Selecting Among The Types of Business Ownership
The selection of a type of business ownership is a decision that a person should make, in consultation with an attorney and an 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:
The most common and the simplest type of business ownership 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.
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 1065; 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.
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.
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.
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. This type of business ownership 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 taxes exactly like general partnerships.
Choosing Among the Different Types of Business Ownership
Choosing among the types of business ownership involves a balancing of competing concerns. In the start-up phase of a new closely-held business, when the company is probably losing money, "pass-through" tax structures (general partnership, limited partnership, limited liablity partnership, S-corporation, or limited liability company) are preferable. Most of these structures have some disadvantages if the entity is successful and wishes to grow and attract capital from outside investors. Partnership structures provide the best legal protection to minority owners, but leave all the owners exposed to unlimited liability. Limited partnership shield limited partners from liability, but limited partners are prohibited from active participation in management. Limited liability partnerships shield some partners from liability but only if they have no involvement in the transaction creating the debt or liability. The most useful type of business ownership for large and growing organizations is the corporation, which combines limited liability, separation of ownership and control (allowing for passive investors) and permanence. The limited liabililty company is the newest type of business ownership and was created by the legislature as a hybrid to get the best of both worlds: limited liability and pass-through taxation. The caveat for business owners setting up an LLC is that these companies are designed to be primarily governed by contract. There are fewer rules and much more legal uncertainty regarding these organizations than with corporations. Therefore, the governance and operations of an LLC needs to be carefully thought through and planned and detailed in an operating agreement.
- Cost of Start-up. ...
- Control vs. ...
- Profits—to Share or Not to Share. ...
- Taxation. ...
- Entrepreneurial Ability. ...
- Risk Tolerance. ...
- Financing. ...
- Continuity and Transferability.
The most common forms of business are the sole proprietorship, partnership, corporation, and S corporation. A Limited Liability Company (LLC) is a business structure allowed by state statute. Legal and tax considerations enter into selecting a business structure.What are 5 options for business ownership? ›
- Sole Proprietorship. A sole proprietorship is when there is a single founder who owns and runs the business. ...
- Partnership. ...
- Pty Ltd - Proprietary limited company. ...
- Public Company. ...
If you want sole or primary control of the business and its activities, a sole proprietorship or an LLC might be the best choice. You can negotiate such control in a partnership agreement as well. A corporation is constructed to have a board of directors that makes the major decisions that guide the company.What factors would you consider in selecting business? ›
- A Business Idea.
- Knowledge or Expertise.
- Market or Demand.
- Start-up Costs.
- Capital and Finance.
Among the first decisions a business owner or practicing professional must make is the best business entity for their organization. This is a crucial decision when starting business because it has far-reaching legal and tax consequences.What legal structure is best for my business? ›
Corporations offer the strongest protection to its owners from personal liability, but the cost to form a corporation is higher than other structures. Corporations also require more extensive record-keeping, operational processes, and reporting.Is LLC a corporation or sole proprietorship? ›
An LLC is very flexible and can also be taxed as a sole proprietorship, a partnership, or a corporation. A sole proprietor also benefits from pass-through taxation, so you'll report your business's income or loss in the same way. The difference is that you don't have the option to file as a corporation.What are the 3 main forms of ownership? ›
There are three common types of businesses—sole proprietorship, partnership, and corporation—and each comes with its own set of advantages and disadvantages. Here's a rundown of what you need to know about each one.What are the 3 basic forms of ownership? ›
The kind of business format you choose will depend very much on the nature and size of your business, and should suit your specific needs. Small and medium enterprises can take one of three forms: they can be either a sole proprietorship, a close corporation (a CC) or a private company (a (Pty) Ltd).
