Deciding which type of business formation, or business entity, is best for your business is one of the most important decisions you'll make regarding your livelihood. It's especially important to choose the best business entity for your business structure because your finances, taxes, and personal liability will be dependent on which type of business structure you choose.
There are five business formation choices:
- Sole Proprietorships
Each business type has its own appropriate business license, so it is important to make the proper selection for your future business and to hire an experienced business lawyer to ensure that everything is being done properly every step of the way.
Forms and Information You Need to Form Your Business
When business planning and becoming a business owner, each type of business requires different forms and paperwork in order to stay in compliance with local laws and ordinances. Which entity is the best form depends on structure, liability, management and tax considerations. No matter which business strucuture you opt to start, having proper identification and business licensure is absolutely imperative.
Sole proprietorships are typically the most simple to begin. Sole proprietorships are unincorporated business structures that require no filing with the requisite state authority. Sole proprietors have total control over the business activity. Sole proprietors have total control over the business activity, revenue, and business decisions. Sole proprietorship is often an appropriate choice for various different individuals such as independent contractors, franchise owners, and small business owners.
Sole proprietorships are often advantageous because all earnings can be passed to your personal income, and business owners are not obligated to register with their state. Licensure, zoning permits, and various other licenses, depending on the type of business, are still required in a sole proprietorship.
While sole proprietorships are the most simple businesses to open, they do come with their own risks. Business owners are liable on a personal level for any and all debts incurred by the business are entirely on the individual, which is referred to as unlimited liability. It is imperative that business professionals have a business attorney on standby in the event of any business dissolutions.
A partnership is formed when two or more individuals join together for profit. In Arizona, partnerships are considered pass-through entities for tax purposes. The partners share in all profits or losses. Business partnerships can be formed by partners holding themselves out as a business for profit. However, it is highly recommended that a partnership create a written agreement drafted by a business law professional. The individuals in the partnership invest their own income and each partner shares profits and losses equally. Business partnerships do not have to register in Arizona.
A business entity taxed as a partnership is a pass-through entity for tax purposes, which means it does not pay an entity level tax. Instead, the partnership's profits and losses are computed and allocated among the partners annually and pass-through to the partners who include their respective share of those items on their income tax returns.
There are three different types of partnerships that can be filed and registered. General Partnership is a partnership in which partners are engaged in the daily operations of the partnership, and share liability for debts and lawsuits.
A Limited Partnership has at least two partners who manage the business and hold all liability for the decisions made, while one or more partners are not engaged in regular business practice and do not hold liability. Lastly, a Limited Liability Partnership has legal protections from liability to any individual.
A Limited Liability Company, commonly referred to as an LLC, is a creature of state statute. LLC’s are the most common and simplistic incorporated entity. LLC’s offer flexibility for business owners and have different options available for tax purposes.
A business entity that is treated as a disregarded entity for tax purposes is an entity with a single owner that is generally ignored for tax purposes even though it is a separate legal entity for state law purposes. Similarly, the IRS differentiates between single-member LLC’s and multi-member LLC’s. The IRS treats single member LLC’s as sole proprietorships for tax purposes whereas multi-member LLC’s are treated as partnerships for tax purposes. For example, a single-member LLC that is treated as a disregarded entity for tax purposes does not file a US federal income tax return. Instead, the sole member of the LLC reports the LLC's income and expenses directly on its own income tax return.
LLC's offer flexibility for business owners, and may choose to use corporate tax rules instead of operating as a partnership.
LLC's do not file corporate tax returns, as they are considered pass-through entities, meaning business owners are responsible for reporting their losses and profits on personal tax returns. The benefit of this is LLC business owners avoid double taxation. Having legal representation when dealing with business tax matters is important for various validation purposes.
A C-Corp, or C Corporation, is a business structure where owners are taxed separately from the entity. All corporations other than S-corporations are C-corporations. C-corporations generally are subject to two levels of tax on their income:
- At the entity level when earned.
- At the stockholder level when distributed.
An eligible C-corporation generally can avoid double taxation by electing on formation to be treated as an S-corporation if it meets the Internal Revenue Code (IRC) requirements for an S-corporation election. C Corporations limit the liability of the investors since they are only able to lose what they have invested into the business entity.
An S-Corp, or S Corporation, is a business that has shareholders, directors, and officers that own stock in the company. These individuals are active in the day-to-day operations of the business and are distinct from its shareholders because they are not responsible for debts incurred by the company. This type of business is also subjected to legal requirements that are not held by other types of businesses.
An S-corporation is a "pass-through" entity for tax purposes, which means it generally does not pay an entity level tax. Instead, the S-corporation’s profits and losses generally pass-through to its stockholders who include their respective share of those items on their income tax returns (whether or not distributed).
Related Content: LLC vs. S-Corp vs. C-Corp
Why Hire a Lawyer when Establishing Your Business
It is important to hire legal assistance when establishing your business because having business law attorneys on standby can help you, as a business owner, prevent lawsuits. Drafting contracts also becomes infinitely easier when you've hired an attorney because it ensures that all of the necessary items needed in the contract have been covered.
Your intellectual property, such as designs, logos, and original work becomes protected through copyrights, patents, or trademarks. At Monahan Law Firm, PLC we can help protect your assets for your business.
Unless opening a home-based business, more often than not, prospective business owners will need to invest in a knowledgeable law professional to find a business property, as well as formulate a business succession plan. An experienced estate planning attorney can help you find a property, and a business lawyer can help you establish a business succession plan.