BUSINESS BASICS: SELECTING THE RIGHT STRUCTURE
By: Sandra L. Clapp, Esq.
If you are considering starting a business or have had a business for many years, it is prudent to understand and select the best business structure to protect your personal assets and provide the greatest tax benefits.
When selecting a business structure, the following considerations may direct the entity choice:
- Multiple owners;
- Risks of the business operation;
- Different voting rights among the owners (silent investors or active owners);
- Unequal division of profits and losses;
- Employees of business;
- Tax implications of business (passive activities or active business);
- Capital contributions of the owners; and
- Long term business plan.
Through exploration of these topics with your legal and tax advisors, you will likely consider the following business structures:
Sole Proprietorship. This is the basic business structure of the individual business owner. A sole proprietorship is formed merely by starting the business. All tax implications of the business are reflected on the income tax return of the owner. If the business operates under a name other than that of the owner, an assumed business name filing should be filed with the Idaho Secretary of State. The owner is personally liable for all liabilities of the business.
Partnership. A partnership is formed when more than two or more people start a business for profit. A partnership files a tax return that allocates all tax implications among the partners based upon their relative ownership. The partners report the tax implications directly on their personal income tax returns. Each partner is jointly and severally liable for all activities of the business operations.
Corporation. A corporation is formed by one or more persons by filing articles of incorporation with the Idaho Secretary of State. The owners (known as shareholders) of the corporation are not personally liable for the debts or obligations of the corporation, but may lose any capital or assets the shareholder has contributed to the corporation. A shareholder has “limited liability” for the debts and liabilities of the corporation. When we discuss “limited liability” for any entity, this does not shelter the owner from liability directly assumed by the owner (such as through a personal guarantee) or for negligence or wrongdoing of the owner. The corporation may elect to be taxed under “Subchapter S” of the Internal Revenue Code and if such election is timely made the corporation is commonly referred to as a “Sub S” or “S” corporation. Federal tax law sets forth restrictions on electing to be taxed as an S corporation. If the “S election” is made, generally the tax implications of the corporation are reflected on the personal income tax returns of the shareholders. If the corporation does not elect to be taxed as a Sub S corporation, the corporation is taxed under “Subchapter C” of the Internal Revenue Code (a “C corporation”). A C corporation is subject to separate income tax implications at the corporate level which can result in double taxation both at the corporate and shareholder levels. A corporation is governed by the board of directors and officers and statutes detail meetings, voting, and management.
Limited Liability Company. A limited liability company (or “LLC”) is formed by one or more persons filing a certificate of organization with the Idaho Secretary of State. An LLC is often described as the informal operation of a partnership with the limited liability of a corporation. An LLC can elect to be taxed either as a corporation or as a partnership. The LLC may choose to be “manager managed” or “member managed.” An LLC is normally governed by the operating agreement adopted by the members or the statutory provisions if there is no operating agreement.
Limited Partnership. A limited partnership has two classes of partners – the general partners (who have unlimited liability for the debts of the limited partnership) and the limited partners (who have limited liability but cannot control the limited partnership). The limited partnership is taxed like a partnership, but the general operations are governed by statute or the partnership agreement.
For further information on starting a business, check out the Idaho Secretary of State website and particularly the business portal (www.idsos.state.id.us) or the Internal Revenue Service website (www.irs.gov). Both websites offer valuable information, but should not take the place of your professional advisors. It is recommended that you consult with your legal and tax advisors to ensure any action taken is appropriate for your circumstances. This article is not intended to replace legal advice applicable to your situation and should be used only for informational purposes.