Business Selection



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BUSINESS ORGANIZATIONS

The most common forms of business organizations include:

Sole proprietorship
Partnership
- general partnership
- limited partnership
- limited liability partnership
Corporation
- Subchapter S corporation
- Subchapter C corporation
Limited liability company

The form in which you conduct your business determines issues such as the extent of personal liability that you have from the business and how the business will be taxed.

A business is an activity performed for profit.

A business differs from a hobby in that a business seeks a profit, is run in a systematic, continuous and regular businesslike manner, and has ordinary commercial principles governing it (such as business and accounting records). A person who collects and sells baseball cards on a regular basis from a store is engaged in a business, while a casual collector, who will occasionally trade a card or two with friends is probably engaged in a hobby. The distinction is important for tax purposes as losses from a business are tax-deductible, while losses generated from a hobby are not.

SOLE PROPRIETORSHIPS

A sole proprietorship is you doing business as yourself, even if you use a fictious name. It is simple, but it affords no asset protection. Anything you or an employee of the business does is your personal liability and exposes your assets to liability.

GENERAL PARTNERSHIPS

An arrangement in which two or more individuals or other persons (such as a corporation and an individual) conduct business as "partners", whether officially or not, is a partnership. In terms of asset protection, general partnerships can be even worse than sole proprietorships. Anything that one partner does affects all of the partners, because each partner of the of the general partnership is personally responsible for all obligations of the partnership. Thus each general partner's exposure to risk is increased by a factor equal to the number of general partners in the business. Most people entering a partnership would be better off forming a limited liability company or a limited liability partnership.

LIMITED PARTNERSHIPS

A Limited Partnership ("LP") is an association of one or more general partners together with one or more limited partners to conduct business for profit as co-owners. The most important feature of a LP is that the limited partner enjoys limited liability as long as s/he does not participate in the control of the partnership business. The general partners of the LP are the ones who are responsible for the obligations of the LP.

In a limited partnership, it is the general partner who remains liable for the debts and obligations of the entity. For larger risk exposure, a corporation may be formed to serve as the general partner. A corporate general partner is protected from direct attack by a judgment creditor because the ultimate liability for the debts and obligations rests with the shareholders. By spreading share ownership, individual exposure is considerably reduced. Even without a corporate general partner, risk can be spread by distribution of limited partnership shares. If a judgment creditor obtains a charging order against one partner, the order goes to that partner's share in distributions from the partnership, and not to the entire business.

LIMITED LIABILITY PARTNERSHIPS

A Limited Liability Partnership or LLP is a relatively new creation that operates much like a limited partnership, but allows the members of the LLP to take an active role in the business of the partnership, without exposing them to personal liability for others' acts except to the extent of their investment in the LLP. Many law and accounting firms now operate as LLPs.

CORPORATIONS

A Corporation is a legal entity that is separate and distinct from its members and shareholders. A corporation enjoys perpetual life, unless expressly limited by law or the articles of incorporation.

S CORPORATIONS

An S Corporation ("S Corp.") is an ordinary business corporation that has elected to be taxed under Subchapter C of the Internal Revenue Code. It is not taxed on its earnings as a corporation, but instead its earnings are passed through to its shareholders for tax purposes.

However, an S Corp. has certain limits on the number of shareholders it may have and who may be shareholders,is limited to one class of stock and has to operate under a group of other rules.

S Corps have the following advantages:

Losses can be passed on to the investors,

Two levels of taxation can often be avoided,

There are no accumulated earnings tax, and

There is limited liability protection.

Conversely, the S Corp. suffers from the following drawbacks:

At-risk limitation, basis limitation on losses, passive loss limitations and investment interest limitations are all in effect,

Individual alternative minimum tax consequences may arise, and

The S Corp. may not be brought forward in a public offering to raise capital.

C CORPORATIONS

C Corporations are ordinary business corporations that have not elected to be treated as Subchapter S corporations.

