A Simple Explanation of Business Formations
Starting a business can be a rollercoaster of emotions: excitement to finally be building your dream, fear of financial instability and then, the uncertainty of the legal aspects of your new endeavor may sink in. Consulting a business law attorney can help you make sense of your legal obligations as a business owner as well as aid in setting up your business in the way that makes the most financial sense for your situation. With the help of an experienced attorney, you can spend more time in the excitement and less time in the uncertainty of your business.
One of the first things to consider when you’re ready to start your business is its formation. There are four basic forms your business can take, each with different financial considerations for your personal assets as well as various obligations where taxes are concerned. Below you will find a list of these four business forms and a brief explanation of each.
In a sole proprietorship, you are the exclusive owner of your business. This is the simplest and least expensive type of business to form. Depending on your occupation, your state or county may require you to hold a business license to operate. Otherwise, there are no incorporation documents to file. You can do business under your name or apply for a DBA (doing-business-as) if you want to operate your business under a different name.
- Protection: As a sole proprietor, you have no personal protection from lawsuits or creditor claims. Your personal assets can be seized to satisfy your business debts.
- Taxes: Sole proprietors report business income and expenses to the IRS on a Schedule C when filing individual income tax returns.
Other than a partnership agreement, there are no documents to file with your state when forming a Partnership. Your partnership agreement states how your business operates and how the profits and losses are shared. As many partnerships are formed between friends, it is advisable to have a business law attorney help you create the partnership agreement so everyone is well informed of the specifics of your agreement.
- Protection: In most states, each partner in a partnership has unlimited liability. This means debts, lawsuits and the action of the one partner become the responsibility of all partners.
- Taxes: The business entity must file a partnership information return with the IRS each year. Profits and losses are reported on each partner’s individual income tax return.
Limited Liability Company (LLC)
Any business owner may form a limited liability company by filing articles of organization or a certificate of formation. Owners of an LLC are known as members and can number as small as one member. This is a common business formation since it offers more protection of personal assets and less risk to the business owner.
- Protection: When you take on debt or open a bank account as an LLC, the LLC itself is responsible for the accounts rather than the members. Profits and losses flow through the company to each member.
- Taxes: LLC members decide upon formation if they want to be taxed as a corporation or a partnership. LLC’s filing as partnerships file the partnership tax returns. LLC’s filing as corporations must file taxes either as a C corporation or S corporation. A qualified business law attorney can help you decide what the proper filing method is for your LLC.
The most formal of the business formations is the Corporation. It is also the most expensive. Your business law attorney will help you file Articles of Incorporation with the California Secretary of State. There are more rules governing ownership of corporations than any other form. For example, only U.S. citizens can be owners. In an S corp, there cannot be more than 100 owners and those owners must be individuals, not partnerships or other corporations. Corporations must conduct annual meetings and file annual reports in their incorporating state.
- Protection: Owners in a corporation have limited liability protection meaning their personal assets cannot be used to satisfy debts owed by the corporation.
- Taxes: Profits and losses are retained at the corporate level in a C corp but are subject to double taxation. Simply put, this means that owners are taxed on their earnings and shareholders are taxed on corporate dividends. Most often, the owners are the shareholders. Both C and S corporations file corporate tax returns, annual reports and are obligated to meet federal and state record-keeping requirements.
A business law attorney at The Law Offices of Young Wooldridge, LLP can inform you of legal options you may not know you have. If you have questions or need help forming your business, contact The Business Law Department at The Law Offices of Young Wooldridge, LLP.