Most flight schools begin as either a sole proprietorship or small business, but what happens when we begin to grow and expand? Of course we celebrate the success, but to protect all that you’ve worked so hard to build, you may want to consider creating a legal entity to protect your personal assets as well as those of your family.
Taking a hard look at the structure of your business will help you determine the most appropriate and beneficial type of entity to form. With proper guidance and good record keeping, you should be able to enjoy the successes you’ve built and rest easy that you won’t be risking your future with any sudden financial catastrophe. Here are the types of legal entities along with some positive and negatives of each type.
Individual ownership (sole proprietor): Usually the way we all start out, a sole proprietorship is generally not as complex as the other structures, but liability rests solely on your shoulders, leaving you exposed and vulnerable. Even if you are covered by insurance, if your aircraft becomes involved in an accident or an injury takes place on your premises you could suffer the harsh consequences of financial ruin. While your taxes are relatively simple to prepare (you usually only need to file a Schedule C along with your personal Form1040), after deductions and expenses, any income from your business will be taxed at your personal income tax rate.
Partnership: Sharing ownership of your flight school with others could justify a partnership; the difference between a partnership and co-ownership, a common source of confusion, is that a partnership is for making a profit in business, while a co-ownership does not. As a partnership your school can operate and purchase and dispose of assets, such as aircraft and office equipment, under the entity of your business. However, a partnership will still not afford greater liability protection to the owners than a sole proprietorship. When it comes tax time, partnerships are considered pass-through entities and must file a return on Form 1065, where the actual profit or loss is then distributed via an IRS 1065 K-1 form to each individual in the partnership. He or she will then be taxed at his or her own individual personal income tax rate.
Limited liability company (LLC): While LLC legal structures can vary from state to state, they are very popular because they help owners to decrease their exposure to liability. An LLC is an unincorporated business association that refers to its owners as “members” with a designated “manager,” although some states allow one-person LLCs as well. Members may own property and do business as the LLC, but they don’t have a property interest in any specific asset or other property owned by the LLC—only a financial interest to share in profits and losses, company distributions, and the right to share in management. In accordance with your specific state laws, members can usually withdraw funds and get paid for their share, as well as assign their financial interests to another individual. Members are not personally liable for the LLC’s debts and obligation, so long as members do not mix personal and LLC funds by maintaining separate accounts. LLC members enjoy greater flexibility when it comes to taxes. For example, if there is only one member of the LLC, he or she will file taxes on Schedule C of his or her personal Form 1040, while a multimember LLC must file as a pass-through type of entity, such as a partnership. However, both situations have the option of filing the LLC taxes as an entity apart from its members by filing an IRS Form 8832, which is taxed as corporate income tax on IRS Form 1120. Consulting with a tax professional is highly recommended to ensure an LLC is maximizing its tax benefits appropriately.
Corporation: While a corporation may seem like the most complicated type of entity to form, it may prove to be worthwhile based on your particular needs in relation to asset and liability protection, and tax considerations. Most states allow a corporation to be held by just one person or many. Enlisting the help of a professional, such as an attorney or corporate service to assist in the preparation and filing of your corporation’s articles of incorporation is highly recommended, especially if you choose to incorporate in a different state than you operate. Many businesses choose to incorporate in states such as Nevada or Delaware because of their simplicity and tax savings. Just make sure you follow the state’s rules where the business is in operation for proper registration. As far as liability protection, creditors generally cannot pursue members/shareholders for personal assets. Save time and money in the long run by enlisting a tax professional when you form the corporation to help you get bookkeeping and recordkeeping properly set up; not only will it make corporate tax preparation a breeze, but it will help to ensure you are retaining the proper entity status.