Formation & Business Planning

The array of possible business forms can overwhelm inexperienced entrepreneurs. Each type of business organization carries complicated legal and taxation implications that affect the entity and its owners far into the future. New businesses must consider start-up expenses, the complexity of the possible business forms, personal liability issues, tax consequences, and the continuing legal burden imposed by statutes and regulations. Some of the most common business entities include the following:

Sole proprietorships combine ownership and management in one person. The owner receives business profits (and losses) directly, with income taxed on the owner's personal return and not at the business level. Sole proprietors hold complete and personal liability for business obligations. While this form requires no statutory establishment (owners can start a business at any time), they must obtain any necessary licenses and abide by employment laws.

Partnerships involve two or more owners operating a business for profit. As with a sole proprietorship, the partners generally hold personal liability for business obligations, but receive profits directly from the business as income. This tax advantage makes partnerships very attractive to some businesspeople. Some legal modifications to the partnership form allow for some limitation of liability, if statutory requirements are met, including limited liability partnerships and limited liability companies.

Limited liability companies (LLCs) and limited liability partnerships (LLPs) are two popular options for new businesses. These organizations combine some tax benefits of partnerships with aspects of corporate limited liability. While this mixture is compelling, limited liability businesses must comply with specific ownership and termination requirements, and may not realize the full extent of either the tax or liability advantages.

Corporations become separate legal entities upon formation. As such, corporations assume liability for their own obligations, thereby insulating the owners, directors, and officers of the business from personal liability. Additionally, corporations can sell ownership interests, or shares, in the company to raise capital. Despite these benefits, the tax treatment of a corporation can cause financial obstacles. The corporation files its own tax return and pays taxes on profits before it pays dividends to shareholders. Shareholders then must pay taxes on the dividends on their personal income tax returns. In some cases, tax rules can mitigate or modify this double taxation effect. Corporations may range in size from large, publicly held conglomerates to small closely held businesses involving family members as shareholders.

Questionnaire: Is My Business Better Suited to Be a Corporation or an LLC?

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Is My Business Better Suited to Be a Corporation or an LLC?

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