What are the different types of tax structures available to businesses?
A sole proprietorship is the easiest and least expensive way to set up a business. You just start up a business and it’s there. You have complete charge of your business — there’s no one else to tell you what to do or how to run the company — you’re in complete control. All profits come to you, and if you need to dissolve the business, it’s fairly easy to do.
A partnership is also fairly easy to establish. There are three types: general partnerships, limited liability partnerships and limited partnerships. The most important thing in a partnership is to draft a quality agreement between the partners. Make sure all partners are on the same page and have everything spelled out in writing. Many times what the company and the partners who own the company start out to do changes over time. Partnerships help bring new energy to the company, and allow more than one person to reach the best decision for the company.
There are several different types of corporations — C corporations, S corporations and limited liability corporations. These have the most protection against legal liability. Any debt of judgment against the company goes against the business and not against your personal finances. Most people can only be held liable for their investment of stock in the company.
What are the risks and benefits of these different structures?
Sole proprietorships have unlimited liability and are legally responsible for all debts against the business, which puts your business and personal assets at risk. It may also be harder to raise funds or to hire high-caliber employees who may want to own their own business in the future.
Partnership profits are shared among all partners and therefore decisions need to be made by all partners (which can sometimes lead to disagreements). Partners are liable for the business actions of their other partners. Partnerships may also have a limited life, and can be inadvertently terminated by a death or withdrawal of a partner.
For corporations the process of incorporation requires more time and money than the other forms of organization. A shareholder of a corporation also deals with double taxation, where the corporation and dividends to shareholders are both taxed. Corporations tend to require more paperwork since they are monitored by federal, state and local tax agencies. Corporations raise funds easier through the sale of stock, and are allowed to deduct some benefits paid to officers and other owners.
Can you change your tax structure down the road, and how easy is it to do this?
Companies should continue to look at and monitor their tax structures as the business grows and develops. As time goes by and tax laws change, your accountant and attorney can help you make decisions as to what is needed to modify your tax structure.
You can change your tax structure over time as you grow or reduce your size, but it may or may not be easy, depending on your current structure. It also depends on the size of your company. If you have a two-person corporation that wants to become an S corporation, it would be very easy to make that change. But it’s harder with a large corporation with thousands of shareholders to get everyone on the same page and to sign off on a change to the structure.
Dennis R. Mowrey is the director, tax and business advisory services, at GBQ Partners LLC. Reach him at (614) 947-5273 or [email protected].
