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 Partnership 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. OREGON STATE UNIVERSITY EXTENSION SERVICE 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 work is a cooperative program of Oregon State University, the U.S. Department of Agriculture, and Oregon counties. Oregon State University Extension Service offers educational programs, activities, and materials without regard to race, color, national origin, sex, age, or disabilityas required by Title VI of the Civil Rights Act of 1964, Title IX of the Education Amendments of 1972, and Section 504 of the Rehabilitation Act of 1973. Oregon State University Extension Service is an Equal Opportunity Employer.