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Choosing a Business Entity

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Elizabeth Focht

on 29 October 2015

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Transcript of Choosing a Business Entity

Choosing a Business Entity
Small Business Law Center at Thomas Jefferson School of Law
So You Want to Start a Business...
Sole Proprietorship
General Partnership
Limited Partnership
Sole Proprietorship:
Common Themes
The Choice for Me?



Please be aware that
the SBLC
will not be able
to provide you with tax advice
. We highly recommend you speak with a tax attorney regarding these issues.

The SBLC Provides

Legal Assistance!
Community Economic Development
Arts & Entertainment Law Project
495 Eleventh Avenue
San Diego, CA 92101

(619) 961-4382

Supporting Community Entrepreneurship
Our Clinics:
Different Types of Business Entities
Please feel free to ask questions throughout today's presentation!
Business owned by one individual

Easy to form and operate

No legal distinction between the individual and the business

Owner pays individual taxes rather than business taxes

The owner of a sole proprietorship is held
for the debts and liabilities of the business!
Sole Proprietorship:
Four Simple Steps

Pick a Name

File Fictitious Name Statement

Obtain Necessary Licenses,
Permits & Zoning Clearance

Obtain Employer Identification Number
Sole Proprietorship: Liability Issues
Sole Proprietorship: The Choice for Me?
Sole Proprietorship: Taxes
General Partnerships: Snapshot
Two or more people engaged in a business for profit

Separate entity from individual partners (unlike Sole Proprietor)

Each partner is responsible for the debts and liabilities of the partnership

Owners pay individual taxes, not business taxes (like Sole Proprietor)
General Partnerships: The Choice for Me?
General Partnerships: Formation
General Partnerships: Liability Issues
General partners are
Jointly and Severally Liable
for all business debts and obligations

Any act in the normal course of business by either partner binds the partnership

General Partnerships: Taxes

Taxed at
, not business level (like a sole proprietorship)

Subject to
self-employment taxes
(15.3% of net income)

elect to be taxed as a corporation
and pay separate income taxes on the business
Limited Partnerships: The Choice for Me?
Limited Partnerships: Formation
Limited Partnerships: Taxes
Pass-through taxation (like a sole proprietor)

Must pay

annual franchise tax
1. Kelly and Tim are computer programmers and partners of CompuChips LP. Kelly is the general partner and Tim is the limited partner. Kelly wants CompuChips LP to start programming video game software, but Tim tells her and the staff that he doesn't want to expand into that area.

Can Tim manage the business in this manner? What if Kelly and Tim were in a general partnership, instead of a limited partnership?
Limited Partnerships: Liability Issues
General Partnerships can be entered into
: "the association of two or more persons to carry on a business for profit forms a partnership,
whether or not the persons intended to form a partnership
Partnerships: Default Rules (Revised Uniform Partnership Act)
Limited Liability Companies (LLC):
LLC: The Choice for Me?
LLC: Formation
LLC: Liability Issues
LLC: Taxes
Corporations: Snapshot
C-Corporation or S-Corporation

Separate legal entity with limited liability

Most structured type of business, requires formal organization and compliance with corporate formalities

Taxation depends on whether C-Corp (business pays separate taxes) or S-Corp (pass-through taxation); must pay $800 annual franchise tax

Corporations: Formation
Corporations: The Choice for Me?
Corporations: Liability Issues
C-Corporations: Taxes
Corporation is a
separate tax paying entity
, meaning the business pays corporate taxes on its earnings

Corporate tax rates generally lower than individual

"Double Taxation"
- business pays corporate taxes on its earnings & owners pay personal taxes on earnings they receive as dividends from the corporation
Helpful Resources
IRS Website
California Secretary of State Website
California Franchise Tax Board Website
Governor's Office of Business and Economic Development Website
San Diego County Website
San Diego County Clerk Website
CalGold Website
Local organizations aimed at small businesses
Thank You!


Consider the personal risks you are willing to take in respect to your assets

Good for small businesses who want to avoid process and cost of incorporation

Gives owners complete control
As a Sole Proprietor,
you ARE your business
- meaning that a lawsuit against your business puts all your assets at risk, including your home, car, and personal finances.

TIP: Purchase
Liability Insurance
to Decrease Personal Liability
Essentially, you are trading the low costs and ease of formation for increased risk of liability.
Pass-Through Taxation
Taxed as an individual, not a business
Owner pays taxes on business income
Ability to write off business expenses

Self-Employment Taxes (15.3% of net income)
Business profits taxed as income to owner, even if money is put back into the business
Jack owns a landscaping business. He also owns his own home and a vehicle. Katie hires Jack to remove a tree in her yard, and this happens:
Unfortunately, Jack doesn't have liability insurance, and Katie sues for the damage to her garage. What does mean for Jack and his landscaping business?
TIP: Create a
written partnership agreement
to avoid default rules!

to know and trust the person you are going into business with!
1. Katie and Jessica have entered into a partnership by selling their handmade jewelry at local street fairs and farmer's markets. During one of their events, Katie sold a chipped glass pendant to a customer, who cut herself. Can Jessica be responsible for the customer's medical bills?

