LEGALSTRUCTURE:法律结构

LEGAL

STRUCTURE

In this article:

Am I too small of a business to bother with

incorporating?

What are the tax implications and liabilities

in being a “sole proprietor?”

Is a partnership the best way to run my

business?

Do corporations pay less tax than individual

small business owners, given the same net

business revenue?

Is an LLC better than a corporation?

How much more record keeping is involved

in a corporate structure? Should I bother?

Does my liability change depending upon

the business structure I‟m in?

Can I more easily raise investor money with

one business structure over another?

Do I need to see a lawyer, CPA, neither, or

both?

Where can I find local, professional advice

regarding my business structure questions?

…and much more!

Before you opened a business, you

selected the legal structure that hopefully

best suited your needs and those of your

particular business at the time. Now that

you have been in business a while you might

want to review your earlier decision. In

choosing a legal structure for a business, you

should consider the following as you review

your current situation:

 What legal structure best serves the

purpose and goals of the business as it

exists today and the business that is apt

to exist in the potential (e.g., five-year)

future?

 What is the risk and what is the amount

of the investors' liability for debts and

taxes under your current legal structure?

 What happens to the business if

something happens to one of the

principals?

 What is the influence of applicable laws

on your business and would changing

your business structure help?

 Can you better attract investment capital

by making a change in your legal

structure? If so, how?

 What are the additional costs or savings

of running your business under each

different possible structure?

 Is making a change in business structure

worth the extra record keeping and

reporting that may be required?

Remember, professional advice is almost

always needed to select or change the legal

structure for a business—seek out assistance

before you act!

TYPES OF BUSINESS STRUCTURES

There are four principal types of business

structures: the proprietorship, the

partnership, the limited-liability company/

partnership (LLC/LLP) and the corporation.

Importantly, within the a corporate legal

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structure, there are both “C” and “S” types

of corporations.

All of the business structures have

their advantages and disadvantages. There is

no one „best‟ legal structure for all

businesses; otherwise, everyone would

choose the same structure, which they

obviously don‟t!

The decision to stay as you are or

change your legal structure should be based

on your specific circumstances, goals, and

needs. These structures, along with their

basic advantages and disadvantages, are

listed below. That said, it‟s worth repeating:

the discussion following is not exhaustive;

you need to see your accountant/CPA, and

perhaps your business attorney, before

finalizing your business legal structure of

choice.

Also remember that you can change

your business legal structure - you are not

locked into it forever. Note however that

there are strict IRS and state regulatory

limits in this regard, so it‟s important to

choose (or change) your legal structure

wisely.

Sole Proprietorship

Sole proprietorship is defined as a business

owned and operated by one person. It is the

simplest form of legal structure. Likely

many small business owners are in this

situation today. To establish a sole

proprietorship, you simply obtain the

necessary licenses and begin operation.

Advantages:

 Ease of formation.

 Sole ownership of profits.

 The owner has control of all decision-

making.

 Flexibility in day-to-day management.

 Relative freedom from government in-tervention.

Disadvantages:

 Unlimited liability. This extends to

all of the proprietor‟s assets,

including the home and car, but may

be lessened by proper insurance

coverage.

 Unstable business life. The business

may be terminated upon the death or

disability of the owner.

 Less available capital, generally

totally dependent on the owner‟s

assets, business and personal.

 Difficulty in obtaining long-term

financing.

 Relatively limited viewpoint and

experience.

Partnership

If you are a sole owner, one of the ways to

initially expand your business (and/or to

obtain additional funding) is to take on one

or more partners. A partnership is an

association of two or more persons to carry

on as co-owners of a business. A

partnership is a formal arrangement that

requires a formal written document to

establish its existence. This document

outlines the contribution by the partners into

the business (financial, material, or

managerial) and generally delineates the

roles of the partners in the business

relationship.

Advantages:

 Ease of formation.

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 Ease of operation.

 Simple bookkeeping and accounting.

 Simply and directly rewards each

partner, generally based upon net

profit.

 Growth and performance facilitated.

 Flexibility in decision-making.

 Relative freedom from government

control and special taxation.

Disadvantages:

 Unlimited liability of at least one

partner.

 Unstable life in the sense that

elimination of either partner

constitutes automatic dissolution of

the partnership.

 Difficulty in obtaining large sums of

capital.

 Firm bound by the acts of one partner

as agent.

 Difficulty of disposing of partnership

interest.

 Higher (personal) tax rates if profits

are healthy.

Limited Liability Companies and Partner-ships

A popular variant of the standard partnership

is the Limited Liability Company (LLC) or

the Limited Liability Partnership (LLP).

The LLC and LLP arose from the

desire of business owners to adopt a

business structure permitting them to

operate like a traditional partnership. This

distributes the income and income tax to the

partners (re-ported on their individual

income tax returns), but also protects them

from personal liability for the business debts,

as with the corporate business form.

As a separate entity, the LLC can

acquire assets, incur liabilities and conduct

business. As the name implies, however, it

provides limited liability for the owners. The

owners risk only their investment. Personal

assets are not at risk.

Advantages:

 Limited liability without limits on

management participation.

 Flexible ownership and capital

structure.

 No double taxation.

 Allocation of tax benefits among

members.

Disadvantages:

 Higher initial cost to establish than

simpler forms of business.

