Business Entity Types
Today, there are several business entity options available for entrepreneurs. Like anything else, each of them has advantages and drawbacks.
A sole proprietorship is a business entity that is virtually indistinguishable from its owner. The cost to create one is often simply a small one-time fee to the state or county officials to register a fictitious business name and the cost of placing an ad in a local paper to notify the public that you are doing business under that name.
There are disadvantages that come along with this easy set-up, though. Sole proprietorships cannot take advantage of special business income tax rates since all income is considered individual income. Sole proprietors are also not protected from personal liability if they get into trouble with a client.
General partnerships are formed by two or more legal entities (any kind of legal entity can be partner), and each of those entities are individually responsible for the partnership. This means that each partner is personally liable for the partnership's debts and legal liabilities. If one rogue partner makes an enemy of a third party, all partners will come under fire.
A limited partnership is much like a general partnership in structure. The main difference is that in a limited partnership, there are two different kinds of partners: general and limited. A limited partner does not take part in the management of the partnership and is not liable for any more than his individual capital investment. This distinction is made to encourage investors to become limited partners so they can share in the profits but not risk any more than their own contribution.
A “C" corporation is a standard state-formed corporation. It is a legal entity once it is formed, so it files its own taxes and is responsible for its own dealings. A “C" corporation can have unlimited numbers of shareholders, and those shareholders can be any kind of legal entity.
A board of directors must be elected, annual meetings must be held, minutes of corporate meetings must be kept, and stock must be issued. All this applies even if you are the only shareholder in the corporation. If these formalities aren't followed, you run the risk of losing your personal liability protection if a court decides that your corporation was just an alter ego of yourself created to keep you safe (sometimes referred to as “piercing the corporate veil").
Additionally, since corporations are taxed on their income and shareholders have to claim dividends as taxable income themselves, shareholders of a “C" corporation are “double taxed" on their dividend income. One way to avoid this is to not issue dividends and simply re-invest income back in the company. Spending income on tax-deductible items is another way. You could also look into forming an “S" corporation.
An “S" corporation is much like a “C" corporation in that it is also its own legal entity, protects its shareholders from legal liability, and requires a significant amount of effort and money to start and maintain. However, an “S" corporation allows shareholders to claim their share of the corporation's income directly on their personal tax return. This gets around the “double taxation" problem of a “C" corporation. The only drawbacks of an “S" corporation are that they may cost a little more to form and they are generally limited to a maximum of 100 shareholders. This makes going public with an “S" corporation practically impossible. However, if your intention is to keep your business relatively small, this is an excellent option.
Limited Liability Company
A limited liability company (LLC) is essentially a hybrid of a corporation and a partnership. An LLC provides the same kind of tax and liability benefits as a corporation, but has the same management structure as a partnership. In the past, LLCs have had more restrictions on them than corporations. For example, at least two people were needed to form an LLC and an LLC's duration was specifically limited. However, in the last few years, states have started loosening these restrictions.
For entrepreneurs, YSL & Associates
will be able to provide consulting on choosing
the right type of entity, filing all required documents,
keeping accounting books, and preparing
Please e-mail us at: firstname.lastname@example.org or call us at: 212-232-0122 for any questions.