Business law is the body of law that applies to the rights, relations, and conduct of persons and businesses engaged in commerce, merchandising, trade, and sales.
How a business is structured impacts taxation, ability to raise capital, personal liability in case of a judgment against the company, and continuity in the case of an owner's death. Deciding on an appropriate company structure is important to the long-term operation and growth of the company.
Many entrepreneurs establish their businesses as sole proprietorships. Essentially, the person and the business are synonymous, and there is no legal distinction between the two. A fine example is a tax preparer who handles his/her clients’ filings with the IRS.
Advantages include having complete control over all the aspects of the business. Meanwhile, among the disadvantages are that raising capital may be difficult and that the business enterprise may be terminated if the owner becomes ill. Since the business is the same legal entity as the proprietor, it ceases to exist upon the proprietor's death. Because the enterprise rests exclusively on one person, it often has difficulty raising long-term capital.
Management of a limited partnership rests with the general partner, who also bears unlimited liability for the company's debt and obligations. A limited partnership allows for any number of "limited partners," whose liability is limited to the total amount of their investment in the company.
Limited partners are sometimes referred to as silent partners - in other words, they can make investments in the company but have no voting power or control over its day-to-day operations. They can be a valuable source of capital in this business structure. Other advantages of a limited partnership include:
Limited Liability Company
Forming a limited liability company (“LLC”) is a good way to protect your personal assets from your company's liabilities. This business format offers protection of your personal property in the event of a judgment against your company. Additionally, setting up an LLC provides an advantage in that the business itself is not responsible for taxes on its profits, as is the case with a corporation (“C-Corp”).
Instead, an LLC's owner reports profit and loss on his/her personal tax returns, similar to the tax reporting for a sole proprietorship or general partnership. This is known as pass-through taxation. Owners report their share of profit and loss on their individual tax returns.
A less monetarily tangible function of the LLC is that it provides enhanced credibility to prospective partners, customers, suppliers and lenders who might look more favorably on your business when you have formed an LLC.
An S-Corporation ("S-Corp") is quite similar to an LLC in that it offers a federal tax status that enables companies to pass through their taxable income or losses to owners/investors in the business, according to their ownership stake in the business.
By electing S-Corporation status, a company can eliminate the disadvantage of double taxation of corporate income and shareholder dividends associated with the C-Corporation tax status. Let us say a corporation makes $300,000.00 in a given year -- if it is an S-Corporation, the business itself will not be taxed for that amount. Instead, company shareholders would be required to pay taxes according to their percentage of ownership of the business. In this scenario, if the company has three shareholders, each with an equal share of company stock, each shareholder will pay taxes on $100,000.00.
If the C-Corporation makes $300,000.00 in a year, then the company would pay taxes at the current federal corporate tax rate of about 34%. If the remaining profits of $198,000.00 are distributed to the three shareholders as dividends, each shareholder will pay taxes on $66,000.00 in dividend income at the current federal dividend tax rate of 15%.
In short, the S-Corporation status offers the following advantages:
The most common type of corporation in the U.S. is the C-Corporation ("C-Corp"). By forming a C-Corp, business owners create a separate legal structure that shields personal assets from judgments against the company. The structure of a C-Corp includes shareholders, directors, and officers.
The additional advantages of a C-Corporation are:
Drawbacks of the C-Corporation structure are that profits are taxed when earned and taxed again when distributed as shareholders' dividends. This is what is known as double taxation. Shareholders in a C-Corporation also cannot deduct any corporate losses. (To avoid these concerns, many small business owners choose to form an S-Corporation instead.)
If your organization is involved primarily in educational, scientific, religious, or charitable endeavors, you will likely want to form a nonprofit corporation for the liability protections and tax advantages this status provides.
Incorporating a nonprofit will establish legal protections that can keep you and your directors’ personal assets separate from the company’s liabilities. There are other benefits to forming a nonprofit, as well.
In general, nonprofit corporations enjoy the following advantages:
While nonprofits are bound by different state laws than for-profit enterprises, generally their formation processes are quite similar. Like a regular corporation, nonprofits must file Articles of Incorporation with the state in which they wish to incorporate. Additionally, the IRS requires organizations seeking tax-exempt status to file Form 1023. Several states also require organizations to file for state-level tax-exemption. The nonprofit status most commonly sought by organizations is the IRS’s 501(c)(3) tax-exempt status. The advantages of being a 501(c)(3) company are:
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