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Business Types or Company Types
One of the most important decisions that you need to make for your business is choosing the right type of legal structure, also known as business type or company type. This decision will have a significant influence on taxes, the amount of formality and paperwork that is required, your personal liabilities, and your capacity to generate more money. It is not something to be taken lightly. Thorough research and consulting business experts are necessary.
A sole proprietorship is the most common form of business type or company type and the easiest to understand and set up. Nevertheless, the owner is personally responsible for all financial obligations of the business and may not be treated as a separate entity. There is no legal division between the owner and the business, and so, the sole proprietorship may dissolve upon the death of its owner, and substantial debts can be passed on to family members.
A partnership has two or more owners that will share the earnings and losses of the company. A business with this structure does not assume the tax liability but are "passed through" to partners to account on their personal income tax returns. Like sole proprietorship, each partner is also personally liable for the financial obligations of the business and may dissolve upon the death of its owners, but the ownership can be passed to family members. Depending on the agreement signed by the partners, ownership may or may not be sold to anyone else.
A corporation is a legal entity separate from the founders, shareholders, and officers. Like an individual, corporations are taxed and held responsible for its actions, hence the avoidance of personal liabilities. Corporations require extensive maintenance of records and documents. C corporations can be subject to double taxation while S corporation (or Subchapter corporation) prevents this by passing through the income and losses on individual tax returns. Forming an S corporation is only applicable to US citizens.
To further explain how C corporations are taxed, they do not pay taxes on every dollar earned because taxes are calculated after deducting all operating expenses first, reducing total taxable income. Shareholders in only get taxed if dividends are distributed to them by the company. If dividends are kept within the company and not distributed, then double taxation does not apply.
Despite of double taxation, this business type or company type is a popular choice because it allows the company to easily generate capital by selling shares or stocks to investors. The number of stocks can be expanded indefinitely at any time to generate more funds without relying on the help of financial institutions.
Corporations are perpetual, which means that death of founders or shareholders will not affect the corporation as it is a legally separate entity.
Limited Liability Company or LLC
A limited liability company or LLC has the benefits of both the corporations and partnerships. The earnings and losses are passed through to individuals instead of the business itself, and at the same time, the owners are not personally liable for the obligations of the business.
The IRS treats single-owner LLCs as sole proprietorships which means single-owner LLCs do not pay corporate taxes and do not have to file a return. The owners of single-member LLCs must report all profits and losses on individual income tax returns.
Multi-owner LLCs are treated as partnerships. Multi-owner LLCs do not pay taxes on business income. Each owner or member of the LLC pay taxes on their portion of profits on their personal income tax returns. Unlike C corporations, owners get taxed regardless if the profit has been distributed or not.
Like corporations, LLCs can survive beyond the death of its owners by inserting a provision in your operating agreement that indicates transfer of ownership to a family member or another person (or organization).
Professional Limited Liability Company or PLLC
A professional LLC or PLLC is only available to some licensed professionals. Some states prohibit licensed professionals to form an LLC, and form a PLLC instead. The requirements and rules vary per state but in general the professions allowed to form PLLCs are lawyers, doctors, engineers, and accountants. Owners of PLLC enjoy the same benefits as LLC except it does not protect individual members from malpractice filed against them, however, they are not liable for each other’s malpractice.
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