When starting a business for yourself, you may wonder what type of business should I start? There are different forms of ownership. The most common types are sole proprietorship, partnership, corporation, limited liability (LLC), and nonprofit corporation.
I am not an attorney or an accountant so I cannot give you legal or tax advice. However, for this article, I can share my experiences and describe briefly different forms of ownership available for you to make your own choice on what works best for you. Keep in mind what is the purpose of your company, how big do you want your company to be, and how would you like to pay Uncle Sam.
An individual or a married couple open a business is commonly known as sole proprietorship. This type of ownership is simple and least expensive to form. Doing Business As (DBA) is a sole proprietorship.
The up side of a sole proprietorship is that it is easy to operate with flexible management and fewer taxes. The business owner is liable for all debts by the business is the downside.
I have established a handful of DBAs for the last twenty years. I chose the sole proprietorship because it was simple, easy to file, and the cheap. Those companies were a temporary service company that required only me.
There are several kinds of partnership such as General Partnership, Limited Partnership, Limited Liability Partnership (LLP), and Limited Liability Limited partnership (LLLP). A general partnership is composed of 2 or more person (generally not married couple). They agree to contribute money, labor, or skill to a business. Each partner shares the profits, losses, management, and liable for debts. Terms and conditions are usually defined in a partnership agreement.
For a limited partnership, there is usually one or more general partners and one or more limited partners. The general partner manages the business and share the profits and losses while the limited partners share the profits and limited losses to the extent of their investment. The limited partners are not involved with every day operations.
The LLP is commonly used by professionals such as lawyers and accountant. This partnership is similar to the General Partnership. However, the partner generally does not have personal liability for another partner of the company.
LLLP is a Limited Partnership that added a statement in its certificate of limited partnership to become an LLLP. The advantage for this structure is that the general partners are shield from liability of obligations of the LLLP.
A corporation is a complex business structure. It has different rights, privileges, and liabilities than an individual. It must have shareholders, directors, and corporate officers. The positive aspects of a corporation may include tax deductions and/or financial benefits. The negative aspect of a corporation may have to deal with increased licensing fees or decreased personal control.
There are two types of corporation when filing for income taxes. They are C Corporation and S Corporation. By default and in general, the corporation is set as C Corporation when filing taxes. The advantage of the C Corporation is that the owners are not personally responsible for the business debts and it does not have a limit on the number of shareholders, foreign or domestic. The disadvantage is that it is doubled taxation. The corporation is subject to the corporate tax and the shareholders are subject to their personal taxes.
The S Corporation offers all the benefit of a corporation but files taxes differently. It does not have to pay for corporate income tax. The shareholders report the company’s income or losses on their personal tax returns. To choose the S Corporation, the shareholders must all agree, sign, and file with the IRS.
Even though S corporation has no corporate tax, there are a handful restrictions:
- Maximum of 100 shareholders
- All shareholders must be a physical person. You cannot use corporations, partnerships, or an entity.
- All shareholders have to be US citizens or residents.
- It must have only one class of stock.
I also have established a C Corporation for my real estate management company. This corporation managed all my real estate rental investments and served as a corporate veil to protect myself from personal liability.
Limited Liability Company
Limited Liability Company (LLC) is defined by state statute. Each state may have different regulations. This is a relatively new form of business structure developed in 1977. Terms and conditions are defined in a special written agreement. It is a more popular form of corporation. LLC has the advantages of partnerships and corporations and avoid the disadvantages of both.
In general, an LLC may include individuals, corporations, other LLC and foreign entities. There is no maximum number of members and a single member is allowed for most states. The owners are not personally responsible for the business debts. LLC has flexible in tax designation. It can file as S Corporation or C Corporation.
One negative which does not apply to all states is the cost. For some states such as New York or Illinois, it is more expensive to form or renew. Another negative is that investors may be reluctant in investing in an LLC.
In the late 90s, I formed a handful LLC entities to own my different long term real estate investments. It was a financial strategy to keep anonymity for my properties. As I sell my real estates, I also closed the LLC that is related to the property. Be aware when you sell or transfer properties from one entity to another. Check your state regulations. For the state of Florida, you will have to pay real estate documentary stamp tax on the value of the property when transfer or sell. The rate is $0.70 per $100, on a $150,000 home would equal to $1050.00 to stamp tax fee.
Nonprofit company is a company that serves the public interests or specific group of individuals forming an ideal or a goal. Some nonprofit companies include religious organizations, charitable organizations, political organizations, membership clubs (Elk Club, country club, etc), School organizations (PTA, PTO, or Booster Clubs).
The nonprofit corporation enjoys the same liability protection of a corporation and an LLC. In addition, the nonprofit can receive money through grants from the government and private foundations. It also can be exempt from income, sales and property taxes. Last but not least, a formal nonprofit corporation allows individuals to donate money tax-free.
In order to receive the federal tax exemption with the IRS and receive the tax benefits mentioned, you need to file the necessary documents with the IRS for a common tax exemption application form called the 501(c)(3). Another common tax exemption is 501(c)(7) which is for social and recreational clubs.
I had an honor and opportunity to form a nonprofit Booster Club with a 501(c)(3) status, to fund raise for an elementary school in Los Angeles when my children were 4 and 6 years old. I ran the corporation for three years successfully. I stepped down and passed my role on to other active parents when we moved to Florida. It was an amazing learning experience.
In this article, we focused primarily the common types of business structure available. I had an opportunity to experience with Sole Proprietorship, LLC, Corporation, and Nonprofit Corporation. Each entity has its own advantages and disadvantages.
When starting out an online business, the simplest form of business could be a sole proprietorship. You fund your own business and not rely on loans just yet. However, when your business expands and grow, it is possible that you may want a loan. Then you may consider transfer your Sole Proprietorship to another different business structure to protect your assets and limit liabilities for your business.
Consult an attorney or an accountant to find the best strategy on how to guide your business into the future. You can also seek out companies such as MyUSACorporation.com for free advice through their online chat or Contact information.
Also, if you have any questions, please feel free to leave your question or comment below. I will get back to you as soon as I can.