They have some very strong advantages:

Limited liability,

No restriction as to the number of shareholders,

Fewer problems with passive loss rules,

Favorable loss carry-forward rules, and

liberal fringe benefit opportunities.

C Corps suffer from several drawbacks such as:

Two levels of taxation,

Subject to accumulated income tax, and

Pass-through of losses to investors is not available.

LIMITED LIABILITY COMPANIES

Available for use in most states, the limited liability company ("LLC") is a relatively new form of entity that combines the advantage of a partnership with the advantage of a corporation's limited shareholder liability, even if the owners participate in the management of the company. LLC's enjoy the following advantages:

Limited liability protection,
No restriction on the number or nature of shareholders,
"Pass through" of entity losses to investors (that is, profits and losses are passed on to partners without being taxed),
Avoidance of two levels of taxation,
Flexibility in design of structure, and
Easy removal of assets from the business.

Conversely, LLC's have the following drawbacks:

Not every state has an LLC Act,
The operating agreement must be carefully drafted,
At-risk limitation, basis limitation on losses, passive loss limitations and investment interest limitations are all in effect,
Individual alternative minimum tax consequences may arise,
It can be more difficult to make a public offering than with a corporation.

STARTING A BUSINESS

To start a business it is a good idea to have an understanding of the business, written business plan, a good understanding of the economics of the business, some experience in a related business, and enough funds to be able to cover your costs until the business becomes profitable.

Before starting a business, it is often a good idea to speak to an accountant and a lawyer so that you understand the tax and legal issues and if desirable, structure the business to minimize taxes and avoid legal problems and reduce the chances for personal liability. A brief, inexpensive consultation can save you huge amounts of money, long term and short term!

The legal structure of your business is extremely important. State law enables you to create a legal entity - a separate "identity" from your own person - under which you can transact business, without the risk of exposing your assets to any personal liability that might arise out of your business affairs.

TAXPAYER IDENTIFICATION NUMBERS

If you are a going to operate a business that has employees you must have a taxpayer identification number, which is often referred to as an "EIN" (employer identification number). An EIN is a number assigned to a business for tax reporting and withholding deposit purposes - it is different from your individual social security number. Both a federal and a state EIN are required.

An EIN is required so that withholdings (federal and state income tax, social security and Medicare taxes, unemployment insurance, and other taxes) can be remitted to the Internal Revenue Service and state tax authorities. The Internal Revenue Service and many state tax authorities publish pamphlets and booklets which can help you determine whether you need a separate EIN for your business.

LICENSES AND PERMITS?

The need for a license or permit depends on the business you engage in, the location of the business, and federal, state, county, city, and local rules and ordinances.

Some businesses and professions require a license from the state (for example, barbers and beauticians, doctors, lawyers, day care providers, and similar principles.

Cities and counties require permits for many business activities (such as construction or elevator operations permits). In addition, many local governments require a business license before you start your business (a license requiring payment of an annual fee or tax to do business in that city or town).

Business activities are generally regulated by government agencies. Many local governments have information centers for small businesses to assist with compliance to local, state and federal regulations.

DO I NEED A TRADE NAME STATEMENT?

If your business will operate under a name different from its official name, you should complete a trade name statement, publish the statement in a newspaper of general circulation, and then record this information with the County Clerk of Court where the business is located. Corporations are generally exempt, as are businesses that use the individual proprietor's own name. If you are "doing business as" (d/b/a), generally you need to comply with trade name rules.

DO I NEED INSURANCE?

Whether you need insurance depends on your business activities and the amount of liability exposure that you have from the activity. In addition, insurance may be required for employees (such as worker's compensation insurance, state disability insurance, or unemployment insurance).

Some common forms of business insurance include:

commercial multi-peril policies (covering a variety of exposures)
liability insurance covering premises, activities, and products
business interruption insurance
surety and performance bonds
employee fidelity bonds
malpractice and errors and omissions coverage

In deciding whether to purchase insurance, an analysis of your risk exposure should be performed. If you are unable to determine your risk of loss from engaging in business, contact a commercial lines insurance broker.

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