The answer to this is based on two factors, liability protection and tax considerations. How much liability protection you want to have is an argument best left to yourself. Then as a business owner, you want to avail of the tax breaks under the law in order to maximize your profits. Let’s take a quick look at the different business structures.
1. Sole Proprietorship: This is the easiest way to start a business. There are no specific costs required and the procedures are simple. You are the sole owner and the income from the business is reported in the owner’s personal tax return. Also, the sole owner has unlimited liability.
2. Partnership: A detailed partnership agreement is recommended when forming a partnership. Some of the items that need to be in writing are:
• Amount of capital contribution
• Rights and duties of each partner
• Method of profit and loss distribution
• Method of cash withdrawals and salaries
• Method of partnership dissolution should it become necessary
In a general partnership, partners have unlimited liability and they can be held liable for the actions of fellow partners. The partnership’s net income is passed through to the partners and reported in their personal tax returns.
3. Corporation: A corporation is a legal entity that exists separate from its owners. It is created by completing and submitting the Articles of Incorporation with the correct state authority. Some of the facts reported on the Articles of Incorporation are the following:
• Purpose of the corporation
• Names and addresses of the incorporators
• Amount and types of capital stock
• Rights and privileges of the stockholders
The main advantage of having a corporation is you limit your liability to the assets of the corporation only. Setting up a corporation will provide personal liability protection (giving you peace of mind) and substantial tax savings.
One of the known tax disadvantage of the ordinary “C” corporation is the double taxation. This is the reason why many business owners elect to operate their corporations under the subchapter S of the IRS Internal Code. An “S” corporation’s net income is passed through to the shareholders and included in their personal tax returns, thus avoiding the dreaded double taxation.
4. Limited Liability Corporation (LLC): This business structure is a hybrid entity that provides limited liability protection to its members and the income is passed through to the members and reported on their personal tax returns. An LLC can be formed for any valid business as long as the nature of the business is not insurance, banking and certain professional service operations. An LLC could be established by filing the Articles of Organization with the Secretary of State.
There are a lot of factors to consider when choosing your business entity. For further information, please contact Joyce Ramos, CPA at 661-310-3455 or visit www.joyceramoscpa.com .