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When starting your own business, the choice of which legal form to use will be one the biggest initial decisions you will need to make, perhaps second only to whether to start your business at all. In choosing one business form over another, you must consider such issues as: personal and business asset protection, taxation, ease of maintenance, management flexibility, capitalization, transferability of ownership, and ability to maintain or share control in relation to others, to name just a few.
In South Carolina, the most common legal forms of business include:
In determining what type of business form to adopt, you might want to keep in mind that a business entity’s initial form need not always be its final organizational form. An individual might begin as a sole proprietor because of the low cost, structural simplicity, and flexibility of carrying out business this way and later form a corporation or limited liability company. Moreover, under South Carolina statutory law, a South Carolina corporation can convert to, or merge with, a limited liability company, just as a South Carolina limited liability company can convert to, or merge with, a corporation.
Similarly, should you initially start a business with another or others, you might begin as a general partnership and later convert to a corporation or limited liability company. Because a general partnership can sometimes be based on nothing more than a handshake or an unspoken intention, its formation can be inexpensive and even deceptively simple.
However, starting as a sole proprietor or a general partnership, for reasons of simplicity, might also bring unwelcome complications and risks, such as exposing your personal assets to risk of loss to business creditors for unpaid debts of the company and to lawsuit judgment holders who might not otherwise have a claim against you individually. Moreover, partners in a general partnership not only have personal liability for the affairs of the business, they are also jointly and severally liable to third parties for promises and actions of the other partners. This means that you and a partner are both individually and collectively fully liable for the debts of the partnership, even though it was not your personal representation or action that created the liability.
In certain circumstances, changing business forms might also subject the entity and/or its owners to different tax code requirements, with negative implications.
Experience also shows that once a business owner begins his or her business, the urgency of day-to-day business dealings and the false sense of security from not having been sued or not having filed bankruptcy in the past, makes it extremely likely that such a business owner will continue as a sole proprietor or general partnership until it is too late. Once obligations to creditors and lawsuit plaintiffs arise, well established laws generally prevent the transfer or protection of personal assets against such debts.
Finally, every sole proprietor or general partnership must carefully consider the fact that should his, her, or their business need to close due to cash flow issues or outstanding liabilities from law suits against the entity and not its owners, a corporation or limited liability company can typically dissolve or file bankruptcy, without negatively impacting the credit rating of its individual owners. However, this would not include any debt of the entity that has been personally guaranteed by the owner or owners.
It is therefore recommended that every business owner do a careful cost-benefit analysis of whether or not to form a corporation or limited liability company prior to commencing business. Given the generally low cost of forming a corporation or limited liability company, which is often only a few to several hundred dollars for uncomplicated business arrangements, most serious business owners elect to form either a corporation or limited liability company prior to the start of business, and certainly prior to the start of incurring any financial obligations, such as an office lease, which might not otherwise be personally guaranteed. If your business enterprise is worth doing at all, it is generally worth doing in a correct and serious manner from the start.
Given the choice between forming a corporation or a limited liability company, most legal professionals who practice in the area of business formation currently prefer the limited liability company ("LLC") where a "closely held" company (a company in which the owner or owners will also make the day-to-day management decisions of the business) is being formed. The LLC form is often preferred because of its organizational and tax flexibility, low maintenance, and (in some instances) greater business asset protection. The owner of an LLC is referred to as a “member.” By default, unless the LLC specifically elects to be taxed as a corporation under Subchapter “C” or Subchapter “S” of the IRS Tax Code, an LLC that is owned by one member (whether a natural person or another entity) is treated as a “disregarded entity” for tax purposes and an LLC that is owned by multiple members is taxed as a partnership. This means that if the member of a one member LLC is a natural person, then he or she is simply taxed as a sole proprietor and the income or loss of the business in generally recorded on Schedule “C” of the owner’s Federal Form 1040 and State Form SC1040 tax returns. If the LLC is taxed as a partnership, the income or loss of the business is generally reported on Federal Form 1065 and State Form SC1065 and the LLC provides each member with a Federal Schedule K and State Schedule SC-K.
Because members taxed as a sole proprietor or partner are considered self-employed for tax purposes, they are typically subject to and make quarterly estimated tax payments on income, as well as for social security tax and Medicare tax purposes, rather than withhold such income, social security, and Medicare taxes from the profit they receive.
Thus, LLCs can generally enjoy all of the personal asset protections of a corporation, without the additional tax administrative burdens often associated with corporations, unless there is a tax benefit for their doing so. Moreover, LLCs are generally not subject to those “formalities” often times associated with standard corporations, such as the requirement to hold annual shareholder meetings or the needing to have a separate board of directors. While in some states, including South Carolina, a corporation can make a special election to also eliminate such formalities, corporations do not enjoy the same tax or organizational flexibility of LLCs. In some instances, particularly in multiple member LLCs, where a member owns a majority interest in the company and is a potential target for law suits, whether such suits have anything to do with the business of the LLC or not, LLCs may offer superior business asset protection over corporations. Thus, there is little reason to wonder why LLCs are quickly becoming the entity form of choice among legal professionals.
However, where a company intends to operate with a corporate management structure or be taxed as a corporation, a corporate entity should also be considered.
In forming a business, you should also consider the fact that sometimes multiple business forms best achieve your objectives and maximize your protection. For example, one company (generally a limited liability company) might be used as a "holding company" to separately own the land and building that you operate in or other important and valuable assets. It would lease the land and building or assets to your primary business, potentially shielding them from claims against your primary business. Additionally, business entities can themselves participate as owners in other business forms. For example, a limited liability company owned by you might itself own multiple LLCs for separate retail locations, real property, or other assets for the purpose of creating “fire wall” protection between them. Alternatively, a corporation owned by you and a limited liability company owned by another might form a partnership or joint venture, as a third business entity in order to avoid some of the dangers inherent in general partnerships, yet each retain exclusive control over certain other business activities. Indeed, many complex configurations are possible.
The point to be understood is that there are always competing advantages and disadvantages to be weighed in choosing any business form or configuration. Such choices must be made with careful consideration and preferably in consultation with a competent business attorney.
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