For most businesses these choices include:
- sole proprietorship
- limited partnership
- limited liability corporation (LLC)
- “S” corporation
We’ll take a look at each of these options, but only with an important caveat: ultimately you must make this crucial decision with the aid of your attorney, and with respect to all local ordinances. Our hope is that this overview will put you in a better position to fully understand the differences, and to make the conversation with your attorney more useful (and shorter, since most will bill by the hour…)
Just what it sounds like – one person running the whole show. That means one person receiving all profits, and that same person liable for 100% of all debts, without limitation. You call all the shots, pocket all the dough, and are on the hook for everything. It is the easiest kind of business to start, and you’ll have to deal with the least amount of red tape. Those are the pros. The cons should be obvious: full responsibilty for all company debts, lawsuits and damages. For example, when signing a lease you will need to PERSONALLY guarantee the entire lease term. You ARE the company. The company is you. You’re not an employee and you cannot receive wages and then deduct them as a business expense. You personally file taxes; the business does not; and you are taxed for all of the company’s profits.
Moving one notch up in the direction of complexity is the partnership, in which two or more individuals share decision making, profits and liability. It is the simplest form of organization involving more than one person. But be aware that each of you will answer PERSONALLY for all of the company’s debts and liabilities. Because two (or more) heads are typically better than one – and always bigger than one – you will enjoy more start-up capital, more resources, more expertise. Assuming, of course, that you get along well together and won’t be fighting tooth-and-nail over every decision.
Many partnerships follow the simple two-person formula of “idea guy” + “money guy”. The “idea guy” in this case is knowledgeable about your particular line of business, and will typically run day-to-day operations, while the “money guy” does just what you’d expect.
It’s fairly easy to begin a partnership – and although a written agreement isn’t required, you definitely want to enter into a written partnership agreement before moving forward. Things don’t have to be equally split in a partnership – you (and your partners) make the rules. So make sure your partnership agreement covers who’s contributing what, how profits will be split, division of duties, and plans for what happens in the event that a partner leaves, moves, or – not fun, but you’ll need to address it – dies.
Slightly more complicated than a partnership, a limited partnership features two different types of partners – one type that is fully liable for the business’ debts, and another type that has no liability for company debts. You must file a Certificate of Limited Partnership with the appropriate state or county regulatory office to operate. In most cases, if you’re looking for a reduction of your personal liability, better options are the three listed below.
If the thought of “100% personal liability” in the Sole Proprietorship gave you the willies, then you definitely need to examine closely some of the benefits of incorporation. A corporation is a separate legal entity from its owners and is taxed as a corporation. This means your house, personal savings, car, and all other personal assets (as long as they’re not used in your business) are safe from creditors and collection agencies.
But liability is limited, not removed from you completely. You still have many personal responsibilities, pursuant to corporation laws. For example, if you/your company fails to comply with regulations, or engages in gross negligence or even criminal acts, you can’t hide behind the company’s logo, point your finger and say, “It was the company, not me!” You personally can be held liable, both civilly and criminally, for such gross misdeeds.
Also, when you’re raising funds for your business, typically at a bank, the banker is very aware of your physical presence and will typically require you and the other officers of the corporation to personallyguarantee any small business loans. So again, you still do carry some liability with a corporation, just not to the extent you would with a partnership or sole propreitorship.
If the company is making profits, how do you personally take profits? You’re no longer the “owner,” remember, you’re a corporate officer, and this means you’ll receive wages from your company. Can you just pay yourself 100% of the profits as your wages? Probably not, because the IRS sets a level of what it considers to be “reasonable wages” according to each industry’s standards. But you will receive wages (within reason), and you will personally pay taxes on them as you would any other income; but, on the other hand, these wages can be deducted from the corporation’s taxes as a valid business expense.
LIMITED LIABILITY COMPANY
LLC’s are becoming more and more popular and with good reason. Like a corporation, you’re not personally liable for the company’s debts, damages and liabilities. But the main difference has to do with tax law – and here’s where you really need a good attorney and/or accountant to steer you through the particulars of your situation. The prime benefit is reduced taxation – you get taxed for income as the owner of the business, but you enjoy an exemption from corporate taxes – so instead of being taxed twice, you’re only paying out once. You will abide by Regulations that govern the internal affairs of your company, something like a partnership agreement. In addition, to qualify as an LLC, your business must have Articles of Organization. These Articles, separate from the Regulations, are similar to corporate articles of incorporation and must be filed with the appropriate state regulatory authority.
If that combination of reduced personal liability and reduced taxation sounds appealing to you (and it should!), you should also consider a possible alternative for your business: the subchapter “S” corporation. In a nutshell, it provides most of the same protection of a corporation while at the same time removing the onus of “double” taxation. Of course there are several stipulations and rules that determine whether or not your business will qualify – so be sure to discuss this option with your attorney.