by Bob Cooper, SCORE Counselor
Prior to starting a new business it is important to select the proper legal structure.
It is possible to start a business by yourself without creating any separate structure; this type of structure is commonly called a “Sole Proprietorship.” In a Sole Proprietorship, all income and expenses are recognized by you on your income tax return, and the business tax ID number would be your social security number. The Sole Proprietorship is the simplest form of business structure, and works well if the business has little likelihood of incurring liability or costs, if something going awry. The owner is liable for all debts and obligations of the business, and therefore the owner’s property is subject to claims of business creditors.
A husband and wife filing jointly can be a Sole Proprietorship. A name for the business can be adopted by the sole proprietor and an assumed name certificate is filed with the County Clerk’s office.
Every form of business structure, other than the Sole Proprietorship, is formed by making application to the State of Michigan, because every other form of business must receive approval from the State before operating. Also, every other form must receive a tax ID number from the Federal Internal Revenue Service in order to file documents with the IRS.
A second form of business structure is a general “Partnership” which is formed by two or more people who will own and operate the business together. The Partnership is controlled by a formal partnership agreement stating a partner’s contribution, control, management and the sharing of losses and profits. The agreement should also attempt to spell out what happens when a conflict arises, such as death of a partner or disagreement between the partners. A Partnership continues by agreement of the partners, unless it is ended by certain acts, such as the death of a partner, as provided by State law. All partners in a general Partnership are liable and responsible for all obligations of the Partnership. A name for the business can be filed as an assumed name with the County Clerk’s office.
A third form of business structure is a Limited Partnership which simply means that one or more of the partners operate the business while others are strictly investors.
Another form is the “Limited Liability Company,” commonly called an “LLC.” The benefit of the LLC is to limit the liability of the owners. When someone has a claim, the claim must be made against the company and not against the owners, as long as the company is operated correctly. The management of the LLC is defined by a management agreement and filed with the State at the time the LLC documents are filed. An LLC files an information return with the IRS. This return tells the IRS the names of the owners and the percentage amount of the income received by the business upon which each owner must pay the taxes.
A “General Corporation” is another type of business structure. The Corporation is the most widely used but the most complex form of structure from the standpoint of paperwork and administration. However the Corporation allows for easy investment by the use of stock or shares in the company. The Corporation has an identity and existence separate from its owners or shareholders. The Corporation gives the most protection to the owners, or stockholders, from claims, which can only be filed against the Corporation. The corporate structure shields the owners and/or stockholders from liability for wrongful actions of the corporation. The Corporation can have a perpetual existence, unlike the other types of business structure. A Corporation is required to file a tax return separate form the tax returns of the stockholders, and is subject to taxation on its income. The Corporation must request permission from the State to do business under a different name.
In the business structures that provide a shield from liability for the owners, the owners must operate the business separately and distinguish it from themselves, as a separate entity.
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