Choosing the Business Entity
After you have decided to start your own business, you will need to decide whether you want to create a separate legal entity for it. If so, how that entity will look and what other steps you need to follow to get it up and running. Although this article is intended to provide general advice on business, you should still seek specific legal advice tailored to your situation.
Sole Proprietorship:
Sometimes, single-owner businesses choose to be sole proprietorships. The business acts as an extension to the owner. The individual tax returns of the owners will account for the profits and losses of each business. This type of business is simple because there aren’t separate corporate or partnership formalities.
All business liabilities will pass through the business owner. This means that, for example, if a customer gets hurt on the premises of the business, or if the business has to pay more than it can afford, the business owner’s personal assets are legal and available to settle those claims.
General Partnership:
A General Partnership can be formed by two or more people who own a business. The general partners decide how they will share the profits and losses of the company and sign a partnership agreement. Profits and losses from the general partnership are then credited to the tax returns of individual partners according to the ownership percentages set out in the partnership agreement. The income tax on the partnership is not separate.
Despite the agreements between partners regarding how profits and losses should be shared, each partner is still responsible for all business liabilities. A creditor or plaintiff may sue any general partner for the entire amount of any judgment or claim.
Limited Partnership:
Limited Partnership is similar to the General Partnership. Profits and losses are divided among the partners. They then flow through to all partners’ tax returns in accordance to the percentages determined by the partnership agreement.
Some partners may be “limited”, meaning they are not subject to personal liability for any debts or judgements against the partnership. A Limited Partnership must have at least one general partner. This general partner will not be subject to any personal liability. Management of the business will be performed by the general partner(s), not the limited partner(s).
Limited Liability Company:
A Limited Liability Company, or “LLC”, is made up of one or more members. An agreement between the parties determines the ownership percentages, profits and losses distributions and voting rights of each LLC member. This agreement is usually reduced to writing. The LLC can choose to be taxed as a partnership, with profits and losses flowing to the owners (as discussed above) or as a corporation (as described below). LLC members are exempt from all liabilities.
Corporation:
Corporations are the most common form of legal business organization. They are owned by one or more stockholders and managed by a Board elected by stockholders. The Board appoints officers to manage the day-to-day operations of the corporation. The company’s stockholders, directors, and officers are generally exempt from any liabilities.
There are two types of corporations for tax purposes: “C” Corporations or “S” Corporations. A “C” corporation is an independent tax entity. Profits and losses are taxed at the corporate level and not through the stockholders’ tax returns. A separate “franchise tax” may be assessed at the state level for the “C” corporation. If stockholders choose to be treated as an S corporation for tax purposes, the corporation will be taxed like a partnership. The corporation’s profits and losses will be passed directly to stockholders according to their stock ownership.
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