Types of Business Entities & Corporation in the USAHow to Decide What Type of Business Entity is good for you before you form or incorporate a Company in USA
When a person plans to set up a business, one of the first questions that crosses one's mind is to determine what business structure is suitable for the intended business. That is to say what business identity one wants to adopt for one's business out of the various options available under law. Taking this decision is necessary for tax purposes and also helps an entrepreneur to plan for the future business expansion. It is here that the present article would come handy as far as basic information about available forms of business organizations are concerned. Try to learn as much as you can before making a decision. In addition, be sure to consult a lawyer to assist you and to answer any questions that you may have.
Now about options for business structuring under law.
FORMS OF BUSINESS ENTITIES
While there are many different forms of business entities, there are four main types in the United States:
3.Limited Liability Company
1. Sole Proprietorship
Sole proprietorship is the simplest form of business type. It is a business owned and controlled exclusively by one person. This person is responsible for the business, including all liability and any profit or loss.
- Inexpensive to form
- Easy to dissolve
- Generally have no tax aspects
- Virtually no formalities to be observed except basic bookkeeping
- Firm's liabilities are treated as personal liabilities of the owner
- On death of the owner sole proprietorship immediately ceases to exist
Profits and losses of the business are of the owner's personal income and the proprietorship firm is disregarded for tax purposes. However, since legally the firm is nothing more than an individual using a trade name, there is no limit to the owner's liability for the firm's obligations.
It is an association of two or more persons (persons being people, corporations, other partnerships, LLC's, trusts or others) to carry on, as co-owners, a business for profit. These individuals are responsible for the business, including all liability and any profit or loss.
The persons intending to enter into a partnership make an agreement to share profits and losses. The partnership is required to file an informational return to the government to report what the profits and losses of the partnership were and how these were allocated to the partners. Since the liability of partners is joint and several, any particular partner can be made to pay the entire debts of the partnership, regardless of the allocation of profits and losses, or capital contributions made into the partnership.
-Relatively inexpensive to form
- Each partner has joint and several liability to the partnership
- Taxation is a bit complex, but the partnership itself pays no taxes
Partnership can be as simple or complex in structure and administration as the partners want it to be. A partnership ceases to exist when certain criteria are met, such as the death or bankruptcy of a partner; or if the partners decide to end the partnership.
There are three kinds of partnerships:
This is the most basic type. It assumes equal partnership, and therefore equal ownership. All management and liability is shared between the partners, unless otherwise specified.
Limited Partnership (a Partnership with Limited Liability):
In limited partnership, one or more general partners manage the business and are personally liable for partnership debts; and there are one or more other limited partners who contribute capital and share in profits but who do not run the business and are not liable for the partnership obligations beyond contribution.
A general partnership may elect to have limited personal liability for its general partners by registering this election with the Secretary of State. In such a case, the partners are responsible to the extent of their investment.
This type of partnership is time-based. Two or more individuals may work together for a particular project or for an extension of time. Upon completion, the partnership is dissolved. If the individuals would like to continue to work together after that, they would then register as general partners.
3. Limited Liability Company
This is a rather new classification that is now allowed in most states.
A hybrid of a corporation (with an ability to limit personal liability) and a partnership (with an ability to assess profits and losses to individuals), this type of organization provides a flexible structure to achieve these ends.
LLC's are extremely flexible, and can be used for a very wide range of businesses. Like partnerships, LLC's can be as simple or complex as the members desire. Depending on state law, an LLC can have the same limited liability for members as a corporation, or have some members with limited liability and some without limited liability (like a limited partnership), or even have no limited liability for any members (like a general partnership). Unlike corporations, some States require that their LLC's designate a date in the future at which the LLC will automatically dissolve. Some States also require that if a member dies, goes bankrupt or meets some other calamity the remaining members of the company must either dissolve or vote to continue.
A LLC functions as a limited liability corporation, but is taxed and operated in a way that is most consistent with a Partnership. However, one must ensure that a Limited Liability business does not have more than two of the four qualities that characterize a corporation (limited liability concerning assets; continuity of life; centralization of management; the ability to transfer ownership interests). If more than two of these qualities are met, the Limited Liability becomes a Corporation and is taxed accordingly.
