Which legal structure works best for your business?
There are four basic types of business entities: sole proprietorships, partnerships, corporations and limited liability companies (LLCs). Other types of entities exist — limited partnerships, professional service corporations and professional limited liability companies — though most small businesses in Washington fall under one of those first four categories.
So which one is right for your company? Making that decision is an important step, and to do so, it’s crucial to understand the differences between your options. Per the Small Business Administration:
Sole proprietorship is a common, simple type of business ownership. If you are in business by yourself and obtain your business license, you are a sole proprietor. It’s an appropriate form of ownership for many small businesses. For federal income tax purposes, the income from the business flows through to the individual, and is reported on the business owner’s Schedule C. A sole proprietorship offers no protection from individual liability, so it’s essential for sole proprietorships to maintain adequate insurance coverage.
Partnership is similar to a sole proprietorship with multiple individuals involved. If you’re in business with at least one other person, and obtain your business license, you have a partnership. The partnership exists regardless of whether the partners have formalized their relationship by executing a partnership agreement.
A partnership agreement sets forth the rights and obligations of each party, and describe what would happen if a partner dies or wants to sell his or her interest in the business.
Similar to a sole proprietorship, a partnership results in federal income tax liability flowing from the entity to the individual partners. A partnership tax return is required, but each individual partner pays his or her share of the business taxes instead of the business itself paying the tax. As in a sole proprietorship, a partnership offers no protection from individual liability.
Corporation is formed by filing Articles of Incorporation with the Secretary of State’s office. One or more individuals can create a corporation.
A key initial decision in forming a corporation is whether it should be a C-corporation or an S-corporation. A C-corporation pays federal taxes both on the corporate level, and on the level of individual shareholders. An S-corporation pays taxes only on the shareholder level. Certain qualifications must be met in order to register as an S-corporation.
Unlike a sole proprietorship or partnership, a corporation that is properly formed and maintained can offer protections against individual liability by its shareholders and officers. In order to form and maintain a corporation, you need to retain both an accountant and an attorney to comply with complex tax requirements and corporate formalities set forth in state Revised Codes.
A limited liability company, or LLC, is formed by filing a Certificate of Formation with the Secretary of State’s office. One or more individuals can create an LLC. An LLC may be taxed in different ways. Consult with your accountant in order to make an informed decision about how your LLC will be taxed, and file the corresponding documents with the IRS. Similar to a corporation, a properly formed and maintained LLC can offer protections against individual liability. Also, you need to retain both an accountant and an attorney in forming an LLC. An attorney can help you prepare key documents, including the LLC Operating Agreement.
This article is featured in the 2017 Small Business Resource Guide, a free publication from Business Examiner Media.