We continue our tour of entities with the limited liability company (LLC).

The LLC  is still considered a relatively new business structure, although it’s been around for more than 30 years. The LLC, like a corporation, is a separate legal entity from its owners.  It is formed by filing articles of organization with the Secretary of State.  An operating agreement is recommended, but not required.  So long as it is properly formed, properly capitalized and properly maintained, it should limit the owner’s personal liability for debts and actions of the LLC to the amount invested in the company. LLCs are owned by members and can be managed either by the members or managers.  Neither members nor managers must live in North Carolina. It is

LLCs are desirable because they are flexible as to management participation and allocation of profits and losses, yet they provide limited liability. It is also possible to make an S-election for an LLC so that it is taxed the same way as an S-corporation. This is valuable when the owner wants to treat some profits as dividends to minimize income tax.  LLCs and S-corporations (which we will discuss in detail in another post) are similar in that they both pass-through income directly to the owners, but they have vastly different rules on deductions, salary and self-employment taxes. 

LLCs do require an annual report to be filed with the Secretary of State. 

LLCs are classified as either single-member or multiple-member, and the designation has a big impact on how taxes are reported. Single-member LLCs owned by an individual report all income and expenses on a schedule to Form 1040. Multiple-member LLCs report all income and expenses on a partnership tax return Form 1065.  LLCs are responsible for all employment-related taxes and must issue W-2s and 1099s as required. Members of the LLC are subject to self-employment taxes on all earnings or shares of the profits.

Our last blog post looked at sole proprietorships.  Today we’ll examine general partnerships.
General partnerships are formed by default without any formalities when two or more individuals agree to conduct business jointly for a profit. Each partner is personally liable to business creditors, no matter which partner entered into the debt.  Each partner can have designated responsibilities and designated financial liability, depending on how the partnership is structured.

Although no formalities are required to form a partnership, we highly recommend a written partnership agreement.   As with the sole proprietorship, a partnership should use adequate insurance to mitigate personal risks. 

From a tax perspective, a partnership is not a separate tax entity. Partnerships file an annual informational return (reporting all income, deductions, gains and losses) on behalf of the business; but all profits and losses are passed through directly to the partners and are reported on their respective tax returns.  Partners are not employees of the company and must be supplied with a K-1 by the company each year.

A Taxing Consideration:  Choosing a Business Structure (Sole Proprietorship)

When people are starting a business, they are often very confused and overwhelmed as to how to choose an entity, or even whether they need one.  Many entrepreneurs look at limiting their legal liability but never consider the tax implications of their business entity.  The only entities which provide limited liability to owners (with respect to both tort and contract liability) are S corporations, C corporations, and limited liability companies. Before selecting the entity, it is essential to review the tax implications as well as the legal ones.

In a series of blog posts, I will discuss the various available entities (sole proprietorship, partnership, limited liability company, C-corporation and S-corporation) and some tax issues associated with each.

Sole Proprietorship:
Many entrepreneurs start their businesses as sole proprietorships, where the owner and the business are one and the same (sometimes known as “hanging out a shingle”). This is certainly the simplest way to begin.  There are no formalities required.  But, if the business is sued or has a hefty tax debt, you are financially responsible. Many risks of having a sole proprietorship can be addressed with insurance. 

From a tax perspective, the business profits are reported on the owner’s personal income tax filings under his/her Social Security number, and the income will be taxed at the owner’s standard personal income rate. The owner must file form 1040, and 1040 ES Declaration of Estimated Tax For Individuals. The owner is responsible for paying self-employment taxes. There are many deductions available as well. 

Once you hire employees, you should consider forming a limited liability entity to protect yourself from the acts of the employee.