I. Introduction
Starting a new business can be a scary venture for a new
entrepreneur. Beyond picking a location, hiring personnel and
establishing a clientele base, deciding how to register the business
can be an important decision with lasting implications. There are five
main categories under which a new business owner can register his or
her new business: sole proprietorship, general partnership, limited
liability partnership, limited liability company or corporation. This
article discusses the pros and cons of registering under each of the
five categories and the legal implications of each option.
II. Sole Proprietorship: Description, Liability, Tax Benefits
A sole proprietorship is the most common type of business
organization. [1] In a sole proprietorship, one person owns and manages
the business and there is no separation between the business entity and
the individual, meaning for tax purposes the individual must file only
one individual tax return. [2] The advantages of having a sole
proprietorship can be great because it is low cost and low effort. [3]
There are no registration requirements for becoming a sole proprietor.
[4] Additionally, a sole proprietor can easily operate in other states
without registering the business in those states. [5] The greatest
disadvantage to having a sole proprietorship is that the business owner
becomes one with the assets of the business- meaning if the business
goes bankrupt or has liabilities, they become the owners liabilities,
as well. [5]
III. General Partnership: Description, Liability, Tax Benefits
In a general partnership (GP), the individual(s) or corporation
designated as the general partner will be held responsible for the
debts and actions of the partnership as a whole or any of its members.
[6]Additionally, all partners share in the profits and liability.
Section 101 of the Uniform Partnership Act defines a partnership as,
"an association of two or more persons to carry on as co-owners a
business for profit." [7] While registration is not necessary to form a
GP, it is best to delineate the terms of the partnership in writing in
case conflict arises. [8] For tax purposes, each owner of the GP will
be taxed on his or her share of the partnership profits. [9]
IV. Limited Liability Partnership: Description, Liability, Tax Benefits
A limited liability partnership (LLP), on the other hand, is
generally reserved for use by specific professions, like accounting and
law firms. [10] Professional firms generally prefer the LLP designation
because it allows individuals to practice without fear of being held
completely liable for malpractice claims in which the individual has no
part. [11] Registering as a limited liability partnership protects the
owners of the partnership from "the debts, obligations, or liabilities
of the partnership resulting from negligence, malpractice or wrongful
acts, or misconduct by another partner, employee or agent of the
partnership." [12] However, a partner will still be liable for any of
the aforementioned conduct that a partner commits or that occurs under
that partner's direct supervision. [13] In an LLP, any partner can bind
the business. [14] Additionally, LLPs are similar to general
partnerships in the way they are run. [15] The profits of an LLP pass
to the partners, who eventually pay them as an income tax. [16]
V. Limited Liability Company: Legal Description, Liability, Tax Benefits
A limited liability company (LLC) is called so because the owners,
also called members, are only subject to limited liability for the
debts and actions of the company. [17] While the members will not be
liable for the mistakes of the company, they will be held liable for
any individual mistakes the member makes. [18] Registering the company
as an LLC also has tax benefits. [19] "LLCs are a 'pass through' tax
entity, which means company profits are passed through the business and
taxed solely on the member's individual tax returns." [20]
Additionally, the members of an LLC report all gains, losses, credits
and deductions as income on their personal tax returns. [21]
VI. Corporation: Legal Description, Liability, Tax Benefits
Unlike the LLP, LLC and sole proprietorship, a corporation is
considered distinct from its shareholders. [22] Since it is considered
a separate legal entity, a corporation is considered of unlimited
duration. [23] "When a company is incorporated it acquires all of the
powers of an individual, an independent existence- separate and
distinct from its shareholders, and an unlimited life expectancy." [24]
Shareholders can easily transfer shares and no member can be held
personally liable for any debts or obligations the corporation incurs.
[25] The advantages of incorporation include limited liability,
possible tax advantages, specialized management, transferable ownership
and a continuous existence. [26] Disadvantages of a corporation include
character restrictions, extensive record keeping and close regulation
by the government. [27]
VII. Legal Implications
As with any foundational business decision, the legal implications
of registering can have a lasting effect on the success of that
business. The sole proprietorship is the most popular option for small
business owners because it is procedurally the easiest to establish and
gives owners the most control. However, the owner is left with full
liability if the business fails, which is a risk for many new
businesses. The LLP is the best option for professional businesses that
may be held liable for the mistakes of employers or the partnership
within that business because it insulates individuals from liability.
The LLC is also a solid option for business owners seeking to limit
liability. While the corporation also limits the liability of corporate
shareholders, incorporating a business can be a heavy feat for a small
business owner and may not be worth the hassle.
VIII. Conclusion
This article outlines the five basic types of business
organizations. Factors to take into account when deciding how to
register a business include size of customer base, number of employees,
tax benefits and overall purpose of the business. Additionally, It is
always wise for new business owners to seek the advice of an attorney
before deciding how to register the business because attorneys have the
perspective and resources to help an owner make the proper decisions
for their business.
[1] Michael A. Muaro, Sole Proprietorship, http://www.sos.state.ia.us/business/sole.html (last visited Nov. 3, 2007).
[2] Id.; Coollawyer, Sole Proprietorship, http://www.coollawyer.com/webfront/bizfilings/sole_proprietorship.php (last visisted Nov. 3, 2007).
[3] Mauro, supra note 1.
[4] Id.
[5] Id.
[6] Internal Revenue Service, Partnerships, http://www.irs.gov/business/small/article/1,,id=98214,00.html (last visited Nov. 13, 2007).
[7] Revised Uniform Partnership Act, 26 U.S.C. § 101 (1997).
[8] Internal Revenue Service, supra note 6.
[9] Id.
[10] Tom Pedreira, Limited Liability Partnership, http://business-law.lawyers.com/business-enterprises/Limited-Liability-Partnership.html (last visited Nov. 3, 2007).
[11] Id.
[12] Id.
[13] Id.
[14] Id.
[15] Id. See discussion accompanying notes 6 through 9.
[16] Pedreira, supra note 10.
[17] Internal Revenue Service, United States Departmente of the Treasury, Limited Liability Company, http://www.irs.gov/business/small/article/0,,id=98277,00.html (last visited Nov. 3, 2007).
[18] Small Business PC, Proprietorship vs. Incorporation, http://www.smallbusinessbc.ca/bizstart-prope.php (last visited Nov. 3, 2007).
[19] Internal Revenue Service, supra note 17.
[20] AllBusiness, Limited Liability Company (LLC) Basics, http://www.allbusiness.com/business-planning/business-structures-limited-liability/1289-t.html (last visisted Nov. 12, 2007).
[21] Id.
[22] Small Business PC, supra note 18.
[23] Id.
[24] Id.
[25] Id.
[26] Id.
[27] Id.