Legal Business Structures

After having set up multiple businesses over the years, and finally deciding to commit to Life, Love & Debt, I know I have vital business information to share.

Remember that to effectively operate as a business, not as an individual, you will need an Employer Identification Number (EIN). Below, I will help you learn which type of business entity you should set up to best suit your business purposes.

Sole Proprietorship

This is simple to form and provides you with complete control of your business. You are automatically considered to be a sole proprietorship if you do business activities without registering as another type of business.

A Sole Proprietorship is not a separate business entity. This means that your business and personal assets and liabilities are not separate and you can be held personally responsible for any debt or obligations of the business. If you are involved in very low-risk business activities, this might be a good avenue for you.

Partnership

If you have decided to start a business with one or more people, this is the simple a simple route to take. There are two types of partnerships: Limited Partnerships (LP) and Limited Liability Partners (LLP).

Limited Partnerships

This type of partnership has only one general partner with unlimited liability. All other partners have limited liability. Usually, this means that the partners with limited liability have limited control over the company, which is documented in the partnership agreement. Profits for LPs are processed through the personal tax returns of the general partner, who must also pay self-employment taxes.

Limited Liability Partnerships

An LLP is similar to a limited partnership but provides limited liability to every owner. It protects each partner from debts against the partnership so that they won’t be responsible for the actions of other partners.

In general, partnerships can be a good choice for businesses with multiple owners, professional groups, and groups who want to test out their business idea prior to forming a more formal business.

Limited Liability Company

This type of entity is extremely common. An LLC lets you take advantage of both corporation and partnership structures. Persons in ownership of an LLC are protected from personal liability in most instances. Examples of personal liabilities can include your vehicle, house, and savings account(s). With an LLC, you are not at risk if the LLC faces bankruptcy or lawsuits.

Profits and losses for an LLC can get passed through to your personal income without facing corporate taxes. Members of the LLC are considered self-employed and they must contribute towards Medicare as well as Social Security. Note that this is a good choice for individuals looking to start businesses that are medium- or high-risk.

*Your personal and company assets are separated in most cases, and your profits and losses are not taxed at the corporate level.

Corporation (C corp)

A corporation or C corp, is a legal entity that is separate from its owners. Corporations can make a profit; they can also be taxed and held legally liable.

Although the designation of Corporation offers the strongest protection to its owners from personal liability, the cost to form this entity is higher than other options. There is also a requirement of extensive record-keeping, operations processes, and reporting.

In differentiation from other entity structures, Corporations pay income tax on profits and in some cases, profits are taxed twice–when profit is made by the company and again when dividends are paid to shareholders on personal tax returns. Additionally, Corporations are independent of shareholders.

Corporations are a good structure for medium- or higher-risk businesses–businesses that need to raise money and/or plan to “go public” in the future.

S Corporation (S Corp)

An S Corp is a special type of corporation, designed to avoid double taxation downfall of C Corp’s. Profits and losses are passed directly through owners’ personal income without being subject to corporate taxes.

Tax on S Corps is not the same in every state. However, many recognize them the same way the federal government does and taxes shareholders accordingly. Some states tax S Corps on profits above a specified limit; other states don’t recognize the S Corp structure and great the business as a C Corp. If you choose to file as an S Corp, you will need to do so with the IRS. States have a different process.

S Corps cannot have more than 100 shareholders at a time and all shareholders must be U.S. citizens. The S Corp life is independent, similar to C Corps. If a shareholder leaves the company or shares their shares, the S Corp can continue doing business relatively undisturbed.

Benefit Corporation (B Corp)

Sometimes called a B Corp, a Benefit Corporation is a for-profit corporation recognized in a majority of U.S. states. B Corps are different from C corps in purpose, accountability, and transparency, however, they are not different in how they are taxed.

B Corps are driven by mission and profit. Shareholders hold it accountable to produce some sort of public benefit in addition to a profit. Some states require B Corps to submit annual benefit reports showing a contribution to the public good.

There are several third-party B Corp certification services. None of the certification services are required for a company to be legally considered a B Corp in a state where the legal status is available.

Nonprofit Corporation

Nonprofit corporations are organized to do charity work, provide education, religious, literary, or scientific work. Because their work benefits the public, nonprofits can receive tax-exempt status, meaning they don’t pay state or federal taxes or income taxes on any profits made.

Nonprofits must file with the IRS to get tax exemption. The processes is different from registering with the state.

Nonprofit corporations need to follow organizational rules that are similar to a regular C Corp. They also need to follow special rules about what they do with the profits they earn.

Nonprofits are often called 501(c)(3) corporations. This is a reference to the section of the Internal Revenue (IRS) Code that is most commonly used to grant tax-exempt status.

These brief descriptions of business structures should provide you with enough information to make a decision. If you have more questions, you should refer to the IRS website.

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