If you are starting your own business, you must choose the form of your business carefully. There are various different business forms, each with its own pros and cons. As such, it is important to fully understand your options before making your decision.
A sole proprietorship is the simplest form of business and is cheap and easy to set up. A sole proprietorship is a single person, known as a sole proprietor, starting a business for profit and there are no filings required. The sole proprietor manages every aspect of the business and all of the profits and losses of the business are reported on the sole proprietor’s individual tax return. While it is easy, cheap, and allows the owner complete control and autonomy, the sole proprietorship offers no liability protection and the sole proprietor is personally liable for all obligations and debts of the business.
A general partnership is similar to a sole proprietorship, except it involves two or more people, known as the partners, agreeing to operate a business for profit. No filings are required to form a general partnership, which makes it relatively cheap and easy to form like a sole proprietorship. However, the partners must agree, preferably in writing, to each partner’s share of control, capital, and profits and losses. The profits and losses of the general partnership are passed through to the partners and reported on their individual income tax returns. General partnerships afford no liability protection to the partners, and the partners are jointly and severally liable for all obligations and debts of the general partnership.
A limited partnership (LP) is similar to a general partnership in that it requires two or more partners agreeing to operate a business for profit. Unlike a general partnership, however, an LP is only formed by filing with the appropriate government entity. The LP has two different types of partners, general partner and limited partner, and there must be at least one of each. The general partners are selected by the limited partners and manage the day-to-day affairs of the LP, while the limited partners are not permitted to participate in the day-to-day management of the LP. In this relationship, the general partners are liable for the obligations and debts of the LP and the limited partners are not, so long as they do not participate in the day-to-day management of the LP. The general partners and limited partners must agree on the share of capital and profits and losses of the LP. The profits and losses of the LP are passed through to the partners and reported on their individual income tax returns.
The corporation is formed by filing with the appropriate government entity and it is a legal entity separate from its owners, known as shareholders. The shareholders have rights to the capital and profits and losses of the corporation and elect directors and officers to manage the day-to-day affairs of the corporation. The shareholders, directors, and officers do not have personal liability for the obligations and debts of the corporation. The corporation is taxed on its profits and losses, and the shareholders may be taxed on amounts of money or the value of property paid out to them by the corporation, with such double taxation being one of the biggest negatives of the corporation. The corporation also has numerous formalities that must be followed and requires extensive record-keeping, which can make it expensive and time-consuming to operate.
Limited Liability Company (LLC):
The limited liability company (LLC) is one of, if not the, most popular business entity form because of the flexibility it offers in ownership, management, and taxation. The LLC is formed by filing with the appropriate government entity and can be structured in myriad ways. It can be structured like a partnership, where the owners, known as members, manage the LLC, in addition to sharing in the capital and profits and losses of the LLC. Or it can be structured like a corporation where the members share in the capital and profits and losses of the LLC, but designate managers to manage the day-to-day affairs of the LLC. Regardless of the structure chosen, the LLC is considered a separate legal entity from its members, managers, and officers, who are generally insulated from personally liability. In addition to the flexibility in structure, the LLC also provides flexibility in the manner in which it is taxed—it can be taxed as a sole proprietor, partnership, or a corporation.
Choosing the correct form for your business is an important decision that can have long-term consequences for your business, as well as you personally. At Starr Law Firm, P.C., we are well versed in the process of starting a business and forming a business entity, including, choice of entity, and will assist and advise you throughout the entire process to help you make a decision that meets your particular needs and intentions. Contact Starr Law Firm, P.C. to begin the process of forming a business today.