Most small businesses fall under this category, which is the easiest to set up due to its simple and informal structure. One person owns all the assets and profits of the business. The owner reports losses and profits on his or her personal income tax return.
Under a sole proprietorship, the business is not a separate, distinguishable entity from the owner. The owner will be liable for debts incurred by the business.
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Partnerships are similar to sole proprietorships, except there are at least two owners. Like a sole proprietorship, the business and its owners are indistinguishable in eyes of the law. Partners can split profits and liabilities according to a Partnership Agreement. Partnerships don't pay taxes. Instead, the individual partners report their share of profits or losses from the partnership.
There are different types of partnership agreements:
- A general partnership assumes equal shares between the partners unless the Partnership Agreement states otherwise.
- A limited partnership limits both the owners' liability and the owners' ability to make management decisions.
- A joint venture is like a general partnership, but lasts for a limited period of time or single project.
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A C-Corporation is a unique entity under the law: it is a distinct entity and therefore can be taxed, sued, and enter contracted agreements. Shareholders (i.e., owners) have limited liability for the debts of the corporation, but officers can be held responsible for their own actions. While corporations receive special rights (eg, they can raise funding through stocks), they are expensive to set up, heavily regulated, and can pay more taxes. C-Corporations generally require the assistance of a qualified attorney.
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The business structure of an S-Corporation is very similar to that of C-Corporations. Both are considered distinct legal entities from their owners (shareholders), and both adhere to the same corporate formalities. There are two differences: first S-Corporations are taxed in a different manner; second, S-Corporations cap the amount of potential shareholders to 100, whereas C-Corporations allow for unlimited shareholders. For more information, please visit our page on How an S-Corporation is Taxed, as well as our page on the differences between S-Corporations and C-Corporations.
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Limited Liability Company
An LLC is something of a hybrid structure. It provides limited liability to its owners, like a corporation, but allows members to determine their how they are taxed. LLCs are not seen as a separate business entity. Members are - in most instances - allowed to determine their business entity classification. They choose to be treated as either a single member LLC, partners in LLC, or file as a corporation.
There are several advantages to LLCs. Beginning an LLC is generally less costly than an S or C-Corp, and the registration paperwork is less burdensome. LCCs have fewer restrictions when it comes to profit sharing amongst members. Members decide amongst themselves through an operating agreement how to divvy profits and losses.
LLCs only exist for a limited period. If a member leaves the LLC, the LLC dissolves. This can be prevented by the LLC operating agreement or the remaining founders can simply reform the LLC. Additionally, all members of an LLC are considered self-employed for purposes of taxation. They must contribute independently towards items like Medicare and Social Security.
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This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.