Options for Your Business Organization
You have decided to start a business or are operating a business but are not satisfied with the entity under which you are operating. After deciding what product you want to sell or what service you wish to offer, perhaps the most important decision you must make early on in the process is the entity under which you will operate. The choice you make will affect your ability to protect your non-business assets, the amount of taxes you will pay (or your ability to write off any losses in the business against other income), whether you can attract other “partners” or secure financing for your venture, whether you can provide employees with fringe benefits and their extent, and the manner in which you will be required to comply with myriad state and Federal laws in any number of areas.
There are a number of business organizations or entities available to you, each having advantages and disadvantages.
You may choose to operate as a sole proprietorship. This has the advantage of simplicity. Everything is in your name. You report any net income or loss on your own tax return. You are personally liable in the event of a loss or judgment against the business. The fringe benefits you can provide yourself are limited to the benefits allowed for self-employed individuals under the Tax Code. Notwithstanding the simplicity of a sole proprietorship, you will still need assistance in establishing your business in areas such as negotiating leases and other agreements in order to properly operate your business, securing financing, and creating a business plan. You will need to determine the extent to which various state and Federal laws apply to your business and what you must do to comply with the laws that do apply.
You may be starting your business with another individual or individuals and are considering a partnership. A partnership is a joint venture between or among two or more competent persons or entities who place their money, effects, labor and skill, or some or all of them, in lawful commerce or business, with the understanding that there shall be a proportional sharing of the profits and losses between them. Like a sole proprietorship, a partner is personally liable in the event of a loss or judgment against the business. Profits, losses and deductions are passed through to the individual partner’s tax returns. Generally, fringe benefits available to a partner under the Tax Code are similar to those available to sole proprietors. Although there is no requirement that a partnership agreement be in writing, the interests of the business as well as all of the partners strongly suggests the need for a written partnership agreement clearly setting forth the objectives of the business, and the interests of each of the partners and their responsibilities. A properly drafted partnership agreement will help to avoid any misunderstandings in the future regarding the partners’ rights and responsibilities and the objectives of the business.
Another entity under which you may do business in Rhode Island is a limited partnership. A limited partnership has both general partners, who may be personally liable in the event of a loss or judgment in the business and are active in the management of the business, and limited partners, who are generally not liable for business losses and who are not active in the operation of the business. Income, losses and deductions are generally passed through to the partners’ tax returns. Fringe benefits, for tax purposes, are generally similar to benefits available to sole proprietorships and general partnerships. A Certificate of Limited Partnership must be filed with the Rhode Island Secretary of State and a detailed partnership agreement is a necessity.
A corporation is a popular entity to use to start a new business. Corporations enjoy limited liability, meaning that judgments against the corporation do not affect other assets of the “shareholders”. For tax purposes, a corporation can be either a “C corp” or an “S corp”. Losses and deductions of C corps do not pass through to the shareholders’ tax returns. The losses and deductions of S corps, on the other hand, do pass through as the S corp is treated for tax purposes similar to a partnership. Available fringe benefits vary. Articles of Incorporation must be filed with the Secretary of State and By-Laws must be created. There must be minutes of meetings of shareholders or directors for every significant corporate event or decision.
In 1992, Rhode Island passed legislation authorizing creation of limited liability companies. A hybrid that attempts to secure the benefits of corporations and partnerships, a limited liability company, as its name implies, limits the liability of the members for the obligations of the business. It can be taxed as a partnership or a corporation or it can be disregarded as a separate entity for tax purposes if it is a one member limited liability company, depending on the decision of its members. Fringe benefits may be affected depending on the choices its members make. Articles of Organization must be filed with the Secretary of State and an Operating Agreement must be created. Like a corporation, minutes of meetings of the management committee or of the members must be drafted for every significant business decision.
The complexity of the decision as to what type of entity you will choose in order to do business should not be left to chance and requires professional assistance. You should do business in an organization that best meets your goals and objectives. Whatever type of business organization you select will require ongoing assistance to assure adequate record keeping and compliance with various state and Federal laws. We are available to assist you in this decision-making process and to help you in implementing your decision.