LIABILITY AND TAXES; The Cost of Doing Business

     Many business owners face personal losses when their businesses are sued for business debts or damage claims. Others pay unnecessary income taxes on business profits. Often such losses and taxes can be avoided if the proper business structure is implemented. Let's examine the most popular business entity options.

     A sole proprietorship is a one owner business and is the simplest entity to form and operate. Only business licenses and fictitious name registration are generally required. In essence, the business and its owner are one and the same. Because the business assets and its debts belong to the owner, the owner is personally accountable to creditors for all debts and is liable for all legal actions against the business.

     A partnership is a business owned by 2 or more persons and is generally governed by a partnership agreement. There are various types of partnerships. In a general partnership, all partners have equal management rights and are personally liable for all partnership debts and claims. Any partner can be liable for the acts of another partner. In a limited partnership, there must be at least one general partner and at least one limited partner. The general partner is personally liable for business debts and claims and manages the business. Limited partners have no personal liability but cannot participate in management. A certificate must be filed with the Secretary of State listing the partners. The partnership is not subject to state or federal income taxes and each partner reports his or her share of the profits on the individual tax return.

     A corporation is an entity separate from its owners. It can be owned by one or more shareholders. The corporate form has become the most popular method of doing business since its shareholders are not personally responsible for debts and claims against the corporation and they may participate in management. However, while there is a limit on personal liability, it is the most complex entity to form and operate. Articles of Incorporation must be filed with the Secretary of State and annual meetings and filings are required. There are 2 basic forms of corporation. In a C corporation there are no limitations on the number or type of shareholders that own stock and it can take advantage of various deductions and fringe benefits. However, the C is subject to state and federal income taxes and is known for double taxation. The corporation must file a corporate income tax return and pays income taxes on net profits. The shareholders again pay taxes on distributions they receive. An S corporation is not subject to state or federal income taxes. Like a partnership, only the shareholders pay income taxes on their percentage of profits and report it on their individual tax returns. The S has some limitations as to the number and type of shareholders (no non-resident aliens or business entities) and certain deductions and benefits are not permitted.

     More recently the limited liability company has gained popularity. It offers the limited personal liability to its owners like a corporation but allows them to manage the business, and, similar to a partnership and S corporation, it is not subject to state or federal income taxes and the owners report their share of the profits on their individual tax returns. In addition, it has no limitations on the type of owner, ie. individual, non-resident, or business entity, it can have, and there is flexibility in the way profits and losses can be allocated among the owners.

     In weighing the advantages and disadvantages of any legal business form, it often comes down to two main considerations: personal liability and taxes. There are other factors, such as the nature of the business, its risk factors, the owners' expertise, plan for management, and profit and loss allocation, that should also be analyzed in choosing a form of business entity. With the right planning, the business owners can protect themselves against personal losses and can save on the tax bill.

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