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Choosing the Right Structure And Entity For Your Small Business

A business entity is an organization or business that has its own legal identity separate from its owners. Ohio recognizes three types of business entities: (1) Corporations, (2) Limited Partnerships, and (3) Limited Liability Companies. Absent the formation of one of these three types of entities, a business will be recognized as a sole proprietorship if the business has a single owner, or a general partnership if the business has multiple owners. Under a sole proprietorship or general partnership, the business owners are personally liable for the debts and actions of their business.

There are four primary reasons for establishing a business entity. First, forming an entity can protect the business owner from liability. Second, forming an entity can, in some circumstances, save the business owner in taxes. Third, forming an entity allows the business owner to structure internal operations, which can limit the opportunity for disputes among co-owners, managers, and even family members. Finally, forming a business entity presents a professional image for a business allowing it to enhance consumer confidence in the business. Which entity is right for any particular business depends on the business owner’s strategies and goals.

I. Corporation

A corporation is a business structure in which ownership of the business is vested in shareholders. Ownership is evidenced by stock in the corporation. Management of a corporation is vested in a board of directors and officers. If formed and managed properly, the liabilities of the corporation are not the liabilities of its individual shareholders, directors, or officers. Corporate law is well established in Ohio with a large body of caselaw, thereby making it an attractive option for some businesses. The most frequently cited downside of forming a corporation is taxation. Ohio recognizes two different types of corporations, each with different tax consequences.

C-Corporation. A C-Corporation pays federal income tax on its earnings. Shareholders also pay federal income tax on distributions that the corporation makes to them. Financial losses of the corporation can offset the tax liability of the corporation but cannot offset the tax liability of its shareholders. This system creates a scenario where the earnings of the corporation are taxed twice. First at the corporate level and again at the shareholder level.

S-Corporation. An S-Corporation is a “flow through entity,” which means corporate income and losses are reported on the shareholders’ personal income tax rather than on that of the corporation. This structure reduces the double taxation that exists for a C-Corporation. Not all businesses are eligible for S-Corporation status and the types of stock issued by an S-Corporation can be limited by law.

II. Partnership

A partnership is an association of two or more people in order to carry on as co-owners of a business. Ohio recognizes four types of partnerships, each with its own tax consequences and varying degrees of protecting partners from the liabilities of the business and other partners.

General Partnership. If co-owners of a business do not take steps to properly form a partnership, their business will be deemed to be a general partnership. Under a general partnership, any partner can bind the business to a contract or debt without authorization from the other partner. Individual partners of a are personally liable for the debts of the partnership regardless of which partner authorized or caused the debt.

Limited Partnership (LP). There are two types of partners under a limited partnership. A general partner has managerial control over the business and the authority to bind the business to contracts or debt. The general partner is liable for the debts of the partnership. A limited partner on the other hand does not have managerial control over the partnership. The limited partner’s liability for the debts of the partnership are limited to the amount of his or her investment in the partnership. There may be multiple general partners or limited partners within a limited partnership.

Limited Liability Partnership (LLP). In a limited liability partnership, all partners have managerial control and the authority to bind the partnership to contracts or debt. However, each individual partner’s liability for the debts of the partnership are limited to the amount of the individual partner’s investment in the partnership.

Limited Liability Limited Partnership (LLLP). A limited liability limited partnership starts out as a limited liability partnership but later files with the Secretary of State to become an LLLP. Under a LLLP, the business has both general partners and limited partners. The general partners have managerial control and can bind the business in contracts and debt. The general partners’ liability for the debts of the business are limited to the amount of their investment. The limited partners do not have managerial control and act more like passive investors rather than actual partners.

III. Limited Liability Company (LLC)

Like a corporation, the owners and managers of a limited liability company are not personally liable for the debts of the business. Unlike a corporation, the LLC structure offers tax benefits by way of pass through taxation in which profits and losses of the business are reported on the owners’ personal income tax. However, an LLC may elect to be treated as a C-Corporation if its owners wish to do so. The LLC structure also allows for greater flexibility in management of the business, which can be in the hands of business owners/LLC members, appointed managers, or appointed directors. The protection and flexibility of the LLC have made it a popular choice among business owners in Ohio, particularly for businesses with just one owner.

Failure to establish one of the above business entities will result in the business being deemed a sole proprietorship or, if there is more than one owner, a general partnership. Under these structures, little to no distinction is made between the business and its owners, thereby providing no protection for the owners. All liabilities of the business, including tax liabilities, will be the liabilities of the owners.

Finally, merely filing the required documentation to form a business entity will not automatically provide business owners with the protections ordinarily afforded by the business entity structure. Rather, business owners must follow established corporate and business formalities and best practices.

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