Business Ownership

Meagan Mckeen

Four Major Types of Ownership

  • Sole Proprietorship
  • Partnership
  • Limited Liability Partnership
  • Corporation - S and C Corps.

As with many things, there are advantages and disadvantages to all of these types.

Under each section there will be a few examples of each.

Sole Proprietorship

This type of ownership is very self explanatory. The individual represents the company legally and fully.


Advantages:

  • Quicker Tax Prep: Filing taxes are generally easier than a corp. Individual and business income are considered the same
  • Lower Start-up costs: The cost of setting up a corp. involves higher set-up fees and special forms. Not in a Sole P.
  • Ease of Handling Money: Much easier than other business structures. No payroll set up is required to pay yourself.


Disadvantages

  • Personally Liable: Your business is not a separate legal entity
  • Lack of Financial Controls: You do not have the same accounting controls as a corporation.
  • Lonely at The Top: It is a business of one. Working alone with no partner.
  • Difficult to raise Capital: If you want to grow your company you will need investors. Investors will take the company more serious if you are a corp.


Policies:

Because the business is unincorporated and also is not a limited liability corporation, the personal assets of the sole proprietor and the business assets are one and the same for liability purposes. Adequate insurance or other protection is important because claims against the business could result in seizing of a home or other assets.

Taxes

DBA and estimated quarterly tax payments.

Sole proprietors must file various tax forms with the Internal Revenue Service and pay any taxes due. These include the 1040 personal income tax return, along with a Schedule C for a business profit and loss; Schedule SE for self-employment and Form ES for estimated taxes. The sole proprietor must file a W-2 wage and tax statement for himself, as well as Medicare, Social Security and income tax withholding on Form 941, the employer's federal quarterly tax return.

What Is A Sole Proprietorship?

Partnership

This type of Ownership deals with a business relationship between two or more people. Each person in this business structure contributes labor, capitol and shares in both the profits and losses of the business.


Advantages

  • Relatively easy to establish
  • Having twice as many owners can benefit the business in the various skills that each partner can bring to the business.
  • Because there is more people, your ability to raise money is increased.


Disadvantages

  • Owners of the business are responsible for the actions of all of the partners.
  • Profits are shared amongst the partners.

C corporation


    A C corporation, under United States federal income tax law, refers to any corporation that is taxed separately from its owners. A C corporation is distinguished from an S corporation, which generally is not taxed separately.


Benefits of using C corporation format

There are a few key reasons for opting to create a C corporation, as opposed to the other business structures, according to Weltman. These include the following:

  • The opportunity to use a medical reimbursement plan. "This enables the corporation to deduct all medical payments up to a fixed dollar amount (set by the corporation, not tax law) while shareholders-employees enjoy this benefit on a tax-free basis," Weltman says.
  • The need for venture capital. A business that needs substantial start-up and/or expansion capital (more than $5 million) may turn to venture capitalists for help. "Usually, such financiers are interested providing money for businesses organized as C corporations because there is more flexibility in making ownership arrangements," Weltman adds.
  • The intention to take the company public. If there is the potential for growing the business to such a level that it can attract financing by becoming a public company traded on a national exchange (such as the New York Stock Exchange), the business must be a C corporation, Weltman says.
  • Tax considerations: Besides the opportunity for shareholder-employees to obtain tax-free fringe benefits, there is another key tax edge for C corporations: The ability to accumulate earnings for future expansion at a lower tax cost than other types of entities.


Drawbacks of Using C Corporation Format

There are also several reasons that argue against forming a C corporation if your business has the option to form under a different legal structure. These include the following:

  • The potential for "double taxation." The chief drawback of a C corporation is the so-called "double taxation" potential. "Profits are first taxed to the corporation," Weltman says. "Then, when they are distributed to shareholders in the form of dividends, they are taxed again; the corporation cannot deduct dividend distributions." However, the threat of a double tax can sometimes be mitigated for following certain strategies.
  • The requirement to file more paperwork. Corporations are required to hold formal board and shareholder meetings and keep accurate minutes of these meetings. In addition, there are a series of tax forms that may need to be filed with federal, state, and even local officials, including corporate taxes (IRS Form 1120), taxes on salaries and other employee compensation (W-2s), and profit distribution to shareholders (Form 1099-DIV). "A C corporation complicates your life," Ennico says. "Most entrepreneurs I work with want to spend their time making or selling their products. They don't want to stay up until 3 a.m. doing paperwork."
  • Filing corporate tax forms may require an accountant. The tax forms for corporations can be complicated and may require you to get some help from an accountant. In addition, corporations have to pay federal taxes by March 15 -- a full month before the individual federal tax filing deadline.

