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How should your business be organized? Business forms 101

Posted by Larry Jones on Dec 7, 2021 9:30:00 AM
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Does it make a difference how your business is organized?

It might make a great deal of difference. For some folks being a Sole Proprietor will work just fine, while for others it could lead to financial disaster. How does one decide? First of all you need to know the answer to some basic questions. Here we go:

  • How much do you personally want to be responsible for business debts and liabilities?
  • Which form of ownership will minimize the tax bill?
  • What form will best help me achieve my short and long term goals?
  • How much money have you borrowed on your business and where did it come from?
  • What skills will the business need that you cannot provide?
  • How much personal control do you want over day-to-day decisions?
  • What will happen to the business if you are unable to manage it?

How you choose to answer these questions is the basis for deciding how to organize your firm.


Business Forms

While it's not feasible to completely cover all of the pros and cons of each form in this blog, a quick refresher will be useful.

Sole Proprietor

This is the easiest form to set up. It also offers the least amount of personal liability protection. The owner of a sole proprietorship enjoys what is known as "pass-through" taxation. That simply means that he can deduct business expenses and file his business taxes on a Schedule C of his personal tax returns. This can be a huge personal tax advantage. Also, you're the boss.

Partnership

This is where 2 or more people go into business together. It's also a "pass-through" entity which can be beneficial from a tax point of view. It's easy to set up initially and the ownership that each partner has is relative to how much he or she brought into it, usually. A written agreement isn't required BUT YOU SHOULD HAVE ONE. Management responsibilities are shared, but every partner is responsible for the business debts of every partner. Choose your partner(s) carefully. It's important to have a buy-sell agreement in case one partner should die, if you want the business to keep going.

Limited Partnership

This is a peculiar form of ownership that gives investors special tax advantages as well as protection from liability. There is one General Partner who exercises fiduciary management, and other limited partners (investors) who exercise no control. The business itself isn't directly taxed. Setting up a limited partnership is complicated and should always be done by a competent attorney.

S-Corporation

This is a form of ownership with limited liability and some tax advantages. Again, this is a "pass-through" entity (S-corps don't pay taxes), and shareholders are taxed according to their percentage of ownership. Their liability works the same way. S-corps are set up just like a C-corp, and should be used when an owner expects high initial losses. 

C-Corporation

This is a separate legal entity from it's owners, and it is taxed that way. Your personal liability is limited to what you have invested, as the corporation issues shares of stock. Your personal management is usually limited. Usually more complicated to set up and organize.

Limited Liability Company

The LLC is superior in protecting owners from personal liability. It enjoys the tax advantages of partnerships and the liability protection of an S-corp. It will offer limited liability like a C-corp.

Here's a little graph that might be helpful in making your decision:

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Tax benefits are greater on the left side of the graph, while liability protection is greater on the right. Costs and complexity will increase as you move from left to right.

Can you change forms later?

Yes, you can. In fact many owners start out as Sole Proprietors and then become an S-Corp or LLC later as their business grows.

Finally, don't be afraid to get some professional advice. Also remember to use a good attorney to help you set up anything more complicated than a Sole Proprietorship. And, as always....none of the above should be construed as legal advice, just as general guidelines to point you in the right direction. Consult a competent attorney for more complete advice.

Until next time,

Larry

Are you retiring soon, or already retired? Are you taking advantage of our weekly webinar? You should be!  To see a list of topics that will be discussed, click here:

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Topics: Business Organization

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