The legal form of organization in business plan is used to decide how the organization will function, how roles will be arranged and assigned, and how relationships will work. These organizational steps should take place at the beginning of the business formation.

Starting a Business

The first step when beginning a business is to name the business. The name must be unique and not in use by another existing entity. The next step is to decide on the organization type your business will use. Each business entity has specific requirements on how they are run including how income is reported. The business types include:

  • Sole proprietorship.
  • Partnership.
  • Limited Liability Company.
  • Limited Liability Partnership.
  • Corporation.
  • S Corporation.
  • Tax-exempt organization.

Each type has advantages and disadvantages that should be reviewed before making a final decision. However, the business type you choose isn't permanent. As the needs of your business change, the business entity type can be changed. Examples include:

  • Changing a sole proprietorship to a partnership due to growth.
  • Switching to a corporation to establish protection that comes with limited liability.

Limited Liability is attractive to business owners because it protects personal assets from any debts or obligations incurred by the corporation.

Business Type Requirements

A major component of selecting a business type is what is required to be legal and the tax implications.

  • Sole proprietorships are owned by one person or a marriage. Their requirements include:
    • Applications to the state government are not required.
    • Dependent on the state, registering the business may be required with the state and/or country.
    • A business license may be required based on the type of business and state requirements.
    • The IRS views all business activity as personal. When filing, personal and business income are seen as the same thing.
    • A sole proprietorship is personally responsible for all aspects of the business. If the business is sold, it can impact any personal assets if you are found liable.
  • Partnerships can be a limited or general partnership. Their requirements include:
    • In a general partnership, two or more sole proprietors are seen by the IRS as having equal responsibility.
    • Any profit and loss distribution is determined by the partnership agreement and is then passed to the individual partners.
    • Profit and loss distribution does not have to match the percentage of ownership.
    • The partnership is not subject to income or franchise tax.
  • Limited partnerships have one or more general partners or one or more limited partners. Their requirements include:
    • The structure and tax implications are similar to a general partnership, but a limited partnership (silent partner) allows for ownership without the requirement of being actively involved in how the business is managed.
    • Business liabilities are limited to the amount invested by the partner.
    • Outside investors can be partners without taking on any liabilities.
  • Limited Liability Companies (LLC) combine the positive aspects of a corporation with the positives of a sole proprietorship (limited liability, the sale of stock) and partnership (shared management decisions, profits.)
    • Personal liability protection is provided without having to meet the administrative and governance procedures.
    • The Articles of Organization determine the ownership percentages, distribution of profit and losses, and voting rights. In corporations, this is determined by stock ownership.
    • Most LLCs use the pass-through method of taxation. This means that taxes aren't paid by the LLC, but by at the personal tax level of the owners. The personal rate is lower than the corporate tax rate. When the LLC files taxes, no money is sent and an owners report is included to show the owners will pay the tax instead.
    • Based on the state, the LLC is subject to a franchise tax.
  • Corporations are legal entities that are separate from those who own and/or formed the organization. Their requirements include:
    • A corporation can be formed as for-profit or nonprofit.
    • Corporations provide a shield from liabilities. This protection is only removed if the owners or board members have been found to be illegally running a corporation and have been breaking federal and/or state laws.
    • Corporations can sell stock in the business.
    • A Board of Directors is used to manage corporate policies and strategies. This is for both for-profit and nonprofit.
    • Corporations continue to exist even in the event of the owner's death, or if owners leave.

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