Starting Right, Starting Best
When starting a new business or working towards developing an existing one choosing the right form of business ownership and structure and then operating it correctly are of critical importance to your success. Careful planning and operation under the various forms of business ownership may allow owners to reduce liability exposure, minimize taxes and ensure that the business can be financed and run efficiently. Likewise, careful planning may ensure the longevity of your business. Even after the death of its original owner proper business structuring can clarify the ownership interests of all participants in the venture. When choosing a business entity you should consider several factors – The degree to which your personal assets are at risk from liabilities arising from your business, how to best pursue tax advantages and avoid multiple layers of taxation, the costs of forming, operating and maintaining the business entity, the preferred management structure, the ability to attract potential investors and offer ownership to key employees and the ability to provide for succession of ownership to future generations or potential buyers. At Bonfiglio & Asterita, LLC, we believe that an ongoing relationship with the right attorney can truly provide a business with a competitive edge to succeed. Our team of experienced attorneys can guide you through the difficult process of selecting the best form of ownership to suit your specific business needs.
The Types of Business Entities – Which One Is Right For Me?
The choice of which form of business entity should be made after weighing the advantages and the disadvantages of several factors that apply to your particular business. You should also keep in mind that there will inevitably be various changes in the nature of your business over time and that such changes may make it more advantageous either to change your entity type or its tax classification throughout the life of your business. The availability of a particular entity type initially depends on the number of owners. A single owner may operate as a sole proprietor, a corporation or a limited liability company. If there are two or more owners of the business then by definition it cannot be a sole proprietorship, however, it can be a corporation, limited liability company, general partnership, limited partnership or in certain situations a limited liability partnership.
What is a Sole Proprietorship?
A sole proprietorship is a business owned by one person. It has no legal distinction from the owner and usually requires no governmental filing other than a fictitious business name statement if the owner is doing business in any name other than a personal name (a “DBA” for “Doing Business As” or “TA” for “Trading As”). A sole proprietorship is probably the most common form of business because it is simple to start and avoids the operating expenses required for other legal entities such as corporations and limited liability companies. However, there is no separation between the business and the owner. Thus, a sole proprietorship offers its owner no personal liability protection from the debts, obligations and other liabilities of the business. Upon the death of an owner the business actually is deemed terminated and the business owner’s assets and the actual business assets can be considered one in the same. As a consequence it may be difficult or impossible to sell a business intact as after the death of the sole proprietor. For tax purposes the sole proprietor and the business is considered one and the same and as a result all income and expenses of the business are to be reported on the sole proprietor’s personal income tax return. This results in one layer of taxation for income earned by a sole proprietor’s business.
From both a legal and tax perspective a corporation is considered a separate and distinct legal entity.. Corporations are created by filing Articles of Incorporation with the state and its structure is typically organized amongst three groups – shareholders, directors and officers. The shareholders elect the board of directors who are responsible for governing the corporation, making major decisions and electing the corporation’s officers who actually operate and run the day to day affairs of the corporation’s business. Since a corporation is a completely separate legal entity from its shareholders who own it the corporation itself is generally responsible for the debts and obligations of the business. Generally, shareholders are therefore insulated from liabilities of the corporation or from claims made against the corporation. In addition to the liability protection shareholders are afford by a corporation there are many other advantages over other types of entities. For instance, the ability of shareholders to sell or transfer their ownership interests in the corporation facilitates estate planning and shares of a corporation can be sold to other investors to raise capital for the corporation to expand or engage in its business operations. Corporations may also take advantage of pension plans, medical payment plans, group life insurance and other fringe benefits available under the Internal Revenue Code. A corporation can exist forever so long as corporate regulations are met and there is no need to cease operations if a shareholder, director or officer dies. A “for-profit” corporation may be taxed in one of two ways — under Subchapter C of the Internal Revenue Code (a “C” corporation) or under Subchapter S of the Internal Revenue Code (an “S” corporation). A corporation taxed at the entity level is known as a C corporation. Income that has been taxed at the entity level will again be taxed if and when it is distributed as dividends to shareholders. This double taxation is perhaps the single greatest disadvantage to operating a business as a corporation. To properly operate a corporation annual meetings, recording of meeting minutes and quarterly tax filings are required and add additional costs to the proper operation of a corporation. However, the limited liability afforded directors, officers, shareholders and employees of C corporations, unlimited growth potential though the sale of its stock, and no limit on the number of its shareholders (subject to registration requirements of the Securities Exchange Act of 1934) have caused the C corporation to be the most commonly utilized type of corporation in America.
The use of an S corporation avoids the C corporation’s problem of double taxation. To elect to be treated as an S corporation certain requirements must be met and an election form must be filed with the IRS. The main requirements are – There may be no more than 100 shareholders, only one class of stock is permitted, shareholders must be individuals, estates, or certain types of trusts and must not be nonresident aliens. If a corporation elects to be taxed as an S corporation and meets the requirements it will be taxed at the federal level very similarly to partnerships and limited liability companies. That is the income, losses and gains will be passed through directly to the shareholders and there will be no tax “at the entity level.” Many small businesses elect to be treated as S corporations for this very reason. S corporations like C corporations continue to provide liability protection to its owners from company debts and liabilities but, the reduced tax filing requirement (annually vs. quarterly C corporation filing requirement) causes the S corporation to be a less expensive entity to operate.
