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Sole Proprietorships, LLCs & Corporations: A Guide To Legal Forms of Business

Andrew Brown

February 15, 2008

For many business owners, it can be difficult to understand the differences between various types of legal business organizations. Across all types there are benefits, drawbacks and rules that apply in reference to tax, liability and structure. What’s important is to be able to clearly understand what is right for your business.

Below is a brief compilation of the basic forms of business ownership in the United States, emphasizing those that are most attractive to small business owners Remember: specifics of each can vary from state to state, so be sure to check with your state’s Secretary of State Office to understand what is best for your business.

Sole Proprietorship: A sole proprietorship is an unincorporated business that is owned by one person. In this way, it is the simplest form of legal organization to start and maintain. You, the owner, include the income and expenses of the business on your own tax return. Similarly, you are also personally responsible for any business liabilities.

Limited Liability Company (LLC): Authorized only in certain states, an LLC is a mixture of a corporation and a partnership. LLCs are becoming a popular structure for small businesses due to their flexibility and low maintenance costs while still offering most of the advantages of a corporation. With an LLC, you separate your business and personal identities, distributing the ownership percentages, P&L and voting powers among owners. LLCs can also offer tax savings, depending on how the LLC chooses to be taxed (either as a partnership, S Corporation or C Corporation).

S Corporation: After the corporation has been formed, the stockholders may elect “S Corporation” status by making a filing with the IRS. Like an LLC, this is another attractive option for many small businesses. An S Corporation is taxed like a partnership — the profits and losses of S Corporations flow through to the federal tax returns of the owners in proportion to their stock ownership. However, they are protected from the liabilities of the business as in a C Corporation.

Corporation (”C Corporation”): In a C Corporation structure, one or more stockholders are the owners, managed by a board of directors elected by the stockholders, and run by officers appointed by the board of directors. However, a single individual can be the sole stockholder, director and officer of the company. All parties are protected from the companyÕs liabilities, including liabilities for their own negligence when acting in their corporate role, except in a few extraordinary circumstances. The corporation files its own tax return and pays taxes, which are graduated based on the company’s taxable incomes.

The ins and outs of each type of business organization as well as the state variances can appear to be overwhelming. Most important, educate yourself, talk to a professional, and consider all your options carefully. For more details, visit http://www.irs.gov/businesses/small/article/0,,id=98202,00.html

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