The Legal Environment
To: Gloria Smithton
From: Donald Phillips cc: Joe Smithton
Re: Business formations to consider
Joe and Gloria,
There are several business formations to consider when trying starting up your own business. The types of formations that I have decided to consider which are as follows:
a) Limited Liability Company
a. If your state statues allow it, you can file articles of organization or a certificate of formation to form a limited liability company. LLCs provide their owners, who are known as members, with limited liability protection. When you open a business bank account or take on debt, the LLC is responsible for the accounts instead of the individual members. LLC profits and losses flow through the company to each member. LLC members must decide if they want to be taxed as a partnership or a corporation. LLCs taxed as partnerships file the partnership tax return and LLCs taxed as corporations must file either a C corporation or S corporation tax return.
a. In a partnership, there are no documents to file with your state. However, partners usually have a partnership agreement drawn up between them stating how the partnership operates and how the profits and losses are shared. Most states hold that each partner has unlimited liability for business debts, the actions of the other partners and lawsuits. The business profits and losses flow through the partnership and are reported on each partner’s individual income tax return. The partnership must file a partnership information return with the IRS every year.
c) Sole Proprietorship
a. A sole proprietorship is the simplest and least expensive type of business to form. There are no incorporation documents to file or business notices to run in the newspaper. You may have to get a state or local business license depending on your occupation. A sole proprietorship has only one owner. You can do business under your own name or apply for a "doing-business-as" name to give your business a distinctive name, but the business and the proprietor remain one entity. You have no protection from lawsuits or creditor claims. Your personal assets can be used to satisfy a business debt or legal judgment. You report your business income and expenses to the Internal Revenue Service on Schedule C, which is filed with your individual income tax return.
These are just three of the formations that I have decided to tell you about. I am going to be telling you about the advantages and disadvantages of all three of these formations.
The first formation I am going LLC. A limited liability company, or LLC, is a relatively new form of business organization that is certainly worth consideration. It has several features that create favorable tax treatments, as well as protection from personal liability. Since the status of the LLC form of organization varies somewhat from state to state, be certain to find out how your state's law applies.
The LLC allows for multiple owners, or members, who enjoy limited liability, as well as a managing member, who also enjoys limited liability and typically is the person responsible for managing the business. The profits or losses of the business pass directly through to the owner's personal income tax return, Form 1040. The LLC files a Form 1065, and then lists each member's taxable profit on Form K-1. The bottom-line profit of the business is not considered to be earned income to the members, and therefore is not subject to self-employment tax.
The following are advantages of the LLC form of business organization:
An LLC allows for an unlimited number of members; however, if the LLC has just one owner, it will be taxed as a sole proprietorship.
The LLC allows for the "special allocation" of profits--the disproportionate splitting of member profits and losses (in different percentages than their respective percentages of ownership). This means that members can enjoy…