When setting up a new business, one extremely important question you must decide early in the process is how to structure the business. The business entity can impact how your business functions, how it is taxed, and whether your personal assets are subject to liability. At Newburn Law, P.C., our experienced business lawyers have helped clients form just about every type of business structure there is. We work closely with our clients' businesses to understand what business structure will suit their business best. Contact us today at 303-847-4987 to schedule a meeting with one of our trusted business attorneys.
What Is a Business Entity?
Business owners must decide how their business will be organized. The type of business structure will usually determine how the business is taxed by the Internal Revenue Service and the state of Colorado, how it operates, and how the owners share responsibilities and liability. Common business entities include:
- Sole proprietorships
- General partnerships (GPs)
- Limited partnerships (LPs)
- Limited liability partnerships (LLPs)
- Limited liability companies (LLCs)
Each type of business structure has pros and cons, so choosing the right business entity requires business owners to work with tax and legal experts to understand which structure is best for them. Consider visiting with one of our experienced business attorneys at Newburn Law, P.C. to help you with your specific goals and vision for your small business.
A sole proprietorship is arguably the most simple business structure. They are owned by one person or one married couple, and it usually does not require the owner to register with the state. The taxation of sole proprietorships is also fairly simple. The proprietor files one individual tax return, declaring the business's profits and losses. The business itself does not file a separate tax return. The downside of sole proprietorships is that, because they are unincorporated, the owner is personally liable for the debts of the company or any judgments against it. Sole proprietorships are usually best for individuals who run small businesses with minimal risk.
Partnerships are exactly what they sound like. They are an unincorporated business structure with multiple owners who conduct business together. When two people enter into profit-making activities together, the default structure is a partnership. There are various types of partnerships.
When two or more people do business together, they may form a general partnership. In this arrangement, all partners share the profits and losses of the business, and they also share the personal liability. Partnerships are also taxed at the individual level, rather than the partnership itself being taxed.
Limited Partnerships and Limited Liability Partnerships
A limited partnership is similar to a general partnership, except in this structure, only one of the partners - the general partner - has unlimited liability for the company, while the others' liability is limited to just their investment. This arrangement is often ideal for investors, who may opt to be limited partners under a partnership agreement. The general partner is often more involved in the day-to-day operation and management of the business, while the limited partners, such as investors, play a more passive role and are only on the hook for the amount of their investment in the company. Limited liability partnerships (LLPs) differ only in that each partner may agree to limit their liability.
A corporation is a more complex business structure than a partnership or sole proprietorship. In a corporation, the business becomes an independent legal entity, separate from the owners. A corporation is made up of directors, officers, and shareholders. Directors and officers are responsible for the management and strategy of the organization, while shareholders are the owners.
Whereas in a partnership or sole proprietorship, the individual partners may be liable for the debts and liabilities of the company, the corporation's assets are managed separately, and the owners are not personally liable for debts or judgments of the company. Corporations are best for high-risk businesses.
Corporations are generally more expensive to form and come with a higher administrative burden, but they are best for businesses that need to raise a lot of money because of the ease of investment. Shareholders can invest by simply purchasing stock in the company, rather than having to join the business as a partner. This makes corporations enticing to investors. Generally, corporations are taxed as separate entities, there are several types of corporations. The structure of the corporation will impact how it is taxed.
A C corporation is a common type of corporation, where the business is taxed on its profits and charged a corporate tax rate. The shareholders do not pay taxes on their share of the profits, but rather they pay taxes on their income from dividends and the sale of stock. This results in what is sometimes referred to as “double taxation,” which means that C corporations pay taxes first at the corporate level, and then again when dividends are distributed.
To avoid double taxations, corporations may elect to be taxed by the IRS as an S corporation, which allows for pass-through taxation. Under this election, the taxation “passes through” to the owners, who pay taxes on their share of the profits. The S corporation is not its own type of business entity, but rather it refers to the tax election. C corporations may be taxed as S corporations, but so may LLCs.
Limited Liability Company
A limited liability company (LLC) is a flexible business structure that offers the owners, or “members,” the ability to choose how they want to be taxed. The LLC limits members' liability to the amount of their investment and allows members to share profits and losses however they see fit. LLCs are a good business structure for riskier businesses with members who have personal assets they want to protect.
Choosing the Right Business Entity
This is not an exhaustive review of business entities. One way to ensure you are choosing the right business entity for you is to speak with an experienced business lawyer in your state. There are significant legal and tax implications involved in setting up your business, and it is important to get it right at the start. Trust the business attorneys at Newburn Law, P.C. to help you analyze your business's needs and choose the right business entity. Contact us at 303-847-4987 to set up a meeting.