Forming a Business in Wake Forest
There are many ways to form a business in Wake Forest, North Carolina, but it isn’t always easy to know which structure is the right one for you. Whether it is a small or larger business, the business owner should consider the advantages and disadvantages of each type of incorporating, creating a Limited Liability Company (LLC), or using another type of business entity. Each of these structures offers a variety of tax advantages, liability protection, and flexibility of management. Most importantly, the type of business entity you establish provides protection for you as the owner.
The Doyle Law Offices, P.A. has been practicing business law in Wake Forest, Cary, Raleigh, and throughout Wake County since 1995. We can help with business entity selection and formation as well as maintenance of corporate formalities and other needs.
Most Common Business Legal Structures for a Business
In deciding the legal structure that is best for your business, you should seek guidance from a professional business formation attorney. First, you need to learn what the different structures are. Then, depending on your situation, you will determine that one or more may be appropriate for your current and long-term goals.
There are four (4) types of legal structures for businesses:
- Sole Proprietorship
- General Partnership
- Limited Liability Company
- Corporations (C-Corp and S-Corp)
A Sole Proprietorship is a business entity that is owned by one individual. There is no legal distinction between the owner and the business with a Sole Proprietorship. This is the most common form of legal structure for small businesses. The costs to create a Sole Proprietorship are very low and little formality is required.
A Sole Proprietorship has pass-through taxation which means that the income (or loss) passes through and is reported on the owner’s personal tax return. The business itself does not file a tax return.
With a Sole Proprietorship, the owner has unlimited liability for any liabilities the business incurs. You can mitigate the risk using insurance and air-tight contracts.
- Easy and inexpensive to establish
- Owner has absolute control over the business
- Owner has unlimited personal exposure to risk
- Investors typically would not invest in a business organized as a sole proprietorship
A General Partnership is an association between two or more people in business to seek a profit. A partnership doesn’t need a great deal of formality, but it does need a Partnership Agreement to be created. A Partnership Agreement stipulates the terms of the partnership by formalizing rules for sharing profits and losses, the percentage each owner has in the business, terms for dissolving the partnership, and management rights.
A Partnership Agreement is best created by an experienced business attorney like Hank Doyle to make sure topics such as capital contributions, management responsibilities, distributions of profits/losses, banking, and dissolution are covered.
A General Partnership must report taxes on an annual information return (Form 1065) with the IRS to report income and losses from operations, but it doesn’t pay taxes. The profits and losses are passed through to the owners based on their profit sharing percentages that are outlined in the Partnership Agreement, and the owners pay the taxes.
Each partner is jointly liable for the partnership’s obligations with unlimited personal liability.
- Fairly easy to create and maintain
- Profits and losses are passed through to the owner’s personal tax returns
- Partners are personally liable for business debt and liabilities
- Can lead to management and oversight issues when there is no Partnership Agreement
Limited Liability Company (LLC)
An LLC is a combination of a corporation, general partnership, and sole proprietorship. The owners of an LLC are called “members.” A member can be individuals, corporations, other LLCs, and foreign entities. Additionally, most states permit an LLC with only one member, called a “single member LLC.” To form an LLC, you must pay a filing fee and must have Articles of Organization at the time the entity is established.
Having an operating agreement is highly recommended and considered a good business practice, but not required in North Carolina. An operating agreement sets out rules for ownership and operation of business much like a partnership agreement. A standard operating agreement includes:
- Ownership interest for each member
- Member rights and responsibilities
- Member voting power
- Profit/loss allocation
- Management structure
- Buy-sell provision
An LLC is a “pass through entity” for tax purposes; business income passes through the business to LLC members who report their share of profits or losses on their individual income tax returns. The LLC only files an informational tax return. Single member LLCs are allowed to report business expenses on Form 1040 Schedule C, E, or F. LLCs with more than one member file a partnership return Form 1065.
LLC members are protected from personal liability for business debts and claims, thus known as “limited liability.” With an LLC, if the business owes money or faces a lawsuit, only the assets of the business itself are at risk. Creditors can’t reach the personal assets of LLC members unless it is a case involving fraud or illegality.
- Owners have limited liability in that the business entity is responsible for all liabilities the company incurs
- Profits and losses for the company are passed on to the member(s) and are only taxed at the individual level
- Allows an unlimited number of members
- An LLC can be subject to taxes at the state level
- Each member’s share of profit represents taxable income even if the profit wasn’t distributed
Corporations (C-Corp and S-Corp)
Corporations are the most complex business structures. A corporation is a legal entity that is separate and independent from the people who own or run the corporation, namely shareholders. A corporation has the ability to enter into contracts separate from that of the shareholders. It also has the responsibility of paying taxes. Corporations are more appropriate for larger established companies with multiple employees and possibilities for sizable liabilities due to the nature of the business. Ownership is designated by issuing shares of stock.
Corporations are more complex entities to create, and they have more legal and accounting requirements. They are more complex to operate than sole proprietorships, partnerships, or LLCs. One of the major disadvantages of a corporation is the high level of governance and oversight by the board of directors, which can prolong the decision-making process when multiple shareholders or investors are involved.
There are two (2) types of corporations, C-Corps and S-Corps. The main difference between the 2 is the tax treatment.
Taxation of a C-Corp:
A C-Corp is recognized as a separate taxpaying entity, filing its own return (Form 1120). It is subject to corporate income tax on any corporate profits. Shareholders pay personal income tax on the corporate profits distributed by the corporation to the owners. Therefore, a C-Corp pays “double taxation.”
Taxation of an S-Corp:
An S-Corp elects to pass corporate income, losses, deductions, and credit through to its shareholders for federal tax purposes. However, the S-Corp entity is required to report income, losses, gains, deductions, credit, etc. on Form 1120S. Shareholders of an S-Corp report the corporation’s income and losses on their personal tax returns and pay federal income tax at their individual rates, avoiding “double taxation.”
Corporation shareholders have limited liability as they are not personally liable for debts and obligations incurred by the company. They cannot lose more money than the amount they invested in the corporation.