One of the concerns
of every business owner is making sure that the business is appropriately
organized. A business may be
operated as a:
The type of entity
that is chosen will affect not only how revenue is treated from a taxation
standpoint but also whether you are personally liable for the debts and
obligations of the business.
Let us help you set
up the business entity that is right for your business.
The
following is a brief description of the different forms of business
organization.
What
is a sole proprietorship?
A
sole proprietorship is a business entity in which one person, called the
"proprietor," owns all of the assets of the business.
How
much liability exposure do I have as a sole proprietor?
Because
a sole proprietorship is not a separate legal entity, the proprietor is
personally responsible for all business debts and legal claims against the
business.
Can I protect myself from this liability exposure?
Yes.
One method of protection is to buy sufficient liability insurance coverage for
your business. This will help
protect your personal assets from claims, provided that the claims do not exceed
the coverage limits of the insurance policy.
Another
method is to write strong, enforceable contracts -- and be sure to keep your
promises.
Are there drawbacks to relying solely on liability insurance coverage?
Yes.
First, all liability insurance policies have per-claim limits. The cost of the policy will be affected by the amount of
coverage you select as well as the type of products or services you provide.
If claims are made against your business that are in excess of the
insurance coverage, you, as the sole proprietor, will then be liable for the
difference.
Second,
insurance covers only tort claims for negligence -- accidents, not intentional
acts. Insurance usually will not cover a loss for a claim based on breach of
contract or arising from an employee or landlord dispute.
How is the sole proprietorship taxed?
All
income from the business is directly taxable to the proprietor.
What
is a partnership?
A
partnership, also known as a general partnership, is an association of two or
more individuals or business entities, called partners, who own and operate a
business together.
How
much liability exposure do I have as a partner?
Like
a sole proprietorship, a partnership is not a separate legal entity.
Therefore, all of the partners are personally responsible for all debts
and legal claims against the partnership. You
can even be held liable for obligations created by your partner without your
permission.
Is
my liability limited to only my "share" of the partnership?
No.
If a claim is made against the partnership, you are personally responsible for
the entire claim. If your other
partners do not have any personal assets and you do, then your assets will be
available to satisfy the entire claim. Your
remedy is only the right to contribution from the other partners.
This is little comfort if they have no assets.
Can
I protect myself from this liability exposure?
Yes.
Like the sole proprietorship, liability insurance can be purchased by the
partnership. The drawbacks of
liability insurance are the same as those explained under the sole
proprietorship heading.
How
is the partnership taxed?
All
income from the business is directly taxable to the partners.
This is sometimes called "pass-through" taxation.
What
is a limited partnership?
A
limited partnership is a special type of partnership which has at least one
general partner and at least one limited partner.
What
is the difference between the general partner and the limited partner?
General
partners are responsible for all debts and legal claims against the partnership
just like in a general partnership. Limited
partners, however, are only responsible to the partnership up to the amount they
invested in the partnership. This
provides a liability shield to the limited partner.
Claimants and creditors of the limited partnership cannot reach through
to the personal assets of the limited partner.
They can reach the personal assets of the general partner.
For that reason, some limited partnerships will have a corporation act as
the general partner.
If
I am a limited partner, how does that affect my relationship with the business?
In
exchange for limited liability, limited partners trade off their right to
participate in the management of the partnership business. If they participate
in the management contrary to their limited partner status, then, in an action
brought by a third party against the limited partnership, the courts will
"re-label" you as a general partner with all the personal liability
that attaches to general partners.
How
is the limited partnership taxed?
All
income from the business is directly taxable to the partners.
What
is a limited liability partnership?
A
limited liability partnership (LLP) is a special type of partnership which
allows the members of the LLP to take an active role in the business of the LLP
without exposing them to personal liability for others’ acts, except to the
extent of their investment in the LLP.
What
is a corporation?
A
corporation is a separate legal entity that can own property, transact business
and become involved in lawsuits.
Who
are the owners of a corporation?
The
owners of the corporation are called shareholders or stockholders.
Do
shareholders have any personal liability for debts and claims against the
corporation?
Shareholders
are not personally responsible for any debts or legal claims against the
corporation; only the corporation itself is responsible. This is known as the
"liability shield." However,
if this “corporate veil” is pierced (which may result if, for example,
statutory formalities are ignored, the corporation is under-capitalized or funds
are co-mingled), shareholders may find themselves without this liability shield.
How
is the corporation taxed?
That
depends on whether it is a C or an S corporation. A C corporation can be taxed
twice on its profits. First, the
business pays the corporate income tax. Then,
the stockholders pay dividends tax on the same profits when they are
distributed.
An
S corporation pays no tax at the entity level.
Designed for small business, the S corporation passes all its profits and
losses directly through to the stockholders for taxation.
Electing S corporation status requires an affirmative filing with the
IRS. S corporation status can
provide many tax benefits for a small business, but significant restrictions
apply. Many small businesses are
better off being C corporations. Your
accountant should participate in the decision which is best for your business.
What
is a limited liability company?
A
limited liability company (LLC) combines features from all of the previous
business forms. An LLC, like a corporation, is a separate legal entity and
the owners, called members, are not personally responsible for any debts or
legal claims against the LLC.
How
is the limited liability company taxed?
Unless
otherwise elected, the LLC is taxed like a partnership; that is, the income of
the LLC is directly taxable to its
members. There is no tax at the
entity level.