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Business Entities Partnership Pros and Cons LLCs and Corporations

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Are you ready to start your business? Or maybe you’re currently running one and wondering which legal structure is best to use. There are many different legal entities to choose from. And each has its own strengths and weaknesses.

To decide which business entity is best for you, you need to see which business entity best fits your situation and weigh the pros and cons carefully. You may also want to consult a tax accountant or lawyer.

Some things that will affect your decision-making and long-term success are liability protection, taxation, administrative complexity, annual requirements, and the ability to raise capital from investors (if applicable).

what are the options?

New businesses in the United States can choose from five basic structures:

You should learn about each business structure and decide which one best suits your needs. Each type is described below, along with the differences between them.

Corporation (aka C-Corporation)

  • A corporation is a separate legal entity created by state law. A corporation is formed by filing a document called the Articles of Incorporation. This document is filed in the state in which the entity does business and is filed with the Secretary of State or similar government agency.

  • Corporations must designate a registered agent to receive the services of process and state communications.

  • By default, corporations are taxed under Subchapter C of the Internal Revenue Code. This is why the company is called C-Corporation.

  • Alternatively, a corporation may elect to be taxed as an S-Corporation (a.k.a. taxed under Subchapter S of the Internal Revenue Code) by filing Form 2553 with the IRS.

  • If the Corporation were to be taxed in its default state (taxed as a C-Corporation), the Corporation would face double taxation. Basically, the Corporation is taxed at the corporate level on its profits. Shareholders are then taxed again at the individual level after receiving distributions (shares of profits).

  • C-Corporations is also responsible for paying state corporate income taxes, where applicable, where it resides and/or does business.

  • Corporations also have statutory requirements such as election of a board of directors, designation of corporate proposals, holding of annual general meetings, and recording of minutes.

  • It is not common for small business owners to use corporations. Instead, it is used by large corporations and technology startups looking to raise venture capital from investors.

LLC (Limited Liability Company)

  • An LLC, also known as a limited liability company, is a separate legal entity created by state law. LLCs are often formed by filing a document called the Articles of Incorporation. However, in some states, this form is also known as a Certificate of Organization or Certificate of Formation. This document is filed in the state in which the entity does business and is filed with the Secretary of State or similar government agency.

  • The LLC must also designate and maintain a registered agent. The registered agent must be located in the state in which the LLC is incorporated. For example, if the LLC is incorporated in Texas, it must designate a registered agent in Texas.

  • LLCs are unique when it comes to tax treatment by the IRS. In other words, there is no “LLC tax classification”. Instead, LLCs are taxed based on the number of owners. Alternatively, the LLC may make an election in the IRS and request that it be taxed as a corporation (C-Corporation or S-Corporation).

  • A single owner LLC is called a disregarded entity. This simply means that the IRS “sees” the LLC. Find out who the owner is and tax the individual or company accordingly. For example, if an American taxpayer is the sole owner of an LLC, the LLC is taxed as a sole proprietorship. An LLC is taxed as a partnership if it is owned by two or more people. If the LLC is owned by another company, it will be taxed as a branch/division of the parent company.

  • Alternatively, the LLC may choose to be taxed as a C corporation (by filing Form 8832) or an S corporation (by filing Form 2553).

  • Sole proprietorships, partnerships, and LLCs taxed as S-Corporations are all known as pass-through entities. This means that there is no corporate level taxation (Corporate Level Taxation). Instead, taxes flow to the owner and are reported and paid on individual tax returns.

  • In a less common setup (LLC taxed as a C-Corporation), the LLC faces double taxation just like a regular corporation.

  • Also, in some cases the LLC can be used for estate planning purposes, but in many cases it is wiser to have the LLC owned by your trust. Of course, it’s best to speak with a real estate planning attorney about such matters.

  • In summary, for many small business owners, LLCs are “the best of all worlds.” It receives the same liability protection as a legal entity, but by default is a pass-through tax entity. Additionally, if the LLC wishes to be subject to income tax treatment by the IRS, the LLC may make the necessary elections. To put it another way, LLCs can pretty much choose how they are taxed while still providing liability protection to their owners.

  • LLCs also have more flexible management options and have less formal annual requirements such as corporations.

  • LLCs are the most popular type of business entity in the United States, primarily because of their flexibility and the personal liability protection they offer their owners.

S Corporation (aka S Corporation)

  • An S-Corporation is unique because it is not a legal entity like an LLC or Corporation. Instead, it’s a tax choice made with the IRS.

  • It’s easier to think of it this way. The S-Corporation’s tax choices are “above” state-level entities such as LLCs and Corporations.

  • This is one of the most common myths at S-Corporation. People think they just need to “form” an S-Corp. you simply can’t. There is no state or federal application to “form” an S-Corp. Instead, he must first form an LLC or corporation and then timely file Form 2553 with his IRS to request taxation under Subchapter S of the Internal Revenue Code.

