In a sole proprietorship, the business and the person are the same, with no legal separations between the two. This means the person is personally and financially responsible for any debts or damages. While solo in name, sole proprietors are able to hire employees or contractors. But, the work done by any employees hired through a sole proprietorship is still legally bound to the sole proprietor.
Again, this keeps the responsibility all on the founder of the sole proprietorship. Unlike a freelancer, a sole proprietor has a registered business name , can hire employees, purchase business insurance, and even obtain higher forms of business licenses. Sole proprietorships are easy to start, making them a great way to give your solo operation a more professional appearance. If you're currently freelancing or plan on starting a small operation that requires only your efforts, a sole proprietorship could be the right choice.
A general partnership is similar to an LLC, in that the members can structure the business as they see fit.
But, in a general partnership, all profits, legal obligations, assets, and losses are shared. All members of a general partnership are responsible for any financial and legal damages, with their personal assets at risk in the event of forfeiture. The primary perk of a general partnership is that it's easy to set up. There's far less paperwork involved than with setting up a corporation or LLC, and it's a great way to make your appearance even more professional.
But, keep in mind all members of a partnership are equally responsible for damages incurred. So, it's a good idea to only go into a partnership with those you trust. Your company is exactly that: yours. Only you know where you want it to be, both in the near future and the far off. Think about your goals to decide which type of corporation or business entity feels right for your company. Your needs will likely change over time, so rest assured your choice of business entity isn't set in stone.
If you realize you may have made the wrong choice, you can always begin the process of restructuring your company. Take your time, do your research, and you'll land on the right business entity for your startup. From there, you can work on your small business continuity plan , and be prepared for anything life throws your way, be it taxes , an unexpected financial crisis, or a new business partner. How does your type of corporation or entity affect your business? The different types of corporations and business structures When it comes to types of corporations, there are typically four that are brought up: S corps, C corps, non-profit corporations, and LLCs.
S corporations An S corporation is a business entity that passes almost all finances through to its shareholders. Non-profit corporations A non-profit corporation is similar to a traditional corporation in structure: There's generally a board of directors, as well as donors or financial backers. Limited liability companies LLCs A limited liability company LLC , also known as a limited liability corporation, is a business entity that prioritizes the separation of the people in the business and their personal liability.
Sole proprietorships A sole proprietorship is a one-person show. General partnerships A general partnership is similar to an LLC, in that the members can structure the business as they see fit. The right type of corporation for you Your company is exactly that: yours. Looking for a way to store, save, and spend your cash while building business credit? Once an LLC is formed, it's good business practice to set out the roles and responsibilities of the members.
The members are individuals with an ownership interest in the LLC. Most LLCs use an operating agreement to define these roles. Drafting an operating agreement is not necessary for an LLC to be valid but it is a prudent course of action. If no operating agreement is created, an LLC is governed by the default rules contained in state statutes.
The operating agreement sets forth the rights and responsibilities of the members. It can define the business relationship and deal with issues of capital structure , the allocation of profits and losses, provisions for the buyout of a member, provisions in case of the death of a member, and other important business considerations. Members can choose how they are taxed. They can be treated as a sole proprietorship, a partnership, or a corporation.
The most common tax option of an LLC is taxation similar to a sole proprietorship. The profits and losses of an LLC are passed through the business to the owner. The owner then has to report the profits or losses on their own personal tax returns.
The LLC itself does not pay any corporate tax. This method avoids double taxation, which is a drawback of corporations. Although an LLC does come with plenty of advantages, there are some disadvantages to consider. LLC members also have to pay a self-employment tax , which includes a There are other drawbacks to an LLC as well. The purpose of an LLC is to protect its members from any liability.
If the company fails to meet its obligations, only the LLC can be a target for creditors, not the assets of the members. However, there are certain situations in which an LLC can be automatically dissolved, leaving members open to risk. Automatic dissolution can be triggered if an LLC fails to report its filings on time, a death or withdrawal of any member occurs, unless succession provisions are outlined in the operating agreement, a change in the structure of the LLC, such as a merger , as well as any terms with expiration dates.
