Friday, July 10, 2009

Who Am I? What Am I? The Dorothy You're Not in
Kansas Anymore Syndrome

Starting your own business can be overwhelming. Between figuring out your niche objective, funding, location and a host of other considerations, we sometimes can find ourselves unable to determine exactly what type of business entity we should be designating our business to.

The first step to starting a business is to know you want to start one. Give yourself a great big round of applause for embracing entrepreneurship and if all goes well independent and generational wealth. The second most valuable consideration is securing the domain name for your business. Once the idea comes into mind and you've decided on a name, I suggest you quickly go online to one of the common domain registrations (i.e. Go Daddy) and secure the domain name. Many may wonder why this is important, chances are 9 out of 10 times your website will be your storefront of any magnitude. A business today without a website can basically consider itself non-existent. Even if your website is just 2 pages, the mere fact that you have an online presence will garner more positive results than negative. The next issue you definitely need to tackle is the designation of a business entity. A business entity refers to the structured way your business will be organized. Will you be a sole proprietor, a corporation, a limited liability partnership, etc. The designation of a business entity is very important as it will determine your tax structure, liability and the degree of flexibility in which you can operate your business.

Listed below are the four common legally recognized business entities:

  • Sole Proprietorship - A business owned and managed by one person or for tax purposes a married couple. Business profits are reported and taxed on the owner's personal tax return. Sole proprietors can register their business name at the Registrar of Deeds within their local county. As a business owner depending on the type of business (i.e. product, services, etc.) you should check with your local laws in determining if any licenses or permits are needed.

Advantages of being a sole proprietor

Disadvantages of being a sole proprietor

Your business is owned and managed by you.

Personally responsible for all business debts.

Perfect if you want a structure that is simple and inexpensive without dealing with governmental filings and rules.

If sued your personal assets will be affected.

Losses can be reported on your personal income tax.

Profits can increase your tax bracket which may lead you to pay higher personal income tax.

  • Limited Liability Company (LLC) – This entity is a cross between sole proprietorship and a corporation. Similar to a sole proprietorship business owners are personally taxed on their business profits. However, once your business starts a generating a profit you can elect to be taxed by the IRS like a corporation. Unlike a sole proprietorship, owners are protected from personal liability, debts and claims. Meaning if your company is sued or bankrupt the only assets that can be attacked are the company's assets. Your personal assets will be untouched. Forming a LLC requires the creating and filing of Articles of Organization with the Secretary of State (many states have a fill-in-the-blank form which only takes a few minutes to prepare, be wary of solicitors who offer this offer at an outrageous charge). When operating as an LLC the management structure must be defined. Manager structure includes member-managed in which several partners manage the company and have pre-defined responsibilities which is often referred to as an Operating Agreement. LLCs can also elect to be manager-managed in which one or more owners are designated as decision makers while the rest of the partners sit back and share in the profits.

Advantages of being a LLC

Disadvantages of being a LLC

Ideal for protection of personal liability, meaning your personal assets cannot be touched.

If a suit is filed due to an employee error your business may not be protected.

Members want the option of reporting profit or loss on their own tax returns OR elect to be taxed like a corporation.

You will have to qualify for one or several exemptions from state and federal securities law if you partner with investors who will not participating the management of your company.

Easy filing with the state using the fill-in-blank form structure.

Some states charge a separate LLC entity level tax.

The primary advantage of an LLC is the ability to enjoy the benefits of a corporation while being able to retain the model of a small business.

  • Limited Liability Partnership (LLP) – A type of partnership that protects a partner from personal liability for negligent acts committed by other partners or employees not under his/her direct control. In some countries, and LLP must also have one general partner with unlimited liability. Unlike corporate shareholders, the partners have the right to directly manage the business, contrary to a corporation in which shareholders are required to elect a board of directors. An LLP also contains a different level of tax liability than a corporation.

Advantages of being a LLP

Disadvantages of being a LLP

Ideal for protection of personal liability, meaning your personal assets cannot be touched.

Not available in all states.

Ability to act like a corporation without the requirement of shareholders.

Strict IRS compliance.

Protection from suits caused by employees or negligent partners.

Many including myself have often wondered about the distinct differences between an LLC and LLP. The differences are all about asset protection. If a hospital was to operate as an LLC and a physician operated in a negligent manner, the hospital can be sued and its assets will be attacked. However, if the hospital is operating as an LLP and a doctor performs irresponsibly the hospital being a Limited Liability Partnership can actually protect its assets. The plaintiff has the ability to attack the assets of the physician usually through mal-practice insurance. If employing personnel while operating as a LLC you may want to consider the contract route as employment offering.

  • Corporation – The mother of all business entities. A corporation is a formal business that is created and regulated by state law. The person operating on behalf of the corporation is the "corporation" itself. Meaning the corporation can enter into legal binding contracts. For example, if Bank of America enters into a contract, you will not see the shareholders or executives listed but the actual name "Bank of America" as the person entering into the contract. Corporations similar too LLCs and LLPs enjoy limited liability whereas in the event of a law suit, debt, damages, etc. the corporation's assets will be affected and the owners/shareholders will not bear any debt responsibility. Due to the complex nature of corporations and their ability to issue stock options corporations have benefited by enjoying significant tax advantages.

Advantages of a Corporation

Disadvantages of a Corporation

Ideal for protection of personal liability, meaning your personal assets cannot be touched.

Complex tax structure.

The ability to generate investment revenue through stock options.

Requires the appointment of officers and board of directors who ultimately are responsible for resolutions.

Ability to convert ownership interests as shares of stock.

Owners must meet legal requirements for stock registration and paperwork which can be a tedious and often repetitive task.

Incorporating my result in higher overall taxes. Dividends paid to shareholders are not tax deductible from business income; therefore double taxation may be imposed.

Forming a business entity is one of the most complex and quite frankly one of the most naïve things we can do. Most sites have tons of legal jargon that is very hard to comprehend. An ideal way to figure out which business entity may suit you best is to conduct research. You can do this by going online to the Small Business Administration or even contact your local SCORE office. SCORE is a great resource in which former or existing entrepreneurs can provide you with a host of free legal advice. For tax laws and structures you may want to research IRS regulations. Lastly, go old school and visit your local library, it is amazing the amount of small business information that is available. Good luck in establishing a business entity; although the work can be arduous in the long run it will be well worth it!

No comments:

Post a Comment