limited control through its votes, and must share much the company’s profits with other shareholders.
The corporation is run by its officers who are responsible to the directors. Shareholders, according to the percentage of the corporation shares they own, can control the directors. In this way a majority owner can get himself appointed as an officer to manage the business.
The corporation, as a separate legal entity, has its own company identity number and pays income tax according to corporation taxes directly to the federal and states. Owners, i.e. shareholders, are paid based on the dividend assigned to each share. Indirectly they receive benefit as the value of their shares increase and then sold. Both of these proceeds go on their own personal income tax. The corporation can retain some of its profits for further growth rather than pay it out in dividends. Everyone is an employee of the corporation as are the officers and are paid accordingly.
The advantage of the C-corporation is that it has almost unlimited ability to raise capital if it goes public through share offerings. And, of course the business liability is restricted to what the corporation owns. If the corporation fails, though, its outstanding shares (owned by shareholders) will lose value to the shareholders, but that’s the extent of loss shareholders will suffer. There are also that a corporation can give to its employees.
The disadvantage is the complexity of fillings and running a corporation. Profits are potentially taxed twice — first at the , and then as dividends on personal income tax.
S-Corporation:
An S-corporation is a corporation with all the complications of a c-corporation. It’s a special type of corporation formed when a corporation files an election for ‘sub s’ status or started as one. It carries the general complications of filings that the C-corporation. And because it’s a separate legal entity, its longevity is independent of any officer or owner.
Because it’s a corporation, liability extends only to what the corporation directly owns — i.e. its assets. Corporate ownership is through shares. But the number of shareholders of an S-corporation is limited. Like the C-corporation, control comes through the percentage of shares owned. Often a single owner will form an S-corporation for the limited liability if offers him along with complete control of the operation as its chief officer.
S-corporation is generally elected so that — unlike a C-corporation — all profits (net income) passes directly to the owners, according to the percentage of shares owned. So it’s taxed like a partnership. All its profits are distributed directly to the shareholders according to k-1 forms and the Form 1120S filed. This eliminates any corporation tax and puts the shareholder share of its income on their personal income tax.
The advantages of the S-corp over the C-corp is the elimination of double taxation as well as distributing losses to shareholders that they can deduct themselves, too.
Disadvantages are that the number of shareholders are limited which restricts funding and there’s no provision for retaining earnings untaxed at the personal level in the corporation, and, of course, the complexity of corporation requirements.
Limited Liability Company (LLC):
The LLC is formed by filing Articles of Organization in the state it begins. An LLC has members rather than partners. Sometimes it can have just one member. States rules determine this. Its filings requirements make it more of a burden than a normal partnership.
The members, according to the Operating Agreement of their LLC, determine how much each will share in the management, profit (and losses) of the business.
The LLC has a finite term of existence. It can’t continue indefinitely. But like corporations, all members of the LLC have a limited liability for debts of the business, unless they have personally guaranteed loans or other debts.
Taxation of an LLC is the same as that of partnerships. This also implies that all profits are taxed at the personal level, but of course they can be reinvested in the company by the members. Although the LLC can request being taxed like a corporation.
Control of the LLC follows the agreement arrangement which formed the LLC.
Only a corporation and a limited liability company afford limited liability to owners who want to directly manage the business. And only a corporation has a natural continuance beyond the participation or life of an owner.
A c-corporation is taxed at corporate rates unlike an s-corporation which must also distribute on profits. The c-corporation can choose to retain earnings rather distribute them as dividends.
Memorandum
TO: Business Owner
RE: Recommendation best business form for you company
Your key concerns are your exposure to liability, continuation of your business if you die, control of business management, and a desire to fund expansion. AC-corporation would best serve these concerns.
Your current sole proprietorship has plenty of profit to warrant the expense of a more complex form of business. You’re also taxed at the highest personal income tax rates.
Your sole proprietorship leaves you wide open for liability problems putting all your personal assets at risk along with your business assets. Transforming to a corporation you’ll need to still carry sufficient insurance but any losses will be restrict to your corporation’s assets.
The corporation has unlimited continuance since it has its own legal identity. Your death or incapacity won’t terminate your business.
You can maintain control of your corporation by owning the majority of outstanding shares. This way you control who will be the management officers and can appoint yourself as one. Through your control you can set all salaries for yourself and others and determine how much the corporation will retain earnings rather than distribute as dividends.
All net income of the corporation is taxed at corporation rates. Besides choosing your salary, you can determine how much to distribute as dividends.
A corporation form allows you to raise capital for expansion because you can sell shares while maintaining your majority ownership. The strength and continuance of the corporation will also increase your ability to sell bonds or raised debt for capital.
This will help you to expand your business to another state and retain the corporation’s identity. Its state income taxation will be affected by the amount of business it does in each state it is.
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