In these situations, an LLC can continue doing business, but the liability structure of the members may alter, defeating the initial purpose of creating the LLC. Prior to the passing of the Tax Cuts and Jobs Act in , an LLC treated as a partnership for tax purposes could automatically be terminated due to tax reasons as well.
This rule no longer applies from the tax year and beyond. Another major disadvantage is the differences among states in the statutes that govern LLCs. This can lead to uncertainty for LLCs that operate in multiple states. The differences in rules and regulations can result in additional paperwork and inconsistent treatment across different jurisdictions. Despite the ease of administration of an LLC, there are significant advantages to using a corporate legal structure. Two types of corporations can be formed: an S corporation and a C corporation.
An S corporation is a pass-through entity, like an LLC, where the owners are taxed on profits and losses of the corporation. A C corporation is taxed at the corporate level, separately from its owners, through a corporate income tax.
C corporations are the most common type of corporation. C corporations have the advantage of allowing profits to remain with the corporation and paying them out as dividends to shareholders.
Also, for businesses that eventually seek to issue stock, a C corporation can easily issue shares to raise capital for further expansion of the business. Corporations offer more flexibility when it comes to their excess profits. What are the most common business structures or entities? Why does your choice of business structure matter?
So, the structure you choose is very important. Sole proprietorship The simplest business structure is the sole proprietorship. Who is a sole proprietorship for? How do you form a sole proprietorship? What should you be aware of? Some states also require a public notice in the form of a newspaper ad. If you have employees, your taxes will be a bit more complicated, but not by much; see the IRS sole proprietorship page for more information.
You might have trouble getting a small business loan: Banks are often reluctant to give business loans to sole proprietorships, as they are seen as less credible.
You are assuming full liability: If your business fails and you become overburdened with debt, your personal assets like your car, house, and personal savings are at risk. You are also personally liable for any legal issues that may come up.
That means that if someone sues you, they could go after your personal assets. Who is a partnership for? How do you form a partnership? This can help you clearly lay out who is responsible for what, and what will happen if you decide to stop working together. See the IRS partnership page for more info on filing your partnership taxes.
Make sure you have a partner you can trust: It should go without saying, but as partners are solely responsible for any bad business dealings or debt that they may incur, make sure that you choose a partner that you trust with your business, your credit score, and your reputation. Who is a limited liability corporation for?
How do you form a limited liability corporation? See the IRS limited liability company page for more info. Depending on your situation, an LLC may be a good alternative to a sole proprietorship. Who is a corporation for? How do you form a corporation? Corporations have more potential to raise capital: Corporations can sell stock, which increases their ability to get investors.
Separate taxation from personal taxes: Corporate taxes are filed separately from personal taxes, meaning that your business will be eligible for corporate tax breaks. See the IRS corporation page for more info. With a sole proprietorship, you can essentially set up a business simply by producing work or making a sale. Double taxation can be a factor: Depending on the type of corporation you establish, this may not be an issue; for example, S corps are not subject to double taxation, as the shareholders are the ones who pay state income tax, not the corporation itself.
However, if you establish a traditional C corporation, you will be responsible for both income taxes on earnings from the corporation, as well as paying taxes on dividends received from the corporation. You will probably want to work with a business accountant on this one—which may be an added expense and hassle for a very small business. Who is a nonprofit for? How do you form a nonprofit? Fundraising will be your main priority: Nonprofits generally rely on fundraising and grants to keep a flow of income into their business.
Ask your attorney Tim Berry, founder of Palo Alto Software maker of Bplans reminds small business and startup founders that choosing a business entity or structure is something to take seriously. Briana Morgaine. Starting or Growing a Business? Check out these Offerings. Liked this article? Try these:. Candice Landau. Back To Top.
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