What Legal Entity Should I operate my Business under?

Dear M & M:

I am confused, what legal entity should I operate my business under?

– Beverly

Dear Beverly:

Generally there are six forms that most businesses chose (Sole Proprietor, Partnership, Cooperative, Corporation, S Corporation and Limited Liability Company).  Obviously if there is more than one person involved in ownership and decision making sole proprietorship is out.

Individual considerations need to be taken into consideration before choosing what legal entity your organization will use. According to the SBA, a sole proprietorship is the simplest and most common structure chosen to start a business.

It is an unincorporated business owned and run by one individual with no distinction between the business and you, the owner. You are entitled to all profits and are responsible for all your business’s debts, losses and liabilities. A partnership is a single business where two or more people share ownership.

Each partner contributes to all aspects of the business, including money, property, labor or skill. In return, each partner shares in the profits and losses of the business. Because partnerships entail more than one person in the decision-making process, it’s important to discuss a wide variety of issues up front and develop a legal partnership agreement.

This agreement should document how future business decisions will be made, including how the partners will divide profits, resolve disputes, change ownership (bring in new partners or buy out current partners) and how to dissolve the partnership.

Although partnership agreements are not legally required, they are strongly recommended and it is considered extremely risky to operate without one. A cooperative is a business or organization owned by and operated for the benefit of those using its services. Profits and earnings generated by the cooperative are distributed among the members, also known as user-owners.

Typically, an elected board of directors and officers run the cooperative while regular members have voting power to control the direction of the cooperative. Members can become part of the cooperative by purchasing shares, though the amount of shares they hold does not affect the weight of their vote.

A corporation (sometimes referred to as a C corporation) is an independent legal entity owned by shareholders. This means that the corporation itself, not the shareholders that own it, is held legally liable for the actions and debts the business incurs.

Corporations are more complex than other business structures because they tend to have costly administrative fees and complex tax and legal requirements. Because of these issues, corporations are generally suggested for established, larger companies with multiple employees. An S corporation (sometimes referred to as an S Corp) is a special type of corporation created through an IRS tax election.

An eligible domestic corporation can avoid double taxation (once to the corporation and again to the shareholders) by electing to be treated as an S corporation.  A limited liability company is a hybrid type of legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership.

The “owners” of an LLC are referred to as “members.” Depending on the state, the members can consist of a single individual (one owner), two or more individuals, corporations or other LLCs. Unlike shareholders in a corporation, LLCs are not taxed as a separate business entity. Instead, all profits and losses are “passed through” the business to each member of the LLC.

LLC members report profits and losses on their personal federal tax returns, just like the owners of a partnership would – SBA.  As one can see each type of legal entity has different legal, tax consequences and the costs to operate and maintain. It would strongly be advised to seek the assistance of an attorney and tax preparer to get opinions on what would best fit your situation.

Source: SBA Choosing Your Business Structure

-M&M

To ask your questions: Call the Small Business Development Center(SBDC) at Cochise College (520)-515-5478 or email schmittm@cochise.edu or contact the Sierra Vista Economic Development Foundation(EDF) at 520-458-6948 or email  hollism@svedf.org

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