Common Business Entities
In a Sole Proprietorship, an individual who owns an unincorporated business operates on his or her own behalf. Business profits and losses are reported on the owner’s tax return and not on a separate business filing. Liabilities of the business are the owner’s personal responsibility, so if someone sues the business for any reason (debt collection, breach of contract, personal injury) the court can directly garnish the owner’s personal bank account and other property. While the sole proprietorship is a simple and relatively inexpensive way to operate business, there are significant liability issues to consider. Operating as a sole proprietor is not usually advisable.
With a Partnership, an agreement is established between two or more people to own the business jointly and share profits and losses. Business liabilities are the potential responsibility of each owner. Profit and loss distribution is determined in the partnership agreement and passes through to the individual partners and is not necessarily determined by the ownership percentages. Control of the business is also determined by the partnership agreement and, unless stated otherwise, is jointly controlled by the partners with each having an equal vote. As with sole proprietorships, personal liability is a risk in the event that a problem arises. Some risk to the partners can be reduced by operating as a Limited Liability Partnership.
Corporations are owned by one or more stockholders, who elect a board of directors to manage the business. Officers may be elected by the board to manage the daily affairs of the business. A major benefit of a corporation is that shareholders are not generally responsible for the liabilities of the corporation. In most cases a claim for breach of contract or personal injury could only be collected against the corporation and not the owners’ personal finances. Each corporation files its own tax return, pays its own taxes, and may be subject to state franchise taxes or other annual fees. Tax rates for corporations are bracketed based upon taxable income. Taxation of corporations and record keeping requirements are sometimes factors that work against operating a new business as a corporation.
Limited Liability Companies (LLC) are very flexible and inexpensive structures to utilize for a business. An LLC features many of the advantages of a corporation without some of the complexities. The LLC Operating Agreement outlines the percentages of ownership, methods of distribution of profit and loss, and voting powers. Taxation is selected by the LLC to be like that of a partnership, an S Corp, or a C Corp. Liability protection is a benefit to the owners and officers, and is similar to a corporation. LLC’s can be fairly easy to operate and do not require the same complicated record keeping procedures that apply to corporations.