Ohio Entity Selection
Entrepreneurs should always consider 2 primary categories when setting up a new business. This includes 1) the tax implications (the IRS piece), and 2) the potential for personal liability for the company's debts or mistakes (the legal piece). This is what distinguishes most business types.
A sole proprietor is someone who owns an unincorporated business by himself or herself. A sole proprietor is actually not an entity for tax purposes, as the IRS taxes the owner as an individual. Liability may also attach to the owner's personal assets, leaving the owner unprotected against company debts or mistakes. If single-owner businesses are not otherwise registered with the Ohio Secretary of State, they will be considered a sole proprietorship.
Partnership (2+ partners, taxed as individuals)
A partnership is the relationship existing between two or more persons who join to carry on a trade or business. A partnership must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but the partnership itself typically does not pay income tax. Instead, it “passes through” any profits or losses to its partners. Each partner includes his or her share of the partnership's income or loss on his or her tax return.
Corporation (either an S-Corp or C-Corp for tax purposes)
A corporation is a legal entity that is separate and distinct from its owners. Owners are called shareholders. The most important aspect of a corporation is limited liability for shareholders. Shareholders have the right to participate in the profits, through dividends and/or the appreciation of stock, but are generally not held personally liable for the company's debts.
Limited Liability Company (LLC)
An LLC is a business structure allowed by state statute. Owners of an LLC are called members. Members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Ohio also permits “single-member” LLCs, those having only one owner. Like a corporation, members are generally not held liable for the company's debts.
IRS Classification: Depending on elections made by the LLC and the number of members, the IRS will treat an LLC as either as a sole proprietorship (a “disregarded entity” for tax purposes), partnership, or an S-Corporation (if an S-election is made).
Sole Member LLC: An LLC with only one member is treated as a disregarded entity for income tax purposes (but as a separate entity for purposes of employment tax and certain excise taxes), unless it files Form 8832 and affirmatively elects to be treated as a corporation.
2+ Member LLC: An LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and affirmatively elects to be treated as a corporation.
Corporations face more extensive start-up formalities than LLCs. This includes adopting bylaws, issuing stock, holding initial and annual director and shareholder meetings, and keeping meeting minutes with corporate records.
Recommendations for LLCs: LLCs are recommended, but not required, to adopt operating agreements, issue membership interests, hold initial member meetings, etc.
LLC Operating Agreements: These are strongly recommended whenever there are 2+ members. Operating agreements may outline ownership, voting rights, rights to sell membership, rights to make decisions, rights on dissolution and a procedure for resolving disputes, among several other important issues.
Partnership Agreements: These are roughly the same as LLC operating agreements, but are entered into between partners in a partnership.
Corporation Types and Tax Differences
Default Classification: When a corporation is originally filed (or chartered) in Ohio, it exists as a C-Corporation. If nothing more is done, it will remain a C-Corporation.
S-Election: An Ohio corporation may become an S-Corporation if special tax treatment (“pass-through taxation”) is sought by filing Form 2553 with the IRS. The “S-election” can be filed anytime after the corporation is formed, with some limitations.
C-Corporations: Are taxed as a separate entity.
- Must report profits and losses on a corporate tax return.
- Pays corporate taxes on its profits.
- Shareholders are not taxed on the corporation’s profits.
- Shareholders report and pay income taxes only on what they are paid by the corporation.
- Shareholders must report dividends as income on their personal tax returns even though the corporation has already paid corporate taxes. This is referred to as “double taxation”, which can be avoided with an S-Corporation.
S-Corporations: Do not pay any income taxes (and are therefore considered pass-through tax entities).
- Individual shareholders (owners) must include their share of the corporation’s profits on their personal tax returns, paying tax at their individual tax rate.
- Shareholders may offset other income by including their share of the corporation’s losses on their personal tax returns provided, generally not to exceed the amount of their investment in the company.
- Are not subject to double taxation because the Corporation does not pay corporate taxes.
Use of Advisory Boards for Direction
Advisory boards are especially helpful for small operations. These boards should be used for providing non-binding input into the company's operations. Advisory boards should not be confused with boards of directors, the latter of which typically make binding decisions for the company.
Advisory boards may also be used to attract investment in the company. A strong advisory board may make investors more confident. Alternatively, some investors may wish to serve on the advisory board. It is always helpful to establish diverse advisory boards, adding members from various disciplines whenever possible. Advisory board meetings should be held regularly (at least 2-3 times per year), and members should have short, renewable terms.