So you have decided to start your own business. Starting your own business can be exciting, fun and often times scary. You may be a good baker, toolmaker, stylist, engineer or architect, but you have never run your own business. The set up of your new business can be very complicated. You should choose your professional team at the outset. This team should include a tax advisor/accountant, attorney, insurance agent and banker.
One of the first choices that you have to make is what form of entity to use for your business. When setting up your business, you have several choices. Your business can be a sole proprietorship, a general partnership, a limited partnership, a C corporation, an S corporation or a limited liability company.
A sole proprietorship is a type of business where you act on your own behalf as the business and your personal assets are at risk for all business liabilities. All income and expenses are reported on your individual income tax return.
A general partnership is an agreement between you and one or more partners to run a business which you and all of your partners have all of your personal assets at risk for company liabilities. A general partnership usually terminates upon the death of a partner. Items of income and expense flow through to you and the other partners to be taxed on your individual income tax returns.
A limited partnership is an agreement between two or more partners to run a business in which at least one of you is a general partner and at least one of you is a limited partner. If you are the general partner, you have unlimited personal liability for partnership debts. As a limited partner, your liability is typically limited to the extent of your capital commitments. Items of income and expense flow through to you and the other partners to be taxed on your individual income tax returns.
A C corporation allows you and other shareholders to have limited liability for most corporate debts. A C corporation is generally going to be taxed on its income as a separate entity. Except for certain qualified dividends, distributions to you and other shareholders in the form of dividends will usually be taxed again on your individual income tax returns.
An S corporation has protection for you and other shareholders in that you have limited liability for corporate debts, just like a C corporation. However, in an S corporation, items of income and expense flow through to you and other shareholders to be taxed on your individual income tax returns.
A limited liability company, also called an LLC, is a type of entity which is owned by one or more persons who own membership interests in the LLC. You and the other members of the LLC can generally choose how the LLC is going to be taxed either as a partnership (or proprietorship if there is only one member), a C corporation or an S corporation.
The choice of business entity is often determined by your tax situation. If you have other income, many times it is advantageous to have a flow-through entity such as a partnership, S corporation, or LLC taxed as a partnership through which to pass start-up losses to you and offset other income.
If the company income is not going to be distributed to you and will just be utilized to build the business or you want certain employee benefits, you may want to use a C corporation. You should review your tax situation with your tax advisor to determine the best form of entity that should be utilized for your business. An experienced business attorney should be used to prepare your organizational documents.
By: Matthew M. Wallace, CPA JD
Published edited March 15, 2009 in The Times Herald newspaper, Port Huron, Michigan as: Starting a business? First step is to pick which type