S Corp.

An S corporation (sometimes referred to as an S Corp) is a special type of corporation created through an IRS tax election. An eligible domestic corporation can avoid double taxation (once to the corporation and again to the shareholders) by electing to be treated as an S corporation.

The advantages of an S corporation often outweigh any perceived disadvantages. The S corporation structure can be especially beneficial when it comes time to transfer ownership or discontinue the business. These advantages are typically unavailable to sole proprietorships and general partnerships. S corporation advantages include:

  • Protected assets. An S corporation protects the personal assets of its shareholders. Absent an express personal guarantee, a shareholder is not personally responsible for the business debts and liabilities of the corporation. Creditors cannot pursue the personal assets (house, bank accounts, etc.) of the shareholders to pay business debts.
  • Pass-through taxation. An S corporation does not pay federal taxes at the corporate level. (Most—but not all—states follow the federal rules. View the Ongoing Corporation Requirements page of our state guides to see if your state recognizes the federal S corporation election.) Any business income or loss is "passed through" to shareholders who report it on their personal income tax returns. This means that business losses can offset other income on the shareholders’ tax returns. This can be extremely helpful in the startup phase of a new business.
  • Tax-favorable characterization of income. S corporation shareholders can be employees of the business and draw salaries as employees. They can also receive dividends from the corporation, as well as other distributions that are tax-free to the extent of their investment in the corporation.
  • Straightforward transfer of ownership. Interests in an S corporation can be freely transferred without triggering adverse tax consequences. (In a partnership or an LLC, the transfer of more than a 50-percent interest can trigger the termination of the entity.) The S corporation does not need to make adjustments to property basis or comply with complicated accounting rules when an ownership interest is transferred.
  • Heightened credibility. Operating as an S corporation may help a new business establish credibility with potential customers, employees, vendors and partners because they see the owners have made a formal commitment to their business.


Disadvantages


  • Formation and ongoing expenses. To operate as an S corporation, it is necessary to first incorporate the business by filing Articles of Incorporation with your desired state of incorporation, obtain a registered agent for your company, and pay the appropriate fees. Many states also impose ongoing fees, such as annual report and/or franchise tax fees. Although these fees usually are not expensive, and can be deducted as a cost of doing business, they are expenses that a sole proprietor or general partnership will not incur.
  • Tax qualification obligations. Mistakes regarding the various election, consent, notification, stock ownership and filing requirements can accidentally result in the termination of S corporation status. Although this is relatively rare, and usually can be remedied easily, it is still an issue that is not a factor with other business forms.
  • Stock ownership restrictions. An S corporation can have only one class of stock, although it can have both voting and non-voting shares. Therefore, there can’t be different classes of investors who are entitled to different dividends or distribution rights. Also, there cannot be more than 100 shareholders. Foreign ownership is prohibited, as is ownership by certain types of trusts and other entities.
  • Closer IRS scrutiny. Because amounts distributed to a shareholder can be dividends or salary, the IRS scrutinizes payments to make sure the characterization conforms to reality. As a result, wages may be recharacterized as dividends, costing the corporation a deduction for compensation paid. Conversely, dividends may be recharacterized as wages, which subjects the corporation to employment tax liability.
  • Less flexibility in allocating income and loss. Because of the one-class-of-stock restriction, an S corporation cannot easily allocate losses or income to specific shareholders. Allocation of income and loss is governed by stock ownership, unlike a partnership or LLC where the allocation can be set in the operating agreement. Also, the necessary accumulated adjustment account can be cumbersome to maintain, requiring input from an accounting professional.
S Corporation vs C Corporation - Explained Benefits of Each

Limited Liability Company (LLC)

It's the least complex business structure. Unlike an s corp or c corp, an LLC's structure is flexible. It also gives you the perk of pass-through taxes, limited liability (obviously), and legal protection for your personal assets. Plus the added benefit of looking more legit than the other guys.


Advantages of an LLC


  • Pass-through taxes. There's no need to file a corporate tax return. Owners report their share of profit and loss on their individual tax returns, meaning you avoid double taxation.
  • No residency requirement. Owners need not be U.S. citizens or permanent residents.
  • Legal protection. Owners have limited liability for business debts and obligations.
  • Enhanced credibility. Partners, suppliers, and lenders may look more favorably on your business when you've formed an LLC.


Disadvantages of an LLC


  • Limited growth potential. You cannot issue shares of stock to attract investors.
  • Lack of uniformity. LLCs can be treated differently in different states.
  • Self-employment tax. Earnings can be subject to this kind of taxation.
  • Tax recognition on appreciated assets. This could happen if you convert an existing business to an LLC. One more way that extra taxation can occur.