Choosing an organization for your business is similar to buying a new car. You have to know what models are available and which of those models has the features and options that fit your needs. For a business, there are basically four “models” or types of organizations to choose from: the sole proprietorship, the partnership, the corporation and the limited liability company.
What is a sole proprietorship?
ItÂ´s a business with one owner who makes the management decisions. The owner and the business are one and the same, with a common identity. Sole proprietorship is the simplest business organization.
How is a sole proprietorship formed and operated?
There almost are no legal formalities to forming a sole proprietorship, so itÂ´s relatively easy. The main step is obtaining a federal employer identification number from the IRS by filing Federal Form SS-4.
If you have employees, you must withhold income tax and FICA (Social Security) from their checks and deposit it with the government. You (the business) also have to pay FUTA (unemployment) and a matching amount of Social Security for them. As the owner, you pay Social Security through the self-employment tax rather than FICA, and you have to make periodic estimated tax payments on income from the sole proprietorship.
What is a partnership?
A partnership is simply an association of two or more persons, as co-owners, who carry on a business for profit.
How is a partnership formed and operated?
A partnership can be either a general partnership or a limited partnership. In addition, a general partnership may be registered as a limited liability partnership (LLP), which provides certain limits on a partnerÂ´s personal liability for the LLPÂ´s debts. No expense or legal formality is required to organize a general partnership, except, to register a general partnership as an LLP, a registration statement must be filed with the state, and filing fees and expenses must be paid. To form a limited partnership, a certificate of limited partnership must be filed with the state, and filing fees and expenses must be paid. ItÂ´s a good idea to have a written partnership agreement, even though one isnÂ´t required. In a general partnership, each partner has an equal voice in managing the business of the partnership unless a written partnership agreement gives management authority to a certain partner or partners. In a limited partnership, the management of the partnership is reserved to a certain partner or partners who are called general partners, whereas the remaining partners, who are called limited partners, do not participate in the management of the partnership.
Tax responsibilities of both a general and limited partnership are the same as those of a sole proprietorship. The partnership must apply for a federal employer ID number and withhold income taxes and FICA from its employeesÂ´ wages. The partnership must pay FUTA and its share of Social Security for its employees. The partners themselves may have to pay self-employment taxes and make periodic estimated tax payments on their share of partnership income.
What is a limited liability company?
A limited liability company (LLC) is a hybrid organization with attributes of both a partnership and a corporation. Members receive “interests” in the LLC in exchange for property, money or services. An LLC offers the corporate advantage of limited liability to its members together with the partnership tax advantage of direct attribution of the LLCÂ´s income or loss to its members. However, to be eligible for partnership tax treatment an LLC must comply with certain IRS requirements to be taxed as a partnership or it will be taxed as a corporation.
How is a limited liability company formed and operated?
To form an LLC, articles of organization must be filed with the state, and filing fees and expenses must be paid. Although not required, the members also should enter into an operating agreement that defines their obligations and duties to each other and the company. An LLC also must apply for a federal employer ID number, withhold income taxes and FICA from its employeesÂ´ wages, and pay FUTA and its share of Social Security for its employees. The members may have to pay self-employment taxes and make periodic estimated tax payments on their share of the LLCÂ´s income.
An LLC may be organized to be managed by its members or by one or more managers. If an LLC is managed by its members, the members have the same broad managing authority as a partner in a general partnership. On the other hand, if the LLC is managed by one or more managers, the managerÂ´s authority resembles the managing authority of a partner in a general partnership, while the members are merely investors in the company.
What is a corporation?
A corporation is an artificial entity that receives its legal existence from a charter granted by the state. There is a complete legal separation between the stockholders (owners) of a corporation and the business of the corporation. Stockholders receive their stock from the corporation in exchange for money, property or services.
How is a corporation formed and operated?
To form a corporation, articles of incorporation must be filed with the state, bylaws and minutes of preliminary meetings must be drafted, and filing fees and expenses paid. A corporation faces the same requirements for obtaining a federal employer ID number, withholding income tax and FICA from its employeesÂ´ wages and paying FUTA and its share of FICA.
The stockholders usually elect a small group of directors to set the corporationÂ´s policies. The directors then elect officers such as president, secretary and treasurer to carry out the normal business functions.
Is the owner personally responsible for all the debts of a business?
In some cases, yes. Risk is a fundamental aspect of every business. So an owner must be aware of possible liabilities arising out of business operations. A sole proprietor, a partner of a general partnership and a general partner of a limited partnership are personally liable for all the debts of the business, including loans, accounts payable, defective products and employee accidents.
Generally, the liability of limited partners, stockholders, and the members of an LLC are limited to what they have invested or committed to invest. Unlike corporate stockholders or members of LLCs, limited partners can lose their limited liability if they actively participate in the limited partnershipÂ´s business. In addition, corporate stockholders and LLC members who have responsibility for managing compliance with certain types of laws, such as tax and environmental, can have personal liability if such laws are violated.
For many closely-held entities, limited liability may exist more in theory than in reality because owners often are required to personally guarantee their entityÂ´s loans and, in some instances, accounts payable. Stockholders also may be liable for the unpaid wages of corporate employees.