  • Once the IRS grants elective status, it is common to refer to the entity as an S-Corporation and its owners as shareholders.

  • In most cases, the primary reason for considering S-Corp tax treatment is self-employment tax savings.

  • S-Corporation owners must receive a “reasonable salary” (subject to self-employment tax), but can receive remaining profits as distributions (not subject to self-employment tax). ). That is the biggest attraction of S Corporation.

  • S-Corporation runs payroll regularly, withholds taxes, files quarterly payroll (federal and state), hires a bookkeeper (or maintains its own books), It is important to remember that you must maintain a complete balance sheet (which must be filed with the IRS), corporate tax returns (Form 1120S, K-1s for shareholders/owners, and additional schedule) and hire an accountant if you don’t already have one.

  • All of the above cost money. And these costs, which average $2,000 to $4,000 for small business owners, must be weighed against the potential self-employed tax savings. To ensure that the S-Corp tax treatment makes sense.

  • S-Corporations can be owned by U.S. citizens, U.S. trusts (depending on taxation method), U.S. real estate, U.S. resident aliens, and U.S. tax-exempt organizations.

  • S-Corporations cannot be owned by non-U.S. residents (aka non-resident aliens), foreign corporations, C-Corporations, partnerships, financial institutions, or insurance companies.

  • If you are considering taxing your entity as an S-Corporation, it is important to consult with your accountant to ensure that the additional costs (and additional filing requirements) are worth the self-employed tax savings. is. Taxing your business entity as her S-Corporation may be a good idea for some, but not necessarily for everyone.

Sole proprietorship

  • A sole proprietorship is an informal “business structure” with a single owner.

  • There are no documents to submit to the Secretary of State or similar government agency to create a sole proprietorship.

  • You simply become a sole proprietorship when you engage in business activities or engage in activities aimed at making money.

  • Sole proprietorships can do business in their own name or submit a DBA (Doing Business As) name. For example, John Doe can do business under the name John Doe. You can also register his DBA with the name “John’s Painting Company”.

  • The advantage of a sole proprietorship is that it is easy to set up.

  • Also, taxes for sole proprietorships are pretty straightforward. Owners simply file a Schedule C and report business income (or losses) on their personal tax returns.

  • The biggest drawback of sole proprietorships is the lack of liability protection for the owner. By law, the owner and his business are one and the same. If the business is involved in litigation, the owner’s personal assets (home, car, bank account, etc.) may be used to settle the business’ debts and liabilities.

  • Another disadvantage of sole proprietorships is that there is no formal “conversion” declaration if they eventually form an LLC or corporation. This means you have to file papers with the state, get an EIN (Federal Tax Identification Number), open a business bank account, and basically start over. For example, it is often easier just to form an LLC.

  • However, if your business has low risk of liability and you don’t have the funds to form an LLC or legal entity, starting your business as a sole proprietorship may be the best way to get your business off the ground.

General partnership (aka partnership)

  • A general partnership (partnership) is mostly two or more sole proprietorships. In other words, an informal “business structure” with multiple owners.

  • In most states, there are no papers to submit to the Secretary of State or similar government agency to create a general partnership (few states require general partnership registration).

  • A partnership can do business in the owner’s name or file a DBA (Doing Business As) name.

  • The advantage of a partnership is that it is easy to set up.

  • However, partnership tax is not as straightforward as for sole proprietorships. For example, a partnership must file a Form 1065 and issue her K-1 to the partner. The partner then reports her K-1 income on her personal tax return.

  • The biggest drawback of partnerships is the lack of liability protection for the owners. Again, legally, the owner and the business are one and the same. If the business is involved in litigation, the owner’s personal assets (home, car, bank account, etc.) may be used to settle the business’ debts and liabilities.

  • A partnership can be a good way to save money and get your business off the ground, but most people quickly transition to a legal entity such as an LLC or a corporation.

Choosing the Best Entity Structure for Your Business

  • Generally speaking, the LLC is the most flexible corporate structure and therefore the most popular choice in the United States.

  • That said, some owners may choose to have their LLC taxed as an S-Corporation to save on self-employment taxes.

  • Alternatively, a large company (or a company raising capital) may prefer to form a joint stock company, especially if health care costs are high.

  • And while sole proprietorships and general partnerships may be good at first, owners can quickly outgrow them or feel uneasy about the lack of personal liability protection.

Conclusion

Choosing the best legal entity for your business is a game of weighing the pros and cons. Considerations include owner liability protection, IRS tax treatment, and reporting requirements. Usually large companies and companies that raise capital from investors choose corporations, but most small business owners choose to form his LLC.

© Copyright 2010 LLC University National Law Review, Vol. XII, No. 220