Choice of Business Entity
Choosing the proper business entity for your business can be an extremely
important decision for both legal and tax purposes. Although there
are many factors to consider when making this decision that may
be unique to your business, here are some general guidelines to
follow when choosing among the following choices:
Sole Proprietorship
A Sole Proprietorship is the most basic form that a business can take. There can be only one owner, and there is no legal distinction between the owner and the business. Money and assets can be freely transferred between the business and the owner, since, from a legal standpoint, they belong to the owner. In addition, any legal action taken against a Sole Proprietorship is actually taken against the owner, so any personal assets the owner may have are not protected from creditors of the business in any way. The income and expenses for this business are reported on the owner’s individual income tax return, and any profit is subject to about 14% Social Security and Medicare tax, as well as being part of taxable income. There are no legal requirements to start a Sole Proprietorship, provided there are no licensing or other requirements for your particular type of business. If the products or services you sell are subject to Sales Tax, you must get a sales tax permit from the Comptroller of Public Accounts, and if you would like to receive checks made payable to a business name (i.e., ABC Services), you must get an assumed name certificate from the District Clerk’s office.
General Partnership
A General Partnership is an unincorporated business with two or more owners. It has a finite existence, which is normally outlined in a Partnership Agreement. However, there is no legal requirement to file a Partnership Agreement with any government agency. The business must file a separate tax return that lists the income, expenses, assets, liabilities and partner’s capital accounts, but it does not pay any tax. Instead, the profits are reported on the individual partners’ tax returns based on their percentage ownership. The partners then pay about 14% Social Security and Medicare tax on their share of the profit and add the profit to their income from other sources. Legal action can be taken against the Partnership or the individual partners, and their personal assets are not protected from creditors in any way.
Limited Partnership
A Limited Partnership is basically the same as a General Partnership, with the exception that some of the partners can have limited liability. Limited Partnership should also be registered with the Secretary of State. This entity form is normally used when one or more partners that have no active role in the business make an investment in the business. These “Limited Partners” cannot participate in any management decisions, and in most cases their personal assets are protected from any creditors of the partnership.
Corporation
A Corporation is a business that has a perpetual life, and can have any number of owners, whose ownership interests are represented by shares of stock. To be formed, it must file Articles of Incorporation with the Secretary of State, and pay a fee of $325. Although there are “kits” available which guide you through the incorporation process, I strongly recommend that you seek the guidance of an attorney who is well versed in all aspects of business law to draw up your Articles of Incorporation and advise you regarding any other legal issues you may want to address, such as a “Buy/Sell Agreement”.
A Corporation is a separate legal entity, which means that it files it’s own tax return, it pays it’s own income tax, and it is liable for it’s own debts. The stockholders are not responsible for most debts of a Corporation, provided the corporate structure has not been violated by any commingling of corporate and personal assets. It is extremely important that a corporation never pay for anything that is a personal obligation of a stockholder!
In addition, since the Corporation is a separate entity, the stockholders cannot simply take money or assets out of the corporation, even if it is owned by only one person. Any payment to a stockholder must be in the form of a salary or a short-term loan (with a promissory note!) or it will considered a Dividend. Dividends are taxable to the person who receives them, and are not deductible to the Corporation. In other words, they are taxed twice! This is what happens to large, publicly held Corporations, but in a small, closely held Corporation, dividends must be avoided at all costs! In most cases, it is advisable to file an IRS election available to small corporations to be an S-Corporation.
In the State of Texas, as well as in most other states, the profits of a Corporation are also subject to a state Franchise Tax. In the State of Texas, this Franchise Tax is basically the equivalent of a 4.4% income tax.
S-Corporation
An S-Corporation is identical to a Corporation from a legal standpoint, in that it shields the personal assets of the stockholders from the business’s creditors. The “S” refers to the IRS election that it has made to pass the profit or loss from the business through to the stockholder’s personal income tax returns, in very much the same way as a Partnership. There are certain qualifications that must be met in order to file this election. There is, however, one major difference between the taxation of a Partnership and an S-Corporation, which can provide tax benefits to the stockholders. The stockholders of an S-Corporation do not have to pay the 14% Social Security and Medicare tax on their share of the business’s profit. However, the corporation must pay a “reasonable wage” to any stockholder who provides services to the corporation. The end result is that if a stockholder does work for the business, he must pay himself a salary that is subject to social security, medicare, and income tax. Any excess is subject to income tax only.
S-Corporations are also subject to the state Franchise Tax, discussed above. In many cases, any wages paid to a stockholder are deductible before calculating this tax.
Limited Liability Company
A Limited Liability Company (LLC) is a fairly new type of business entity that provides some of the characteristics of corporations and partnerships. It can have one or more “members”, who own percentages of the LLC. The income passes through to the members of the LLC, like a Partnership, but the individual members generally are not responsible for the debts of the business, like a Corporation. The downside to LLC’s, if you operate in Texas, is that the profits are normally subject to both Social Security and Medicare tax, like a partnership, and to the state Franchise Tax, like a Corporation. There is a way around this. If you are operating as an LLC in Texas, please contact us so you can get the advice you need. There can be other advantages to this business form for professional organizations such as a group of physicians, however, because if legal action is brought against one member for his individual acts, the other members’ shares of ownership are protected from any judgment.
Choosing the proper business entity is crucial to the long term success of any business, so choose wisely! If you would like to discuss these options further, or would like a referral to an attorney who can help you draw up the necessary paperwork, please contact us!
