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One of the first challenges faced by individuals establishing a business is deciding whether to do business under a separate business entity. Most people form a separate business entity to limit their personal liability and take advantage of different tax treatment for entities. By doing business as a corporation or limited liability company, you may protect your personal assets (home, car, bank accounts, etc...) from being taken to satisfy business debts or lawsuit judgments. Business may be conducted under one of several forms of business entities; the most common are:
Sole Proprietorships - An individual engaging in business by him or herself personally without forming a separate entity such as a corporation or LLC. The business has no separate legal existence apart from its owner. While the simplest form of ownership, the owner has unlimited personal liability for business' debts and legal liability in the event the owner is sued in court. A sole proprietor engaging in business in a name other than his or her name must file a fictitious business name statement with the county recorder's office. Sole proprietorships pay the highest tax rates (Federal, State and Self-Employment) and have very few deductions allowed by the Internal Revenue Code.
Partnerships - An association of two or more persons that act as co-owners of a business without forming a separate business entity. The partnership may be based on an informal oral agreement or a complex written agreement. Partnerships are either general partnerships, where all members are general partners, or limited partnerships, which contain at least one general partner and one or more limited partners. In both types of partnerships, general partners, similar to sole proprietors, have unlimited personal liability for business debts and legal liability in the event the partnership is sued in court. General partners are also liable for the actions of their partners. Limited partners have limited financial and legal liability, but have limited control over the partnership's affairs. For income tax purposes, the business is not taxed as a separate entity, but is a conduit where the business' profit or loss flows through to the partners. A limited partnership must file articles of organization with the Secretary of State's Office.
Corporations - A corporation is a legal entity recognized as separate and apart from its owners (shareholders). A corporation is formed by filing articles of incorporation with the state and drafting bylaws for its operation. A corporation is treated as a separate entity or person from its owners and even has its own Federal tax identification number, similar to an individual's social security number. Most laypersons think of corporations as public companies traded on a stock exchange, however, the vast majority of corporations are privately held and owned by a single person or small groups of individuals. Corporations are attractive entity choices because the shareholders/owners have limited personal liability, however, an improperly formed or operated corporation may be disregarded by a court ("piercing the corporate veil") causing the shareholders to incur personal liability. Corporations can be either under IRC subchapter C or S. Very different tax rules apply to each type of entity. C corporations are allowed to have a medical reimbursement plan under IRC section 105 for its owners while an S corporation can not. S corporations are flow through entities similar to the partnership but with some very different exceptions. S corporations can only be owned by individuals and only up to a maximum of 75 shareholders.
Limited Liability Companies (LLC) - An LLC is similar to a corporation in that it is a legal entity recognized as separate and apart from its owners and offers the same limited liability protections for its owners via the charging-order rules. However, LLCs are easier to operate because they do not have the same formalities required of corporations. The LLC is formed by filing articles of organization with the state and drafting an operating agreement for its operation. An LLC also obtains a Federal tax identification number. Like shareholders of a corporation, an LLC's owners have limited personal liability, however, an improperly formed or operated LLC may also be disregarded by a court causing the owners to incur personal liability.
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