The Quick Guide to ORGANIZATIONAL TYPES - … Quick Guide to... · Sole Proprietorship ......
Transcript of The Quick Guide to ORGANIZATIONAL TYPES - … Quick Guide to... · Sole Proprietorship ......
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TABLE OF CONTENTS
03 Introduction
04 Key Factors to Consider
05 Common Organizational Types
06 Sole Proprietorships
07 Partnerships (General, Limited and Limited Liability)
09 Limited Liability Company
10 Corporations
12 Conclusion
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INTRODUCTION
Are you ready to start a business? Maybe you already operate a
business, but never gave much thought on how to set it up.
Choosing an organizational type is an important step toward getting your business underway
and it should not be taken lightly as the structure you choose will impact your taxes, liability and
paperwork duties.
With this Quick Guide, we hope to help you understand the general features of some common
organizational types so you can determine which structure makes the most sense for your
business.
The common organizational types we will look at are:
Sole Proprietorship
General Partnerships
Limited Partnerships (LP) and Limited Liability Partnerships (LLP)
Limited Liability Company (LLC)
Corporations (C-corporation and S-corporation)
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KEY FACTORS TO CONSIDER
What structure makes the most sense for your business?
The organizational type you select should match your business needs. Consider these key factors
when deciding which type makes the most sense for you.
Taxation
The organizational type you choose will determine
how you or your business is taxed. There can be many
tax nuances involved in running a business. Based on
your individual situation and goals, what are the
opportunities to minimize taxation?
Management
Every business has its decision-makers. Consider the
needs of the business as well as the owner(s).
The Future (Continuity and Transferability)
What happens to the business down the line when
you’re no longer able to run it or decide to sell?
Certain organizational types can be more easily
transferred than others.
Formality and Expenses
Expenses, complexity and legal responsibilities vary by
organizational type. How will it impact your
administrative costs and record-keeping?
Legal Liability
Who or what entity will be legally responsible for judgments against the
business? A successful judgment against a business, such as worker
injury or general liability (if someone falls on a wet floor, for example),
could result in the owner being personally liable. The protection of
personal assets is one of the main reasons people incorporate;
however, it’s not always necessary. Insurance and well written contracts
can help manage risks to business owners.
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Sole Proprietorship
If you intend to work alone, this may be the route to take.
A common structure for small businesses, a sole proprietorship is usually owned and operated by
one individual and there is no legal distinction between the business and the owner. Some say
this is the simplest structure.
Creation and formality of a sole proprietorship is relatively
simple and low cost.
Since there is no separation between the individual and the
business, pass-through taxation is a feature of a sole
proprietorship, which means the business doesn’t pay tax on
its income but “passes through” so its profits or losses are
reported on the owner’s personal tax return. Often, sole
proprietors also need to make quarterly estimated tax
payments.
As a sole proprietor, you have complete control over the
business and are the main decision-maker.
The business can last as long as the owner is alive and
operating, or until you choose to sell. The business can also be
transferred to family through the estate planning process.
The sole proprietor assumes full liability of the business, which
places your personal assets at risk. But as previously
mentioned, contracts and insurance can help manage risks.
Key Considerations
Unlimited personal liability
Pass-through taxation
Simplest to form
Lowest cost to form
Owner has full control over business
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Partnerships
Plan to have two or more people own and operate the business?
If your business will be owned by more than one individual, consider structuring as a partnership.
Ordinarily, there are General Partnerships and Limited Partnerships (LP) or Limited Liability
Partnerships (LLP).
General Partnership
In a General Partnership, all owners are personally liable for
the business and can make decisions on behalf of the
business, unless stated otherwise in a partnership agreement.
A partnership agreement is a written agreement to help
guide and protect you and the business. Agreements typically
cover: profit distribution, management duties, banking,
bookkeeping and termination.
Like a sole proprietorship, general partnerships benefit from
pass-through taxation, making them tax reporting entities,
not tax paying entities. Business profits or losses are
reported on the owners’ personal tax return.
A partnership can be transferred or exist as long as
determined in the partnership agreement.
Establishing a general partnership requires more expense and
formality than a sole proprietorship, but is still reasonable
and lower maintenance.
Find more information on how to form a Partnership or
other business entity in California at sos.ca.gov.
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Partnerships, Continued
Limited Partnerships (LP) and Limited Liability Partnerships (LLP)
Limited partnerships have both general and limited partners. General partners own and manage the business operations and
limited partners have little control over how the business is run. Typically involved as investors, limited partners are only
personally liable up to their investment, whereas the general partners assume unlimited liability.
Limited partnerships have similar tax treatment as general partnerships with pass-through taxation. However, if you’re an
investor in an LP, LLC or S-corps and not actively involved in the business (i.e. you don’t have material participation), it could
limit the deduction to only other passive income you may have, which is something to consider and consult with a
professional about.
Like general partnerships, a limited partnership can be transferred or survive as determined in the partnership agreement.
Creating an LP or LLP requires a filing with the state, possibly including the partnership agreement. In California, an LLP
structure can only be formed by persons licensed to practice in the fields of public accountancy, law, or architecture.
Key considerations when establishing a partnership
The amount of each partners’ investment.
The role and responsibilities of each partner.
Creating a buyout agreement in case a partner wants to withdraw down the road.
What happens to a partner’s shares should the partner pass or become disabled?
Can partners invest in or be part of similar businesses or competitors?
How will partnership ownership transfers be handled?
How will disputes be settled?
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Limited Liability Company (LLC)
An LLC generally offers liability protection similar to that of a
corporation but is taxed differently.
A Limited Liability Company (LLC) is an unincorporated entity in which owners can benefit from
limited personal liability. Owners of an LLC are called members and only one member is needed to
form an LLC.
