This week’s MasterLesson takes a look at corporate structure. While every entrepreneur should speak with their attorney and accountant before choosing a structure for their start-up, we’ve outlined the basics.

Cor-po-ra-tion (kôr’pə-rā‘shən)
n.

Derived from the Latin “corpus” (body), representing a “body of people,” that is, a group of people authorized to act as an individual.
The different types of corporate/business structures include the following:

• S-corporation
• C Corporation
• LLC
  • LLP
  • SP
  • GP
• Non-profit

Each state has its own laws regarding corporations, but the Internal Revenue Service, for federal tax purposes, recognizes only two types of for-profit corporations: S-corporations and C-corporations. Limited liability companies (LLC) and limited partnerships (LLP) are generally taxed on a flow-through basis, although they may elect to be taxed as S-corporations. Non-profits are tax exempt.

Descriptions:

S-Corporation:

This is a valid entity that elects to be taxed under sub-chapter “S” of the Internal Revenue Code. In general, S-corporations generally do not pay corporate income taxes on its profits. Shareholders in the S-corporation pay income tax on their proportionate shares of the S-corporation’s profits. Of course, the shareholders must report the income and pay related taxes regardless of whether shareholders receive distributions from the S-corporation. An S-corporation can have a maximum of 100 shareholders. It can also issue only a single class of stock, which may make the provision of stock options difficult.

C-Corporation:

Unlike with an S-corporation, C corporations are required to pay income tax on their profits, and they have no limits on the number of shareholders in the company, foreign or domestic. C Corporations can also be subject to the Alternative Minimum Tax (AMT), although no corporation can be subject to the AMT in its first year (regardless of profits). This double-taxation is a negative attribute for C Corporations, but it is somewhat mitigated by the ability to offer stock options (which an S-corporation may not be able to do because of its single stock status). It can also re-classify debt as equity and end-of-year bonuses are one method used to reduce income to zero.

LLC:

Limited Liability Company (not corporation) is a popular corporate structure choice for businesses. As their name suggests, LLCs have limited liability for their members, which means that members are not held responsible for acts and debts of the company. LLCs do not require an annual meeting for shareholders. They don’t incur double-taxation. However, it may be more difficult to raise capital for an LLC, as investors may be more comfortable investing funds in the better-understood corporate form with a view toward an eventual IPO. Many states (including Alabama, California, Kentucky, New Jersey, New York, Pennsylvania, Tennessee, and Texas) levy a franchise tax or capital values tax on LLCs. All income members receive is taxed at ordinary income rates and subject to FICA tax. For tax purposes, the profits and losses are distributed among the members and taxed at the individual level.

LLP:

LLP is a company designation which is legislated exclusively on the state level. Limited liability is different than a General Partnership (see below) because limited liability is extended to all partners and not just a subset of non-managing partners. Therefore, their personal assets can be used to pay off debts incurred by the LLP. In a LLP, all partners have the right to manage the business directly; therefore, organizing your company as an LLP is beneficial when all shareholders want an active role in management.

Sole Proprietorship (SP):

The IRS defines a sole proprietor as someone who owns an unincorporated business by himself or herself. A sole proprietor is completely liable for all acts and debts of the company and does not enjoy the same protections as incorporated LLC and LLP companies. However, if you are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation. A sole proprietor is not a corporation. Instead, the person who organizes him/herself as a sole proprietor must pay income taxes on all wages earned. The lifespan of the business is also uncertain. As soon as the owner decides not to have the business anymore, or the owner dies, the business ceases to exist. A sole proprietor is also responsible for his or her own health insurance, and he may find difficulty finding any if one of the family members to be covered has a previous health issue.

Another disadvantage of a sole proprietorship is that as a business becomes successful, the risks accompanying the business tend to grow. To minimize those risks, a sole proprietor has the option of forming an LLC. Such an LLC would still be treated as a sole proprietorship for income tax accounting purposes.

General Partnership (GP):

This is an arrangement in which two or more individuals or other persons (such as a corporation and an individual) conduct business as “partners,” whether officially or not. General partnerships offer even fewer protections than sole proprietorships. Actions performed by one partner affect all partners, because each one is personally responsible for all obligations of the partnership. Many spouses and partners register joint assets according to the different categories of a general partnership:

1. Tenants in Common: When one partners dies, that partner’s portion of the partnership is transferred to his / her heirs.
2. Joint Tenancy with Rights of Survivorship: When one partner dies, the entire interest goes to the surviving partner.
3. Tenancy in Entirety: Each partner owns whole and part. Therefore if someone wants to sue partner one, they can’t sue partner one on his/her own because partner two is whole owner of the assets as well.

A general partnership is taxed as pass-through, meaning the profits are taxed as income at an individual level rather than at a company level.

Non-profit organization:

501(c)(3) organizations are exempt from income taxes. A non-profit corporation is an organization formed for the purpose of serving a purpose of public or mutual benefit other than the pursuit or accumulation of profits. It is important to know what a nonprofit corporation is not. A nonprofit is not a way for ordinary businesses – or people – to shield assets or avoid paying income tax. It is not an alternative business form for any regular type of business.

Non-profits are recognized and authorized by Congress (as well as state legislatures), which determined that certain types of enterprises should be free from the burden of having to pay income taxes. In giving these corporations tax exempt status, however, Congress imposed specific requirements and limitations on their activities. The IRS tends to strictly enforce these rules. Failure to “play by the rules” can result in the corporation losing its tax-exempt status.

“http://business-law.freeadvice.com/business-law/general_partnerships.htm”

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