Most small businesses start out as either a sole proprietorship or a partnership, but many eventually explore the transition to another entity. Contact an attorney or accountant to learn the advantages and legal requirements of each to decide which form is best for you.
This is the simplest and least regulated form of organization with minimal legal start-up cost. A person (or couple) owns and operates the business and is responsible for procuring financing. The sole proprietor has total control and receives all profits, and business income is taxed as personal income. The major disadvantages include potential personal liability for the owner and potential dissolution of the business upon the owner’s death.
A partnership is relatively easy to form and can provide additional financial resources. Each partner is an “agent” for the partnership and can hire employees, borrow money, and operate the business. Profits are taxed as personal income and the partners are still personally liable for debts and taxes. Personal assets can be attached if the partnership cannot satisfy creditors’ claims. A special arrangement, called a “limited partnership,” allows partners to avoid personal liability. Limited partnerships must be registered and must also pay a franchise fee. When entering into any partnership, a written agreement is essential.
Limited Liability Company
The limited liability company is treated as a partnership for U.S. income tax purposes and also provides the limited liability of a corporation. This option may be the preferred choice for certain new operations and joint ventures. Owners of limited liability companies are called “members.” These are comparable to stockholders in a corporation or limited partners in a limited partnership. To create a limited liability company, articles of organization are filed with the secretary of state. The members must also execute an operating agreement, which defines the relationship between the company and its members. Not all states have this option available.
The most complex of business organizations, the corporation acts as a legal entity that exists separately from its owners. While limiting the owners from personal liability, this creates a “double taxation” on earnings (corporate tax and personal tax). Corporate structure may be advantageous because it allows capital to be raised more easily through the sale of stocks or bonds and can continue to function even without key individuals. It also enables employees to participate in various types of insurance and profit-sharing plans. Costs to incorporate vary from state to state. Contact the secretary of state for more information. A special type of corporation, an S corporation, allows owners to overcome the double tax and shareholders to offset business losses with personal income. S corporations are subject to an annual surcharge.