Limited Liability Company, Sole Proprietorship or Corporation for a minority or women run business

Whether currently in business, or if you are considering the creation of a small business, one of the first decisions is choosing which form of business entity will work best for you. This decision is just as important for a minority or women owned company. Find tips below, as well as resources (including non-profits) that can provide you with free or low cost legal advice to help you decide what entity to select.

On a side note, I have been a volunteer mentor with SCORE for several years. I work with existing small businesses as well as people seeking to start a business. I always, strongly recommend that a small business set up as a Limited Liability Company (LLC). It is affordable and most importantly, will help protect you and your personal assets (such as your house or savings) from a lawsuit.

Note even if you are already in business, you can also change the structure. However, the type of entity selected can impact your legal exposure, taxes, personal assets and more. Most small businesses choose with a sole proprietorship, LLC (Limited Liability Company), partnership, or corporation. They each have pros and cons, but we will explore the differences between them below.

Partnerships and sole proprietorship

Sole proprietorships provide owners with complete control. It is estimated by Black Demographics that over 60% of Black American businesses are Sole Proprietorships. American Express and their State of Women-Owned Business Report estimates that about 10% of women owned businesses are sole proprietorships. Guidant Financial also reports that about 35% of Black Businesses were started by women.

A sole proprietorship has no set up costs, is run by one person, and requires no separate tax return. The downside with this entity is that it provides zero legal protection – someone could sue you for your personal assets like home, savings, and all assets. In fact, the majority of these business entities just use a tax program such as Turbo Tax to do their taxes!

A partnership involves two or more owners. The entity requires little paperwork beyond a partnership agreement laying out the duties of each person, such as who owns what percentage of the business, who makes decisions/has a controlling interest, and their individual obligations. The agreement also needs to state what happens when the partnership dissolves. Note it is strongly recommended when choosing this entity to ensure one person has controlling interest/decision making. You do not want a 50 – 50 split as that can paralyze the business and/or increase the chance for conflict. Note a partnership can be set up as a Corporation or LLC as well.

The entities above can be created quickly at a low or zero cost. Since women and minorities, in particular the black community and women, have been facing sexism and racism issues, and therefore have lower assets, the lost cost of a sole-proprietorship or partnership may be tempting – but it comes with risk. In both cases, income is generally accounted for as part of the owner’s personal income tax return. One major drawback of both sole proprietorships and partnerships is that the personal assets of an owner or partner may be at risk to pay liabilities incurred by the business.

Limited Liability Company or Corporation

Forming a business as a limited liability company (LLC) or as a corporation protects the personal assets of the members and shareholders. It is estimated that about 10% of Black American businesses are LLCs and the balance are Corporations. The Amex State of Women-Owned Business Report indicates that about 70% of women businesses are LLCs

Many owner-run businesses choose to form as an LLC, and this business structure is commonly used by professionals ranging from lawyers and health care providers to architects and consultants. Comparing the advantages and disadvantages of LLCs and corporations will help you make the right choice for your business. Even find a quiz to help you decide.

Limited Liability Companies – An LLC is typically formed under the laws of the state in which it is created and may be a one-person business or involve multiple owners and employees. Owner assets are protected from liability in the event of business bankruptcy. Similarly, personal assets are protected if an employee, business partner or the business itself is sued for negligence. However in order to get that protect, the business owner needs to keep their business and personal finances separate; this means separate checking accounts, savings, credit cards, etc.

To form an LLC a Certificate of Formation is filed with the appropriate state division. Payment of a small registration fee may be required. One person must be designated as a registered agent. In most cases, registering as an LLC can be completed online. If there is more than one owner, business owners are called “members”, and each member owns a percentage of the business. State laws usually include strict limits governing the transfer of a member’s interest and outlining specific actions that must occur if a member leaves the LLC or dies.

LLCs are not required to file federal tax returns, hold annual meetings or maintain voluminous records. In states that require LLCs to file an annual report, the required content is often little more than the name, address and a brief description of the type of business involved. Some states require payment of an annual fee.

An LLC can choose to be taxed as a sole proprietorship, partnership or as a corporation. Members must usually pay self-employment taxes on income received from the LLC. In summary, an LLC is the choice of many small businesses where moderate financial risk exists and owners want to protect personal assets.