Though only one member is needed to form an LLC, an LLC can have any
number of members, which can be individuals, partnerships or corporations.
Members can equally manage the business or members can designate one or
more owners to manage the operations.
Owners of an LLC have limited liability and are not held personally liable for the
debts and obligations of the business, except in cases of fraud, illegal activity or
failure to separate the business activities from personal affairs (such as using a
personal bank account for business affairs).
Pass-through taxation is also a feature of an LLC and members report their
share of profits or losses on their personal tax returns. However, the LLC
business does file an informational tax return. Also, in California, an LLC pays an
annual tax of $800. In addition, if your LLC's net annual income exceeds
$250,000, you may be required to pay an additional fee, which can range from
$500 to over $11,000.
Perpetual life is not a standard feature of an LLC as the company dissolves when
all members pass away. However, you can include provisions in your operating
agreement to prolong the life of the LLC. In California, an LLC is dissolved by
the consent of all the members unless all members previously agreed in their
operating agreement that such consent is not necessary.
To form an LLC, you must pay a filing fee when you submit your articles of
organization and an operating agreement may also be required.
Key Considerations
Limited liability
Pass-through taxation
Greater flexibility in distributing profits
Flexible management options
No stock
More costs and paperwork to form
Annual taxes and possible fees
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CORPORATIONS
One of the biggest benefits for a business that incorporates is the
liability protection for the owner.
A corporation is an independent legal entity that is separate from its owners. As the corporate
process is more costly and complex, it is generally established by larger companies with multiple
employees or by companies that provide a product or service that come with greater liability risks.
A corporation is more costly and complex because as an independent legal
entity, it has the responsibilities of complying with more regulations and tax
requirements, which can require the assistance of an attorney as well as more
accounting and tax preparation services.
It also comes with benefits such as protection of personal assets, transferable
ownership, indefinite continuity and the ability to raise funds through the sales
of stock.
There are two principal types of corporations: C-corporations (C-corps)
and S-corporations (S-corps). The major difference between the two is the tax
treatment. A C-corps is a separate tax paying entity that files its own tax return.
The owners of a corporation also pay personal income tax on distributed
corporate profits, which creates the issue of double taxation.
S-corps, on the other hand, are pass-through entities that pass corporate
income, losses, deductions and credit through to the shareholders who report
the income and losses on their personal tax returns – allowing them to avoid
double taxation on corporate income.
In California, C-corps and S-corps pay a minimum tax of $800 annually or a
percentage of income, whichever is greater. (See CA tax rates on pg. 11)
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CORPORATIONS, Continued
Management and ownership structures are generally the
same for C-corps and S-corps, in which a board of directors is
chosen by the shareholders. The board is legally required to
meet at least one time a year.
As mentioned earlier, corporations benefit from indefinite
continuity. As an independent entity, the life of the
Starting a corporation requires paying the applicable fees and filing the proper forms with your Secretary of State’s office, which
includes articles of incorporation. Most articles of incorporation establish:
• Company name
• Company purpose
• Company stock quantity and price
• Resident agent name and address
Key Considerations (C-corps)
Limited liability
Company is taxed (double taxation)
More costs and complex to form
Stock options
Complex ownership and management
Indefinite continuity possible
(S-corps)
Same as C-corps except for pass-through
taxation
corporation may remain undisturbed even in the event of a death or disability of an owner or shareholder. Transferring ownership
can be done by the sale of stock, and additional owners can be added in the way.
Keep in mind that although there is more paperwork and regulations to deal with as a corporation, it has its benefits and can still
be a viable option for your business. For example, the first $100,000 of a corporation’s income is federally taxed at 22.25%, whereas
tax for an individual could be as high as 43.4%. So, if your business makes less than $100,000 a year, a C-corps may provide better
tax outcomes.
CA Corporate Tax Rates
Entity type Tax rate
C-Corporations 8.84%
C-Corporations – Bank & Financials 10.84%
S-Corporation 1.5%
S-Corporation – Bank & Financial 3.5%
Alternative Minimum Tax (AMT) 6.65%
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CONCLUSION The organizational type you choose will impact how you own your
business, pay taxes, get paid and administrative duties.
Writing a business plan is a great first step in determining the appropriate organizational type for your
business. It will help you identify your business structure, strategies and needs. Carefully consider the
unique needs of your business and its owners and get expert advice from tax and legal professionals.
When your business is up and running...
Partner with us at American River Bank! For over 30 years, we’ve provided professional and personalized
business banking services and lending solutions to businesses of all industries. Learn how we can give
your business more reach at (800) 544-0545 or visit AmericanRiverBank.com
Resources & Information
California Secretary of State
California Franchise Tax Board
U.S. Small Business Administration
Questions to ask yourself
Who will own the business?
Is this a partnership? Is anyone else
involved?
Who will manage the business?
Does your product or service have
significant liability risk?
How much financing is needed?
Will you have investors?
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The information in this guide was provided by: 1. The Federal Deposit Insurance Corporation in partnership with the U.S. Small Business Association: “Organizational Types and Considerations for Small
Business” 2. Entrepreneur.com: “Choose your business structure” 3. Investopedia.com: “Introduction – Forms of business organization” 4. William A. Robotham, CPA, Executive Partner, Pisenti & Brinker LLP
Disclaimer: The Quick Guide to Organizational Types is intended as general guidance only and may not apply to particular situations or circumstances. The content of this guide is not intended to provide authoritative financial, accounting, investment, legal or other professional advice. American River Bank makes no claims or guarantees regarding the accuracy or timeliness of this information and material.
The Quick Guide to
ORGANIZATIONAL
TYPES