As a simple and effective tax structure, many multi-member LLCs will find the partnership tax status to be an ideal choice. However, if your company plans to seek funding from outside investors or other types of passive owners, you may want to consider being taxed as a corporation.What type of business ownership is most common? ›
The sole proprietorship is the most common form of business organization. One person conducts business for him or herself. A sole proprietorship is not a legal entity. It has no life of its own separate and apart from the owner of the business.What is the safest form of business ownership? ›
A C corporation, or just a regular corporation, is its own entity kept separate from its owners. This means they offer the most protection in terms of personal liability.
Considerations for deciding which business type is best suited to the new entity's needs and goals include: the number of owners, protection from personal liability, taxation, management structure, and investor considerations.Which form of business ownership is the most advantageous and why? ›
The limited-liability company (LLC) accomplishes exactly that. This form provides business owners with limited liability (a key advantage of corporations) and no “double taxation” (a key advantage of sole proprietorships and partnerships).Why is a partnership the best form of ownership? ›
Advantages of a partnership include that: two heads (or more) are better than one. your business is easy to establish and start-up costs are low. more capital is available for the business.Which form of business ownership is the easiest to establish? ›
A sole proprietorship is the easiest and simplest form of business ownership. It is owned by one person. There is no distinction between the person and the business. The owner shares in the business's profits and losses.How do I classify my LLC? ›
Classifications. Depending on elections made by the LLC and the number of members, the IRS will treat an LLC as either a corporation, partnership, or as part of the LLC's owner's tax return (a “disregarded entity”).How do I categorize my LLC? ›
LLCs are classified as “pass-through” entities for tax reasons, meaning the business profits and losses will flow through to the personal tax return of each member. An LLC can also elect to be taxed as an S-Corporation or a C-Corporation. To be taxed as an S-Corporation, the LLC must file IRS form 2553.How can an LLC avoid double taxation? ›
When a business is organized as a pass-through entity, profits flow directly to the owner or owners. In turn, these are not taxed at the corporate level and again at the personal level. Instead, the owners will pay taxes at their personal rate, but double taxation is avoided.
The most common types of business ownership structures are:
- Sole proprietorships.
- General partnerships.
- Limited partnerships.
- C corporations.
- S corporations.
- Limited liability corporations (LLCs)
In terms of tax implications, sole proprietorships are considered a “pass-through entity.” Also known as a “flow-through entity” or “fiscally transparent entity,” this means that the business itself pays no taxes.What is better for taxes LLC or S Corp? ›
Taxes on S corporations are lower than on non-S corp. LLCs. As an LLC owner, you'll incur steep self employment taxes on all net earnings from your business, whereas an S corporation classification would allow you to only pay those taxes on the salary you take from your company.Do LLC pay more taxes than sole proprietorship? ›
LLCs do not pay more taxes than Sole Proprietorships. Both an LLC and a Sole Proprietorship qualify for pass-through taxation. Pass through taxation basically means that any profits and losses from the LLC or Sole Proprietorship are “passed through” to the business owner and taxed as personal income.How do you decide between sole proprietorship and LLC? ›
Differences between LLC and sole proprietorship
The most significant difference is whether you have limited liability for the business' debts and obligations, as with an LLC, or whether the business' liabilities and obligations fall to you personally in the event of a lawsuit or debt collection.
- Sole proprietorship.
- S corporation.
- Limited liability company.
- Sole proprietorship. ...
- General partnership. ...
- Limited partnership (LP) ...
- Limited liability company (LLC) ...
- Non-profit. ...
- C corporation. ...
- S corporation.
The ownership pattern of corporate enterprises can be broadly of three types: (i) Widely dispersed, ownership particularly amongst large number of individual shareholders; (ii) Promotors' dominated shareholding pattern where promoters may be owning 30% to 80% or more vis-a-vis individual shareholders who own less then ...Why is a sole proprietorship best? ›
Minimal paperwork and low set-up costs are two major benefits of having a sole proprietorship. In addition, there is the ease of maintaining it. In fact, according to the SBA, it's the simplest and least expensive business type you can establish.What are the 4 forms of business? ›
There are 4 main types of business organization: sole proprietorship, partnership, corporation, and Limited Liability Company, or LLC. Below, we give an explanation of each of these and how they are used in the scope of business law.
