There are three main factors to consider when chosing a structureÂ for your business: taxes, liability, and organizational structure.Â The four primary forms of doing business are discussed below.Â Each form has specific advantages and disadvantages which mustÂ be considered when establishing your business. Remember thatÂ you can chose one type of business structure now and changeÂ it later if it is avantageous for you. As such, you may chose toÂ operate as a Sole Proprietorship now and change to a SubchapterÂ S Corporation at a later date. The tax and liability considerationsÂ of the different structures can be quite significant. A visit withÂ your accountant regarding your specific financial situation mightÂ be worthwhile before deciding which form of business to use.
Your business is completely owned by you. You own all the assetsÂ and are entitled to all of the profit; you are also responsible forÂ all liabilities and any losses. It is especially easy and inexpensiveÂ to start a sole proprietorship and there are no additional incomeÂ taxes to prepare other than your personal income tax form.
Partnership (Including Limited Partnerships)
Your business is owned and operated by you and at least oneÂ other person. Together you share profits and losses, and theÂ assets and liabilities of the company according to a writtenÂ partnership agreement (recommended, but not required) or anÂ oral understanding. Partners pay income taxes on the individualÂ share of the profits, but no seperate income tax on the business.Â In most states, your partner can not be your spouse as you areÂ considered one legal entity. Partnerships are also relatively easyÂ and inexpensive to form. The downside to a partnership is thatÂ you and your partner have legal liability for one another’s acts.
Limited partnerships are similar to general partnerships exceptÂ that there are two types of partners; general partners and limitedÂ partners. Limited partners are typically investors who, unlikeÂ general partners, are limited in legal liability to an amount basedÂ on their capital contribution to the business. A limited partnershipÂ is limited to 35 owners. Both general and limited partnershipsÂ enjoy the benefits of partnership taxation.
Corporation (Including Subchapter S)
A corporation is a separate legal entity formed in conjunctionÂ with other owners, or by you alone. A corporation does businessÂ in its own name, separate from you and the other owners. AÂ corporation must have articles of incorporation and bylaws. YouÂ often need a lawyer to properly establish a corporation. OwnersÂ are usually limited in their liability to an amount equivalent to theirÂ investment in stock. Corporations must pay corporate incomeÂ taxes, and the owners must pay individual taxes on any salariesÂ or dividends they receive from the corporation. A corporation isÂ formed by filing Articles of Incorporation with the Secretary ofÂ State. Shares of stock are issued to the shareholders, bylaws areÂ adopted, and a board of directors is elected. Corporations costÂ more to establish but there can be significant advantages.
A subchapter S corporation is formed by making a special IRSÂ election. This election allows the flow-through taxation treatmentÂ similar to that of partnerships and LLCs. An S corporation isÂ limited to 75 stockholders.
Limited Liability Company (LLC)
The LLC is a relatively new form of doing business that combinesÂ characteristics of a corporation and a partnership. Like aÂ corporation, it is a separate entity and carries liability protectionÂ for all of its members, but like a partnership, an LLC does notÂ pay taxes as it has the benefit of flow-through taxation. TheÂ owners are called members. The key factor determining whetherÂ the LLC qualifies for partnership tax treatment is its similarityÂ to a corporation. In order to qualify as an LLC a company canÂ only have two of the following four traits of a corporation:Â limited liability, continuity of life, centralized management, andÂ free transferability of interests. An LLC is created by filing aÂ form called, Articles of Organization with the Secretary of State.Â Most states require that the LLC have some type of an operatingÂ agreement.