Corporate Structure Review
Determining the appropriate corporate structure for your small business can be daunting. But separating the business from your personal affairs for tax and legal reasons can:
- Provide a barrier that protects your home and assets from creditors
- Ease ownership transfers
- Allow for a more flexible pension plan
- Facilitate capital-raising for expansion
It is common for a business owner to change the business structure as it evolves and tax and financing issues become more complex.
The following define some common corporate structures, offering both the advantages and disadvantages of each.
- An unincorporated business owned by one person.
- The simplest type of organization: the business does not exist apart from the owner.
- Simple to organize and easy to discontinue.
- Minimal legal restrictions.
- The owner has maximum freedom to make decisions.
- The owner receives all profits.
- The individual owner has unlimited liability for all debts of the business.
- Business financing is limited to what the owner can secure or produce personally, which may hinder expansion.
- Business and personal creditors can claim all of the proprietor's assets.
- A relationship between two or more persons who operate a trade or a business.
- Easy to organize and has a definite legal status.
- May have greater financial strength than a sole proprietorship.
- Combines managerial skills and judgments of the partners.
- Each partner has a personal interest in the business.
- Each partner has unlimited liability for the debts of the business and the acts of employees and the other owners.
- Divided authority for decision-making.
Limited Liability Company or Partnership (LLC or LLP)
- A separate legal entity formed by filing articles of organization with the state secretary's office.
- Combine certain features of partnerships with the limited liability feature and other features of corporations.
- Individual members are not personally liable for debts or liabilities, except to the extent of their investment in the company.
- An LLC or LLP is not a federal tax entity and is generally treated as a sole proprietorship or a partnership by the IRS.
- An S corporation is a small business whose shareholders elect to have corporate income taxed similarly to a partnership.
- The income, losses, tax credits, and other tax items of the corporation flow through the corporation to the shareholders. Thus, income is only taxed once, at the shareholder level.
- Most fringe benefits provided by the corporation are taxable as compensation to employee-shareholders who own more than 2 percent of the corporation.
- Limited to 75 shareholders (100 shareholders for tax years after 2004).
- A legal entity that has a life, rights, and duties separate from its owners, which are the stockholders.
- Formed by the transfer of money, property, or both by the prospective shareholders, in exchange for corporate stock.
- The life of the business is perpetual.
- Stockholders have limited liability.
- Simple transfer of ownership, via sale of stock.
- Management may be more efficient.
- Easier for corporations to raise capital and to expand than it is for other forms of business.
- Adaptable to both small and large businesses.
- Subject to tax on income at the corporate level. Dividends are taxed again to the shareholder.
- May be more difficult and more expensive to organize than other forms of ownership; may require an accountant and an attorney.
- Subject to many state and federal controls.
- The corporate charter filed with the state restricts the types of business activities the corporation may conduct.
In choosing a structure for your business, consult with an attorney and a CPA who specialize in business formation. There are also several online services that provide the necessary state and federal forms and filing information, though some are more comprehensive than others.