Last month I wrote about the importance and benefits of turning your hobby-business into a legitimate, legal business. As promised, I am now going to explain four of the most common business entites. Read below about Sole Proprietorships, General Partnerships, Corporations and Limited Liability Companies. Each state has different requirements for business formations, so the information below is general and applies to all states. Consult an attorney in your area to learn more about forming a legal business in your state.
A Sole Proprietorship (S.P.) is the simplest business entity that a person can use to legally operate a business. An S.P. is not a legal entity, but rather refers to the individual who owns and operates the business. Here are some key facts you should know about Sole Proprietorships:
- Least expensive method of business formation.
- There may be state specific requirements for formation, such as filing for a d.b.a. (doing business as) with the State Comptroller. State sales tax laws apply.
- There is only one business owner.
- For tax purposes, profits are actually personal income for the business owner, also called pass-through taxation.
- Business owner maintains unlimited personal liability for business debts, taxes, damages from defective products, etc.
- This is the minimum requirement for legally operating a business.
A General Partnership (G.P.) another simple business entity. It is substantially similar to a Sole Proprietorship; where an S.P. has one business owner, a G.P. has two or more business partners that jointly own the business. In most other aspects, the two business entities are identical. Here are some key facts you should know about General Partnerships:
- Inexpensive method of business formation.
- There may be state specific requirements for formation, such as filing for a d.b.a. (doing business as) with the State Comptroller; State sales tax laws apply.
- There are two or more owners.
- For tax purposes, profits are actually personal income for the business partners, also called pass-through taxation.
- Business partners maintain unlimited personal liability for business debts, taxes, damages from defective products, etc.
- No governing document or formalized agreement between the business partners is required; all formation requires is a mutual agreement to operate a business together and to commence operation of the business.
- By default, all partners share equally in management responsibilities, liability, ownership percentage and profits; this default can be overridden by the execution of a Partnership Agreement.
Corporations (Corps.) are business structures that form a legal entity which is separate from the business owners. Corporations maintain their own earnings and protect the owners from unlimited personal liability. Here are some key facts you should know about Corporations:
- Formation requires the filing of Articles of Incorporation with the state.
- The owners of a Corporation are called Shareholders. Shareholders obtain their ownership by investing or purchasing Shares of the Corporation.
- Shareholders are paid through Dividends. A Dividend is a payment from the Corporation, usually taken out of the Corp’s profits.
- A Corporation is managed by Directors and Officers. Directors decide the corporations’ policies and sit on The Board. Officers carry out the day-to-day functions of the Corporation.
- Shareholders’ liability is normally limited to the amount he has invested; the Corporation maintains the balance of the liability.
- A corporation is a separate, tax-paying entity; The Corp. pays tax on its income and the shareholders also pay tax of dividends they receive from the Corp. This results in a double taxation, which can be avoided if you choose to form your corporation as an Subchapter S Corporation, which is not subject to entity taxation.
Limited Liability Companies
A Limited Liability Company (LLC) can best be described as a cross between a partnership and a corporation. An LLC combines the tax benefits of a Partnership and the liability protection of a Corporation. Here are some key facts you should know about Limited Liability Companies:
- The owners of a LLC are called Members; there is no requirement as to the number of Members an LLC must have.
- There are state specific requirements for formation, such as filing Articles of Operation or a Constitution with the Secretary of State.
- For tax purposes, profits are actually personal income for the Members, also called pass-through taxation. This is the same tax benefit as a Sole Proprietorship and a General Partnership.
- Members’ personal liability is limited; the LLC maintains the majority of liability in the same way a Corporation does.
- Members must execute an Operating Agreement which details how the LLC will be managed; the LLC is bound by the terms of the Operating Agreement.
[DISCLAIMER: This article does NOT contain legal advice and NO attorney-client relationship arises from reading it. Always contact an attorney in your jurisdiction to learn about laws applicable to you.]