The sole proprietorship is a simple, informal structure that is inexpensive to form; it is usually owned by a single person or a marital community. The sole proprietorship is typically used for a business structure as it is easy to form and inexpensive. The owner operates the business, is personally liable for all business debts, can freely transfer all or part of the business, and can report profit or loss on personal income tax returns. This structure is risky if you have employees or a lot of personal assets.
Partnerships are inexpensive to form; they require an agreement between two or more individuals or entities to jointly own and operate a business. Profit, loss, and managerial duties are shared among the partners, and each partner is personally liable for partnership debts. Partnerships do not pay taxes, but must file an informational return; individual partners report their share of profits and losses on their personal return. Short-term partnerships are also known as joint ventures.
If you must start a partnership, make sure a partnership agreement is written up so everyone is on the same page. While it’s “we’re the best of friends and nothing will change that” in the beginning, many businesses have failed because they skipped this simple step. Decide what each person’s roles and responsibilities are, how to settle disagreements (especially in an even number partnership) and how to handle partner’s salaries when the business has a losing month.
Most of the money made in the first 2-3 years will need to be mostly reinvested into the business which often leads to some hard feelings.
C Corporation (Inc. or Ltd.)
This is a complex business structure with more startup costs than sole proprietors and partnerships. A corporation is a legal entity separate from its owners, who own shares of stock in the company. Corporations can be created for profit or nonprofit purposes and may be subject to increased licensing fees and government regulation than other structures. Profits are taxed both at the corporate level and again when distributed to shareholders.
Shareholders are not personally liable for corporate obligations unless corporate formalities have not been observed; such formalities provide evidence that the corporation is a separate legal entity from its shareholders. Failure to do so may open the shareholders to liability of the corporation’s debts. Corporate formalities include:
- Issuing stock certificates
- Holding annual meetings
- Recording the minutes of the meetings
- Electing directors or ratifying the status of existing directors
While there are lots of books and information on the internet, corporations should always be assisted by a qualified attorney. If you don’t follow all the steps and procedures you are at risk of losing your liability protection and that’s why you want a corporation
Sub Chapter S Corporation (Inc. or Ltd.)
This structure is identical to the C Corporation in many ways, but offers avoidance of double taxation. If a corporation qualifies for S status with the IRS, it is taxed like a partnership; the corporation is not taxed, but the income flows through to shareholders who report the income on their individual returns.
Limited Liability Company (LLC)
The LLC is generally considered advantageous because it combines the limited personal liability feature of a corporation with the tax advantages of a partnership and sole proprietorship. Profits and losses can be passed through the company to its members or the LLC can elect to be taxed like a corporation. LLCs do not have stock and are not required to observe corporate formalities. Owners are called members, and the LLC is managed by these members or by appointed managers. Each state will have it’s own set of LLC statutes so be sure to review them against the corporation to see which one is best for you.
Keep in mind that all of the different structures have their individual pros and cons. Regardless of which one you choose, you get to write off all of your expenses (just like a sole proprietorship or partnership) and are not likely to save any more money on taxes by choosing one over the other. (There are occasions but not typically until you are making mid six-figures). While there is a lot of information on the internet, be sure to get legal review to be sure everything is in place.