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| Alternative Business Forms |
| Resources >>Closely Held Corporations>>Alternative Business Forms |
Selecting a Business Structure
The decision regarding business structure is a decision that a person should make, in consultation with an attorney and accountant, and
taking into consideration issues regarding tax, liability, management, continuity, transferability of ownership interests, and formality of
operation.
Generally, businesses are created and operated in one of the following forms:
Sole proprietorship: The most common and the simplest form of business is the sole proprietorship. In a sole proprietorship, a single
individual engages in a business activity without necessity of formal organization. If the business is conducted under an assumed name (a
name other than the surname of the individual), then an assumed name certificate (commonly referred to as a DBA) should be filed with the
state or county. A sole proprietorship is not considered to be an entity separate from the owner, may not be owned by more than one
person, and provides no protection against liability to the owner. Sole proprietorship income is reported on Schedule C of the owners Form
1040. Profits are treated as income of the owner, and losses are deductible to the owner.
General partnership: A general partnership is created when two or more persons associate to carry on a business for profit. A partnership
generally operates in accordance with a partnership agreement, but there is no requirement that the agreement be in writing and no state-
filing requirement. Partnership are usually terminable at will or at the death of any of the partners, and partnership interests cannot be sold
or transferred without the consent of the other partners. Partnerships are considered in most states to be an entity separate from the
partners, so that a partnership can own property and sue and be sued in its own name. However, a partnership provides no liability
protection to its owners. In fact, each partner is jointly and severally liable for all debts of the partnership. General partnerships report their
income to the IRS in a Form 065; however, partnerships do not pay taxes. Rather, each partner’s share of the profits or losses is reported
on a Form K-1. Each partner’s share of the profits is taxed as income of that partner, and each partner’s share of any losses is deductible.
Corporation: Formation of a corporation requires filing documents with the state government. A corporation is a legal person, separate from
its owners, with the characteristics of limited liability, centralization of management, perpetual duration, and ease of transferability of
ownership interests. The owners of a corporation are called “shareholders.” The persons who manage the business and affairs of a
corporation are called “directors.” However, state corporate law does provide for shareholders to enter into shareholders’ agreements to
eliminate the directors and provide for shareholder management. Choosing the best management structure for your corporation is a
decision you make with the advice of an attorney. Shareholders are not liable for the debts of the corporation. Ordinarily, a corporation is a
tax-paying entity, which reports its income on a Form 1120. Shareholders do not pay taxes on corporate income; nor are corporate losses
deductible by the shareholders. However, if the corporation distributes its excess profits to its shareholders through a dividend, then that
money is taxed twice: First, the corporation pays income tax on the profits; then the shareholder pays income tax on the dividends.
S Corporation: An “S” corporation is not a matter of state corporate law but rather a federal tax election. S Corporations are exactly the
same as other corporations (“C Corporations”) in terms of their organization and treatment under state law. A for-profit corporation elects to
be taxed as an “S” corporation by filing an election with the Internal Revenue Service. Please contact the IRS or competent tax counsel
regarding the decision to be taxed as an “S” corporation and the requirements for filing the election. Federal law restricts the number and
type of shareholders who can own stock in an S Corporation. If a corporation elects to be an S Corporation, then it is taxed exactly like a
general partnership.
Limited Liability Company: A limited liability company is created by filing a documents with the state. The limited liability company (LLC) is not
a partnership or a corporation but rather is a distinct type of entity that has the powers of both a corporation and a partnership. Depending
on how the LLC is structured, it may be likened to a general partnership with limited liability, or to a limited partnership where all the owners
are free to participate in management and all have limited liability, or to an “S” corporation without the ownership and tax restrictions
imposed by the Internal Revenue Code. The owners of an LLC are called “members.” A member can be an individual, partnership,
corporation, trust, and any other legal or commercial entity. Generally, the liability of the members is limited to their investment and they may
enjoy the pass-through tax treatment afforded to partners in a partnership. As a result of federal tax classification rules, an LLC can achieve
both structural flexibility and favorable tax treatment. Nevertheless, persons contemplating forming an LLC are well advised to consult
competent legal counsel. A limited liability company can be managed by managers or by its members. The management structure must be
stated in the certificate of formation. Management structure is a determination that is made by the LLC and its members.
Limited Partnership: A limited partnership is a partnership formed by two or more persons and having one or more general partners and one
or more limited partners. The limited partnership operates in accordance with a partnership agreement, written or oral, of the partners as to
the affairs of the limited partnership and the conduct of its business. While the partnership agreement is not filed for public record, the
limited partnership must file a certificate of formation with state. General partners are fully liable for the debts of the partnership, while limited
partners are not liable for the debts of the partnership, but may not participate in management of the business. Limited partnerships are
taxed exactly like general partnerships.
Limited Liability Partnership: In order to limit the liability of its general partners, most states allow a general partnership may opt to register
as a limited liability partnership. Legally, the limited liability partnership is exactly the same as a general partnership, except that general
partners are not held liable for claims against the partnership in which they had no personal involvement. Limited Liability Partnerships are
taxed exactly like general partnerships.
