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Basic Business Entities
Business entities come in many forms based on the type and needs of the business. They are structured to protect the assets of the business and the proprietors, and minimize taxes and legal liability. Four of the most simple types of entities are: Sole Proprietorship, Partnership (General and Limited), Limited Liability Company and Corporation (C and S).
A Sole Proprietorship is the simplest entity, defined as an individual conducting business. The benefit of a sole proprietorship is that the individual receives all profits but pays self-employment taxes on all earnings. The operation is also simple. The individual makes all business decisions with no meetings or minutes required. The liability is assumed completely by the individual, and all assets may be transferred upon the sole proprietor’s decision. This type of entity has no protection against lawsuits, but is easy to administer.
General Partnerships are defined as two or more individuals conducting business for profit, the benefits are that the partners split profits (or losses), but the entity pays self employment taxes on earnings. Daily operation is simple, in that either partner may bind or make commitments on behalf of the partnership, and no meetings or minutes needed. All partners are jointly and separately liable for all obligations of the partnership. The benefit is that the partners split all profits but pays self-employment taxes on all earnings. This type of entity has no protection against lawsuits, but is easy to administer.
Limited Partnerships are also defined as two or more individuals conducting business for profit. The difference between General Partnerships and Limited Partnerships is that the general partners have all the liability risk and the limited partners have no liability. The powers and responsibilities are defined by agreement. Limited partners are prohibited from management and control of the partnership, except what is on the list. Again, general partners are jointly and severally liable for the obligations of the partnership, whereas limited partners have no liability.
A Limited Liability Company is a legal entity organized under the laws of the state with at least one member. The benefits of this kind of company are that members share in profits and losses and can elect to avoid SE taxes. Operation can be by members (any member can bind the LLC) or by manager (only the manager can bind the LLC). An LLC is liable for its own debts with no personal liability/negligence to members. A Limited Liability Company, structured properly, will protect the members of the LLC’s personal assets.
C-Corporations are legal entities organized under the laws of the state. The duration is perpetual in most cases, there must be at least one shareholder and a corporation may declare dividends. Shareholders receive the profits of the corporation (as dividends –with no Self Employment Tax) and salary tax must be paid on salaries. In terms of operation, shareholders own the corporation, directors are elected by the shareholders, officers manage day-to-day operations of business and meetings are required. In terms of liability, a corporation itself is liable for its own debts/negligence. The directors, and officers are liable to corporation for personal acts but have no personal liability to shareholders.
S-Corporations are a special type of tax election where the number of shareholders is limited to no more than 100 and there is no corporate level tax. The difference between a C-Corp and S-Corp is how it is taxed. The S-Corp has one pass-through tax to the shareholders, and no corporate tax. A company would switch to a corporation format when the business needs to raise capital to operate or grow. At that point shares would be authorized and then sold on private or public exchanges.
Please contact the firm if you need legal assistance with business formations, tax law, acquisitions, and mergers. If you are interested in learning more about the tax benefits of these business entities, read more here.