Some new or start-up businesses operate as sole proprietorships due to the ease and low cost of starting up. However, if the business owner desires to operate in one of the legal forms or entities, the most common and practical choices include the partnership, regular or C corporation, S corporation or limited liability company (LLC). A basic description of each is outlined:
Occurs when a single individual engages in business (in some states a husband and wife business might be considered a sole proprietorship). The advantage of a sole proprietorship is the ease of starting. There are usually no formal requirements to do business as a sole proprietor, except that some states require a general business license for all businesses, regardless of the form or entity. The disadvantage of a sole proprietorship is the risk of liability. If someone sues the business and gets a judgment, and they are entitled to satisfy (collect) on the judgment by going after not only the business assets but also the personal assets or property of the individual owner of the business.
Is defined as the operation of a business for profit by two or more individuals. The advantages and disadvantages of a partnership are similar to that of a sole proprietorship. A partnership is fairly easy to start with few formal requirements in most states. A written partnership agreement is recommended. However, the risk of liability becomes more pronounced in a partnership because personal assets are at risk for the actions of the other partners as well as their own.
Regular or C Corporation
This basic corporation is another legal form or structure for conducting business that is authorized by all states. Corporations have sometimes been called legal fictions, meaning they exist only because the state law authorizes their existence. Corporations were first authorized by state laws to provide a form of doing business where a person could invest money in a business venture without subjecting their personal assets or property to liability.Corporations are considered separate legal entities from the people who own them, the shareholders. Thus, if a corporation is sued and a judgment from a court is rendered against the corporation, the law allows the judgment holder to satisfy the judgment (collect or get paid) only from the assets of the corporation and not the private property of the shareholders.This is called limited liability protection. In a sole proprietorship or partnership, a judgment can be satisfied from the personal property of the individual owners of the business if there are insufficient business assets to satisfy the judgment. A corporation is a taxable entity and must pay income taxes on its net income each year. The corporation must file a return on IRS form 1120.
An S corporation is initially formed as a regular or C corporation and is operated and treated as a Corporation for all purposes except for taxes. An S corporation provides the same liability protection as a regular Corporation. The shareholders can elect to be taxed similar to a partnership by filing the S election form (form 2553) with the IRS. An S corporation possesses the important characteristic of being a “pass-through” entity for federal and (most) state income tax purposes. A pass -through entity is one in which the profits or losses are not paid by the entity, but rather are reported by the owners (shareholders) on their individual tax returns. This is done on a prorata basis depending on shareholder’s percentage of ownership. An S corporation is required to file an informational tax return on IRS form 1120S.The S corporation offers the two main benefits that most small business owners seek; 1) limited liability protection and; 2)pass-through of income and losses for tax purposes.
Limited Liability Company (LLC)
A limited liability company or LLC is a non-corporate business entity formed pursuant to the authority by a state statute that provides its owner protection against personal liability from creditors and other third parties. While other business entities like corporations also provide protection from creditors, an LLC possesses the important characteristic of being a “pass through”entity for federal and (most) state income tax purposes. A pass-through entity is one in which the profits or losses are not reported by the entity for tax purposes, but rather are reported by the owners (members) on their individual tax returns. The LLC form of business offers the two main benefits that most small business owners seek; 1) limited liability protection and; 2) pass-through of income and losses for tax purposes.