Maybe you’ve just decided to start a new business out of the blue, or maybe a hobby of yours matured over the years to eventually earn you money. People come to you for your expertise, your support, or your handiwork and they’re paying you for it. Cash is easy to handle, but then you started accepting checks made out to your own name and then PayPal payments linked to your personal bank account. Now it’s grown beyond the point where you can account so casually for the revenue, so you’re thinking about formalizing your business endeavor. Should you form a sole proprietorship, a partnership, a limited liability company, or an S or C corporation? In this article, we’ll discuss some of the pros and cons of the various choices of business entities to help you decide which is best for you. You can always change it later, but the process requires time, effort, and funds, so it’s best to plan ahead for the long term.
The simplest form of business is just you doing the work yourself, under your own name; it’s called a sole proprietorship. You should account for your business income and expenses, but you can comingle the funds with your own. Save receipts for your expenses and keep a tally of your income. If your business is small, this is probably your best choice, as there’s little extra bureaucracy or red tape – you don’t need to register your business, you probably don’t need a lawyer or an accountant, and you can still take your business expenses as a tax deduction on your IRS Schedule C, as long as you make profit more years than not.
If your product or service is taxable in the municipalities in which you sell it, you may need to register with your state or local tax office in order to collect and remit sales & use tax on the goods and services you sell. Here in New York, they let you keep a tiny percentage of the sales tax you collect, to compensate you for the paperwork and recordkeeping incurred. If you perform value-add services on someone else’s taxable goods, such as finishing and reselling unfinished birdhouses, you can get a “resale” certificate to provide to your vendors so that you won’t be charged sales tax on the intermediary goods you purchase for resale. When you buy an unfinished birdhouse for $10, you won’t pay sales tax on it, but when you resell it for $20 you’ll collect and remit sales tax on that amount from the consumer. Remember that you are the consumer of the paintbrushes you use to paint or stain those birdhouses; you can deduct their cost from your profit for income tax purposes, but you’re still required to pay sales tax on them.
There are a few varieties of ways to form a sole proprietorship; as mentioned, the easiest is to simply operate under your own name with your own social security number. If you’d rather establish a separate name for your business (called a “doing business as” or “DBA”), contact your county clerk for the process. If you’d rather establish a separate tax ID for your business (called a “taxpayer identification number,” “employer identification number,” “TIN,” or “EIN”), contact the IRS or visit their Website for the form. There is typically a fee to establish a DBA, but a TIN or EIN is free. When you get the DBA paperwork, bring a copy to your bank to open an account in the business’ name. The sole proprietorship offers a few perks, including deductions for business expenses and lets you create a separately-identified entity under which to conduct business operations, while keeping your paperwork minimal and your legal & accounting costs low. The downside is that you are the business – there is no distinction, legally or financially, between the business’ obligations and your own. If your product injures someone or you damage property while performing services, you are personally liable. If your business commits to financial obligations that it cannot repay, the creditors will pursue you, personally.
The next entity to consider is called a partnership. In a few respects, this is better than a sole proprietorship, but in other ways it’s much worse. A partnership is basically you and one or more people entering into a business endeavor together. You can each invest as much as is agreed, work as much as agreed, and take as much of the profit as is agreed. It’s definitely best to create a separate tax ID for this type of arrangement, and a “doing business as” (rather than using any partner’s own name). When you take your DBA paperwork to the bank to open accounts, you will specify who has signing privileges on the checks and how many signatures are required on each check. The big advantage of a partnership is that together you can do more; you share the management responsibilities and have a greater source of capital than any one of you might have individually. The downside is that each partner has full authority to commit the business to obligations to which every partner is jointly and severally liable. That means that your partner can subscribe to magazines, sign up for a cell phone plan, or take out a loan, and if he stops paying, the creditors can come after you for the money. If your partner disappears, it’s a lot easier for them to get a judgment to levy your savings, garnish your wages, or take a lien on your property than on your absent partner’s. On the other hand, it’s often hard to find good help, so if you and two friends want to open a deli together, it may be more encouraging for each of you to work there as partners, each sharing in the profits, rather than one of you hiring the other two as hourly employees.
