Choosing a Business Structure
Choosing the right legal structure for your business is essential in order to minimize liability and to maximize tax benefits. Following is a brief explanation of some of the business types available in Colorado.
Sole Proprietorships and General Partnerships
In a sole proprietorship or a general partnership, there is no legal distinction between the owner and the business. All proceeds that the business earns go to the owner, who is responsible for any and all debts and other legal liabilities of the business. General partnerships are created automatically whenever two or more persons carry on a business activity for a profit. No written agreement is required. From a legal perspective, it is rarely beneficial to operate a business as a sole proprietorship or a general partnership.
A corporation provides maximum liability protection for its owners, the shareholders, but is subject to a separate income tax not applicable to other entities such as S-corporations or LLCs. It may or may not be the best choice for small business owners due to its complexity and formal reporting requirements. However, corporations are often the best choice when it comes to maximizing tax advantages.
An S-corporation combines the liability protection of corporation with the flow-through taxation of an LLC. That is, the shareholders of the S-Corporation are allocated a pro rata share of the corporation’s net income and report that income on their individual tax returns. S-Corporation owners (shareholders) can limit, to an extent, the amount of self-employment tax they pay, unlike members of an LLC. An S-corporation may have up to 100 shareholders, none of which may be entities, unless the entity is another S-corporation, an estate, or a non-profit organization. Certain trusts also may be shareholders in an S-corporation.
Limited Liability Company (LLC)
A Limited Liability Company, like a corporation, provides protection from personal liability to its owner or owners, called members. LLC involve members instead of shareholders and managers instead of a board of directors. The members can choose to vest management in either the managers or the members. Like a partnership or S-Corporation, an LLC is a pass-through entity for federal income tax purposes. However, LLC members are generally advised to claim their entire share of the LLC’s profits as income, unlike shareholders in an S-Corporation, who can limit, to a degree, the amount of self-employment tax they pay.
There are several other business structure options available in the state of Colorado, including limited partnerships, limited liability partnerships or registered limited liability limited partnerships, and limited partnership associations. Contact the Thode Law Firm today to determine which structure is best for your business.