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Business Entity Descriptions

Business Entity Descriptions
Provided by Business Filings Incorporated (www.bizfilings.com)

Sole Proprietorship

A sole proprietorship is a business owned and operated by an individual, and can only have one owner. Starting a sole proprietorship is quick, fairly uncomplicated and relatively inexpensive. You do not need file documents with the state to form your business, as you do with corporations and Limited Liability Companies. If you plan to conduct businesses under a trade name, rather than your individual name (i.e. Field's Landscaping rather than John Field) you will need to file a DBA (Doing Business As) with a local or state office. There may be additional licenses required by the state and city where you will operate your business (sales tax licenses, liquor licenses, etc). These requirements vary by state. Another thing to consider is that legally, with a sole proprietorship, the owner and the business are the same. The owner is personally responsible for the debts of the company.

Some advantages of a sole proprietorship include:

  • Relatively little time and expense required for creation.
  • Relatively few required formalities and regulatory requirements.
  • Some states do not impose a fee for the mere privilege of existing.
  • No separate income tax filing for the company - income and losses are reported on the owner's tax return.

The primary disadvantage of a sole proprietorship is:

  • The owner is personally responsible for the debts of the company, meaning the owner's personal assets may be used to satisfy business debts.

General Partnership

As with sole proprietorships, general partnerships are fairly easy to establish. Partnerships can have 2 or more owners of the business. Partnerships also do not have to file documents with the state in order to form, as do corporations and Limited Liability Companies, although they may need state and/or local licenses to operate.

Partnerships should have detailed partner agreements in place at the time of formation. Partner agreements should clearly address the rights and responsibilities of each partner - such as the amount of capital each partner will contribute, what will happen if more capital is needed, how profits and losses will be distributed, which partners are responsible for particular management tasks, what happens if a partner wants out of the partnership, what happens if a partner dies, etc. Not having such an agreement could place your investments at risk and provide for a lot of extra time and expense, if the business encounters problems.

Some advantages of general partnerships include:

  • Relatively little time and expense required for creation.
  • Relatively few required formalities and regulatory requirements.
  • Some states do not impose a fee for the mere privilege of existing.
  • No separate income tax filing for the company - income and losses are reported on the owners' tax returns.
  • Flexibility in establishing the responsibilities (capital, management, etc.) of the partners.

Some disadvantages of general partnerships include:

  • Partners are personally liable for the debts of the partnership.
  • Partners are responsible for the business-related actions of all other partners.

Corporation

The standard corporation, also called a C Corporation, is the most common corporate structure. Companies must file certain documents with the state in order to become incorporated. The corporation is a separate legal entity that is owned by shareholders. The standard corporation is allowed to have an unlimited number of shareholders, who are typically protected from the debts and liabilities of the corporation. A shareholder's personal liability is typically limited only to the amount the shareholder invested in the company.

Corporations do experience double-taxation. Corporations are considered a separate legal, taxable entity from the owners for income tax purposes. Therefore, corporations pay tax on their earnings. If corporate earnings are then distributed to shareholders in the form of dividends, dividend income is taxed as regular income to the shareholders. By distributing corporate income in the form of dividends, the corporation does not receive the reasonable business expense deduction. The double taxation occurs at (1) the corporate level and (2) at the individual level. S Corporations and Limited Liability Companies are "pass-through" entities that are not subject to double taxation.

Some advantages of a corporation include:

  • Shareholders are not typically personally liable for the debts of the corporation.
  • The ownership of the corporation is easily transferable through the sale of stock.
  • Corporations have unlimited life extending beyond the illness or death of owners.
  • Tax benefits such as insurance, travel and qualified retirement plans are deductible.
  • Additional capital can be easily raised through the sale of stock (shares) in the corporation.

Some disadvantages of a corporation include:

  • The possibility of double taxation.
  • Corporations are more expensive to form and operate than sole proprietorships and partnerships.
  • More corporate formalities (annual paperwork) and more state and federal rules and regulations than with sole proprietorships and partnerships.

S Corporations

An S Corporation is a standard corporation that has elected a special tax status with the Internal Revenue Service. S Corporations have the same limited liability protection of standard corporations. The S Corporation's special tax status eliminates the possibility of the double taxation that occurs with a standard corporation. The standard corporation pays a federal corporation income tax on its profits. Double taxation then occurs if the corporation distributes profits in the form of dividends to the shareholders, because the shareholder must then report the dividend as personal income and pay taxes on it.

The S Corporation election is quite beneficial when profits from the company will be distributed to the owners each year. By taking the S Corporation election, the income and/or loss of the corporation is reported directly on the shareholders' individual tax returns.

To be classified as an S Corporation, a corporation must make a timely filing of Form 2553 with the IRS. In order for this election to take effect in the current calendar year, the election must be made by March 15, if the corporation is a calendar year taxpayer. A corporation can decide later to elect S Corporation status, but this election would not take effect until the following calendar year.

Some advantages of an S Corporation include:

  • Avoidance of possible double taxation.
  • Shareholders are not personally responsible for the debts and liabilities of the corporation.
  • Most other advantages of a corporation apply to an S Corporation.

Some disadvantages of an S Corporation include:

  • In order to qualify for S Corporation status, the corporation can have only one class of stock.
  • Shareholders must number fewer than 75.
  • Shareholders must be individuals, estates or certain qualified trusts and all must consent in writing to the S Corporation election.
  • Shareholders cannot be non-resident aliens.
  • More corporate formalities (annual paperwork) and more state and federal rules and regulations than with sole proprietorships and partnerships.

Limited Liability Company

The Limited Liability Company (LLC) is a distinct business entity that offers an alternative to partnerships and corporations by combining the corporate advantage of limited liability protection with "pass-through" taxation. The LLC is taxed like a partnership or S Corporation. The LLC's income is not taxed at the entity level; however, the LLC does complete a tax return. The income or loss of the LLC as shown on this return is "passed through" the LLC and is reported on the owners' individual tax returns.

The LLC is owned by its members and does not have any restrictions on the number of members it can have. Members are analogous to partners in a partnership or shareholders in a corporation, depending on how the LLC is structured. A member will more closely resemble shareholders if the LLC utilizes a manager or managers, because the members will not participate in the management of the LLC. If the LLC does not utilize managers, then the members will more closely resemble partners, because they will have a direct say in the decision-making of the company. A member's ownership of the LLC is represented by "membership interest", just like a partner's interest in a partnership or a shareholder's interest in a corporation.

Some advantages of LLCs include:

  • Pass-through taxation where earnings are treated like those in partnerships and S Corporations.
  • Members are not held personally responsible for the debts and liabilities of the company.
  • No restrictions on the number of owners (members) allowed.
  • Flexibility in structuring the management of the company.
  • The LLC does not require as much annual paperwork and have as many formalities as corporations and S Corporations.

Some disadvantages of LLCs include:

  • More paperwork required than with a general partnership.
  • Ownership is harder to transfer than with a corporation.

About the Author

Article provided by Business Filings Incorporated at www.bizfilings.com. Visit them for all your incorporation needs.

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