 Poor tax treatment of fringe benefits.

 Harder to obtain financing because

of the limited liability.

The Corporation

Depending on the actual or expected size of

your business, you may want to consider

incorporation. Incorporation is by far the

most complex form of business structures.

Importantly, a corporation is a state-regulated legal entity making the company

distinct from the individuals who own it. In

California, a corporation is formed by the

authority of the State of California (see

for more

information).

All corporations are comprised of

three groups of people: shareholders,

directors, and officers. The procedure

ordinarily required to form a corporation

begins with a subscription for capital stock,

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and a tentative organization created. Then,

approval must be obtained from the state (in

California, the California Secretary of State).

This approval is in the form of a charter for

the corporation, stating the specifics and

limitations of your particular enterprise.

Advantages:

 Limited liability of stockholders.

 Ownership is readily transferable.

 Separate legal existence.

 Tax rates for corporations are

different than those for private

individuals, usually advantageous,

but not always.

Disadvantages:

 Activities limited by charter and

various laws.

 Extensive government regulations

and reports.

 Generally has limitations as to the

number of stockholders, citizenships

and other factors.

Subchapter S (or “Sub-S”) Corporation

OK, this gets a little complicated, but follow

along: the Subchapter S Corporation is a

legal corporation that is afforded special tax

treatment under Subchapter S of the Internal

Revenue Code.

Under California (and other state

laws), the S Corporations retain the normal

features of corporations, to include limited

liability, but for federal tax purposes they

are treated much like sole proprietorships

and partnerships.

The profits are taxed at the

individual rather than corporate rate; hence,

the stockholders report corporate income,

loss, deductions, and credits on their

individual tax returns.

In most all other aspects, the S

Corporation operates in compliance with

state and federal laws relating to

corporations, just as a regular (or “C”)

corporation.

Importantly, the law prohibits S

incorporation for the sole purpose of

obtaining limited liability status.

Advantages:

 Limitations of the stockholders‟

liability to a fixed amount of

investment.

 Ownership is readily transferable.

 Separate legal existence.

 Stability and relative permanence of

existence.

 Relative ease of securing capital.

Disadvantages:

 Activities are limited by charter and

various state laws.

 Minority percentage stockholders

may be exploited.

 Extensive government regulations

and reports.

 Fewer financial incentives for the

manager.

 All Sub-S corporate profits are

„passed through‟ to your personal tax

return at higher tax rates than for a C

Corporation. If your Sub-S

Corporation is highly profitable

(bottom-line “net”), then you will

probably be paying more tax via

your personal (1040, Schedule C)

return.

The “C” Corporation

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The C Corporation is similar to the S-

Corporation just discussed, but with some

important differences regarding human

resources/employee laws, pensions, benefits,

and taxation. That said, the major factor

(this varies state-by-state) is that in a C-

Corporation, you cannot pass net profits

through to your personal (1040) tax return,

Finally, remember that you can go

back and forth switching between the two

corporate structures, but you will be limited

by state law as to how often action is to

initially meet with your CPA and even

possibly with your legal counsel to

determine the optimal choice for your

as you can with a Sub-S corporate structure.

In a C Corporation, tax on the

corporation‟s net profit is calculated at

(lower) federal and state corporate tax rates,

while salary paid to employees, including

the business owner(s) working for their

corporation, are taxed at the federal and state

personal (higher) tax rates. Confusing? Well,

yes, perhaps! A good CPA can find the

optimum balance in taxation - in other

words, how much pay you actually take out

of your C Corporation can become a major

tax issue.

Okay, S or C - what‟s right for you?

Good question, but, difficult to answer in

this basic presentation. The best course of

action is to initially meet with your CPA and

even possibly with your legal counsel to

determine the optimal choice for your

circumstances.

In general, tax-wise, with all other

things equal, higher corporate net profit

lends itself more to a C Corporation

structure. Lower corporate net profit lends

itself more to the Sub-S corporate structure.

Finally, remember that you can go back and

forth switching between the two corporate

structures, but you will be limited by state

law as to how often

circumstances.

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BUSINESS STRUCTURE COMPARISON

Limited

Sole

C Subchapter-S Liability

Corporation Corporation Company

Limits owner

liability X X

Company name

protected X X

Unlimited term of

existence X X

No limit to

number of owners X

No citizenship

requirements X

May be owned by

another business X

May issue shares

of stock X X

Profit and loss on

personal tax

returns X

Owners can split

profit and loss X

Annual meetings

not required

ADDITIONAL SOURCES OF

INFORMATION

 /business-structures/

 /sref/pdf/

 /law/org/

PROFESSIONAL HELP FROM

SOLANA BEACH BUSINESSES

& OTHER CHAMBER MEMBERS

 The Solana Business Forum (click on

“Business Services”, then on

X

X

X

X

X

X

Limited Proprietor-Partnership ship

X

X

X

X X X

“Accountants”) Chamber Members are

noted as are those who give discounts to

other chamber members.

 Mayfield & Assoc., (858) 793-8090

 Jeffrey Segal Law Office, (858) 793-5473

Entire contents copyright © 2010

by Edward Sarkis Balian, Ph.D.

All rights reserved.

Unauthorized duplication or distribution

by any means is strictly prohibited.

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