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When starting a business, choosing the proper legal structure is crucial. It impacts your liability protection, tax obligations, and overall management. Ensure you understand the critical differences among LLCs, corporations, and partnerships.
1. Ownership Structure
Who owns what is an essential factor of doing business. Ownership comes with benefits, obligations, and other complexities. It’s important to wisely consider the implications of the different types of ownership structures.
LLC (Limited Liability Company)
LLCs have owners known as “members.” Each member holds a percentage of ownership, referred to as “membership interest.” These members can include individuals, corporations, other LLCs, and even foreign entities. The ownership details are outlined in the LLC’s operating agreement, which specifies ownership percentages, management, and procedures for handling new or departing members.
Corporation
Corporations have shareholders who own shares of company stock. Shareholders’ ownership percentages correspond directly to the number of shares they hold. Corporations can easily authorize additional shares or transfer existing shares to other parties.
2. Liability Protection
LLC
LLCs offer limited liability protection to their owners and members. This means that personal assets are shielded from business debts and legal claims, and members are generally not personally liable for the company’s obligations.
Corporation
Like LLCs, corporations also provide liability protection. Shareholders’ personal assets are separate from the company’s liabilities. This separation prevents “double taxation,” where both the business and its owners are taxed on the same income.
3. Tax Flexibility
LLC
LLCs enjoy flexibility in their tax classification. They can be taxed as:
1. Sole Proprietorships:
An LLC can choose to be taxed as a sole proprietorship if it has only one member (owner). In this case, the LLC’s income and expenses are reported on the owner’s personal tax return, and the LLC itself does not file a separate tax return. This option simplifies tax reporting, but the owner is personally liable for the company’s debts and legal obligations.
2. Partnerships:
If an LLC has multiple members, it can elect to be taxed as a partnership. In a partnership, each member reports their share of the LLC’s profits and losses on their individual tax returns. Partnerships offer flexibility in profit distribution and allow members to participate actively in management decisions.
3. C Corporations:
Although less common for LLCs, some choose to be taxed as C corporations. C corporations have their own separate tax entity, and their profits are subject to corporate income tax. This option may be suitable for LLCs planning to reinvest profits, raise capital through stock issuance, or have complex ownership structures.
4. S Corporations:
LLCs can also elect S corporation (S corp) status. S corps provide pass-through taxation, similar to partnerships. The LLC’s income and losses flow through to the individual members’ tax returns. S corps have restrictions on the number and type of shareholders, making them ideal for smaller businesses.
Corporation
Corporations follow specific tax rules. They issue dividends based on the number of shares owned. In contrast, LLCs can elect how profits are shared or distributed.
1. Dividends:
Corporations issue dividends to their shareholders. Dividends are a portion of the company’s profits distributed to those who hold shares (stock) in the corporation. They are typically paid in cash or additional shares of stock.
2. Shareholders:
The amount of dividends a shareholder receives depends on the number of shares they own. If you own more shares, you receive a more significant proportion of the dividends.
3. Taxation:
Dividends are subject to taxation at both the corporate level (corporate income tax) and the individual level (tax on dividends received by shareholders), which is often referred to as “double taxation.”
4. Operating Structure and Reporting:
LLC
LLCs have a more flexible operating structure. Owners can customize management and decision-making processes. Reporting and recordkeeping requirements are generally less stringent than those for corporations.
Corporation
Corporations have a standardized and rigid operating structure. They must adhere to formalities such as holding regular shareholder meetings, maintaining detailed records, and following specific corporate governance rules.
5. Transferability of Ownership
LLC
Ownership interests in an LLC are less straightforward to transfer. Changes in membership require updates to the operating agreement, and some states even require dissolving the LLC if a member leaves.
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Shares in a corporation are easily transferable, which makes corporations appealing to business owners seeking outside investors or planning for future growth.
6. Partnerships
A partnership is an unincorporated business structure formed by two or more parties who come together to manage and operate a business. These parties, known as partners, contribute various resources such as capital, labor, skills, and experience. Unlike corporations and LLCs, partnerships don’t provide limited liability protection. Partners share profits directly, avoiding double taxation. However, at least one partner must assume responsibility for business debts and legal matters.
Structure of Partnerships
Partnerships can involve individuals, corporations, other partnerships, or legal entities. They may choose to create a partnership agreement that outlines their roles, rights, and responsibilities. General partners actively manage the business and have unlimited legal liability for the partnership’s actions and obligations. However, there are other types of partnerships with limited liability that professionals may elect to pursue.
Seek Legal Guidance to Structure Your Business
Choose your business structure based on your specific needs, goals, and preferences, but don’t let the complexities overwhelm you. Remember, consulting legal and financial professionals is essential to ensure compliance with state laws and regulations.
Call 480-467-5636 to schedule a consultation to discuss your business plan with AVID Eqs. Group, LLC, today. Our experienced team will help you create a business structure that maximizes your success.
