Building a business requires possessing the proper tools, dedication and ability to turn a vision into reality. It is because of this level of commitment that makes strategic planning so important. All the effort you have invested in the business deserves to be protected, preserved and positioned for long-term success. Whether you establish your business as a Sole Proprietorship, Partnership, Corporation or LLC, owning your own business can present some unique challenges. Considerations include tax optimization, risk management and succession planning.
In a sole proprietorship or regular partnership, operations are the easiest, but the owners/partners bear full personal liability for any business risk. The best way to mitigate this risk is by maintaining appropriate insurance coverage such as liability, professional and business insurance. Tax optimization involves reducing liability by maximizing deductions against taxable income. Succession planning helps ensure business continuity by establishing wills, trusts, powers of attorney, and clear guidelines for transitioning or winding down the business in the event of retirement, incapacity, or death.
Limited Liability Partnerships (LLP) and Limited Liability Companies (LLC) offer the next level of protection for business owners because they exist as separate legal entities. In an LLP, limited partners can receive legal protection while earning passive income for the capital they provide to the firm, while the general partners run the operations and may be personally liable for business obligations. Accounting, medical and legal firms often operate as LLPs. LLCs are run by shareholders instead of a general manager, and all shareowners have protection from personal liability if operated correctly. In both structures, profits and losses typically pass through directly to the partners’ personal returns for taxation purposes.
S-Corporations are similar in concept to LLCs. They are both pass-through entities for income tax purposes and each owner will receive their proportionate share of distributions. However, since they are structured as subtitle S-Corporations, a board of directors is required and strict adherence to corporate governance is needed. The owner of an S-corporation also has the flexibility to decide what compensation can be taken as salary and what level can be distributed as dividends. S-Corp owners should consult with their tax advisors when making that compensation decision because there are guidelines around the appropriate salary levels typical in a given industry. S-corps also have restrictions on the number and type of owners.
C-Corporations are the most formal structure and represent the model most Americans recognize from education and movies. They have a board of directors and face more auditing since a C-Corp pays taxes at its own level. This is often seen as a disadvantage because the dividends provided to shareholders are also taxed (“double taxation”). A C-Corp is often seen as the structure most conducive to a sale when owners want to exit the business. For each of the entities mentioned in this article, having a clear buy-sell agreement is crucial to ensuring a smooth transition when partners retire, become incapacitated or pass away.
Good ownership requires the best decisions for your circumstances and the choice of structure can make a lasting impact. If you are thinking about becoming a business owner, let us work together to ensure the business you create supports all of your goals both now and for years to come.
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