Know the right legal structure for your business.
When starting a business, one of the most fundamental decisions you can make relating to taxes is the type of legal structure you choose for your company. Apart from taxes, this decision can also affect the amount of paperwork you will be required to file, the extent of personal liability you will face, and your potential to bring in personal profit.
Keeping in mind that every business structure comes with different tax and financial consequences, you should consider all factors and make an informed decision based on your business’s needs.
Types of Business Structures
A sole proprietorship involves one individual who owns and controls the business. This is the simplest of all the structures, being the easiest to set up or take apart with little government regulation. There is no legal separation from the individual and the business entity. As a result of this, the business owner is not protected from any liabilities incurred by the business. For instance, all debt from the business entity would be directly tied to the business owner. On the other hand, the business owner would also receive all profits directly from the business entity.
Partnerships, both general and limited, have a similar structure as the sole proprietor. A general partnership is one in which two or more people agree to operate a business. Any liability for the business is tied to the partners and in turn, could potentially collect assets from those same partners.
A limited partnership, however, can only hold a limited partner liable to the money they have invested in the business, keeping their personal assets safe. In a limited partnership, there must be at least one general partner, with the limited partner having no presence in the management of the business.
The limited liability partnership is a similar business structure as a limited partnership, apart from one key detail: it has no general partners. The owner(s) of an LLP have limited personal liability for business debts. LLPs are well suited for professional groups such as lawyers and accounts, and in the state of California and many others, you may only file as an LLP as a professional.
There are two types of corporation, C corporation, and S corporation. Both differ from the previous business structures in that a business entity is on its own, separate from the founding individual(s). A C corporation, the most common type of corporation in the US, refers to a corporation that is taxed separately from its owner(s). This differentiates itself from the S corporation, which is in many cases not taxed separately.
Both types of corporations are comprised of shareholders, directors, and officers. However, C corporations are subject to double taxation while S corporations can be what are called pass-through tax entities. This allows S corporations to avoid being taxed both as a corporation and on a shareholder’s personal income taxes. Moreover, another factor to consider between these two structures is the growth potential. A C corporation has no restriction on ownership, which is key for unlimited growth potential. S corporations, on the other hand, are restricted to no more than 100 shareholders.
A limited liability company is a hybrid of the above business structures. The prime advantage of this structure is its flexibility, with personal liability protection and pass-through taxes. The LLC’s lack of a residency requirement also makes it favorable to those looking to start a business entity in the US. The downside to this structure is its restriction on growth in regards to issuing stock and the difficulty of changing laws across states, which would impact your business if it decided to go national.
The attorneys at Bridge Law LLP will meet with you and help you determine how best to set up your company based on your business goals.
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*The information presented in this article does not constitute legal advice and is not intended to create an attorney-client relationship. The information presented in this article is not tax advice.