Law Office of Kimberly L. Stevens

As the tax season is upon us, many of us start wondering if we have established our businesses in the best manner possible.  Of court, business owners always worry about issues such as liability, but at this time of year most people just want to know how their taxes will be affected.  Tax implications can be controlled with a little bit of planning.

Choosing the appropriate form and structure for a specific business venture involves several considerations; such as control, liability, simplicity, flexibility, continuity and taxation.  Proper formation and organization are important. 

A defectively formed organization may subject the owners to personal liability and may cause transactions to be called into question.  Formation is the actual choice of entity and filing the appropriate forms with the Secretary of State’s office.  Organization is the combination of actions by which those who will own and manage the business determine who will own, who will manage, and the way the business will operate.

In addition to taxes, one important consideration is the degree to which personal liability can be limited.  A sole proprietor is not insulated from liability arising from the operation of the business.  Similarly, a general partner in a partnership is not insulated from tort, professional or contractual liability.  However, LLC members and corporate shareholders are not subject to tort or contractual liability.  They may still be liable for any personally guaranteed obligations of the company, but the overall liability is greatly reduced.

A brief description of the features of each type of entity can be found below:

1. Sole Proprietorship – a business owned directly by one individual
   1. No state formation or annual filings are required.
   2. Owner retains direct control and management of the business.
   3. Personal liability for debts, errors and omissions is unlimited.
   4. Taxes are filed as a Schedule C on the owner’s tax returns, and the entire net profit is subject to self-employment tax.
2. General Partnership – an association of two or more persons formed to conduct business for profit.
   1. No state formation or annual filings are required.
   2. Partnership owns property of the business and partners have equal rights in control and management, unless they have an agreement that states otherwise.
   3. Personal liability for debts of business and professional errors of other partner.
   4. Partners report their share of the profits on the owner’s tax returns, and the entire share is subject to self-employment tax.
3. Corporation – a legal entity formed pursuant to state statute, it exists independent of its shareholders and has most of the same powers, rights and duties that an individual has.
   1. Formed by filing with the state articles of incorporation, and adopting by-laws.
   2. Corporation owns all property, shareholders participate in the profits of the company.  A board of directors governs the corporation’s affairs and selects corporate officers.
   3. No personal liability on the shareholders or board of directors, unless the corporate “veil” is pierced.
   4. C corporations are taxed as a separate entity from its shareholders.  Compensation, dividends and other distributions are taxed at the recipient’s individual tax rate.
   5. S corporations are not taxed as an entity, but all income is attributed to shareholders in proportion to stock ownership.
4. Limited Liability Company – a hybrid entity, part sole proprietorship and part corporation.
   1. Form by filing with the state articles of organization, and adopting an operating agreement.
   2. Managed by members or managers.
   3. No personal liability for members or managers, other than for professional services provided.
   4. One member LLCs are taxed as sole proprietorships and LLCs with two or more members may elect to be taxed as either a partnership or an S corporation.

As you can see, as a business owner you have several options available for setting up your business entity.  Remember, each business’ situation is different and before deciding on an entity you should speak with legal and tax advisors.  The Law Office of Kimberly L. Stevens has experience in establishing entities and can assist you in making your business run smoothly and efficiently.  Please call us to set up an appointment today.

This entry was posted on Sunday, February 3rd, 2008 at 9:16 am and is filed under Articles. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.