Types of Business Formations

by Michelle Strait; Updated September 26, 2017
Choosing a business structure is an important step when starting a business.

Numerous legal choices go along with starting a business. One choice is deciding what is the best legal formation for your business. The Internal Revenue Service states the type of formation you choose impacts your taxes, paperwork, ability to get a loan and personal liability. Review the types of formations available in order to choose the best one for your situation.

Sole Proprietorship

A sole proprietorship is a common type of business formation. According to Nassau County's Office of the County Clerk, a sole proprietorship is the easiest and cheapest business formation to start. When you choose this type of formation, you're declaring yourself as the sole owner. You are responsible for every aspect of the business. You report losses and gains on your personal tax return because your business isn't taxed separately. You also are liable for any debts or damages caused by the business. If the business owes money, that means you have to pay it. If anyone is hurt in conjunction with your business, then you are liable for damages.

Partnership

Unlike a sole proprietorship, a partnership is a business started by more than one person. The profits and liabilities associated with the business are shared among all partners. You can form a partnership with an an oral agreement between you and the other owners. An alternative is to have a legal partnership agreement drawn up by a lawyer. According to Bradley University's Turner Center for Entrepreneurship, all members of the partnership agree to contribute time, money, skills and labor to the business. In return, all members share in the profits and benefits. It's important that all partners agree on things such as splitting profits, solving business problems and adding new partners.

Corporation

A corporation offers an amount of protection not offered by a sole proprietorship or partnership. Business.gov states that a corporation is an independent entity, which means it's separate from its owners. You and the other owners, known as shareholders, aren't personally responsible for paying debts or any other expenses incurred by the corporation. A corporation can consist of one or more people, but the business takes the financial and legal hit if the business is sued or goes into debt. In addition to protecting your personal assets, a corporation also allows you to hire yourself and take part in employee benefit plans.

Limited Liability Company

The IRS states a limited liability company (LLC) is allowed only by state statute. Unlike other business formations, the federal government doesn't recognize an LLC as a legitimate business formation for tax purposes. When it's time to pay taxes, you must declare your LLC as a sole proprietorship, corporation or partnership. The benefits of an LLC include limited personal liability for debts and other actions of the business. When you're part of an LLC, you're known as a member and not an owner or shareholder. LLC members can consist of foreign businesses, partners and other corporations. In some states, an LLC can consist of one member.

About the Author

Michelle Strait is a professional writer with over five years of experience. She has written for several publications, including "Writer's Digest." She has also created logic puzzles for "Penny Press Magazine." Strait graduated from the University of Alabama with a bachelor's degree in journalism and English.

Photo Credits

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