Chapter 5
Choosing A Legal Business Structure
he legal form under which you set up your business can have a huge impact on the way you run your operation and how it is taxed.
Mile Markers |
*The legal form of your business determines a lot about your taxes and legal liability.
*A sole proprietorship is a simple, flexible structure for new owner-operators with few outside financial interests.
*For an expanding owner-operator business, some form of incorporation might work best. |
There are six ways you can set up your trucking business:
- Sole proprietorship
- Partnership
- C corporation
- S corporation
- Limited liability company
- Limited liability partnership
Deciding what form to use can be complicated. What is right for one trucking business may be wrong for another. Tax laws change continually, and state laws can influence your choice. If you’re just starting out, or if you’re thinking about changing the legal structure of your business, seek the advice of a tax attorney or a Certified Public Accountant who is experienced in trucking.
There are three main things to consider when you choose a legal form for a business: asset protection, taxation and simplicity. Each business form has advantages and tradeoffs.
A sole proprietorship is a business owned by one person. Eighty percent of businesses in the United States are sole proprietorships, and the majority of owner-operators are sole proprietors. A sole proprietorship requires no formal setup; it begins when you start earning money.
In the eyes of the law, the owner of a sole proprietorship is the business, and the business is the owner. Debt incurred by the business is the responsibility of the owner. If you are a sole proprietor, and your business gets into financial trouble, creditors can seize everything you own: your rig, your boat, your personal vehicle, your house and so on. The same is true for legal liability. If you have an accident while driving and injure someone, the injured party can try to collect your business assets and your personal assets.
Because the owner and the business are the same, when the sole proprietor dies, so does the business. Typically, the disposition of property from a sole proprietorship is addressed in a will or estate plan. In the absence of a will, the owner’s spouse gets the truck and the bills.
Because the government
doesn’t recognize a sole proprietorship as being separate from its owner, income taxes are fairly simple. You file IRS Schedule C, Profit or Loss from Business, which details your business income and expenses, along with the 1040 form. If you operate more than one business, or if you file jointly with your spouse and she owns a business, you have to file only a Schedule C for each business. In addition, because there’s no employer to withhold Social Security taxes, a sole proprietor must pay his own taxes
quarterly.
 A partnership is similar to a sole proprietorship, except that it is owned by more than one person. The partnership isn’t taxed as a collective entity. The individual partners are taxed, and they file individual income tax returns.
A partnership is easy to form. A handshake or verbal agreement is all you need to establish a legally binding arrangement. As in a sole proprietorship, the partners are the business, so in case of legal or financial judgments, injured parties or creditors can come after the personal assets of the partners.
The ease of establishing a partnership can be misleading. Partnerships, even those involving spouses and children, should have a written agreement that stipulates the role of each partner, as well as distribution of profit and loss. The agreement also should spell out a formal method for resolving conflict, such as naming an arbitrator.
A partnership has no life beyond the death of one of the partners. Unless there is a formal partnership agreement, the state decides distribution of assets.
A limited partnership consists of one or more general partners who manage the day-to-day activities of the business and one or more limited partners who are investors with no active role in the business.
A limited partnership is covered by the Uniform Limited Partnership Act and is subject to state regulation regarding formation, reporting and operation.
In a limited partnership, a general partner is treated like a partner in a regular partnership, but a limited partner is treated like a shareholder in a corporation. The general partners are at personal risk, whereas the limited partners enjoy limited liability equal to their investments. Limited partnerships can be complicated and are not preferable for most owner-operator businesses.
Whereas sole proprietorships and partnerships are indistinguishable from their owners, a corporation is treated as separate from its owners, shareholders and employees.
Incorporation laws differ from state to state, and the cost of incorporating varies from a few hundred to a few thousand dollars. In addition to setup costs, incorporation requires numerous forms, records and formal annual meetings.
The two main types of corporations are the C corporation and the S corporation.
To set up a C corporation, you must file articles of incorporation with your state. Although do-it-yourself kits for incorporating are available, it’s best to hire an attorney to avoid mistakes and to address the particular laws of your state.
