Wednesday, October 2nd, 2019
By Vanessa Macedo MacRae
When starting a business, there are numerous choices to make. One of the most important is what type of legal structure will your business be? That decision affects all matters of your business such as tax consequences, organizational requirements and liability.
As we discussed before, people must be aware whether their business relationships raise to the level of a partnership. General partnerships provide one of the highest levels of liabilities in the business world since the partners are responsible for the other partners’ wrongdoing acts and for the obligations of the partnerships. Limited partnerships can shield partners from liability from each other wrongdoings, but the partners would remain liable to the partnership’s obligations. Thus, with the development of business laws it is unlikely that a business lawyer would recommend a partnership structure for a business.
There are diverse types of entities and there is no “one size fits all”, however, there are a few general rules that can serve as a guide for business owners.
- Will the business look for outside investors and/or are the owners looking to limit their role in the business? If yes, forming the business as a corporation may be strategic. A corporation can issue shares and a business can sell those shares for investment. The shareholders may or may not participate in the business decisions by voting, since some corporations can issue non-voting shares. On the other hand, corporations have very rigid structure which can be costly. It is necessary to keep business records, to hold required meetings and to elect directors. For a business of a smaller scale, the corporation may not be the right fit.
- Are you going to be the only one running the business? If yes, the sole proprietorship may be a good option at first. A sole proprietorship provides a simple structure and there is no requirement to file a separate tax return, so many sole business owners are attracted to it. The disadvantage is the high self-employment tax owed from all profit of the business and the personal liability. Some accountants use the formula that until the business profits more than $50,000/ year, there is not much advantage to avoid the self-employment tax. Additionally, a good insurance coverage may be enough depending on the business.
- Is your business owned by a small number of members that are going to be actively involved in the business? If yes, a limited liability company (LLC) may be a contestant. Although LLC’s were created in the 70’s, it has recently become a phenomenon among small and mid-sized businesses. The LLC provides the limited liability of a corporation without its rigid structure. The members of an LLC have more flexibility to run their business and can elect different ways of being taxed, which appeals to a lot of businesses today
It is important to consult with your attorney and a tax advisor to take a closer look to your business.
Next blog in this series will discuss the different tax consequences of an LLC.
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