One of the first decisions that you will have to make as a business owner is how the company
should be structured. This decision will have long-term implications, so consult with an
accountant and attorney to help you select the form of ownership that is right for you. In
making a choice, you will want to take into account the following:
- Your vision regarding the size and nature of your business.
- The level of control you wish to have.
- The level of "structure" you are willing to deal with.
- The business's vulnerability to lawsuits.
- Tax implications of the different ownership structures.
- Expected profit (or loss) of the business.
- Whether or not you need to re-invest earnings into the business.
- Your need for access to cash out of the business for yourself.
SOLE PROPRIETORSHIPS
The vast majority of small business
start out as sole proprietorships. These firms are owned by
one person, usually the individual who has day-to-day responsibility
for running the business. Sole proprietors own all the assets
of the business and the profits generated by it. They also assume
complete responsibility for any of its liabilities or debts.
In the eyes of the law and the public, you are one in the same
with the business. |
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Advantages of a Sole Proprietorship
- Easiest and least expensive form of ownership to organize.
- Sole proprietors are in complete control, and within the parameters
of the law, may make decisions as they see fit.
- Sole proprietors receive all income generated by the business
to keep or reinvest.
- Profits from the business flow-through directly to the owner's
personal tax return.
- The business is easy to dissolve, if desired.
Disadvantages of a Sole Proprietorship
- Sole proprietors have unlimited liability and are legally responsible
for all debts against the business. Their business and personal
assets are at risk.
- May be at a disadvantage in raising funds and are often limited
to using funds from personal savings or consumer loans.
- May have a hard time attracting high-caliber employees, or those
that are motivated by the opportunity to own a part of the business.
- Some employee benefits such as owner's medical insurance premiums
are not directly deductible from business income (only
partially deductible as an adjustment to income).
Federal Tax Forms for Sole Proprietorship
(only a partial list and some may not apply)
- Form 1040: Individual Income Tax Return
- Schedule C: Profit or Loss from Business (or Schedule C-EZ)
- Schedule SE: Self-Employment Tax
- Form 1040-ES: Estimated Tax for Individuals
- Form 4562: Depreciation and Amortization
- Form 8829: Expenses for Business Use of your Home
- Employment Tax Forms
PARTNERSHIPS
In a Partnership, two or more people
share ownership of a single business. Like proprietorships,
the law does not distinguish between the business and its owners.
The Partners should have a legal agreement that sets forth how
decisions will be made, profits will be shared, disputes will
be resolved, how future partners will be admitted to the partnership,
how partners can be bought out, or what steps will be taken
to dissolve the partnership when needed;. Yes, its hard to think
about a "break-up" when the business is just getting
started, but many partnerships split up at crisis times and
unless there is a defined process, there will be even greater
problems. They also must decide up front how much time and capital
each will contribute, etc. |
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Advantages of a Partnership
- Partnerships are relatively easy to establish; however time
should be invested in developing the partnership agreement.
- With more than one owner, the ability to raise funds may be
increased.
- The profits from the business flow directly through to the partners'
personal tax returns.
- Prospective employees may be attracted to the business if given
the incentive to become a partner.
- The business usually will benefit from partners who have complementary
skills.
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.
Types of Partnerships that should be considered:
- General Partnership
Partners divide responsibility for management and liability, as
well as the shares of profit or loss according to their internal
agreement. Equal shares are assumed unless there is a written
agreement that states differently.
- Limited Partnership and Partnership with limited liability
"Limited" means that most of the partners have limited
liability (to the extent of their investment) as well as limited
input regarding management decisions, which generally encourages
investors for short term projects, or for investing in capital
assets. This form of ownership is not often used for operating
retail or service businesses. Forming a limited partnership is
more complex and formal than that of a general partnership.
- Joint Venture
Acts like a general partnership, but is clearly for a limited
period of time or a single project. If the partners in a joint
venture repeat the activity, they will be recognized as an ongoing
partnership and will have to file as such, and distribute accumulated
partnership assets upon dissolution of the entity.