General Partners and Limited Partners
General Partner
manages day-to-day operations
Limited Partner
provides capital contributions

Good opportunity for
financial support and decreased liability risks
, depending on roles
General Partners have

Limited Partners' liability is
limited to their investment
in the business
Each partner shares
equal control
and is entitled to
equal share of profits

and debt obligations
regardless of the amount of initial contributions

If partners disagree, majority vote controls

Unanimous consent required
for amending the partnership agreement, adding a new partner, and completing extraordinary transactions

Important to
keep these roles separate
If a Limited Partner exercises management control, then he or she risks losing the protection of limited liability
Legal entity separate from its owner(s)

Limited liability protection

Very few formalities; easy to operate

Tax election: corporate or individual
Subject to $800 yearly franchise tax

Limited Liability Company (LLC)
C-Corp & S-Corp

Limited liability allows for protection of personal assets

Flexibility in tax election and allocation of losses & profits

Can choose member-managed or manager-managed structure

LLC cannot be formed by any professional service businesses
Articles of Incorporation
with the Secretary of State ($70 filing fee)

Appoint a registered agent

Statement of Information
($20 filing fee)
Convenient E-file option

LLC's are subject to an
annual franchise tax
TIP: Create an LLC Operating Agreement!
Pass-through taxation, similar to partnership or sole proprietorship

May elect to be taxed as a corporation

Must pay
$800 annual franchise tax
LLC offers limited liability protection: the owners are
not personally liable
for the debts and liabilities of the business
No formalities required
Easily formed at low costs
Can start business immediately
TIP: Think very carefully about who you choose to partner with!
TIP: Create a partnership agreement!
Certificate of Limited Partnership
with the Secretary of State ($70)

Required Information:
Name & Address of the Partnership
Name & Address of the General Partner(s)
Name & Address of Agent for Service of Process
Other Considerations: Obtaining a Business License
Certain types of businesses must obtain
business license(s) and permit(s)
from the city, and pay annual business taxes

1. Lisa and Lilly own Healthy Habits, LLC. Healthy Habits sells organic foods and juices to grocery stores. Unfortunately, Lisa includes some expired juices in an order, and the customers who buy the juice get sick.

Are Lisa and Lilly liable to the grocery store for sending them the juice? Are they liable to the store's sick customers? What about Healthy Habits' liability?

What if Lisa intentionally used fruit
that she knew would get people sick?
Remember to keep business and personal accounts separate!

Corporate Structure
Shareholders - owners of the business
Directors - elected by shareholders
Officers - manage day-to-day operations

Easier to
attract outside investors
and receive private financing; but
consider costs
of incorporation

High level of protection in exchange for
formal incorporation
procedures & adherence to
corporate requirements

Either pay corporate taxes
elect pass-through taxation
TIP: Create a
written partnership agreement
for your limited partnership!
a member acts
OR.... a member
pierces the corporate veil
Multiple Step Process
Articles of Incorporation ($100)
Agent of Service ($30)
Statement of Information ($25)
Corporate Bylaws
Corporate Record Book
Appoint Corporate Directors

Generally, shareholders of a corporation have
no personal liability
for the business
However, in some circumstances
shareholders CAN be held liable if there is
inadequate separation
between the company and its owner(s)

TIP: Do not co-mingle personal and business assets and adhere to corporate formalities!
S-Corporations: Taxes
Tax election
that the business files with the IRS

S-Corp status allows for pass-through taxation at the federal level, meaning the
business does not pay federal income taxes

Business still has to pay
annual franchise taxes to the state

Must have 100 or less shareholders
Shareholders are private individuals
No non-resident alien shareholders
Can only issue one class of stock
1. Carrie, Josh, and Laura are best friends and shareholders of GoodEats, Inc., a local restaurant. Because of their close personal relationships, the group holds meetings sporadically when they feel like it, and don't keep minutes or record of the meetings. They have a corporate record book with a few random receipts of business purchases, but do not have an up-to-date record of business expenses for the year. Josh, unbeknownst to Carrie and Laura, sometimes uses profits from GoodEats to pay his bills.

One day, a customer slips and falls at GoodEats, and sues the restaurant. The restaurant does not have sufficient funds to cover the lawsuit. Can Carrie, Josh, or Laura be held personally liable?
To see if and what type of licenses you need to obtain, visit:
and search their database based on your type of business and location
Other Considerations: Filing a Fictitious Business Name
FBN, or "doing business as" (DBA) is required if the business name is anything different from the legal principal

Example 1: if Anna, a sole proprietor, wants to name her business Careful Cleaning, she would have to file for a DBA
Example 2: If Jeans by Jules, LLC wants to do business as Jule's Jeans, it would have to file for a FBN
Must pay $800 annual franchise tax!
Limited Partnership: Snapshot
Two or more partners with at least one general partner and one limited partner

Liability depends on role as General Partner (unlimited liability) or Limited Partner (limited liability protection)

Pay taxes at individual level
TIP: Consult a trusted accountant to determine whether your LLC should choose pass-through taxation or corporate taxation
Full transcript