When beginning a business, you must decide what form of business entity to establish. Your form of business determines which income tax return form you have to file. The most common forms of business are the sole proprietorship, partnership, corporation, and S corporation. A Limited Liability Company (LLC) is a relatively new business structure allowed by state statute. Legal and tax considerations enter into selecting a business structure.

  • Sole Proprietorships
  • Partnerships
  • Corporations
  • S Corporations
  • Limited Liability Company (LLC)

Sole Proprietorship

The sole proprietorship is a simple, informal structure that is inexpensive to form; it is usually owned by a single person or a marital community. The owner 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.

Limited Liability Company (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.

General Partnership

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

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.

Which business structure is right for me?

  Sole Proprietorship General Partnership Limited Partnership C Corporation S Corporation Limited Liability Company (LLC) 1 Limited Liability Partnership (LLP)
Limited Liability No No Yes 2 Yes Yes Yes Yes
Pass-through Tax Treatment 3 Yes Generally yes Generally yes No Generally yes Yes Yes
Difficult to Form/Maintain No Not very Not very Yes Yes Somewhat Somewhat
Continuity of Life No No No Yes Yes State law may limit LLC life to a set number of years 4 No
Centralized Management Yes Generally no, but partners can elect a committee of managers Yes Yes Yes Generally yes, since members can elect a committee of managers The partnership agreement can centralize management
Interests Freely Sold/Transferred Yes 5 Generally no Generally no Yes Not to ineligible S shareholders Yes, but transferee often has more limited rights unless all other members approve of a sale/transfer No
Available in All States Yes Yes Yes Yes Yes Yes No
Maximum  Number of Owners One More than two More than two More than two Maximum of 75 Shareholders 6 More than two More than two
Minimum Number of Owners One Two Two One One Generally two Two

1 Assumes that the LLC opts for tax treatment as a partnership.
2 Limited liability is available only to the limited partners.
3 In certain circumstances, partnerships and S corporations may be taxed at the entity level.
4 Generally, termination dates for LLCs provided for under state law may be overridden in the LLC agreement.
5 Sole proprietor sells business assets rather than an interest in a business entity.
6 Refer current IRS guidelines.

For more information go to :

IRS website:http://www.irs.gov/businesses/small/article/0,,id=98359,00.html
SBA website:http://www.sba.gov/smallbusinessplanner/start/chooseastructure/index.html