If you have a great idea and are ready to put it into practice in the form of a new business, but you may be wondering what is the best legal entity for you to operate as? All business structures have their advantages and disadvantages, so let’s look at some of the options.
The simplest form of business is as a sole trader. This is just you owing everything and being responsible for operating the venture. From a tax point of view, any profits are declared on your tax return. They are added to any other income you have for the tax calculation. By the same token, if you have made a loss, that is deducted from any other income and could result in a tax refund.
You have to make payments of tax quarterly, based on an estimate of what the current year’s profits will be. These quarterly payments are due of the 15th in April, June, September, and January. You will only be taxed once on your profits, but the method of calculating your payment can sometimes be complex.
Another advantage is that you will have complete control over how your business is run, but there are some disadvantages too. You basically are the business, so if it has any debts they are your debts and that can put your own personal assets at risk.
It can also be harder for a sole trader to raise finance, as banks and loans companies are very aware of the limited scope of recovering their money of the business does not work.
A partnership is when two or more people own the business. There are two types, a general partnership, and a limited partnership.
In a general partnership, the partners assume the same responsibilities as a sole trader. In a limited partnership, there is a mixture of general and limited partners. The general partners will run the business and have the same responsibility for the liabilities, where the limited partners are investors only. They are not involved in the day-to-day running of the business and have no responsibility for any of the partnership debts. The biggest risk to them is losing the cash they invested.
Tax-wise, each partner has to pay tax on their share of the profits, and this is filed on their own tax returns. They do have to declare the full profits of the partnership, but will not be taxed on the other partner’s shares.
The biggest drawback is that any individual partner can take out loans, finance on new vehicles or something similar without the signature of any of the other partners. However, they are all responsible for any debts incurred in this way.
The only way for any protection against this is to have this like this banned in a partnership agreement. The agreement should also clearly define the duties of each partner, what will happen if one of them wants to leave, and any restrictions on who they can sell their share of the partnership to. It is best to have a partnership agreement drawn up by an attorney that specializes in this area. They are a legal document that is meant to protect everyone involved.
Limited Liability Companies (LLC’s)
Limited liability companies were first introduced to the US in 1977, as the more time that has passed, the more popular they have become. They are particularly good for small business owners.
Anyone starting an LLC will not be liable for any of the debts of this separate legal; entity, which has to be one of the biggest advantages of all. It means their own assets are protected, unless they personally guarantee a loan with a bank, for example.
There is no limitation on the number of shareholders an LLC can have, and unlike with the limited partnerships, they can all be involved in the day-to-day running of the business.
To set up an LLC you have to file articles of the organization with the secretary of state for the state you intend to operate in. Some states will also require you to have an operating agreement, which is not unlike a partnership agreement.
Different states have different rules relating to LLC’s with some stipulating that they must be dissolved after 30 or 40 years. In reality, the company is dissolved if a member dies, quits or retires anyway. The tax treatment of LLC’s also varies from state to state, but the individuals involved will report their share of any profits on their own tax returns.
If you want to operate as an LLC in several states it can become very complicated and you need advice and the services of an experienced accountant who has the knowledge to deal with such a situation.
Of course, these are not the only options for running a business in the US. There are corporations, but these are complex and expensive to set up. Under the umbrella of corporations, there are others such as ‘s’ corporations and ‘c’ corporations where the rules and regulations differ slightly. Just as with the other options discussed, they have their advantages and disadvantages, but because of the initial costs involved it tends to be larger companies that decide to operate as a corporation.
What you have to remember is that at the end of the day you need to choose the best for you, but that is liable to change. None of us can control the changes in laws made by the politicians and lawmakers of the US, and this can mean what is best for you this year will not be so good next year.
Therefore, you need to be flexible and not be afraid to change the structure of your business if the need arises. That might seem costly, but in the long run, it could save you a lot of money. Whatever type of business you are now or in the future, having the right advice is vital. What is best for your friend in the bar might not be the best for you. Always seek professional help, and then you can have the peace of mind of running your nosiness in the right way.