Starting a Business? Know Which Business Entity Is the Best Fit

Those considering going into business for themselves should understand the benefits and drawbacks of the different types of business entities before they begin.

Sole Proprietorship

Sole proprietorships are the simplest business entities to set up. If one person is going to own the business, the owner need not register with the state. Depending on the type of business the owner runs, however, he or she may need to secure a business license or license to perform certain work.

The main drawback to a sole proprietorship is that the owner's liability is not limited in any way. If the business incurs a debt or there is a judgment against the business in a lawsuit, the creditors can come after the owner's personal assets, such the owner's home, vehicle or bank account.

The income a sole proprietorship generates counts as income for the owner. A benefit is that the business does not pay business taxes the way that other business entities do. Owners need to be diligent about withholding taxes from their profits so they can pay federal and state income taxes as well as Medicare and Social Security taxes.

Partnership

Similar to sole proprietorships, partnerships are also very easy to form. As long as two people are in business together and share profits, they have a partnership - whether or not they ever signed an agreement. Partnerships need not register with the state to exist. People can have one of three types of partnerships: general, limited and joint venture.

The partners are personally liable for all the debts of the partnership. The owners are also jointly and severally liable for the debts, meaning that a creditor may go after one of the partners for the entirety of the debt the partnership owes.

On the other hand, partnerships do not pay business taxes. The partners pay taxes on the income the partnership generates through their own personal income taxes.

Limited Liability Company

A Limited Liability Company is a business organization that shields the owners of the LLC from personal liability for the LLC's debts. There is no minimum number of people needed to form an LLC, but a person does need to file paperwork with the state to register the LLC.

LLCs have a pass-through tax structure, where the business itself does not pay taxes. The owners pay taxes on the LLC's profits on their own income tax returns.

Corporation

Corporations are the most complex business structures to set up. The owners need to file Articles of Incorporation, write bylaws and issue stock to shareholders. The owners also must set up a board of directors. Those running the corporation need to follow several formalities and keep detailed business records in order to retain corporate status.

Taxation on corporations differs based on whether the company is an S Corporation or a C Corporation. A C Corporation pays taxes on any profits it generates directly from the business. An S Corporation divides the profits among owners and the owners are responsible for paying taxes on the profits on their income tax returns.

Contact an experienced business attorney in your area for more information on establishing a business.