We will start with discussing your current structure, a Sole Proprietorship. Since you currently are operating this way, it will be easiest, and make the most sense to explain it to you. As with the rest of the structures, we will go through a list of each of the seven characteristics of a business. Liability-First is a concern for you, liability, say for instance, in the situation of a contract employee. This could end up being a major concern for you. It is one of the larger disadvantages of a sole proprietorship. When it comes to liability, you, your finances, and your assets, are not kept separately.
What this means to you and your family is if anything ever happens, all of the liability and expenses falls to you. Huge drawback. Income Taxes- Next is income taxes. This is something I would actually consider an advantage. You and your business are taxed as one unit. You also have the ability to reduce your income tax by writing off your expenses. Longevity or continuity of the organization. – Longevity and continuity of your sole proprietorship is, well, nonexistent. Since you are the business, when you are no longer here, your business is no longer here. Again, another drawback.
Control: Whether or not control is an advantage or disadvantage is all up to you to decide. You have complete control over everything. Since you don’t have a partner, boss, board, or shareholders to answer to, you have complete control over your business. I see this as an advantage. Profit retention is all yours. You keep all of your profit, and will not be splitting it with anybody. This is another advantage. Location is another great advantage of a sole proprietorship. It is fairly simple to move your operation. Say for instance, you just had a new grandkid in another state, and want to move closer.
You simply end your sole proprietorship in your current state, and apply for a new one the next state. Easy as that. Next we can compare a General Partnership to what your current Sole Proprietorship. And we will go step by step making it a very easy comparison. Liability for a General Partnership is the same as for a Sole Proprietorship. You have no separation when it comes to you and the business. Taxes for a General Partnership are similar in a sense to the Sole Proprietorship, being a pass through entity. You and your partner will be able to write off expenses to decrease your taxable income.
No federal income taxes are imposed on the partnership. When it comes to longevity, General Partnerships don’t have much. Say, for instance you have a partner, who passes away, the partnership is immediately dissolved. This can have create serious problems for the remaining partner or partners. There are plans that can be put into effect to protect all concerned parties. If this is the route you decide to take, I highly recommend that you look into a buy-sell agreement. When it comes to the topic of control, you can easily see what the difference is going to be between a General Partnership and a Sole proprietorship.
Being that you will have a partner, you will have to make decisions as a team. You may set forth guidelines in the beginning, of who will be in charge of different topics and decisions. As you can see, this could be bad, if you want to have complete control, or great, if there are decisions you’re not exactly the best at making. General partnerships have split profit retention. You will be splitting the profits equally between all of the partners. This isn’t exactly bad, sense you will also be sharing the responsibilities with those same partners, as well as sharing the work load.
Location is a benefit for general partnerships. There is very little, if any paperwork needed to operate in another state. Which makes your possible desire to operate and expand your business to another state very simple. Convenience is clear with a general partnership. To start you just need to have a written or verbal agreement. Limited Partnership is your next option. There is actually a couple of different ways you would be able to set this up, but they are generally the same topics. Liability is a major difference in a Limited Partnership versus a General Partnership.
If you wanted to have a partner, with limited partnership, they will only be liable for the amount of control they have. They will not be in management, will not have much say in the day to day of the business decisions. The can be looked at as simply an investor in the company. Your liability is still the same. If your financial debt cannot be satisfied by the business assets, you are responsible with personal assists. Your Limited Partnership will also not be taxable. You will be able to write of the expenses just the same as the General Partnership and Sole Proprietorship.
So far, all of the businesses we have discussed have benefits from taxes. Longevity of a Limited Partnership company is a little tricky. If the limited partner passes away, their portion of the assets are due to the limited partner’s personal representative. During a separation, the limited partner has priority to their shares over the General partner. The death of the limited partner doesn’t affect the business; however the death of the general partner can end the business. In a Limited Partnership, with you being the General partner, you will have complete control of the business.
As previously mentioned, you will be running the day to day and your limited partner will be more or less a silent partner. Profit retention is going to depend on how much the limited partner has invested in the business. You will work out the details on the front end, and that will determine what each of you get. The nice thing is, you will get to keep most of the profit. Locations for a Limited Partnership are the same as with a General Partnership. Since all you have to do is have a written or verbal agreement, it is very easy to establish your Limited Partnership in another state.
This is a convent way for you to get extra help when needed, but to also give you the great income, and decision making powers. Your next option would be what is called a C-Corporation. When it comes to your liability in a C-Corp, it is very limited. Your business is what is liable for the losses. If, say, your business fails, you are only responsible for the money you paid into the business. If that does not cover all debts, creditors can’t come after your personal assets. This is how you can protect your personal assets. Income taxes are now going to be a little different than the previously discussed businesses.
