Anyone starting a business in New York has several options of entities to use to conduct his business. As a business owner, it would be wise from inception to have a clear idea and vision of where the business will go because this will aid him in deciding the appropriate entity to use. The several entities he can choose from are: sole proprietorship, general partnership, business corporation, limited liability company, and limited partnership.
1. SOLE PROPRIETORSHIP
A business owner can conduct his business by registering as a sole proprietorship. This option is the easiest to set up with the lowest cost because it simply requires one to file a business certificate with the office of the county clerk in the county where the business is located. There are no annual filings nor is there a need for formal bookkeeping. One can begin to start selling goods and services. There is no corporate tax because everything is recorded in the personal tax return.
However, there are some major disadvantages. First, the sole proprietor is personally liable for all of the sole proprietorship’s business expenses, debts, product liability claims, property-related injury, and civil damages for inappropriate or insufficient service. Second, it can’t take on debt because all debts are personally guaranteed by the sole proprietor. Third, it has the inability to raise capital because it doesn’t have equity shares. Lastly, there’s no business life after the death of the sole proprietor.
For some businesses that are low cost and low liability ventures, this could be a viable option. Examples are small scale entrepreneurs, conducting their business from home, who foresee the business as not more than a weekend operation or part-time hobby. There are other better options for the business owner who is serious in scaling and growing his business.
2. GENERAL PARTNERSHIP
A general partnership is similar to a sole proprietorship, except that it is owned by more than one person. It contemplates a legal structure where two or more people are collaborating to undertake jointly a business activity. The business certificate is also filed with the county clerk where the business is located. It doesn’t have corporate tax because each partner’s share of the losses or profits are recorded in their individual tax returns.
However, similar to a sole proprietorship, the partners are personally liable for the debts of the partnership. Not only that, they are also personally liable for the acts of the other partners. There is no separate business entity from the partners and the partnership is terminated upon the death or withdrawal of one of the partners.
For this reason, a general partnership is ideal only for small businesses with little income, no property, no future plans to hire, and with moderate growth expectations.
3. BUSINESS CORPORATION
A lot of the biggest companies in the world are registered as business corporations. To form a corporation, the business owner needs to file a certificate of incorporation with the NYS Department of State. Corporations are attractive to business owners because the shareholders are not liable for the debts or expenses of the corporation. There is also business continuity because the life of the corporation is not dependent on a particular person, unlike in sole proprietorships and general partnerships. Its ability to issue stock makes it easier to raise capital and for investors to buy in.
However, incorporating can be expensive and time-consuming. It requires annual filings and is subject to double taxation – the corporation will be taxed on its income, while dividends distributed to shareholders will also be taxed. It also requires the observation of certain corporate formalities, such as holding regular meetings of directors and keeping records of corporate activity.
4. LIMITED LIABILITY COMPANY
Small business owners may opt for a limited liability company (LLC), rather than a sole proprietorship. It is formed by filing an articles of organization with the NYS Department of State. New York requires LLCs to publicize their existence to the general public. The LLC can be owned by one or more persons, and the owners are not personally liable for the debts or expenses of the LLC. There are less corporate formalities than a corporation. It is not required to hold regular meetings. Professionals, such as lawyers and accountants, who form LLCs for the purpose of practicing their profession are called PLLCs. For tax purposes, it is similar to a sole proprietorship or general partnership, in that it is a pass thru entity – the profits and losses are carried by the members who report them in their individual tax returns. This could be good or bad depending on how one sees it. For a corporation, income is not immediately distributed to the shareholders unless there is a declaration of dividend. For the LLC, the members must immediately recognize the profit and bear the tax on income, even if that income is re-invested back to the LLC for the company’s further growth and development. The LLC, however, can elect to be taxed like a corporation.
5. LIMITED PARTNERSHIP
Similar to the LLC, a limited partnership needs to publish their existence to the general public. It is formed by filing a certificate of limited partnership with the NYS Department of State. In this business structure, one or two partners need to be general partners who are personally liable for the debts and expenses of the partnership. The limited partners are protected from liability. Just like a partnership, the partners can deduct business costs and recognize profits in their personal income tax return. However, because general partners carry all the risk, this structure is not advisable.
BUT WAIT.. WHAT’S S CORP AND C CORP?
S Corp and C Corp are not necessarily a different business structure. Instead, they are corporations which are given different tax treatments by the IRS. The default structure is the C Corp. If the business owner would like to be a S Corp, it needs to file additional documents with the IRC and comply with certain requisites. C Corps can have more than 100 shareholders from any part of the world, while S Corps are limited to 100 shareholders who must either be a US citizen or a US resident. C Corps can have multiple classes of stock, whether preferred in distribution of dividends or voting, while S Corps can only have one class of stock. The major difference, however, is in the tax treatment – Unlike the C Corp, the S Corp does not have corporate income tax – the shareholders are taxed on the income of the corporation – so there is no double taxation.
Previously, the S Corp was preferred than the C Corp due to the pass-thru taxation benefit, but with the 2017 tax reform act, the corporate tax rate was lowered to 21% while the maximum personal tax rate is 37%. However, if you plan on an IPO, you want to issue preferred stock or you want share to be freely transferable, C Corp is the better option.
SHOULD I FORM MY CORPORATION IN NEW YORK OR DELAWARE
Delaware used to be the preferred state for incorporation due to its friendly corporate environment and predictable body of law. However, if you incorporate in Delaware and want to do business in New York, you still need to register as a foreign corporation in New York which is an added cost. For this reason, if you’re a new business and your operations are in New York, it is better to just simply register as a corporation in New York.
Once you’ve formed the business entity, you still need to get an Employer Identification Number (“EIN”), register with the NYS Tax Department, open a bank account, obtain necessary licenses or permits (including a sales tax permit), lease office space and hire staff, and remember to file the annual reports, tax returns, and other obligations.
Starting a business is not easy, but can be rewarding. If you are ready to start a business, you need an experienced lawyer beside you to guide you through the process so you can concentrate on what’s more important: running the business.