Business Formation

 

When starting a business, choosing the type of entity to form involves two fundamental questions: 1) will you be protected from personal liability for business debts; and 2) how will you and your business be taxed? There are no simple answers to these questions, and I highly encourage you to consult with an attorney and an accountant. I have assisted many entrepreneurs with the formation and structure of their new business. Please call 216.225.9181, Email, or use the contact form to schedule aconsultation.

 

When selecting a business entity, consider these options as starting points:

 

Sole Proprietorship

This is a business you operate yourself, in your name or trade name, with no partners or formal entity. If the business operates under a trade name (i.e., Mom's Deli), a fictitious name registration must be made with the state Secretary of State's office, but there will be no state franchise taxes due. You remain personally liable for business debts. You report income and expenses on Schedule C of your personal 1040 tax return, and pay income and self-employment tax on your profits. These are best for small businesses with no employees in industries with little legal liability. In our modern litigious climate, I encourage all my business clients to consider some type of formal entity.

 

General Partnership

A general partnership is a business association between two or more partners that have not formally organized the business as a business entity. A general partnership may or may not have a written partnership agreement that spells out the rights and duties of the partners relative to partnership assets, liabilities, income or loss, and control of business. General partners are "jointly and severally" liable for all partnership debts. This means that each partner can be held liable by a third party for an entire debt of the partnership. Partnerships file an informational tax return (Form 1041), and partners pay Social Security and Medicare on all partnership earnings.

 

Limited Partnership

A limited partnership is a business association between two or more partners formed through the filing of a Certificate of Limited Partnership with the Secretary of State. In addition, limited partnerships are required to have written partnership agreements. In sole proprietorships and general partnerships, the owners are all actively involved in the operation of the business. In a limited partnership, there are two groups of owners: (a) the general partner(s) who operate the business and are personally liable for partnership debts, and (b) limited partners who do not participate in the operation of the business, and are not liable for partnership debts. The partnership files an informational return 1041, and passes income and expenses to partners. The general partners pay self-employment tax on all partnership earnings. Limited Partner distributions are taxed as passive income.

 

C-Corporation

This is a separate legal "person" organized under state law by filing Articles of Incorporation with the Secretary of State. A corporation is owned by its shareholders, whose liability for business debts are limited to the shareholder's investment in the corporation. A corporation files its own return, pays tax on profits, and chooses whether or not to pay dividends. If you form a corporation, as an employee your salary is subject to income and employment tax; dividends are taxed at preferential rates. C-Corporations are best for business owners who want limited liability, and desire the broadest range of benefits.

 

S-Corporation

This is a separate legal "person" organized under state law in the same manner as a C-Corporation, but elects not to pay tax itself by filing Form 2553 with the IRS. Instead, it files an informational 1120S return, and passes income and losses through to shareholders in proportion to their ownership. As an employee, your salary is subject to income and employment tax; however, pass-through profits are only subject to ordinary income tax. S-Corporations are best for businesses owners who are actively involved in the business, and do not need to accumulate capital for day-to-day operations.

 

Limited Liability Company (LLC)

This is an association of one or more "Members" organized under state law by filing Articles of Organization with the Secretary of State. Like a corporation, a Member's liability for business debts is limited to your investment in the company. Single member LLCs are taxed as sole proprietors. Multiple member LLCs can elect to be taxed as partnerships or corporations. This tax flexibility and asset-protection strength make LLCs the entity of choice for many new businesses.

 

If you are planning to start a new business or to restructure an existing one, please call 216.225.9181, Email, or use the contact form to schedule a consultation.