The type of business that you are in will guide your choice of legal entity. If you are a solo Freelance consultant, then operating as a Sole Proprietor is most likely appropriate. However, if your business exposes you to liability, then it is highly recommended that you spend a few dollars and protect your assets by establishing a separate legal entity. Many business entities evolve as they grow, transforming from Sole Proprietorship to Limited Liability Company to Corporation.
LIMITED LIABILITY COMPANY
The LLC is a relatively new option. It creates a separate legal entity and may be used by a solo entrepreneur or a multi-owner business. It is required that an EIN be obtained for the business and a certificate of organization be filed with the Secretary of State, along with a fee of about $500 paid annually.
There is no limit on the number of owner–partners in an LLC. A certain degree of protection from liability is granted, as in an S Corporation. It is highly recommended (but not required) that in a multi-owner LLC an operating agreement be written that names a managing partner and other specific partner roles and responsibilities.
Single owner LLC tax filing is similar to the Sole Proprietorship. On April 15 you file schedules C and SE and form 8829 if claiming a portion of your home as an office. Quarterly estimated taxes are due on the 15th of January, June and September reported on form 1040–ES.
Additionally, an LLC with 2+ members must file form 1065, the informational Annual Return of Income. Owner–partners file form 1040 with schedules E and SE, plus estimated quarterly taxes on form 1040–ES.
Be advised that an LLC is dissolved in a bankruptcy or upon the death of a partner. Include contingency plans in the partner’s agreement so you don’t find yourself in business with the spouse or children of the deceased, for example.
A partnership is a non-corporate legal business entity that is formed by 2+ people (or entities) who desire to do business as co-owners. GPs can be formed by individuals, corporations, estates or trusts. This classification also includes joint ventures and syndicates.
A GP is not a separate legal entity, so there is no requirement to register the partnership with the state. Partners will be on the hook for any business liabilities, including unauthorized actions by partners who acted on behalf of partnership business interests.
Absolutely, write a partnership agreement. Include the purpose, goals, partner contributions and responsibilities. Management duties, decision making power, permissible and restricted business activities outside of the partnership and financial matters such as access to financial records and expense authorization should also be specified.
Moreover, spell out how profits and losses will be distributed, the penalties for failing to fulfill responsibilities and contributions and the procedures to follow should a partner die.
Partners are taxed on the income/losses of the partnership on schedule C, filed with their personal 1040, along with form 1040–SE self employment tax. The partnership as an entity must file form 1065 Annual Return of Income on April 15. Quarterly estimated taxes are due on the 15th of January, June and September.
This format is similar to the GP, with the exception that a partner(s) agrees to contribute resources to the business entity without becoming involved in its day to day affairs. These are “silent partners”, often investors.
LPs have a share of ownership but neither operate nor manage the business or act officially on its behalf. They have a liability to the business and its creditors that is proportional to what they have invested. LPs and GPs receive a share of business profits/losses based on percent of ownership. Again, it is recommended that an agreement for LPs be written.
As with GP, form 1040 with schedule C and form 1040–SE will be filed on April 15 and quarterly taxes reported on 1040–ES and filed on the 15th of January, June and September.
More next week and thanks for reading!