There are four main types of business formations, and each one has its own advantages and disadvantages. Some are easy and inexpensive to form while others provide you limited liability protection that protects your personal assets from creditor claims and lawsuits stemming from your business operations. Some business owners start off using one type of business formation and then change to a different form as their businesses grow.
A sole proprietorship is the simplest and least expensive type of business to form. There are no incorporation documents to file or business notices to run in the newspaper. You may have to get a state or local business license depending on your occupation. A sole proprietorship has only one owner. You can do business under your own name or apply for a “doing-business-as” name to give your business a distinctive name, but the business and the proprietor remain one entity. You have no protection from lawsuits or creditor claims. Your personal assets can be used to satisfy a business debt or legal judgment. You report your business income and expenses to the Internal Revenue Service on Schedule C, which is filed with your individual income tax return.
In a partnership, there are no documents to file with your state. However, partners usually have a partnership agreement drawn up between them stating how the partnership operates and how the profits and losses are shared. Most states hold that each partner has unlimited liability for business debts, the actions of the other partners and lawsuits. The business profits and losses flow through the partnership and are reported on each partner’s individual income tax return. The partnership must file a partnership information return with the IRS every year.
Limited Liability Company
If your state statues allow it, you can file articles of organization or a certificate of formation to form a limited liability company. LLCs provide their owners, who are known as members, with limited liability protection. When you open a business bank account or take on debt, the LLC is responsible for the accounts instead of the individual members. LLC profits and losses flow through the company to each member. LLC members must decide if they want to be taxed as a partnership or a corporation. LLCs taxed as partnerships file the partnership tax return and LLCs taxed as corporations must file either a C corporation or S corporation tax return.
Corporations are the most formal and expensive of the different business formations. You form a corporation by filing the Articles of Incorporation with your state’s department of corporations. Corporations provide limited liability protection for their owners. C corporations retain their profits and losses at the corporate level but have double taxation. They are taxed on their earnings, and shareholders are taxed on their corporate dividends. With S corporations, profits and losses flow through the business to the owners. Both C and S corporations must file corporate tax returns, file annual reports with their incorporating state, conduct annual meetings and meet federal and state record-keeping obligations.