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 have the right information 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. State filings are not required, and you do not need to pay any fees. The trade-off for this lack of formality is that the sole proprietorship has few other advantages. However, any income earned will be reported on your regular tax return. This creates a 7-9x greater risk of audit. Not to mention, the organizational form provides no protection from individual liability. This means that if you are sued, and they win, then you will 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, you are not required to file with the state or pay any fees. 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. They also share expenditures, income, and property. As with sole proprietorships, partners are taxed on their personal income tax returns. This is 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. State law and the Internal Revenue Code specifically recognize corporations.
Corporations are defined by 3 principles. First, that shareholders invest money in a business. Second, that officers manage the corporation. And third, that a board of directors governs the corporation. If handled properly, the shareholders enjoy limited liability. Shareholders may also receive dividends, or a portion of the corporation’s profits. Dividends depends on how the corporation is structured, as well as the decisions made by the board of directors.
Forming a corporation requires filing specific paperwork in the state of incorporation. It also involves subsequent legal filings, such as an annual report. Most states also require corporations to hold annual shareholder meetings. Furthermore, corporations are taxed. Similarly, shareholders are also taxed. They are taxed on both earned dividends as well as earnings received when they sell their stock.
Alternative Business Entities
Over the years, states have developed additional, alternative forms of business entities. These alternate forms can 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. 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 Bridge 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.