Congratulations! You’ve decided to embrace the American Dream and start your own business. This is an exciting time, but before your first dollar is earned, you need to make sure you organize yourself properly. Proper business ownership will help in protecting yourself from possible legal and tax liabilities.
DISCLAIMER: I am not a tax accountant, CPA, or attorney. The advice that follows is not an attempt at legal advice and should not be taken as so.
The first thing to decide when starting a business is what type of ownership to hold the business with. Businesses can be organized in several ways. Each one different, especially in how they affect the business owner’s legal and tax liabilities. Read through each form to see which one is best for your new money maker!
By far the easiest form of ownership is sole proprietorship. As I had mentioned in an earlier post, all one has to do in this beautiful country is say, “I want to be in business!” And poof! Business started. With this, the business that is formed and its owner are essentially one and the same. Any assets, profits, or gains the company makes are 100% the owner’s responsibility. Unfortunately, any liabilities, losses, or debts are also 100% the owner’s responsibility.
Now just because the business and the owner are treated as the same entity does not mean it’s wise to co-mingle funds or keep poor records. Remember, you’re running a business now. Even if it carries your name, it’s still a business. When tax time comes, you will be asked to fill out a “Schedule C” tax form which is a very basic income statement. The beauty of this is that if you lose money, you can use these losses to offset other income you make.
Many cities require businesses to file for a business license in the city in which they expect to do business. Most of the time, this is a fairly easy process and can be done over the counter at city hall, costing between $25-$100.
If you want to step up your sole prop game and receive checks under a different name than your own, you may want to consider filing what’s called a “fictitious business name statement.” The rules for filing one of these documents vary from county to county, but you can find specific information at your county recorder’s office. It’s essentially a document that is filed at the county recorder’s office that notifies the world that you, Mr./Mrs. Business Owner will thereby be “doing business as” (dba) a different company name.
For example, Jan Smith wants to start a company called “Furniture Deluxe.” She fills out a fictitious business name statement and records this at the county recorder. They also require her to post an ad in a local newspaper for three consecutive weeks. Afterward, she’s officially in business and can open bank accounts and receive payments under the Furniture Deluxe business name.
This form of business ownership is best for smaller companies with fewer liabilities because the business owner’s assets are at risk. Any claims against the business are claims against the owner as well. As with all forms of business ownership, I would recommend obtaining a liability insurance policy. Most industries will be fairly inexpensive and will still protect you and your assets from business liabilities that may arise. If your business is expected to take on lots of debt, or if you personally have many assets you wish to protect, or if you are in the business of alcohol, major manufacturing, or any other high-risk industry, perhaps liability insurance and a different form of ownership are better suited for you.
A partnership is a good form of business ownership if you aren’t the sole owner of the company. There are three major types of partnerships: General Partnerships, Limited Partnerships (LP), and Limited Liability Partnerships (LLP).
With general partnerships, all partners are personally liable for business debts both jointly and separately and any partner can make decisions that affect the business as a whole.
In a limited partnership, one partner acts as the investor (or limited partner) and is liable only for what they invested in the company. The other partner acts as the main decision maker. This partner is often personally on the hook for all business liabilities.
Limited liability partnerships are very common among doctors, lawyers, and other professionals. This form of ownership protects each partner’s personal assets from actions by another partner.
Each state has varying laws on partnership formation and it’s best to check with local laws. Partnerships must file returns with the IRS each year, but the partnership’s income is not subject to double taxation as the profits and losses pass through to the partners.
Limited Liability Company (LLC)
LLC stands for limited liability company. As its name implies, this form of business ownership limits the liability of its owners. For the most part, the owners can’t lose anything more than they put into the company unless of course the owners commit fraud, fail to separate the activities of the company from their personal ones, or do something grossly negligent.
LLC laws are somewhat different based on the state you do business or the state you form your LLC. I’ve personally set up several LLCs before. They are set up with the state’s Secretary of State. You will need to draft a few documents including your LLCs articles of organization and operating agreement. These act as the company’s bill of rights and lay out things like who are the owners, what are their responsibilities, and what happens when they want to sell their portion of the business. For a small fee, IncFile.com can help you form any type of business, including LLC’s. After signing up, IncFile.com can have your new LLC up and running in no time.
Corporations are a bit more complex than LLCs. However, they offer a similar goal, which is limit the liabilities of the owners. Similar to LLCs, a corporation, and an LLC are individual entities, whereas the sole proprietorship is the same entity as the individual. Corporations require separate accounting, tax forms, annual paperwork filing, and specific record keeping. There are two types of corporations: S corporations and C corporations. I would advise you to meet with your accountant to determine which one is best for you.
C corporations are completely separate entities that pay their own separate taxes on their income. It can hold or retain earnings year to year, but its income is still taxed when earned. If the time comes when you personally want to make a dividend distribution, you will be taxed personally as well. This is called double taxation and is why many smaller companies choose to file with an S corp.
S corporations are considered pass-through entities and any income they generate is not taxed at the corporate level, but is passed through to its owners and taxed as individuals. C corporations are often taxed at a lower tax base than personal income taxes, so it may still be worth it to file with this form of ownership.
To qualify for S corporation status, the corporation must meet the following requirements:
- Be a domestic corporation
- Have only allowable shareholders
- May be individuals, certain trusts, and estates
- May not be partnerships, corporations or non-resident alien shareholders
- Have no more than 100 shareholders
- Have only one class of stock
- Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).
As a word of caution, it can be easy to forget to hold the required meetings and file the required paperwork. If corporation is the entity you choose, make sure you are on top of your state’s filing requirements. Otherwise, there’s a chance you will be held personally liable for your company’s liabilities.
As mentioned earlier, IncFile.com can help you form any type of business. In starting any new venture, you must thoroughly decide what is your best route. Review the business ownership forms above and weigh the options of what would fit with your specific business model. And also, cheers to your new business!