Determining the type of business is an important process. Below are the different types of businesses to select from. Each has their own advantages and disadvantages. Careful thought should be taken in this decision making process.
We have researched many companies that specialize in getting people setup in their respective business types. DSE Consulting Inc. has contracted with only a few compaines we feel provide the best service and cost effective product to best suit our customers.
Once you have made your decision, you can select your choise of ad banners on this page or the "Business Filings" link at your left. When complete go back to main and select the next business step to get your business on the right track.
Sole Proprietorship
A sole proprietorship is a one-person business that is not registered with the state as a corporation or a limited liability company (LLC).
Sole proprietorships are so easy to set up and maintain that you may already own one without knowing it. For instance, if you are a freelance photographer or writer, a craftsperson who takes jobs on a contract basis, a salesperson who receives only commissions, or an independent contractor who isn't on an employer's regular payroll, you are automatically a sole proprietor.
However, even though a sole proprietorship is the simplest of business structures, you shouldn't fall asleep at the wheel. You may have to comply with local registration, business license, or permit laws to make your business legitimate. And you should look sharp when it comes to tending your business, because you are personally responsible for paying both income taxes and business debts.
Personal Liability for Business Debts
A sole proprietor can be held personally liable for any business-related obligation. This means that if your business doesn't pay a supplier, defaults on a debt, or loses a lawsuit, the creditor can legally come after your house or other possessions.
By contrast, the law provides owners of corporations and limited liability companies (LLC's) with what's called "limited personal liability" for business obligations. This means that, unlike sole proprietors and general partners, owners of corporations and LLC's can normally keep their house, investments, and other personal property even if their business fails. If you will be engaged in a risky business, you may want to consider forming a corporation or an LLC.
Paying Taxes on Business Income
In the eyes of the law, a sole proprietorship is not legally separate from the person who owns it. The fact that a sole proprietorship and its owner are one and the same means that a sole proprietor simply reports all business income or losses on his or her individual income tax return -- IRS Form 1040, with Schedule C attached.
As a sole proprietor, you'll have to take responsibility for withholding and paying all income taxes -- something an employer would normally do for you. This means you'll have to pay a "self-employment" tax, which consists of contributions to Social Security and Medicare, and pay estimated taxes throughout the year. For more information, see How Sole Proprietors Are Taxed.
Registering Your Sole Proprietorship
Unlike an LLC or a corporation, you generally don't have to file any special forms or pay any fees to start working as a sole proprietor. All you have to do is state that your business is a sole proprietorship when you complete the general registration requirements that apply to all new businesses.
Limited Liability Company (LLC)
Start-up entrepreneurs have a new choice in determining how to legally organize their companies: the Limited Liability Company (LLC). The LLC offers many of the advantages of both corporations and partnerships, with few of the drawbacks. The LLC can be added to the three well-established forms: sole proprietorship, partnership, and corporation.
The LLC offers the advantages and benefits of corporations and partnerships, without many of the disadvantages. Thus, it provides tax advantages and flexibility to entrepreneurs and investors.
Consider some of the problems of the well-established legal organizations: An S Corporation offers certain tax advantages, but is restrictive in key areas regarding stock ownership and investment. A partnership offers greater ownership and investment flexibility than an S corporation, but it lacks the protection of individual limited liability that is found in an S or C corporation.
Over the last few years, LLC's have become an option for entrepreneurs in all states. In effect, the LLC is a hybrid entity that possesses both corporate and partnership characteristics. Like a corporation, an LLC
shields the owners, or "members," as they are known, from personal liability for the organization's debts and liabilities.
LLC's also offer pass-through tax advantages similar to an S corporation; however, there are no limitations on the number and type of owners of an LLC. An S corporation is limited in the number and type of shareholders it can have. Nor can it own more than 80% of the stock of another corporation. Not only is an LLC free of such limitations but, like a partnership, an LLC offers important flexibility in planning distributions or allocations.
In a conventional partnership, there are limitations on who can participate in management decisions, so as to preserve protections on liability. All members of an LLC can participate in the management, without risking loss of liability protection. Moreover, the earnings of an LLC are not subject to corporate taxes; instead, the profits flow through to the owners in proportion to their ownership.
For start-up entrepreneurs, the LLC deserves serious attention as a form of organization that provides the best of corporations and partnerships.
Partnership
By definition, a partnership is a business with more than one owner that has not filed papers with the state to become a corporation or LLC (limited liability company). There are two basic types of partnerships: general partnerships and limited partnerships. This article discusses general partnerships, the more common structure in which every partner has a hand in managing the business.
The partnership is the simplest and least expensive co-owned business structure to create and maintain. However, there are a few important facts you should know before you begin.
Personal Liability
First, partners are personally liable for all business debts and obligations, including court judgments. This means that if the business itself can't pay a creditor, such as a supplier, lender, or landlord, the creditor can legally come after any partner's house, car, or other possessions.
