Selecting a legal structure for your company is one of the most important business decisions you will make. Your choice will dictate the amount of paperwork the company will have to do, your ability to raise funds, your personal liability, and how much you have to pay in taxes. Each option has its advantages and drawbacks, and knowing what they are will make your decision a better-informed one.
With sole proprietorships, the business and its owner are essentially the same thing. You manage and control everything and all profits come to you. Entrepreneurs in Maryland frequently form sole proprietorships because the process is simple and affordable. All you need to do is get a business license and then get to work. There are, however, potential disadvantages. They include:
- You are personally taxed for any profits
- You are personally liable for the company’s debts and your assets can be taken to pay them off.
General partnerships are owned by two or more people. Each partner is entitled to a role in both daily operations and decision-making, and profits are shared according to the amount of capital contributed by each partner. Unlike sole proprietorships, a partnership can hold assets and incur debts in its own name.
Like all business entities, general partnerships have their potential drawbacks. They include:
- Increased personal liability, as one partner can be held responsible for the acts of the others
- The partners are personally responsible for all taxes due.
A corporation is a business entity that legally owns and operates the company on behalf of its shareholders (owners). It is created by filing articles of incorporation with the state and shields its shareholders from personal liability for any lawsuits or claims brought against the business. Corporations can also raise additional funds through the sale of stock.
A separately taxable business entity, C corporations are an attractive prospect because they can have multiple classes of stock and an unlimited number of shareholders from anywhere in the world. They also have the widest range of IRS-permitted deductions and expenses. Disadvantages that need to be considered include:
- Multiple internal and external obligations and formalities, such as filing annual reports and holding shareholder meetings
- Shareholder dividends cannot be deducted from business income, so the income could be double-taxed.
S corporations are pass-through tax entities, meaning that taxes are not paid at the corporate level. All income and losses are ‘passed through’ to the shareholders, so any losses can offset income on their tax returns. This can be an advantage during the new business’s start-up phase.
- S corporations must follow the same corporate formalities as C corporations
- Any tax owed by the business is paid by the owners personally
- There can be no more than 100 shareholders, all of which must be American citizens
- They can only have one class of stock
Also known as Benefit corporations, B corporations are legally required to create materially positive impacts on society. Instead of focusing on shareholder benefits, the goal is benefiting ‘stakeholders,’ which includes the company’s owners, employees, and the public. In October 2010, Maryland became the first state to approve the B corporation.
Potential drawbacks include expanded reporting requirements and director liability for shareholder derivative suits over matters such as violations of loyalty or duty of care.
Limited Liability Company
The Limited Liability Company, or LLC, is a popular entity choice because of its flexible operating model and wide range of possible tax classifications. It also features the limited liability protection of a corporation and the pass-through taxation of a partnership. LLC members have the option of choosing to be taxed as a partnership, C corporation, or S corporation. Potential disadvantages are as follows:
- Unless they have elected to be taxed as corporations, single-member LLCs are disregarded entities for tax purposes. Courts have held that the owners of these companies are responsible for the employer’s portion of federal payroll taxes.
- LLCs are not a good choice for companies that seek venture capital or intend to be publicly traded.
For assistance in selecting a Maryland business entity that matches your personal and business goals, contact us today or call 410-296-6485.