Business Consulting

 

Business Consulting

There’s a lot to consider in starting your own business: developing a business plan, obtaining sufficient funding, marketing and a host of other concerns. Also critical is determining the organizational structure that best suits the business, because it will impact operating efficiency, the way you report income, the taxes you pay and your personal liability.

There are four basic types to choose from:

  • Sole Proprietorship
  • Partnership — General and Limited
  • Corporation — S Corporation and C Corporation
  • Limited Liability Company (LLC)

To make an informed decision, you must consider income tax law and tax rates, as well as issues such as transferability, control and potential legal liability. These matters likely will be complicated, and errors can be costly. That’s why it’s important to do research and seek out the advice of an MAG consultant who can help you understand how business structure impacts your organization’s bottom line.

Management Issues

  • Formation
  • Operation & Control
  • Investment
  • Continuity Transferability
  • Legal Liability

Formation

Sole Proprietorship — As simple as opening a bank account for the business; some states and municipalities may require obtaining a license or permit.

Partnership — Started through an oral agreement, though a written agreement is advisable (and is required in some states) to agree on points such as profit/loss percentages; business decisions; addition and withdrawal of a partner; and terms of operation. Some partnership allocation structures may subject you and your business to more IRS scrutiny.

Corporation — Corporate documents are filed with the state and an annual fee is paid. Separate corporate bank accounts and records are created, and assets and money generated by the corporation are owned by the corporation (not the shareholders).

Limited Liability Company (LLC) — Created through articles of organization and an operating agreement; owners are called members and are not personally liable for the entity’s debts and liabilities.

Operation & Control

Sole Proprietorship — Ultimate control rests with a single owner.

Partnership — Requires at least two partners who own the business and share in the profits and losses. The partnership agreement explains who will control and manage the business. In a general partnership with no agreement, all general partners have equal management rights and control. In a limited partnership, the management and control of the business is handled by the general partners.

Corporation — Bylaws (operating rules) are created to establish and explain the rules governing the organization. The shareholders have sole authority to approve articles of incorporation, mergers and dissolution of the company, and they elect the directors. Directors are responsible for major decisions, including selection of company officers.

LLC — Single-owner LLCs operate like sole proprietorships; multiple-member LLCs operate and are taxed like partnerships, although members may elect to treat and tax an LLC as an S or C corporation if they wish.

Investment

Sole Proprietorship — Limited to the assets and borrowings of the owner.

Partnership — Based on the number of partners and the written agreement, which should also explain how a departing partner will be paid for part ownership when he or she leaves, dies or retires.

Corporation — S Corporations can issue one class of stock to up to 75 shareholders (increased to 100 for years beginning after December 31, 2004). C Corporations can issue different classes of stocks and bonds and can increase borrowing capacity.

LLC — Rules are similar to a proprietorship for single-member LLCs, and to a partnership for multiple-member LLCs.

Continuity Transferability

Sole Proprietorship — Continues until abandoned or upon death of the owner. Assets and liabilities can be freely transferred by selling all or a portion of the assets.

Partnership — Continues subject to the partners’ agreement and as long as all of the general partners remain in the partnership. The partnership dissolves if a general partner dies or leaves the partnership, unless the agreement provides for continuation of the business by the remaining partners.

Corporation — Can exist in perpetuity even if one or more owners die. Ownership can be transferred by sale of stock. Continuing S corporation status depends on limiting ownership to 100 shareholders.

LLC — For multi-owner LLCs, continuity and transferability are determined by the organizing and operating documents and may affect the LLC’s ability to choose corporate or partnership tax status.

Legal Liability

Sole Proprietorship — Unlimited personal liability. Creditors can make claims against your business and personal assets. Insurance may cover some risk.

Partnership — General partners are fully liable for all liabilities of the partnership, no matter which general partner incurred them. Limited partners are responsible only to the extent of their investment.

Corporation — Shareholders are liable only to the extent of their investment in the business.

LLC — Liability rules are similar to corporate shareholders; members are not personally liable for the debts and liabilities of the LLC.

Tax Issues

Taxability of Income

Businesses can be taxed at the entity level or are considered pass-through entities wherein income or loss is taxed at the owner level and reported on individual income tax returns.

Sole Proprietorship — Income or loss reported directly by owner.

Partnership — Income or loss is passed through to partners using Schedule K-1.

S Corporation — Income or loss is passed through to shareholders using Schedule K-1; the amount reported is based on percentage of stock ownership.

C Corporation — Income is reported and tax paid through the corporate tax return. Shareholders then pay income taxes on dividends distributed by the corporation, with “qualified dividends” subject to lower tax rates.

LLC — Single-owner LLCs operate like sole proprietorships; multiple-member LLCs operate and are taxed like partnerships, although members may treat and tax an LLC as an S or C corporation.

Compensation and Payroll Taxes

Employees are paid a salary, and federal, state and Social Security taxes are withheld. The employer matches the Social Security taxes withheld for each employee. An individual who is self-employed pays federal, state and Social Security taxes on net self-employment income.

Sole Proprietorship — Must pay self-employment taxes as part of their quarterly estimated tax payments.

Partnership — General partners are subject to selfemployment taxes on their share of self-employment income from the partnership (whether or not distributed); limited partners are not subject to self-employment taxes.

S Corporation — Income and Social Security taxes are withheld from wage income paid to shareholderemployees.

C Corporation — Same as S Corporation, above.

LLC — Treated according to the tax treatment selected. If treated as a partnership, active members must pay quarterly estimated self-employment taxes, but inactive members are not subject to self-employment taxes.

Tax Years

Sole Proprietorship — Must use the proprietor’s tax year, e.g., the calendar year.

Partnership — If one or more partners using the same tax year own interests in the profits and capital of more than 50 percent, the partnership must use the tax year of those partners. This generally is a calendar year. However, a partnership can
(1) establish a business purpose for a different year;
(2) make a Section 444 election; or
(3) elect to use a 52-53-week tax year referenced to its required tax year or a tax year elected under Section 444.

Corporation — S Corporations may use the calendar year; a tax year elected under Section 444; or a 52-53- week tax year ending with reference to the calendar year. C Corporations may select any fiscal year unless they are classified as a Personal Service Corporation (PSC): a company with the principal activity of providing services in the fields of health, law, accounting, engineering, architecture, performing arts or consulting.

LLC — Treated according to the tax treatment selected.

Pros & Cons

Type Pros Cons
Sole Proprietorshp • Inexpensive to start and simple to run
• One level of tax on net income
• Inexpensive to start and simple to run
• One level of tax on net income
Partnership • Ownership not limited to one person
• One level of tax on net income
• Income and expenses allocation is
unrelated to percentage of ownership
• Unlimited personal liability
• Each partner legally responsible for
the business acts of other partners
• Requires separate tax returns
S Corporation • Limited personal liability for shareholders
• One level of tax on net income possible
• Requires separate tax returns
• Restrictions on adding investors
• Income and expenses must be allocated
according to percentage of ownership
C Corporation • Limited personal liability for shareholders
• Easy to transfer ownership/add investors
• Perpetual continuity presumed
• More costly to set up and maintain
• Requires separate tax returns
• Net earnings may be double taxed
LLC • Limited personal liability for members
• All members can participate in management
• Income and expenses may be allocated in a manner unrelated to percentage of ownership
• Not automatically perpetual like S or C corps
• More costly to set up and maintain

Which is Right for Your Business?

There are many factors to consider, from business type to tax implications. An MAG CPA has the background and expertise to help you make your decision — and form your business properly from the start.

For more information about our Business Consulting Services, please contact us today!