There are a few exceptions to this personal liability. Some of the partners can have limited personal liability if the partnership is set up as a limited partnership. This is a partnership in which only the general partner, who runs the business, has personal liability, while the limited partners, who are basically passive investors, can lose no more than their stake in the partnership. Also, some states allow special limited liability partnerships (LLP's). More commonly, though, businesspeople who are particularly concerned about personal liability choose to incorporate their business or operate as a limited liability company (LLC).
Joint Authority
In addition, any individual partner can usually bind the whole business to a contract or other business deal. For instance, if your partner signs a year-long contract with a supplier to buy inventory at a price your business can't afford, you can be held personally responsible for the money owed under the contract.
There are just a few limits on a partner's ability to commit the partnership to a deal -- for instance, one partner can't bind the partnership to a sale of all of the partnership's assets. But generally, unless an outsider has reason to know of any limits the partners have placed on each other's authority in their partnership agreement, any partner can bind the others to a deal.
Joint Liability
Each individual partner can be sued for and required to pay the full amount of any business debt. If this happens, an individual partner's only recourse may be to sue the other partners for their shares of the debt.
Because of this combination of personal liability for all partnership debt and the authority of each partner to bind the partnership, it's critical that you trust the people with whom you start your business.
Partnership Taxes
A partnership is not a separate tax entity from its owners; instead, it's what the IRS calls a "pass-through entity." This means the partnership itself does not pay any income taxes on profits. Business income simply "passes through" the business to the partners, who report their share of profits (or losses) on their individual income tax returns. In addition, each partner must make quarterly estimated tax payments to the IRS each year.
While the partnership itself doesn't pay taxes, it must file IRS Form 1065, an informational return, each year. This form sets out each partner's share of the partnership profits (or losses), which the IRS reviews to make sure the partners are reporting their income correctly.
Corporation
Forming a corporation limits your personal liability for business debts, but running one takes work.
Most people have heard that forming a corporation provides "limited liability" -- that is, it limits your personal liability for business debts. What you may not know is that there's more to creating and running a corporation than filing a few papers. You'll need to keep good records to handle the more complicated corporate tax return and, in order to retain your limited liability, you must follow corporate formalities involving decision making and record keeping. In short, you've got to be organized.
Limited Personal Liability
One of the main advantages of incorporating is that the owners' personal assets are protected from creditors of the corporation. For instance, if a court judgment is entered against your corporation saying that it owes a creditor $100,000, you can't be forced to use personal assets, such as your house, to pay the debt. Because only corporate assets need be used to pay business debts, you stand to lose only the money that you've invested in the corporation.
Exceptions to Limited Liability
There are some circumstances in which limited liability will not protect an owner's personal assets. An owner of a corporation can be held personally liable if he or she:
- personally and directly injures someone
- personally guarantees a bank loan or a business debt on which the corporation defaults
- fails to deposit taxes withheld from employees' wages
- does something intentionally fraudulent or illegal that causes harm to the company or to someone else, or
- treats the corporation as an extension of his or her personal affairs, rather than as a separate legal entity.
This last exception is the most important. In some circumstances, courts can rule that a corporation doesn't really exist and that its owners should not be shielded from personal liability for their acts. This might happen if you fail to follow routine corporate formalities such as:
* adequately investing money in ("capitalizing") the corporation
* formally issuing stock to the initial shareholders
* regularly holding meetings of directors and shareholders, or
* keeping business records and transactions separate from those of the owners.
Liability Insurance
Incorporating should never take the place of good business insurance. Even though forming a corporation protects your personal assets, you should use insurance to guard your corporate assets from lawsuits and claims.
A solid liability insurance policy can protect you against many of the risks of doing business. For instance, if you operate a clothing store, good business insurance should adequately cover the bill if someone slips and falls in your store.
Also, insurance can protect you where the limited liability feature will not. For example, if you personally injure someone while doing business for the corporation, say by causing a car accident, liability insurance will usually cover the accident so that you won't have to use either corporate or personal assets to pay the bill. However, insurance won't help if your corporation doesn't pay the bills: commercial insurance usually does not protect personal or corporate assets from unpaid business debts, whether or not they're personally guaranteed.
Paying Corporate Income Tax
If an owner of a corporation works for the corporation, that owner is paid a salary, and possibly bonuses, like any other employee. The owner pays taxes on this income just like regular employees, reporting and paying the tax on his or her personal tax return.
The corporation pays taxes on whatever profits are left in the businesses after paying out all salaries, bonuses, overhead, and other expenses. To do this, the corporation files its own tax return, Form 1120, with the IRS and pays taxes at a special corporate tax rate.
Alternatively, corporate shareholders can elect what's called "S corporation" status by filing Form 2553 with the IRS. This means that the corporation will be treated like a partnership (or LLC) for tax purposes, with business profits and losses "passing through" the corporation to be reported on the owners' individual tax returns.
Forming a Corporation
To form a corporation, you must file "articles of incorporation" with the corporations division (usually part of the secretary of state's office) of your state government. Filing fees are typically $100 or so.
For most small corporations, articles of incorporation are relatively short and easy to prepare. Most states provide a simple form for you to fill out, which usually asks for little more than the name of your corporation, its address, and the contact information for one person involved with the corporation (often called a "registered agent"). Some states also require you to list the names of the directors of your corporation.
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