When it comes to starting a business, one of the most important decisions you’ll need to make is what type of business structure you’re going to use. The choice you make on this decision will affect your taxes, amount of paperwork your business is required to do, and the personal liability you face. There are several different business structures and today we’re going to break down the differences of each of them.
First, here are the most common business structures:
- Sole Proprietorship
- General Partnership
- Limited Liability Company (LLC)
Now, let’s break them down and learn about the differences:
A sole proprietorship is the most common business structure used for a few simple reasons: it is easy to create, owned by one person, and offers the complete control to the owner.
Something to keep in mind, for sole proprietorships, an owner of a sole proprietorship cannot be on payroll and collect a wage, so there are no taxes withheld from your business income and you therefore need to make quarterly estimated tax payments if you’re expecting to make a profit. The estimated taxes will include both the income tax and self-employment taxes for Social Security and Medicare. In addition, as the owner of a sole proprietorship, you are personally liable for all financial obligations and debts of the business, and any assets that you own in your name alone are subject to attachment to pay the debts of the business. It is also important to know that sole proprietorships operate under fictitious names, and in Pennsylvania filing to register a fictitious name does not give you exclusive rights to use the name.
A general partnership is a business that is owned by two or more people. Each individual contributes to the business through money, property, labor or skill and shares the profits and losses of the business. The individuals in a general partnership are not considered employees so they cannot be on payroll and collect a wage, and will therefore not have taxes withheld from their pay and will need to pay quarterly estimated tax payments. Each individual must report their share of the partnership profit or loss on their Form 1040 tax return. As with a sole proprietorship, the individual partners are personally liable for all financial obligations and debts of the partnership and any assets the partners own in their individual names are subject to attachment to pay the debts of the partnership. Also like a sole proprietorship, a general partnership operates under a fictitious name that the general partnership does not have exclusive rights to.
The corporation is the most complex out of all of the business structures and is generally suggested for larger companies. Corporations have shareholders and generally have a board of directors and officers. The shareholders own the corporation, elect the board of directors, and vote on fundamental issues, such as mergers, consolidations, dissolution, or sale of the corporation’s assets. The board of directors elect the officers of the corporation and oversee issues that generally fall between fundamental issues and the day to day affairs of the corporation. The officers of a corporation (president, secretary and treasurer) oversee the day to day affairs of the corporation. At a minimum, the shareholders and board of directors of a corporation must have an annual meeting each year.
Unlike a sole proprietorship or general partnership, a corporation has exclusive rights to the name that it registers under when it files its articles of incorporation with the Commonwealth of Pennsylvania. Also, unlike a sole proprietorship or general partnership, an owner of a corporation who works for the corporation can be on payroll and collect a wage. The owners of a corporation only need to pay estimated quarterly taxes on earnings the owners receive that are in excess of any wage the owner receives. Finally, the liability of an owner of a corporation for the debts of the corporation is limited to the owner’s investment in the corporation. An owner of a corporation is only personally responsible for the corporation’s debts if the owner expressly agreed to be responsible for such debts.
Under the Internal Revenue Code, corporations can be taxed as either c-corporations (c-corps) or s-corporations (s-corps). A corporation that elects to be taxed as a c-corp pays its own taxes. C-corps suffer from the classic double taxation problem because after the corporation pays its taxes, any distributions made to the shareholders (over and above any wages paid to the shareholders) are then taxed again at the individual level of the shareholder. A corporation that elects to be taxed as an s-corp does not pay any taxes. Any income or loss of the corporation is reported on the tax returns of the individual shareholders, in proportion to their ownership interest in the corporation. In this regard, an s-corp is taxed similarly to a partnership. For certain businesses that generate higher amounts of income, there are certain tax advantages that corporations can take advantage of, which tax advantages are not available to sole proprietorships or general partnerships.
Limited Liability Company
A Limited Liability Company (LLC) is, relatively speaking, the newest business structure and is popular for individuals who don’t want their business to be a traditional sole proprietorship, partners who don’t want to utilize the general partnership format, or individuals who don’t want to deal with the complexities of the corporate structure. LLCs are similar to corporations in that like corporations the owner or owners have limited personal liability for the debts of the business, and registering an LLC with the Commonwealth of Pennsylvania gives you exclusive rights to the name you register under. An LLC can be taxed as a sole proprietorship, partnership, s-corp, or c-corp. LLCs are very flexible entities and can be equally perfect for a small sole proprietorship type business or a larger high revenue business with multiple owners and employees. LLCs generally provide all of the protections of a corporation, with the flexibility of operating as a sole proprietorship or general partnership. Due to the flexible nature of an LLC, the LLC is often the perfect entity for many different business ventures.
Now that we discussed what the differences are for each business structure, it is time for you to decide which is best for you. If you would like to sit down and discuss further the differences and the legal aspects, give us a call today.
Sher & Associates, P.C. is a law firm located in Kutztown that can assist you in any of the following areas: business law, real estate law, and estate planning. We assist many individuals, businesses and families in and around Fleetwood, Blandon, Topton, Hamburg and Oley.