One major decision for operating a horse business is determining which legal business organization to use. The one that fits your situation depends on liability, control, number of owners, and tax purposes. You may even find that you want to use several forms of business organization for your horse operation – for example, one for a business and another for ownership of land.
The major types of business ownerships are:
1. Sole Proprietorship
- This is the most common form of business ownership in the United States. The owner is the sole owner with all the profits, losses. and liability.
- Profits are accrued to the owner and taxable at individual level by the Internal Revenue Service. All income is reported on Schedule C or F as a self-employment income.
- There is no legal filing required to form entity.
- The owner is responsible for all losses.
- Owner has unlimited control, which in turn means unlimited legal and financial liability; personal assets are at risk.
- Single owner
- Simple formation of entity, simple record keeping
- Can easily move from state to state
- No double taxation
- Individual possesses unlimited personal liability, with no protection
- Self-employment tax is paid on all net income
- Entity ceases upon death of individual
2. General Partnership
- A general partnership is a formal or informal business arrangement between two or more individuals.
- The partners are equally responsible for decisions, liability, taxes, debts, and profits.
- The partnership will file a separate form (1065 tax form) with the income split as agreed upon and reported on the individual partners' tax form.
- One partner is personally responsible for the actions of the partner(s). One partner's personal assets can be at risk as a result of debt, actions, and missteps of the other partner in conducting partnership business.
- Simple-to-form entity
- No double taxation
- Pools talents of two or more individuals
- Easier record keeping, but the books must balance
- Partners have unlimited personal liability, with no protection
- Partners pay self-employment tax on net income
- There are no tax-free benefits to partners
- Entity ceases when one partner leaves or dies
- Also known as a general corporation, C Corporation is a common vehicle used to organize your business.
- It has the same set of rules that are used in a major corporation with an unlimited number of shareholders.
- The entity is governed by a board of directors elected by the corporate shareholders.
- All income is reported on the corporate income tax return. Tax returns are filed on Form 1120.
- The "owners" are the holders of the corporation's common stock. They are not at personal risk or liability for actions of the corporation.
- The corporation must be registered in the owners' state and have a set of rules which must be followed to be considered a corporation.
- It is suggested to not put land into a corporation due to tax reasons.
- Owners have limited liability
- The corporation does not cease upon death of a stockholder
- Owners can be an employee and receive fringe benefits such as health care deductibles
- Entitled to an extra 15% tax bracket
- Profits may be subject to double taxation
- Corporation taxed on net income
- Dividends are non-deductible
- Time-consuming registration and record keeping process
- A corporation with 100 or fewer shareholders. (All family members are counted as one shareholder.)
- Very similar to a C Corporation except that earnings are taxed at the individual level.
- A separate tax return on Form 1120-S, while income is reported on corporate tax return and is passed through to shareholders' individual income tax returns.
- Formed by filing Articles of Incorporation with the Secretary of State and by adopting bylaws.
- Corporation doesn't pay any taxes but is rather distributed to the stockholders who report the income as self-employed income.
- Only one stockholder required
- Limited stockholder liability
- No double taxation; income passed through to stockholder
- Stockholder distributions are not subject to self-employment tax
- Can bifurcate income to limit self-employment taxes; pay yourself wages, rent for land, building, machinery, etc.
- All income flows through shareholders to limit retained earnings
- Limited to one class of stock
- Generally must have fiscal year end as December 31
- Limited to 100 shareholders
- Stockholder must receive wages from corporation
- The entity debt can be more than the deductions
- Benefits over 2% are not allowed for employee owners
Sole Proprietorship versus S Corporation: In most cases, it would be beneficial for a taxpayer to be an S Corporation to avoid having all income subject to self-employment tax. However, one must always think about a few factors before becoming an S Corporation:
- The amount of net income you generate
- The initial cost of incorporating
- The time and cost associated with filing an extra tax return
- Value of limited liability
4. Limited Liability Company (LLC)
- A flexible "hybrid" business organization with two or more members.
- LLC has the flexible option to report taxes as a partnership or a corporation.
- This is formed when Articles of Organization are filed with the Secretary of State.
- Provides an extra "shield" of liability protection as long as the business operates according to the bylaws and rules of the LLC.
- Also provides flexible options for transferring land or business ownership shares.
- Members have limited liability to LLC equity
- No double taxation
- Not limited to one class of stock
- Must have at least two members
- Cannot provide tax-free benefits to partners
- State law may limit the life of an LLC
- Considered "1 Person" for FSA payments
- Entity ceases when a member leaves or dies
- Managing member pays self-employment tax on his or her portion of net income
Limitations of LLCs and Corporations:
- Many people use corporations and/or LLCs for protecting personal assets from business liability, for taking advantage of tax advantages, or for ease in transferring ownership shares in business or land.
- Both structures require registration and a set of business operational rules.
- Some use these agreements to protect the business from the impact of a divorce. Financial liability cannot be eliminated because banks will require the owners of land that is used as collateral to allow a lien on the property.
They don’t prevent you from being sued, so it's still important to have liability insurance.
Is a Corporation or an LLC right for your horse business?
- How many owners are involved?
- Are you exposing personal assets to potential risk of loss?
- Are other business assets at risk?
- What is the potential for liability?
- Are you considering passing ownership to the next generation?
- Are there non-active owners who want liability protection?
- Will a change in business structure provide tax savings?
- LLCs are very popular today. But be sure that you know why you are getting a LLC.
- You need a lawyer who is familiar with your business and with LLCs.
- Don’t accept “boilerplate fit-all” agreements. Be sure to ask lots of questions and consider all points.
- Be sure you follow the LLC agreement, or you will likely lose any liability protection you were striving for.
- Consider separating assets for different ownership models if needed.
How Do You Own Your Business?
Funded in part by the North Central Regional Center for Rural Development (NCRCRD)
NOT LEGAL ADVICE: This resource has been prepared for general information purposes only. The information presented here is not legal advice. Legal advice is dependent upon the specific circumstances of each situation. Also, the law may vary from state to state so that some information in this resource may not be correct for your jurisdiction. The information in this resource cannot replace the advice of competent legal counsel licensed in your state.