How Do Various Forms of Business Operate?
There are several types of business entities available to entrepreneurs and business owners. Each form has legal and tax benefits and consequences. To learn about the business entities available in your state and which would best serve your goals, consult an experienced business attorney. The following is basic information on how various business entities operate:
Sole Proprietorship. In a sole proprietorship, one owner controls the business and assets. A sole proprietorship is not taxed separately from the owner. The owner declares the business income or loss on the owner’s personal income tax return (often referred to as pass-through taxation). The business owner is personally liable for all of the business’s debts and obligations.
General Partnership. In a general partnership, two or more persons agree to operate a business together for profit. Each partner has the power to make contracts on behalf of the partnership and these contracts are binding on all of the partners, even if they did not consent. Each partner is personally liable for all of the partnership’s liabilities, and a creditor is entitled to collect all monies due to it from any of the partners. Similar to a sole proprietorship, the partners declare their respective shares of partnership income or loss on their individual income tax returns.
Limited Partnership. In a limited partnership, one or more general partners manage the business and are personally responsible for all of the partnership’s liabilities. One or more limited partners contribute capital and receive a share of the business profits but are limited in their liability to the extent of their investment and participation. Limited partners do not take part in managing the business, and if they are too active managing the business, they may lose their limited partner status and risk becoming personally liable for the business debts and obligations. As with a general partnership, the partners declare their shares of partnership income or loss on their individual income tax returns.
Limited Liability Company. A limited liability company has members who usually own and manage the business. But a limited liability company may have non-owner managers run the company instead of members. Most states allow a single person to operate as a limited liability company, but some states require that a limited liability company consist of at least two individuals. Members are not personally liable for the debts and obligations of the limited liability company. The members declare company income or loss on their individual income tax returns (pass-through taxation).
Corporation. Unlike a sole proprietorship or a partnership, a corporation is recognized for all purposes as a legal entity separate from its owners. A corporation requires a specific structure, and each role within it has limits and obligations. Often, shareholders are investors who have little say in the management of the corporation. Shareholders elect a board of directors and the board of directors designates officers to carry out the business of the corporation.
“C” Corporations. A “C” corporation refers to a tax designation that most corporations hold. A “C” corporation is a separate tax-paying entity whose profits are subject to corporate income tax rates. Shareholders are not personally liable for the debts and obligations of the corporation.
“S” Corporations. The “S” corporation designation is the alternative to a “C” corporation for tax purposes. The “S” corporation may have no more than one hundred shareholders, and the shareholders must be U.S. citizens or resident aliens. There can be only one class of stock. An “S” corporation is taxed like a partnership; it enjoys pass-through taxation. Generally, the shareholders are not personally liable for the debts and obligations of the “S” corporation. Thus, they enjoy the same personal protections as shareholders of a “C” corporation.
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