The decision regarding business structure is a decision that a person should make, in consultation with an attorney and accountant, and
taking into consideration issues regarding tax, liability, management, continuity, transferability of ownership interests, and formality of
operation.
Generally, businesses are created and operated in one of the following forms:
Sole proprietorship: The most common and the simplest form of business is the sole proprietorship. In a sole proprietorship, a single
individual engages in a business activity without necessity of formal organization. If the business is conducted under an assumed name (a
name other than the surname of the individual), then an assumed name certificate (commonly referred to as a DBA) should be filed with the
state or county. A sole proprietorship is not considered to be an entity separate from the owner, may not be owned by more than one
person, and provides no protection against liability to the owner. Sole proprietorship income is reported on Schedule C of the owners Form
1040. Profits are treated as income of the owner, and losses are deductible to the owner.
General partnership: A general partnership is created when two or more persons associate to carry on a business for profit. A partnership
generally operates in accordance with a partnership agreement, but there is no requirement that the agreement be in writing and no state-
filing requirement. Partnership are usually terminable at will or at the death of any of the partners, and partnership interests cannot be sold
or transferred without the consent of the other partners. Partnerships are considered in most states to be an entity separate from the
partners, so that a partnership can own property and sue and be sued in its own name. However, a partnership provides no liability
protection to its owners. In fact, each partner is jointly and severally liable for all debts of the partnership. General partnerships report their
income to the IRS in a Form 065; however, partnerships do not pay taxes. Rather, each partner’s share of the profits or losses is reported
on a Form K-1. Each partner’s share of the profits is taxed as income of that partner, and each partner’s share of any losses is deductible.
Corporation: Formation of a corporation requires filing documents with the state government. A corporation is a legal person, separate from
its owners, with the characteristics of limited liability, centralization of management, perpetual duration, and ease of transferability of
ownership interests. The owners of a corporation are called “shareholders.” The persons who manage the business and affairs of a
corporation are called “directors.” However, state corporate law does provide for shareholders to enter into shareholders’ agreements to
eliminate the directors and provide for shareholder management. Choosing the best management structure for your corporation is a
decision you make with the advice of an attorney. Shareholders are not liable for the debts of the corporation. Ordinarily, a corporation is a
tax-paying entity, which reports its income on a Form 1120. Shareholders do not pay taxes on corporate income; nor are corporate losses
deductible by the shareholders. However, if the corporation distributes its excess profits to its shareholders through a dividend, then that
money is taxed twice: First, the corporation pays income tax on the profits; then the shareholder pays income tax on the dividends.
S Corporation: An “S” corporation is not a matter of state corporate law but rather a federal tax election. S Corporations are exactly the
same as other corporations (“C Corporations”) in terms of their organization and treatment under state law. A for-profit corporation elects to
be taxed as an “S” corporation by filing an election with the Internal Revenue Service. Please contact the IRS or competent tax counsel
regarding the decision to be taxed as an “S” corporation and the requirements for filing the election. Federal law restricts the number and
type of shareholders who can own stock in an S Corporation. If a corporation elects to be an S Corporation, then it is taxed exactly like a
general partnership.
Limited Liability Company: A limited liability company is created by filing a documents with the state. The limited liability company (LLC) is not
a partnership or a corporation but rather is a distinct type of entity that has the powers of both a corporation and a partnership. Depending
on how the LLC is structured, it may be likened to a general partnership with limited liability, or to a limited partnership where all the owners
are free to participate in management and all have limited liability, or to an “S” corporation without the ownership and tax restrictions
imposed by the Internal Revenue Code. The owners of an LLC are called “members.” A member can be an individual, partnership,
corporation, trust, and any other legal or commercial entity. Generally, the liability of the members is limited to their investment and they may
enjoy the pass-through tax treatment afforded to partners in a partnership. As a result of federal tax classification rules, an LLC can achieve
both structural flexibility and favorable tax treatment. Nevertheless, persons contemplating forming an LLC are well advised to consult
competent legal counsel. A limited liability company can be managed by managers or by its members. The management structure must be
stated in the certificate of formation. Management structure is a determination that is made by the LLC and its members.
Limited Partnership: A limited partnership is a partnership formed by two or more persons and having one or more general partners and one
or more limited partners. The limited partnership operates in accordance with a partnership agreement, written or oral, of the partners as to
the affairs of the limited partnership and the conduct of its business. While the partnership agreement is not filed for public record, the
limited partnership must file a certificate of formation with state. General partners are fully liable for the debts of the partnership, while limited
partners are not liable for the debts of the partnership, but may not participate in management of the business. Limited partnerships are
taxed exactly like general partnerships.
Limited Liability Partnership: In order to limit the liability of its general partners, most states allow a general partnership may opt to register
as a limited liability partnership. Legally, the limited liability partnership is exactly the same as a general partnership, except that general
partners are not held liable for claims against the partnership in which they had no personal involvement. Limited Liability Partnerships are
taxed exactly like general partnerships.
Author:
Eric Fryar
Eric Fryar
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| Last Updated: 2/20/2011 |