Which Business structure is right for you?

April 12, 2016

 

One of the most important decisions to consider when planning for your business is what type of business structure to form.  Not only will this determine the amount of taxes you might pay but the amount of additional accounting you may have to do.

For example, perhaps until now, you have been a casual seller and have been selling under your personal user ID, selling occasional household items and have suddenly realized you have become much busier lately and feel you have really “caught on to something” by selling online. You have heard or read a thing or two from others about reporting taxes, protecting yourself from potential lawsuits and other such legalese. 

Whether legal issues actually come to fruition, with advanced planning you may be able to avoid such disasters with proper planning.  Listed below are the various business structures to consider:

Please note: the information below outlines the basic forms of business structures. It is always good practice to consult with a professional, attorney or CPA and seek advice before starting a business.

Sole Proprietorship:  One of the most common, easiest and simplest forms of business structure.  It is an unincorporated business activity and is owned by one individual.  A sole proprietor owns the business assets in his or her own name and is personally liable for the business debts. Basically speaking, the business has no legal identity separate for that of the owner. 

Advantages:     
Ease of creation, formation and dissolution
Minimum startup costs
Complete managerial control
Control and ownership of business assets
Legal restrictions are minimal
                         
Disadvantages:  
Fully bear tax burden on Individual tax return
Unlimited legal and liability 
Venture capital and formal funding may be harder to acquire

Partnership:  There are various forms of partnerships including General Partnership, Joint Venture, Limited Partnership (LP), Limited Liability Partnership (LLP) to name a few.  In general, two or more individuals legally form a business entity (assigned a taxpayer identification number) and assets and liabilities are “passed-thru” to the shareholders.  That also means the tax liability is also passed-thru to the partners’ individual tax returns. 

The partnership’s existence is formalized through a partnership agreement. The association of two or more partners is formed to carry on day-to-day operations and the decision making of the business. A primary disadvantage is liability-each partner is personally liable for the financial obligations

Advantages:      
Fairly easy to form
Direct management and control of business and operations
Profits flow directly to the partners
Ability to raise capital much greater with more than one owner

Disadvantages:  
Does not offer liability protection; personal assets are at stake
No tax advantage when compared to a sole proprietorship
Divided authority in decision making
Interests in the partnership may be difficult to sell or dispose of

Corporation:    A legal entity formed under State law, referred to as a “C Corp” distinct from the individuals and retains separate ownership of assets and liability.  Ownership of the corporation is represented by the outstanding shares of corporate stock.  Formation of a corporation creates a “double taxation” tax liability created at the entity level and the tax liability flowing out to share holders. Special paperwork is filed based upon state requirements and an E.I.N is required upon formation. 

Advantages:     
Separate legal entity and shareholders have limited liability for debts or judgment against the corporation
Can raise funds and transfer ownership with the sale of corporate stock
Costs and expenses may be deductible to the corporation resulting in tax advantages
Centralized management potentially resulting in more efficiencies and better decision making
                        
Disadvantages: 
Very complex and may be expensive to organize and form
Complex regulation and tax preparation
Double taxation- once for the corporation and second for it’s’ shareholders

Limited Liability Company LLC:  Structured to offer liability protection of a corporation but the single taxation element of a Partnership. 

Advantages:     
Profit and losses are passed thru to partners
Ease in transfer of ownership and dissolution
Management ease and ability to transfer to non-members
                        
Disadvantage:  
Tax return required may be complicated to prepare        
Out of state businesses may complicate status if LLC is not recognized
Changes of partner status may create issues 

Reviewing the characteristics of the various business formations should be followed by careful consideration of the following:

  1. Cost of formation- Legal and ongoing professional recordkeeping and administration will need to be analyzed to determine the feasibility of whether or not they will easily offset by ongoing profits.

  2. Risk analysis- What liability risk can the owner and or partners assume?

  3. Tax implications- From simple to complex, tax considerations must be in alignment with  individual and company business goals. 

 

Some examples:

 

Sole Proprietorship

Joe and Martha have been selling on eBay for 2 years.  They began with selling household items that began to clutter and draw dust. The first year or so they would sell several items over a month but now they have found after becoming Top Rated Sellers, they have found the number of items sold in a month easily total 100 or more and they have now accumulated some extra funds in their Paypal account and are thinking about buying some additional items to sell as their personal items have all been sold. After talking with Joe’s brother, a CPA, Joe and Martha found the need to keep better records and were advised that some of their costs such as postage could actually be deducted on their Individual Tax Return.  For the current year, Joe and Martha have decided to continue to operate the business by themselves and obtain a Business License and will become a Sole Proprietorship.  Their income and expenses will be reported on Schedule “C” of their Individual Tax return.

 

Limited Liability Corporation

Sherry and Donna have been friend for a long time and several years ago worked together to sell their unused baby clothes on eBay.  Of course 2 heads are better than one and networking in their neighborhood has amounted to selling for other busy Moms.  Sherry and Donna now have enough funds saved aside to lease the local spot in the strip mall down the street.  They have hired a CPA and are ready to open their store.  Because there will be a fair amount of business and traffic Sherry and Donna have decided not to ever allow business to sever their friendship and have agreed to form an LLC.  This will protect their individual personal assets from being seized in case they are ever sued.  Also Sherry and Donna will receive their proportionate shares of profits and understand their company will not incur a tax liability but both Sherry and Donna will have personal responsibility for including the activity on their personal tax returns.  Sherry and Donna will form an LLC and file a form 1065 at year end. 
 

Corporation

After 5 years of being in business, Samantha now runs a full-time sporting goods store.  The inventory that she cannot sell in her retail store she has found the prefect market to liquidate in her eBay account. Not only does she buy from companies in the United States, she has opened her purchasing to a new connection she found during her recent visit in China.  Samantha is very happy with the inventory price but is a bit concerned of any recourse she may have with the new pogo stick she is stocking in her store. Up until now Samantha has been a sole proprietor but after meeting with her CPA she had been advised of many tax deduction opportunities available to her.  Samantha has 12 employees now and is looking to expand and raise some venture capital.  Her CPA ran some projections and found that forming a corporation not only will save her money but seems to be a perfect way to expand her business and meet ongoing financial demands.  Donna will be forming a corporation and her CPA will file a form 1120S at year end.

 Opening a Business Account on eBay
After forming your business you may decide to use your business name on eBay.  This may have several advantages which may include utilizing your existing company name and branding, ease of recordkeeping and continuation of building your business and expanding your customer base. You can easily change your existing member name to your business name.  For more information see the link below:

 http://pages.ebay.com/help/account/how-to-register-business.html

 Quick Checklist
»Visit CPA & Attorney
»Create an email address specific to your business
»Create a business entity (apply online for an E.I.N. as applicable)
»Apply for a business license
»Order business card and letterhead
»File for a Resale Sales Tax Number
»Open a business checking account
»Apply for a business only credit card
»Upgrade your Paypal account to suite your business needs
»Register all copyrights, trademarks, and patents

 

Keep away from people who try to belittle your ambitions.
Small people always do that,
but the really great make you feel that you too can become great. 
~ Mark Twain

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