The Right Fit
by Andrew K. Jacobson |
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The
two most important factors in deciding the right business entity are limited
liability and the tax treatment
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In recent years,
new business have had several entities to choose from, depending on the needs
of the business and the owners. The two most important factors in deciding the
right business entity are limited liability and the tax treatment.
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Limited
Liability
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"Limited
liability" is available when the business respects certain obligations,
such as obtaining a license from the state, keeping certain records and keeping
the accounts of the business from the accounts of the owners. If this is done,
the liabilities of the business generally are not passed on to the owners of
the business.
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Tax
Treatment
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How the profits
of the entity are treated tax-wise is also an important consideration.
Corporations pass their profits to their shareholders, and the shareholders pay
taxes on their share of the dividends, at the shareholder's tax rate
("double taxation").
Some entities,
like general partnerships, can "pass-through" their profits to their
owner without the problem of "double taxation".
The task of the
new business owner is to choose the entity most compatible with the interests
of the owners.
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Sole
Proprietorships
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Sole
proprietships are the classic one person working alone. The owner is fully
liable for all liabilities. The business's income is treated as the income of
the owner, and the expenses of the business are taken as a business deduction.
However, only one person can be in charge, and the business cannot sell part of
itself.
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General
Partnership
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When two or
more people own a business, they can choose to be a general partnership. No
paperwork is required, but the owners ("partners") need to agree who
owns how much; that should be in writing and signed by the owners. There is no
limit to the liability of the partners for the debts of the partnerships. The
profits are distributed to the partners. The partnership ends when one of the
partners leaves.
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Corporations
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The
"classic" entity form is the corporation. The owners enjoy the right
to limit their liability for the debts of the corporation - an important
consideration in a society that can attack business decades later for issues
like asbestos, tobacco, or mold.
However,
California has an annual franchise tax of $800, plus taxes on the profits of
the business.
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Limited
Liability Companies
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A new form of
business is the limited liability company ("LLC"). While and LLC
enjoys the right to limit the liability of owners, it can have the tax
treatment of a partnership (no double taxation).
However, the LLC
form is not available in professions subject to certain government licensing
requirements, like general contractors, lawyers or doctors.
Confused? Talk to
your lawyer or accountant to decide what is best for you. While the initial
cost can seem bothersome, the right choice can save tens of thousands of
dollars later.
(Andrew K.
Jacobson is the founder of Bay Oak Law in Oakland, California, and had been
practicing law for entrepreneurial clients since 1990.)
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