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Choosing a business entity can be stressful. Your business can take on the form of one of many business entities.
Choosing a business entity is more an art than a science. When deciding which entity to choose, you can consider many perspectives. However, two of the most important perspectives are the tax implications and the exposure to liability you may have as a business owner. (Note that these are only two of many other countless perspectives to take.)
It is important to discuss your personal situation with a Tax Attorney-CPA to ensure that you consider all relevant perspectives.
For each of the following business entities, ONLY the tax implications and liability exposure are discussed.
A sole proprietorship is the simplest type of business entity. It requires little or no paperwork. Just start doing business; you don't have to do anything else.
Business income or losses pass through to your personal tax return.
You are personally liable because no legal entity shields you from liability or business obligations.
Because sole proprietorships are so closely held, future expansion is not investor-friendly.
General partnerships are automatically formed when two or more owners start doing business together. Similar to a sole proprietorship, little or no paperwork is necessary to form a general partnership.
For a general partnership, unless explicitly stated in the partnership agreement, the implication is that the general partners share in the management of the partnership and in the partnership’s profits and losses.
A general partnership is a flow-through entity. This means the partnership itself does not pay taxes. Rather, its income and expenses flow through to each of the partners, who pay taxes at the individual level.
Similar to a sole proprietorship, each partner in a general partnership is personally liable because no legal entity shields them from liability or business obligations.
In a general partnership, all partners are jointly and severally liable for each partner’s negligence and/or misconduct. Not only do general partnerships refrain from providing you with personal protection from liability, they expose you to more potential liability through the actions of your partners.
Because general partnerships are so closely held, future expansion is not investor-friendly.
A limited partnership has two different types of partners: general partners and limited partners. General partners typically manage the partnership, while limited partners simply share in the partnership’s profits and losses.
Limited partnerships are created when the general partners execute a partnership agreement, then file a "Certificate of Limited Partnership" (and pay associated fees).
In addition, the New York State Revised Limited Partnership Act requires that the formation meet the publication requirement (i.e., publicizing the formation in two local newspapers within 120 days of formation).
A limited partnership is a flow-through entity. This means the partnership itself does not pay taxes. Rather, income and expenses flow through to the general and limited partners, each of whom pays their own individual taxes.
General partners are involved in the partnership’s operations. Accordingly, as with a general partnership, they are personally liable for the limited partnership’s business liabilities.
Limited partners share in the profits of the limited partnership, but not entirely in the losses; a limited partner can lose only up to the amount of their investment in the limited partnership.
Because a limited partnership has two different types of partners (general and limited), it is easier to expand.
A corporation is formed when a "Certificate of Incorporation" is filed with the New York Department of State (and when associated fees are paid). Unlike with an LLC (discussed below), no publication requirement exists. However, some other requirements can be costly to form/maintain:
A corporation is a separate taxable entity, unlike a partnership, which is a flow-through entity. Shareholders (i.e., the corporation’s owners) can lose some profit through double taxation, as both the net income of the corporation and the profits distributed to the shareholders are taxed.
However, some benefits are associated with the taxation of a corporation. The corporation’s owners do not pay taxes on any profits that the corporation does not distribute (meaning only the corporation will pay taxes). Generally, corporations have a lower tax rate than individuals. This can be especially appealing if you are looking for a corporation to invest in itself and not take many distributions.
A corporation is a legal entity separate and distinct from its shareholders (i.e., the corporation’s owners). Accordingly, shareholders receive personal protection from business-related liabilities (i.e., lawsuits and liens).
A corporation is the easiest business structure to expand because it allows business owners to sell shares of its stocks (i.e., stock offerings). Therefore, growing or expanding your business (i.e., raising capital) is extremely easy.
LLCs are hybrids of a corporation and a partnership. LLCs get limited liability benefits similar to those of a corporation and the operational flexibility of a partnership.
An LLC is formed when "Articles of Organization" are filed with the Department of State (and when associated fees are paid).
In addition to the filing of the "Articles of Organization," LLCs have a publication requirement. The newly formed LLC must publicize its formation in two local newspapers within 120 days of filing.
Furthermore, an LLC has an additional operating agreement requirement. Within 90 days of filing, the LLC must adopt a written operating agreement. This operating agreement is an internal document and is not filed with the Department of State.
Unlike corporations, LLCs are not separate taxable entities. An LLC is a flow-through entity, similar to a partnership. This means profits and losses pass through to each individual owner, who pays their own taxes. The LLC itself does not pay taxes.
LLCs are legal entities distinct from their owners. Accordingly, like with corporations, LLCs give their owners personal protection from business-related liabilities (i.e., lawsuits and liens).
LLCs, like corporations, are easy to expand because they allow membership interests to be bought and sold.
In certain circumstances, the proper formation entity might be a Limited Liability Partnership or an S-Corp. Please schedule an appointment to determine whether either of those two business entities are options for you.
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