From Jean Murray,
Your Guide to US Business Law / Taxes.
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Business Organization Forms

You may have heard people talk about “Sub-S” corporations, LLCs and PCs and their relative merits. You will need to decide which form of business is right for you. Here is a brief description of each form:

• Sole Proprietorship
  A sole proprietorship is a business run by an individual. The owner is the business; the owner has all of the profits and losses of the business. The owner also has all the control and all the liability from the business operations. Business taxes are paid by the owner through his or her personal income tax return.
  
  
• Partnership
  A partnership is a business which operates like a sole proprietorship, but with several individuals running it. The partners share the profits/losses, have control and liability for business operations. Partnership taxes are paid by the partners on their personal tax returns, in proportion to their share of ownership.
  
  
• Corporation (or C-Corporation)
  A corporation is a business which is set up as a separate legal entity from its owners. The Board of Directors makes operational decisions. Owners are protected (shielded) from liabilities of the corporation, and the corporation pays corporate income taxes.
  
  
• S-Corporation (or Subchapter-S Corporation)
  A small business corporation may elect to be classified as an S-Corporation, to have the liability protection of corporate status, but taxed at individual rates. Here is a more detailed comparison between a C-Corp and an S-Corp .
  
  
• Limited Liability Company (LLC)
  A limited liability company is formed by "members" whose liability is limited to their investment. An LLC is often used in place of partnerships to limit liability, while having the option of being taxed through the personal tax returns of the members. Here is more information on LLCs vs. Corporations.

Which Business Organization Form Should I Select?

Here are some questions to ask yourself as you consider what business legal form to use:

How much does it cost to set up? The costs range from minimal, for a sole proprietorship, to expensive, for a corporation. Here is a list, in order of cost from lowest to highest:

• Sole Proprietorship
  All you need is a business license for your city, possibly a “fictitious name” statement, and a business checking account.
  
  
• Partnership
  You will need an attorney to help you with the partnership agreement.
  
  
• Limited Liability Company (LLC)
  You will need to apply to your state Secretary of State to become an LLC, by filing Articles of Organization. You may be able to do this filing yourself, or you can get an attorney to help.
  
  
• Corporation
  You will need to pay an attorney to help you set up your corporation correctly, in the state where you will be operating, including a corporate charter and by-laws.

What happens to the business if I am no longer there? If you want the business to continue, form a corporation, or put provisions in your partnership agreement or LLC operating agreement to allow the business to continue without you. If you choose a sole proprietorship, the business ends if you leave or die or can no longer run the business.

How much control do I have? Select a sole proprietorship or single-member LLC if you want complete control. In a partnership or multi-member LLC, you will have to share control with your partners or the other Members. In a corporation, you will have a Board of Directors helping you make decisions, so if total control over the business is important to you, don’t incorporate.

Who receives the profits and the losses? If you want all the profits, you must assume all the losses. Set up as a sole proprietorship or an LLC to keep all the profits (after taxes, of course!). If you set up as a corporation, you will have to give some money to the other shareholders in the form of dividends.

Who pays the taxes? In a corporation, the business pays the income taxes, at the corporate tax rate. In most other forms, you can decide to pay taxes through your personal tax return, depending on your personal tax rate.

What is my liability? As a sole proprietor, you will have all of the business liability for bad debts of the business, as well as for other liabilities, such as for negligence, product liability, or professional liability. You can limit your liability by setting up an LLC or, even better, by forming a corporation. Because the corporation is a separate entity, you may be shielded personally from the liability of the corporation. This is a tricky area, so make sure you understand your personal liability in each of these forms of business. Find out more from your attorney before you make a decision.

In the end, whatever factor is most important to you will determine the form of business ownership you choose. Talk to your CPA and your attorney for more advice and information.