Legal Entities for Rural Entrepreneurs

From agriculture-based organizations to engineering enterprises to handicrafts, rural entrepreneurs establish businesses of all varieties and sizes. But no matter the scale orlocation of the business, the business’s legal structure plays a considerable role in the owner’s legal accountability for the products and actions of the company. To ensure rural small business owners have all the facts regarding business structure, here is a fast guide to what entities are available for your rural business and how each can defend you from future legal disasters.

Sole Proprietorships

By far the least complex business structure to form—a sole proprietorship is considered a nonentity in the United States. Therefore, it does not need to register formally in its native state.

While sole proprietors are self-employed, it’s wise to operate your business under a company name and maintain separate bank accounts for personal and business activities; This is especially crucial for small rural enterprises, such as crafts or small farming. Without proper separation, the Internal Revenue Service may consider your activities a diversion instead of an official business. And engaging in a pastime excludes the owner from declaring any business expenses and credits available to business owners.

Suppose a sole proprietor doesn’t register a company name with the state. In that case, the business owner’s first and last name is, by default, the business’s name. Rural entrepreneurs who prefer to operate their enterprises under a different name must register for a “fictitious name” or a “trade name” with the Secretary of State of their states. By filing a DBA or “Doing Business As,” the owner has established a separate professional business identity.

However, a distinct business name does not transition into a legal separation between the sole proprietor and the business. In a sole proprietorship, profits and losses are transmitted through to the owner and lodged with the owner’s taxes on a Schedule C (IRS Form 1040) “Profit or Loss from Business.” Although the sole proprietor is not an employee of the business, they are still responsible for paying self-employment taxes such as Social Security and Medicare. Typically, sole proprietors file taxes and business documents with their social security numbers; however, once the sole proprietor hires an employee (or several employees), the owner must obtain a Federal Tax ID number or Employer Identification Number (EIN) from the IRS. (Most banks require you to have an EIN to establish a business bank account, so it’s a good idea to get one as soon as feasible.)

In a sole proprietorship, the owner is exclusively liable for the legal and financial debts of the business. So, if the owner fails to pay their bills or gets sued by a customer or vendor, their personal assets (home, car, checking and savings accounts, etc.) are on the line to satisfy the debts.

Partnerships

Like sole proprietorships, businesses with more than one owner who does not register for another legal entity in their native state are considered partnerships. In a partnership, each partner possesses an equal portion of the assets and liabilities by default (and the partners are personally liable for the legal and financial debts of the company). However, the partnership division of assets and liabilities does not have to be equal if the partnership agreement specifies the specifics.

Partnerships may have some state guidelines to follow, depending on the state and how the partnership is structured:

General Partnership (G.P.)

A general partnership is straightforward and doesn’t require you to register with the state. In a G.P., all participants have equal authority to make company decisions about financing and contracts. Also, each partner retains equal liability and is held responsible for the company’s debts and legalities. G.P. proprietors are also not deemed company employees and must pay employment taxes on their share of the profits (owner draws).

Limited Partnership (L.P.)

Limited partnerships must register with the state and observe state guidelines, which may require reserving an L.P. business name, allocating partner duties, and periodic reporting obligations. L.P.s typically have one designated general partner and one or more limited partners. Limited partners may invest money and share in company profits and liabilities but not participate in the company’s daily operations.

C Corporation

As described above, the sole proprietorship and the partnership structures provide the business owner with no legal separation from the company. Alternately, many business owners choose to incorporate their companies for the personal liability protection it offers the proprietors and shareholders. In a C Corporation, the business is legally separate from the proprietors, and all corporation activities (profits, losses, etc.) belong solely to the corporation. The proprietors of a C Corp are employees of the company, are issued a W-2, and the company is responsible for paying its share of the payroll taxes. Plus, because of the protection from liabilities, founding a C Corp makes raising money from investors simpler.

C Corps may have the most compliance requirements and are the most costly business structure to establish. Though the process of establishing a C Corp may appear complex, C Corps offer the greatest protection from personal liability for the owner(s) of the business. Each state has its guidelines for forming a C Corp, but, in general, incorporating as a C Corp involves:

• Choosing a distinctive business name and registering the name with the state.

• Selecting a board of directors to supervise the activities of the C Corp and represent the shareholders.

• Formally registering the business by filing Articles of Incorporation with the Secretary of State.

• Obtaining an Employee Identification Number (EIN) or Federal Tax ID number from the IRS.

• Drafting corporate bylaws to document how the company operates.

• Holding regular board meetings and taking meeting minutes.

• Submitting an initial report (if required) and submitting annual reports to inform the state of any changed company information.

• Obtaining any required business licenses and permits to operate legally in the location of the business.

• Because the C Corp is its entity, it also submits corporate taxes separately, which results in double taxation for the business proprietors. The final line? A C Corp offers the most protection if your rural-based business makes any product or provides services where you may be sued or want to protect your personal assets.

Read Also: Habits of Highly Successful Entrepreneurs

Limited Liability Company (LLC)

The limited liability company (LLC) offers rural entrepreneurs the tax benefits of the sole proprietorship, with the liability protection of the C Corp without the formality of the corporate structure and the complexity of establishment. By default, profit and losses pass through to the LLC members (owners) and are taxed at the members’ personal income tax rates. The LLC must also register and operate under state law regulations. LLCs are structured as single-member (one proprietor) or multi-member (more than one owner). Also, in a multi-member LLC, the company can be member-managed or managed by a designated (non-member) manager.

Although LLCs must also register in their native state, the initial and follow-up steps are typically less cumbersome. In most states, establishing an LLC involves:

• Choosing and registering a distinctive business name.

• Filing a “Articles of Organization” document with the Secretary of State.

• Creating an LLC Operating Agreement to define the company’s management structure, investor contributions, profit division, and other contingencies.

• Some states also require a “Statement of Information,” which documents the company’s name, associate information, and business address.

In addition, LLCs have the flexibility to choose how they want to be taxed. By default, single-member LLCs are taxed as sole proprietors, and multi-member LLCs are taxed like a partnership. However, LLCs can choose to be taxed similar to a C Corp and take advantage of the tax credits and deductions only allowed to corporations. But this will generate double taxation.

If they choose the S Corp tax election, the LLC members will be treated as employees. However, only their wages and salaries are subject to self-employment taxes. The residual proceeds are deemed distributions and not subject to social security and Medicare taxes. LLCs must file IRS Form 2553 by March 15 of the current tax year to elect S Corp status with the IRS.

The Cooperative

Another business structure for rural entrepreneurs is the cooperative or “co-op.” A co-op is a business or organization owned by and operated for the benefit of its members. The cooperative’s profits and revenues get distributed among all the members, also known as user-owners.

Cooperatives are popular in rural communities because they increase bargaining power, reduce costs, obtain products and services, and take advantage of new and existing market opportunities.

Usually, a board manages the cooperative, but the other members vote to control the cooperative’s direction, such as whether the co-op should incorporate. To learn more about rural cooperatives, see the SBA’scooperative website.