Starting a new commercial venture is an exciting proposition but along with the anticipation of success and prosperity come responsibilities and decisions that need to be taken, first and foremost being the question of choosing the right type for the new organization. This is an extremely important decision as it affects the vital aspect of the new entity namely- taxes, compliances, liabilities of the owner and the avenues for raising funds. In this article, we will list out the legal formats and the related business structure tips for benefit of new entrepreneurs.
The most common form and a popular one for small business owners as it provides complete control over every aspect of the new enterprise. The details of the profit and loss of the venture are reported through Schedule C form with 1040 (personal tax return) and Schedule SE forms. The net income is then transferred to the personal tax return of the owner and this feature is what makes it appealing as any losses sustained can be balanced by earnings from other sources. The biggest drawback of this format is that as the owner is completely responsible for the firm’s liabilities, his/her personal assets are at risk for the settling of any debts or legal claims filed against the organization. Another disadvantage is most financial institutions are not sure about the credibility of such ventures and therefore show little enthusiasm in giving funds to them.
A good choice for two or more individuals starting a business together looking to give a formal structure to the new enterprise, a partnership can be of two kinds :
General Partnership: When the distribution of the duties, profits or any liabilities of the company is even among all the partners, the arrangement falls under this category.
Limited Partnership: This mode is used for partners who do not want to share the load of managing operations and are only investing money in the outfit. The general partners take care of running the administration while the limited ones put in the required funds. It is a more complicated structure than the general format and used only if the situation demands so.
Both forms of the partnership have tax benefits similar to the sole proprietorship as the profits or losses are passed on to the partners, who have to report the details of their share of the income, deduction, and credits in the Schedule K-1 form apart from mentioning of the gains made in their personal tax returns. No income tax is levied on a partnership firm but the earnings made have to be reported via Form 1065. These arrangements require legal and accounting assistance and hence setting them up may be a costly affair besides the liabilities of the partners towards the firm’s debts and obligations being complete.
Limited Liability Corporation
As the reader may have noted by now that in case things go wrong with the organization structured in one of the two above listed formats, the personal assets of an owner or partner at risk for settlement of debts or any other issue. This type safeguards an individual’s personal property from these hazards with the liability limited to only the investment made in the commercial entity. One of the most important business structure tips for an upcoming entrepreneur would be to opt for this setup as it also features the very beneficial tax structure of partnerships with any earnings or losses incurred passing on to the owners. Any organization opting for LLP company registration can have as many shareholders that it wants with every member allowed a say in operational matters. The rules and requirements for the incorporation differ from state to state and the inherent complexities require the hiring of professionals not only for registration but also later on for maintaining all the records necessary for tax and other compliance.
People looking at starting large enterprises with many employees register their ventures as corporations which are treated as completely separate entities from their founders giving them the benefit of limited liability. These companies can raise funds through stocks besides enjoying better credibility in the eyes of lending institutions. Their formation is governed by the rules of the state where they are located and require compulsory professional help for processes like name registration, articles of incorporation filing and fulfilling other compliance requirements. A look at their different types will help in choosing the right one:
C Corporation: Any number of shareholders can combine to form this but the income tax on the profits earned has to be paid twice- once by the company and secondly by every individual stakeholder on his/her personal share.
S Corporation: Ideal for small setups as the profit or loss is transferred to the shareholders who have to declare the same in their personal tax returns apart from enjoying the protection of limited liability for personal assets.
A new commercial setup requires thoughtful approach and meticulous planning for giving it a sure-footed start and these business structure tips would give an entrepreneur a fair idea about the right type of incorporation for the new venture.