Intro to Five Common Business Legal Structures

Your business structure is the legal form under which you conduct business with your customers and suppliers, and under which you will enter your contractual relationships. This list is at best only a general guideline. You need to speak with your legal and accounting professionals to obtain the best advice for your personal situation. Sole Proprietorship. This is the most common legal business form. In fact, most businesses start out as a sole proprietorship. In this simple structure, you, the entrepreneur, are the owner of all of the assets – and exposed to all of the liabilities of the business. Within the limits of the law, you are in complete control and can make choices about the business as you see fit. Profits of a sole proprietorship flow directly to personal income and are reported for tax purposes on your 1040 Schedule C. The proper gain or loss from business activity is then reported on Form 1040. You are also expected to file Form1040 ES, along with Form 4562, which covers depreciation and amortization of assets, employment tax forms if you have employees and Form 8829 if you use your home for business purposes. Shortcomings of a sole proprietorship include the deductibility of some expenses, in particular, medical insurance, as well as some difficulty in raising capital. Federal tax forms for a sole proprietorship (a partial list, and some may not apply)
● Form 1040: Individual Income Tax Return
● Schedule C: Profit or Loss from Business (or Schedule C-EZ)
● Schedule SE: Self-Employment Tax
● Form 1040-ES: Estimated Tax for Individuals
● Form 4562: Depreciation and Amortization
● Form 8829: Expenses for Business Use of your Home
● Employment Tax Forms

If this sounds a little daunting – relax. It’s not really that complicated. Make sure to add an accountant to your list of expenses when developing a business plan.

Partnerships.
Partnership structures are an option when two or more people own and control the business. General partners in a general partnership are responsible for the day-to-day activities, management of the business, and are liable for all of the debts and obligations of the partnership. Limited partnerships protect passive investors and their liability to the partnership are specifically outlined in the partnership agreement, which generally limits their liability to a contractual amount. Partnerships are relatively easy to establish, but you must be prepared to invest in the professional time, energy, and legal effort to create the partnership agreement. The agreement sets forth how you intend to run the partnership and how you intend to deal with serious disagreements and dissolution.
Off-the-shelf partnership agreements will not suit your needs. The appropriate use of such form agreements is to get you thinking about the needs, rights and constraints you want in the final agreement – but they are not the customized documents you want for a final agreement. The profits and losses from a partnership flow directly through to the partner’s personal tax returns. The ability to raise funds is generally enhanced when compared with a sole proprietorship. One disadvantage is that general partners are jointly and individually liable for the actions of the other general partners. As choices about a business’s future are shared, there will eventually
be disagreements. Federal tax forms for a general partnership (a partial list, and some may not apply)
● Form 1065: Partnership Return of Income
● Form 1065 K-1: Partner’s Share of Income, Credit and Deductions
● Form 4562: Depreciation
● Form 1040: Individual Income Tax Return
● Schedule E: Supplemental Income and Loss
● Schedule SE: Self-Employment Tax
● Form 1040-ES: Estimated Tax for Individuals
● Employment Tax Forms

Corporations.
Corporations charters are issued / granted by a state. It may or may not be the state in which you
are located. If it is not the state where you are doing business, you will have to domesticate the corporation in the state where you are doing business. The Corporation is a unique legal entity, and a barrier to many types of liability – meaning that shareholders may be protected from many types of liability that a business can be exposed to. A corporation that is legally constructed and properly operated should prevent claims from flowing through to the shareholders. The owners of a corporation, the shareholders, control the corporation by electing a board of directors to oversee the major policies and choices of the corporation. The board of directors hires senior management and directs them as to how the company is to be run. One of the advantages of a corporation is that the shareholders have limited liability for corporate debts. Generally, shareholders can only be held accountable for the purchase price of the shares. Corporations can raise additional funds through the sale of stock, but must be careful not to run afoul of state or federal securities laws. A corporation may also elect to structure itself as an S corporation if certain requirements are met. This option enables the corporation to be taxed similarly to a partnership. One note on liability – while liability may not flow through to shareholders, officers and directors can be held liable for their actions, such as the failure to withhold tax payments with the consequence of misrepresenting the corporate status to a third party. A corporation requires a little bit more time and money to establish than other forms of business structures. Corporations are monitored by federal, state and local agencies, and almost always have more paperwork to process. Incorporation usually results in higher overall taxes because the earnings are paid out in dividends after the federal government taxes the earnings, and dividends are then taxed when received by the shareholders, unless you have elected an “S” corporation. In a small corporation with few shareholders who all work for the company, this double tax can usually be avoided by authorizing the payment of bonuses. Also, understand that as a small corporation many lenders, landlords and creditors will ask for, or require personal guarantees for all contracts. Federal tax forms for regular or “C” corporations (only a partial list and some may not apply)
● Form 1120 or 1120-A: Corporation Income Tax Return
● Form 1120-W Estimated Tax for Corporation
● Form 8109-B Deposit Coupon
● Form 4625 Depreciation
● Employment Tax Forms
● Other forms as needed for capital gains, sale of assets, alternative minimum tax, etc.

