Business Entity FAQs

Choosing a Business Entity

Selecting a particular form of business organization may be a difficult step in starting a business. Each type of organization raises different considerations relating to, among other things operations, personal liability, and tax status. Each state has authorized different types of companies, below are brief explanations of the most common types.

It is hoped that these short descriptions will be of use in selecting a type of organization.

What is a Sole Proprietorship ?

A sole proprietorship is the simplest form of business, in that it is not a separate entity in an of itself. The sole proprietor directly owns and operates the business and is directly responsible for its debts.

What is a General Partnership?

The general partnership is the oldest and simplest form of business organization. Indeed, individuals who engage in a common effort to make and share profits are legally partners whether they know it or not.

All partners share unlimited personal liability for the obligations of the partnership. With respect to taxes, the owners of a partnership are generally taxed only once.

What is a Limited Partnership?

Limited partnerships must have one or more general partners and one or more limited partners. In most states the organizational documents filed with the Secretary of State's Office are not required to identify the limited partners.

Limited partners are not normally personally liable for the debts of the limited partnership. It is certainly possible for limited partners to lose the amounts they have invested. Beyond that, limited partners will normally be subjected to personal liability for the debts of the limited partnership only if they are actively engaged in the management of the entity.

What is a Limited Liability Partnership?

The key word for LLP's is "partnership". They are more like general partnerships than LP's because all of the partners in an LLP benefit from some liability protection. The intent of the legislation creating this entity is to provide protection from personal liability for a partner in a general partnership for the acts of the partnership and other partners in the absence of the partner's own negligence, misconduct, or wrongful act. LLP's are taxed like partnerships.

What is a Limited Liability Company (LLC)?

The limited liability company has some of the characteristics of a sole proprietorship, some of a partnership, and some of a corporation. An LLC may, for tax purposes, be disregarded, be taxed like a partnership or taxed like a corporation.

The LLC has members rather than shareholders. Managers or members may exercise day to day management. The LLC is a business organization that operates under a contract (called an operating agreement) between the owners, much like a general partnership.

In order to have a legal existence, in most states the LLC must file Articles of Organization with the Secretary of State. The members are protected from personal liability for the acts of the LLC in much the same manner as corporate shareholders. Unlike limited partnerships, personal liability is not imposed on members for participating in management of the LLC.

What is a Corporation?

The corporation is the original structure for providing personal liability protection to the owners of a business. Although a corporation is now easier to organize, it may not be the best choice of entity for starting up a business. A corporation must have a board of directors that may be one person. A corporation must also maintain certain books and records and hold annual meetings of shareholders. In small, closely held corporations, the documentation of these activities may be more onerous than is warranted.

Unless qualified as an "S" Corporation pursuant to extensive IRS rules, a corporation is subject to double taxation, i.e.; income is taxed at the corporate level and when it is distributed to shareholders as a dividend.

In addition to taxation and personal liability, other factors may enter into the decision on type of entity. These include:

• The perceived needs for a given management structure
• The need for ease in transferring all or part of the ownership
• The need for withdrawing the investment in the future
• The need to conduct the business in more than one state either initially or in the future