Common Forms of Business Organization
Business formation comes in four main types. They are Sole Proprietorship, Partnership, Limited Liability Company, and Corporation. Each type has specific advantages and disadvantages.
Sole proprietorships are the least expensive and simplest business structure. To be a sole proprietor does not require incorporation documents or public business notices. Depending on the occupation, someone beginning a sole proprietorship might need a state or local business license. As the name suggests, a sole proprietorship has a single owner. Sole proprietorships come with no protection from lawsuits or creditor claims while personal assets can be used to satisfy business debts or legal judgments. Sole proprietors report their business income and expenses on Schedule C to the IRS.
Partners in a partnership draw up agreements that detail how the partnership operates and how the profits and losses will be shared. In most jurisdictions, each partner can be held liable for business debts, the actions of other partners, and lawsuits. Both losses and profits flow through the partnership and are reported on each partner’s individual tax returns while the partnership must file an information return annually with the IRS.
Limited Liability Company
Limited liability companies (LLCs) require articles of organization or certificates of formation. LLCs give owners, called members, limited liability protection meaning the LLC is responsible for accounts instead of individual members. Losses and profits flow through the LLC to each member and the members decide if they want to be taxed under partnership rules or corporation rules. LLCs choosing partnership file partnership tax returns and LLCs taxed as corporation file C corporation or S corporation tax returns.
Corporations are more expensive and formal that the other three types of business formations and require filing Articles of Incorporation with state department of corporation. An advantage of corporations is the way they provide limited liability to their owners. There are C corporations and S corporations. C corporations keep profits and losses at the corporate level, but come with double taxation. S corporations come with profits and losses flowing through the business to corporate owners. C and S corporations both file corporate tax returns, file annual reports in their state, conduct annual meetings, and fulfill federal and state record-keeping obligations.