Corporations – A corporation is a separate legal entity from its owners. The two most popular corporate entities for businesses are C corporations and S corporations. Corporations can make profits and be taxed, sued and held legally liable. A corporate structure is often the preferred choice of businesses that need to raise money or that are considered medium to high-risk enterprises.

A C corporation can be owned by one or more persons, with no limits. Unlike an LLC, a corporation must hold regular meetings of a Board of Directors, maintain written minutes of such meetings and file annual reports. Also unlike an LLC, a C corporation must file an annual federal tax return, and taxes must be paid on corporate profits. This is generally the choice for a bigger business, in particular one that may go public at some point in the future.

If dividends are paid to shareholders, those shareholders will also have to pay taxes on the dividends. This essentially amounts to double taxation on corporate profits. Shareholders in C corporations also cannot deduct corporate operating losses from personal income as they are allowed to do with an LLC.

An S corporation is a special form of corporation often chosen to avoid double taxation. It is generally the choice for smaller minority or women owned businesses – if they go the corporate route. Note immigrant businesses also often choose S Corporations – but all shareholders need to be US citizens.

Profits and some losses in an S corporation can be accounted for as part of the owners’ personal income without being subject to the corporate tax rate. How the corporation will be taxed depends on the state law under which the S corporation was created. S corporations must file with the IRS to acquire S corporation status in addition to following formation requirements of the state.

Unlike C corporations and LLCs, an S corporation is limited to no more than 100 shareholders, all of whom must be U.S. citizens. This is a big reason it is a better option for smaller businesses. Shareholders cannot be corporations or partnerships.

Need help deciding business entity?

Get help in deciding the best business entity. Women and minorities can turn to business centers as well as legal help if/when needed. There are organizations that focus on women run businesses or founders, and they include Equal Legal (phone 310) 507-0995). There are fixed costs and even some free advice or forms to use to help decide the best entity.

Minorities, including Black business owners or Hispanics can turn to the Urban League. The national non-profit offers a host of career programs, business start up classes, workshops, and classes. Most of the advice, and they can help you decide whether a LLC, corporation, or sole proprietorships is the best option. Call 212-558-5300.

There are free workshops and classes (including online) that can help minority as well as women owned businesses (or entrepreneurs) decide on an entity. There is Alison Fundamentals of Business Entity Law, One from SCORE, and there are also free SBA resources.

Free Business Entity information can provide to low income families or senior citizens who may be interested in starting a business. Legal Services Corporation is a nationwide, non-profit group that helps with a wide range of Civil Matter. Minorities or inner city residents who often live near an office are some of the main candidates who LSC helps.  Assistance in setting up a business, completing forms, and related support is just one service offered. Call 202-295-1500.

If you need an attorney to help you decide on the business structure or help with filing a LLC, corporation or business entity, be wary of legal fees. Black owned small businesses, Latinos, females and startups often are challenged when it comes to funding, and every expense counts. Find tips for saving money on business legal costs.

Other Corporate and LLC Differences

While an LLC can be dissolved or required to comply with strict requirements when a member leaves the LLC, corporations are perpetual and continue to do business as if nothing happened if a shareholder leaves the company or dies.

While salaries and profits in an LLC are subject to self-employment taxes, in corporations only salaries are subject to those taxes. Fringe benefits such as group and medical insurance, parking and medical reimbursement plans are treated as taxable income for LLC members and shareholders who own more than 2% of an S corporation. However, such benefits do not have to be reported as income by C corporation shareholders.

Unlike an LLC, corporations can raise money from outside investors by selling shares of the company. However this can be challenging for minority, especially Black owned businesses. In fact, the number one source of funds for a Black owned business is their personal savings or borrowing money from friends/family according to Guidant Financial. Shares are generally easy to transfer from one person to another. The ability to transfer a membership interest in an LLC is usually very restricted.

There are numerous factors must be considered when forming a business. The LLC structure works well for many small women or minority owned businesses whose owners want to protect personal assets and take advantage of LLC tax benefits and management flexibility. This is what I recommend to clients that I talk to as part of SCORE, regardless of whether they are women or minority run, started by immigrants, or anyone else. A corporate structure requires greater formality and record keeping but is the necessary choice for business owners who have big plans requiring outside investment. Specific requirements to establish a new business can usually be obtained from the state division responsible for commerce or economic development.

By Jon McNamara