Choosing A Corporate Form For Your Business

Whether you are starting a new business or expanding your existing enterprise, you will benefit from evaluating your options for the legal structure of your business. To determine the business entity that will best serve your business and tax planning needs, you may benefit from seeking advice from legal and financial professionals.

The Sole Proprietorship

A sole proprietorship is the simplest form of business to start and maintain. Broadly speaking, in order to start a sole proprietorship you can simply start doing business under your own name (or a fictitious name - a d/b/a) and Social Security number. You must still obtain any licenses or permits required for your business, but the sole proprietorship itself has no special legal formalities or requirements.

Despite the ease of operating as a sole proprietorship, there are distinct disadvantages to choosing the sole proprietorship  as the form for your business:

  • A sole proprietorship is subject to pass-through taxation, meaning that business profits are declared on the owner's personal tax return.
  • A sole proprietor has no shield against personal liability for the operation of the business.
  • A sole proprietor's personal assets can potentially be reached by creditors or through lawsuits to satisfy business debts or liabilities.

By definition, a sole proprietorship has only one owner. If you have a partner in your business, you may form a partnership or other business form, but you may not operate as a sole proprietorship.

The Partnership

A partnership is a business entity that is typically comprised of two or more individual partners. Under some circumstances a partnership may be formed between other business entities, or between a business entity and individual partners.

A partnership is relatively simple and inexpensive to create and maintain. However, partnerships face tax and liability issues that are similar to those of a sole proprietorship, and partners may potentially be held personally responsible for all of the debts and obligations of the partnership.

The most common forms of partnership are:

General Partnership

All partners have some management authority. Most business partnerships take the form of a general partnerships.

Limited Partnership

In a limited partnership, one or more general partners direct the business operations of the partnership. The enterprise also includes one or more limited partners who have no management role.

Limited partners have little or no role in the management of the partnership and, in return for giving up that authority, limited partners' responsibility for the debts and liabilities of the partnership is limited to the value of their investment in the partnership.

A general partner may be an individual, or may be a separate business entity, such as a corporation or LLC.

Limited partnerships are often used for real estate transactions, through which investors join the enterprise as limited partners while a general partner manages the property.

Limited Liability Partnership

In a limited liability partnership, some or all partners enjoy some degree of protection from liability. Partners may be shielded against personal liability for the debts and obligations of the partnership. Partners may also be protected from personal liability for actions of other partners or employees of the partnership, in which they had no personal or supervisory role.

The personal assets of a limited liability partner remain subject to debts or obligations that they have personally guaranteed, and for liabilities and other obligations that arise from their own actions and conduct.

The Limited Liability Company

A limited liability company, or LLC, is a form of business that gains many of the advantages of a corporation but with fewer formalities and burdens than are required of a traditional corporation. An LLC retains many of the advantages of a sole proprietorship or partnership, while providing members with greater protection from personal liability. People who hold an ownership interest in a LLC are referred to as members.

By default a LLC has pass-through taxation, such that profits distributed by the LLC are declared as income on its members' personal income tax returns. If the members of a LLC find that they would benefit, the LLC may opt to be taxed in the same manner as a C Corporation such that the LLC is able to retain income that is taxed at the corporate tax rate.

The Corporation

A corporation is a business entity that is formed under state laws that govern business corporations.

A corporation is recognized as an independent legal person apart from its shareholders and directors. Unless limited in its duration by state law or through its own articles of incorporation, a corporation continues indefinitely.

  • A corporation may enter into contracts, obtain loans, and pay taxes on its own behalf.
  • A corporation continues to exist even after its founders or shareholders pass away or transfer their shares to others.

A corporation's owners or shareholders benefit from limited liability for the obligations of the corporation. Even in the event that the corporation cannot pay its obligations, shareholders are normally shielded from the corporation's creditors beyond the value of their shares.

Ownership of a corporation may be transferred through sale of stock. Depending upon how the corporation is structured, and is classes of shares, the sale or transfer of a controlling interest in the corporation will not necessarily affect the management structure or operations of the corporation.

Corporations come in a number of varieties, including:

C Corporation

A C Corporation is the standard business corporate form. C corporations pay taxes on their profits at the corporate tax rate under Subchapter C of the U.S. tax code.

S Corporation

An S Corporation is a corporation that has elected for its profits to be taxed in the manner of an unincorporated entity (pass-through taxation).

Not all corporations may opt to become S Corporations, as there are legal restrictions on the number of shareholders, classes of share, and foreign ownership that may prevent a corporation from electing S status.

Professional Corporation (PC)

A business that is incorporated to perform professional services, such as the practice of medicine, accounting or law, may opt to incorporate as a professional corporation. Historically, providers of professional services were not permitted to incorporate and had to operate as sole proprietorships or partnerships. Under current law, many professional practices incorporate as PCs or LLCs.)

Nonprofit Corporation

A nonprofit corporation obtains special treatment under state law, but is subject to restrictions as to its ownership and as to what may be done with its profits at the end of the year.

A corporation must be formed as a nonprofit in order to qualify for a federal tax exemption as a 501(C)(3) charitable organization, but mere fact that a corporation is registered as a nonprofit does not mean that the corporation is a charity or that contributions to the corporation are automatically tax deductible.

Close Corporation

Also known as a closely held corporation, a close corporation is owned by a small group of shareholders. The maximum number of shareholders is defined by state law, usually in the range of a maximum of 30 - 50 shareholders. Shares of a close corporation are not traded on a stock exchange or through a dealer network (over-the-counter trading).

Public Corporation

A corporation that has shares that are traded through a stock exchange or dealer network. Public corporations are more heavily regulated than non-public corporations.

Copyright © 2005 Aaron Larson, All rights reserved. No portion of this article may be reproduced without the express written permission of the copyright holder. If you use a quotation, excerpt or paraphrase of this article, except as otherwise authorized in writing 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.

This article was last reviewed or amended on May 8, 2018.