4. Business Corporation
A business corporation is a legal entity established by individual(s) under the laws of a state to conduct particular types of business or transactions.
Kinds of Corporations
From the functional point of view, there are two kinds of corporations-a business corporation and a not-for-profit corporation.
A business corporation is formed for the purpose of transacting business in the broadest sense of the word, and these transactions are conducted to return a profit.
A not-for-profit corporation is formed for the purpose of advancing a particular objective of an organization which is not established to make a profit. Generally, this includes charitable, benevolent and educational organizations.
Business and not-for-profit corporations are either domestic or foreign corporations. A domestic corporation is the one incorporated under the laws of one of the states of the United Sttaes. A foreign corporation is the one that has been incorporated under the laws of another state or country and, by registering with a different state in United States, may be authorized to do business within that state.
A business corporation is more complex than a partnership or a sole proprietorship. In fact, by incorporating, a new legal person is created. A corporation is an entity that is separate from its owners, so that regardless of what happens to shareholders, the corporation continues until it is legally dissolved. Depending on state law, a corporation can be owned by just one person and have just one director and officer. The owner(s) of a corporation are known as shareholders. The shareholders elect directors to set the policies of the corporation and represent their interests. The directors appoint the officers of the corporation to manage day to day operations. Corporations are legally required to follow more formalities than any of the other entities, including annual meetings of the shareholders and directors, as well as board approval of most significant acts by the corporation. A corporation is separate from its shareholders. It means that a shareholder cannot just take company's funds for him/herself without documenting the reason and entering a board resolution into the corporate records.
Taxation of corporations is much more complex than sole proprietorships or partnerships. Depending on the number of, residency of and type of shareholders, a corporation can elect to be treated for tax purposes as if it were a partnership (an S corporation), and therefore not pay taxes itself, or it can be treated as a taxable entity (a C corporation). An S Corp allows its shareholders to treat profits as distributions and to pass them through to their personal tax return.
- The corporation exists separately from its shareholders, directors and employees.
- A corporation is a 'person' in the eyes of the law. A corporation functions in the same manner as a person and has the same rights and responsibilities as a person. - The corporation may make contracts, assume liabilities, sue and be sued.
- The corporation and its shareholders and directors have specific duties and obligations to each other.
- Liability of shareholders is limited to the amount of shares held by them.
- Centralization of Management
- Shareholders can transfer ownership interests
- Continuity until dissolved according to law
CONSIDERATIONS FOR DECIDING THE MOST SUITABLE BUSINESS ENTITY
1. Sole Proprietorship:
In this situation, one owns the business oneself and can reap whatever financial benefits come from it. One can make decisions on one's own and guide the growth of the business without having to consult with any other entity. This also means that no other employee will ever have the chance to have own stocks.
This may sound pretty good. But be aware that with a sole proprietorship, there is no distinction between one's business life and one's personal life as far as taxes and other financial obligations are concerned. As far as the government is concerned, proprietor and the firm are one and the same. This could have negative repercussions on the proprietor. Moreover, as a sole proprietor, one's business will exist only as long as one continues to own it.
In the same way as a sole proprietorship, a partnership draws no financial distinction between a partner's personal and business finances. There are also inherent risks in partnerships. It is important to draft a "partnership agreement" to outline what happens if there is a disagreement among partners, if one wants to end the partnership, if one of the partners dies, etc.
3. Limited Liability Company
LLC's are extremely flexible, and can be used for a very wide range of businesses. The members (equivalent to shareholders or partners) can, but need not, have limited liability; can, but need not have, managers (equivalent to directors and officers) and can elect to be taxed either as corporations, or as partners (if they have two or more members) or be disregarded for tax purposes like a sole proprietorship.
4. Business Corporation
Becoming "incorporated" brings with it many advantages. Your business becomes a separated entity (from you) and is chartered by the state in which it is located. This means that your business can enter into contracts, it pays taxes of its own, it can be sued. The owner becomes a shareholder and has the option to sell the business if things don't work out for continued ownership. The negative piece of this option is that it is more expensive than the others and takes a bit more time. It is subject to much more compliances as compared to a Sole Proprietorship or Partnership or Limited Liability Company.
Therefore, some issues to consider when deciding include personal protection from liability, tax liabilities, and business continuity.