The 3 types of business entities that are most common are the sole proprietorship, limited liability company (LLC), and corporation. Each has their own distinct advantages and disadvantages, depending on what you and your business need.What are the pros and cons of a sole proprietorship? ›
|The Pros||The Cons|
|Complete control and flexibility to run the business as you see fit||Personally liable for all business debts, you're all by yourself|
An LLC can help you avoid double taxation unless you structure the entity as a corporation for tax purposes. Business expenses. LLC members may take tax deductions for legitimate business expenses, including the cost of forming the LLC, on their personal returns.Who has the most power in an LLC? ›
President is the most popular title for the highest ranking manager in an LLC. The LLC Operating Agreement typically gives the President general management powers over the business. This includes the ability to open bank accounts for the LLC.Should my LLC be a partnership or corporation? ›
The best tax classification for an LLC depends on whether you want your business profits to be taxed at your personal income tax rate, or at the corporate tax rate. If you'd prefer personal tax rates, you can classify it as a disregarded entity or as a partnership. Otherwise, you can classify it as a corporation.What are the types of business ownership and give example of each? ›
The most common forms of business ownership are sole proprietorship, partnership, limited liability partnership, limited liability company (LLC), series LLC, and corporations, which can be taxed as C corporations or S corporations.Which form of business ownership has no risks? ›
The sole proprietorship may be a suitable choice for a one-person start-up operation with no employees and little risk of liability exposure.How do entrepreneurs decide which form of business ownership to establish? ›
FACTORS TO CONSIDER WHEN CHOOSING A BUSINESS OWNERSHIP MODEL
These are: Legal requirements for establishing a business and complying with regulations e.g. tax requirements. The expected ability of the enterprise to exist independently of its owners.
The owners in a corporation are referred to as shareholders; if operating as a C corporation, there can be an unlimited amount of owners. However, if operating an S corporation, which is a subset of a C corporation, then there can only be a maximum of 100 owners.What are the 3 major forms of ownership? ›
Business ownership can take one of three legal forms: sole proprietorship, partnership, or corporation. It is important to select the most appropriate form of ownership that best suits your needs and the needs of your business.
Disadvantages of creating an LLC
States charge an initial formation fee. Many states also impose ongoing fees, such as annual report and/or franchise tax fees. Check with your Secretary of State's office. Transferable ownership. Ownership in an LLC is often harder to transfer than with a corporation.
In order to split ownership in an LLC, you will need to draft an LLC operating agreement. This operating agreement document will outline how profits and losses are divided among LLC members and other controlling provisions such as voting rights and management structure.Is it better to be a single member LLC or multi member LLC? ›
A single-member LLC is easier for tax purposes because no federal tax return is required, unless the business decides to be treated as a corporation for tax purposes. The income is reported on the member's tax return. A multiple member LLC must file tax return, and give the members K-1 forms to file with their returns.What is the most popular type of ownership? ›
Sole proprietorships are the most common kind of business ownership, accounting for 73% of all US businesses (around 23 million people). A sole proprietorship automatically exists as soon as you undertake business activity not covered by another entity type.What are the 10 types of business ideas? ›
- Cleaning service. Consider starting a cleaning business if you don't mind doing the dirty work others cannot do for themselves. ...
- Freelance Writing Business. ...
- Amazon Kindle Publishing. ...
- Daycare. ...
- Pet Grooming. ...
- Aerial Photography. ...
- Build and Sell Themes Online. ...
A sole proprietorship is the easiest and simplest form of business ownership. It is owned by one person. There is no distinction between the person and the business. The owner shares in the business's profits and losses.How many types of business ownership are there? ›
Broadly speaking, there are 4 different types of business structures (not including nonprofit organizations): sole proprietorship, partnership, corporation, and LLC.