Considerations When Selecting an Organizational Structure for Your by mmcsx


									FS 323
November 1994

Considerations When Selecting an
Organizational Structure for Your Business
A.M. Morrow

   A business is something you do with         deductibility of employee benefits          business owners, including the sole
the objective of making a profit. You          such as health insurance, group term        proprietor.
may be raising something to sell               life insurance, and retirement plans           The sole proprietorship files a tax
apples, livestock, or Christmas trees;         The desire for the business to              form, either IRS Schedule C or C-EZ,
you may be performing services for             continue after the death of the current     reporting income or losses, but the
someonealtering clothes, trucking              owner                                       income or losses appear on the owner's
cattle, or repairing lawnmowers; or you        The time, effort, and cost of setting       federal income tax return and are taxed
may be manufacturing or making                 up and maintaining the business             as personal income. The owner pays
somethingfence posts or wedding                organization                                Social Security tax on his or her income
gowns. If you have a business, you have        There are four basic forms of busi-         from self employment.
some form of business organizationa         ness organization: the sole proprietor-           While no paper work is necessary to
sole proprietorship, a partnership, a       ship; the partnership, which may be a          establish a sole proprietorship, profes-
corporation, or a limited liability         general or a limited partnership; the          sional help is recommended to assist in
company.                                    corporation, which for tax purposes may        setting up the bookkeeping system,
   When starting a business, or when        be a "C" or an "S" corporation; and the        employee payroll systems, etc.
changing from one organizational            limited liability company.
structure to another, business owners
should know the relative advantages and
                                            Sole proprietorship                                A partnership is the voluntary
disadvantages of each business structure        A common form of business owner-           association of two or more people for
and how the structure they select will      ship is the sole proprietorship. It is the     the purpose of making a profit. Each
help them meet business, personal, and      least complicated form of business             person contributes money, property,
family goals. The best structure for one    ownership and is the easiest to set up and     labor, or skills, and each expects to
business may not be the best for another.   to terminate. The business is owned and        share in the profits and losses.
The best structure for a new business       controlled by one person; the owner is             A partnership is the same as a sole
may not be suitable as the business         the business. The funds for the business       proprietorship with respect to taxes and
expands.                                    come from the owner's personal                 liability. Each general partner has
    A business may be owned by one          investments, loans, and sometimes from         unlimited personal liability for all debts
person or more than one person. Before      friends or family members.                     and obligations of the partnership and
going into business with someone else,          All of the owner's personal assets         acts of the partners. A partnership is not
take a good hard look at both the           can be made available to satisfy debts         a taxable entity. However, it must figure
business and the potential business         and taxes owed by the business or any          its total income and file IRS Form 1065,
owners. Can the people work together?       legal damages resulting from lawsuits          which provides information on partner-
Is the business financially strong enough   filed against the business. This means         ship income or losses for the year. Each
to support two or more families? And if     the owner's personal assetscar, home,          of the partners must report on his or her
the people are in business together, what   bank accountsare subject to claims by          individual tax return his or her share of
form of business organization is most       creditors for satisfaction of business         the partnership incomegains, losses,
appropriate?                                loans, contracts, and legal judgments.         deductions, or creditseven if the
   Some issues to consider in choosing a    Often, the business is a sole proprietor-      partnership income is reinvested in the
form of business organization are:          ship, but assets used in the business          business rather than distributed to the
   The source of funds needed for the       land, vehicles, equipmentare owned             partners.
   business                                 jointly by husband and wife. Therefore,
   Liability for personal injury, product   even though the business is owned by
   liability, contracts, and taxes          one, the assets of both may be subject to      Alice Mills Morrow, Extension family
   Taxation issues including the tax        business liabilities. Liability insurance      economics specialist, Oregon State
   treatment of profits/losses and the      for business activities is important for all   University.

