When creating a business, there are different organizational forms from which you can choose. Traditionally, you may be aware of three types, sole proprietorships, partnerships and corporations. There are, in fact, other kinds and knowing what each form has to offer is integral when choosing the type of business organization that is best for your company.
Sole Proprietorships and Partnerships
Sole proprietorships and partnerships are similar forms of organization and together comprise about 80% of the businesses in the United States. The main difference between the two is that a sole proprietorship has one owner and a partnership has two or more owners. Otherwise they are generally treated identically. There are benefits to forming as either of these types of businesses. This includes favorable tax treatments and lower costs to organizing. The downside is that the owners have unlimited liability. What this means is that since you are the business, not only is your business up for grabs if you fall behind on payments of debt or find yourself on the wrong end of civil litigation, but your personal assets are fair game as well.
Corporations are an entirely different story. After paying the fees associated with forming as a corporation, your business now exists as an entirely separate legal entity. Barring any gross negligence, you are personally free from liability in the event that something goes wrong. This however comes at a price: double taxation. Not only are profits taxed at the corporate level, but when paying yourself a salary, fee, or dividend, you are taxed again. Sole proprietorships and partnerships are not subject to double taxation as the income for your business is reported on your tax return.
There are two common forms of corporations, C-corporations and S-corporations:
C-corps are the most common form and are described above. In order to be a publicly traded company, you generally have to be a C-corp. A C-corp can issue shares to a virtually unlimited number of investors and is a popular choice for those with a large amount of resources. A corporation also has unlimited life, as it is its own legal entity, whereas the existence of a sole proprietorship relies on the existence of the owner.
An S-corp is less common and has some restrictions that must be met in order to qualify as such. This includes but is not limited to having a maximum number of shareholders (100), it must be a domestic corporation where none of the shareholders may be non-resident aliens, and must not be one of the restricted types of business which cannot be an S-corp (for example, insurance companies and financial institutions cannot be S-corps.) Commonly, due to the aforementioned restrictions, S-corps are formed for use with family businesses. The benefit is that if you can meet the requirements to become an S-corp, you avoid double taxation and enjoy all of the benefits associated with a C-corp.
An LLC (limited liability company) is a hybrid form of business that combines the benefits of a sole proprietorship or partnership with the benefits of a corporation. The protective limited liability of a corporation shields the owners or “members” as they are called, from personal financial liability. As it is not a separate legal entity like a corporation, all the profits pass through the LLC and are paid by its members as individual income tax, thus avoiding double taxation. An LLC’s members are required to pay self-employment taxes such as Social Security and Medicare.
Limited Liability Partnerships are another option available in most states, however they may be restricted to professionals such as attorneys, accountants or architects. Despite the similarity in names, LLPs do not offer the same amount of limited liability as an LLC. Generally in an LLP, each partner is protected from personal liability due to claims against other partners. Like an LLC, this form of business organization avoids double taxation.
Now what do I do?
After determining what type of business you will be forming, we can work together to determine what form of business organization will best serve your needs. Please feel free to email me or call me at (401) 383-9694 for more information.