The next category of business entities, including corporations and limited liability companies, is a bit more complicated. It dates back to early British seagoing expeditions. Wealthy investors sponsored ships to find new lands rich in resources. If the expeditions went well the ships returned with gold, spices, or slaves, but if the expeditions went poorly, the ships were lost at sea and all hands drowned. The investors rarely embarked on these adventures themselves, instead hiring crews. When the ships returned successfully, the crew was paid and the investors took their cuts of the profit, but when the ships sunk, these investors didn’t want to be sued by the families of the crewmen for the loss of their bread-winning family members. Thus, limited liability companies were born. Investors could buy and sell shares of the company, and while their upside profit potential was theoretically unlimited, their liability for losses was limited to just the amount of their investment. The company could mismanage its ships, property, and other assets, eventually making the shares of ownership worthless, or the company could be sued by the families of lost crews and be required to pay all of their assets out, but in no event would the investors be on the hook for any more than the amount they had already invested. The limited liability company was treated as an entity separate from the investors – a fake person. In fact, that’s loosely what corporation means.
The most important thing to understand about this category of business entity is that these types of businesses are all separated, legally and financially, from the people who own them. This category insulates its owners from the business’ financial and legal obligations. If the business owes more than it earns, the owners are not personally liable. If the business hurts someone or damages property, the owners are not personally liable. There is one caveat, though: just forming one of these business entities does not assure you of this protection; you are responsible for continually maintaining “corporate formalities.” If a plaintiff can demonstrate, for example, that you routinely comingle business funds with your own, personally pay certain business expenses, or have the business pay certain personal expenses, they may be able to convince a judge to “pierce the corporate veil” and treat you and the business as the same. It is up to you to keep proper records, to maintain proper financial accounting, to use business funds to pay business debts, and to hold and formally document annual shareholder and board meetings, even if you’re the only shareholder and board member.
Besides the extra ongoing effort, a corporate veil costs a bit more to establish than forming a non-corporate business entity. You will probably need a lawyer, and you may want an accountant, too. In fact, speak with them first to determine which type of business entity is most appropriate. The corporation can have a separate name from that of the owner(s), and should have a separate TIN or EIN. You’ll receive a filing receipt of some sort from your state’s Division of Corporations – it may be called “Articles of Incorporation” or “Articles of Organization” – and instead of the DBA certificate used for a non-corporate entity, this is the document you’ll need to open bank accounts in the business name.
A corporation’s profits are not necessarily its owner’s profits; you have choices about how to handle them. This is one of the other big advantages to forming a corporate entity: greater control over the business finances. With a sole proprietorship, after you deduct expenses, remaining profit is taxable as self-employment, and since taxes, social security, or Medicare weren’t withheld from it, you’ll have to pay it yourself. With a corporate entity, the directors and officers (i.e., you) decide how to treat the corporate profits. You may pay it to the directors and other employees as salary (and be responsible for the associated income taxes), you can reinvest it to expand the business, or you can distribute the profits to the shareholders (which results in lower tax obligations). There are three such entities we’ll address herein: the C corporation (also known as a “C Corp”), the S corporation (or “S Corp”), and the limited liability company (LLC).
The traditional corporation is the C corporation. Most of the big companies whose names you know are C corps: Proctor & Gamble, Coca Cola, IBM, Frito Lay, Microsoft, and McDonalds. C corps can have a virtually-unlimited number of shareholders, who may be individual citizens, foreigners, or other companies. Shares may be closely held by a limited few or may be publicly traded, such as on the New York Stock Exchange. C corporations have extensive recordkeeping and financial obligations, and since each is treated as a fake person, it pays taxes on its own earnings. Some corporations, like Microsoft, don’t pay out any dividends, effectively reinvesting all of their profits, but most small corporation shareholders prefer to receive their cut of the profit, and are then responsible for paying income tax on the distributions they receive. This results in double-taxation, where the company pays corporate tax on the profit it earns, and then the shareholders pay income tax on that profit again when it is distributed to them.
To get around this double-taxation, you may prefer to form one of the other corporate entities. There are some restrictions on who can be an owner of an S corporation, but if your business qualifies, the corporation’s profit flows through and is only taxed once, on its shareholders’ tax returns. To form an S corporation, you start by forming a regular C corporation, and then submit an application to the IRS and to your state tax office requesting to be treated as an S corporation. S corporations have been around for a long time, and have sued and been sued enough to create a good-sized body of legal precedent. If you’re not familiar with the concept, the US legal system operates primarily by precedent. Rather than continually reinvent the wheel, if you’re in court for circumstances materially-similar to a previous court case, your lawyer will cite the previous case, and the judge will probably render a judgment comparable to the way the previous judge decided that case.
