One of the first problems facing the founder of a new business is which legal form to choose. As he looks into the matter, he finds a confusing mix of simple and inexpensive forms -- some that seem complicated and costly, and others that fall in between. After discussing the matter with his attorney and a few colleagues, he realizes that his best move is to consider the type of business he's in, the financial situation and whether he has partners. Next, he should choose the form that best suits his -- or the ownership team's -- needs at the time of launching the business.
If you're in business by yourself -- for example, as a freelancer or the lone owner of a small business -- you're a sole proprietor. There's no need to file special forms with government authorities or pay fees to start your business. If you want to operate under a name other than your own, however, -- using a fictitious name or "doing business as" (DBA) name -- you'll have to register the name with your state. As a sole proprietor, you'll be personally liable for your business activities and debts. Your business profits are taxable on your individual tax return. If you're running a small service business and there isn't much chance of being sued, it would be appropriate for you to operate as a sole proprietor. The same would be true if you don't anticipate having to borrow large amounts to finance your business.
If you have one or more co-owners in your business and personal liability isn't an issue, you could form a partnership. You and your partners must complete a partnership agreement and register it with the state. Your business name is the same as the name given in the agreement. If you want to operate under a different name, you must register a fictitious name or DBA with your state. As with the sole proprietorship, the owners are responsible for reporting their share of the partnership's profits or losses on their personal tax returns. A partnership would be appropriate for a low-risk business where personal liability isn't a concern and there's no need to borrow large sums from banks. Examples might be a consulting firm or a local retail business. Partnerships are nearly as easy and inexpensive as sole proprietorships to set up and maintain.
If you're forming a business that will need to raise capital from outside investors and borrow regularly from banks, the appropriate legal structure for your company is probably the corporation. The founder or ownership group must register the corporation according to state regulations. This complicated and often expensive process involves filing articles of incorporation and issuing stock certificates to the initial shareholders. Other requirements include obtaining licenses and permits, obtaining a tax identification number and registering with federal, state and local revenue agencies. In a regular corporation -- also known as a C corporation -- the business is a separate taxable entity. Shareholders' liability is generally limited to the extent of their investment in the company's stock.
A regular corporation can avoid double taxation of income (once to the corporation and once to the shareholders) by electing to be treated as an S corporation. Profits of the corporation "pass through" the organization and owners report their share of the profits on their personal income tax filings. They can also use corporate losses to offset income from other business activities.
Limited Liability Company
The limited liability company -- LLC -- contains elements of both partnerships and corporations. Many small-business owners adopt the LLC legal form because of its flexibility. LLCs provide limited personal liability to their owners -- called members -- in most U.S. jurisdictions. This business entity is a type of unincorporated association. The primary characteristic of an LLC is the availability of pass-through income taxation. Each LLC member reports his share of the LLC's income on his individual income tax return.