Why Your Business Structure Matters
The structure you choose for your business will guide business decisions. Some of the most common business structures are sole proprietorships,[1] limited liability companies (LLCs), C corporations, S corporations, and general partnerships (GPs). This article outlines key factors to consider when choosing a business entity, such as liability protection, ownership structure, funding, and tax classifications.
Personal Liability Protection
Safeguarding personal assets is a critical consideration for many business owners. Business entities, not their owners, are generally responsible for the debts, obligations, and liabilities of the business; however, it is important to seek legal counsel to avoid common mistakes that can void such protection, such as mixing personal and business funds or breaching legal obligations.
Note. General partnerships do not offer personal liability protection. With a general partnership all partners are jointly and severally liable for partnership obligations. In other words, each partner can be liable for the full amount of a debt, obligation, or liability of the partnership.
Ownership and Capitalization
The structure chosen dictates who the owners can be. C corporations are often the most appealing choice for outside investors.
LLCs: can have more than one class or group of members or membership interests.
C Corporations: can have multiple classes of stock as well as different series of stock with different rights and preferences.
S Corporations: only one class of stock permitted; however, certain debt instruments may be treated as a second class of stock under federal rules. An S corporation cannot have more than 100 stockholders and all stockholders must be individuals or eligible trusts, and U.S. citizens or resident aliens. Nonprofits can also own stock in an S corporation.
General Partnerships: can have more than one class of owners or groups of partners.
Tax Classifications
The tax classification of a business dictates the federal tax rules that apply. For tax purposes, businesses can be classified as one of the following: disregarded entity, C corporation, S corporation, or partnership.
Disregarded Entity: A disregarded entity is an entity with a single owner that is generally ignored for tax purposes. The owner is considered to own the assets (and subject to all business liabilities). Under this classification, the business owner reports the entity’s income and expenses on their tax return. This is the default tax treatment for single-member LLCs.
C Corporation: C corporations are subject to double taxation. In other words, they are taxed at the entity level when profits are made and at the shareholder level when profits are distributed as dividends. This is the default tax classification for corporations.
S Corporation: Under this classification, profits and losses pass through to the entity’s shareholders who include their respective share on their tax returns. C corporations can elect to be taxed as S corporations, but the election must be made by certain deadlines to avoid adverse tax consequences.
Partnership: Partnership profits and losses are allocated among members annually and pass through to the partners to be included on their personal income tax returns. Businesses that choose this tax classification are subject to self-employment tax. This is the default tax classification for multi-member LLCs and partnerships.
Before forming an entity, I highly recommend that you contact a lawyer and an accountant to assist with forming the best structure for your business’s goals.
For assistance, call me at (682) 238-1603 or email me at aisha@prmrcounsel.com.
[1] A sole proprietorship is an unincorporated business that one person owns and manages. The owner is essentially the business and, therefore, responsible for all debts, obligations, and liabilities of the business.