Maximize Your Business with The Right Structure by Michael Casey

One of the first of many decisions to be made when starting a new business is to decide on what the legal and tax structure of the business will be. Generally, the choices are:

* Sole Proprietor. * Partnership. General or Limited Liability. * Corporation. Designating a tax status of C or S. * Limited Liability Company. A partnership hybrid.

A brief discussion of each follows. Each structure must be considered in light of income tax implications, the presence of partners or investors and liability.

Sole Proprietor. This is self employment at its purest form. You are the sole owner and operator.

From the tax perspective, you file a Schedule C on your form 1040 detailing you income and expenses. In addition to federal and state income taxes, your net profit is subject to federal self employment taxes which is the self employment version of FICA and Medicare. The current rate is 15.3% (the same rate as a corporation and employee pay combined), capped at $102,000 in 2008 on the FICA portion of 12.4%. As with wages, the Medicare portion of 2.9% does not have a ceiling cap.

On the liability side, there is no shield for personal liability when operating a business as a sole proprietor. You are on the hook.

Without a doubt, this is the easiest form of business structure to form. Your social security number is your federal tax identification number and there are no forms to file to form the business. An exception to this would only be a filing with the county register of deeds if you want to reserve a fictitious trade name (i.e. a doing business as name).

Partnerships. This structure is available when there are two or more individuals join together to form a business. Partnerships agreements are governed by state law so variations between states can be significant when establishing a partnership agreement.

Partnerships are required to get a federal tax identification (FEIN) at the onset of the business. The FEIN serves as an identifier of the partnership very similar to the function of the social security number for an individual.

The partnership agreement will spell out the division of profits, losses, capital contributions, guaranteed payments and tax allocations of each partner. It can be as simple or complex as the partners agree to. The financial results of the partnership's business is then reported and allocated to each partner on federal form 1065. Each partner receives a K-1 which reports the partner's share of items of income and expense. If the partner is active in the business, the same self employment tax liability arises as it does in a sole proprietorship. From a liability perspective, a partner is assigned a status or general or limited. General partners have unlimited liability while limited partners usually have liability up to their investment in the partnership.

Corporations. Corporations are persons under the law, albeit "artificial" ones. They are formed by Articles of Incorporation and rule by corporate by-laws. They have deemed to have an indefinite life.

The corporation, when formed, may elect to be taxed a C or S corporation. Regardless of the tax election, a FEIN must be obtained. There are special requirements that must be met to elect an S status, such as a limitation of 100 shareholders or less. It is widely held that S corporations receive more favorable tax treatment because their earnings are taxed only once, at the shareholder level. In this respect, they are similar to partnerships and LLC structures as "pass-through" tax entities. A C corporation pays income taxes at the corporate level and its shareholders pay tax on dividends distributed to them. Upon liquidation, the C Corporation is again subject to corporate level taxThis double taxation feature is a drawback to owners, but in some instances, only a C tax status is appropriate for a corporation.

The advantage of conducting business as a corporation is the limitation of liability to the owners. Because corporations are artificial persons, liability can be imposed upon it. Under some circumstances, the "veil may be pierced" on corporate liability and extended to directors and shareholders

Limited Liability Company. This form of organization is a hybrid of sorts; it offers limited liability to owners and a single level of taxation as a "pass-through" entity.

A LLC can elect to be taxed as a sole proprietor, a partnership or an S corporation, since all are pass-through entities and afford a single level of taxation. .A FEIN is required at formation.

An LLC affords limited liability that is not available to general partnerships or sole proprietorships. It is not uncommon now for individuals to form a single member (one owner) LLC for liability purposes, but individual state laws must be checked in this regard.