The Quick Guide to

ORGANIZATIONAL TYPES Which one is right for your business?

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TABLE OF CONTENTS

03 Introduction

04 Key Factors to Consider

05 Common Organizational Types

06 Sole Proprietorships

07 Partnerships (General, Limited and Limited Liability)

09 Limited Liability Company

10 Corporations

12 Conclusion

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INTRODUCTION

Are you ready to start a business? Maybe you already operate a

business, but never gave much thought on how to set it up.

Choosing an organizational type is an important step toward getting your business underway

and it should not be taken lightly as the structure you choose will impact your taxes, liability and

paperwork duties.

With this Quick Guide, we hope to help you understand the general features of some common

organizational types so you can determine which structure makes the most sense for your

business.

The common organizational types we will look at are:

Sole Proprietorship

General Partnerships

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

Limited Liability Company (LLC)

Corporations (C-corporation and S-corporation)

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KEY FACTORS TO CONSIDER

What structure makes the most sense for your business?

The organizational type you select should match your business needs. Consider these key factors

when deciding which type makes the most sense for you.

Taxation

The organizational type you choose will determine

how you or your business is taxed. There can be many

tax nuances involved in running a business. Based on

your individual situation and goals, what are the

opportunities to minimize taxation?

Management

Every business has its decision-makers. Consider the

needs of the business as well as the owner(s).

The Future (Continuity and Transferability)

What happens to the business down the line when

you’re no longer able to run it or decide to sell?

Certain organizational types can be more easily

transferred than others.

Formality and Expenses

Expenses, complexity and legal responsibilities vary by

organizational type. How will it impact your

administrative costs and record-keeping?

Legal Liability

Who or what entity will be legally responsible for judgments against the

business? A successful judgment against a business, such as worker

injury or general liability (if someone falls on a wet floor, for example),

could result in the owner being personally liable. The protection of

personal assets is one of the main reasons people incorporate;

however, it’s not always necessary. Insurance and well written contracts

can help manage risks to business owners.

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COMMON ORGANIZATIONAL TYPES

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Sole Proprietorship

If you intend to work alone, this may be the route to take.

A common structure for small businesses, a sole proprietorship is usually owned and operated by

one individual and there is no legal distinction between the business and the owner. Some say

this is the simplest structure.

Creation and formality of a sole proprietorship is relatively

simple and low cost.

Since there is no separation between the individual and the

business, pass-through taxation is a feature of a sole

proprietorship, which means the business doesn’t pay tax on

its income but “passes through” so its profits or losses are

reported on the owner’s personal tax return. Often, sole

proprietors also need to make quarterly estimated tax

payments.

As a sole proprietor, you have complete control over the

business and are the main decision-maker.

The business can last as long as the owner is alive and

operating, or until you choose to sell. The business can also be

transferred to family through the estate planning process.

The sole proprietor assumes full liability of the business, which

places your personal assets at risk. But as previously

mentioned, contracts and insurance can help manage risks.

Key Considerations

Unlimited personal liability

Pass-through taxation

Simplest to form

Lowest cost to form

Owner has full control over business

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Partnerships

Plan to have two or more people own and operate the business?

If your business will be owned by more than one individual, consider structuring as a partnership.

Ordinarily, there are General Partnerships and Limited Partnerships (LP) or Limited Liability

Partnerships (LLP).

General Partnership

In a General Partnership, all owners are personally liable for

the business and can make decisions on behalf of the

business, unless stated otherwise in a partnership agreement.

A partnership agreement is a written agreement to help

guide and protect you and the business. Agreements typically

cover: profit distribution, management duties, banking,

bookkeeping and termination.

Like a sole proprietorship, general partnerships benefit from

pass-through taxation, making them tax reporting entities,

not tax paying entities. Business profits or losses are

reported on the owners’ personal tax return.

A partnership can be transferred or exist as long as

determined in the partnership agreement.

Establishing a general partnership requires more expense and

formality than a sole proprietorship, but is still reasonable

and lower maintenance.

Find more information on how to form a Partnership or

other business entity in California at sos.ca.gov.

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Partnerships, Continued

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

Limited partnerships have both general and limited partners. General partners own and manage the business operations and

limited partners have little control over how the business is run. Typically involved as investors, limited partners are only

personally liable up to their investment, whereas the general partners assume unlimited liability.

Limited partnerships have similar tax treatment as general partnerships with pass-through taxation. However, if you’re an

investor in an LP, LLC or S-corps and not actively involved in the business (i.e. you don’t have material participation), it could

limit the deduction to only other passive income you may have, which is something to consider and consult with a

professional about.

Like general partnerships, a limited partnership can be transferred or survive as determined in the partnership agreement.

Creating an LP or LLP requires a filing with the state, possibly including the partnership agreement. In California, an LLP

structure can only be formed by persons licensed to practice in the fields of public accountancy, law, or architecture.

Key considerations when establishing a partnership

The amount of each partners’ investment.

The role and responsibilities of each partner.

Creating a buyout agreement in case a partner wants to withdraw down the road.

What happens to a partner’s shares should the partner pass or become disabled?

Can partners invest in or be part of similar businesses or competitors?

How will partnership ownership transfers be handled?

How will disputes be settled?

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Limited Liability Company (LLC)

An LLC generally offers liability protection similar to that of a

corporation but is taxed differently.

A Limited Liability Company (LLC) is an unincorporated entity in which owners can benefit from

limited personal liability. Owners of an LLC are called members and only one member is needed to

form an LLC.

