When starting a business venture, one of the first decisions to make is to determine what form of business entity to establish. The business structure you choose will have legal and tax implications,
so it is very important to understand at least the basic differences amongst the most common forms of business entities; namely:
- Sole Proprietorships (or DBA);
- Limited Liability Companies (LLC);
SOLE PROPRIETORSHIPS (or DBA)
A sole proprietorship (also known as DBA, short for “doing business as”) is the simplest and least expensive structure that may be chosen to start a business.
It is an unincorporated entity owned and run by one individual with no distinction between the company and its owner, who is entitled to all profits and has unlimited personal liability for all the company’s debts, obligations and losses.
Because the sole proprietor and its business are one and the same, there is no legal separation between him/her and the business, with the consequence that the business itself is not taxed separately. The sole proprietorship’s income or loss becomes the individual’s income or loss, which means that it must be included in his/her personal tax return.
A partnership is a vehicle where two or more people share ownership. Generally, each partner contributes to all aspects of the business, including money, property, labor and skills and will share in the profits and losses of the business.
There are two main forms of partnerships:
1) General Partnerships; where liabilities and managerial duties are divided equally among partners. Furthermore, partners are not only liable for their own actions, but also for the decisions made by the other partner(s); and the personal assets of all partners can be used to satisfy the partnership’s debts.
2) Limited Partnerships; where some partners may have limited liability (to the extent of each partner’s investment percentage in the partnership), but will also have limited input with management decisions (the Limited Partners). However, limited partnership must have at least one general partner, which will have unlimited liability.
Regarding taxes, a partnership must file an “annual information return” to report the income, deductions, gains, losses, etc., from the business’s operations, but the entity itself does not pay income taxes: it “passes through” any profits or losses to its partners, which will include their share of the partnership’s income or loss on their individual tax return.
A corporation is an independent legal entity that is separate from the people – so called “shareholders” – who own and may control and manage it. This means that the corporation itself, not the shareholders who own it, is held legally liable for its actions and the debts incurred, while the shareholders have limited legal and financial liability. Generally, shareholders cannot be sued individually for corporate wrongdoings and their personal assets are protected from the creditors of the corporation (they can generally only be held accountable for the amount of capital committed to invest in the company).
Shareholders elect a Board of Directors which make business decisions and oversee policies, and appoint the Officers (President, Treasurer and Secretary), responsible for the day-to-day operations.
There are two different kinds of Corporations:
1) “C” Corporations (in reference to Subchapter “C” of Chapter 1 of the Internal Revenue Code, “IRC”, which governs them) are legally considered separate entities from their owners. Income is taxed at the corporate level and it is taxed again when it is distributed to owners as dividends, what is known as “double taxation”.
2) “S” Corporations (named after subchapter “S” of Chapter 1 of the IRC)
is a special type of corporations created through an Internal Revenue Service (“IRS”) tax election. After a corporation has been formed, it may elect “S” Corporation Status by adopting an appropriate resolution and completing and submitting a form to the IRS. In order to qualify for “S” Corporation Status, the corporation must meet the following requirements: be a domestic corporation (located within any state in the US), have only US citizen or US resident shareholders, have no more than 100 shareholders, have only one class of stocks, not be an ineligible corporation (i.e., certain financial institutions, insurance companies and domestic international sales corporations). What makes the “S” Corporation different from the “C” Corporation is that the corporate income is taxed only once, similar to how sole proprietorships and partnerships are taxed. All profits and losses are passed through directly to the shareholders, who report them on their personal tax return, while the business itself is not taxed.
LIMITED LIABILITY COMPANIES (LLC)
The Limited Liability Company, also known as LLC, is a relatively new form of business created in 1977 in Wyoming and now recognized in all 50 states and the District of Columbia.
It can be best described as a hybrid between a corporation and a partnership because it provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership.
Owners of an LCC are called members and may include individuals and entities (whether domestic or not).
There are two different management structures of a LCC:
1) Member management: assume that members participate equally in the management of their business. This is more frequent to find in small LCCs.
2) Manager management: in which one or more owners (or even an outsider) is designated to take responsibility for managing the LCC. Only the named managers get to vote on management decisions and act as agents of the LCC.
There is no maximum number of members. Most states also permit “single member” LCCs (i.e., those having only one owner).
The peculiarity of this kind of company is that, just like shareholders of a corporation, all LCC owners are protected from personal liability for business debts and claims: only LCC assets are used to pay off business debts, while owners stand to lose only the money that they have invested in the company. However, a LCC doesn’t have the corporate formalities (Board meetings, Shareholders meeting, minutes, etc.) or extra levels of management (Shareholders, Directors, Officers), but the easy management of a partnership. Moreover, unlike “C” corporations, LCCs are not taxed as a separate business entity. Instead, business income is “passed through” the business to the members, who report their share of profit – or losses – on their personal tax returns, just like the owners of a partnership would.
A cooperative is a business organization owned by and operated for the benefit of a group of users using its services.
Profits and earnings generated by the cooperative are distributed among the members, also known as user-owners, who contribute equity capital.
Regarding the tax treatment, cooperatives operate as “S” Corporations and receive a “pass-through” designation from the IRS.
Cooperatives are common in the healthcare, retail, agriculture, art, restaurant industries and NYC apartment buildings.
Be aware that this is just a general illustration of the various forms of business existing in the United States. Each of them needs an in-depth analysis, which will be done in the forthcoming articles.
Cav. Piero Salussolia , Esq.
Dott.ssa Angela Cappuzzello (not admitted in Florida)
This article was written with effort and dedication in order to provide valuable information on diverse topics. Please feel free to share this information with your colleagues and friend so long as you do not modify or alter its contents and our contact information.