Choosing Your Business Structure

A business may be conducted through a variety of organizational structures.  A specific business structure is generally chosen for liability and / or tax reasons.  There are several types of business organizations:

Sole Proprietorship

One person operating a business as an individual is a sole proprietorship.  The sole proprietorship is the most common form of business organization.  Profits are taxed as income to the owner personally.  This rate is usually lower than the corporate tax rates would be.  The owner has complete control of the business but faces unlimited liability for its debts.  Since this is a fairly simple type of legal structure, there is very little government regulation and reporting.

General Partnership

A partnership exists when two or more persons join together in the operation and management of a business venture.  Partnerships, like sole proprietorships, are subject to relatively little regulation and are fairly easy to establish.  A formal partnership agreement is recommended in order to address potential conflicts before they arise; for example, who will be responsible for performing each task, what, if any, consultation is needed between partners before major decision are made, if a partner dies, and so on.  Under a general partnership, each partner is liable for all debts of the business.  All profits are taxed as income to the partners based on their percentage of ownership.

Limited Partnership

Like a general partnership, a limited partnership is established by an agreement between two or more individuals.  In a limited partnership, however, there are two types of partners.  A general partner has greater control in some aspects of the partnership; for instance, only a general partner can decide to dissolve the partnership.  General partners have no limitations on the dividends they can receive from profits and so incur unlimited liability.  Limited partners can only receive a share of profits based on the prorated amount on their investment, and the liability is similarly limited in proportion to the investment.

"C" Corporation

A "C" corporation is a legal entity made up of persons who have received a charter legally recognizing the corporation as a separate entity having its own rights, privileges and liabilities, apart from those of the individuals forming the corporation.  It is the most complex form of business organization and is comprised of three groups of people: shareholders, directors, and officers.  The corporation can own assets, borrow money and perform business functions without directly involving the owner(s) of the corporation.  The corporation, therefore, is subject to more government regulation than proprietorships or partnerships.  Corporate earnings are subject to "double taxation" when the corporation is taxed and when passed through as stockholder dividends.  However, corporations have the advantage of limited liability, but not total protection from lawsuits.

Subchapter "S" Corporation

A special section of the Internal Revenue Code permits a corporation to be taxed as a partnership or sole proprietorship, with the profits taxed at the individual rather than the corporate rate.  To qualify as a Subchapter "S" corporation, a business must meet certain requirements.  For more information, contact the IRS and request IRS publication 589.

"LLCs" and "LLPs"

The Limited Liability Company (LLC) is rapidly becoming a very popular business form.  An LLC combines selected corporate and partnership characteristics while still maintaining status as a legal entity distinct from its owners.  As a separate entity, it can acquire assets, incur liabilities and conduct business.  As the name implies, however, it provides limited liability for the owners.  LLC owners risk only their investment.  Personal asset are not at risk.  The Limited Liability Partnership (LLP) is similar to the LLC with the exception that it is aimed at professional organizations.