In March, we took a little diversion from our discussion of establishing a business. Now that we have seen the final economic stimulus package from Congress, it’s time to get back to focusing on that subject.
You will be faced with many crucial decisions as you set things up, or even purchase an operating business, but none is more critical than establishing the right advisory team. Your team should include people who complement your own skills and can get things done, allowing you to concentrate on building your business.
Typical advisors might include:
One critical choice you will face is the form in which you will do business. The main structures available for that are discussed in the following paragraphs.
The simplest form is the sole proprietorship, a business model in which the business in an extension of you. That means you have unlimited liability for your business activities and anything that happens in connection with them. If, for example, you have a store and a customer slips and breaks a leg, he or she can sue you and get not only your business assets, but also your personal ones. The income from a sole proprietorship is taxed only once on your Federal Form 1040. This type of business is appropriate only if you are in a professional setting with no employees.
Close to a sole proprietorship is a single owner limited liability company (LLC). The business is a separate legal entity and insulates you from some liability. While none of the entities available will prevent you from being personally liable for any acts you perform directly, a single owner LLC will shield you from liability for acts of your employees (and slip and fall ones). Tax on the income of a single-owner limited liability company is treated and reported the same as a sole proprietorship. One business where this is very useful is real estate. If you own real estate, as well as a business, you should put the business operations in one LLC and the real estate in another. If you own multiple properties, you should put those properties in separate LLCs. Doing so will protect your other properties if a claim arises against one of them.
LLCs can also have multiple owners. If you are in business with someone else, LLCs provide the protections we have already discussed, but they also protect your assets if your business partner is sued. For example, let’s say your business partner was Bernie Madoff and you truly had no idea of what he was doing. While any assets of the LLC you set up with him would be forfeited, creditors and victims would not be allowed to get to your personal assets like they could with Bernie’s. LLCs with multiple partners must file a Partnership Return of Income. Partners then report their share of income or loss on their personal returns.
Other possible forms of business that provide a single layer of taxation include general partnerships, limited partnerships and limited liability partnerships. General partnerships typically offer no significant liability shield to partners. Limited partnerships provide significant protection to the non-operating or limited partners, but not the partner who is designated as the ‘general partner’ (and every limited partnership requires at least one general partner). They provide much the same protection as limited liability companies, except partners are generally liable for normal operating activities. That protection is from general liability claims and claims resulting from the actions of their partners and employees.
This brings us to the entity that provides the greatest protection for owners. A corporation is considered ‘a person’ for legal and income tax purposes. Basically, the owners buy stock in the company. It then reports its income or loss separately of the owners and pays its own taxes. Except for any liability resulting from their personal acts, owners, officers and directors are protected from company liabilities. Accordingly, personal assets are typically protected. The drawback to this form of business is that it carries with it double taxation. First, the entity is taxed on its income. Then, if it pays dividends to the stockholders, the stockholders pay another tax on the dividends.
To get around the double taxation in a corporation, Congress has allowed certain corporations to elect treatment as ‘S corporations’. Subject to some limits, a corporation can essentially move to a single layer of taxation by electing such a status. The income is then reported on the stockholders’ tax return, much like a partner would report partnership income. Rules for S corporations are fairly complicated, though.
Hopefully, you have gotten the idea that setting up a business can be a complex task. If you are faced with so many choices just in the form of business you will use, think of the other choices you face as you navigate the start-up process. This is the reason you need a strong team of advisors. The best place to start is with your friends and business associates - ask them and other business people for referrals. Chances are, they know someone or have friends who can give you good direction. You can also go to the State Society of Certified Public Accountants, State Bar Association and Insurance Department in your state to look for reputable advisors. Once you have developed a reasonable list of possible advisors, give them a call. Interview them much like you would a potential employee. Even though they won’t technically be employees, they will work for you. Be certain that you can work with the people you ultimately choose and that you are comfortable with their personality and qualifications. Above all, make sure they will follow every legal avenue in their service to you. Any professional who even hints at skirting the law should be avoided.
Setting up your new business will test your resolve. Not only must you go through the work of acquiring licenses, setting up accounts and a myriad of other tasks, you will also need to select a good team to advise you. Establishing that team will make it less stressful for you to perform start up tasks and can help you avoid costly mistakes. Let us know if you are in need of a good accountant. We can certainly help you in that area, and perhaps in others as well.
Have a great April.