Business Entity Selection

RUNNING HEADER: ENTITY SELECTION

Business Entity Selection

Business Entity Selection

People go into business to make money. Unfortunately, not everyone considers the proper way to structure his or her business so that it can make money in an optimal way while operating within the framework of the law. Failing to select a structure for a business carefully can mean the loss of that business and of its associated assets. I will discuss various types of business entities that exist and the pros and cons of each. Specifically, I will explore

* Sole Proprietorships

* General Partnerships

* Limited Partnerships

* Corporations

* Limited Liability Corporations

I will also discuss following business situation:

* Joe's Lawn Care and Landscape Equipment Rental

I will determine whether the business is effective in operation, as business currently exists, or if there is a need to make changes to the business entity.

Sole Proprietorship is one individual or married couple in business. Sole proprietorships are the most common form of business structure. This type of business is simple to form and operate and may enjoy greater flexibility of management, less legal regulation, and fewer taxes. Although this is the easiest form of business to start, "the income and losses are treated as personal and will be filed on a Schedule C along with the regular Form 1040 tax return" (IRS, 2004). If profits are minimal, the owner will be paying less in income taxes with this form of business than with a corporation. However, the business owner is personally liable for all debts incurred by the business. Sole proprietorships cannot take advantage of special business income tax rates since all income is considered individual income. In addition, sole proprietors are not protected from personal liability if they get into trouble with a client. If an upset client decides to sue, they sue the proprietor personally. If the proprietor must declare his company bankrupt, he files for bankruptcy personally. Moreover, by definition, a sole proprietorship can have only one owner, and that owner must be a "natural person" (i.e., not a corporation, trust, LLC, or other such entity.) Finally, one cannot sell or inherit a sole proprietorship.

A General Partnership is composed of two or more persons (usually not a married couple) who agree to contribute money, labor, and/or skill to a business. Each partner shares the profits, losses and management of the business and each partner is personally and equally liable for debts of the partnership. In terms of asset protection, general partnerships can be even worse than sole proprietorships. Anything that one partner does affect all the partners, because each partner of the general partnership is personally responsible for all obligations of the partnership. Thus each general partner's exposure to risk is increased by a factor equal to the number of general partners in the business. (General Partnership, 2004)

Formal terms of the partnership are usually contained in a written partnership agreement. The benefits of this type of entity are that it is only slightly more complicated to set up than a sole proprietorship. In addition, business income and tax liability passes through to each partner so no separate tax filings are necessary for the entity. Unfortunately, each partner holds financial liability for the actions or inactions of the other partner in connection to the business. Additionally, the sharing of ownership depends on how the partnership agreement is drawn up, which may result in neither partner having as much control of the business as they might with a sole proprietorship.

A Limited Partnership is composed of one or more general partners and one or more limited partners. The general partners manage the business and share fully in its profits and losses. "Limited partners share in the profits of the business, but their losses are limited to the extent of their investment" (Taylor, 2002). Limited partners are usually not involved in the day-to-day operations of the business. In this structure, there is usually no limit to the number of participating partners and it has the advantage of pass-through taxation. However, the downside of this structure is that it can be complex to manage due to the various levels of partnership participation.

A corporation is an association of individuals created by law and existing as a single entity or individual, with powers and liabilities independent of its stockholders. Management consists of its directors and officers elected by shareholders. The shareholders can and do often change, but the business continues despite any changes in ownership status. It can enter into contracts, pay taxes, and is liable for debts and claims. A corporation's officers and directors are generally shielded from personal liability for the corporation's debts and losses. However, there are certain situations where this is not the case. Additionally, a shareholder's creditors cannot reach the assets of the corporation to satisfy its debts. The corporation must pay federal taxes on all profits, and shareholders pay taxes on their dividends.

A Limited Liability Corporation (LLC) is composed of one or more individuals or entities through a special written agreement. The agreement includes provisions for management, ability to assign interests, and distribution of profits and losses. Limited liability companies can engage in any lawful for profit business or activity other than banking or insurance, although filing with the Office of the Secretary of State is required.

A LLC is a"...business structure that is a hybrid between a partnership and a corporation" (Definition.com). Its owners are shielded from personal liability and all profits and losses pass directly to the owners without taxation of the entity itself. State laws, which would require a board of directors, officers, and by-laws, do not apply. Furthermore, the owners of a LLC do not lose their limited liability status if they participate in the management of the corporation as they would in a limited partnership.

I will now look at the hypothetical of the businesses and recommend a business entity to best suit the needs of the business. Joe's Lawn Care and Landscape Equipment Rental. Joe is operating a