A sole proprietorship is a business entity that is virtually indistinguishable from its owner. The cost to create it is frequently only a small, one-time fee to state or county officials to register a fictitious business name, and the cost of placing an ad in your local paper to notify the public that you are doing business under that name.
There is, however, a price for this easy setup. Sole proprietorships cannot take advantage of special business income tax rates because all income is considered individual income. Sole proprietors are also not protected from personal liability if they get into trouble with a client.
General partnerships are formed by two or more legal entities (any kind of legal entity can be a partner), and each of those entities are individually responsible for the partnership. This means that each partner is personally liable for the partnership’s debts and legal liabilities. If one rogue partner makes an enemy of a third party, all partners will be held accountable
A limited partnership is much like a general partnership in structure. The main difference is that in a limited partnership there are two kinds of partners: general and limited. The limited partner does not take part in the management of the partnership and is not liable for any more than his or her individual capital investment. This distinction is made to encourage investors to become limited partners so they can share in the profits but not lose more than their own contribution.
A C corporation is a standard state-formed corporation. It is a legal entity once it is formed, so it files its own taxes and is responsible for its own dealings. A C corporation can have an unlimited number of shareholders and those shareholders can be any kind of legal entity.
A C corporation must elect a board of directors, hold annual meetings, keep minutes of corporate meetings, and issue stock. This applies even if you are the only shareholder in the corporation. If these formalities are not followed, you run the risk of losing your personal liability protection if a court decides that your corporation was just an alter ego of yourself created to keep you safe (sometimes referred to as “piercing the corporate veil”).
Additionally, because corporations are taxed on their income and shareholders must claim dividends as taxable income, shareholders of a C corporation are double taxed on their dividend income. One way to avoid this is to not issue dividends and simply reinvest your income with the company. Spending your income on items that are tax-deductible is another way to avoid being double taxed. You could also consider forming an S corporation.
An S corporation is like a C corporation in that it is also its own legal entity, protects its shareholders from legal liability, and requires a significant amount of effort and money to start and maintain. However, an S corporation allows shareholders to claim their share of the corporation’s income directly on their personal tax returns. This avoids the double taxation problem of a C corporation. The drawbacks of an S corporation are that they may cost a little more to form and they are generally limited to a maximum of 100 shareholders. This makes going public with an S corporation practically impossible. However, this is an excellent option if your intention is to keep your business relatively small.
Limited Liability Company
A limited liability company (LLC) is essentially a hybrid of a corporation and a partnership. An LLC provides the same kind of tax and liability benefits as a corporation, but has the same management structure as a partnership. In the past, LLCs have had more restrictions on them than corporations. For example, at least two people were needed to form an LLC and an LLC’s duration was specifically limited. However, in the last few years, states have started relaxing these restrictions.