Federal Tax Forms for Partnerships
(only a partial list and some may not apply)
- Form 1065: Partnership Return of Income
- Form 1065 K-1: Partner's Share of Income, Credit, Deductions
- Form 4562: Depreciation
- Form 1040: Individual Income Tax Return
- Schedule E: Supplemental Income and Loss
- Schedule SE: Self-Employment Tax
- Form 1040-ES: Estimated Tax for Individuals
- Employment Tax Forms
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; it can be sued; it can enter into contractual
agreements. The owners of a corporation are its shareholders.
The shareholders elect a board
of directors to oversee the major policies and decisions.
The corporation has a life of its own and does not dissolve
when ownership changes. |
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Advantages of a Corporation
- Shareholders have limited liability for the corporation's debts
or judgments against the corporations.
- Generally, shareholders can only be held accountable for their
investment in stock of the company. (Note however, that officers
can be held personally liable for their actions, such as the failure
to withhold and pay employment taxes.)
- Corporations can raise additional funds through the sale of
stock.
- A corporation may deduct the cost of benefits it provides to
officers and employees.
- Can elect S corporation status
if certain requirements are met. This election enables company
to be taxed similar to a partnership.
Disadvantages of a Corporation
- The process of incorporation requires more time and money than
other forms of organization.
- Corporations are monitored by federal, state and some local
agencies, and as a result may have more paperwork to comply with
regulations.
- Incorporating may result in higher overall taxes. Dividends
paid to shareholders are not deductible form business income,
thus this income can be taxed twice.
Federal Tax Forms for Regular or "C" Corporations
(only a partial list and some may not apply)
- Form 1120 or 1120-A: Corporation Income Tax Return
- Form 1120-W Estimated Tax for Corporation
- Form 8109-B Deposit Coupon
- Form 4625 Depreciation
- Employment Tax Forms
- Other forms as needed for capital gains, sale of assets, alternative
minimum tax, etc.
Subchapter S Corporations
A tax election only; this election enables the shareholder to treat
the earnings and profits as distributions, and have them pass thru
directly to their personal tax return. The catch here is that the
shareholder, if working for the company, and if there is a profit,
must pay herself wages, and it must meet standards of "reasonable
compensation". This can vary by geographical region as well
as occupation, but the basic rule is to pay yourself what you would
have to pay someone to do your job, as long as there is enough profit.
If you do not do this, the IRS can reclassify all of the earnings
and profit as wages, and you will be liable for all of the payroll
taxes on the total amount.
Federal Tax Forms for Subchapter S Corporations
(only a partial list and some may not apply)
- Form 1120S: Income Tax Return for S Corporation
- 1120S K-1: Shareholder's Share of Income, Credit, Deductions
- Form 4625 Depreciation
- Employment Tax Forms
- Form 1040: Individual Income Tax Return
- Schedule E: Supplemental Income and Loss
- Schedule SE: Self-Employment Tax
- Form 1040-ES: Estimated Tax for Individuals
- Other forms as needed for capital gains, sale of assets, alternative
minimum tax, etc.
LIMITED LIABILITY COMPANY (LLC)
The LLC is a relatively new type of hybrid business structure that
is now permissible 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
complex and formal than that of a general partnership.
The owners are members, and the duration of the LLC is usually
determined when the organization papers are filed. The time limit
can be continued if desired by a vote of the members at the time
of expiration. LLC's 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.
Federal Tax Forms for LLC
Taxed as partnership in most cases; corporation forms must be used
if there are more than 2 of the 4 corporate characteristics, as
described above.
In summary, deciding the form of ownership that best suits
your business venture should be given careful consideration. Use
your key advisors to assist you in the process.
(from Small Business success,
a workshop series sponsored by the
Ohio Women's Business Resource Network) |