If you’re starting a new business and wondering what type of business entity to form, you’re not the only one. Oftentimes, as we are sitting down with an entrepreneur, one of the first questions asked is what type of business organizational structure is best? Unfortunately, there is no one size fits all panacea for every business owner’s needs.
There are several different business structures to be aware of when forming your company.
This is not truly a business entity but is the type of business formed when someone has not done any business formation planning. While it is the simplest business form, it is also the one fraught with the most liability. As a sole proprietor, there is no distinction between the business operations and the business owner. As an individual, all of the business’ debts, losses and liabilities are the responsibility of the business owner. If someone sues the business, they are suing the business owner and attacking the business owner’s personal assets.
Similarly this is essentially when two plus people come together to contribute money, labor, and skill towards a common enterprise. They also share in the profit and loss of that enterprise. Again, this type of structure is typically due to a lack of planning and is almost never due to the recommendation of an attorney advisor. The main reason is that each partner is personally exposed to the debts, losses, and liabilities of the partnership. Not only is one held legally responsible for their own actions but they are also held legally liable for the actions of their partners under this structure.
Corporations, if structured correctly, shield the owner/shareholder from the debts, losses, and liabilities of the business. They are taxed either as a “C-Corp” or as an “S-Corp.” The failure to make an election to be taxed as an S-Corp will result in treatment as a C-Corp. There are also many qualifying factors to meet in order to be treated as an S-Corporation. For example, there are limits on who or what may act as a Shareholder of an S-Corporation, and there are limits on the number of individuals or entities the S-Corp may have as Shareholders.
Many small to mid-sized business owners elect to be taxed as an S-Corporation. An S-Corporation’s profits are passed to the shareholder and taxed at the individual shareholder’s rate. Dividends may be issued from the Corporation to the Shareholder to pay for the cost of the taxes that become due on the income of the corporation.
However, with the recent Tax Cuts and Jobs Act of 2017 many business owners are re-evaluating the C-Corporation structure. The tax rates for C-corps were dropped dramatically under the Tax Cuts and Jobs Act of 2017, but the C-Corp is still subject to double taxation. Double taxation means that the Corporation is taxed on its income at the C-Corp tax rate. Then the dividends issued to Shareholders are taxed again either at that individual Shareholder’s individual income tax rate or as long-term capital gains depending upon the characteristics of the dividend. As such companies that are largely capital intensive and need a substantial amount of cash on hand with shareholders at higher tax rates may want to re-evaluate the C-Corp taxation structure.
Limited Liability Company
Similarly, a Limited Liability Company or LLC is a popular entity formation due to the fact that it affords the owner, referred to as the “Member,” limited liability protection from the Company’s debts, losses and liabilities. LLCs are a bit more flexible from the tax perspective and may be taxed as a partnership or an S-Corporation. If the LLC has only one member then, by default, the LLC is a “disregarded entity” for tax purposes and the member is not recognized by the IRS as separate from the entity but the individual may actively make the election to be taxed as an S-Corporation. When determining whether to be taxed as a partnership or an S-Corporation a CPA should be consulted to determine the most tax efficient structure for a business owner.
The determination of the correct type of structure looks to several different factors. The type of business, owner relationships, and plan for the future will all impact what type of structure is best for a particular individual business owner. Please contact our team to schedule a consultation with one of our start-up business planning attorneys to evaluate what is best for you and your business.
Our attorneys are here to help you plan and strategize for the future of your business and your personal planning.