What is a Limited Liability Company?
A limited liability company or “LLC” may be formed by one or more owners called members. It provides members with limited liability protection for their personal assets in most cases just as a corporation does for its shareholders. It also offers the members with “pass-through” taxation like a sole proprietorship or partnership avoiding the potential of double taxation in a C corporation. Like a corporation, an LLC is formed at the state level by filing Articles of Organization with the Secretary of State, and in some states LLC’s are required to publish legal notice of its formation. For a single member LLC this is essentially all that is required to begin operating a business as an LLC. If the LLC has two or more members, they will need to enter into an operating agreement similar to a partnership agreement which should be in writing. This often requires the expertise of an attorney to be properly prepared and adds to the cost of forming an LLC. However, an LLC may have an unlimited number of owners. There are no restrictions on the type of persons who may be owners. LLC’s are not generally required to conduct annual meetings or maintain minutes thereof and are permitted to issue more than one class of equity interest. One of the main advantages of an LLC over a corporation is the greater flexibility in the management of the business. An LLC may be managed solely by its members, by one or more managers (who may also be members), or by its members and officers. Though an LLC and an S corporation are both “pass-through” tax entities, an LLC is not subject to the same requirements that must be met in order to form and operate an S corporation. LLC’s may also provide for allocations of profits, losses and distributions disproportionate to the percentage of equity interest held in the LLC. A disadvantage of an LLC as compared to a corporation is that the use of an LLC may cause difficulty in raising capital from outside investors or when offering ownership interests to employees. The corporation structure has been in existence far longer than the LLC and is better understood and trusted with respect to its structure and how ownership interests are represented by stock certificates. These characteristics have less certainty and may be more difficult to comprehend in an LLC because of the potential complexity of an LLC operating agreement. Skilled and experienced legal counsel can assist in overcoming these shortcomings and LLC’s have become more popular and recognized in the business community as a preferred business entity of choice.
What Are the Types of Partnerships?
When your business has two or more owners then there are three types of partnership entities available other than an LLC – a general partnership, limited partnership or limited liability partnership. A general partnership is an association of two or more persons carrying on a business venture as co-owners for profit. Next to a sole proprietorship a general partnership is the easiest entity to form under most state laws. Although a formal written partnership agreement is not required to form a general partnership, the partners should ordinarily set forth the rights and duties in a written document. In the absence of a written agreement when two or more people who engage in a business together do not specifically choose any other entity type they will be treated as a general partnership if there is an understanding between them that they will share in profits and losses of the business. Each partner in a partnership has personal liability for the obligations of the partnership. General partnerships are limited in their ability to raise capital from outside investors because of the prospect of potential personal liability and the usually limited market for resale of a general partnership interest. One of the advantages of a general partnership is that like a sole proprietorship the business itself is not directly taxed. Income, losses and gains are instead passed through to the general partners in accordance with the allocations provided in the partnership agreement. A particular advantage to this form of business is that the partners can agree among themselves as to how income, losses, and gains are to be divided among the partners.
A limited partnership is a partnership in which the duties and obligations of the partners are divided between one or more “general partners,” and one or more “limited partners.” The formation and operation of limited partnerships are generally regulated under state statutes defining the obligations and duties of partners and imposing other obligations. A general partner is responsible for managing the partnership and its operations. General partners are personally liable for all of the partnership’s debts and obligations. A limited partner is usually not personally liable for the partnership’s debts and obligations, but is prohibited from taking part in the partnership’s management and day to day operations. The risk of a limited partner is usually limited to the money or other assets invested in the partnership. As a result it is far easier to market limited liability partnership interests as an investment particularly with respect to projects such as a real estate development. In contrast to a general partnership a limited partnership requires a written partnership agreement that should address certain issues, such as the role of the limited partners and the effect that the death, bankruptcy or insolvency of a partner may have on the continued existence of the limited partnership. In addition, a certificate of limited partnership is usually required to be filed in the state in which the partnership is formed. Consequently, a limited partnership is normally more expensive to form than a general partnership. Partners of a limited partnership are generally taxed in the same way as partners of a general partnership. They are also given the same flexibility to allocate profits, losses and gains regardless of the percentage of equity interest in the partnership.
A limited liability partnership is an entity that is usually reserved for certain licensed professionals. Each state determines which professionals may form a limited liability partnership but, they typically include attorneys, accountants, architects, certain medical professionals and other licensed professions. Limited liability partnerships are partnerships in which the liability of all the partners is limited. Generally, the partners in limited liability partnerships are not responsible for the debts, obligations or liabilities of the partnership resulting that are incurred by the negligence, malpractice, wrongful acts or misconduct by another partner, employee or agent of the partnership. A partner of a limited liability partnership is liable for other partnership debts, obligations and his or her own negligence, malpractice, wrongful acts, or misconduct and that of any person under their direct supervision and control. Limited liability partnerships are formed by either filing a registration certificate with the Secretary of State or in some states by filing a certificate to convert an existing general partnership to a limited liability partnership. Limited liability partnerships are governed like general partnerships and have a similar degree of management flexibility.
At a consultation, we can examine the needs and opportunities of your business. Call 877-808-9120 or complete the send an email form to gain professional insight through our offices in Staten Island and Red Bank.
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