How to Choose a Small Business Structure / Legal Form in Wilmington, NC
The small business structure is one of the early and most important decisions a small business entrepreneur must take at startup. There are several basic business structures, or legal forms of organization, available to small business in in North Carolina; including Sole Proprietorship, General Partnership, Limited Liability Partnership (LLP), Corporation (C), S-Corporation, Limited Liability Company (LLC) and Non-Profit Organizations. The legal form of the small business affects its decision-making authority, financial liability, regulation, and taxation.
Factors Influencing the Choice of a Small Business Structure / Legal Form
The factors that will influence your choice of business structure include:
- Personal expectations and continuity of existence,
- Nature of business activity and scale of operations,
- Stability, flexibility, and future needs of the business,
- Fixed and operating capital requirements,
- Risk and liability owners will take,
- Level of control you choose to have over your business,
- Participation by employees, investors, partners, and others,
- Sharing and division of profits,
- Cost and complexity of formation and ongoing administration, and
- Tax implications and government regulations.
Sole Proprietorships and Partnerships as Small Business Structures
What is a Sole Proprietorship?
A Sole Proprietorship is a business that is independently owned and operated by an individual. As small business owner you run the business solely by yourself and you have complete control over management decisions and policies. But you are personally and legally liable and responsible for all your actions, obligations, debts, claims, and taxes.
A Sole Proprietorship is the default business structure. In other words, the IRS consider your small business a sole proprietorship if you run a business without choosing another legal business structure. A Sole Proprietorship is the simplest form of small business structure and treated as an extension of the owner.
It is not incorporated and thus not a legal business entity. For tax purposes, the profits or losses of the small business are combined with the owner’s other income sources and taxed at owner’s individual tax rate. It may be problematic to raise capital and it depends on owner’s credit record.
What Is a Partnership?
A partnership is an arrangement between two or more people to manage a small business and share its profits and liabilities. Business partners agree to commit money, property, skills, or labor and share in the management decisions. A partnership allows you to find business partner(s) with complimentary skills, and you do not have to run the small business by yourself.
A partnership is not a corporation or separate tax entity, and it is viewed as an extension of its owners for legal and tax purposes. Your partnership income is added to your income from other sources and taxed at your personal tax rate. There may be tax benefits to a partnership compared to a corporation since a corporation pays taxes on its earnings and then you will pay taxes on your salary.
It is a simple small business structure that can be established with minimal formal documentation. It is advisable that partnerships have a formal written agreement with provisions for roles and responsibilities, salary, benefits, death, disability, liability, and dissolution.
General Partnership Small Business Option
A general partnership is a partnership where all partners share equally in its profits and losses. All partners are held legally responsible for their own actions and the actions of the other partners. Furthermore, each partner is held personally liable for all debts, taxes, and other claims against the partnership.
Limited Liability Partnership (LLP) Small Business Option
A Limited Liability Partnership (LLP) is a partnership that has both general partners (as discussed above) and limited partners. Limited partners are essentially investors (silent partners) that do not take part in the day-to-day operations of the business and who are also not liable beyond their investment in the business. Professional business such as law firms, accounting firms, and wealth managers often form limited liability partnerships (LLPs).
Forming Corporations as Small Business Structure
What is a Corporation?
A corporation is a legal entity under the authority of state law and detached from the people who own and manage its operations. Corporations can hire employees, make a profit, be taxed, enter contracts, sue/get sued, own assets, and borrow capital. A corporation is a small business structure that provides the strongest protection to owners if you choose to separate personal and business’s liability.
A corporation is incorporated by a group of shareholders who have ownership of the corporation. Each shareholder has a percentage of ownership in the business based on the number of shares owned. Corporate owners (stockholders) have limited liability, but they have limited involvement in the company’s operations. The board of directors elected by stockholders, controls the activities, and steers the direction of the corporation.
Small business entrepreneurs can incorporate, by filing articles of incorporation are with the Secretary of State’s office. After incorporation, the IRS automatically classifies the corporation as a C corporation. Formalities required by law include having a board of directors; maintaining corporate minutes; maintaining corporate records and filings; and more. Governmental agencies regulate and supervise corporations. Corporations are subject to corporate income, property, franchise, sales, and other taxes.
C Corporation Small Business Option
A C Corporation is the most popular form of incorporation and has the attributes of a corporation as discussed above. C corporations are subject to double taxation. The corporation itself is taxed as a business entity, and the profits that owners receive are taxed at their individual levels. By issuing stock C corporations can raise large chunks of capital and ownership is easily transferable by shareholders trading stock.
S Corporation Small Business Option
A S corporation is a corporation that elects to pass corporate losses, income, deductions, and credits through to the shareholders for federal tax purposes. Shareholders of S corporations report these flow-through items on their personal tax returns. Their taxes are based on their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. To become an S corporation, the corporation must file documentation with the IRS signed by all the shareholders. The IRS requires the corporation to be domestic and limited to 100 shareholders. Visit the IRS website – click here.
Limited Liability Company (LLC) Small Business Option
Limited Liability Company (LLC) is small business structure that is frequently used by small business entrepreneurs. A limited liability company (LLC) is legally detached from its owners. It is a hybrid structure with the legal protections of a corporation (limited personal liability) while allowing for the tax benefits of a partnership (avoiding double taxation). Members can be individuals, trusts, partnerships, corporations, or even other LLCs. Members have management control of business without risking liability. A limited liability company (LLC) is free of regulations imposed on S corporations by the IRS.
What is a Non-Profit Organization?
A nonprofit organization (NPO) is a legal entity organized and operated for a shared, public, or social benefit. Small businesses choose this non-profit organization small business structure when their mission or area of activity relate to charity, education, science, religion, literary, public safety, or cruelty-prevention. A broad array of nonprofit organizations exists, including schools, churches, social clubs, political organizations, business associations, and consumer organizations.
Nonprofit organizations are regulated under Section 501(c) of the Internal Revenue Code and not C corporations. Nonprofit corporations do not exist to make money, and all donations and other revenue are spent to further their purposes and programs. However, they receive the same limited liability protection as for-profit corporations. This means that directors or trustees, officers, and members are not responsible for the debts and liabilities of the organization. Lawsuits can only target the organization’s assets.
Nonprofit entities generally seek approval from government to be tax-exempted and qualify to receive tax-deductible contributions. Small nonprofits that do not seek tax-exemption do not need to incorporate and file any organizing documents. However, without forming a legal entity, everything you own is at risk.