[ Consultation Services • Choice of Business Entity • Tax Planning ]
Sole Proprietorship
A Sole Proprietorship is the most basic form that a business can take. There can be only one owner, and there is no legal distinction between the owner and the business. Money and assets can be freely transferred between the business and the owner, since, from a legal standpoint, they belong to the owner. In addition, any legal action taken against a Sole Proprietorship is actually taken against the owner, so any personal assets the owner may have are not protected from creditors of the business in any way. The income and expenses for this business are reported on the owner’s individual income tax return, and any profit is subject to about 14% Social Security and Medicare tax, as well as being part of taxable income. There are no legal requirements to start a Sole Proprietorship, provided there are no licensing or other requirements for your particular type of business. If the products or services you sell are subject to Sales Tax, you must get a sales tax permit from the Comptroller of Public Accounts, and if you would like to receive checks made payable to a business name (i.e., ABC Services), you must get an assumed name certificate from the District Clerk’s office.
General Partnership
A General Partnership is an unincorporated business with two or more owners. It has a finite existence, which is normally outlined in a Partnership Agreement. However, there is no legal requirement to file a Partnership Agreement with any government agency. The business must file a separate tax return that lists the income, expenses, assets, liabilities and partner’s capital accounts, but it does not pay any tax. Instead, the profits are reported on the individual partners’ tax returns based on their percentage ownership. The partners then pay about 14% Social Security and Medicare tax on their share of the profit and add the profit to their income from other sources. Legal action can be taken against the Partnership or the individual partners, and their personal assets are not protected from creditors in any way.
Limited Partnership
A Limited Partnership is basically the same as a General Partnership, with the exception that some of the partners can have limited liability. Limited Partnership should also be registered with the Secretary of State. This entity form is normally used when one or more partners that have no active role in the business make an investment in the business. These “Limited Partners” cannot participate in any management decisions, and in most cases their personal assets are protected from any creditors of the partnership.
Corporation
A Corporation is a business that has a perpetual life, and can have any number of owners, whose ownership interests are represented by shares of stock. To be formed, it must file Articles of Incorporation with the Secretary of State, and pay a fee of $325. Although there are “kits” available which guide you through the incorporation process, I strongly recommend that you seek the guidance of an attorney who is well versed in all aspects of business law to draw up your Articles of Incorporation and advise you regarding any other legal issues you may want to address, such as a “Buy/Sell Agreement”.
A Corporation is a separate legal entity, which means that it files it’s own tax return, it pays it’s own income tax, and it is liable for it’s own debts. The stockholders are not responsible for most debts of a Corporation, provided the corporate structure has not been violated by any commingling of corporate and personal assets. It is extremely important that a corporation never pay for anything that is a personal obligation of a stockholder!
In addition, since the Corporation is a separate entity, the stockholders cannot simply take money or assets out of the corporation, even if it is owned by only one person. Any payment to a stockholder must be in the form of a salary or a short-term loan (with a promissory note!) or it will considered a Dividend. Dividends are taxable to the person who receives them, and are not deductible to the Corporation. In other words, they are taxed twice! This is what happens to large, publicly held Corporations, but in a small, closely held Corporation, dividends must be avoided at all costs! In most cases, it is advisable to file an IRS election available to small corporations to be an S-Corporation.
In the State of Texas, as well as in most other states, the profits of a Corporation are also subject to a state Franchise Tax. In the State of Texas, this Franchise Tax is basically the equivalent of a 4.4% income tax.
S-Corporation
An S-Corporation is identical to a Corporation from a legal standpoint, in that it shields the personal assets of the stockholders from the business’s creditors. The “S” refers to the IRS election that it has made to pass the profit or loss from the business through to the stockholder’s personal income tax returns, in very much the same way as a Partnership. There are certain qualifications that must be met in order to file this election. There is, however, one major difference between the taxation of a Partnership and an S-Corporation, which can provide tax benefits to the stockholders. The stockholders of an S-Corporation do not have to pay the 14% Social Security and Medicare tax on their share of the business’s profit. However, the corporation must pay a “reasonable wage” to any stockholder who provides services to the corporation. The end result is that if a stockholder does work for the business, he must pay himself a salary that is subject to social security, medicare, and income tax. Any excess is subject to income tax only.
S-Corporations are also subject to the state Franchise Tax, discussed above. In many cases, any wages paid to a stockholder are deductible before calculating this tax.
Limited Liability Company
A Limited Liability Company (LLC) is a fairly new type of business entity that provides some of the characteristics of corporations and partnerships. It can have one or more “members”, who own percentages of the LLC. The income passes through to the members of the LLC, like a Partnership, but the individual members generally are not responsible for the debts of the business, like a Corporation. The downside to LLC’s, if you operate in Texas, is that the profits are normally subject to both Social Security and Medicare tax, like a partnership, and to the state Franchise Tax, like a Corporation. There is a way around this. If you are operating as an LLC in Texas, please contact us so you can get the advice you need. There can be other advantages to this business form for professional organizations such as a group of physicians, however, because if legal action is brought against one member for his individual acts, the other members’ shares of ownership are protected from any judgment.
Choosing the proper business entity is crucial to the long term success of any business, so choose wisely! If you would like to discuss these options further, or would like a referral to an attorney who can help you draw up the necessary paperwork, please contact us!
[ Consultation Services • Choice of Business Entity • Tax Planning ]
We are a tax and accounting practice, working for individuals and businesses. Our vast experience allows us to find the best solutions to our clients' needs. Our understanding of current technology allows us to communicate clearly and efficiently, and also recommend systems that are time efficient for our clients. We work to ensure that you pay the legal minimum in tax, and most importantly, our goal is your success!
