Starting a Business?  Consult with a Business Lawyer to be Sure you Consider all of your Options.

As a Business Law Attorney I’ve had the pleasure of helping many clients start their first business venture. The first step a client is usually faced with is choosing which type of legal organization to choose. The most common organizations or entities are: sole proprietorship, partnership, limited liability company (LLC), and corporations. Business Law is a complex topic, and a comprehensive comparison between these various types of business organizations is beyond the scope of this blog post. That being said, I will attempt to address some of the basic characteristics of each type of entity.

Sole Proprietorship

A sole proprietorship has only one owner. The owner and the business share the same identity. Therefore, a sole proprietorship offers no liability protection for the owner, and the owner is responsible for all debts and obligations of the business. With respect to tax matters, if the sole proprietorship has no employees, then the owner can use his or her own Social Security number as the Tax ID number for the business. Generally all income and expenses related to the business flow through to the owner and are reported on his or her individual income tax returns. Therefore, the owner is subject to self employment tax and must be sure to make timely periodic estimated tax payments to the federal and state tax authorities. If the business does have employees, a federal employer identification number (EIN) must be obtained from the Internal Revenue Service, and the business must comply with all withholding and payment requirements concerning federal unemployment tax, Medicare, and Social Security. If the business deals with the sale of goods and services, the required tax must also be paid to the state tax authority.

Partnerships

A partnership consists of two or more individuals who operate a business as co-owners. In Wisconsin there are different kinds of partnerships including: a general partnership, a limited partnership, and a limited liability partnership. With a general partnership each partner has equal input in the management of the business, and each can bind the business and the other partners. In a limited partnership there are general partners and limited partners. The general partners actually manage the business, while the limited partners are typically investors who have minimal management authority. Limited partners are generally not personally liable for the obligations or debts of the partnership.  A limited liability partnership is a type of general partnership that offers all of the partners the greatest insulation from liability. However, there are exceptions to this limited liability, including liability arising from the omissions, negligence, wrongful acts, misconduct or malpractice of the partner, or a person acting under the partner’s supervision and control. With respect to tax matters, all partnerships are required to file a tax return. However, the net income (or loss) of the partnership flows through to the partners, usually in proportion to their interest in the entity. Furthermore, if partners are paid wages for the services they perform for the business, they are subject to self employment tax and must be sure to make timely periodic estimated tax payments to the federal and state tax authorities. If the partnership has employees, it must comply with all withholding and payment requirements concerning federal unemployment tax, Medicare, and Social Security. If the business deals with the sale of goods and services, the required tax must also be paid to the state tax authority.

Limited Liability Company

A limited liability company (LLC) is not a corporation, but it does offer its members the limited liability advantages of a corporation. A limited liability company consists of one or more members, who receive an interest in the LLC in exchange for their contributions to the entity, which are typically in the form of money, property or services. Management of an LLC may be vested in the members of the LLC, or in one or more managers (who may also be members). If the LLC is member-managed, each member is an agent of the LLC for the purpose of its business, and each member has a vote in the business decisions of the LLC.  This is similar to the authority under a general partnership, except that the members of an LLC generally enjoy the benefit of limited liability without being personally liable for the debts incurred by the business or its members. If the LLC is manager-managed, the manager’s authority is similar to that of a general partner in a limited partnership as discussed above.  The remaining members of the LLC have no management authority, but they contribute capital or services to the entity that are essential to its formation and operation. With regard to tax matters, depending upon the number of members of the LLC, and the tax election made by the entity, an LLC is taxed either as a corporation, a partnership, or as part of the owner’s tax return (a “disregarded entity”) as is usually the case with a sole-member LLC. If taxed as a corporation the entity is responsible for the tax liability. If taxed as a partnership or a disregarded entity, the income and losses pass through to the LLC members. If the LLC has employees, it must comply with all withholding and payment requirements concerning federal unemployment tax, Medicare, and Social Security. If the business deals with the sale of goods and services, the required tax must also be paid to the state tax authority.

Corporations

A corporation is a legal entity, distinct from its stockholders. The stockholders are the owners of the corporation, and they receive shares of stock in exchange for the money, property or services they have provided to the entity. A board of directors is elected by the stockholders to manage the affairs of the corporation. Officers are elected by the board to conduct the daily business affairs of the corporation. Generally, shareholders, directors and officers are not personally liable for corporate actions or debts. However, this veil of protection can be pierced in certain cases, including misconduct or undercapitalization. Officers and directors can also be personally liable for failure to pay required withholding taxes.  With regard to taxation, a corporation can choose to be taxed as a subchapter C corporation, or a subchapter S corporation.

For tax purposes, a C corporation is recognized as a separate tax paying entity. The corporation pays taxes based upon its income. The C corporation receives no tax deduction for the income it pays to shareholders in the form of dividends, but the shareholders must pay tax on the dividends. This results in a situation known as double taxation.

An S Corporation is generally exempt from income tax. It passes any profits (or losses) through to its shareholders. Therefore, corporate profits are taxed only once, at the shareholder level, and the shareholders receiving the income are taxed at their individual tax rates.

Corporations must also comply with all withholding and payment requirements concerning federal unemployment tax, Medicare, and Social Security for corporate employees. If the corporation deals with the sale of goods and services, the required tax must also be paid to the state tax authority.

Conclusion

With several of the entities discussed above, there is certain documentation that must be filed with the appropriate state agency in order to comply with all applicable statutes and regulations. It is also essential that you consult with a qualified tax professional to ensure that the proper tax elections and filings are made; the tax considerations discussed above are merely introductory.  There are numerous other factors to consider when forming a business, including regulatory compliance, insurance needs, trade-name protection, and authority to conduct business in other states, just to name a few. Starting your business is an important venture. Be sure to consult with a qualified Business Law Attorney to guide you through the process. Contact Attorney Stephen Kosa today at (715) 386-4125.