Corporation, Sole Proprietorship, Partnership or Limited Liability Corporation?

The most common forms of business are sole proprietorship, partnership, corporation and limited liability corporations. One form is not necessarily better than another, but everyone must assess his/her own requirements. Seek professional advice from an accountant if you remain uncertain after doing research. Each business entity may have disadvantages as well as advantages for you. The type of business entity you choose depends on liability, taxation and record keeping.

Sole Proprietorship

A sole proprietorship is any unincorporated business owned entirely by a sole person. The sole proprietorship is the most common form of business organization because of its ease to form. However, the owner is personally liable for all financial obligations and debts of the business, with no limits. States all have their own laws. Sole proprietors can operate any kind of business, but it cannot be an investment or hobby. It can be a large or small company, or one with no employees. Sole proprietors are required to keep sufficient records to comply with federal tax requirements.

Partnership

A partnership is a relationship between two or more persons who run a trade or business together. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business. There is no limit to the amount of partners in a partnership, and it holds a single level of taxation. Each owner can be held personally liable unless within a limited liability partnership. No limit is placed on its duration, and general partners manage the company within a partnership agreement document. State law determines specific regulations. Multiple classes of interests are allowed, and there are no restrictions as to the types of owners involved.

Corporation

A corporate structure is more complex than other business structures. It requires complying with more regulations and tax requirements and may require more tax preparation services than the sole proprietorship or the partnership. Corporations are formed under the laws of each state and are subject to corporate income tax at the federal and usually also at the state level. The corporation is treated like an entity, and it handles the business’ responsibilities. Like a person or sole proprietorship, the corporation can be taxed and held legally liable for its actions. However, a corporation’s owner generally is not personally liable for the debts of the corporation, though there may be state exemptions.

Earnings distributed to shareholders as dividends are taxed at individual tax rates on their own personal tax returns.

 

Subchapter S Corporation

The Subchapter S corporation is a variation of the standard corporation. The S corporation allows income or losses to be passed through to individual tax returns, similar to a partnership. Rules for Subchapter S corporations can be located in Subchapter S of Chapter 1 of the Internal Revenue Code.

An S corporation has the same corporate structure as a standard corporation. It is a legal entity, chartered under state law, and is separate from its shareholders and officers. There typically is limited liability for corporate shareholders. Generally, an S corporation is exempt from federal income tax except for certain capital gains and passive income. It is treated in the same way as a partnership, since taxes are not paid at the corporate level.

Limited Liability Company

A Limited Liability Company (LLC) is relatively new. A minimum of two partners are required for tax benefits, otherwise there are no limitations or particular types of owner requirements. Ownership interests can be of many classes, i.e., a corporation may be a partner in an LLC. The LLC can be ongoing, and though its partners are called “members”, managers also can manage an LLC. State law limits transfers of power and interest. An LLC is treated with a single level of taxation if structured properly. An LLC is limited except for an individual’s own professional errors.

LLCs are popular because, similar to a corporation, owners generally have limited personal liability for the debts and actions of the LLC. Other features of LLCs are more like a partnership, providing management flexibility and the benefit of pass-through taxation. Most states also permit “single member” LLCs, those having only one owner. There also are limited liability partnerships.

There are some types of businesses that cannot be LLCs, including banks and insurance companies. Individuals should check each state’s requirements as well as the federal tax regulations for clarification. There are special rules for foreign LLCs.