What You Should Know about Types of Company Ownership
Before you establish your business, you’ll need to determine which of the business entity types you plan to establish. There are 3 main types of company ownership or business structures, along with a couple of sub-type. Each type has specific legal and tax implications. Therefore, it’s important to choose a structure that best meets your individual situation. I often encourage clients to consult with their accountant and/or lawyer, as those two individuals tend to have a firm understanding of the legal structures, as well as special insight to your personal financial and/or personal factors.
A sole proprietorship (SP) is the most common and usually the easiest business structure to establish. As a sole proprietor, you alone are responsible for the assets and liabilities of your company. A sole proprietor is structured in a way that the business is aggregated with your personal affairs. That is, you will file your business taxes (on a schedule C) with your personal taxes (on the 1040 series). Since your business and personal are aggregated, there’s really no legal separation. That means, you are responsible for paying for damages or fulfilling the legal obligations of your business.
Often times, people are concerned about forming a sole proprietor because they fear possible legal ramifications down the road. I tell my clients not to rule out a sole proprietor because of this. Rather, I encourage them to seek business insurance, as it can offer you the protection you seek while also keeping this simple business structure. Even though it’s not required, I highly encourage owners to keep their personal and business affairs separate despite the aggregation.
Limited Liability Company (LLC)
The LLC is a bit of a hybrid between the partnership and corporation, both of which I’ll talk about next. If used effectively, the LLC can provide some of the liability protection of a corporation, while keeping the operational flexibility of the partnership. In addition, the LLC can be structured to file under corporate or personal taxes.
One caution I mention to my clients is the need to keep their business and personal affairs separate with a LLC. Whereas everything is aggregated with a SP, meaning there’s no real difference between the business and person, the LLC does have a clear separation, or at least you should keep the separation clear. Not doing so can put your limited liability protection in jeopardy.
Though partnerships aren’t considered a main business structure, I still want to mention it. Partnerships are diverse in that they can vary depending on the arraignments made between the parties and the responsibility each partner has toward the business. I highly encourage my clients to have a partnership agreement that clearly spells out each partner’s duties, as well as buyout clauses.
A corporation is the least common structure of a company. Whereas private individuals own sole proprietorships, LLCs, and partnerships, shareholders own corporations. The C Corporation can have an unlimited number of shareholders.
One point I like to mention to my clients is that if they work for the corporation, they are employees who receive wages just like other workers. This also means that when it comes to legal actions against the corporation, the employees are not liable. Likewise, the shareholders are not held liable for a corporation. Instead, the corporation, which is a legal independent entity, is responsible for the actions and debts incurred by the business.
When all is said and done, once you create a C corporation, you can be the only shareholder, you can be one of many shareholders. You can choose to work for the corporation or choose not to work for the corporation and just receive the benefits of being a shareholder. Additionally, you can also sell your shares and even choose to work for the company as an employee without holding ownership.
Lastly, when it comes to taxation, the C corporation is taxed on the earnings, then the shareholders are taxed on their dividend distribution. This is where the concept of double taxation comes from.
An S corporation is very much like a corporation in terms of liability. One main difference between an S corporation and C corporation is in regards to taxation. While a C corporation experiences double taxation (the company is taxed on income and the shareholders are taxed on dividends), the S corporation passes the earnings to the shareholders, who are responsible for the taxes on an individual level. One other difference is the number of shareholders allowed with an S corporation. The C corporation can have infinity and beyond shareholders. On the other hand, the S corporation is limited to just 75.
Often clients ask me which business entity is right for them. My answer is always along the lines that it depends on their personal and financial situation. Each structure has pros and cons to it. Again, I stress the importance of visiting with your accountant and/or lawyer to determine which structure best fits your unique situation.
What’s your favorite business structure and why?