If you’re thinking of starting a business, you have a choice of the form of business. Four major types of business formations exist. Each type has unique advantages and disadvantages you need to consider. Some are easy to create, while others will protect your personal assets from lawsuits which could arise from your business activities. It is possible to start with one formation and grow into another one as your business expands.
Sole Proprietorship
The most affordable and simple kind of business form is the sole proprietorship. Paperwork is limited and there are no incorporation documents, but state or local business licenses may be required. Under a sole proprietorship, a business only has one owner. The name can be the legal name of the owner, or a doing-business-as (DBA) name. The owner is personally responsible for the debts of the business and any lawsuits brought against the sole proprietorship. The sole proprietorship is not a separate business enity. Business profits and losses are filed on your personal income tax return.
Partnership or Limited Partnership
When two or more persons do business with no formal filing, they are in a general partnership. Most general partnerships require no filings with the state. The general partners should have a partnership agreement in place before they start business but it is not mandatory. This general partnership agreement will detail how the business operates and how profits and losses are divided among partners.
In most states, every partner will be jointly and personally responsible for the debts of the general partnership, any lawsuits and the actions of other partners. Each year, the partnership must file an information return with the IRS for tax but the general partnership is not a separate tax paying entity.
When two or more persons do business where one or more of them is a general partner and one or more of them is a limited partner, they are in a limited partnership. The limited partnership differs in several key aspects from a general partnership. First, limited partnerships must register with the state. Second, only the general partner is liable for the debts of the limited partnership, any lawsuits and the actions of other partners. The limited partners have no personal responsibility and only risk the loss of their investment in the limited partnership. The limited partners have limited control over the operations of the limited partnership. The general partners have all of the control over the operations and workings of the limited partnership. Limited partners are like silent investors. Like general partnerships, a limited partnership must file an information tax return each year but it is not a separate tax paying entity.
Limited Liability Company
A Limited Liability Company is formed when you file Articles of Organization with the state. Also create an Operating Agreement that describes how the company is to operate. An LLC offers its owners, called members, limited liability protection. If the business takes on debt, it is the LLC which is responsible, instead of its members. Profits and losses go through the LLC and are shared among members. Those who form an LLC must decide whether they want to be taxed as a partnership or a corporation. LLCs that are taxed as corporations can file a C or S corporation tax return. LLC’s can be managed by the members or by authorized managers as described in the Operating Agreement.
Corporation
A corporation is the most familiar business form. You will need to file Articles of Incorporation with the state. Just like with an LLC, there is limited liability protection for the owners called shareholders. The shareholders must meet annually to elect a board of directors. The board of directors must meet annually to set policy, ratify actions of the corporation since the last meeting, make resolutions about company activities, and elect officers to run the day-to-day activities of the corporation. Typically the officers are President, Vice-president, Secretary and Treasurer though other officers are available. There are two main types of corporations, the C corporation which retains profits and losses but requires shareholders to pay taxes on corporate dividends, or an S corporation where profits and losses flow through to the shareholders.
In deciding which form is best for you, consult your legal and tax advisors.