Though only one member is needed to form an LLC, an LLC can have any

number of members, which can be individuals, partnerships or corporations.

Members can equally manage the business or members can designate one or

more owners to manage the operations.

Owners of an LLC have limited liability and are not held personally liable for the

debts and obligations of the business, except in cases of fraud, illegal activity or

failure to separate the business activities from personal affairs (such as using a

personal bank account for business affairs).

Pass-through taxation is also a feature of an LLC and members report their

share of profits or losses on their personal tax returns. However, the LLC

business does file an informational tax return. Also, in California, an LLC pays an

annual tax of $800. In addition, if your LLC's net annual income exceeds

$250,000, you may be required to pay an additional fee, which can range from

$500 to over $11,000.

Perpetual life is not a standard feature of an LLC as the company dissolves when

all members pass away. However, you can include provisions in your operating

agreement to prolong the life of the LLC. In California, an LLC is dissolved by

the consent of all the members unless all members previously agreed in their

operating agreement that such consent is not necessary.

To form an LLC, you must pay a filing fee when you submit your articles of

organization and an operating agreement may also be required.

Key Considerations

Limited liability

Pass-through taxation

Greater flexibility in distributing profits

Flexible management options

No stock

More costs and paperwork to form

Annual taxes and possible fees

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CORPORATIONS

One of the biggest benefits for a business that incorporates is the

liability protection for the owner.

A corporation is an independent legal entity that is separate from its owners. As the corporate

process is more costly and complex, it is generally established by larger companies with multiple

employees or by companies that provide a product or service that come with greater liability risks.

A corporation is more costly and complex because as an independent legal

entity, it has the responsibilities of complying with more regulations and tax

requirements, which can require the assistance of an attorney as well as more

accounting and tax preparation services.

It also comes with benefits such as protection of personal assets, transferable

ownership, indefinite continuity and the ability to raise funds through the sales

of stock.

There are two principal types of corporations: C-corporations (C-corps)

and S-corporations (S-corps). The major difference between the two is the tax

treatment. A C-corps is a separate tax paying entity that files its own tax return.

The owners of a corporation also pay personal income tax on distributed

corporate profits, which creates the issue of double taxation.

S-corps, on the other hand, are pass-through entities that pass corporate

income, losses, deductions and credit through to the shareholders who report

the income and losses on their personal tax returns – allowing them to avoid

double taxation on corporate income.

In California, C-corps and S-corps pay a minimum tax of $800 annually or a

percentage of income, whichever is greater. (See CA tax rates on pg. 11)

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CORPORATIONS, Continued

Management and ownership structures are generally the

same for C-corps and S-corps, in which a board of directors is

chosen by the shareholders. The board is legally required to

meet at least one time a year.

As mentioned earlier, corporations benefit from indefinite

continuity. As an independent entity, the life of the

Starting a corporation requires paying the applicable fees and filing the proper forms with your Secretary of State’s office, which

includes articles of incorporation. Most articles of incorporation establish:

• Company name

• Company purpose

• Company stock quantity and price

• Resident agent name and address

Key Considerations (C-corps)

Limited liability

Company is taxed (double taxation)

More costs and complex to form

Stock options

Complex ownership and management

Indefinite continuity possible

(S-corps)

Same as C-corps except for pass-through

taxation

corporation may remain undisturbed even in the event of a death or disability of an owner or shareholder. Transferring ownership

can be done by the sale of stock, and additional owners can be added in the way.

Keep in mind that although there is more paperwork and regulations to deal with as a corporation, it has its benefits and can still

be a viable option for your business. For example, the first $100,000 of a corporation’s income is federally taxed at 22.25%, whereas

tax for an individual could be as high as 43.4%. So, if your business makes less than $100,000 a year, a C-corps may provide better

tax outcomes.

CA Corporate Tax Rates

Entity type Tax rate

C-Corporations 8.84%

C-Corporations – Bank & Financials 10.84%

S-Corporation 1.5%

S-Corporation – Bank & Financial 3.5%

Alternative Minimum Tax (AMT) 6.65%

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CONCLUSION The organizational type you choose will impact how you own your

business, pay taxes, get paid and administrative duties.

Writing a business plan is a great first step in determining the appropriate organizational type for your

business. It will help you identify your business structure, strategies and needs. Carefully consider the

unique needs of your business and its owners and get expert advice from tax and legal professionals.

When your business is up and running...

Partner with us at American River Bank! For over 30 years, we’ve provided professional and personalized

business banking services and lending solutions to businesses of all industries. Learn how we can give

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Resources & Information

California Secretary of State

California Franchise Tax Board

U.S. Small Business Administration

Questions to ask yourself

Who will own the business?

Is this a partnership? Is anyone else

involved?

Who will manage the business?

Does your product or service have

significant liability risk?

How much financing is needed?

Will you have investors?

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The information in this guide was provided by: 1. The Federal Deposit Insurance Corporation in partnership with the U.S. Small Business Association: “Organizational Types and Considerations for Small

Business” 2. Entrepreneur.com: “Choose your business structure” 3. Investopedia.com: “Introduction – Forms of business organization” 4. William A. Robotham, CPA, Executive Partner, Pisenti & Brinker LLP

Disclaimer: The Quick Guide to Organizational Types is intended as general guidance only and may not apply to particular situations or circumstances. The content of this guide is not intended to provide authoritative financial, accounting, investment, legal or other professional advice. American River Bank makes no claims or guarantees regarding the accuracy or timeliness of this information and material.

The Quick Guide to

ORGANIZATIONAL

TYPES