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The answer depends on what kind of business it is and how the
business owner would like to arrange his/her tax liabilities and the
other realities that come with business ownership and
operation.
We can start our discussion by looking at a
partnership. This is a common form of business arrangement
because it doesn’t take a whole lot of paperwork to arrange, and is
often formed inadvertently due to lack of proper filing or even
ignorance. A partnership is nothing more than a voluntary
association between two or more people who agree to collectively own
and operate a business. Each partner is proportionally
responsible for all of the profits, losses, liabilities, and other
happenings of the business. It is simple to arrange, but
offers little in the way of protection from personal liability for
the individual partners.
This is why corporations and LLCs
are beneficial: they offer differing levels of protection
against personal liability.
Corporations
Corporations are an excellent way to protect
owners against personal liability for losses and taxes, because they
function as separate legal entities. More than just a legal
entity, corporations are recognized as legal persons that can own
property, file taxes, sue, be sued, sign contracts, and exist apart
from its owners. This is beneficial for the owners of a
corporation because all liabilities are applied to the corporation
itself and are not passed on to the individual owners.
The
owners of a corporation are those who own shares of the
corporation. Since a corporation pays taxes on its profits as
though it were a person and is individually liable for losses, the
shareholders are protected against these things. However, when
the profits are passed on to the shareholders in the form of
dividends, the individual stockholders are responsible to pay taxes
on these. This is both a benefit because the corporation is
responsible for its own profits and losses, and a detriment because
taxes are paid twice (once by the corporation for profits and once
by the shareholder for dividends).
Corporations offer huge
benefits because of liability protection, but this comes at a
certain price. The price is the observance of corporate
formalities. These formalities include holding annual
meetings, keeping minutes of meetings, submitting annual reports,
appointing directors and officers, and issuing stock. These
formalities must be observed regardless of the number of
shareholders. If not, then the “corporate veil” could be
pierced and the shareholders could be found personally liable for
the corporation’s debts.
Limited Liability Company
An LLC fits somewhere between a partnership and a
corporation. It offers liability protection similar to a
corporation, but has operational and tax advantages similar to a
partnership. Generally, the owners of an LLC, which are
referred to as members, are not liable for the debts or obligations
of the company. This offers a level of liability protection
similar to a corporation. However, the members are responsible
for the profits and losses of the LLC since they pass straight
through to them in a similar manner to partnerships.
Another benefit to LLCs, beyond the liability protection, is the
ease of maintenance. There are fewer paperwork filing and
record keeping requirements. For example, LLCs do not need to
keep minutes of meetings or file annual reports. There is also
the ability for LLC owners to decide how they wish to allocate their
profits and losses unlike the allocation of dividends based on share
ownership for corporations.
The way an LLC is taxed can get
tricky depending on the state where it is formed since some states
recognize LLCs as sole-proprietorships or partnerships. Still
other states allow an LLC to choose how it is taxed which offers
some flexibility. The flexibility and state specific rules for taxation can be both a
benefit and a detriment to choosing this business form.
Conclusion
Both corporations and LLCs offer liability protection and ways of
arranging profits and losses that can be more beneficial than plain
partnerships. In making the decision as to which would best
suit a business’s needs, some factors need to be weighed such as
whether stock will be issued publicly, how tax liability will be
dealt with, and how much organizational maintenance is
manageable.
Each state has its own laws governing these business formations and there can be subtleties in
how they are formed and how they function. It is recommended
to seek the advice of an attorney or accountant for specific
questions about a business formation and how it could affect a new
business owner. |
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