Alicia Sisk Morris CPA | Types of Business Organizational Forms – Which one is best for me?
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Types of Business Organizational Forms – Which one is best for me?

25 Nov Types of Business Organizational Forms – Which one is best for me?

Organizational Forms – Creation and Considerations- Which one should I choose???

According to the Missouri Small Business and Technology Development Center (published on the website KCSourcelink.com), they have produced a list of advantages and disadvantages of each form of business organization.

Sole Proprietorship

A sole proprietor is a person who is the sole (only) owner of a business. She/he is entitled to keep all of the profits and will be responsible for all of the liabilities of the business.

Advantages of a Sole Proprietorship

  • Easiest and least expensive form of ownership to organize.
    • Sole proprietors are in complete control, and within the parameters of the law, may make decisions as they see fit.
    • Profits from the business flow-through directly to the owner’s personal tax return.
    • The business is easy to dissolve, if desired.

Disadvantages of a Sole Proprietorship

  • Sole proprietors have unlimited liability and are legally responsible for all debts against the business.  Their business and personal assets are at risk.
    • May be at a disadvantage in raising funds and are often limited to using funds from personal savings or consumer loans.
    • May have a hard time attracting high-caliber employees, or those that are motivated by the opportunity to own a part of the business.
    • Some employee benefits such as owner’s medical insurance premiums are not directly deductible from business income (only partially as an adjustment to income).

Partnerships

A Business partnership is an organization in which two or more people manage and operate a business entity. They are equally and personally liable for the debts from the business and will share in the profits or losses.

 Advantages of a Partnership

  • Partnerships are relatively easy to establish; however time should be invested in developing the partnership agreement.
    • With more than one owner, the ability to raise funds may be increased.
    • The profits from the business flow directly through to the partners’ personal tax return.
    • Prospective employees may be attracted to the business if given the incentive to become a partner.
    • The business usually will benefit from partners who have complementary skills.

Disadvantages of a Partnership

  • Partners are jointly and individually liable for the actions of the other partners.
    • Profits must be shared with others.
    • Since decisions are shared, disagreements can occur.
    • Some employee benefits are not deductible from business income on tax returns.
    • The partnership may have a limited life; it may end upon the withdrawal or death of a partner.

Types of Partnerships that should be considered:

  1. General Partnership
    Partners divide responsibility for management and liability, as well as the shares of profit or loss according to their internal agreement.  Equal shares are assumed unless there is a written agreement that states differently.
  2. Limited Partnership and Partnership with limited liability
    “Limited” means that most of the partners have limited liability (to the extent of their investment) as well as limited input regarding management decision, which generally encourages investors for short term projects, or for investing in capital assets.  This form of ownership is not often used for operating retail or service businesses.  Forming a limited partnership is more complex and formal than that of a general partnership.
  3. Joint Venture
    Acts like a general partnership, but is clearly for a limited period of time or a single project.  If the partners in a joint venture repeat the activity, they will be recognized as an ongoing partnership and will have to file as such, and distribute accumulated partnership assets upon dissolution of the entity.


Corporations

Corporations are a form of business operation that is a separate and distinct legal entity from its owners. It is guided by a group of officers known as the board of directors.

Advantages of a Corporation

  • Shareholders have limited liability for the corporation’s debts or judgments against the corporation.
    • Generally, shareholders can only be held accountable for their investment in stock of the company.  (Note however, that officers can be held personally liable for their actions, such as the failure to withhold and pay employment taxes.
    • Corporations can raise additional funds through the sale of stock.
    • A Corporation may deduct the cost of benefits it provides to officers and employees.
    • Can elect S Corporation status if certain requirements are met.  This election enables company to be taxed similar to a partnership.

Disadvantages of a Corporation

  • The process of incorporation requires more time and money than other forms of organization.
    • Corporations are monitored by federal, state and some local agencies, and as a result may have more paperwork to comply with regulations.
    • Incorporating may result in higher overall taxes.  Dividends paid to shareholders are not deductible from business income; thus this income can be taxed twice.

Subchapter S Corporation

A tax election only; this election enables the shareholder to treat the earnings and profits as distributions, and have them pass through directly to their personal tax return.  The catch here is that the shareholder, if working for the company, and if there is a profit, must pay his/herself wages, and it must meet standards of “reasonable compensation”.  This can vary by geographical region as well as occupation, but the basic rule is to pay yourself what you would have to pay someone to do your job, as long as there is enough profit.  If you do not do this, the IRS can reclassify all of the earnings and profit as wages, and you will be liable for all of the payroll taxes on the total amount.

Limited Liability Company (LLC)

The LLC is a relatively new type of hybrid business structure that is now permissible in most states.  It is designed to provide limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership.  Formation is more complex and formal than that of a general partnership.

The owners are members, and the duration of the LLC is usually determined when the organization papers are filed.  The time limit can be continued if desired by a vote of the members at the time of expiration.  LLC’s 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.

 

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