FOR ENTREPRENEURS IN USA

DOING BUSINESS IN USA

Introduction

Entrepreneurs are one of the important lifelines of an economy. Those entrepreneurs willing to undertake risk for their creative ideas and start their own business venture gets connected with the economy of the country, where they operate. However, for translating our ideas into reality, it becomes imperative that every action must be adhered according to the law in order to avoid the whole thing to become a futile exercise. One of the important things in the entire process is to channelize the activities through proper structure of your business entity. Business entity is formed in order to carry out the business activities generally in the form of proprietorship, partnerships, corporations or limited liability companies. The business entity shall act as the mirror for conducting the business that has separate legal existence apart from its owners. Each country has its own set of laws and by-laws, which govern the formation, management, and administration of the business entities. It is in the best interest of the entrepreneurs to decide a suitable form of a business entity according to business activity to be carried on. This article intends to highlight the types of business entity to carry on the trade or business in USA. An entrepreneur can initiate his business in any of the following manner:

1)    Sole Proprietorship;

2)    Partnership;

3)    Corporations;

4)    Limited Liability Companies.

The form of organization most appropriate and suitable for the business shall be decided after analyzing the pros and cons of each of the business activity that an individual is willing to undertake.

A. Types of Business Entities

A brief about types of business entity available for starting any business in USA are mentioned below. 

(A) Sole Proprietorships: conducting business through this form of organization is probably the easiest form. This type of business entity is suitable to those entrepreneurs who are unwilling to share the control and management of their business affairs. They are the sole owners of the business whose control and management lies with the sole owner; enter into business contracts as sole proprietor, personally liable for the liabilities arising out of the business. In order to carry on the business, as sole proprietor, there is no requirement of any formal procedure rather it can be carried on as unincorporated entity. The tax liability for the business is clubbed under the head Income from Business or Profession (Schedule C) while filing the personal income tax return. If the business earns profit, sole proprietor is liable to pay income tax as well as self- employment tax on the income earned, however, on the other side, if the business incurs losses commonly known as Net Operating Loss (NOL), then the loss can be carried back in the past year or carried forward in the future years to offset the taxable income.

(B) Partnerships: when two or more persons, whether individual, corporation having mutual agreement, decides to conduct the business by way of sharing capital, profit and losses this is commonly known as Partnership. This form of business entity is realistic and beneficial when each of the partners has different expertise and skills for conducting the business. For eg. one partner may have the capacity to manage the business efficiently whereas the other partner can contribute towards the capital. The entity incorporated as partnership has separate legal entity for matters like entering into contracts, buying and selling goods, entering into employment agreements etc. However, when the partnership is unable to pay the liabilities arising out of the business contracts, then the partners become separately and jointly liable for all the losses on behalf of the firm.  The profit/loss arising out of the business is shared between the partners in mutually agreed ratio and the partners are furnished with the copy of Schedule K-1 (Form 1065) to form part of their personal tax return. Partners, while filing their personal return shall also include Schedule K-1 representing their share in the partnership firm taxable at personal level. Profit arising out of the business increases the income liable to be taxed and thereby increasing the personal tax liability, whereas the loss decreases the taxable income and tax liability. Partnership firm has the obligation to file annual information return to report the income, deductions, gains, losses etc. from its operations. The partnership firm is not liable to be taxed at the partnership level, and thereby avoiding the taxation of same income twice as is the case of corporation.

(C) Corporations: Corporation is legal entity formed by the people who agree to contribute cash, property or both in exchange for the corporation’s capital stock commonly referred as the shareholders. Corporation is a separate legal entity who has the capacity to enter into contracts, conduct business in its name, capacity to sue and be sued. The management and conduct of business affairs vest in the Board of Directors who is elected by the shareholders. These types of corporations are commonly referred to as C Corp, liable to file their return under Form 1120. Corporations are generally taxed at higher rate of taxation in comparison to proprietorship and partnerships. Also, the income distributed to shareholders by way of dividend is taxed again at the personal level which leads to the taxation of the same income twice.

(D) S Corporations: In order for the corporation to be treated as S corporation, the entity must satisfy all five conditions as briefed below:

(i) It must be a domestic corporation,
(ii)It must have only individuals, certain trusts, and estates as shareholders. Corporation, Partnerships or non-resident alien cannot be member in the S Corp,

(iii) It must not have members exceeding 100,

(iv) It must have only one class of stock,

(v) It must not be an ineligible corporation like financial institutions, insurance companies and domestic international sales corporations.

The entity incorporated as C Corp may file the election with Internal Revenue Service in Form 2553 duly signed by all the shareholders to treat the corporation as S Corp. The advantage of being considered as S Corp is that it avoids the double taxation of the same income since all the income and losses are pass through its members by way of Schedule K-1 (Form 1120S) and also the income shall be taxed at personal rate of taxation rather than at the high corporate rate of tax. S Corp furnishes Schedule K-1 (Form 1120S) to all its members, to include the same as part of their personal income tax return.

(E) Limited Liability Company (LLC): In USA, the conduct of LLC is governed by the state statutes.  The rules and regulations for each state may be different regulations and should be followed depending upon the state involved. The owners of LLC are known as Members. Individuals, corporations, LLC and foreign entities can also become members in the LLC. The number of members in LLC can vary from one, two or more than two. LLCs with only one member are considered as Disregarded entity for tax purposes, thereby form part of personal income tax return. Whereas LLC with at least two members is considered as Partnership for tax purposes except when the company chooses to be elected as corporation with the Internal Revenue Service in Form 8832.

Conclusion

Any business activity can be carried on by an entrepreneur in the form of any legal entity which best suit his requirements considering all the features, benefits and limitations of the business entity to choose from. Its pros and cons from legal and financial perspective definitely needs proper evaluation to avoid any lossess.

The article is not advisory in nature and is only informatory. Dimpy Gulati who is Partner of Delhi Based Law Firm, Legal Imperials is the Financial Consultant of the firm has contributed this article due legal research and her experience. In case of any question or clarification, she can be approached at dimpy.partner@legalimperials.com.