A Glimpse into Forms of Business Entities
A Glimpse into Forms of Business Entities
Abstract
In today's economy, more and more job seekers and employees are turning to entrepreneurialism as a potential solution to the job market. However, many of these same people struggle with the first steps. This article discusses one of the very first steps, organization formation, and the importance of selecting the right type of organization, sole proprietorship, partnership, or corporation. This article takes a glimpse at each of these organization types in an effort to help would be entrepreneurs make the proper choice.
Many employees as well as job seekers are now looking at entrepreneurship, which is a viable option versus employment at a company because of the job market. However, the question asked by many when starting a company is what form of business should I start? Further, what are the advantages and disadvantages of each form? This brief article discusses the three main types of businesses, proprietorship, partnership, and corporation.
A proprietorship is a small business, perhaps like your local hardware or corner drug store. This is an unincorporated business owned by one individual. Sole proprietorships may operate under your name or a trade name, such as a plumber or electrician. The advantages include the ease and general inexpensiveness of starting this form of business, few government regulations, and the lower income taxes when compared to corporations. Essentially, a sole proprietorship makes no distinction between you and your business. The legal and tax consequences associated with sole proprietorships flow from this fundamental element. In a sole proprietorship, you avoid the double tax. A double tax occurs when you conduct business through a corporation. The corporation pays taxes and then the individual pays again on any income from the business. As a sole proprietorship, you can also deduct business losses to the extent of your total income from all sources.
The main disadvantage is the fact that the owner assumes full liability. A second disadvantage can be found in the tax discussion from earlier. In a sole proprietorship, you may find that you pay higher income taxes.
A partnership is a business arrangement between at least two people. Partnerships offer many of the same advantages as proprietorships do, which include easy and inexpensive startup costs and lower income taxes. Similar to proprietorships, the main disadvantage is the unlimited liability factor. Partners are personally liable for all business debts and obligations. What this means is that if the business cannot pay a creditor, then the partners must pay (which includes homes, cars, etc.).
It is important to consider that partnerships can have exceptions to personal liability. For example, some partners can have limited personal liability if the partnership is set up as a limited partnership. In this instance, only the general partner, the partner responsible for running the business, has personal liability. The limited partners are passive investors whose loses cannot exceed the stake in the partnership.
The final alternative is the corporation. There are many types of corporations, but this article covers only a high overview of a corporation. A corporation is a legal entity created under the state laws of the state in which the business is formed.
The business consists of a person or group who become shareholders. The entity is separate for the members. The corporation can enter into contracts as a person could, pay taxes separately from the owners, and sue or be sued. One of the chief advantages is limited liability. Because a corporation is considered a separate legal entity from the shareholders, the shareholders have limited liability from the corporation's debts and personal assets of the shareholders are not at risk if something should happen that requires corporate debts or liabilities to be satisfied. In general, corporations pay taxes separate from owners (although some corporations allow choices to be made, such as a Limited Liability Corporation, LLC). Corporations also have unlimited lives, or a perpetual existence. They continue to exist until shareholders dissolve it or merge with another business. Also, consider that shares are freely transferable. Again, consider that because the corporation is a separate entity, the corporation's existence does not depend on who owns or invests in the corporation. Just because shares are passed on does not insinuate the corporation has been dissolved.
For some, the corporation would seem like the most sense, but there are disadvantages. For example, filing fees and attorney fees can be exorbitant when creating a corporation, often costing several thousand dollars. It is not recommended that a person or group of persons attempt to form a corporation without the aid of an attorney because the paperwork is a huge component of the corporation establishment and filing it wrong could create bigger problems and even taxation problems later. Tax consequences are also very real. The potential for double-tax consequences exists, which means the company pays taxes on profits and the individual on income and dividends. As stated earlier though, some forms of corporations can alleviate this issue.
It is the hope that this article offers a brief glimpse into your choices as an entrepreneur. Many job seekers and even those employed are beginning to turn towards ownership as a possible solution, deciding that working for someone else is not necessarily the best way any longer. If you are considering business ownership, this is one of the first and most important decisions you will make.
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