Which Business Entity Do I Choose?
You have many structures to choose from when forming your business. Your choice is an important one and will depend on your business model and long terms goals. It is advisable to consult with a business law attorney before selecting your business structure. Here are a few pros and cons of each:
A sole proprietorship is not a legal entity and no filing with the Washington Secretary of State is necessary. An individual or married couple may form a sole proprietorship simply by running a business. The sole proprietor has full control and management and operations of the business. However, the person or persons running the business are personally liable for all debts and obligations of the business. The sole proprietorship is not a taxable entity. This means that the taxes flow-through from the business to the owner. A sole proprietor has to pay self-employment tax on all income.
A general partnership is also not a legal entity and does not need to register with the Washington Secretary of State. A general partnership is composed of two or more persons who agree to invest money or contribute labor to the business. Each partner shares in the profits and losses of the business. Each partner also shares in the management of the business and is personally liable for all debts of the partnership. This means that essentially, one partner could be liable for the debts or obligations incurred by another partner.
It is highly advisable to consult with a business law attorney to draft a partnership agreement that can further define the obligations of each partner. In this agreement, you can indicate how much each partner is to initially invest in the business, which partners will have control over the operations of the partnership, how income and losses are shared, how ownership can be transferred and much more.
Like a sole proprietorship, a general partnership is not a taxable entity. Taxes flow-through from the business to the owner. Each partner pays taxes on their share of the income and can realize their share of the losses against other income.
Limited Liability Company
A Limited Liability Company, or LLC, is one of the most popular business entities and with good cause. A LLC consists of one or more members who may be individuals or other legal entities such as a corporation or another LLC. A Board of Directors and Offices are not required and neither are annual meetings and the accompanying paperwork.
To form an LLC, you must file a Certificate of Formation with the Washington Secretary of State and pay the $180.00 filing fee. You must have a registered agent with an office located within the State of Washington.
An LLC can either be member-managed, where each of the members work together in running the business or manager-managed, where the members elect a manager to run the business. Member-managed LLCs are the most common. Whereas it is not required by the Secretary of State, it is advisable that you hire a business law attorney to draft an operating agreement outlining how the business of the LLC will be run.
One of the most beneficial aspects of an LLC is that each member is NOT personally liable for the debts and obligations of the LLC. The only instance where a member will be held personally liable is if he or she did something that constituted gross negligence or a knowing violation of the law.
Typically, the profit or loss of an LLC flows-through to the members in proportion to their percentage ownership in the LLC. This allocation can be altered by the operating agreement.
If an LLC has a single member, it is taxed as a sole proprietorship with profits and loses flowing-through to the member. That is, the profits of the LLC are taxed once at the individual’s tax bracket rate. In this instance, the single member can file IRS form 8832 which allows pass-through taxation as if the LLC did not exist. If the LLC has more than one member, it is taxed like a partnership and must file an IRS 1065 partnership tax return. The profits flow-through to each member and each member paying taxes at their individual tax bracket rate. An LLC may choose to be taxed like a corporation but this only occurs in rare circumstances.
A C-Corporation is typically formed if you are starting a large organization with a large amount of employees that needs to raise a large amount of capital. A C-Corporation is also typically formed if you are planning a publicly traded large company. This is because the shares of stock of a C-Corporation are easily transferable. There is no limited to the amount of people who can own shares in a C-Corporation.
A C-Corporation is formed by filing Articles of Incorporation with the Washington Secretary of State and paying the $180.00 filing fee.
In a C-Corporation, the owners of the company, the shareholders appoint a Board of Directors to manage the company. The Board of Directors then elects Officers (President, Vice-President, Secretary, etc.) who run the everyday business of the company. Annual meetings are required as is the accompanying paperwork such as meeting minutes.
Like in LLC, a C-Corporation offers protection from personal liability to its directors and officers. The “corporation veil” as it is called, can only be “pierced” in instances of gross negligence, knowing violation of the law, or intentional misconduct.
The major disadvantage of a C-Corporation is that it is subject to double taxation. That is, the corporation is taxed once at the corporation’s tax bracket rate when the business makes a profit and a second time at the individual’s tax bracket rate when those profits are distributed to the shareholders. Some tax benefits for employees and certain deductions are available to C-Corporations but the double-taxation deters most business from forming a C-Corporation.
An S-Corporation is another popular business structure. An S-Corporation is very similar to a C-Corporation except that an S-Corporation is not subject to double taxation. The shareholders of an S-Corporation are taxed once at their individual tax bracket rate. Losses also pass through to the shareholder and the shareholder may take these losses against other income.
Forming an S-Corporation is almost identical to forming a C-Corporation. You must file Articles of Incorporation with the Washington Secretary of State and pay the $180.00 filing fee. The shareholders appoint a Board of Directors and the Board of Directors appoints officers. Annual meetings must be held and meeting minutes must be taken. The shareholders, directors and officers are not personally liable for the debts and obligations of the company.
To avoid double taxation, you must “check the box” as an S-Corporation on IRS Form 2553. If you do not, you will have essentially formed a C-Corporation. Certain tax-deductible benefits, such as health and life insurance benefits, are available to employees of an S-Corporation. It is important to note that unlike a C-Corporation, an S-Corporation is limited to 100 shareholders, all of whom must be individuals.
A Nonprofit Corporation is often referred to as a 501(c)(3) corporation after the IRS code section that governs them. A Nonprofit Corporation enjoys a preferred tax status and in return is required to further an ideal or goal other than the interests of profit.
To form a Limited Partnership, or LP, you must file a Certificate of Limited Partnership with the Washington Secretary of State and pay a $180.00 filing fee.
A LP consists of one or more general partners and one or more limited partners. The general partners manage the business, share fully the profits and losses and have personal liability for the LP’s debts and obligations. A limited partner shares in the profits of the business but their losses are limited to the extent of their investment in the company. That is, limited partners can only lose what they put in and they are not personally liable for the debts of the LP.
In the past, limited partners could not be involved in the daily operations of the LP. If they participated in the daily operations of the LP they would lose their limited liability protection. However, the Washington Uniform Limited Partnership Act, codified in RCW 25.10.321, states that limited partners may maintain their limited liability even if they participate in the business.
LPs are taxed the same as general partnerships in that each partner is taxed on their share of profits at their individual tax bracket rate.
Limited Liability Partnership
A Limited Liability Partnership or LLP is the same a general partnership except that one partner is not personally liable for the negligence of another partner. Many law firms and accounting firms form LLPs. To form a LLP you must file a Limited Liability Partnership Registration form with the Washington Secretary of State and pay the $180.00 filing fee.
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