When you start a business, you will have to decide which business structure (also legal structure or business form) to adopt. If you're simply in business for yourself and don't plan on hiring employees, you may be able to get by as a sole proprietorship. However, large business entities generally incorporate, which provides certain benefits in terms of liability protection and the complexity needed for a large business.
Each business structure has its pros cons, and since every business has unique needs and goals, you need to do your research before choosing. The following is an overview of the various types of business structures, which include sole proprietorships, partnerships (both general and limited), limited liability companies (LLCs), corporations, nonprofit corporations, and co-operatives (co-ops).
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A sole proprietorship is perhaps the simplest of all the different types of business structures. Unlike LLCs and corporations, there are no papers to file and no fees to pay in order to set up a sole proprietorship. You are the sole owner of your business, and you simply have to begin business operations in order to create a sole proprietorship.
In terms of the legal entities involved in a sole proprietorship, you and the sole proprietorship are the same thing. This means that you will pay taxes on any business profit as income on your personal taxes, and if your business has any liabilities (like a court judgment or a past due debt), you are personally liable for them.
A partnership is like a sole proprietorship in that it is simply a business that is owned by two or more people. Similarly to a sole proprietorship, the owners of a partnership do not need to file any papers or pay any fees to set up a partnership, the partnership simply begins when you start a business with one or more other people. Also like a sole proprietorship, each partner will report their share of the business profits on their personal taxes as income, and each partner is personally liable for any debts, claims or other liabilities that the business is responsible for.
Unlike a general partnership, a limited partnership costs money and can be very complicated to set up. Limited partnerships are not the best choice for a small business that has a small potential for personal liability. Limited partnerships are normally organized by one or more persons, the "general partners," that are responsible for getting others to join the partnership as "limited partners."
The general partners run the day to day operations of the limited partnership for the most part. The general partners are personally liable for any debts, judgments or other liabilities that the limited partnership has, except if the general partner is a corporation or a LLC. In addition, just like a partner in a normal partnership, the general partners in a limited partnership will share in the business profits and report this income on their personal income taxes. The limited partners are not personally liable for any of the limited partnerships liabilities, and are correspondingly not included in many of the day to day operations.
LLCs and Corporations
Although creating and maintaining a corporation or an LLC will probably be more complex and costly than forming a sole proprietorship or partnership, it may be worth it for your small business depending upon the type of work you plan on doing. Perhaps the main reason you would want to organize your business as an LLC or corporation is to shield yourself from any personal liability that may arise from your small business' dealings.
Although LLCs and corporations are alike in many respects, what truly sets a corporation apart from the other types of business structures is that a corporation is its own legal and tax entity. A corporation pays its own taxes on any profits that it keeps and the owners of a corporation only pay income taxes on monies they draw from the corporation in the form of salaries, dividends and bonuses.
A LLC, just like a corporation, provides limited liability to the owners of the LLC for the business' liabilities, including debts, judgments and others. Where the LLC differs from a corporation, however, is in terms of taxes. Unlike a corporation, a LLC is not its own, separate tax entity, and the owners of the LLC must pay personal income taxes on their share of the profits that the LLC keeps during the tax year.
Organizing your business as a corporation or a LLC makes sense in two situations. First, if the business in engaged in a dangerous activity that makes it more likely to be sued, or if the business has the potential of racking up large amounts of debt, then a corporation or a LLC may be a good idea to shield the owners from personal liability. Second, if any of the owners of a business have large amounts of personal assets that they want to shield from any potential liability associated with the business, a corporate or an LLC could be the best option.
A nonprofit corporation is simply a corporation that was formed with the intent to carry out a purpose that is charitable, educational, literary, religious, or scientific. A nonprofit corporation can solicit charitable givings from the public, and can also seek to raise funds by seeking private grant money from companies and individuals. One of the largest benefits to a nonprofit corporation is that the money that is taken in for the charitable purpose is normally not taxed by either the federal or state governments.
A Co-Op is a business that is most associated with grassroots organizations. These businesses are owned and operated by the members of the Co-Op in a democratic fashion. Much of the time, a Co-Op is formed by consumers that want to create a friendlier place of business. As such, these organizations often spring up in the form of a grocery store or a child care center. There are some states that have written laws regarding the setup and operation of Co-Ops. If you would like to find out if your state has laws regarding Co-Ops, you should contact your secretary of state.
Learn More About Types of Business Structures by Talking to an Attorney
There are plenty of factors to take into consideration when choosing a business structure, including liability concerns and plans for future expansion. The best way to make an informed decision when choosing a business structure is to speak with a business organizations lawyer who can provide legal advice based on your specific situation.