CONSTRUCTION Accounting ARTICLE -
Is Your Business Structure Still a Perfect Fit?

Target Audience: Construction Industry Professionals, Limited Liability Companies (LLCs), Contractors, Construction Business Owners, Construction Accountant Interest, S Corporations, Sole Proprietorships, Partnerships, C corporations, Business Restructuring Interest

You wouldn’t dream of allowing a construction project to run unsupervised according to the original plans, because circumstances can change. The same is true of your business structure: The ownership form that was once a perfect fit may now need to be adjusted. Beginning with the two most popular choices, here’s a snapshot of each.

1. Limited Liability Companies (LLCs)

LLCs are a form of partnership, so, for tax purposes, they are considered “pass-through” entities. That means owners must include their entire share of business income on their personal tax returns — regardless of how much they take out for themselves.

The advantage: LLCs shield owners’ personal assets from business-related debts and court judgments. In fact, depending on the size and type of project, setting up an LLC for each job may help protect each project individually.

Another advantage of the LLC structure is that there’s no limit to the number of partners, who are called “members.” A downside to LLCs is that income for the owners could be subject to self-employment taxes.

2. S Corporations

An S corporation also is a “pass through” entity and, as a result, is similar to an LLC for tax purposes. And that’s perhaps the biggest advantage to an S corporation — unlike a C corporation (see below), profits flow directly to owners’ personal tax returns rather than being taxed at the corporate level first. Owners’ income is also typically exempt from employment taxes. Moreover, S corporation owners generally aren’t personally liable for business risks.

An S corporation can issue stock but to only 100 shareholders, and the company can’t issue both common and preferred stock. Additionally, an S corporation’s profits must be distributed in proportion to each owner’s share of the business. Certain business entities, however, cannot be S corporation shareholders, and non-U.S. citizens are precluded as well.

3. Sole Proprietorships

The easiest and least expensive way for one person to start a business, a sole proprietorship requires no forms or fees, and there are no structure-related government or regulatory agency rules to follow. Tax-wise, you just report income on your individual return.

The problem is that the owner of a sole proprietorship is the business. Thus, the owner’s personal assets — including a home — are at risk. And the threat of a financially devastating lawsuit is particularly prevalent in the construction business, where disputes are common and employees are subject to significant safety risks.

4. Partnerships

Similar to sole proprietorships, partnerships can be easy and inexpensive to establish. They require only partnership agreements among the owners. Like LLCs, partnerships are “pass through” entities for tax purposes, and partnership income may be subject to employment taxes.

Like sole proprietorships, however, partnerships don’t protect personal assets from creditors — if an owner is a general partner. (Limited partners are liable only up to the amount of their investments.)

5. C Corporations

C corporations are generally the most complicated entity type to form and run. A C corporation must have officers and a board of directors, and it must comply with government financial reporting and operational requirements. Owners generally aren’t, however, personally liable for business risks.

C corporations can issue as much stock to as many shareholders as they desire, making it easy for new partners or owners to buy in — and for retiring partners to sell out. Businesses formed under this structure may also issue a variety of forms of stock (common, preferred, voting and nonvoting) to draw investors while limiting ownership power.

One distinct disadvantage to C corporations, however, is that income is taxed twice — once at the corporate level and again at the personal level, when profits are paid out as dividends. In fact, this may be the primary reason few contractors choose this structure.

Change Cautiously

The good news about all business structures is that you can change them. There are, however, tax and legal implications — and a significant amount of administrative effort — to doing so. And regardless of which structure you use, a formal operating agreement is always a good idea.

Find out how our expertise in construction accounting can add value to your business. Email us or call us at 1 (888) 875-9770.

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