If you’re thinking of starting a business in Alabama, you should be aware of the different legal entities available. Whether you choose to start a C Corporation or remain a sole proprietorship, you need to understand that each entity has various advantages and disadvantages at tax time. In this article, we will walk you through your legal options and explain each one.
In a sole proprietorship, a single individual runs an unincorporated business with no legal separation between the business and its owner. As the owner, you are entitled to all your profits, but are also responsible for all of the company’s debts, liabilities, and losses. Because you and your business are one entity, it is not taxed separately. The income the business makes is your income.
When you conduct transactions and activities for reasons other than shareholder financial gain, you need to form a non-profit corporation. While you’re allowed to make a profit, it must be put towards the goals of the company rather than become dividends for shareholders. Most activities and transactions of a non-profit won’t be commercial in nature. You’ll receive protection from personal liability and won’t have to pay taxes.
When two or more people enter into a general partnership, they agree to operate the business together and share ownership. The owners are liable for the business, as in a sole proprietorship, and there is no real distinction between the company and its owner. Individual partners are taxed on their income rather than taxes being paid on the business itself.
Limited Liability Company
Limited liability companies combine the operational flexibility and tax efficiencies of a partnership with the limited liability of a corporation. Members of an LLC report their profits and losses on a personal federal income tax return rather than being taxed as a separate business entity. However, they’ll have to pay self-employment taxes.
Limited Liability Partnership
Partners in an LLP are taxed according to partnership law, but the partners have limited liability. An LLP limits the liability of each partner against the actions of the others, but this does not cover everyday commercial obligations. It also doesn’t limit your liability for your own poor actions.
In a C corporation, the business is an independent legal entity owned by shareholders. What this means is that the corporation is legally liable for the debts and actions of the business instead of them being the responsibility of the shareholders who own it. Corporations have complex legal and tax requirements and costly administrative fees. That’s why we only recommend choosing this structure if you have a large, established company with multiple employees.
A corporation is a separate tax-paying entity that pays income tax on its profits and are sometimes taxed twice – once when the company achieves a profit, and second when the dividends are transferred to shareholders on their personal tax returns.
An S Corporation is formed through an IRS tax election, making it different than other legal structures. It doesn’t have to pay double taxes, but to be considered for this legal entity, you’ll have to charter the business in the state where it’s headquartered. S Corporations are separate from their owners, which limits an owner’s financial liability. However, they won’t shelter you from all litigation. An employee’s actions during a workplace incident can still come back to bite you.
The main difference between an S corp and a traditional corporation is that profits and losses can be tracked on your personal tax return. Also, only the shareholders, and not the business itself, are taxed. Just be sure that shareholders are paying themselves a reasonable wage, or the IRS might reclassify extra corporate earnings.
Take the Next Step
When you’re ready to set up a business in Alabama, contact Tanika Finney for advice. She can help you choose the best structure for your situation and take care of any tax issues that arise so you can just focus on running the company.