C corporations are notorious for double taxation, which means that the corporation is taxed, and the owners are taxed on their dividends and salary.
The S corporation, however, offers the limited liability of a C corporation without double taxation. The owners or shareholders are taxed only on personal income, as in a partnership or sole proprietorship. In addition, the net income of an S corporation is available for distribution among the shareholders as dividends. In a C corporation, dividend payments are taxed, but in an S corporation, they are not.
To be taxed as an S corporation, you must file articles of incorporation and make an election to be taxed as an S corporation by filing IRS Form 2553.
S corporations are restricted to a limited number of employees. In addition, the corporation can have no foreign shareholders, and corporations and partnerships cannot be shareholders.
 A limited liability company offers benefits similar to those of an S corporation, but without the membership limitations. Like an S corporation, an LLC offers liability protection for the owners, and profits pass through the owner's personal income tax returns. This means no double taxation.
Because each state treats LLCs differently, trucking operations set up as LLCs encounter problems. If you have an Ohio LLC, for example, and you have an accident in New York, liability could be affected.
Another drawback is that an LLC is expensive to set up, often costing hundreds of dollars more than establishing a corporation.
Nevertheless, the liability protection, simplicity and flexibility of LLCs make them a good fit for certain types of operations.
In most states, a business can be set up as a limited liability partnership. An LLP is expensive to establish and more complicated than other forms of business. It is not a good way for a small trucking company to set up
property as well as the corporation’s property. In this case, incorporation offers no advantage over a sole
proprietorship.
Some experts think that one-truck owner-operators don’t need to incorporate. Instead, they recommend that truck owners get adequate insurance to cover the possibility of a lawsuit.
For owner-operators who are starting out with one truck and have few outside financial interests, a sole proprietorship is simple and flexible. If you add trucks and drivers, you might
consider incorporation.
When you ask lawyers, accountants or owner-operators about the best form of business, you’ll get different answers. Before you decide, have your accountant run the numbers on each option. Compare them based on your income as a sole proprietor. Consider the legal risks involved in each form.
| More On Incorporating |
In both C and S corporations, the business must withhold federal and state income taxes and Social Security taxes from the owners’ salaries. The corporation is required to file quarterly reports of employee withholdings. The owners file personal tax returns.
A corporation must have a checking account that is used only for business. Some corporate assets must exist, and those assets must be kept separate from the owner’s. The law requires a
corporation to elect officers, hold regular (usually quarterly) meetings and take minutes of those meetings.
The common belief is that a
corporation offers a legal shield for its owners for wrongful acts committed by the corporation, as well as a shield against creditors. The belief is that if an employee of the corporation is
negligent, the owners are spared legal ramifications, and only corporate assets – not the owners’ personal assets – can be seized to satisfy a court judgment.
But plenty of one-person businesses are disguised as corporations, and what may look like a corporation may not act like one. If a court finds a corporation to be a sham, the owner may find himself responsible for debts and lawsuits.
In addition, for a newly formed one- or two-person corporation, a lender may require a personal guarantee from the owners before lending money. In that case, the owners are personally liable for repayment, regardless of corporate status.
The same thing applies in any accident in which the trucker is deemed to be at fault. If you, as a driver, are also a corporate officer, you can be liable in case of a judgment for personal injury. The injured party can sue you and take your personal assets, regardless of your status as an officer.
Or suppose that you, as the owner, shareholder and board member of a corporation, want to borrow $25,000, and you sign the note as president of the company. If you can’t repay the debt, the bank can seize your personal property as well as the corporation’s property. In this case, incorporation offers no advantage over a sole proprietorship.
Some experts think that one-truck owner-operators don’t need to incorporate. Instead, they recommend that truck owners get adequate insurance to cover the possibility of a lawsuit.
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Resource |
| For additional information on starting and expanding a business, contact the Small Business Development Centers of the U.S. Small Business Administration:
www.sba.gov/sbdc
(800) 827-5722 |
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