Choosing the correct business entity in Arkansas

“Choice of entity” is terminology which references the legal form your business will take – legal creations which allow a business to take on an existence apart from its owners, even though the owners still control the business.  Potential choices for your business include corporations, partnerships, limited partnerships, limited liability companies, and Subchapter-S corporations.

One of the primary considerations in selecting a business organization is protection of the owners of the business from liability.  Other considerations include tax treatment (state and federal), management structure, future ownership, and capitalization.  This blog article discusses some of the issues you should consider when forming a new business.  The tax information provided is courtesy of Neil Denman of Denman and Associates, CPA.  http://www.denmancpa.com/.

Sample Business Entities Available in Arkansas

• Corporation (Sub-S or Sub-C)
• Limited Liability Company
• Professional Limited Liability Company
• Partnership
• Limited Partnership
• Sole-Proprietorship

Corporations

• The corporation exists apart from its owners or shareholders.  A corporation can buy and sell property, enter into contracts, sue and be sued.  Elected officers and the board of directors manage the corporation.  Requires Articles of Incorporation and Bylaws.
• Subchapter C Corporations – may have unlimited shareholders and may be traded publicly. The primary disadvantage to the C Corporation is double taxation, whereby (1) the corporation pays the taxes and net taxable profits and (2) its shareholders pays tax on all the money taken from company (income and payroll taxes).
• Subchapter  S Corporations – generally known as “pass through” corporations, whereby the net income of the corporation is simply reported on the personal tax returns of the shareholders.  There are limits on S corporation formation and ownership (one class of stock, may not have corporation shareholders, limited in number of shareholders) and it is difficult to deduct losses.  The income is not subject to self-employment tax and the shareholders must be paid a “reasonable” salary.
• Corporations engaged in professional services must be formed under the Professional Corporations Act.

Limited Liability Companies (LLC)

• Combines many of the features of a partnership with those of an S Corporation.
• Allows income reporting on personal income tax returns of the ”members,” but with the liability protection of a corporation.
• Lacks many of the restrictions that apply to S Corporations.
• Governed by an Operating Agreement.
• May be “Member Managed” or managed by an outside Manager.
• Allows members to engage in management without risk of losing their limited liability status.
• Tax Information:
  • Allows for tax flexibility, is easier to deduct tax losses and excellent for rental real estate.
  • Income and losses flow-through the LLC and are reported on the individual member’s tax return.
  • Operating earnings are subject to self employment tax.
  • Special tax elections may apply to Limited Liability Companies.

Partnerships

• A General Partnership is an unincorporated business allowing the owners no legal protection (see Sole Proprietorship).
• Anyone involved in a Partnership should consider a thorough Partnership Agreement.
• Does not protect the personal assets of the business partners from claims against the partnership.
• Shares its profits and losses among the partners according to their ownership percentage.
• Tax Information:
  • Partners are required to claim income or loss on their personal income tax return.  It is easier for a general partner to deduct tax losses.
  • Operating earnings are subject to self employment tax.
  • Like LLCs, partnerships offer flexibility for tax purposes and are excellent for rental real estate.
  • Special tax elections may apply to partnerships.

Limited Partnerships (LP) and Limited Liability Partnerships (LLP)

• Limited Partnerships consist of general partners and limited partners.  The general partner(s) manages the business and have no liability protection.  The limited partner(s) are usually investors that are not involved in the day-to-day running of the business and whose liability is limited to the extent of their investment.
• Limited Liability Partnerships are similar to Limited Partnerships, however all Partners often take an active role in the management of the business.  The members are provided some liability protection from actions of the other partners, but not from their own actions.  Generally utilized by groups of professionals such as doctors, lawyers, etc.
• Tax Information:
  • Like LLCs and Partnerships, Limited Partnerships and Limited Liability Partnerships allows for tax flexibility, are easier to deduct tax losses and are excellent for rental real estate.
  • All income and losses flow-through to the members and are reported on their individual tax return.

Sole Proprietorship

• The sole proprietorship is the default form of ownership for an unincorporated company with one owner.
• All aspects of the business are unavoidably personally associated with the owner of the business.  The owner and the business are indistinguishable.
• All income, debts, and liabilities exist solely against the owner.  Any legal action by or against the business will be in the name of the owner, personally, “doing business as” his company.
• The owner has sole control and responsibility of the business.  A sole proprietorship is easily formed, allows important decisions to be made quickly, and typically has fewer legal restrictions.  The business has limited life and cannot be transferred to others.
• State and local business licenses and permits are still required.
• Tax information:
  • All income and losses are reported on the owner’s personal tax return
  • All earnings are subject to self-employment tax.  Self-employment tax is equivalent to Social Security and Medicare taxes.  15.3% of income is subject to self-employment tax (7.65% employee and 7.65% employer).  Most credits will not offset the self-employment tax.

Corporate Formalities

Regardless of the choice of business entity, there are corporate formalities which must be followed pursuant to Arkansas law.

The Arkansas Code Annotated contains over 450 pages of legislative acts associated with corporate formation and governance.  The advice and assistance of a lawyer, CPA and additional qualified professionals is crucial to ensure compliance with applicable law.

* All tax information was provided by Denman & Associates, CPA, PA, 310 Natural Resources Dr., Little Rock, AR 72205.  Contact them by phone: (866) 362-3905, or visit their website here.

IRS Circular 230 disclosure:  To ensure compliance with requirements imposed by the IRS and other taxing authorities, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed on any taxpayer or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.  Thank you.