Choosing the Right Business Organization
Two Important Decisions
There are two decisions every entrepreneur must make fairly early in the life of a startup business.
1. Will you go into business alone or with a partner?
2. What type of legal business organization will you use?
The Business Organization You Choose……is one of the most important decisions you make. Your decision affects your level of risk, the taxes you pay, and how much accounting help you will need.
The choices for your business organization and a brief description are:
• Sole proprietorship—a sole proprietorship has no separate legal existence from its owner. Liabilities for business debts are not limited to assets of the business. The owner of the business is responsible for all debts incurred by the business. The owner can have the business under his/her name or “doing business as” (DBA). The business, since it is not a separate legal entity, does not file a separate tax return. Accounting for a sole proprietorship is the most simple of legal forms.
• Partnership—a partnership consists of two or more individuals who co-own a business. Although the business is not taxed separately, it must prepare a return which indicates the distribution of partnership profits and losses to the co-owners. The amount of money and time invested by each partner should be written down in a partnership agreement. In a partnership, any partner can be held liable for the entirety of the business’ debts.
• Limited partnership—a limited partnership is similar to a partnership except that there are one or more general partners in addition to one or more limited partners. The general partners are in the same position as partners above, having authority to act as agents of the partnership, having management control over the business, and being liable for the debts of the business. The limited partners, on the other hand, have limited liability, meaning they are only liable to the extent of their investments. Limited partners do not have authority over the management of the business. They invest in the business and receive a share of profits and losses as stated in the partnership agreement.
• Corporation—a corporation is a legal entity separate from the persons that formed it. Owners of a corporation are known as shareholders. The shareholders elect a Board of Directors who hires managers to manage the corporation. In a small corporation the owners, directors and employees may be the same people. Accounting for a corporation can be more complicated than for other forms of organization. The corporation is taxed on its profits and owners may receive dividends which are taxed again.
• “S” Corporation—an “S” corporation is one that has made an election to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code. Subchapter S corporations do not pay federal taxes. Instead, profits and losses are divided among the corporation’s shareholders who then report them on their income tax returns. “S” corporation owners thus enjoy the advantage of limited liability and profits are not subject to double taxation. However, accounting systems are as complicated as regular corporations. There are certain legal restrictions to your ability to form an "S" corporation. There may also be tax situations where a regular corporation is advantageous to an "S" corporation.
• Limited liability company (LLC)-an LLC is a legal form of business that offers limited liability to its owners and is also a type of corporation. It provides its owners with characteristics of both a corporation (limited liability for it owners) and a partnership or "S" corporation (pass-through income taxation, meaning owners are taxed only at the individual level, not at the company level first). LLCs have become very popular for their flexibility and they are often well suited for a single owner. However, LLCs may have a more difficult time raising capital with an eye toward an Initial Public Offering. Also, many states levy a franchise tax which a partnership or a sole proprietorship would avoid.
If you have decided to form an LLC or a corporation your question may be, "Which one?" The answer isn't always clear -- but because your choice will affect the legal and tax status of your business, it's the most important question you'll need to answer. "LLC or Corporation?" will help you make the right choice with plain-English explanations.
Two Important Decisions
There are two decisions every entrepreneur must make fairly early in the life of a startup business.
1. Will you go into business alone or with a partner?
2. What type of legal business organization will you use?
The Business Organization You Choose……is one of the most important decisions you make. Your decision affects your level of risk, the taxes you pay, and how much accounting help you will need.
The choices for your business organization and a brief description are:
• Sole proprietorship—a sole proprietorship has no separate legal existence from its owner. Liabilities for business debts are not limited to assets of the business. The owner of the business is responsible for all debts incurred by the business. The owner can have the business under his/her name or “doing business as” (DBA). The business, since it is not a separate legal entity, does not file a separate tax return. Accounting for a sole proprietorship is the most simple of legal forms.
• Partnership—a partnership consists of two or more individuals who co-own a business. Although the business is not taxed separately, it must prepare a return which indicates the distribution of partnership profits and losses to the co-owners. The amount of money and time invested by each partner should be written down in a partnership agreement. In a partnership, any partner can be held liable for the entirety of the business’ debts.
• Limited partnership—a limited partnership is similar to a partnership except that there are one or more general partners in addition to one or more limited partners. The general partners are in the same position as partners above, having authority to act as agents of the partnership, having management control over the business, and being liable for the debts of the business. The limited partners, on the other hand, have limited liability, meaning they are only liable to the extent of their investments. Limited partners do not have authority over the management of the business. They invest in the business and receive a share of profits and losses as stated in the partnership agreement.
• Corporation—a corporation is a legal entity separate from the persons that formed it. Owners of a corporation are known as shareholders. The shareholders elect a Board of Directors who hires managers to manage the corporation. In a small corporation the owners, directors and employees may be the same people. Accounting for a corporation can be more complicated than for other forms of organization. The corporation is taxed on its profits and owners may receive dividends which are taxed again.
• “S” Corporation—an “S” corporation is one that has made an election to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code. Subchapter S corporations do not pay federal taxes. Instead, profits and losses are divided among the corporation’s shareholders who then report them on their income tax returns. “S” corporation owners thus enjoy the advantage of limited liability and profits are not subject to double taxation. However, accounting systems are as complicated as regular corporations. There are certain legal restrictions to your ability to form an "S" corporation. There may also be tax situations where a regular corporation is advantageous to an "S" corporation.
• Limited liability company (LLC)-an LLC is a legal form of business that offers limited liability to its owners and is also a type of corporation. It provides its owners with characteristics of both a corporation (limited liability for it owners) and a partnership or "S" corporation (pass-through income taxation, meaning owners are taxed only at the individual level, not at the company level first). LLCs have become very popular for their flexibility and they are often well suited for a single owner. However, LLCs may have a more difficult time raising capital with an eye toward an Initial Public Offering. Also, many states levy a franchise tax which a partnership or a sole proprietorship would avoid.
If you have decided to form an LLC or a corporation your question may be, "Which one?" The answer isn't always clear -- but because your choice will affect the legal and tax status of your business, it's the most important question you'll need to answer. "LLC or Corporation?" will help you make the right choice with plain-English explanations.
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