Most new businesses start as sole proprietorships. This is the simplest form of ownership for a sole owner and requires little more than a tax ID number. However, when there are concerns over taxation or liability issues, or when there are multiple owners, other business organization types should be considered. Which organization type is best for your business depends on a number of factors, including the type of business, the number of business owners and the level of concern over taxation and liability issues.
A partnership is the easiest business organization type to create, as it only requires an agreement, which can be verbal or written. In a partnership, the owners manage and control the business, and all revenue flows directly through the business to the partners, who are then taxed based on their portions of the income. The partners are personally liable for debts and any liabilities that result from the operation of the business.
When one partner leaves the business, it is dissolved unless there is an agreement in place that allows it to continue. A business continuation agreement typically stipulates the terms under which a partner can transfer his share of the business for some financial consideration. The same agreement should provide for the transfer of a deceased partner's share so the surviving family members receive fair compensation from the remaining partners.
Limited Liability Company (LLC)
The creation of a limited liability company (LLC) requires an operational agreement and a state filing of articles of organization. Similar to partnerships, owners of an LLC have direct management control over the company, and the company is required to file an information return. The owners file their own individual returns based on the revenue that flows to them directly through the business.
The primary difference between a partnership and an LLC is the latter is designed to separate the business assets of the company from the personal assets of the owners, which insulates the owners from the debts and liabilities of the company.
In terms of the sale or transfer of the business, a business continuation agreement is the only way to ensure the smooth transfer of interests when one of the owners leaves or dies.
There are two types of corporations – S corporations and C corporations – which are legal entities based on filings of articles of incorporation with the state. The primary difference between the two is in their tax structures. A C corporation is a tax entity in and of itself, so it files a tax return and is taxed based on business revenue. A double taxation could occur when the shareholders or owners file individual returns based on any income they receive in the form of dividends from the corporation. An S corporation is similar to a partnership and LLC in that it files an information return, but the revenue flows directly to the shareholder owners who then file individual returns.
In most other aspects, the two business structures are the same. In both structures, the business is controlled by a board of directors who are answerable to the shareholders. The board hires the senior management team. Business assets and liabilities belong to the company, and the sale or transfer of interests is conducted by the sale of shares to anyone who wants to buy the interest.
Ultimately the type of business organization selected comes down to the owners' level of concern over management control, liability exposure, tax issues and business transfer issues. Because of the tax and legal implications involved, the guidance of a qualified tax attorney is essential in selecting the most suitable form of ownership.