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Liability of Owners in Various Business Structures
One of the first decisions facing a new business owner is what business structure to select. Too often, however, this decision is made with too little information and without a full understanding of the long-term consequences. There are several factors to consider when making this important decision: taxation, record-keeping, management, and liability. It is well worth an hour or two with a qualified attorney to ensure that you make the best decision in selecting your business structure. The money and time saved by starting off in the right direction will pay off in the long term. The following is an outline of the differences in just one of the factors, liability exposure, of the most widely-used structures.
Sole proprietorships make up the largest number of businesses in America, accounting for over 20.6 million businesses in this Country alone. (Calculated using the number of tax returns filed by business type, last reported by the U.S. Census Bureau in 2008: http://www.census.gov/compendia/statab/cats/business_enterprise/sole_proprietorships_partnerships_corporations.html ). Although it may offer other benefits, the sole proprietorship offers the least amount of protection from liability to its owner. The owner is personally liable for any and all debts, liabilities, or losses incurred by the business. This means that when a sole proprietorship fails or needs to liquidate for any reason such as a major lawsuit, the owner’s assets are fair game when it must meet as many obligations as possible. Houses, cars, furniture, and personal bank accounts are all exposed in the world of the owner of a sole proprietorship.
Much like sole proprietorships, the owners of a partnership expose their personal assets to liability. The only difference from a sole proprietorship is that the owners in a partnership can be held liable for liabilities incurred by someone else, any of the other partners. Each partner is “jointly and severally” liable for the liabilities of the business. This means that if one partner racks up debt and moves to Brazil, the remaining partner or partners are left holding the bag, and thin personal assets may be reached by creditors. The entire amount of the outstanding debt may be collected from all, one, or some of the partners. This factor alone means that partnerships are almost never a good choice from a liability perspective.
A C Corporation is its own legal entity, separate from any of its owners, managers and employees. As such, it offers a high level of protection to its owners’ personal assets. When a C corporation incurs a debt, none of people involved with the corporation are personally on the hook for its payment. When a C corporation liquidates, it uses the corporation’s assets to pay them, and the creditors are not able to force the owners or any of the agents of the corporation to use personal assets. They are protected by the corporate structure. (There are exceptions, however, when creditors attempt to “pierce the corporate veil,” but this is an issue for a different article).
The S Corporation has exploded in popularity, because of its tax advantages for a small business owner. As in a C Corporation, owners of an S Corporation do not expose their personal assets in the event that the company needs to be liquidated or if it cannot meet its financial obligations with business assets.
Limited Liability Company (LLC)
As stated above, LLCs have grown in popularity over the past several years because, like S-Corporations, they allow the owners to protect their personal assets, offer tax advantages, and are exceptionally flexible. The LLC offers liability protection similar to that of an S Corporation.
When focusing only on the difference in liability to owners, it may seem obvious which structure or structures are “the best.” However, when considering the other factors such as taxation, management, and record-keeping, it becomes clear that no one structure is always superior, and each case is dependent on the goals, operations, and preferences of the individual business and its owners. There is no “one size fits all” solution when it comes to selecting the best business structure for each unique business. Make your selection only after understanding each structure and how they apply to your business and seek the advice of trusted advisors. This is truly one of those times when a little more time and attention at the outset will save a world of regret and expense down the line.
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