Choosing the right business entityPublished 10:53pm Sunday, September 15, 2013
One of the most important decisions a business owner will make is the selection of the legal structure or form of the business.
Typically, the choice of the proper business entity will be determined by three factors: taxes, personal liability and extent of formality and documentation required. Generally, the choices for the typical entrepreneur will be a sole proprietorship, a corporation or a limited liability company. In some special circumstances a professional corporation, partnership, limited partnership, limited liability partnership, professional corporation, professional limited liability company, non-profit corporation or low-profit limited liability company may be considered.
Following is a brief summary of the attributes of a sole proprietorship, a corporation and a limited liability company.
A sole proprietorship exists when one person owns and operates the business without forming any kind of entity. Thus, no documentation or filing is required to form this type of business. The profits and losses of the business are reported on the person’s individual state and federal tax returns.
The person operating the sole proprietorship is personally liable for all liabilities incurred in operating the business. A sole proprietor may operate the business under his or her name or under a trade name. If a trade name (called an assumed name in North Carolina) is to be used, a form must be filed with the register of deeds in the county where the sole proprietorship does business.
A corporation is a separate legal entity from its owners and is formed by filing articles of incorporation with the Secretary of State, along with a filing fee. Once the corporation is formed, it must adopt bylaws, which control the internal operation and management of the corporation. Then, it must issue stock to its owners (its shareholders) in exchange for stock. The corporation is managed by directors, elected by the shareholders, and by officers, elected by its directors. The directors make major decisions and the officers are responsible for the day-to-day operation of the business. The major advantage of a corporation is that the owners are not personally liable for the liabilities of the corporation, so long as the formalities of operation of the corporation are observed.
One of the disadvantages is the documentation and formalities required in operating and managing the corporation. As the corporation is a separate entity, it must file separate state and federal income tax returns and pay taxes on its profits and losses. This may result in the profits of the business being taxed twice – once at the corporate level and once at the shareholder level as a result of profits distributed to the shareholders.
It is possible to avoid this double taxation by filing an liS” corporation election (Form 2553) with the IRS. The profits and losses of an “S” corporation are taxed only once to the shareholders. There are certain eligibility requirements to be met in order to become an “S”corporation, including having a maximum of 100 shareholders and having only one class of stock. As becoming an “S” corporation is only a tax election the corporations retains all of the other characteristics of a corporation.
A limited liability company is often the entity of choice for a small business. A limited liability company (or “LLC”) is formed by filing articles of organization with the Secretary of State. An LLC may have one or more members, who are the owners of the LLC. Although not mandatory, the members may enter into a written operating agreement, which may contain provisions regarding membership, voting, transfer of membership and any other desired provisions.
An LLC is managed by managers; often just the members. Each manager of an LLC has equal voice in the operation and management of the LLC, unless the operating agreement provides otherwise. An LLC is extremely flexible and may be structured in many different ways. Much less formality must be observed in operating and managing an LLC than is required with a corporation.
As an LLC is a separate entity the members do not have personal liability for the liabilities of the LLC. So long as the proper form is filed with the IRS, the profits and losses of the business will be taxed to the members of the LLC and not to the LLC.
In conclusion, the best form of entity for a new small business will often be a limited liability company or an “S” corporation. However, there some circumstances where a corporation (without the “S” election) may be appropriate, at least for a period of time.
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– article written by Mike Frye