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Choose a business structure that’s right for you

By Keith E. Johnson, CPA

Your decision to start a new business is the first step toward joining the real power fueling the American economy. The second decision you must now make concerns how you want your business to be structured. opportunity1

Businesses can be structured in a number of different ways—sole proprietorship, partnership, limited liability company (LLC), a C-Corporation (“regular” corporation), or an S-Corporation. Each of these structures has its advantages and disadvantages.

• Sole proprietorship. This is the most common way to structure a business initially. It provides flexibility for the owner in terms of payroll and paperwork, and it allows the owner to take advantage of full deductibility of necessary business expenses.

A sole proprietor files a business tax return in the form of a Schedule C, which is attached to the personal Form 1040.

A sole proprietorship is a good way for business owners to “get their feet wet” before taking on the more formal responsibilities of running a corporation. However, this structure has two major disadvantages: As a sole proprietor, you have unlimited liability, which means if you get sued because of an accident, the plaintiff can claim your personal assets (such as your car, home, or personal possession) as well as your business assets. Additionally, you are responsible to pay a 15.3% self-employment tax (Social Security and Medicare) on net profits over $400 per year . The self-employment tax is on top of the income tax the profit generates.

• Partnership. A partnership is a business formed when more two or more persons pool their assets together to form a business. Partnerships are taxed in the same way as sole proprietorships.

One of the main disadvantages of a general partnership concerns personal liability: Partners are personally liable for the business’ debts and liabilities. Also, each partner may be liable for the debts and actions of the other partner(s). For these reasons, general partnerships are rare today; they have largely been replaced by the LLC (limited liability company).

• LLC. The LLC is a relatively new concept that combines the flexibility of a partnership and the limited liability of a corporation.

Owners of an LLC business do not have to pay the self-employment tax of a sole proprietorship, yet they can still deduct their business expenses on their personal tax return. The LLC also pays no business tax on the federal level. Finally, an LLC affords limited liability, which means that in a lawsuit, personal assets are protected. A plaintiff is generally limited to the acquisition of business assets.

The LLC either files taxes using a Schedule C on the owner’s personal Form 1040 (one owner LLC), a Form 1065 ( Federal Partnership return), or a Form 1120S (S-corporation).

Unfortunately, in the case of a one-owner LLC, an LLC does not preclude paying self-employment tax on net profits. And a multi-owner LLC requires more maintenance with regard to business continuity and division of profits.

Anyone entertaining an LLC with partners should have an attorney draw up Articles of Organization to protect the interests of all owners.

• C-Corporation. The regular C- Corporation is a popular form of business organization. It provides limited liability for the owners and some tax benefits for fringe benefits that may not be available to other types of entities.

A C-Corporation requires filing Articles of Incorporation the Secretary of State. In Florida, filing is done at the Florida Division of Corporations, www.sunbiz.org. The filing fee for a corporation is usually $87.50.

C-Corporations are not without disadvantages. They require completing considerable paperwork, such as issuing stock, filing annual reports, and maintaining corporate meeting minutes. Taxation is also a disadvantage of this business structure. In a C-Corporation, profits and distributions are both taxed—a double taxation situation. The C-corporation is subject to federal corporate tax on profits, and the owners are subject to tax on dividend distributions. The corporate taxes are filed on the IRS Form 1120.

• S-Corporation. To overcome the double taxation hit on small business owners, Congress created the small business, or S-Corporation entity. This entity allows the same limited liability as the C-Corporation or LLC; it avoids double taxation since it avoids taxes on corporate profits; and it allows owners to take probable initial losses on their own individual income tax return.

The operating results of the S-corporation are filed on IRS form 1120S, and a Schedule K-1 is given to each owner, detailing the effect of their ownership on the profits or losses of the company. Owners are taxed on their share of the profits or losses, depending on their percentage of ownership.

Although S-Corporations offer many advantages to small business owners, they also have some disadvantages. The structure puts restrictions on owner compensation, fiscal years, and fringe benefits .

To attain S-Corporation status, you must file a Form 2553, S-Corporation Election when you create your company. S-Corporation, incidentally, is a federal designation and does not apply in Florida. Therefore potential S-Corporation owners need to file the proper paperwork with both the IRS and the State of Florida.

Which business structure is right for you? Among the factors to consider are:

• The number of employees your business has,

• The type of business,

• The number of owners,

• Your marital situation,

• Other income, and

• Expected profitability.

One “size” does not fit all. Years ago, the pitch-person in a commercial for Fram oil filters used to say, “You can pay me now, or pay me later.” Invest in the help of an attorney or CPA to help you decide your business structure. A few hundred dollars of expert advice in the beginning can mean the prevention of thousands of dollars in tax and legal bills later on.

keithjohnsonwebKeith E. Johnson, CPA, can be reached at 904-727-0077 or www.kjohnsoncpa.com.


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