In this video, learn about how businesses are formed and the legal and financial implications of specific formations.
- Becoming an entrepreneur is intriguing to some, but scary for others, and fear is understandable because entrepreneurs take on considerably higher financial risk than normal to turn their great ideas into viable businesses. What many entrepreneurs struggle with early on is how to structure their businesses so that they have the best possible legal and financial protections. Let's take a look at the options business owners have to form their businesses, and the legal and financial implications of each.
A sole proprietorship is owned by a single person. This is the easiest type of business to form. If you don't formally register as a business, the IRS automatically considers you a sole proprietorship. In this form of business, your personal assets and liabilities are not considered separate from your business, so you can be held personally liable for any debts or financial obligations of the business. Sole proprietorships are ideal for people who want to test their business ideas before making a big commitment.
A partnership is formed when at least two people go into business together. There are two types of partnerships, limited partnerships, or LP, and limited liability partnerships, or LLP. In an LP structure, there's one general partner who is responsible for all liabilities the business incurs. The other partners have limited liability and limited control over company operations. The profits of an LP are reported on each partner's personal income taxes, and the partner with unlimited liability must pay self-employment taxes.
An LLP is similar to an LP. The main difference is that each partner has limited liability. This protects the partners from each other's legal and financial actions. Law firms, accounting firms, and financial services firms are typically formed as LLPs. Corporations are a more complex business structure, and there are five types. C corp, S corp, B corp, close corporation, and non-profit corporation.
A C corp exists separate from the owners. Profits belong to the corporation, the corporation can be taxed, and the corporation is responsible for liabilities it incurs. While costly to form and maintain, corporations provide the best protection from liability for its owners. Corporations also have an easier time raising money than other business structures because they can sell stocks. Next, an S corporation passes profits and losses on to shareholders, which shareholders report on their personal taxes.
This avoids the double taxation that C corps sometimes deal with. A benefit corporation, or B corp, is taxed in the same way that a C corp is taxed. However, a B corp exists for some public good, so there's both a financial and public benefit aspect to a B corp. Kickstarter.com, the crowd funding platform, is an example of a benefit corporation. Their mission is to bring creative projects to life.
A close corporation is similar to a B corp without the governance requirements that corporations must adhere to. Close corporations are usually owned by a small group of shareholders. Non-profit corporations, sometimes called 501(c)(3), which is the portion of the federal tax code that make non-profits tax-exempt, are established for charity, education, religious, literary, or scientific work. Though non-profits don't pay taxes on their profits, they have to follow the IRS rules about what they do with the money they earn.
Finally, a limited liability company, or LLC, is the combination of a partnership and a corporation, where profits and losses are incurred by and taxed to the members of the LLC. The owner's personal assets are protected from bankruptcy or lawsuits made against the LLC. To be effective HR professionals, you have to think like a business person. This begins with understanding how your organization is structured.
- Modeling ethical standards
- Managing legal risks
- Finding and interviewing candidates
- Designing training and measuring its effectiveness
- Designing total rewards
- Promoting diversity and inclusion
- Employee engagement strategies
- Managing complaints and grievances
- Implementing workplace programs