Forms of Business
One of the first decisions that a business owner must make is what form of business will be used for the company. There are 4 basic forms of business to choose from. They are as follows:
* Sole Proprietorship
* Sub S Corporation
* Limited Liability Company (LLC)
Most small businesses start out as sole proprietorships. Mainly because it is so simple to form. You basically need a business license and a checking account. This form of business has one owner who makes all decisions and is personally responsible for all the liabilities of the company. They own all the assets of the business and receive all the profits generated. In the eyes of the government the owner and the company are one in the same.
The advantages of a sole proprietorship are numerous. First, this is the easiest form of business to organize. No attorney or accountant is needed. You share control and profits with no one. Taxes are relatively simple. A schedule C is filed along with your personal return. Most tax programs include this at no additional charge. If you wish to dissolve the company it is fairly easy and straight forward to do.
The disadvantages of a sole proprietorship are numerous as well. All of the liability of the company falls on the owner personally. In other words if the business incurred a liability from a lawsuit the owner would be personally liable. (a liability insurance policy can help cover this) Some benefits like health insurance are not fully deductible. Also, you will have to pay social security on all the companies profits. In other words there are some tax disadvantages. On the other hand, you can deduct some expenses that you would not normally be able to deduct and get your profit down for tax purposes. Lastly, a sole proprietor will generally be taken less seriously than an incorporated business or an LLC. Borrowing money may be more difficult because of this. Also, audits by the IRS may be a little more frequent for this form of business.
In a Partnership, two or more people share ownership of a single business. Like proprietorships, the law considers the business and the owners as the same. In this form of business there will be a partnership agreement which will spell out all the terms of the partnership including who makes decisions, how profits are divided, buyout provisions, etc… Because you now have two or more people involved the paper work and upfront planning is multiplied. Getting an attorney involved would for this type of business probably be a good idea. Like marriages, partnerships tend to develop problems and everything should be agreed upon and written down ahead of time.
The advantages of a partnership are similar to a sole proprietorship. Additionally, more capital can be raised with a partnership and more expertise will be present in the business. Profits flow directly to the partner’s tax returns.
Disadvantages are the same as a proprietorship but also include lack of control by any one partner, liability for one partner because of the actions of another partner and the possible dissolution of the partnership if one partner passes away. Also, having to share profits is another disadvantage.
Disadvantages of a Partnership
-Partners are jointly and individually liable for the actions of the other partners.
-Profits must be shared with others.
-Since decisions are shared, disagreements can occur.
-Some employee benefits are not deductible from business income on tax returns.
-The partnership may have a limited life; it may end upon the withdrawal or death of a partner.
-General Partnership – Partners divide responsibility for management and liability as well as profit or loss according to their partnership agreement. Everything is equal unless otherwise stated.
-Limited Partnership – Limited means that most of the partners have limited liability. This type of partnership is generally not used for standard business. More for short term projects where someone is looking for investors. Forming a limited partnership is more complex than a general partnership.
-Joint Venture – Like a general partnership, but it is clearly for a limited period of time and / or a single project.
Subchapter S Corporations
A corporation chartered by the state in which it is headquartered is considered by law to be a unique entity, separate and apart from those who own it. A corporation can be taxed separately from its owners. It is liable for itself and can be sued and can enter into contractual agreements. The owners of a corporation are its shareholders. The corporation has a perpetual life until dissolved and does not cease to exist when ownership changes.
A Sub S Corporation is actually a tax election only and is done through the IRS . This election enables the shareholder to treat the earnings and profits as distributions and have them pass through directly to their personal tax return much like a proprietorship or partnership. People prefer this type of ownership because of limited liability personally and tax savings. The shareholder is not personally liable for what the corporation does. However, in the case of negligence there would be no protection for the individual who was negligent. To further explain this liability shield assume an employee borrows a company car and injures someone while they are drunk. The employee would be personally liable since they were negligent and were driving. Secondly, the corporation would be liable since it owned the car. But lastly, the shareholders of the company would not be personally liable for the event. As far as taxation goes a shareholder can take a fair salary and take the rest of earnings in the form of a draw. If the salary was fair and reasonable they can save social security on the draw portion. If it is not reasonable the IRS can make the shareholder pay social security on all earnings and even go back to previous years. The general rule is to pay yourself a fair salary before you take draws.
Limited Liability Company (LLC)
The LLC is a relatively new type of business structure that is now available in most states. It is designed to provide the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. Formation is more complicated than a general partnership or sole proprietorship but easier than a Sub S corporation.
The owners are members, and the duration of the LLC is normally decided when the organizational documents are filed. LLCs must not have more than two of the four characteristics that define corporations: Limited liability to the extent of assets, continuity of life, centralization of management, and free transferability of ownership interests. If the company has more than two it must file as a corporation.
Before you decide on the business form you will use you should sit down with your accountant and discuss all of the facts and how they will affect you. Once a business form is elected it is difficult to undo.
In closing I will say that most people choose either an S Corporation or an LLC for a parking lot striping company. Mainly for the liability limits and the tax advantages. Also, with a corporation you will almost always have a separate name which you can choose. When you sell the business you simply transfer your shares to another person and you are done.
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