SOLE PROPRIETORSHIP

Sole proprietorships are often recommended by accountants and attorneys because of their simplicity. For example, from a tax standpoint, a sole proprietor does not have to file a separate business tax return. A Schedule C is attached to your 1040 and filed with the IRS. Gains and losses from the business are simply combined with other personal taxable items.

However, there are many issues to consider.

• With no legal distinction between yourself and your business, any business liabilities are also your personal liabilities. If you are sued, you may receive a judgment against your personal assets so you are risking everything you have for your business.
• A sole proprietorship can find it difficult to raise capital, since it can only be accomplished if you can qualify for a personal loan.
• Sole proprietorships have been historically limited in their ability to participate in such things as federally qualified pension plans and medical reimbursement plans that are available to other business entities.

Advantages

• Ease of Formation
• Pass-Through Tax Treatment (e.g., Simplicity of Reporting)

Disadvantages

• Personal Liability
• Lack of Continuity
• Lack of Investment Flexibility

PARTNERSHIP

There are two different types of partnerships that vary in terms of control, flexibility and liability protection. These are general partnerships and limited partnerships.

General Partnership: This type of entity is formed when two or more people come together for the purpose of conducting a business. In forming a partnership, all partners must agree on which duties they will each take on and what percentage of ownership they will each hold. Typically this is done with a partnership agreement that should be put together by a lawyer. Similar to sole proprietorships, partnerships have many of the same advantages and disadvantages. Like sole proprietorships, partnerships are easy to form, but they are taxed according to the tax levels of each partner. Likewise, no liability protection is offered. Again, businesses should seriously consider the consequences of litigation without any shield to protect the owners’ personal assets.

Advantages

• Ease of Formation
• Pass-Through Tax Treatment (e.g., Simplicity of Reporting)

Disadvantages

• Personal Liability
• Lack of Continuity
• Lack of Investment Flexibility

Limited Partnership: Limited partnerships are composed of a minimum of two types of participants: general partners and limited partners. General partners accept the responsibility for and take all the risks involved in managing and conducting the business. Limited partners, on the other hand, are investors who share some risk, depending on the amount invested, but who have no participation in the actual management of the entity. Limited partners simply enjoy the profits and share in the losses on the basis of what is stipulated in the partnership agreement. These provisions provide limited liability protection, but they do not allow any privacy for the parties involved.

Limited partnerships are often used for estate planning purposes. These vehicles allow individuals to control their assets, while still having the ability to pass ownership of those assets along to their heirs.

Advantages

• Pass-Through Tax Treatment (e.g., Simplicity of Reporting)
• Financial Flexibility
• IRS Discounting upon Death (e.g., Lower Estate Taxes)

Disadvantages

• Liability of the General Partner(s)
• Lack of Control for the Limited Partners
• Lack of Investment Flexibility

LIMITED LIABILITY COMPANY

The LLC structure can be used to hold property and transact any type of business. LLC structures are similar to partnerships, limited partnerships, S corporations, and trusts. An LLC is a flow-through entity. It passes all of the LLC profits and losses directly to the members of the LLC. Individual members are therefore taxed at their personal tax rates.

LLCs are owned by members, which are like shareholders in a corporation. Unlike S corporations, which are limited to 75 shareholders, the LLC can have an unlimited amount of members. A member's ownership interest in the LLC is referred to as a 'membership interest'. It is like stock in a corporation. All members of an LLC can manage the business; management can also be delegated to fewer than all members or to a single manager. A manager can be an individual, a partnership, a corporation, or, in some states, such as Nevada, even another LLC. This offers tremendous flexibility for estate planning and asset protection.

This is not to say that building business credit cannot be accomplished with a sole proprietorship or partnership. At NCH, Inc., we will work you to build credit, no matter which structure you choose.

Disadvantages

• Federal Security Limitations: The LLC is only available to privately owned companies. If a company were to go public, it would have to be a C corporation. With merger laws, it would be relatively easy to convert an LLC to a C corporation.
• Loss of Pass-Through Tax Treatment: This occurs when an LLC is viewed as a corporation, which happens when there is an election filed with the IRS and the LLC qualifies for three of the four criteria that define a corporation. If it is taxed as a partnership, pass-through treatment still applies for taxes.
• State Tax Treatment: Some states impose an income or franchise tax on LLCs.

CORPORATION

One of the most consistently dynamic business structures is the corporation. Offering tremendous flexibility and advantages that generally outweigh all other business structures, the corporation is the most secure entity in business.

