Part 2: Does your business need limited liability protection?
Last week I posted about types of business entities that do not offer any limited liability protection. You can read about that HERE.
Sole proprietorship and general partnerships are the fastest and easiest ways to start a business, however, these types of entities do not offer limited liability protection.
Limited liability protection just means that you, as an individual, cannot be sued against your personal assets from business outcomes. Instead, all debts incurred will be under the company’s name and against company assets.
If you think your business will benefit from limited liability protection, there are four different types of entities that will offer this protection: C-Corporation, LLC, S-Corporation, and LLP.
Each type of entity will have different tax classifications and will define owners’ rights within the organization slightly differently.
C-Corporation
C-Corporations are highly structured organizations. They are the most traditional type of entity and have been around for many years. In order to classify as a C-Corporation, there are a TON of requirements that you must fulfill. Some examples include:
Filing with the state
Maintaining Articles of Incorporation
Maintaining bylaws
Submitting shareholder information
Maintaining a board of directors
Submitting notices when the board of directors meet or if shareholders need to vote
Issuing stock
Keeping very specific files organized
Like I said, these are highly structured!
A note on Tax classification…
Without getting too much into the tax-weeds, here are some tax items you can expect if you have a C-Corporation
The corporation will be taxed on their yearly net profits
The corporation will have payroll taxes
If you are an owner (aka shareholder), then you are taxed on whatever profits you, as a shareholder, received.
If you also work within the corporation, you will be taxed on whatever your payroll is.
If there are any dividends being paid on stocks that you own, you will need to pay capital gains tax
So why would anyone want to classify as a c-corporation?
The simplest answer is that (1) there are a few tax benefits to this type of entity and (2) this structure makes it easier to raise funds/find investors.
Limited Liability Corporation (LLC)
Structure
LLCs are probably the most common type of business structure for individuals. You still have to file with the state but there isn’t as much government oversight as to how you run your business.
For instance, if you decide to start an LLC it is not required by law to have an operating agreement. In fact, I have had a few clients that come to me with an LLC as part of their estate, and have been operating for years, but do not have an operating agreement. This usually occurs when individuals attempt to create their LLC on their own, via an attorney. (And, while this is totally legal, it is not wise to not have an operating agreement!)
Tax Classification
LLCs offer much more flexibility, with fewer statutes but will also be taxed differently. Profits are taxed through the owner. LLCs can have a single owner or multiple owners, but regardless, all profits pass through the LLC and are taxed individually to members.
S-Corporation
Structure and Tax Classification
As far as the structure goes, an S-Corporation is very similar to an LLC. There are special rules that make this type of entity unique, but to make things simple — think of it as an LLC that is taxed in a different way. In fact, one of the biggest advantages of an S-Corporation is the tax advantage.
With an S-Corporation, taxes are covered by the business.
So, you (as the owner) take a payroll from the business. This means that you are responsible for paying yourself for working within the business. Since the business is employing you, the total profit of the business is reduced — thus you will save money on taxes.
I am not an accountant and cannot give you tax advise, but this is why people consider s-corporations.
Limited Liability Partnership (LLP)
In a Limited Liability Partnership, or LLP, each partner can limit their liability from the action of the other partners. If you remember from my last post, this is different than a general partnership — where each person is liable as an individual and also liable for their partners’ actions.
LLPs are very similar to LLCs, however, LLPs are typically used in businesses that offer professional services – such as attorneys, physicians, psychologists, etc.
Sum It Up…
Most businesses will benefit from having limited liability protection. How you structure your business will determine your tax classification as well as each owner’s rights.
If you want your business to provide limited liability protection, it is best to sit down with an attorney (as well as an accountant) to discuss which option is best suited for the type of business you own!
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