Which legal form is right for your small business?
The average person who is starting their own business may not be aware of the variety of different business forms that exist for them to choose from. They may be aware of the general partnership and corporation, but know very little about the limited liability corporation or the S corporation. Then, even if they are aware of the different forms, they may not know the differences between them. Below is a list of a few of the more popular business forms, a brief explanation of some of the major differences between them and some advice on which ones to choose.
1. Sole Proprietorship and General Partnership
These two entities are the default business forms; if you just up and start your company with no state filings you will legally be considered a sole proprietorship or a general partnership. The main difference between a sole proprietorship and a general partnership are the number of owners involved. In a sole proprietorship there is only one individual while a general partnership is formed with any number of people greater than one. These forms allow the owners a great deal of autonomy, but they provide little protection from liability and few tax benefits. The owners of these entities are directly liable for all the debts of the business and the gains and losses of the company must be reported on the individual owners income taxes. Although these forms are easy to create, a new business owner may want to consider one of the forms below in order to receive greater protection.
2. The Corporation
This form is universally available and it provides protection from the problem of personal liability. In the corporation the owner’s liability for debts is generally limited to the amount that he or she has invested. Thus, debtors normally cannot recover from the personal assets of the owners. When it comes to the taxation of corporations however, it is a mixed bag. The corporation is taxed as a separate entity, meaning it files its own tax return independent of the owners. This can be an advantage, but it comes at a cost: corporations are subject to what is known as “double taxation.” Under the federal income tax scheme corporations pay a corporate tax on their profits and then those profits are taxed again when they are distributed to the owners in the form of dividends. The corporation tends to be the choice of larger business ventures, but a small start-up company may prefer to go with the Limited Liability Company as it combines the advantages of the general partnership and the corporation.
3. The Limited Liability Company
The Limited Liability Company, or LLC, is a fairly recent creation, but it is quickly becoming one of the most popular in the country. The LLC possesses many of the best attributes of the corporation without taking on the worst ones. The LLC grants its owners protection from limited liability so, like the corporation, the owner’s liability is limited to the amount of their initial investment. However, unlike the corporation, the LLC allows the owners to choose whether or not they want to be taxed like a corporation or as a general partnership. Thus, the owners can choose to be subject to “double taxation” or have the gains and losses reported on their individual returns. More and more business owners are choosing the LLC because of this combination of liability protection and tax flexibility. For many new business owners, the LLC may be an ideal choice.
Other differences exist between the above business forms, and they may make one or the other options a better fit for your company. Additionally, other business forms exist, such as the S corporation or Limited Liability Partnership. For further information regarding which forms are best for you conduct some of your own research or contact a small business attorney, but whatever you do, make sure your choice is an informed one.
Guest post by Joseph Pometto, J.D.