Because a corporation is considered a 'person' with rights of its own under the law, a stockholder (owner or partial owner) is a holder of shares of stock in the corporation and is NOT IN LEGAL DANGER for the acts of the corporation. In other words, you, as the owner, are not responsible. You are not the employer of those working for the corporation nor are you the owner of corporate property. In addition, a corporation is a citizen in the state wherein it was created and does not cease to be a citizen of its state of domicile by engaging in business or acquiring property in another state.

The important point to remember is that, when you own a corporation, the corporation exists as a separate entity or person. You can live anywhere you choose because it is the corporation's 'state of residence' that dictates the requirements. You will find that Nevada is the state with the greatest benefits for protecting you and your corporation.

C CORPORATIONS

C corporations offer more protection and options for business owners in almost every case.

• In almost every category, C corporations will pay less in tax than an individual. The C corporation tax table is the only one in which the tax rate drops when you start making millions. That's why every Fortune 500 company is a C corporation.
• C corporations have no limitations on shareholders. Shareholders can live anywhere in the world and can be any type of entity.
• There are far fewer criteria for a C corporation, as compared with an S corporation, so you have the options you need to achieve whatever level of privacy and asset protection you desire. C corporations will give you the most flexibility, which is why NCH, Inc., recommends them in most instances.

S CORPORATIONS

There are certain qualifications that the corporation must meet in order to elect S corporation status. To elect S corporation status, your corporation must meet all of the following requirements.

• It must be a domestic corporation formed in the U.S.A.
• It may have no more than 75 shareholders.
• It may only have individuals, estates or certain trusts as shareholders.
• It may not have non-resident alien shareholders.
• It may only have one class of stock.
• It must be a small business corporation (financial institutions, such as banks, insurance companies, building and loan associations or mutual savings and loan associations, cannot take advantage of an S corporation election).
• It must conform to state statutory restrictions, which limit the transfer of shares/ownership of the company.

S corporation status is appropriate for:

• Companies expecting start-up losses during the initial years of operation.
• Companies with no intent of going public in the future.
• Companies that do not expect to issue multiple classes of stock.
• Companies that might be subject to the Alternative Minimum Tax.
• Owners live in a state with no personal state income tax.
• Sales are less than $250,000 per year.

COMPARISION OF C CORPORATIONS AND S CORPORATIONS

Corporations vary in their structure and organization. A corporation is not just a corporation. You will need to select from various types. The two typical corporations that most CPA's or attorneys will recommend are S and C corporations. In explaining the differences between S and C corporations, one should keep in mind that every state has different laws for corporations. What an accountant may tell someone in California may not be true in Nevada.

S Corporation

• Allows for limited liability of the owners/officers/directors.
• Typically runs on a calendar year.
• Full disclosure of corporate owners.
• Profits pass through to the individual tax return 1040. No tax brackets separate from the personal tax brackets apply.
• All profits are taxed even if not distributed.
• State taxes will apply for individuals who are located in a state with an individual state tax.

C Corporation

• Allows for limited liability of the owners/officers/directors.
• Runs on a fiscal year, which may be designated by the board of directors, rather than on a calendar year.
• Nevada requires no disclosure of corporate owners.
• Profits are taxed at corporate rates on an 1120 return separate from the individual return.
• Profits can be kept as retained earnings.
• Nevada has no state corporate tax of any kind.

Enlarge

C corporation status is appropriate for:

• When owners live outside the country
• When owners live in a state with a state income tax
• When several individuals or other entities are involved in ownership
• When sales are greater than $60,000 per year.

S corporation status is appropriate for:

• Companies expecting start-up losses during the initial years of operation.
• Companies with no intent of going public in the future.
• Companies that do not expect to issue multiple classes of stock.
• Companies that might be subject to the Alternative Minimum Tax.
• Owners live in a state with no personal state income tax.
• Sales are less than $250,000 per year.

LLC status is appropriate for:

• When the business is a partnership
• When real estate is owned for investment purposes
• When several entities own the business
• When the owner is seeking complete protection from personal liability

The best structure for building business credit for your company is one that will:

• Separate you from your business
• Have its own federal tax identification number
• Separate your company's business debt from owners/officers

The business structures that provide these are the following:

• S Corporation
• C Corporation
• Limited Liability Company (LLC)

While these are favorable business structures, there are benefits to the sole proprietorship and limited partnership business structures. At FSC we will work with you to build credit, no matter which structure you choose.