Types of Business Structures
Generally a sole proprietorship is owned and run entirely by a single person.
In the case of a sole proprietorship, the business is not legally a separate
entity from the individual. The individual owner assumes a great deal of
liability as his/her assets are not considered to be separate from that of the
business. Also, the debts of the business are not considered to be separate
from the individual. If the owner is married any property owned in conjunction
with another person such as (community property) would also be considered
"assets" of the business. Consequently this business structure could entail a
great deal of risk and liability for the owner. Should anything go wrong, what
might have been considered private property (i.e. cars, homes, land, bank
accounts, etc.) could be seized in a lawsuit against the business.
A general partnership is made up of two or more partners going into business
together. Like a sole proprietorship the individuals involved are personally
responsible for all debts and legal obligations of the business. The most
dangerous trait of a general partnership is that the individual partners are
liable for the debts and legal obligations incurred by the other partners when
doing business on behalf of the company. A partnership is dissolved upon the
death or withdrawal of a partner unless certain precautions are taken.
Unlike a general partnership which is designed to continue during the lives of
the partners, a joint venture is created with a specific project in mind. It
generally dissolves once the project has been completed. Members of the joint
venture are exposed to full legal liability.
A limited partnership is made up of general partners and limited partners.
General partners participate in the day to day business activities of the
company, exercise managerial power, contribute capital, share in the profits
and are held personally liable for all company debts and legal obligations.
Limited partners only contribute capital and share in the profits but take no
part in the management of the company nor are they held responsible for company
debts or liability. For the limited partners a benefit of this type of
organization is that they may participate in any profits the company may
produce without risking more than the capital they are willing to contribute.
The general partner, however, is subject to full legal liability. That is why a
separate corporation or limited liability company is often created to serve as
the general partner.
Limited Liability Partnership (LLP)
A limited liability partnership is created to protect partners from liability
caused by other partners. (E.g. a partner gets into an at-fault accident while
running errands and the company is sued.) However, it does not generally shield
the partner who caused the liability. A limited liability partnership can
operate more informally and flexibly than a corporation, and is accorded full
partnership tax treatment. Some states such as California impose limitations on
who may form an LLP. In California, with few exceptions, only attorneys,
certified accountants and architects may form an LLP.
Limited Liability Company (LLC)
Limited liability companies are popular because they essentially combine the
best of both worlds; the limited liability of a corporation and the favorable
taxation accorded to partnerships. Just as limited partnerships and
corporations are considered to be separate legal entities from their
member/owners, so are LLCs. Most states have allowed for single member/owner
LLCs. One should note that IRS rules and regulations regarding single-owner
LLCs (may be taxed as a corporation or disregarded entity for taxation
purposes) can be different from those with more than one (may choose to be
taxed as a partnership or corporation).
A corporation is a separate legal and tax entity from the owners. This type of
general, for-profit corporation is referred to as a "C" corporation (referring
to Chapter C in the IRS code). To be incorporated an Incorporator must draft
legal documents and, file the documents with the appropriate government agency
and pay the required fees. A corporation is owned by shareholders and is
managed and controlled by the board of directors who elect the president and
determine the policies and actions to be taken by the corporation. In order to
maintain corporate status (included limited liability and favorable taxation)
certain simple formalities must be observed in order to keep the corporate
shield in tact. These formalities include, but are not limited to; annual
meeting of the board of directors, the issuing of stock, keeping of corporate
minutes and the appointing of corporate officers.
An "S" corporation begins as a "C" corporation. After the initial filing an
additional form (form 2553) is filed with the IRS to change to "S" corporation
status (referring to Chapter S in the IRS code). There may be additional state
filings required. Once this process is complete, the IRS treats the corporation
like a partnership or sole proprietorship instead of a separately taxed entity.
This results in shareholders' individual tax returns reflecting income
generated or losses accrued by the corporation. Converting to an "S"
corporation affects the tax status but does not generally effect the legal
protection offered by the corporation. Often a reasonably small salary is paid
and a large Schedule K-1 distribution is paid to the employee/owner to help
lower Social Security and Medicare taxes. Note: This information is for general
informational purposes only not a substitute for advice from a licensed tax
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