If you are launching a business, then you are considering a sole proprietorship or LLC partnership or corporation as the form for your business. Selecting the proper entity is an important decision that can determine whether you achieve success, failure, asset protection, and favorable tax treatment.

About Sole Proprietorships, LLCs, Corporations, and Partnerships

The ideal entity depends on a number of factors, which includes the industry, location, ownership structure, and exit strategy.

Entity 1: Sole proprietorship. Sole proprietorships are perhaps the most common and are the easiest to form. It is allowed only for businesses with one owner. Note that there is no legal distinction between the owner and the business, for asset protection and tax purposes, in a sole proprietorship.

A sole proprietorship's main benefits:

  • preferable tax treatment; and
  • ease of formation.

As mentioned, however, that an owner’s personal assets are not protected so that the owner can be personally compelled to use personal finances for the business’s obligations, including lawsuits against the business.

Entity 2: Partnership. Partnerships are entities owned by two or more persons run for a profit. Like sole proprietorships, partnerships are easy to form and have minimal upfront costs. Each individual partner can contribute either money, labor or skills for ownership in the business.

A partnership's main benefits:

  • preferable tax treatment; and
  • ease of formation.

There is, however, personal liability for business obligations. Also, it is common for partners to disagree on material issues, leading to tedious and long-running legal battles. To minimize this risk, it is recommended to create a partnership agreement.

Entity 3: LLCs. LLCs are created by and governed under state law. With respect to tax treatment, LLC owners elect how they want to be taxed by the IRS, like a sole proprietorship, partnership or corporation. Launched in Wyoming in 1977 as legal LLCs, since 1996, all states have laws that govern the formation of an LLC.

Some features of an LLC:

  • Those creating an LLC do not have to be U.S. citizens or permanent residents.
  • Others, including lenders, may have more faith in your business when it is an LLC.
  • Note that an LLC can be have different tax treatment in different states and LLC earnings may be subject to self-employment tax in certain locales.
  • Appreciated assets could be subject to tax if you decide to convert your existing business into an LLC.

Entity 4: Corporations. People create corporations, mainly, to limit shareholders and owners from many company liabilities. There is a trade-off to this feature: Corporations account for this privilege through double taxation because business profits are taxed both at the corporate level and on personal level through dividends paid to shareholders.

Comparison and Advantages

  • A partnership can be viewed as the opposite of a corporation. While one person, at least, is responsible for company debts and litigation, the profits go directly to the owners, circumventing the "double taxation" issue. Partnerships are easy to form, just have two or more people who work together form a partnership, regardless of whether they acknowledge such a partnership.
  • LLCs offer limited liability protection to its owners and members. What’s more, profits go directly to members because LLCs are essentially an ideal business structure.
  • Corporations have a lot of mileage and are well known, thereby making the legalities of them well known. In addition, they can issue stock, providing it with the ability to more easily raise capital than a partnership or LLC.
  • An S corporation structure also avoids double taxation, in some circumstances. For example, when the S corporation pays all profits to shareholders in the form of salary.
  • An LLC is best for small business tax matters.

Small Companies

LLCs are ideal for small companies. Corporations are required to hold annual shareholder meetings, which is not ideal for small companies due to the annual filing fees. Also, if complex corporate formalities are not followed to the letter, shareholders might be required to forfeit their limited liability status, thereby being held personally liable for the corporation’s debts and obligations.

Because LLCs cannot issue stock, LLCs might find it difficult to attract multiple investors due to investors typically wanting a physical certificate as proof of ownership.

Also note that certain types of businesses, e.g. a bank, cannot create an LLC.

If you need help with determining what corporate form is best for your business, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.