There are four main types of business entities: Sole Proprietorship, Partnership, Limited Liability Company, and Corporations. Each one has its own advantages and disadvantages. Some are easy and inexpensive to form while others provide you limited liability protection that protects your personal assets from creditor claims and lawsuits.
The simplest and least expensive type of business to form is the sole proprietorship. There are no incorporation documents to file or notices. A sole proprietorship has only one owner. You can do business under your own name or apply for a “doing-business-as” name to give your business a distinctive name, but the business and the owner remain one entity. You have no protection from lawsuits or creditors. Your personal assets can be used to satisfy a business debt or legal judgment. You report your business income and expenses to the IRS on Schedule C, which is filed with your individual income tax return.
In a partnership, there are no documents to file, however, partners usually have a partnership agreement which addresses how the partnership operates and how profits and losses are shared. Generally, each partner has unlimited liability for business debts, actions of the other partners, and lawsuits. The business profits and losses flow through the partnership and are reported on each partner’s individual tax return. The partnership must file a partnership return with the IRS every year.
Limited Liability Company
You must file articles of organization or a certificate of formation to form a limited liability company. LLCs provide their owners (i.e., members) with limited liability protection. When the company opens a business bank account or take on debt, the LLC is responsible for the accounts instead of the individual members. LLC profits and losses flow through the company to each member and LLC members decide if they want to be taxed as a partnership or a corporation. LLCs taxed as partnerships file the partnership tax return and LLCs taxed as corporations must file either a C or S corporation tax return.
Corporations are the most formal of the different business formations. A corporation is formed when you file the Articles of Incorporation. Corporations provide limited liability protection for the owners. C corporations keep their profits and losses at the corporate level but have double taxation. They are taxed on their earnings, and shareholders are also taxed on their corporate dividends. With S corporations, profits and losses flow through the business to the owners. Both C and S corporations must file corporate tax returns, file annual reports, conduct annual meetings and meet federal and state record-keeping obligations.