Overview of Business Entities

Choosing the best way to legally structure your business is one of the most important decisions
you will make. No single business structure will suit every kind of business.
Considering the owners (or owner), their financial condition and what activities the business will
be engaged in, you must decide whether your requirements will be best met by a sole
proprietorship, partnership, corporation, or limited liability company (LLC).

The overview presented here is intended as a brief introduction to the different ways businesses
can be organized. It is not intended to serve as a substitute for professional assistance. Since state
statutes vary, it may be advisable to seek more detailed advice from local professionals who are
familiar with the specific requirements of the state in question. And, since taxes are a prime
consideration, it is important to consult with your accountant or tax advisor.

While you can always change the legal and/or tax structure of your business if and when it
makes sense to do so, it is not always simple and easy to do so. A wise decision now could pay
dividends for years to come.

1) Sole Proprietorships

Just go into business by yourself and you have a sole proprietorship, the simplest form of
business. Unlike a corporation or a limited liability company (LLC), a sole proprietorship does
not have to be registered with the state. Anyone can establish a sole proprietorship at anywhere
and at any time.

For tax purposes, business income and expenses are reported on the owner’s personal tax return.
You should be aware that, in the eyes of the law, the owner and the business are one and the
same. Therefore the owner will be personally liable all of the obligations and liabilities incurred
by the business. If you want the business name to be other than yours, you will need to apply
from the appropriate government agency.

Even though a sole proprietorship may be the simplest, cheapest and quickest way to get into
business, it may not be a wise choice if personal liability is a concern as liability is unlimited.
A sole proprietorship works best for sole owners who want ease of operation with as little paper
work as possible and are willing to accept the disadvantage of being personally liable for the
debts and obligations of the business.

2) General Partnerships

The primary difference between a general partnership and a sole proprietorship is simply that it
is a business owned by two or more persons. When two are more people start a business, it is
automatically a general partnership unless it is specifically organized as a corporation or LLC, or
the partners choose to operate it as a limited partnership.

Like a sole proprietorship, there are no organizational documents that must be filed with the
state. It is easier to operate than a corporation since no meetings or reporting is required although
it is advisable to have a partnership agreement setting forth the relationship between the partners.
The partnership does not pay any income taxes but does file an informational return. Each
partner reports their share of the business income and expense on their individual tax return.
Each partner is personally liable for not just their share but the entire amount of the obligations
and liabilities of the business. Like a sole partnership, a general partnership may not be the right
choice if personal liability is a concern.

General partnerships best suit multiple owners of a business who want a business that is simple
and easy to form and operate yet are willing to accept the disadvantage of being personally liable
for the debts and obligations of the business.
  Limited Partnerships

Limited partnerships are partnerships that are formed by two or more persons who choose to
operate the business as a limited partnership instead of as a general partnership.

Like corporations, they are formed by filing required documents with the state. A limited
partnership must have one or more general partners and one or more limited partners. In a
limited partnership, the general partner(s) make decisions and run the business while all limited
partners (“silent partners”) do not take part in its operation. General partners are solely liable for
the obligations and liabilities incurred by the business, allowing the limited partners to invest in
the business without such liability. '

Protection of limited partners’ personal assets is one of the major reasons business owners
choose a limited partnership. Limited partnerships enjoy the same pass through tax treatment as
other partnerships.

Limited partnerships may be the answer for those who want pass-through tax status without
personal liability (for limited partners only) without forming an LLC or S Corporation. Setting
up limited partnerships can be expensive and should not be done without consulting a specialist
in this field first.

3) Corporations/Company

Official documents must be filed with the appropriate state in order to form a Corporation. A
Corporation is recognized by the law as an individual entity, separate from its shareholders
(owners), many times treated as a human being. Its most important characteristic is the fact that
shareholders, directors and officers enjoy limited liability for the debts, obligations and liabilities
of the business as well as liability stemming from possible legal action.

Protection of shareholders’ personal assets is one of the major reasons business owners choose to
incorporate. Normally, shareholders cannot lose more than the amount they invested in the
corporation. If the corporation goes bankrupt, the shareholders will not be liable for its debts.
Should someone sue the corporation and the corporation is found liable, they can take the
corporation’s property to satisfy the judgment but if that property does not satisfy the judgment,
they will not be able to take a shareholder’s personal assets, i.e. home, car, or bank account.

Corporation shareholders do not report any of the business income and expense on their
individual tax return. The corporation files tax returns and pays its income taxes (at generally
lower tax rates than would individuals) while the individual shareholders report and pay personal
income taxes only on monies paid them by the corporation.

It should be noted that shareholders are required to pay income taxes on income from dividends
paid by a Corporation even though income taxes have previously been paid by the corporation.

Corporations best serve owners who want the limited liability, a more formal business structure,
the ability to reduce overall income taxes and accumulate assets in the business, and ways to
more easily raise capital

 Limited Liability Companies (LLC’s)

Articles of organization must be filed with the appropriate state to form an LLC. While an
operating agreement does not have to be filed, it is an important document that should set forth
the members’ rights and responsibilities, their share of ownership, their voting rights, their shares
of profits and losses and their distribution rights, all of which can be different and without regard
to their capital contribution. One or more managers make management decisions and “run the
business” for the inactive members.

As its name implies, an LLC provides the same limited liability for its members as does a
corporation. Members enjoy limited liability for the debts, obligations and liabilities incurred by
the business as well as liability stemming from possible legal action.

Normally, members cannot lose more than the amount they invested in the LLC. If the LLC goes
bankrupt, the members will not be liable for its debts. Should someone sue the LLC and it is
found liable, they can take the LLC’s property to satisfy the judgment but if that property does
not satisfy the judgment, they will not be able to take a member’s personal assets, i.e. home, car,
a bank account.

Protection of members’ personal assets is a major advantage of an LLC. An exception to a

An LLC can choose to be taxed as a corporation or choose the pass through tax structure of
proprietorships, partnerships and S Corporations. And the distribution of profits and losses can
differ from members’ share of ownership. While an LLC and an S Corporation are essentially
alike, an LLC is much more flexible and is easier and less complicated to operate than a
corporation.

For those who want the same limited liability as a corporation but without the formal structure
and more cumbersome ongoing requirements, an LLC’s flexibility and simplicity offer a distinct
advantage over a corporation.

 Nonprofit Corporations

Nonprofit Corporations are formed for purposes other than making a profit, usually by groups
involved in activities that typically benefit society in general.

Members occupy the position held by stockholders in a for-profit corporation and, along with the
directors and officers, are entitled to the same limited liability afforded standard corporations.

Dues paid or donations made would normally be the most that members, directors and officers
could lose. As with other corporations, limited liability does not apply if the corporate form has
been used to perpetuate a fraud or evade the law.

Tax exempt status is not automatic and all nonprofit corporations are not necessarily tax-exempt.
In order to qualify for tax exempt status, the corporation must be organized for one of the
purposes allowed in the Internal Revenue Code. Obtaining tax-exempt status is generally
required in order to be eligible to receive grants from the government and private foundations. A
tax-exempt status also allows donors to deduct contributions from their income taxes.

In a nonprofit corporation, any money that remains as profits, after deducting expenses from
gross receipts, cannot be distributed to the members, directors or officers but must be used to
further the corporation’s purposes.