If you’re setting up or thinking about a brand new business, you must first decide on the legal structure. Below is a breakdown from the SBA (Small Business Administration) of the various legal statuses recognized on the Navajo Nation. 

 

LLC

A limited liability company is a hybrid type of legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. The "owners" of an LLC are referred to as "members." Depending on the state, the members can consist of a single individual (one owner), two or more individuals, corporations or other LLCs. Unlike shareholders in a corporation, LLCs are not taxed as a separate business entity. Instead, all profits and losses are "passed through" the business to each member of the LLC. LLC members report profits and losses on their personal federal tax returns.

Advantages

Limited Liability. Members are protected from personal liability for business decisions or actions of the LLC. This means that if the LLC incurs debt or is sued, members' personal assets are usually exempt. This is similar to the liability protections afforded to shareholders of a corporation. Keep in mind that limited liability means "limited" liability - members are not necessarily shielded from wrongful acts, including those of their employees.

Sharing of Profits. There are fewer restrictions on profit sharing within an LLC, as members distribute profits as they see fit. Members might contribute different proportions of capital and sweat equity. Consequently, it's up to the members themselves to decide who has earned what percentage of the profits or losses.

Disadvantages

Limited Life. In many states, when a member leaves an LLC, the business is dissolved and the members must fulfill all remaining legal and business obligations to close the business. The remaining members decide if they want to start a new LLC or part ways. However, you can include provisions in your operating agreement to prolong the life of the LLC if a member decides to leave the business.

Self-Employment Taxes. In the US, members of an LLC are considered self-employed and must pay the self-employment tax contributions towards Medicare and Social Security. The entire net income of the LLC is subject to this tax.


L3C
 

The low-profit, limited liability company, or L3C, is often referred to as a hybrid of a nonprofit and for-profit organization. More specifically, it is a new type of limited liability company (LLC) designed to attract private investments and philanthropic capital in ventures designed to provide a social benefit. Unlike a standard LLC, the L3C has an explicit primary charitable mission and only a secondary profit concern. But unlike a charity, the L3C is free to distribute the profits to its members/owners.

Advantages

PRI Ready. L3Cs are designed to take advantage of Program Related Investments (PRIs) by private foundations and could allow a venture to tap into new sources of capital.

New Funding Sources. The L3C may be an attractive option for entities with a clear business plan identifying committed private foundation investors whose charitable purpose is consistent with the L3C's social objectives.

Social Branding. The L3C brand communicates the media entity's commitment to a social goal and may serve as a marketing tool for attracting nonprofit and socially-conscious for-profit investors as well as consumers.

Disadvantages

Restricted Purposes. An L3C may not be organized for political or legislative purposes.

Viability of Private Foundation Investment. PRIs are not yet common among private foundations and securing them may be difficult. Additionally, given the challenges of securing investments from private foundations, the efforts necessary to provide market-rate returns on commercial investments in the L3C could be significant.

No tax-deductions Compared to a non-profit, an L3C may make it more difficult for a venture to receive donations since such contributions will not be tax deductible.


Sole Proprietorship

A sole proprietorship is the simplest and most common structure chosen to start a business. It is an unincorporated business owned and run by one individual with no distinction between the business and you, the owner. You are entitled to all profits and are responsible for all your business’s debts, losses and liabilities. Sole proprietorships have a simplified registration process on the Navajo Nation and in most US States. 

Advantages

Easy and inexpensive to form: A sole proprietorship is the simplest business structure to establish, and allows you to migrate up to an LLC or corporation later.

Complete control. Because you are the sole owner of the business, you have complete control over all decisions.

Easy tax preparation. Your business is not taxed separately, so it’s easy to fulfill the tax reporting requirements for a sole proprietorship. The tax rates are also the lowest of the business struct­u­res.

Disadvantages

Unlimited personal liability. Because there is no legal separation between you and your business, you can be held personally liable for the debts and obligations of the business. This risk extends to any liabilities incurred as a result of employee actions.

Hard to raise money. Because you can’t sell stock in the business, investors won't often invest. Banks are also hesitant to lend to a sole proprietorship because of a perceived lack of credibility when it comes to repayment if the business fails.

Heavy burden. You alone are ultimately responsible for the successes and failures of your business.


C-Corp

A corporation is an independent legal entity owned by shareholders. The corporation itself, not the shareholders that own it, is held legally liable for the actions and debts the business incurs.

Because corporations tend to have costly fees and complex tax and legal requirements, they are generally suggested for established, larger companies with multiple employees.

Corporations can sell ownership shares in the business through stock offerings. “Going public” through an initial public offering (IPO) is a major selling point in attracting investment capital and quality employees.

Advantages

Limited Liability. When it comes to taking responsibility for business debts and actions of a corporation, shareholders’ personal assets are protected.

Ability to Generate Capital. Corporations are able to raising capital for their business through the sale of stock.

Corporate Tax Treatment. Corporations file taxes separately from their owners. Owners of a corporation only pay taxes on corporate profits paid to them in the form of salaries, bonuses, and dividends, while any additional profits are awarded a corporate tax rate, which is usually lower than a personal income tax rate.

Disadvantages

Time and Money. Corporations are costly and time-consuming to start and operate. Incorporating requires start-up, operating and tax costs that most other structures do not require.

Double Taxing. In some cases, corporations are taxed twice - first, when the company makes a profit, and again when dividends are paid to shareholders.

Additional Paperwork. Because corporations are highly regulated by federal, state, and in some cases local agencies, there are increased paperwork and record-keeping burdens associated with this entity.


S-Corp

What makes the S-Corp different from a traditional corporation (C-Corp) is that profits and losses can pass through to your personal tax return. Consequently, the business is not taxed itself. Only the shareholders are taxed. There is an important caveat, however: any shareholder who works for the company must pay him or herself "reasonable compensation." Basically, the shareholder must be paid fair market value, or the IRS might reclassify any additional corporate earnings as "wages."

Advantages

Tax Savings. One of the best features of the S Corp is the tax savings. While members of an LLC are subject to employment tax on the entire net income of the business, only the wages of the S Corp shareholder who is an employee are subject to employment tax. The remaining income is paid to the owner as a "distribution," which is taxed at a lower rate, if at all.

Independent Life. An S corp designation allows a business to have an independent life, separate from its shareholders. If a shareholder leaves the company, or sells his or her shares, the S corp can continue doing business relatively undisturbed. 

Disadvantages

Stricter Operational Processes. As a separate structure, S corps require scheduled director and shareholder meetings, minutes from those meetings, adoption and updates to by-laws, stock transfers and records maintenance.