|Overview Of Business Structures|
There are many forms of conducting business, but the following four types are the most popular. For an overview, see the Entity Comparison Chart.
The biggest risk to the Sole Proprietor and the Partnership is that the owners have unlimited personal liability exposure for the debts of or claims against the business. If anything happens in the business, the owners are liable and third party creditors and claimants can reach the owners’ personal assets, including their home, vehicles and bank accounts, to satisfy the business obligation. Obviously, this is a tremendous risk to the owners and certainly not an incentive to engage in business in either of these forms.
Both LLCs and Corporations provide asset protection to their owners since these entities are statutory entities, meaning they are formed by complying with provisions contained in the Arizona statutes. Both LLCs and Corporations are entities separate and apart from their owners. It is very important that the owners of these entities comply with all requirements of the statutes that govern them. The failure to do so can result in “piercing the corporate veil,” which allows company claimants and creditors to reach the assets of the owners to satisfy company obligations. We’ll discuss this in more detail later. Each state has statutes that govern Corporations and LLCs, but this website is designed solely for businesses operating in Arizona so all information provided in this site will deal with Arizona laws.
Here’s a more detailed look at each form of conducting business.
According to the Small Business Association, the vast majority of small businesses start out as Sole Proprietors. A Sole Proprietor business is owned by one person, usually the individual who is responsible for operating the business. The Sole Proprietor also assumes complete responsibility for any and all of the business liabilities or debts. In the eyes of the law and the public, the individual is the business.
Advantages of a Sole Proprietorship
Disadvantages of a Sole Proprietorship
In a Partnership, two or more individuals are collectively engaged in a business. Just as with a Sole Proprietor, the law does not distinguish between the business and its owners.
Partnership Agreement: The partners should have a legal agreement, called a “Partnership Agreement,” that clearly states how the partnership will be operated and administered, such as:
While it is challenging to think of parting ways when the business is just beginning, the smart, proactive business owners will address these important issues as they form the business. Current statistics show that 80% of Partnerships fail. When partners cannot agree how to handle important issues and they don’t have a Partnership Agreement, the end result may require court action to dissolve the partnership and divide the assets. This process is incredibly expensive, time consuming and generally an overall challenging experience.
Advantages of a Partnership
Disadvantages of a Partnership
A Corporation, sometimes referred to as a C-Corporation, is formed by complying with the state’s statutory requirements. It is the most complex type of business organization. The Corporation is considered to be a unique entity, separate and apart from those who own it. Since a Corporation is a separate entity, it can be taxed, it can be sued, and it can enter into contracts. The Corporation is owned by its shareholders who offer money and/or property in exchange for shares or stock. The shareholders elect a board of directors to oversee the major policies and decisions of the Corporation. The board of directors appoints officers who manage the day-to-day operations of the Corporation.
Advantages of a Corporation
Disadvantages of a Corporation
An S-Corporation is a general Corporation that makes a tax election to be treated as an S-Corporation.
Why elect S-Corporation status?
The shareholder salary must meet standards of “reasonable compensation.” This can vary by geographical region as well as occupation, but the basic rule is to pay the shareholder the same pay as the Corporation would have to pay someone to do the job. If the company fails to do this, the IRS can reclassify all of the dividends/profit as wages, and the shareholder will be liable for the payroll taxes on the total amount of compensation.
To qualify as an S-Corporation, the Corporation must meet the following criteria:
Since tax laws change with some frequency, check with your accountant for updated information and to determine if this option is a good choice for your business.
Limited Liability Company (LLC)
An LLC is formed by complying with the state’s statutory requirements. The LLC is considered to be a unique entity, separate and apart from those who own it. Since an LLC is a separate entity, it can be taxed, it can be sued, and it can enter into contracts. The LLC is owned by members and can be operated by one or multiple members or the members can appoint a manager or multiple managers to operate the LLC.
The LLC is a hybrid business structure and it combines the protection of Corporation and the tax efficiencies and operational flexibility of a Partnership. Formation is more complex and formal than that of a general Partnership.
A single-member LLC can be taxed as a Sole Proprietor, a C-Corporation or an S-Corporation. A multi-member LLC can be taxed as a Partnership, a C-Corporation or an S-Corporation. If the LLC does not make any tax elections with the IRS, then the default tax classification for a single-member LLC will be taxed as a Sole Proprietor and the default tax classification for a multi-member LLC will be taxed as a Partnership. Check with your accountant to determine which tax option is the best choice for your business.
Advantages of an LLC
Disadvantages of an LLC
Given the various tax options, it is important to work with the company’s accountant to make the best tax election.