Choosing A Form For Your Business
By Aaron Larson
August, 2004; Last Reviewed Dec., 2010.
- Choose Your Business Entity
- The Sole Proprietorship
- The Partnership
- The Limited Liability Company
- The Corporation
As you start a new business or expand an existing enterprise, you will benefit from considering your options for the legal structure of your business. It will usually be beneficial to seek advice from legal and financial professionals, in determining the form which will best serve your business and tax planning needs.
A sole proprietorship is the simplest form of business to start. Ordinarily, all you need to do is start operating as a business under your own name (or a fictitious name - a d/b/a) and Social Security number, obtain any required licenses or permits, and you're in business.
But there are some distinct disadvantages to operating as a sole proprietorship, which you should consider when determining if this business form is right for you. A sole proprietorship is subject to pass-through taxation, with profits declared on the owner's personal tax return. There is also no shield against liability, and a sole proprietor's personal assets can be reached to satisfy business debts or liabilities. By definition, a sole proprietorship has only one owner. If you have a business partner, you may be a partnership or choose a different business form, but you cannot operate as a sole proprietorship.
The partnership is a business entity ordinarily comprised of two or more individuals, although under some circumstances a partnership will be formed between other business entities, or between individuals and a business entity. The partnership is relatively inexpensive and simple to create and maintain, but poses tax and liability issues which are similar to those of a sole proprietorship.
General Partnership - Most partnerships take the form of "general partnerships", where all partners have some management authority.
Limited Partnership - In a limited partnership, there are one or more "general partners" who direct the business of the partnership, and one or more "limited partners" who have no management role. The general partner may be another business entity, such as a corporation or LLC. This structure is often used for real estate transactions, where investors sign on as limited partners, and the general partner manages the property. Limited partners have little or no role in the management of the business, and in return for surrendering that authority their responsibility for business debts and liabilities is limited to the amount of their investment.
Limited Liability Partnership - The partners to a limited liability partnership are shielded against the debts and obligations of the partnership, and against liability for actions of their partners or employees in which they take no part and have no supervisory role. However, their personal assets may remain subject to other debts they have personally guaranteed, and for obligations or liabilities arising from their own conduct.
A limited liability company, or LLC, is a business entity that enjoys many of the advantages of being a corporation, including limited liability, while avoiding many of the more singificant burdens imposed on corporations, and while retaining many of the characteristics of unincorporated entities such as partnerships and sole proprietorships. By default, an LLC has pass-through taxation, with members declaring their share of profits as income on their personal tax returns. An LLC may opt to be taxed in the same manner as a C Corporation, in the event that it would benefit from being able to retain income and pay taxes on that income at the corporate tax rate.
A corporation is a business entity created under state law, which stands as an independent legal "person" apart from its shareholders and directors. Accordingly, a corporation may enter into contracts, obtain loans, and pay taxes on its own behalf, and it continues to exist even after its founders or shareholders die or transfer their shares to others. A corporation's owners or shareholders receive the benefit of limited liability for the obligations of the corporation, and are thus ordinarily shielded from the corporation's creditors even in the event that the corporation cannot pay its obligations. Unless limited by state law or its own articles of incorporation, a corporation continues indefinitely. Ownership can be transferred through sale of stock, and the sale or transfer of a controlling interest in the corporation does not necessarily affect its management structure or operations.
C Corporation - A C Corporation is a standard business corporation, which pays taxes on its profits at the corporate tax rate under Subchapter C of the tax code.
S Corporation - An S Corporation is a corporation which has elected for its profits to be taxed in the manner of an unincorporated entity. Not all corporations can opt to become S Corporations.
Professional Corporation (PC) - A special type of corporation incorporated to perform professional services, such as the practice of law or medicine. (Historically, professionals were not permitted to incorporate. Now, many professional practices incorporate as PC's or LLC's.)
Nonprofit Corporation - A nonprofit corporation obtains special treatment under state law, but is subject to restrictions as to its ownership and to what may be done with its profits at the end of the year. While a corporation must be a nonprofit in order to qualify for a federal tax exemption as a "501(C)(3)" charitable organization, the mere fact that a corporation is registered as a nonprofit does not mean that the corporation is a "charity" contributions to the corporation are automatically tax deductible.
Copyright © 2004 - 2011 Aaron Larson. All rights reserved. No portion of this article may be reproduced without the express written permission of the copyright holder. If you believe you may lawfully use a quotation, excerpt or paraphrase of this article under the Fair Use exception to copyright law, except as otherwise authorized by the author of the article, you must cite this article as a source for your work and include a link back to the original article from any online materials that incorporate or are derived from the content of this article.