As you decide to open your business, one of the first decisions you will need to make is what form the entity will have. Each choice has advantages and disadvantages. When you’re making this decision, it’s good to speak to both a lawyer and an accountant.
Basically, this is someone running a business without an entity. You are your business; there is no separation. The advantage of this model is that anyone can start a business easily. You will need to file a “Doing Business As” (DBA) form with the local county government. That way they know that Aunt Nellie’s Homemade Crafts is run by Stuart Whitmore. Anything you earn is taxed as your personal earnings and there is no protection for your assets against any liabilities incurred by your business. Other than county registration (and any trade licenses necessary), there are no entity filing requirements.
This is like the Sole Proprietorship but with another person joining with you. This brings a significant additional risk: once you form a general partnership, you have another person who can bind you to decisions and put you at risk – including being solely responsible for all of the partnership’s debts. (This risk is not true for a Limited Partnership, which we will discuss in a moment.) Like a Sole Proprietorship, income passes through to the individuals forming the partnership for tax purposes. Other than county registration (and any trade licenses necessary), there are no entity filing requirements.
Corporation / Professional Corporation
Incorporation is the most prevalent form of entity in use. When you form a corporation, you create a new legal entity in which the risks and rewards of the business will be held. This means that you protect your personal assets in case of business loss. It also means that unless you create what is known as a “subchapter S” corporation the profits of the company stay at that level, and the company itself is taxed on its income. You, your attorney and your accountant should discuss what the best model is for you from a tax liability perspective. There are also annual filing requirements for corporations with the state, and certain information is public. There are no limits on the number of potential shareholders/investors (except for a subchapter S entity) which makes it easier if you need to raise additional capital later. Certain professions are required to form either a PC (Professional Corporation) or a PLLC when creating an entity (e.g., accountants, attorneys, doctors, engineers and the like). PCs can only be owned by members of that particular profession and a certificate of good standing is often needed before the entity will be recognized by the state.
Limited Liability Company / Professional Limited Liability Company
An LLC has a lot to offer an entrepreneur: limited liability so that your personal assets are protected from business risks; and an option as to how to tax the income (either as personal earnings, or to be treated as a corporation). There are no annual filing requirements with the State, but there isn’t as much flexibility if you want others to contribute capital to the business (i.e., adding members to an LLC is more cumbersome than issuing shares in a corporation). Like the PC, certain professions are required to form a PLLC when forming an entity (again, accountants, attorneys, doctors, engineers) and only other members of that profession are able to be co-owners. A PC or PLLC doesn’t protect the owners from professional malpractice claims, however.
Limited Partnership / Limited Liability Partnership
Limited Partnerships and Limited Liability Partnerships cure the problem presented in general partnerships of personal liability on behalf of the partners for the business debt. They also solve the problem of the partnership dissolving upon the death of any one partner. A Limited Partnership has one person or entity that acts as a General Partner, and all other members of the firm as Limited Partners. As long as the limited partners do not actively manage the business (with certain exceptions), they maintain their limited liability and are only exposed to the extent they have a financial stake in the limited partnership. A limited partnership also has some flexibility about allocating profits to maintain a tax advantage for the participating partners. A Limited Liability Partnership is created when two or more persons (not entities), each of whom are a professional authorized by law to render a professional service, register as a limited liability partnership. Just like a PLLC, each member of an LLP remains personally liable for his or her own professional malpractice claims. The advantage that an LLP has over other forms of entities (including a PLLC) is that each partner is protected from the debts of the other partners arising from professional malpractice lawsuits.
As you can see, there are number legal and financial implications implicit in the choice of which entity to operate your business as. Careful consideration and consultation with a lawyer is essential in protecting yourself and your personal assets.