Selecting the best entity for your business can be complex and should be done with competent professional assistance, according to Harvey Smalheiser, A SCORE counselor and a semi-retired corporate financial and tax executive, and Jonathan W. Anderson, a Raleigh attorney who focuses on entrepreneurship, real estate transactions, and employment law. Shop Talk reporter Virginia Bridges spoke with Anderson and Smalheiser about entity options. Here are their edited comments.
Q: What is a sole proprietorship?
A: The business is owned and operated by an entrepreneur and all business operations, assets and liabilities are attributable to the owner. It’s a simple and inexpensive way to operate a business. Business net income and losses are reported on the owner’s personal tax return and can reduce income tax liability. The life of the business is tied to the entrepreneur’s involvement in it. Business liabilities are the personal responsibility of the entrepreneur, and sole proprietorships are more difficult sell than other types of entities.
Q: What are the different types of partnerships, and how do I determine which is best for me?
A: In a general partnership, each partner is liable for all of the partnership debts. It is most commonly used when all of the partners are actively involved in running the day-to-day affairs of the business. A general partnership can be formed when two proprietorships agree to do business together and split the profits. This form should generally be avoided.
A Limited Liability Partnership allows certain partners to limit their share of partnership liabilities to the capital they have contributed to the partnership. There must be at least one general partner who has unlimited personal liability for partnership debts. An LLP is typically used when the limited partners are not actively involved with the day-to-day business operations and are akin to investors.
Q: Should I choose a corporation, a proprietorship or a partnership?
A: The ability for shareholders to shelter their personal assets from corporate debt is the primary reason businesses choose to operate as a corporation. Proprietorships and partnerships may be forced to terminate due in the event of the business owner’s death. However, a corporation’s existence is not tied to their shareholders’ existence and can be perpetual. Also, corporate interests are represented by shares of stock which are generally easily transferrable. On the downside, a corporation is taxed on its profits and losses. If any of the after-tax profits are distributed to the shareholders as a dividend, the shareholders report that income on their returns and pay taxes accordingly. Double taxation can be avoided if the corporation elects S Corporation treatment or is a Limited Liability Company.
Q: What are the differences between LLCs and corporations?
A. A Limited Liability Company is a hybrid entity containing attributes of a corporation, a sole proprietorship and a partnership. An LLC’s operating agreement provides flexibility to its members as to how their affairs will be governed. An LLC can have one owner (similar to sole proprietorship) or multiple owners (similar to a partnership or a corporation). The owners generally have the same absence of personal liability as the shareholders of a corporation.
LLC ownership units are generally easier to transfer than sole proprietorship or partnership interests but somewhat less easy to transfer than shares in a corporation. An LLC’s life can exist beyond that of its present owners, and LLCs are not subject to federal or state income tax as its profits or losses flow through to its members. Also, LLCs are not subject to the North Carolina franchise tax.