Which legal form works best for you?
THIS ARTICLE IS FROM the 2006 edition of the Overdrive Partners in Business manual, co-written by American Truck Business Services, presenter of the Partners in Business seminars. The program is sponsored by Freightliner Trucks and Castrol. To order a manual, call (800) 633-5953, Ext. 1135. Visit this site for more excerpts and program information.
There are six ways to set up your business:
- Sole Proprietorship
- C Corporation (C Corp)
- S Corporation (S Corp)
- Limited Liability Company (LLC)
- Limited Liability Partnership (LLP)
About 80 percent of U.S. businesses are sole proprietorships, and the majority of owner-operators are sole proprietors. Each business form has its advantages and disadvantages, and one may work better than another for your particular situation. However, experts recommend getting the advice of a CPA, tax attorney or business services provider who specializes in the trucking industry before making a decision.
SOLE PROPRIETOR. This is a business owned by one person. It is the least expensive, easiest and least regulated type of business structure. There is no for- mal setup; it begins when you start earning revenue as an owner-operator. This typically is the best choice for owner-operators starting a new business.
The only downside is liability. In the event of an accident, for example, you could be liable for millions of dollars in damages and medical expenses. That’s why it’s important to carry bobtail insurance and why your carrier buys millions of dollars in fleet liability insurance. It would be unusual to lose everything in the event of accident liability if you are properly insured.
PARTNERSHIP. A partnership is similar to a sole proprietorship but is owned by more than one person. The individuals forming the partnership are taxed separately, as they would be if they were sole proprietors. A partnership is easily formed, but a written agreement is strongly recommended. Your business services provider can help you create a simple contract.
Advantages of a partnership include access to extra startup capital and a co-driver who can help you drive more miles. To be successful, co-driving partners should be compatible socially and professionally. Each should bring something to the table that the other person lacks. One may be strong in financial matters, for example, while the other may have mechanical expertise.
Each partner is held responsible and personally liable for the actions of the other in a partnership.
Special types of partnerships include:
Family partnership. Members of a family can be partners. However, family members (or any other person) will be recognized as partners only if certain Internal Revenue Service criteria are met.
Husband-wife partnership. If spouses operate a business together and share in the profits and losses, they may be partners whether or not they have a formal partnership agreement.
CORPORATION. A corporation differs from a sole proprietorship or a partnership in that it is treated as a separate entity from its owners, shareholders and employees. Incorporation laws differ from state to state. The cost to set up a corporation varies from a few hundred dollars to a few thousand dollars.
In addition to those costs, incorporating requires numerous forms, records and formal annual meetings. Incorporating outside your home state can lead to problems. Incorporating is not a good choice for most owner-operators because the costs usually exceed the benefits.
There are two types of corporations:
- “C” Corporation. This is its own entity and pays taxes on the income it earns. The driver is an employee of the C corporation and should receive a paycheck from the corporation. If the driver does not receive a paycheck, the amount taken out of the corporation is a dividend and subject to double taxation both at the corporate and individual level. This is usually not the best choice for an owner-operator.
- “S” Corporation. This allows the driver, still an employee, to report the income of the S corporation on his personal tax return. Since the income is taxable at the individual level, no double taxation exists. S corporation earnings are not subject to self-employment tax. However, compensation must be considered “reasonable,” or it will immediately be a red flag to the IRS and potentially trigger an audit.
Owner-operators are tempted to set up corporations to avoid liability, protect assets and avoid taxation. However, if these maneuvers are not considered legitimate by the courts and IRS, the owner-operator may find himself responsible for all debts, lawsuits, taxes and penalties should the corporation be disqualified as such.
LIMITED LIABILITY COMPANY (LLC). Like the S corporation, the LLC offers protection for owners. Profits pass through the owner’s personal income tax return, so you are not subject to double taxation, such as in a C corporation. LLCs are simpler and more flexible than corporations.
There may be problems for the owner-operator, however, because each state treats LLCs differently. For instance, if the LLC is set up in Wisconsin and an accident occurs in another state, liability protection may be affected. LLCs can be expensive to set up.
LIMITED LIABILITY PARTNERSHIP (LLP). The LLP can also be expensive and complicated to set up and is generally not recommended for owner-operators.