There are five basic ownership forms. However, most new small businesses starting out are initially formed as sole proprietorships.
The sole proprietorship is a simple, informal structure that is inexpensive to form. It is usually owned by a single individual. The owner who operates the business is personally liable for all business debts, can freely transfer all or part of the business and can report profit or loss on personal income tax returns.
Partnerships are inexpensive to form; they require an agreement between two or more individuals or entities to jointly own and operate a business. Profit, loss, and managerial duties are shared among the partners and each partner is personally liable for partnership debts. Partnerships do not pay taxes, but must file an informational return. Individual partners report their share of profits and losses on their personal return. Short-term partnerships are also known as joint ventures.
C Corporation (Inc. or Ltd.)
This is a complex business structure with more startup costs than many other forms. A corporation is a legal entity separate from its owners, who own shares of stock in the company. Corporations can be created for profit or nonprofit purposes and may be subject to increased licensing fees and government regulation than other structures. Profits are taxed both at the corporate level and again when distributed to shareholders.
Shareholders are not personally liable for corporate obligations unless corporate formalities have not been observed; such formalities provide evidence that the corporation is a separate legal entity from its shareholders. Failure to do so may open the shareholders to liability of the corporation's debts. Corporate formalities include:
- issuing stock certificates
- holding annual meetings
- recording the minutes of the meetings
- electing directors or ratifying the status of existing directors
Corporations should always be assisted by a qualified attorney.
Sub Chapter S Corporation (Inc. or Ltd.)
This structure is identical to the C Corporation in many ways, but offers avoidance of double taxation. If a corporation qualifies for S status with the IRS, it is taxed like a partnership; the corporation is not taxed, but the income flows through to shareholders who report the income on their individual returns.
Limited Liability Corporation (LLC)
The LLC is generally considered advantageous for small businesses because it combines the limited personal liability feature of a corporation with the tax advantages of a partnership and sole proprietorship. Profits and losses can be passed through the company to its members or the LLC can elect to be taxed like a corporation. LLCs do not have stock and are not required to observe corporate formalities. Owners are called members, and the LLC is managed by these members or by appointed managers.
(Learn more about each of these forms, including the advantages and disadvantages of each…….)