You’re starting your own business, but what type of legal entity will you establish for the business? It can be difficult to balance the advantages and disadvantages of these structures. So let’s review the options and simplify those considerations:
A sole proprietorship is the simplest form of business entity. In this scenario, one person is responsible for the company, its profits and its debts. The most common way to structure your business, it is easy to form and gives complete managerial control to the owner. At the same time, the owner is then personally liable for all financial obligations to the business.
When the entity is owned by two or more individuals, it is a partnership. The partners agree to share in both the profits and losses of the business. These profits and losses are reported on the partners’ individual tax returns. However, each partner is still personally liable for the financial obligations of the business.
- Limited partnerships (LP): when one general partner has unlimited liability, and the other partners have limited liability. The limited liability partners also tend to have a limit on their controls over the company, as documented in a partnership agreement.
- Limited liability partnerships (LLP): limited liability is given to all owners of the company. An LLP protects partners from the partnership’s debts, so they are not responsible for the actions of their partners.
Limited liability company (LLC):
This business structure is a hybrid that limits personal liability for its owners, partners or shareholders, while enjoying the tax and flexibility benefits of a partnership. Therefore, personal assets will not be at risk if the LLC faces bankruptcy or lawsuits.
Corporations are viewed as entities that are separate from their owners. Therefore, a corporation has legal rights that are independent of its owners. Corporations come in five different types:
- C Corporations: these legal entities are separate from their owners. Therefore, they make profits, are taxed and can be held legally liable. Shareholders are provided with strong protection against personal liability, and the departure of a shareholder or sale of stock doesn’t disturb the continuation of business by the C Corporations.
- S Corporations: much like partnerships or LLCs, owners have limited liability protections and avoid double taxation by passing profits and some losses directly to the owners’ personal income while avoiding corporate tax rates. There are special limits on S Corporations.
- B Corporations: benefit corporations are driven by mission and profit. So while they service society in some way, they maintain a for-profit structure.
- Closed corporations: traditionally smaller companies with an informal corporate structure, closed corporations do not participate in public trading and are typically run by a few shareholders without a board of directors.
- Nonprofit corporations: organized for the purpose of charity, education, religious, literary or scientific works. As benefits to the public, they are tax-exempt.
Cooperatives are owned and operated for the benefit of those using its services. Cooperatives are generally run by an elected board of directors or officers, while regular members have voting power to contribute to the direction of the cooperative. Members join by purchasing shares, but the amount of shares they hold does not increase or decrease the weight of their votes.
In our next blog, we will dive deeper into the advantages and disadvantages of these structures, and the tax implications of each. Visit the Simma Flottemesch & Orenstein blog to follow along.