Common Business Structures

March 25th, 2010 · 12:48 pm @ jeffrey  - 

Sole Proprietorship

A sole proprietorship is a business owned by one individual.

  • Filings with the State.  Aside from obtaining a Master Business License and any local permits, no special paperwork or filings with the state are necessary to establish your business legally so long as you use your own name as the name of your business.  If you decide to use a tradename (for example, Joe Johnson wants to operate as Joe’s Bar and Grill), you must register the trade name with the State when you submit your Master Business License Application.
  • Employees.  A sole proprietor can have employees.
  • Taxes.  Income and expenses are reported on Schedule C attached to your Form 1040 Individual Tax Return, and income is taxed at individual tax rates.
  • Personal liability.  A sole proprietor is personally liable for all debts and obligations of the business.
  • Community Property Liability.  If a sole proprietor is married, the couple’s community property, including the spouse’s income, is at risk to satisfy debts and other obligations of the business.
  • Limited ability to fund losses.  Liability insurance may be able to fully fund losses incurred as a result of professional or general negligence, but the owner remains personally responsible for operating liabilities (office expense, payroll, taxes) and liabilities not funded through insurance.

Recommended where:  1) the owner has limited resources, 2) the owner is not sure whether the business will be successful, and 3) liability protection is not a major concern.

A corporation is an entity organized to carry on a business either for profit or not.

  • Filings with the State.  Articles of Incorporation and filing fee are required as well as annual maintenance and filings.  A corporate name must include the designation Incorporated, Corporation, Limited or some abbreviation of these words such as Inc., Corp. or Ltd.
  • Taxes.  Two options are available:  1)  C Corporation -  Subject to federal corporate tax rates.  Profits distributed as dividends are taxed as ordinary income to the shareholders; and 2)  Subchapter S Corporation -  Must qualify and file an election.  Profit is taxed at each shareholder’s individual tax rates rather than the corporate rates.  Self-employment tax does not apply to shareholder wages.
  • Employment Taxes.  The corporation pays employment taxes; shareholders do not pay employment taxes unless they are also employees.
  • Personal liability.  The shareholders are generally shielded from responsibility for the corporation’s debts and liabilities, but the “corporate veil” may be pierced for willful actions, such as breach a fiduciary duty, violation of law, or fraud.

Recommended where the owners:  1) work in the business, 2) want the tax advantages of a Sub S corporation, and 3) either want or are willing to deal with the formalities of a corporate structure.

Limited Liability Company (LLC)

A limited liability company functions more like a partnership but has liability protection similar to a corporation provided that requirements are met.

  • Filings with the State.  A Certificate of Formation and filing fee are required.  The entity name must include the designation Limited Liability Company or some abbreviation of that term such as LLC or L.L.C.
  • Taxes.  Treated same as a partnership, but an LLC may elect to be treated as a corporation for tax purposes and may lose its ability to be treated as a partnership if it has more than two of the characteristics of a corporation:  1) continuity of life; 2) centralized management; 3) free transferability of interests, and 4) liability for debts limited to the value of assets.
  • Allocation of profits and losses are as specified in the LLC agreement; otherwise, they are allocated according to the value of each member’s contributions.
  • All earnings of members are subject to self-employment tax.
  • Personal liability.  The LLC itself, rather than its members, is responsible for the debts, obligations and liabilities of the LLC, but members who participate in the management of the LLC are personally liable for certain acts and omissions, such as gross negligence, intentional misconduct or a knowing violation of law.
  • Professional LLCs (PLLC) must maintain a minimum of $1 million of professional liability insurance.

Recommended where the owners:  1) do not work in the business (e.g., passive income such as real estate rental income), and 2) there is only one owner or the owners know each other well (domestic partners, spouses, family members).

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