FIN 571 Finance Instructor
Hello Mr. Owner. I hope that this email finds you well. I am responding to your email dated March 24, 2015 in reference to developing a business plan. First of all, congratulations is in order on your decision to start your own business! This is an exciting step in your future and it would be my pleasure to assist you in any way that I can. Whether you choose to take on partners or not, I have gathered information for you on six types of business structures. You mentioned that you are not yet sure on how the business will be financed, so I gathered information on the costs to start each business also. To ensure clarity on all the options available to you, I have compiled a list of the advantages and disadvantages of each, and possible tax consequences for each scenario, as per your request.
1. Sole Proprietorship- This is going to be your least expensive type of business to start. With a sole proprietorship, one advantage is the decisions of the business lie in your hands (Parrino, Kidwell & Bates, 2012). This means that any changes that will be made for the company lie solely in your hands, there is no middle man. A disadvantage is that if you decide to get out of the business, it will cease to exist. As for the taxing of a sole proprietorship, the IRS identifies that you will use the same form to file both your business taxes and your personal taxes. So if you typically use a 1040, this will be the same form used for your sole proprietorship which can simplify your tax return.
2. General Partnership- The cost to start up a general partnership can be costly. One disadvantage of a general partnership is that debts and actions by one partner are also connected to the other partner thus that partner is also liable for them. This means if one partner incurs a ton of debt, the debt is not only with him but with the other partners also. On the other hand, an advantage of this type of business is that each partner is responsible for the operation of the business. This means that you can potentially be responsible for a successful company in the long run. One tax benefit for a general partnership is that it must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax (irs.gov).
3. Limited Partnership- Starting up a limited partnership is also costly. Limited partnerships are more costly to form because the partners must hire an attorney to draw up and maintain the partnership agreement, which specifies the nature of the relationship between the partners (Parrino, Kidwell & Bates, 2012). The advantage of this type of business is that it is simpler than most structures and it requires less paperwork. For you this means you could potentially start your business in a matter of weeks. A disadvantage of this structure is who you decide to partner with. Most people start limited partnerships with friends or colleagues, which can be sensitive. Either you ruin your friendship with that person or you can develop and even stronger bond. A definite tax advantage of a limited partnership is that profits and losses of the business are passed to the respective partners. Therefore, no income taxes are paid by the business.
4. Limited Liability Company (LLC) - An LLC overall starting up will cost you. One advantage of this type of business is that it can continue if the owner decides to leave. In your case, if you have children and you wish for your business to continue after you retire, with an LLC that can be accomplished. One disadvantage is that LLC’s typically have to pay more fees to file and some states even require them to renew their business annually (Spadaccini, 2007). This can become costly and honestly a frustration for the business owner. A tax benefit of an LLC is that certain federal taxes are not applicable for you.