Choosing an entity is often the first major legal decision an entrepreneur must make. In recent years the options have increased. A sole proprietorship owner may have a sole proprietorship, a corporation (C or S), or a limited liability company. An organization with multiple owners can be formed as a general partnership, corporation, or limited liability company (“LLC”) (note that limited partnerships and limited liability companies will not be discussed in this article). On what basis does a company make this important decision? Certain key factors help form a guide to answering this question.

Single owner
This is the easiest, least expensive, and least regulated type of organization for the individual. The only legal need to form this business is to start operations. It is recommended that you file an assumed name registration in all states in which the business will operate and check the zoning and licensing laws for the business location. Additionally, all marketing materials must be trademarked and/or copyrighted.

As a result of the simplicity and low costs involved in a sole proprietorship, many sole proprietorship businesses choose this option. However, there are some negatives to consider. The most important reason for choosing one of the other options is that the person is fully responsible for any and all claims from customers, employees, vendors, or others.

General Partnership
Similar to sole proprietorship in the facility of formation, the only requirement to form a general partnership is that two or more persons engage in a business for profit (Uniform Partnership Law). Expenses and profits do not need to be shared equally. While there are no formal requirements, it is strongly recommended that a written partnership agreement be signed between the partners. Like a sole proprietorship, the general partnership is not taxed as an “entity.”

There are disadvantages in a general partnership. Partners in a general partnership have unlimited personal liability not only for their own torts and contracts, but also for those of the other partners. The death or separation of one of the partners causes the dissolution of the general partnership. Caution should be exercised to prevent the partnership from being considered a corporation by the IRS and then taxed as such.

Corporation
A corporation that is owned by a limited number of people is known as a “closely held corporation.” Like a partnership, most if not all of the shareholders are involved in running the business. However, unlike a partnership, all shareholders or owners of the corporation have limited liability for the acts and omissions of the other owners. Additionally, avoiding personal liability for business debts and court judgments is another advantage of a corporation. Generally speaking, a creditor can only collect against the assets of the business, not against the personal assets of the owners.

Because a corporation is a separate legal entity from its specific shareholders, business continues regardless of who owns the shares. Corporations offer the opportunity to attract investors who can own shares in the company without having to worry about personal liability. Tax deductions can be taken for benefits provided to their employees and owners. Corporations often have a more favorable tax rate structure to allow owners to save profits at a lower rate.

There are two types of for-profit corporations, the “C” corporation and the “S” corporation. These refer to IRS statutes that dictate different tax treatment for the two types of entities. A “C” corporation is required to pay corporate income taxes and shareholders pay taxes on their compensation and/or dividends. For this reason, many small organizations choose to be “S” corporations. An “S” corporation does not pay income taxes; profits and losses are transferred to the owners. However, the owners of an “S” corporation cannot be corporations, partnerships, or LLCs.

Some of the disadvantages of forming a corporation are the costs and paperwork involved. Incorporation costs vary by location, but typically run into the several hundred dollars. Corporations are required to hold annual board and shareholder meetings, and minutes must be kept of the actions of directors and shareholders.

limited liability company
The LLC is a relatively new entity. It was created to combine some of the advantages of a general partnership and a corporation while eliminating some of the disadvantages of both. The owners of an LLC, called “members,” have limited liability similar to that of the shareholders of a corporation. However, in structure, the LLC is more like a partnership.

The LLC can be managed by the members or by a manager. Usually there is no board of directors or officers. Corporate formalities such as meetings and minutes are not required. Gains and losses are transferred to the owners on their personal tax returns and are not separately taxed to the entity. The members of the LLC do not have to be individuals and the voting power and the share of profits and losses do not have to be identical; for example, an owner may receive X% of the profits and own Y% of the LLC and have Z% of the voting rights. It is obvious to see why LLCs are so popular.

In conclusion, there are many factors to consider when choosing the form of entity for your business. The advice of your accountant or tax advisor and attorney should be considered before making a selection. We welcome any questions you may have.

THIS ARTICLE IS NOT INTENDED TO PROVIDE LEGAL ADVICE OR TO ESTABLISH AN ATTORNEY-CLIENT RELATIONSHIP.