Is it time to convert your sole proprietorship or partnership?

February 06, 2018

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It may be time to protect yourself from the risks faced by your business. Consider the following scenarios:

  • You teach yoga classes and a client blames you for back pains she is experiencing.
  • You love creating designer wedding cakes, and a member of the wedding party comes down with food poisoning.
  • You provide business consulting services. Your client blames you for the failure of his new venture.
Small businesses frequently start out as sole proprietorships (one owner) or partnerships (multiple owners). A sole proprietorship or a partnership is a simple way to organize a business since there is less paperwork and no separate tax return. The business operates under the business owner’s name or an assumed name.

Common reasons for using a sole proprietorship or partnership include:

  • The owner(s) simply started selling a product or services.
  • The owner(s) wanted to check out the viability of a new business before incurring additional legal and tax preparation costs.

However, since the owner of the business and the business are the same, the owner is liable for any business problems, debts, claims or litigation matters.

When should you make a change to your legal structure?

Generally, as soon as possible. Setting up your business in a separate entity enables you to protect your personal assets.

What will a separate entity cost?

You will incur the costs of forming a separate business entity. In addition, each year you will need to prepare a separate tax returns for the business.

What entity should I choose?

The type of entity that is best suited for your business depends on many factors, including the type of business you have and your financial and business growth goals.

LLCs

LLC stands for Limited Liability Company. LLCs have rapidly become the most popular business entity type for new and small businesses, largely because they are considered to be simpler and more flexible than corporations. The LLC business structure combines the pass-through taxation of a partnership or sole proprietorship with the limited liability protection of a corporation.

Corporations

One of the benefits of using a corporate form is the ability to issue stock, which is particularly attractive if you are raising money and seeking investors in your business venture.

  • All corporations are required by law to observe a number of corporate formalities to ensure that the corporation is operating as a separate entity. These formalities include holding regular meetings of directors and keeping records of corporate activity.
  • Profits from corporations may be “double taxed” that is, the corporation is taxed on any profits earned, and the individual stockholders are taxed on the dividends they receive.

S Corporations

If they qualify, either LLCs or corporations can make an election for tax purposes to be treated as an S corporation. The biggest advantage of making the S election is profits and losses of the business pass through to the business owner’s personal income tax, and thus avoid the corporation “double taxation” issue.

Other matters

Insurance

There are some circumstances when you can still be liable for claims. You may also want to consider liability insurance.

Personal Guarantees

You may be required to provide a personal guaranty, which makes you personally responsible under the terms of the guaranty. Typically, personal guarantees are required on business loans and leases.

Business legal issues are complex. Business owners should consult with their legal and tax advisers on such matters. For more information on business legal matters, please contact Kathy Tremmel at Tremmel Law, PLLC at (512) 539-0317 or kathy@tremmellaw.com.

Kathy Tremmel

Tremmel Law

Kathy Tremmel has significant experience both as a business attorney and corporate executive. Her career spans both legal practice and business management and she opened her own solo law practice in January 2010. In additional to running her own practice, she also is of Counsel with Selman, Munser & Lerner, which is a business transaction law firm in Austin, Texas. Ms. Tremmel has more than 10 years’ experience as a business attorney, providing transactional legal services to a diverse client base, from start-up ventures to well established companies. She helps companies with all their contracts, including customer agreements, non-compete agreements, employment agreements, buy-sell agreements, loans, and leases, helps people set up new businesses, and represents buyers and sellers of businesses. In addition, Ms. Tremmel has 10 years of management experience working with start-up companies. As VP of Operations at Tusker Group, an international litigation support company, Ms. Tremmel led international teams, managed production and quality issues, handled price negotiations, worked closely with clients to determine the scope of their projects, provided project management services, and developed, implemented and documented best practices for processing and training. Ms. Tremmel earned a Doctor of Jurisprudence from the University of Colorado School of Law and a Bachelor of Arts from Dartmouth College. She is a Texas licensed attorney and a certified Project Management Professional.
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