Beyond Planning – Setup
Over the past months, the focus of these articles has been on preparing to open a business. Now the focus shifts to what it takes to setup a business and execute your plan.
Business setup depends upon what legal structure you have selected. The options are:
• Sole proprietor
• Limited liability partnership
• Limited liability company
• Subchapter S.
Each entity has legal, tax, personal liability, and other features to evaluate in making your decision on which structure is right for you – as a business and as a business owner/operator.
Sole proprietorships are the “default” for many people. They require minimal paperwork to establish and are in existence with a name and a privilege license. For tax and legal purposes, there is no difference between the company and the individual who owns the business. The owner and ALL of his/her assets are subject to claims and liability should something go wrong.
Partnerships are essentially combinations of sole proprietorships. They do require formal agreements as to how the business will be run and what each partner will contribute and how each will share in the profits and losses of the business. One of the key things to be aware of with partnerships is that each partner becomes liable for the actions of every other partner, not just him/herself.
That unlimited liability from partners led to the creation of limited liability partnerships that are used by “professionals” – doctors, lawyers, architects, CPAs, etc. The limited liability aspect reduces the risk and liability for actions that your partner(s) take.
Limited liability companies are companies owned by one or more parties and while separate legal entities, they are not separate tax entities. The LLC files a “memo” tax filing that details the activities of the company and the amount of profits or losses that PASS THROUGH the entity to its owners and onto the owner(s) personal taxes. Lochs are hybrids of partnerships and corporations that provide substantial protection between the company liability and personal liability, while enabling the earnings (or loss) to flow to the owners without double taxation. [Note: For the purpose of this article the LLC is being treated as a partnership for taxation. LLCs can opt for corporate taxation, but that is beyond the scope of this article.]
Corporations can take two forms. Both forms are separate legal and tax entities. C corporations are the first step that all corporations take. If the corporation will be owned by a limited number of entities or individuals, it may choose to be taxed similarly to an LLC, as a flow-through entity. Again this means the company files its own tax return, but it is merely reporting the results of operations for tax purposes and the amounts that will be passed to individual tax returns of the owner(s).
The points explained above are just a few of the distinctions between the business structure types. Each has many other points to consider on their own and as they relate to your personal situation and the nature of the business conducted.
Some of the other factors to consider in deciding the appropriate legal structure include:
• Degree of risk in operations
• Amount of personal assets to protect
• Scope of activities
• Nature of products or services
• Span of geographic operations
• Multiple State
The infrastructure of the business and things like bank accounts, tax identification numbers, and a myriad of other details require time and timing to get them properly established. For instance, requesting your federal employer identification number (EIN) comes before you get your state department of revenue number. The identification numbers that the bank need differs depending upon whether a business is a sole proprietorship or another legal form.
It is also important to understand that the business structure you select today, doesn’t have to be the same business structure you have next month or next year. A lot of factors impact what legal and tax structure is right for you at various stages of life and business. There are business and personal implications to each option and to changing structures. If you do not consciously make a choice and take the steps to create a specific legal entity, you will by default begin as a sole proprietorship (or a partnership). There isn’t anything wrong with that initial step. As things progress with the business, periodically re-evaluate if the initial choice is still the best choice. Talk with your attorney, CPA, and other experienced business advisors concerning options, issues, risks, and opportunities as your business grows.
Copyright © 2004 F.O.C.U.S. Resource, Inc.