When starting a business, the first step is to determine what form of business entity to establish. There are different tax, liability and other consequences to evaluate with each organizational structure. Engaging an attorney to aid in this process can help make sure that your business opens and operates in compliance with federal and state laws and will help your business limit its liability exposure. To get started, we have provided a brief summary of the most common forms of business entities and organizations:
Types of Business Entities
Sole proprietorship
A sole proprietorship is a business that is owned by one person and is not a separate legal entity apart from the owner. Few formalities are required to form a sole proprietorship. In most countries, including the United States, you do not have to register your business unless you plan on occupying a local space. In some cases, it will also depend on the industry you plan on entering.
The good news with a sole proprietorship is that the taxes are flexible, require less paperwork, and you get to manage your own time. Some of the disadvantages of a sole proprietorship are that because you are the sole owner, it may be harder to build your business credit and request business
Partnerships
Partnerships are businesses legally owned by two or more people who will carry on a business for profit. Typically, the partners have an equal right to manage and conduct the business and have equal voting rights as to matters in the ordinary course of business.
When it comes to taxes, the partnership does not shoulder the taxes it will incur. Instead, the net profit is calculated, and then the owners pay income tax on their individual tax returns. The different types of partnerships are general partnership, limited partnership, and limited liability partnership (LLP).
General Partnership
In a general partnership, the owners participate in the business operations and share liability for every legal action, process, and transaction. This is the default form for a co-owned business when no other form is elected or if it is not properly formed.
Limited Partnership
A limited partnership is a business organization created under state limited partnership statutes. There are two classes of partners in a limited partnership. General partners hold managerial power and therefore are subject to unlimited liability. Limited partners are not intended to be active in the management of the partnership and are therefore not personally liable for the debts and obligations of the partnership unless the limited partner participates excessively in the management of the business.
In absence of an agreement to the contrary, a limited partner does not have any voting rights. A limited partnership enjoys pass-through taxation – i.e., it does not pay taxes on profits as the profits are being earned. Instead, the partners pay taxes on their share of profits in conjunction with their personal income tax returns.
Limited Liability Partnership
A limited liability partnership is a type of partnership where the liability of each owner is separated and protected by the law. This means that the state or government prevents the owners from being responsible for the actions of their business’ co-owners under this type of partnership.
Corporation Business Entities
In a corporation, the liability of the business is separate and distinct from its owners. Shareholders are seen as owners of the corporation and have the power to appoint a board of managers of the corporation who can delegate the management of the corporation to certain officers. In a corporation, certain corporate formalities must be observed, such as issuing stock, holding meetings, and keeping minutes for such meetings. The shareholders are not personally liable for the acts or debts of a corporation, except in very limited circumstances when a court “pierces the corporate veil” of limited liability.
There are different kinds of corporations from a tax code perspective. These types of business entities include:
Non-profit
A non-profit corporation is one made for the betterment and interest of the public. Most nonprofits are 501(c)(3) organizations, which means they are formed for religious, charitable, scientific, literary, or educational purposes. 501(c)(3) organizations are eligible for federal and state tax exemptions.
S – corporation
If an entity has 100 or fewer shareholders and meets other specific Internal Revenue Service requirements, including certain shareholder ownership restrictions, it can take advantage of the pass-through tax privileges of a partnership, while still enjoying the limited liability benefits of a corporation. S-corporations are considered pass-through tax entities, allowing them to avoid being taxed at the corporate level and again on shareholders’ personal income tax returns.
C – corporation
A C-corporation is a legal structure in which the owners enjoy limited liability. Unlike an S-corporation, tax law does not restrict who can own stock in a C-corporation. From a tax perspective, a C-corporation is “double taxed” meaning that the profit of a corporation is taxed to the corporation when earned, and then taxed to the shareholders when dividends are distributed.
Limited Liability Company
A limited liability company is sometimes characterized as a hybrid of a partnership and a corporation. The members of a limited liability company enjoy limited liability for the debts and actions of the company. Like a partnership, a limited liability company gets the benefits of pass-through federal taxation, meaning that the owners alone, and not the company, pay tax on profits as profits are earned.
A limited liability company must have one or more members, must file a certificate or articles of organization to be considered legally formed, and enter into an operating agreement to regulate the affairs of the company, conduct of its business, and govern relations among members, managers (if any) and the company. Another benefit of this type of business organization is the ability to have flexibility in the management structure of the company – a limited liability company can be managed by the members of management can be delegated to one or more managers.
Ringenberg-Rattner Law
The attorneys at Ringenberg & Rattner Law are here to help. Our attorneys have the experience and background needed to provide a full range of corporate legal services for businesses in all stages of life. Contact our experienced team of lawyers in Omaha today to schedule a consultation.