That’s one of the main differences with a limited liability company (LLC) – it’s a comparatively-younger business entity, and there hasn’t been as much legal precedent created for it yet. So far, I’m told that judges largely seem to be giving it the same respect as S corporations, but without as large a body of case law, it’s not impossible for some judge to render an unexpected, inconvenient decision that will itself be precedent for other judges to follow. Two other differences are that an LLC is required to have an operating agreement, and is required to satisfy publication requirements. The operating agreement is a simple document you can create yourself, describing some basic facts about the company and its relationship with its members. Search online for samples, or buy a template from a legal aid or legal forms provider. The publication requirements vary by municipality, but if you’ve ever wondered about all those legal notices in the classified section of your newspaper, this is why people take out such ads. In New York, LLCs are required to take out such ads in one daily publication and one weekly publication, each approved by the local County Clerk, and then submit a form and fee to the Dept of State with copies of the two affidavits of publications from the newspapers.
Business entities like businesses come in many shapes and sizes. Depending on what kind of business you have, you may be limited in your choice of entities for that business. A short and to the point definition of an entity for your business, is a business that is created to make money. This business can be owned by a single owner, or a several owners. Depending on where your business is located, you may have to meet some legal requirements for your business entity. Let’s review the different kinds of entities for you to choose from.
One type of business entity and the most common that you will find is the sole proprietorship. Which is a business that is operated and owned by only one person. The owner is the one that benefits from all profits made by the business, but also resumes all responsibility for it as well. If you are not looking to go into business with anyone else, and just for yourself, this may be the ideal entity for you and your business.
When you have more than owner for your business, the entity you may want to consider is called a general partnership. This type of company is owned by more than one person, which all share in the profits made by the company, as well as all of the responsibility that the company requires.
A corporation is a business entity that has a board of directors. The board of directors make the major business decisions and vote on changes for the company. The money that is made from a corporation is split with the shareholders of the company.
Limited Liability Partnership
Another type of entity to consider for your home business is the limited liability partnership. This business is a lot like a corporation with the exception of the board of directors. The owners can either manage the business themselves, or offer that position to someone else.
A business entity that is called the limited partnership is owned by general partners which are active in the company, and limited partners which are more or less just investors. This type of company is ran by the general partners, and the limited partners are somewhat limited in the role that they can play in the company.
With all of the many business entities that you can choose from, you are sure to find the best one that suits the business that you want. Be sure to thoroughly research each one of the entities and make sure that you are following all of the laws in the state that you are doing business in.
It’s rare for the average Joe to know what a Business Entity Search is without having it explained to them, but once they do, they usually retain it. The same concept that’s true in our relationships with the opposite sex and society at large applies to our dealings with other businesses: we all want to work with somebody we trust. A Business Entity Search helps you to find whether a certain company has potential for fraud or not, by checking their details in state and local databases. Further, it helps you locate whether the business has shut down or is still functioning.
There are many forms and types of business entities, and the all fit in the following broad categories:
Sole proprietorship – This is a type of business entity where there is only one sole owner and there is no legal difference between the owner and the business. This is probably the simplest entity – the owner does all the work, he gets all the credit, he takes all the profits, he absorbs all the losses, and if there’s any legal liability – you guessed it, he’s all on his own. On the positive side, a sole proprietorship comes with the least amount of paperwork, and you can use your business expenses as a tax deduction. On the downside – If you get in debt and default, the creditor can dig into your personal assets for recovery.
Partnership – this is a legal entity which has more than one owner bound in a contract. The profits and losses are shared according to terms stated in that contract, but they have unlimited liability i.e. their personal assets can be targeted in case of default. This type of entity has the advantage of having larger capital than sole proprietorship, as more than one owner is involved. But it comes with disadvantages – partnerships can fail, and people can be unpredictable. I’ve seen more than one business partnership fall apart because a partner got too fond of billing things “to the business” and drove his partner to the poorhouse.
Private limited companies – this is the first type of legal business entity with limited liability, i.e. the personal assets of the owners cannot be used in case the business goes bankrupt. It requires fairly large amounts of capital, and the business ownership is divided among a group of private shareholders. The shares are generally sold within the company, and hence the decision-making (and the money) is not to be made public. These entities are treated as an individual separate from the people involved in the day-to-day operations.
Public Limited Companies – this is the largest type of business entity in terms of capital. The capital comes from public shareholding, as the Public limited company needs to be registered with a stock exchange. They have unlimited liability and usually the ownership is separate from management. They are required to show their financial statements, shareholder meetings, and performance publicly once a year at least, hence decision-making is not private. Failure to keep up those standards could get a corporation stripped of its personhood – an ugly experience for everyone involved.
Each business entity has its own rules and regulations. Why’s that important to a prospective searcher? Well, when an investor is ready to open her checkbook, she can check the viability of her investment according to the legal form of business. After all, all business entities, either having limited or unlimited liability, need to be registered with their state.
Once you’re know what kind of business entity you’re dealing with, it becomes a lot easier to get information from other databases.