Most businesses are well served by choosing a variation of one of the four major organizational forms: (1) sole proprietorship, (2) partnership, (3) limited liability company and (4) corporation. Each has its own specific advantages and disadvantages. A core focus on the personal liability ramifications and tax implications of each type of entity should guide a new business owner in his or her selection. Contact The Leo Law Firm in Chicago, Illinois, today to schedule a consultation with an attorney to learn more about the formation and management of business entities.
The basic sole proprietorship is a business with one owner that is not registered with a state as a limited liability company (LLC), partnership or corporation. Business decisions are managed by the owner. Its establishment is relatively inexpensive and comparatively uncomplicated. However, the business owner and his or her assets have no protection from personal liability. Any action by the sole proprietor or an employee may expose the owner to personal liability for business debts or legal judgments. The profits or losses from the business are reported on the owner’s personal tax return.
The two common types of partnerships are general partnerships and limited partnerships.
A general partnership is an association of two or more persons who carry on as co-owners of a business for profit. In a general partnership, each partner participates in the day-to-day management of the business and each general partner is personally liable for the entire amount of any business-related obligation. Each general partner is also usually legally bound by any valid business agreement or transaction made by any other partner. General partners report profits and losses on their personal income tax returns.
In a limited partnership there is at least one general partner who manages the business operations and at least one limited partner who may contribute capital, but does not have substantial management control. The general partner is personally liable for the business’s debts and liabilities. A limited partner has limited liability, meaning that the limited partner can only be liable to the extent of his or her capital contribution. To form a limited partnership, most states require the filing of a certificate with the secretary of state. Limited partnership agreements can be very complex.
Limited liability companies
A limited liability company (LLC) combines elements of partnerships and corporations. To create an LLC, there is most often a filing of articles with a branch of state government charged with LLC oversight. In general, this filing will be with the secretary of state’s office. Most states allow the formation of an LLC with only one person. In addition to the articles, there should also be a written LLC operating agreement that sets out the LLC members’ rights and responsibilities. While filing of this agreement may not be required, it should be completed to ease management of the LLC.
Similar to limited partners, the owners, called members, of the LLC only risk losing money that has been invested in the LLC. Only LLC assets are used to pay the LLC’s debts. Therefore, with certain exceptions, the members of the LLC are protected from personal liability. As in a partnership, LLC owners report profits and losses on their personal income tax returns. Therefore, the LLC is not a separate taxable entity.
A corporation is a legal and tax entity that is separate from the people who own, control and manage it. A corporation is a legal person. Effectively, this means that the corporation can enter into contracts, take on debt and pay taxes apart from its owners. Therefore, with some exceptions, the owners of the corporation are personally protected from the corporation’s liabilities and creditors. Generally, an owner only stands to lose what he or she invested in the corporation.
Each state has its own procedure for establishing a new corporation, but most states require the filing of articles of incorporation with the secretary of state. Other matters at start-up usually include drafting corporate bylaws, holding the initial meeting of the board of directors, and issuing ownership stock.
Speak to a business lawyer
Choosing the correct business form is an important step in starting a new business. Contact The Leo Law Firm in Chicago, Illinois, today to schedule a consultation with an attorney to discuss choosing the correct business entity for your situation.
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