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Choosing a Business Entity

Once you've decided to start a new business or buy an existing one, you need to consider the form of business entity that's right for you. Basically, three separate categories of entities exist other than sole proprietorship: partnerships, corporations, and limited liability companies. Each category has its own advantages, disadvantages, and special rules.

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If two or more people are the owners of a business, then a partnership is a viable option to consider. Partnerships are organized in accordance with state statutes. However, certain arrangements, like joint ventures, may be treated as partnerships for federal income tax purposes, even if they do not comply with state law requirements for a partnership.

In a partnership, two or more people form a business for mutual profit. In a general partnership, all partners have the capacity to act on behalf of one another in furtherance of business objectives. This also means that each partner is personally liable for any acts of the others, and all partners are personally responsible for the debts and liabilities of the business.

Limited partnerships

A limited partnership differs from a general partnership in that a limited partnership has more than one class of partners. A limited partnership must have at least one general partner (who is usually the managing partner), but it also has one or more limited partner. The limited partner(s) does not participate in the day-to-day running of the business and has no personal liability beyond the amount of his or her agreed cash or other capital investment in the partnership.

Limited liability partnership

Some states have enacted statutes that provide for a limited liability partnership (LLP). An LLP is a general partnership that provides individual partners protection against personal liability for certain partnership obligations. Exactly what is shielded from personal liability depends on state law. Make sure you consult competent legal counsel to understand the ramifications in your state.

C corporations

A corporation that has not elected to be treated as an S corporation for federal income tax purposes is typically known as a C corporation. Virtually all large corporations are C corporations. C corporations typically offer more flexibility in terms of stock ownership and equity structure.

However, C corporations can subject its owners to double taxation. The distributed earnings of your incorporated business may be subject to corporate income tax as well as individual income tax.

S corporations

Qualifying as an S corporation offers a potential tax benefit unavailable to a C corporation. If a qualifying corporation elects to be treated as an S corporation for federal income tax purposes, then the income, gains, deductions, and losses of the corporation are generally passed through to the shareholders. Thus, shareholders report the S corporation's income, gains, deductions, and losses on their individual federal income tax returns, eliminating the potential for double taxation of corporate earnings.

It is important to note that S corporation treatment is not available to all corporations. It is available only to qualifying corporations that file an election with the IRS. Qualifying corporations must satisfy several requirements, including limitations on the number and type of shareholders and on who can own stock in the corporation.

Limited liability company

A limited liability company (LLC) is a type of entity that provides limitation of liability for owners, like a corporation. However, state law generally provides much more flexibility in the structuring and governance of an LLC as opposed to a corporation. In addition, most LLCs are treated as partnerships for federal income tax purposes, thus providing LLC members with pass-through tax treatment. Moreover, LLCs are not subject to the same qualification requirements that apply to S corporations.

Choosing the best form of ownership

There is no single best form of ownership for a business. Each type of entity has advantages and disadvantages. Very often the decision is made by what sounds good. Some prefer Widgets, Inc. while others might like the sound of Widgets, LLC.

Even after you have established your business as a particular entity, you may need to re-evaluate your choice of entity as the business evolves. An experienced attorney and tax adviser can help you decide which form of ownership works best for your business and limiting your liability exposure.

To learn more about choosing a business entity, contact MNM Vested, LLC.

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