Subchapter S corporations refer to a tax election choice for the corporation made with the IRS, not to the incorporation process of the entity. Subchapter S status is not determined at the time of incorporation but rather at the time you apply for your taxpayer identification number from the IRS. The catch here is that if the shareholder is working for the company, and if there is a profit the
shareholder must pay himself a reasonable compensation for his work. A person working for a corporation, owning the corporation, and receiving dividends but no wages is simply waving a red flag in front of the IRS. Federal tax forms for subchapter S corporations (only a partial list and some may not apply)
● Form 1120S: Income Tax Return for S Corporation
● Form 1120S Schedule K-1: Shareholder’s Share of
Income, Credit, and Deductions
● Form 4625 Depreciation
● Employment Tax Forms
● Form 1040: Individual Income Tax Return
● Schedule E: Supplemental Income and Loss
● Schedule SE: Self-Employment Tax
● Form 1040-ES: Estimated Tax for Individuals
● Other forms as needed for capital gains, sale of assets,
alternative minimum tax, etc.

Limited Liability Companies (LLC).
Limited Liability Companies represent a relatively new hybrid business structure and are permissible in most states. They are designed to provide the limited liability features of a corporation along with the tax efficiencies and operational flexibility of a partnership. Its formation is more complex then for a general partnership. The ownership of the LLC are the members. Management of the LLC can be vested in the members where it is a member-managed LLC or can be vested in a manager where it is a manager-managed LLC. The members and managers can be persons, corporations, partnerships, or trust foundations – it doesn’t matter. The unit of ownership in an LLC is a membership unit. The duration of the LLC is finite and its date of termination /windup is disclosed with the organizational papers at the time they are filed. Although the termination/windup limit can be continued if desired, the LLC must not have more than two of the four characteristics that define corporations: limited liability to the extent of assets, continuity of life, centralization of management, and free transferability of ownership interests. The tax forms for LLC will be either corporate tax forms or partnership tax forms, depending upon the tax election taken at the time of formation.

Special Forms of Structures
There are also specialty structures for companies in some states. The Limited Liability Partnership, or LLP, is organized to protect individual partners from personal liability for their negligent acts or acts of other partners or employees not under their direct control. This structure is not recognized by every state, but the common restrictions include that the LLP must provide a professional service such as medicine or law for which each partner is licensed. A Professional Service Corporation (PSC) must be organized for the sole purpose of providing a professional service for which each shareholder is licensed. The advantage is limited liability for the shareholders. This is an option available to certain professionals such as doctors, lawyers, and accountants. You will need to check with your state to find out which occupations qualify.

A Limited Partnership is typically a more complex formation and requires a least one general partner who is fully responsible for the partnership’s obligations and normal business operations. A limited partner is often an investor who is not involved in the day-to-day operations. This structure shields such investors from liability beyond the amount of their investment. The limited partners do not pay tax, but must file a return for informational purposes and pass, on a pro rata basis, a share of profits and losses to the partners via K-1.Nonprofit Corporations are typically formed for civic, educational, charitable and religious purposes. This structure enjoys tax-exempt status and limited personal liability. Nonprofit corporations are managed by a board of directors, or trustees, and assets must be transferred to another nonprofit group if the corporation is dissolved. Being chartered as a nonprofit doesn’t mean you don’t owe taxes, just that the accumulation of donations and assets are exempt from taxation as long as the nonprofit status is maintained. UBIT – Unrelated Business Income Tax may be assessed is there is commercial activity that does not substantially related to the non-profits core functions. Nonprofit status is elected at the time of formation with the state, and requested from the IRS. Nonprofit status is not always granted.

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