So you’ve made the decision that you want to start your own business. One of the very first decisions you will have to make is to choose what form of organization that you’d like for your business. There are a number of choices with various tax consequences.
A Sole Proprietorship is owned and controlled by one individual. This person receives profits from the businesses but also is personally liable for all of the losses. A sole proprietor is also responsible for the debts and obligations. Any income or expenses of a business are reported on that sole proprietor’s individual income tax return, and those same profits are taxed at an individual income tax rate.
A General Partnership is a business that’s owned by two or more persons who want to carry on the business as a partnership. Partners in a General Partnership share the rights and responsibilities to manage the business equally. Further, each partner is responsible for debts and obligations of the business. Any distributions of profits, debts, and allegation of responsibilities are usually defined in a written agreement. Any income or expenses are reported on Federal and State informational tax returns that are filed by the partnership. Usually, partners are taxed on their profits on their individual income tax rates.
Limited Partnership (LP)
A Limited Partnership in contrast to a General Partnership is where limited partners share in the partnerships liability equal to the amount of their investment in the limited partnership. A limited partnership must have one general partner that has the responsibility to control the limited partnership. The general partner is also responsible for the debts and obligations of the limited partnership. Limited Partnerships are generally more complex than General Partnerships.
Limited Liability Partnership (LLP)
A General Partnership can choose to register as a Limited Liability Partnership merely by filling out a limited liability partnership registration. A benefit of registering as a Limited Liability Partnership is that the personal assets of the partners are not subject to liabilities incurred by the partnership in tort or contracts. This is different than a General Partnership because a partner in a General Partnership can be personally liable for the debts of the partnership. If you do chose to create a Limited Liability Partnership the name of your company must contain either the words “Limited Partnership”, “Limited Liability Partnership,” or the abbreviation “LP” or “LLP,” or the words “Limited Liability Limited Partnership” or the abbreviation of “LLLP.”
A Corporation is different than any type of partnership because it creates a separate legal entity. A Corporation is owned by one or more shareholders. The Shareholders of the corporation have a Board of Directors and those Board of Directors are responsible for managing and controlling the corporation. Because a corporation has been set up as a separate legal entity distinct from its shareholders, the corporation itself is responsible for its debts and obligations. Shareholders for the most part cannot be implicated in the Corporation’s debts.
For tax implications, because a Corporation is a separate legal entity it is also taxed as a separate entity. The Corporation can be a chapter “C” Corporation or a chapter “S” Corporation. Those two distinctions refer to different subchapters of the Internal Revenue Code.
- A C Corporation reports its income and expenses on a corporate tax return and is taxed at a corporate income tax rate. If a Corporation wants to be taxed as an S Corporation it means that the Corporation may have only one class of stock, no more than 100 shareholders, and no shareholders that are non-resident aliens or non-individuals.
- An S Corporation is taxed similarly to a partnership but the income and expenses of an S Corporation flow through to the shareholders and profits are taxed to the shareholders at their individual tax rate.
Closely Held Corporation
If a Corporation has shares that are held by a relatively small number of shareholders, then it is a Closely Held Corporation. That relatively small number of shareholders cannot exceed 35. Most Closely Held Corporations involve a small business where almost all shareholders are actively managing and advising the business. A Closely Held Corporation is attractive because it allows for the benefits of being a corporation, meaning it is taxed as a separate legal entity and its shareholders are immune from liability; however it still retains a more simplified business approach than a partnership does.
Limited Liability Company
A Limited Liability Company has the limited liability characteristics of a Corporation and can elect to be treated as a Sole Proprietorship, Partnership, or Corporation for tax purposes. A Limited Liability Company can have one or more members.