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Choosing the Right Corporation
Examine Options Carefully for Organizing Your Business
Like most owners of growing firms, you might wonder about the best way to protect your assets and conduct your daily activities. For some businesses, forming a corporation is the best solution. Others benefit most from the creation of a Limited Liability Partnership.Like most owners of growing firms, you might wonder about the best way to protect your assets and conduct your daily activities. For some businesses, forming a corporation is the best solution. Others benefit most from the creation of a Limited Liability Partnership.
Suppose you are the sole proprietor of a retail firm, and a customer falls and gets hurt in your store. Your assets, such as your home, could be used to satisfy business litigation awards. When you have a general partnership (two or more people conduct a business), partners are not only liable for themselves but also the actions of other partners. Insurance policies can protect you up to a certain point, but you might still be open to risks without a formal way to conduct business. Below are a few different routes to protect yourself against personal liability.
LP/LLP | Corp and S- Corp | LLC | |
Liability Protection | To limited partners only | Yes | Yes |
Created at the state level | Yes | Yes, with S-Corp requiring IRS approval | Yes |
Tax status, IRS | Partnership | Corporation taxes, except for S-Corp | Flexible. It could be taxed as a corporation or sole proprietor, or partnership. |
Advantages | Can complement an existing general partnership | Recognized way to conduct business Possibility of endless life to the firm. | Simple to setup and maintain Flexible options for taxation No annual meetings or keeping minutes |
Disadvantages | Unlimited liability of general partners Death of partners dissolves the LLP | Complex to set up and maintain Except for S-Corp, double taxation | A relatively new form of business that may not be fully understood by banks and investors Possibility of being dissolved upon death of a member |
Limited Liability Partnership (LP or LLP)
This entity type is a more formal way of doing business than a general partnership. Limited partnerships include both public and limited partners. Limited partners are usually investors with not much say in the industry. An LLP can be formed after a general partnership has been set up and works well. For example, a father and son own a business using an informal available partnership setup. However, now they need funds to improve and open a new branch. While other family members and friends might be willing to help, they’re not interested in the risks involved – so they choose to be limited partners.
The LLP is not a separate entity as far as taxes are concerned. This means the LLP doesn’t pay individual income taxes, and profits/losses flow directly into the partner’s tax returns. Note that an LLP is required to file an annual information return using Form 1065 and K-1s to all partners.
The rules about opening an LLP and documentation vary by state. Check out with the Secretary of State or another department for registration and compliance requirements. In California, the LLP structure is used primarily by certain professional services, and firms must pay an annual fee of $800.
One of the main advantages of an LLP is that it’s easy to attract investors, who might become silent partners without dissolving the original general partnership. On the other hand, the chief disadvantage of this type of structure is that you still have general partners who have liability over the business. The death of any partner dissolves the partnership.
Corporation
A corporation is a separate entity created at the state level. A corporation has rights and liabilities distinct from the owners, shielding them from personal liability for business activities – a significant advantage of a corporation. If a product hurts a customer and he sues, corporate owners are not at risk of losing their assets. A corporation has stockholders as owners and distributes profits and losses through dividends. Income doesn’t automatically flow through the owners.
A corporation is an older, more traditional entity conducting business in the United States. It’s easy to transfer ownership through the transference of stocks, allowing for more flexibility and the possibility of eternal life. When a stockholder dies, the effect on the business is not as high as in the case of a sole proprietorship or a partnership. Banks and investors tend to be more comfortable with a corporation than a Limited Partnership or Limited Liability Company.
Corporations file separate tax returns and pay taxes at their rate. This often causes the problem of double-taxation of owners, who are taxed on dividends, while corporations are taxed on earnings. Certain corporations qualify with the IRS to be S-Corporations and can avoid corporate taxation.
Professionals, such as doctors and attorneys, form professional corporations that offer lower liability protection for negligence or malpractice. This sub-type of corporation is preferred when compared to a general partnership, where professionals are liable for the malpractice of other owners.
A disadvantage of corporations is the work involved in dealing with specific legal and financial requirements at both state and federal levels, such as holding annual members’ meetings. Also, some states charge corporations fees. For example, corporations operating in California pay $800 a year in fees even if they have losses or are based in other states.
Limited Liability Company (LLC)
LLCs are a viral structure for a firm because it’s simple and easy to set up, providing business owners with flexibility not available with the other types of entities. It allows the benefits of liability protection similar to a corporation and offers the option of “pass-through” taxation, like a partnership.
An LLC with only one owner can be considered a “disregarded entity,” with profits and losses flowing directly into the owner’s personal tax return. There is no need to hold annual meetings or submit minutes with this entity. However, it needs bylaws or an operating agreement to avoid losing liability protection. The LLC can also be treated as a corporation for income tax purposes – this level of flexibility can be very appealing to many business owners.
An LLC is not a corporation, and its creation differs from a corporation. Certain circumstances, such as making the company insolvent because of excessive partners’ distributions, can make owners personally liable for the debts of the LLC. Some states, such as California, don’t allow licensed professionals to form professional limited liability companies (PLLC).
Note that when a member of the LLC dies, the LLC may dissolve, depending on the state the company resides in and its operating agreement. Also, note that an LLC is a relatively new form of business, and state laws continue to change regarding this type of entity. Banks and investors may prefer to invest in a corporation they are more familiar with than an LLC entity.
Considering the types of entities available for business owners who want to formalize their operations and protect themselves from liability, it’s always a good idea to talk to professionals familiar with the various options. Don’t wait until your assets are at risk to take care of the liabilities of owning a business – be proactive and consider your options now.