When you first start operating a small business, you may be the only employee not see any need to establish a separate entity for the business. Operating this way is referred to as a sole proprietorship regardless of the number of employees you may have. In the eyes of the law you and the business are one and the same. This means that all of your assets, business and personal, are at risk for liabilities that the business alone incurs. If you have more than one owner and make no other provisions, you are treated as a general partnership and again creditors of the business make collect from personal assets of every general partner.
The laws of all 50 states provide a means by which you can separate your business and personal assets so that creditors and others dealing solely with the business can reach only the assets of the business. Known as limited liability entities, there are several flavors to choose from and one may be better suited to your particular business than the others.
Limited Liability Partnerships
Two or more individuals who share a small business can form a or limited liability partnership (“LLP”). With the latter structure, every partner has limited liability, so they will not face personal lawsuits or have their assets seized on behalf of the business unless they have personally guaranteed the partnership’s obligations.
Limited liability companies
With a limited liability company, or LLC, you enjoy the protections of a corporation without the associated legal requirements such as annual meetings. Owners of an LLC, known as members, have limited liability as with an LLP.
Like partnerships, LLCs may be pass-through structures for tax purposes. This means that you report your share of the company’s profits and losses on your individual tax return and you are subject to self-employment tax. Depending on your circumstances you may be able to choose to be taxed at the LLC level like a “C” corporation.
Corporations offer tax advantages since owners receive a salary based on the work they do and can also receive dividends. You do not have to pay self-employment tax. Unless you elect to file your taxes as an “S” corporation, the government taxes the profits both at the corporate level and at the individual level. Unfortunately, not all corporations are permitted to elect “S” corporation treatment, in which case, it may be better to operate as an LLC.
When exploring these options, you should consult a business attorney and your tax professional. Although it appears quite easy to form a limited liability using online forms provided by most states, these forms do not cover all of the issues that you need to address in setting up your business entity. This is especially the case when you have more than one owner. We have seen some terrible situations when owners have tried to do it themselves and then decide they no longer want to continue the business together. This can lead to a very messy “business divorce.”