Thursday, January 20, 2011

Are You Setting Yourself Up to Win?

Being an entrepreneur requires a multitude of decisions.  Make sure you surround yourself with the proper advisors for each critical or legal decision you need to make.

The right Attorney, Banker, Accountant and marketing professional can eliminate a host of problems and potentially costly errors as you build your success. Make sure you hire specialists who are willing to listen to you and your needs, and respond quickly when you need them.

A few questions to ask yourself when setting up your support team of professionals:
  > What professional advisors to you need?  Attorney, Accountant, Banker, Marketing, Advertising, Internet, and ??
    >  Do you know the good and bad points about going it alone as a sole proprietor?
    >  Do you think you may need a partner? Or will you be forming a Corporation?
    >  Have you discussed your plans with your team of advisors?
    >  Have you investigated adequate insurance coverage for your business?
    >  Are you familiar with the legal permits and licenses for your business and location?

One of the first major decisions you will have to make as you start your new business is which form of legal company structure it will take.  To a large degree this decision may be dictated by the way you have organized your operations and whether you intend to work on your own or in conjunction with others.

Before making the final decision on which structure is best for your business, it is recommend that you do ample research to understand all the advantages and disadvantages for you and your business.

The form of company structure you choose can have a significant impact on the way you are protected under the law and the way you are affected by income tax rules and regulations.  There is no “one size fits all” for the legal structure of your company. There are five basic forms of Company Structures.  Each has its own benefits and drawbacks and is treated differently for legal and tax purposes. The following is only a general list. You should consult an attorney and accountant for the answers as to which is the best structure for you.

1.   Sole Proprietorship
This is the most common form of business organization. It is the easiest to set up and is owned and run by one individual and in which there is no legal distinction between the owner and the business. The owner receives all profits, is liable for all the taxes and has unlimited responsibility for all losses and debts. Every asset of the business is owned by the proprietor and all debts of the business are the proprietor's. This means that the owner has no less liability than if they were acting as an individual instead of as a business.

A sole proprietor may use a trade name other than his or her legal name after filing a “doing business as” (DBA) statement with the local authorities.   

It is difficult to raise money and attract investors to a sole proprietorship. The sole proprietorship does not survive the owner  and therefore makes it more difficult to sell your business. So if growing your business into a large company is a goal, then consider one of the other business structures.

2.   Partnerships
A partnership involves two or more people who agree to co-labor to achieve and share profits or losses of the business. The basic form of partnership is a general partnership, in which all partners manage the business and are personally liable for its debts.

There are three general types of partnership arrangements:
>  General Partnerships assume that profits, liability, and management duties are divided equally among partners. If you opt for an unequal distribution, the percentages assigned to each partner must be documented in the partnership agreement.
>  Limited Partnerships (also known as a partnership with limited liability) are more complex than general partnerships. Limited partnerships allow partners to have limited liability as well as limited input with management decisions. These limits depend on the extent of each partner’s investment percentage. Limited partnerships are seen as attractive to investors of short-term projects.
>  Joint Ventures act as general partnership, but for only a limited period of time or for a single project. Partners in a joint venture can be recognized as an ongoing partnership if they continue the venture, but they must file as such.

There are many factors to consider when selecting which type of partnership or your business. You should consult an attorney and accountant for the answers as to which is the best structure for you.

3.   C Corporation
A corporation is an independent legal entity owned by shareholders. This means that the corporation itself, not the shareholders that own it, is held legally liable for the actions and debts incurred by the business.

A corporation is an independent legal entity. This means that the corporation itself, not the shareholders that own it, is held legally liable for the actions and debts incurred by the business.

Corporations are more complex than other business structure You can be a one person corporation and hold all the shares. Liability is different as shareholders are not typically held liable for the actions and debts of the corporation. Shares of stock can be sold to raise capital (Securities laws apply) and shares of stock can be easily transferred.  Corporations must have annual meetings, Board of Directors meetings, corporate minutes, and stockholder meetings.  There are many more tax options available to corporations than to sole proprietorships or partnerships. Corporations are taxed at corporate rate and possible double taxation: Dividends are taxed at the individual level if distributed to shareholders.  If you are the sole shareholder, then you would be subject to the taxes of the corporation as well as the funds transferred to you as a shareholder. Plus, you might be subject to self employment tax.

4.     S Corporation

An S Corporation or S Corp is a special type of corporation created through an IRS tax election. An eligible domestic corporation can avoid double taxation (once to the corporation and again to the shareholders) by electing to be treated as an S corporation.

An S Corp is a corporation that has received the Subchapter S designation from the IRS. A business must first be chartered as a corporation in the state where it's headquartered to be considered an S Corp. According to the IRS, S Corporations are "considered by law to be a unique entity, separate and apart from those who own it." This allows for a limit on the financial liability for which an owner (aka "shareholder") is responsible. Nevertheless, liability protection is limited - S Corps do not necessarily shield owners from all litigation such as an employee’s tort actions as a result of a workplace incident. 

What differentiates the S Corp from a traditional corporation (C Corp) is the ability to have profits and losses pass through to the shareholder's personal tax return. Consequently, the business is not taxed itself, only the shareholders. There is an important caveat, however: any shareholder who works for the company must pay him or herself "reasonable compensation." Basically, the shareholder must be paid fair market value, or the IRS might reclassify any additional corporate earnings as "wages."

5.     Limited Liability Company. 

A limited liability company is a hybrid-type of legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership.

The “owners” of an LLC are referred to as “members.” Depending on the state, the members can consist of a single individual (one owner), two or more individuals, corporations, other LLCs, and even other entities.

Unlike shareholders in a corporation, LLCs are not taxed as a separate business entity.  Instead, all profits and losses are “passed through” the business to each member of the LLC.  LLC members report profits and losses on their personal federal tax returns, just like the owners of a partnership would.

Each state has specific requirements for setting up a business entity, and you can also find professional incorporation services in your state. 

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