The Basic Types of Business Structures

Learn More About the Legal Structures of a Business

Sole Proprietor

  • A sole proprietorship is considered the simplest form of doing business. In most cases, you simply obtain your business license and you are in business.
  • Income is taxed at your individual level. Sole proprietors are also subject to a 15.3% self-employment tax on all income earned from the business.
  • Zero asset protection. As a sole proprietor there is no separation, you are the business. This means if your business gets sued, your personal assets are at risk. If you get sued, your business assets are at risk.

Partnership

  • A Partnership is considered the riskiest form of doing business. Typically, two or more people get together to conduct business or purchase an asset.
  • Gains or losses of the Partnership are passed through to the individual partners and are included on their individual tax returns.
  • In a Partnership all parties are liable for the company’s actions, and personal assets can be at risk to satisfy a judgment. In some cases, an individual partner’s personal liability could “flow through” the partnership to the other partner(s).

Corporation

  • A Corporation is a separate legal entity that is created by statute and regulated under the laws of the state in which it was formed.
  • A Corporation is owned by shareholder(s). Shareholders can be individuals or other entities such as another Corporation, Limited Liability Company, (Family) Limited Partnership or a Trust.
  • Shareholders of a Corporation cannot be held personally liable for the actions of the business except in the case of outright fraud. If the Corporation is properly established and maintained, the individual shareholders are not personally liable for the losses of the business and creditors may only look to the Corporation and the business assets for payment.
  • A Corporation may choose to have multiple classes of stock.
  • A Corporation is taxed separately from its owners on its profits.
  • Profits of the Corporation may be distributed to its shareholders (issue dividends) where the income would be taxed again as passive income. This would result in what’s commonly called “double taxation”.
  • A Corporation is required to observe corporate formalities to ensure the integrity of the “corporate veil”. Corporate formalities consist of the holding and documentation of all company meetings, the formal approval of major corporate decisions through resolution and the approval of the board of directors, officers and shareholders.

“S” Corporation

  • All “S” Corporations start out as a regular Corporation. By filing form 2553 with the IRS, you are electing that the Corporation be treated like a partnership for tax purposes. Profits and losses are “passed through” to the shareholders in proportion to their percentage ownership
  • “S” Corporations have all the limited liability protection of a regular Corporation. However, they are not allowed many of the same fringe benefits that regular Corporations do
  • “S” Corporations are restricted to no more than 75 shareholders; Shareholders must be U.S. citizens and natural persons (or certain types of Trusts)
  • Allowed only one class of stock
  • Like the Corporation, the “S” Corporation is required to maintain formalities to ensure the integrity of the “corporate veil”

Limited Partnership

  • Controlled (managed) exclusively by the general partners who are elected by the limited partners
  • General Partners have complete control in regards to the management of the LP but have no liability protection from judgments against the LP or lawsuits from the Limited Partners (owners)
  • Limited Partners have no control of the LP and therefore have limited liability from judgments against the LP
  • Partners in a LP have charging order protection against their interest from personal judgments

Limited Liability Company

  • Limited Liability Company (LLC) are a hybrid between a Corporation and a Limited Partnership and combine the best of both. LLCs provide the liability protection of a Corporation with the pass-through taxation of a Partnership
  • LLCs are very popular due to their flexibility in management, and the personal liability protection offered to its managers and members
  • LLCs don’t have the restrictions on membership that an S-Corporation has on shareholders. LLCs also allow members to participate in the management of the LLC without losing their liability protection (unlike the General Partner of a limited partnership, which has unlimited liability)
  • LLCs have the greatest flexibility in regard tax classification with the IRS and to the distribution of profits and losses. Unlike the “S” Corporation, distribution is not necessarily based on percentage of ownership
  • Members of LLCs have charging order protection against their membership interest from personal lawsuits
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