    A partnership is formed with an oral
or written agreement. A written agree-                                 The four basic forms of business organization
ment, prepared with advice from an
attorney, is recommended. Following                Sole                        Partnership             Corporation             Limited Liability
are some of the items that should be               Proprietorship                                                              Company (LLC)
covered in the partnership agreement:
   Names and addresses of the partners
    and the name of the partnership                                            General                 "C"
   Purpose of the partnership                                                  Partnership             Corporation
   Duration of the agreement and
   method of review and termination of                                         Limited
   the agreement                                                               Partnership            Corporation
   Who is contributing what resources
   (cash, personal property, real estate,
   labor, and services) and how they
   will be contributed (outright to           directors and incorporators, location of               is not a separate taxable entity; income
   partnership, on a use only basis,          the main office, duration of the corpora-              is allocated to the shareholders and is
   or rental)                                 tion, amount and kinds of capital stock                taxed at their personal rates.
   How profits will be calculated             issues at the outset, and description of
                                              the voting rights of shareholders. The                 Limited liability company
   and shared
                                               articles of incorporation should be                       A limited liability company (LLC) is
   How decisions are to be made
                                              prepared with legal counsel.                           a new form of business organization
   Limitations on the activities of                                                                  available in some states, including
   the partners                                   Once formed, a corporation must have
                                              annual business meetings; keep minutes                 Oregon, Idaho, and Washington. When
   How partnership assets are divided                                                                properly formed and maintained, the
   when the partnership is terminated         and records of its activities; specify
                                              policies concerning salaries and fees,                 LLC has the limited liability features of
   There are two kinds of partnerships
                                              dividends, etc.; and file tax and other                the corporation and the tax features of
general and limited. In a general
                                              required reports. It is extremely impor-               the partnership.
partnership, two or more people
                                              tant to get legal and accounting advice.                   The owners of the LLC are called
contribute assets to the partnership and
                                                  The primary advantage of the                       members, and the LLC must have at
these general partners share the manage-
                                              corporation is its "limited liability." The            least two members. The organizer(s) of
ment, profits, and losses. The general                                                               the LLC file the articles of organization
partners are personally liable for all        corporation is fully liable for all its
                                              business obligations; individual share-                with the secretary of state. Because this
partnership debts and liabilities and acts                                                           is a new form of business organization,
of any of the partners.                       holders are liable only to the extent of
                                              their investment. In practice, however,                and because there are differences from
   A limited partnership must have at
                                              owners of small, closely held corpora-                 state to state, extreme care is needed in
least one general partner and one or                                                                 drafting the documents for the LLC.
more limited partners. The limited            tions often are required to personally
                                              guarantee the debts of their corporation.              Creating an LLC is not a do-it-yourself
partnership is a way for the general                                                                 job; legal help is essential.
partner(s) to get additional capital          The corporation does offer shareholders
                                              some protection from liability claims.                     Any business, regardless of its
without giving up management control.                                                                structure, needs its own separate bank
General partners manage the business          However, it is not a substitute for a
                                              formal comprehensive business and                      accounts and bookkeeping system. Any
and have unlimited liability for the debts                                                           business owner, regardless of the
of the business and acts of the partners.     personal liability insurance program.
                                                  For tax purposes, a corporation must               business structure, needs a comprehen-
Limited partners take no active role in                                                              sive business and personal liability
the management of the business, and           choose whether it is a "C" corporation or
                                              an "S" corporation. A "C" corporation                  insurance program. Work closely with
their liability is limited to the extent of                                                          your accountant, attorney, and manage-
their partnership investment.                 pays taxes on its income. When income
                                              is passed on to the shareholders in the                ment and insurance consultants on
Corporation                                   form of dividends, it is taxable income to             specific issues related to your particular
   A corporation has a legal and tax          the shareholders. This double taxation is              situation.
identity separate from its owners. The        a disadvantage.                                            Your choice of business organization
owners are called shareholders. A                 A special form of the corporation,                 depends in part on the characteristics of
corporation is chartered by the state, and    called the tax-option or Subchapter S                  each type of business organization and
articles of incorporation must be filed       corporation, can be used for tax purposes              on your situation, preferences, and
with the secretary of state. The articles     (chiefly for corporations with 35 or                   objectives. Do not make a decision
of incorporation include such things as       fewer shareholders). The "S" corporation               without careful study.
the name of the corporation, purpose of
the corporation, names and addresses of       Extension Service, Oregon State University, Corvallis, O.E. Smith, director. This publication was
                                              produced and distributed in furtherance of the Acts of Congress of May 8 and June 30, 1914. Extension
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                                              Oregon counties.
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