Common Business Structures
The single owner of a business is a sole proprietor. The single owner has sole control and responsibility. The sole proprietorship is easily formed, allows important decisions to be made quickly, and may enjoy fewer legal restrictions. The sole proprietor’s responsibilities include:
• Procuring all capital
• Personal liability for all claims against the business
• Showing business profits as part of the owner’s individual taxable income
• Obtaining local business licenses
• Registering the name of the business with the appropriate state agency
A partnership is an association of two or more people acting as co-owners of a business for profit. A partnership can be created by an oral or written contract between the individuals. It is wise to have an attorney draw up a partnership agreement specifying rights and obligations of the partners. Almost any management and profit-sharing agreement can be arranged. A general partnership:
• Requires no official registration beyond that required for a sole proprietorship
• Extends liability to the personal assets of the business partners
• Is required to file information returns with the Internal Revenue Service and State Tax Commission
• Shares its profits and losses among the partners with each partner taxed at personal income tax rates.
Limited partnerships are more closely regulated than general partnerships, permitting investors to become silent or limited partners without assuming unlimited liability. There must be at least one general partner who manages the business, and one or more limited partners whose liability is limited to the extent of their investment. In a limited partnership:
• General partners share full liability
• Limited partners may take no part in running the business
• The limited partnership is created by filing documents with the appropriate state agency
A corporation is a more complex form of business organization. A corporation is a legal entity and exists apart from its owners or shareholders. As a separate entity, it has its own rights, privileges and liabilities apart from the individuals. A corporation:
• Must file its Articles of Incorporation with the appropriate state agency
• May be formed for profit or nonprofit purposes
• It has limited liability
• The liability of shareholders (or owners) to creditors is ordinarily limited to the amount of each shareholder's capital stock investment
• It unaffected in its continuity by death or transfer of shares by any of the owners
• Requires more extensive record keeping
• Pays taxes on its profits; taxes on dividends are paid by its shareholders
The S Corporation combines parts of the corporate and partnership forms of business organization. The Internal Revenue Code permits a privately held corporation to avoid corporate taxation by having each shareholder report the share of corporate income on his or her individual income tax return.
The S Corporation generally does not pay tax itself. However, there are two situations which may result in tax to the corporation:
1. Excess net passive income
2. Tax on certain capital gains
In addition, the S Corporation:
• Remains a corporation in the view of the state and complies with state corporation regulations
• Must have only one class of stock
• Uses a calendar tax year or shows a business purpose for adopting a fiscal year
• Must have the consent of all shareholders to have S Corporation status
• Must be made up of shareholders that are individuals, estates, or trusts, but not corporations
• Can only have shareholders that are United States citizens or residents
• Cannot be a member of an affiliated group of corporations
▸ Most financial institutions, insurance companies and domestic international sales corporations are also ineligible.
▸ See IRS regulations for more information.
• Taxes nonresident shareholders using the maximum state individual income tax rate
• Prohibits certain types of income and business activities
In most states, people licensed in certain professions may form a professional corporation which provides them with the benefits of the corporate form for the business aspects of their practices, while preserving the personal relationship between the professionals and those they serve. A professional corporation may only be organized for the purpose of furnishing one specific professional service and the ancillary services associated with that profession. Unlike traditional business corporations, no individual may be an officer, director or shareholder of a professional corporation unless that individual is licensed to perform the same profession as that for which the professional corporation was formed. However, an unlicensed person or nonprofessional may serve as either the secretary or treasurer of the professional corporation. Another distinctive feature of the professional corporation is that shares of the corporate stock may only be issued to persons who are licensed to render the specific professional service. Likewise, a shareholder may voluntarily transfer his or her shares in a professional corporation only to those persons who are duly licensed to render the same professional service as that for which the corporation was organized.
Articles of Incorporation for a professional corporation must be filed with the appropriate state agency.
A nonprofit corporation is created to help people achieve a common purpose. It is an organizing structure useful to small and large-scale activities, involving only a few people or many hundreds of people. It provides a useful and inexpensive structure for the enterprise of groups of all sizes, from community campaigns or events to perpetual and diverse activities by hundreds and thousands of people. A nonprofit corporation may be formed for any lawful purpose, but not for financial profit. It does not require large sums of money and it can be prepared initially by following a few simple rules:
• It may not have shareholders or pay dividends
• It may compensate members, officers, and trustees (in reasonable amounts) for services rendered
Special Note: Nonprofit incorporation status does not guarantee that your organization will be granted tax-exempt status, nor does it ensure that your contributors can deduct their gifts from reported personal income. Nonprofit incorporation is generally a prerequisite to applying to the Internal Revenue Service for preferential tax status, under IRS Code section 501(c)(3).
Limited Liability Company
The Limited Liability Company (LLC) combines many favorable characteristics of corporations and limited and general partnerships. The LLC provides limited liability to its members and offers them the same favorable IRS tax treatment enjoyed by partners in general and limited partnerships. A Limited Liability Company:
• Must file Articles of Organization with the appropriate state agency
• Allows members to manage the company themselves or to elect managers
• Allows members to engage in management without risk of losing their limited liability status
• Follows simple registration and annual reporting requirements similar to those of corporations and limited partnerships
• May be taxed by the IRS as either a corporation or as a partnership, depending on its structure