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Business Structures: Ownership and Liability Differences

The most common differences in business structures are ownership, liability and tax considerations. When it comes to liability, it’s important to consider where you, as an owner, could personally afford liability risks. Protecting personal assets is a key reason people incorporate their business, and while some structures are easier to form than others, it can be difficult to change your entity’s structure down the line, so avoid restricting your business’s ability to grow in your selection.

Sole Proprietorship: Sole proprietorships are simplest to form, and if you don’t register your business as another entity, you’ll automatically be considered a sole proprietorship. Owned by one individual, this structure comes with the greatest personal liability. As the business grows, your personal liability will increase. Therefore, this structure is best for lower risk businesses. Also consider that it is difficult to obtain outside funding for sole proprietorships.

Partnerships: Partnerships are owned by two or more people. The partners will share in any profits, losses and decision-making responsibilities. These entities require an operating agreement that outlines the roles of its owners and the percentage of profits they each receive. Consider that you will be held liable for both decisions you make, and those made by other owners. Funding for these entities will generally come from the personal accounts of its owners, their personal credit or by taking on more partners.board room

Limited Liability Company (LLC): Forming an LLC protects you from personal liability if you don’t act in a manner that is in any way illegal, unethical or irresponsible when carrying out business activities. Personal assets and company assets are deemed separate under this entity. This structure is great for medium-high risk businesses and owners with a lot of personal assets they want to protect.

Corporation: Incorporating your business makes it a separate entity from its owners. That entity can be sued, own and sell property, and sell ownership rights in the form of stocks. No individual owner has sole or primary control. Instead, most corporations have a Board of Directors to answer to. More specifics apply depending on the type of corporation…

C Corp: C-corps are ideal for medium-high risk businesses, businesses that need to raise outside funds and businesses that intend to go public or eventually be sold. As you can see, forecasting where you would like to see your business go or grow into, is important to many of these considerations.

S Corp: S-Corps are intended for smaller corporations. There can be no more than 100 owners, and all must be United States citizens.

B Corp: B-Corps differ from other types of corporation in purpose, accountability and transparency. In some states, B-Corps are required to submit annual benefit reports to demonstrate that they are indeed contributing to the public good.

Closed Corporations: Closed corporations are similar to B-Corporations. However, these generally smaller companies are usually barred from public trading.high rise

For a more simplified depiction of this breakdown, reference the following table:

Business structure Ownership Liability Taxes
Sole proprietorship One person Unlimited personal liability Personal tax only
Partnerships Two or more people Unlimited personal liability unless structured as a limited partnership Self-employment tax (except for limited partners)

Personal tax

Limited liability company (LLC) One or more people Owners are not personally liable Self-employment tax

Personal tax or corporate tax

Corporation – C corp One or more people Owners are not personally liable Corporate tax
Corporation – S corp One or more people, but no more than 100, and all must be U.S. citizens Owners are not personally liable Personal tax
Corporation – B corp One or more people Owners are not personally liable Corporate tax
Corporation – Nonprofit One or more people Owners are not personally liable Tax-exempt, but corporate profits can’t be distributed

 

Later this week, we’ll delve into the tax differences and implications of each of these business structures.

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Choosing a Business Structure: Types of Entities

You’re starting your own business, but what type of legal entity will you establish for the business? It can be difficult to balance the advantages and disadvantages of these structures. So let’s review the options and simplify those considerations:

Sole proprietorship:

A sole proprietorship is the simplest form of business entity. In this scenario, one person is responsible for the company, its profits and its debts. The most common way to structure your business, it is easy to form and gives complete managerial control to the owner. At the same time, the owner is then personally liable for all financial obligations to the business.

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Partnership:

When the entity is owned by two or more individuals, it is a partnership. The partners agree to share in both the profits and losses of the business. These profits and losses are reported on the partners’ individual tax returns. However, each partner is still personally liable for the financial obligations of the business.

  1. Limited partnerships (LP): when one general partner has unlimited liability, and the other partners have limited liability. The limited liability partners also tend to have a limit on their controls over the company, as documented in a partnership agreement.
  2. Limited liability partnerships (LLP): limited liability is given to all owners of the company. An LLP protects partners from the partnership’s debts, so they are not responsible for the actions of their partners.

Limited liability company (LLC):

This business structure is a hybrid that limits personal liability for its owners, partners or shareholders, while enjoying the tax and flexibility benefits of a partnership. Therefore, personal assets will not be at risk if the LLC faces bankruptcy or lawsuits.

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Corporation:

Corporations are viewed as entities that are separate from their owners. Therefore, a corporation has legal rights that are independent of its owners. Corporations come in five different types:

  1. C Corporations: these legal entities are separate from their owners. Therefore, they make profits, are taxed and can be held legally liable. Shareholders are provided with strong protection against personal liability, and the departure of a shareholder or sale of stock doesn’t disturb the continuation of business by the C Corporations.
  2. S Corporations: much like partnerships or LLCs, owners have limited liability protections and avoid double taxation by passing profits and some losses directly to the owners’ personal income while avoiding corporate tax rates. There are special limits on S Corporations.
  3. B Corporations: benefit corporations are driven by mission and profit. So while they service society in some way, they maintain a for-profit structure.
  4. Closed corporations: traditionally smaller companies with an informal corporate structure, closed corporations do not participate in public trading and are typically run by a few shareholders without a board of directors.
  5. Nonprofit corporations: organized for the purpose of charity, education, religious, literary or scientific works. As benefits to the public, they are tax-exempt.

Cooperative:

Cooperatives are owned and operated for the benefit of those using its services. Cooperatives are generally run by an elected board of directors or officers, while regular members have voting power to contribute to the direction of the cooperative. Members join by purchasing shares, but the amount of shares they hold does not increase or decrease the weight of their votes.

In our next blog, we will dive deeper into the advantages and disadvantages of these structures, and the tax implications of each. Visit the Simma Flottemesch & Orenstein blog to follow along.

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