When a person or group of people starts a business, among the first decisions is to decide which kind of entity (S-Corp, C-Corp, LLC, LLP, etc.) to be. What you choose can have consequences for limited liability, legal obligations and taxation. This guide will examine some of the aspects of each. I can't make the decision for you as to which entity you decided upon, and you should talk to an attorney and probably an accountant, but at least you will know which questions to ask your lawyer or your accountant. In addition, this guide may, at least, help you to eliminate some of your choices right off the bat.
The Sole Proprietorship
By far the most common form of business entity in the United States is the sole proprietorship ("SP"). In fact, roughly 73% of all businesses are this form according go the Small Business Administration. In addition to being the most common, this is likely the easiest to form. While there may be certain licensing requirements depending upon the state where you are doing business, start doing business and you are a SP. Therein lies some of the biggest advantages to being a sole proprietor. In addition to the simplicity, being an SP means that there are few, if any, formalities (shareholder meetings, filing of minutes, election of officers etc.) the law requires of an SP. However, this form has some significant drawbacks. First and foremost, you are personally liable for the debts and obligations of a sole proprietor. For instance, if you, as an SP, deliver widgets, for instance. During a widget delivery, you hit a car, causing an accident, injuring the driver and a pedestrian as well as running your delivery car into a diner. While the SP itself will be liable for the pedestrian's and driver's personal injuries and any damages running into the diner cause, you will be personally liable for these items. That means these people could come after your house, your bank accounts and any other personal property to satisfy any judgments. Certainly, a major drawback of this type of entity.
The next common type of entity is the corporation, which makes up 20% of all business forms in the United States. There are essentially two types of corporations, "S-Corporations" and "C-Corporations". Their distinctions are generally limited to the way the government taxes each entity.
The biggest benefit to incorporating is the limited liability it offers to the owners (shareholders) of the corporation. Consider the car accident scenario above. With the limited liability that a corporation offers, while the injured parties could legitimately sue the corporation, they could not sue you (or the other owners) in your (their) personal capacity. In other words, your personal assets are safe from the reach of the courts in that regard. However, with the benefit of limited liability goes responsibilities. The corporation must hold shareholder meetings, must vote for officers on a periodic basis and must elect a board of directors on a periodic basis. While I will address this later, suffice it to say, that the corporation must demonstrate that it does, in fact, operate as an entity separate and apart from its owners. In that regard, it can enter into contracts in its own name, incur debts in its own name and make money in its own name.
However, one often finds in law that rules apply except when they don't. In that regard, the law will presume limited liability. However, there are instances in which a court will "pierce the corporate veil." This means that there are instances where a person who incorporates will have their personal assets placed in peril even when the corporation finds itself in a lawsuit. This happens when a court finds that the corporation was nothing more than the person's "alter ego" or the corporation really did not act separately. This is why having things such as by-laws, shareholder agreements and holding shareholder meetings and board meetings and electing a board of directors and appointing officers is so important, even for corporations that may have only one or a few shareholders. These "formalities" are important to maintaining the legal fiction of separate, corporate personhood with limited liability.
Limited Liability Company
Another entity is the limited liability company, or the "LLC." Please note that this is not a limited liability corporation. The reason is that a corporation is an entity of limited liability any way.
Limited liability companies operate very much like corporations. However, they are a very customizable entity, which is why they are so popularity. While there are similarities to corporations, there are differences in terminology. For instance, while the owners of a corporation are called shareholders, the owners of an LLC are called members. Similarly, while the shareholder agreement governs the corporation, the member agreement governs the LLC. The laws that govern LLCs, as with other entities, are fairly uniform throughout the Unite States. However, New York (and Georgia, I believe), have an odd "publication" requirement for and LLC doing business within the state. After the formation of an LLC, the LLC must publish its existence for a number of weeks in both a daily and weekly newspaper. The clerk of the county where the LLC is resident has a listing of approved newspapers. There are provisions in the law if the county where the LLC is does not have newspapers sufficient to satisfy the publication requirement. Typically, in those instances, the LLC would have to publish in newspapers of an adjacent or closest county.
Finally, the government does not tax LLCs as separate entities. In fact, similar to an "S-corporation," the income and losses pass through to the individual, and the individual records them on his/her tax return. The LLC reports the income/loss on form K-1, which means the IRS taxes the LLC as a partnership.
These are basic questions to consider when looking into forming a business. Each has disadvantages and each has advantages. It's always best to consult an attorney if you have questions. It is always best, however, to not be completely ignorant of the issues you will face. After all, knowledge is power. Ultimately, you can protect yourself from an unscrupulous attorney who may try to charge you for things that are simple and you can do for yourself, if you just do some research.
Finally: for the litigious types. This is meant for informational purposes only. Laws change which means the information in this can change. Moreover, each state has its own way of doing things which can be both significant an minor.