Solid legal structures, which include a business entity and customized contracts, are essential for business success.
There are several types of business structures in the U.S. Each structure has different tax, income, and liability implications for businesses owners and their companies. Accountants are a good resource when determining the type of business entity.
Sole Proprietorship
Sole proprietorship is the simplest organizational structure available for businesses. A sole proprietorship is just a single person who does business through a fictitious business name. Businesses that typically form sole proprietorships are home-based businesses, shop or retail businesses, and one-person consulting firms.
Partnership
A general partnership is usually two or more people who do business together without forming a formal, separate business entity. Each partner has equal share in the net profits and losses of their business.
While doing business as a sole proprietor or a general partner, then there’s really no separation between the business’ and personal assets in the event that there is a claim against the business. Personal business assets are often commingled. Even a separate credit card that has the business name is usually under a personal social security number. Sometimes business accounts are operated from personal accounts, which makes it difficult for a future potential buyer of a business to determine what they’re buying and what they’re not buying.
It is very important in a general partnership to keep track of each partner’s doings and sayings as each partner is responsible for the other.
Corporations
The most complex organizational structure for businesses is the corporation. There are two common types of corporation structures: Subchapter C and S. The difference between the two subchapters stem from different tax rules. A C corporation is subject to what’s called double taxation, meaning the income and losses of the corporation are taxed at the corporate level. Then to the extent the corporation makes profits which are distributed to the shareholders as a dividend, then the individual shareholders are taxed again on the profits.
A corporation has shareholders, a board of directors, and officers. A corporation is required to have an annual corporate meeting where the shareholders elect the directors and the directors appoint the officers. Corporations should always have special meetings when significant activities occur for frigidity.
Limited Liability Company
The limited liability company (LLC) structure is considered a hybrid as limited liability companies can be formed as corporations or partnerships. LLCs have managers that are the equivalent of a board of directors. The officers run the day-to-day activities of the business. Members are the equivalent of shareholders. An LLC can be manager-managed, meaning a single manager or multiple managers, or member-managed meaning any person that’s member is also a manager.
The taxation of LLCs also depends on its structure. It varies state by state, but each state does have an annual fee that gets paid by LLCs, as well as corporations. A lot of people don’t realize that an LLC can elect to be taxed as an S corporation. This structure allows small business owners to take advantage of the flexibility of an LLC.
It’s imperative to keep LLC accounts separate from personal accounts. Personal expenses should never be on a corporate credit card or an LLC corporate credit card, unless it can be justified through a tax advisor or called a distribution.
Insurance
Oftentimes business owners don’t even know that insurance for their business is needed—no matter how small—or what kind of insurance. Or a business may have a certain amount of insurance coverage, but a claim exceeds the amount that the policy limits.
Business owners should always consult with an experienced insurance broker, one that is experienced with writing business or commercial policies of insurance. An insurance broker will be able to bundle together different types of insurance.
Employer’s liability Insurance is a good policy to have if a business has employees, though it’s not required. Workers compensation insurance is required even if a business has only one employee. Sometimes professional liability (also known as errors and omissions coverage) can apply in other circumstances, such as consulting services.
Agreements and Contracts
It’s important to have a customized contract. Too many business owners will copy and paste sections from different contracts from others or online services.
For example, a benefit of an LLC is the operating agreement, which is the key document in that entity. An owner can specify levels of authority between the managers and members in that document. Certain limits on the authority of one person or another are able to be placed. No special meetings or minutes are needed long as there is a written operating agreement.
Important contracts are also with independent contractors. When hiring independent contractors, a business owner needs to have a written contract specifically stating they are independent and not an employee of the business.
Next steps
Whether you’re in the process of considering which type of entity to form or if your business has been established for years, having a strong relationship with a business attorney and tax advisor will help determine what is the best taxation structure for the entity. Even after a business structure is established, remember that the circumstances that make one type of business organization favorable are always subject to changes in the laws. It makes sense to reassess the form of business from time to time and having the right team in place makes this process easier.
The knowledgeable team at Chase Law Group, P.C. is always available to answer questions and provide consultation for small businesses. Sign up in the upper right corner on any page on this site.