A partnership is an easy entity to create. In its simplest form (e.g., you and your compadre are 50/50 partners), each partner pays a self-employment tax on his or her share of the partnership’s net profits, and each partner has 100 percent liability – even for acts committed by the other partner. Obviously, you’d have to know and trust your partner.
IRS Defines a Partnership:
A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.
A partnership must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it “passes through” any profits or losses to its partners. Each partner includes his or her share of the partnership’s income or loss on his or her tax return.
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A limited liability company is very flexible. It can be taxed as a sole proprietorship, a partnership, an S corporation or a C corporation. It does not require as much paperwork as an S or C corporation to be kept in good standing with the state corporation authority. A self-employment tax may or may not apply. Liability protection is good, and asset protection is excellent. Make sure to consult an experienced attorney when selecting to be “member-managed” or “manager-managed” and when drafting the operating agreement. These can significantly impact taxes and liability.
IRS Defines a Limited Liability Company
A Limited Liability Company (LLC) is a business structure allowed by state statute. LLCs are popular because, similar to a corporation, owners have limited personal liability for the debts and actions of the LLC. Other features of LLCs are more like a partnership, providing management flexibility and the benefit of pass-through taxation.
Owners of an LLC are called members. Since most states do not restrict ownership, members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit “single member” LLCs, those having only one owner.
A few types of businesses generally cannot be LLCs, such as banks and insurance companies. Check your states requirements and the federal tax regulations for further information. There are special rules for foreign LLCs.
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The Right Wrapper
The “wrapper” you choose for your business should be based on your long-term plans, your vision for the company, and your current personal and financial situation. Unlike the holiday kind, this wrapping will become part of your business. It dictates what you can and cannot do, what you are and are not liable for, and how much tax you pay. Once selected, it can be expensive to change. Other factors can come into play also, such as succession planning, accepting investors and creditor protection. Consult professional advice before choosing. It’s your business. Make the most of it.
Armando G. Roman, president of Phoenix-based Roman & Co. CPAs, is co-author of “Make the Leap: Shift from Corporate Worker to Entrepreneur.” Comments can be sent to email@example.com.