So you’ve decided to start a business. It’s a very exciting time, but fraught with many decisions. One of the first, which can impact everything from taxation to liability, is the choice of a business entity. Should you opt for a traditional sole proprietorship, a partnership, a corporation, or an alternate business entity? Today we will discuss these different types of business entities so you can be best informed when the time comes.
Types of Business Entities
The simplest form of business entity is a sole proprietorship. There are no formalities with this structure. No filings are required with the state and no fee must be paid. The trade-off for this lack of formality is that the sole proprietorship has few other advantages. Any income is reported on your regular tax return (creating a 7-9x greater risk of audit), and the organizational form provides no protection from individual liability, which means if you are sued and they win, you pay out of your personal assets.
The most traditional type of partnership is called a general partnership. This type of business entity is also very informal. As with sole proprietorships, no filings are required and no fees must be paid. In fact, a partnership may be found to exist even without a formal or informal agreement between the parties.
The essence of a general partnership is that the partners share management and control of the business, as well as expenditures, income, and property. As with sole proprietorships, the partners are taxed on their personal income tax returns, in proportion to their share of the income. General partnerships provide no personal protection from liability.
Only one type of traditional business entity helps to limit legal liability: the corporation (or limited liability company). A corporation is a much more formal legal structure, one that is specifically recognized by state laws and the Internal Revenue Code.
Corporations are built around the notion that shareholders invest money in a business, which is managed by officers and governed by a board of directors. If handled properly, the shareholders enjoy limited liability. Shareholders may also receive dividends, or a portion of the corporation’s profits, depending on how the corporation is structured and decisions made by the board of directors.
Forming a corporation requires filing specific paperwork in the state of incorporation, as well as subsequent legal filings, such as an annual report. Most states also require corporations to hold annual shareholder meetings. Corporations are taxed, and shareholders are taxed on dividends they earn, as well as earnings received when and if they sell their stock.
Alternative Business Entities
Over the years, states have developed additional, alternative forms of business entities to leverage advantages such as pass-through taxation and limited liability. Alternative business structures include limited partnerships, limited liability companies, and “S” corporation status. State law dictates the availability of these alternatives and in our LIFT Start-Up Session, we will help you to identify the best possible legal structure for your business.
Call today to make an appointment with KCKW Law Firm. We offer a complete spectrum of legal services for businesses and can help you make the right selection. We also offer a LIFT Start-Up Session, which includes employment structuring, financial, and tax systems you need for your business.