Starting a New Business
1. Sole Proprietorship
2. General Partnership
3. Limited Partnership
4. C - Corporation
5. S - Corporation
6. Limited Liability Company
Business Entity Types
There are several business entity options available for entrepreneurs. Like anything else, each of them has advantages and drawbacks.
A sole proprietorship is a business entity that is virtually indistinguishable from its owner. The cost to create it is frequently only a small one-time fee to the state or county officials to register a fictitious business name and the cost of placing an ad in your local paper to notify the public that you are doing business under that name.
There is a price for this easy set-up, though. Sole proprietorships cannot take advantage of special business income tax rates since all income is considered individual income. Sole proprietors are also not protected from personal liability if they get into trouble with a client.
General partnerships are formed by two or more legal entities (any kind of legal entity can be partner), and each of those entities are individually responsible for the partnership. This means that each partner is personally liable for the partnership’s debts and legal liabilities. If one rogue partner makes an enemy of a third party, all partners will come under fire.
A limited partnership is much like a general partnership in structure. The main difference is that in a limited partnership, there are two different kinds of partners: general and limited. A limited partner does not take part in the management of the partnership and is not liable for any more than his individual capital investment. This distinction is made to encourage investors to become limited partners and so they can share in the profits but not lose more than their own contribution.
A “C” corporation is a standard state-formed corporation. It is a legal entity once it is formed, so it files its own taxes and is responsible for its own dealings. A “C” corporation can have unlimited numbers of shareholders, and those shareholders can be any kind of legal entity.
A board of directors must be elected, annual meetings must be held, minutes of corporate meetings must be kept, stock must be issued. And all this applies even if you are the only shareholder in the corporation. If these formalities aren’t followed, you run the risk of losing your personal liability protection if a court decides that your corporation was just an alter ego of yourself created to keep you safe (sometimes referred to as “piercing the corporate veil”).
Additionally, since corporations are taxed on their income and shareholders have to claim dividends as taxable income themselves, shareholders of a “C” corporation are “double taxed” on their dividend income. One way to avoid this is to not issue dividends and simply re-invest your income back in the company. Spending your income on items that are tax-deductible is another way. You could also look into forming an “S” corporation.
An “S” corporation is much like a “C” corporation in that it is also its own legal entity, protects its shareholders from legal liability, and requires a significant amount of effort and money to start and maintain. However, an “S” corporation allows shareholders to claim their share of the corporation’s income directly on their personal tax return. This gets around the “double taxation” problem of a “C” corporation. The only drawbacks of an “S” corporation are that they may cost a little more to form and they are generally limited to a maximum of 100 shareholders. This makes going public with an “S” corporation practically impossible. However, if your intention is to keep your business relatively small, this is an excellent option.
Limited Liability Company
A limited liability company (LLC) is essentially a hybrid of a corporation and a partnership. An LLC provides the same kind of tax and liability benefits as a corporation, but has the same management structure as a partnership. In the past, LLCs have had more restrictions on them than corporations. For example, at least two people were needed to form an LLC and an LLC’s duration was specifically limited. However, in the last few years, states have started loosening these restrictions
For starting up entrepreneurs, MEI CPA, P.C. will be able to provide you consulting on choosing right type of entities, filing all required documents, keep your accounting books and prepare your tax returns. Please e-mail us at: firstname.lastname@example.org or call us at: 718-975-3363for any questions.
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