You still are going to be able to reduce the business taxes by the utilization of any and all of your expenses and depreciation, but now, if you chose to pay dividends, you can see double taxation. I still see this as a benefit for your business. On top of that, your current insurance you have now will be able to write more of that expense off. You also have two options of how you can be paid, first, by previously discussed dividends, second, and what I would recommend, is whatever salary you chose. The salary option is the better option, thanks to the fact that it will be an expense that the business can write off.
Longevity: When you die, your business does not die in a corporation. A key member, yes, but not the business, since you are kept separately. Control in a C-Corp is decided by shareholders who will elect the board. For instance, you would be elected as the CEO, and would control the day to day operations. You would also make all of the decisions that affect the business, including dividends. Profit retention will depend on how you decide to pay out dividends. Again, the dividends are the excess profits made in a given year. You as the President and CEO, as elected by the shareholders, will decide when and how much is paid out.
So, as you can see, you decide how profit retention will be decided. When it comes to location of a C-Corp, most states, in some ways, what’s called the Model Business Corporation Act. And the general rule of thumb is, incorporate in the state that you are doing your most work. Or, if you do a large amount of interstate business, you will want to look at which state has more favorable laws. Some things to look at are taxes and powers granted to the corporation. S-Corporation This is your next option, which is very similar to a C-Corp, but we will go step by step on each aspect of it.
Liability: Liability for a S-Corp is similar to a C-Corp. Since you have incorporated, you will separate yourself from the liabilities of the corporation. You will only be financially responsible for what you actually pay into the business. Income Taxes: This is where you will see the biggest difference between a S-Corp and a C-Corp. This is by far the more favorable for you to go with a S-Corp. Business losses and expenses are passed through to the investors, so this will help you reduce your personal income. Longevity: Like the C-Corp, a S-Corp does not die with the loss of a shareholder, or key member.
This is a huge advantage over a partnership. Control of a S-Corp mirrors that of a C-Corp. The shareholders/investors will vote on who will run the company on a day to day basis. That person will likely be you, and you will decide how the business runs. To go back to being a C-Corp, the shareholders must vote on it. Profit Retention is dividends which are excess profit. S-Corps usually write off so much in expenses that they do not have dividends to pay. Therefore, you won’t have to pay out any profits. Location: You will follow similar guidelines for an S-Corp as you would for a C-Corp.
You will want to incorporate with which ever state is the most favorable with their laws. Limited Liability Corporation This is the final option for you. It is often called an LLC. You could look at an LLC as a hybrid, where it is combining different aspects of S-Corps, C-Corps, and partnerships. It is very closely related to an S-Corp, with more advantages and less disadvantages. Liability: Like a Corporation, and like the name says, you will have a limited amount of liability. Your personal assets will be protected, and you are liable for what you pay in.
As well as if you have investors or partners. Income Taxes: Like partnerships and S-Corps, you are not double taxed, and you can still use all of the expenses as write offs. Longevity of an LLC is very favorable. Even though in most states, the LLC ends for several reasons, including your death, most states will let the remaining members vote to continue business. Control in an LLC may vary. If you decide to become an LLC without having investors, you will still be the owner, and have complete control. If you decide to bring in investors, the control will be decided by the members of the LLC.
Profit Retention will be all yours if you do not bring in investors. If you bring in investors, the profits which are dividends will be divided equally. Location is very easy, with just simple paperwork to be filed out for the states you wish to operate in. You will file Articles of Organization for the each state. An LLC is very convenient, and will give you the best of both worlds. You will have the tax benefits like a sole proprietorship or partnership, but the limited liability like a Corporation. Plus with the ease of creating it, it is very convenient. Memorandum To:Business Owner CC:
From:Noah Bracking Date: [ 7/18/12 ] Re:Business Structure Recommendation Confidential Upon review, of each different business option, as well as your desired needs, it is our recommendation that you set up an LLC. The reason you should be setting up an LLC is that you will gain the benefits of having limited liabilities of a corporation, but give you the huge tax benefits of a partnership. Also, concerning liabilities, you mentioned the contract workers. If your worst fears are met, and there is a serious problem, and you’re sued, they can only come after the business, and not your personal assets.
Your concerns about what will happen if bills and liabilities of the business if you should fail, and how your personal assets are protected is answered, by having the liabilities limited to the business itself and what you paid in. You mentioned your desire to expand, and maybe offer shares to your family. This is a great option because interest cannot be transferred unless approved by the members. So, if for instance, your wife is a partner, and you get divorced, and she wants to sell, you must first approve the sale. Creating an LLC will also insure that you maintain control of the company.
You will be the managing member of the LLC, and control the company for the day to day. In terms of your profit retention, that is going to be based solely on how you wish to set it up. If your business does have a surplus of profit, the profits will be divided between the members. It would also be very easy to operate in more than one location. You mentioned that you would possibly be operating in a neighboring state, and with an LLC, the paperwork to file in the next state is very easily done. As you can see, LLC is by far, your best option. This option will address your concerns, and protect your personal assets. a