Essential Guide to Starting a Business

Ownership

A sole proprietorship is an enterprise owned by a single individual, known as the “sole proprietor.” A sole proprietorship automatically arises anytime a single person conducts business. It does not need to be registered with the government in order to be official. The name of a sole proprietorship is simply the name of the owner. If a sole proprietor wants to do business under a different name, they must file a “Doing Business As (DBA)” with their state government.

Personal Liability

There is no legal distinction between a sole proprietorship and the individual who owns it. As such, sole proprietors are personally liable for their business’s debts, losses, and contractual obligations. This means that if a sole proprietor fails to repay a debt or to fulfill a contract, then a court may hold them personally legally responsible. This can result in having to file for bankruptcy or pay a garnishment drawn out of any regular income they receive.

Taxation

Sole proprietors simply file their taxes on their personal annual tax returns each year in the same way as most individuals. This is known as “pass-through taxation,” because the responsibility for paying taxes passes through from the business to the individual owner. However, since they do not have taxes withheld from their business income, they must pay their taxes quarterly. The quarterly taxes include income taxes and self-employment taxes for medicare and social security. As you will see, this is different from income received by corporations, which is taxed twice: once at the corporate level when the corporation pays its taxes and a second time at the individual level on any personal income received from the corporation. This is known as “double taxation.”

Maintenance

Sole proprietorships are easy to maintain, as the owners have no special requirements to meet other than keeping records of their dealings and paying taxes. Note that certain types of businesses, such as those in the food, hospitality, construction, liquor, or firearm industries, may be required to obtain government permits or licenses in order to be allowed to conduct business.

Ownership

A general partnership is the same as a sole proprietorship in nearly every way except that it has multiple owners. Like a sole proprietorship, a partnership is automatically formed whenever two or more people carry on the same business together.

Personal Liability

Like a sole proprietorship, partners may be held personally liable for the partnership’s debts and other legal obligations. However, if one of the partners does not actually help run the business, that partner is considered a “silent” or “passive” partner and will not be held personally responsible. This situation results in a different business entity, called a “Limited Partnership,” and often occurs when one of the partners is simply an investor and does not participate in managing the partnership’s day-to-day operations.

Taxation

Like a sole proprietorship, partners file their annual taxes on their personal tax returns and are responsible for paying quarterly taxes to the IRS and their state tax authority.

Maintenance

Like a sole proprietorship, general partnerships are easy to form and maintain compared to other entity types.

Ownership

LLCs may only be formed by registering with the appropriate state government office. The owners of an LLC are called “members,” and an LLC may be formed with only a single member or with many. The law provides members with great flexibility in how they choose to structure their ownership rights and responsibilities.

Personal Liability

As implied by its name, an LLC “limits” its owners from personal liability for the LLC’s debts and legal obligations. For example, if an LLC is sued by creditors and a court holds that it is liable to the creditors, then the LLC itself will be responsible for repayment out of its own assets, not the personal assets of the members. This is one of the huge advantages of forming an LLC compared to a sole proprietorship or partnership.

Taxation

The IRS allows LLCs to choose whether they want to be taxed like a sole proprietorship with pass-through taxation or like a corporation with double taxation.

Maintenance

While LLCs require some initial effort to be set up and registered with their state, they require much less ongoing work than maintaining a corporation.

Ownership

Corporations may only be formed by registering with the appropriate state government office. The owners of a corporation are called “shareholders,” and a corporation may be formed with only a single shareholder or with many. Corporations have to follow more ownership rules than LLCs. However, one major advantage of forming a corporation is that they are allowed to sell ownership shares (called “stock”) publicly so long as they follow the federal Securities and Exchange Commission (SEC) rules regarding public stock offerings. This can help corporations raise capital faster than other entity types.

Personal Liability

Like an LLC, shareholders are protected from personal liability for the corporation’s debts and legal obligations.

Taxation

Corporate income receives double taxation. The income is taxed when the corporation pays its quarterly taxes and then again when the shareholders pay their individual income taxes. 

Maintenance

Corporations must meet various state requirements in order to continue doing business. These include filing annual reports, creating bylaws, holding regular board meetings, and issuing stock. Compared to other entities, these requirements are usually more time consuming and costly.

Types of Corporations

• C Corporations: C corps refers to corporations that fall under IRS subchapter C. These are the standard for-profit corporations.

• S Corporations: S corps refers to corporations that fall under IRS subchapter S. These are corporations that file a special request with the IRS to receive pass-through taxation status. They must meet specific requirements in order to qualify, including having fewer than 100 shareholders, only one class of stock, and no nonresident alien shareholders.

• B Corporations: B corps are benefit corporations. These are a relatively new type of corporation, available in 35 states and the District of Columbia. B corps are for-profit corporations that have a legally defined purpose of creating a positive impact on society, workers, the community, or the environment. This means that the corporation is allowed to make decisions that are not strictly motivated by profit, preventing shareholders from pushing for profit at the expense of its other, more socially minded goals.

• Nonprofit Corporations: Nonprofits are corporations formed to carry out charitable, educational, religious, literary, or scientific purposes. Unlike other types of corporations, nonprofit corporations do not issue stock or have owners. Instead, they are controlled by a board of directors. While nonprofits are allowed to earn a profit, they are not allowed to disburse their profits to the directors. Nonprofits may become exempt from paying taxes but only if they submit an application with the state and federal government and are approved. In order to maintain their tax-exempt status, they must meet regular reporting requirements aimed to show that they are using their funds for their approved purposes. While their directors and employees may be paid a salary, these salaries are made public in their reports and must meet certain criteria for reasonableness when compared to similar nonprofits in their industry.