When setting up a new business you can choose from several legal business forms  :

• Sole Proprietorship
• General Partnership
• Limited Partnerships (LP)
• C Corporation
• S Corporation
• The Professional Corporation
• Limited Liability Company (LLC)

Please note :  There is not one “do all, end all” business entity type that is right for all situations .  Sorry, but every situation is different and may require a particular entity type that is more beneficial in your particular circumstances than other entity types.  How do you know which entity type is best for you ?  This is a major area of importance  where  you  should  seek “wise counsel” and do your own due diligence.  There is probably no area of business planning that I have seen that people make the wrong decision than the area of the type of entity choice.  Seek “wise counsel”.

Warning:  The following general narrative description of each entity type is not intended to be a complete comprehensive study of each entity type.

 1.  Sole Proprietorship:  The great advantage of operating a new business as a sole proprietorship is that it is  easy to do  and does not require any formal action to set it up.  You can start your business today as a sole proprietorship – there is no need to wait for an attorney to  create  and file documents or for the government to approve them. 

 Of course, you may need an industry specific business license, and a few states require you to register to do business.   On the county level you can register the name of your business as a D.B.A (Doing Business As).

 When you run your  new business  as a sole proprietorship, you are the business.  As the owner , you will be personally liable for any debts or taxes of the business or claims, such a legal damages resulting from a lawsuit.  This is the main reason why many entrepreneurs choose a different form of entity.

As a sole proprietorship, the business’ income and deductions are filed on Schedule C attached to your Form 1040.  You also pay self-employment tax on your business net income. Their are many benefits however when it comes to small business tax deductions.  It would be wise to investigate these deductions in advance of your business formation choice.

2.   The General Partnership :  When you enter into an agreement (verbal or written with another party to do business together) you are acting in Partnership with one another.  The business is operated as if it were one person.  This is like the sole proprietorship, except with twice the exposure .  Each is responsible for everything each of you own, owe, do and have done.  You have joint and several liabilities with your partners.  This means you are completely liable for everything, whether you are involved or not.  The partnership files a separate tax return Form 1065 and each partners’ respective income flows to their personal  tax return  via a K-1.

 Partnerships are a lot  like marriages; they usually start out with a great deal of trust but have a high break-up rate.  Be advised that partnerships are easy to get into, require a lot of patience and understanding to live with, and are often costly and painful to get out of.

 3.  Limited Partnerships:  LPs are pass through entities that have the same basic characteristics as a general partnership expect that the LP has limited partners who typically have neither liability for business activities nor management responsibilities.  These limited partners are liable or at risk only to the extent of the amount they have invested in the LP.  The general partner, having responsibility and fully liable for the activities of the partnership, provides full direction and management of the LP.

 The LP files a separate tax return Form 1065 and each partners’ respective income flows to their personal return via a K-1.  The general partner, however, may be an entirely different form of entity and reports its respective share of income via a K-1, also.

4.  The Corporation:   A Corporation is a separate legal entity overseen  by state  laws  .  It operates through its bylaws as well as resolutions written and adopted by its shareholders and directors.  It must not function as the alter-ego of its stockholders.  In other words, you must remain separate from your corporation.  Corporate formalities (the flow of activity and paperwork) must be followed to maintain a corporation as a separate legal entity.  The main reason most businesses incorporate is to limit owner liability to the amount  of money invested  in the business.  The Corporation files its own tax return (Form 1120) and pays its own taxes on the business net income.  

5.  The “S” Corporation:  The first thing to understand about S Corporations is they are just like any other corporation in terms of corporate law requirements, limited liability of shareholders and all other corporate aspects, except regarding tax treatment.  Once a corporation has elected to be treated as an S corporation, its shareholders will generally report their share of the corporation’s taxable income on their personal tax returns.  The S Corporation files Form 1120S, and each shareholder respective income flows to their personal return via a K-1.

 6.  The Professional Corporation :  Although most of us consider ourselves a professional in our field, there are select groups that the IRS considers “professional”.  These professionals of health, veterinary services, law, engineering, architecture, accounting, actuarial science, performing arts, or certain consulting services are admired so much that when incorporating, they are required to file as a Professional Service Corporation (PSC).  This PSC is also admired with its own flat tax rate of 35%. ( Holly Cow  !)  Your options for relief as a PSC are few but effective.  The S Corporation is a viable alternative.

 7.  The Limited Liability Company (LLC):  The LLC is a relatively new form of business organization that offers advantages and benefits not otherwise obtainable when operating as an S Corporation or partnership.  The LLC combines the corporation characteristic of limited liability for all investors with the income flow-through attributes of a partnership and offers flexible allocation of profit and loss. 

As an LLC, you have to elect how to be taxed:

• Proprietorship (Available to only single member LLC)
• Partnership
• C Corporation
•  S Corporation

Please note:  Do your due diligence in choosing the proper legal and tax form of business entity.  Some business structures can create unnecessary taxes.  It would be  very wise  to  study  all of the small business tax deductions that are available.  Also, keep in mind that you may want to and be able to  change  business entity types during the  duration  of your  company  .    Last but not least  , you should also consider the tax ramifications within your chosen entity type of your “exit strategy”.

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