by Glenn Lyon, MacGregor Lyon, LLC
General Partnership
One of the simplest and most common ways for small businesses to bring in additional capital or someone with sought-after complementary skills is in the form of general partnerships. In these types of partnerships, stakes are evenly divided among each partner unless otherwise specified in a partnership agreement. All gains and losses general partnership are routed directly through to the individual partners’ personal tax returns and the business is typically not taxed as a separate entity, although it must still file a return detailing the revenues and expense of its partners (Form 1065). And because payroll isn’t required for general partners, if a company consists entirely of partners and has no employees, the paperwork requirements can be much simpler than that of a corporation.
However, general partnerships have some distinct disadvantages. The most important of these involves the risk exposure to the partners, who are jointly and severally (individually) liable for any debts or judgments against the company, which means the partners’ personal assets (home, car, investments, etc.) could be vulnerable to creditors. Also, many state laws mandate that if any one of the partners leaves or dies, the partnership is immediately dissolved, which can make succession planning more and legally tenuous.
Limited Liability Company (LLC)
Started nearly 30 years ago as a hybrid between corporations and traditional partnerships, LLC’s have proven to be an increasingly popular strategy for small business owners. LLC’s allow multiple owners of a company to directly share in profits as they would in a sole proprietorship or general partnership while shielding their various personal assets from liabilities or debts incurred by the business, protections normally found only in fully incorporated companies. A simple Operating Agreement establishes the LLC and sets up the rules for governing the company as well as the rights and responsibilities of each partner, or member.” As part of an LLC, members have the flexibility to chose whether to pass-through company profits to their personal tax returns or to have the business taxed as a separate entity.
Subchapter S Corporation (S-Corp)
Similar to traditional C-Corporations in every way except for a different tax structure, S- Corps have become quite popular among many small business owners. This is because S-Corporations offer the same tax advantages of sole proprietorships or partnerships—where all income is passed through to the shareholders’ individual tax returns—as well as offering the liability protections inherent to a corporation. The downside of S-Corporations includes increased administrative costs, a much more extensive set of rules and by-laws to follow regarding corporate governance, and closer scrutiny by the IRS. Also, federal regulations require that all S-Corporation shareholder- employees are paid prevailing wages (subject to Medicare, FICA, and any applicable state income taxes), before any profit distributions can be made.