By Kurt English, Esq.
As the owner of a sole proprietorship, you will have unlimited personal liability .When you start a business, you should consider what type of structure you want. If you don’t choose a structure, the government will decide for you. You might not like the result. We will review the major types of business structures so that you can think about which one might be best for your business.
Unlimited Liability Entities:
Sole Proprietorship
If you start a business by yourself without taking any formal legal steps, your business is a sole proprietorship. If you take no steps except to file a Fictitious Business Name Statement, your business will also be a sole proprietorship.
As the owner of a sole proprietorship, you will have unlimited personal liability for anything that happens as a result of your business activities. All of your personal assets will be at risk. All income from a sole proprietorship is shown on your personal tax return.
General Partnership
If you and at least one other person start a business together without taking any formal legal steps, your business is a general partnership. If your group takes no steps except to file a Fictitious Business Name Statement, your business will be a general partnership. You and each of your partners have unlimited personal liability for your own actions, and the actions of each of your partners. A partnership is the riskiest form of business ownership. You can control your actions more easily than the actions of other people.
Recommendation
Instead, many experts recommend that before starting a business it makes sense to consider going through the formal process of establishing a limited liability entity discussed below.
Limited Liability Entities:
Corporation
If you file the necessary papers required in a state, called Articles Of Incorporation, you can create a corporation. If operated properly, a corporation can limit the personal liability of its owners (called shareholders) to the amount they each invest in the corporation. Starting a corporation may cost over $100 in fees and several hundred dollars of legal fees.
Normally, your corporation would be a “C” corporation. C corporations are taxed as separate entities. If you own a C corporation as the only shareholder, and if you don’t remove all of the income each year, you may pay two levels of taxes: corporate income taxes in the year the income is earned; and personal income taxes in the year the corporation pays the profits to you. C corporations can have any tax year, not just January to December. Your tax advisor may find this helpful with your personal tax planning.
The IRS allows your corporation to “pass through” its income and losses to its shareholders to avoid double taxation. If you want to do this, you file a form with the IRS, declaring “S” corporation status. You avoid the potential double taxation of a C corporation. But S corporations must have a January to December tax year, just like individuals.
Limited Liability Company
A limited liability company is a blend of attributes of partnerships and corporations. It gives its owners limited personal liability like a corporation, but has the tax complexity of a partnership. It is started by filing Articles Of Organization.
Seek Advice From Your Lawyer and Accountant First
The impact of the various liability and taxation issues on you can be substantial. They are different for different people who are in different circumstances. Many experts agree that the best way to protect yourself is to seek competent tax and legal advice from professionals licensed to practice in your state.
A competent lawyer can help you to perform the corporate formalities necessary to maintain the corporation’s limited liability feature. A competent CPA or tax advisor can help you with overall tax planning to optimize both your tax consequences and your company’s tax consequences. If you get good advice before your start your business, you could save thousands, and even millions, of dollars later.
HBM Disclaimer: Neither the author of the Home Business® Magazine is providing tax or legal advice. You should hire a CPA or a lawyer for such advice tailored to your specific circumstances.
The author is an attorney licensed to practice law in California. He can be reached at frfi@hotmail.com.
