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Show Me the Money: Setting Your Company Up for Success

by Roseann Freitas | Feb 24, 2020 2:57:39 PM

When Jerry Maguire pulls the fish out of the tank and asks
his coworkers who is with him on his new business venture, the voices remain
silent. As everyone continues to stare at Tom Cruise’s character, Renee
Zellweger’s character, Dorothy agrees to the new adventure where Jerry will put
the client’s needs before his own. For many owners, starting a business isn’t
as dramatic; however, all owners have similar details to work out.

The type of business structure is part of the starting
process. All new companies need to decide if they are Sole Proprietors,
Partnerships, Corporations (C -Corp), S Corporations (S-Corp), or
Limited-Liability Corporations (LLC). With the selection of business structure,
you are determining the legal liability and tax responsibilities. How do you
know which one you should choose? What is the impact, and how does that affect
your taxes?

One factor determining the type is ownership. If the new
entity has only one owner, then you are looking at a Sole Proprietor. As a sole
proprietor, you make all the decisions. The taxes of the company are on your
1040 form, Schedule C and Schedule SE. If the company takes a loss, then it can
offset any other sources of income to reduce tax liability. However, you are
solely responsible for the company’s liabilities and could find raising capital
harder as a sole proprietorship is a higher risk for lenders. Forming a sole proprietorship
is inexpensive.

When two or more start a business, they can form a
partnership. There are two types of partnerships, general and limited (LP). General
partners manage a company jointly and are the ultimate decision-makers. With
the ability to call the shots, comes the liability too. General partners share
responsibility for debts and liabilities incurred by all partners. A limited
partner is an investor, not an owner, and has only  limited liability for the company and does not
make the decisions. A partnership files a 1065 federal return, and each partner
receives a Schedule K-1. The taxes are passed onto the owner’s 1040 form.  Forming a partnership costs more than a sole proprietorship.

A corporation (C-Corp) is a separate legal entity. The
C-Corp’s shareholders are the owners; however, shareholders are not liable for
the actions of the corporation. Other advantages of a corporation are the ability
to raise capital via common or preferred stock, and the C-Corp doesn’t dissolve
with the death of an owner. A disadvantage is double taxation, where the
company pays taxes, and stockholders are taxed on their dividends. Setting up
and maintaining the corporation increases the administrative costs with the
need for lawyers and CPAs.

Another option attractive to small business owners is an S
Corporation. The S Corp protects the owner from the company’s liabilities like
a C corporation; however, unlike the C Corp,  the company isn’t taxed twice.  The S corporation’s taxes are passed onto the
owner/shareholders. If the company doesn’t have any inventory, the cash basis
of accounting can be elected instead of the accrual basis. By having up to 100
shareholders, the S corporation has more opportunities for investors and
capital; however, the entity is allowed only one class of stock. The
disadvantages are increases in legal and accounting fees due to filing
requirements, the requirement of articles of incorporation, and meetings with the
board of directors and shareholders.

One of the newer types of business structures is the Limited
Liability Company (LLC). An LLC provides liability protection to the owners and
can have unlimited stockholders. The entity’s taxes are passed onto the owners
and avoid double taxation.  If an LLC has
one member, it is considered a disregarded entity, which means the entity is
separate from the owner, except for tax purposes. An LLC with one member is
taxed as a sole proprietor, and an LLC with more than one member is taxed as a
partnership unless a form 8832 is filed, which indicates the election to be
taxed as a corporation. An LLC must file articles of organization in their
respective state, and each state has different requirements. An LLC dissolves
when a member dies, quits, or retires.

When figuring out the best type of business structure, liability, taxes, capital, and fees are part of the process. Consult with a business expert for your situation and look to BBB.org to find a trustworthy professional. Setting your company up right from the start will allow you to get to the point where you can say  those famous words from Jerry Maguire, “Show Me The Money.”  

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