After deciding to establish a business, you must choose the type of legal structure that best suits your business. Most small businesses start out as either a sole proprietorship or partnership, but other options may be better for your particular business. Each structure has trade-offs briefly discussed below. Be sure to contact your attorney and/or accountant to learn the details and legal requirements of each.
This is the simplest and least regulated form of organization with minimal legal start-up costs. One person owns and operates the business. The profits and business income are taxed as personal income. The major disadvantages are unlimited personal liability of the owner for all claims, taxes and debts against the business and the potential dissolution of the business upon the owner’s death.
A partnership is relatively easy to form and can provide additional financial and managerial resources. Each partner is an “agent” for the partnership and can individually hire employees, borrow money and operate the business. Profits are still taxed as personal income and the partners are still personally liable for all partnership debts and taxes.
A special arrangement, called a “limited partnership,” allows partners to avoid personal asset liability. There are special income tax rules for Limited Partnerships. When entering into any partnership, a written agreement is essential.
Limited Liability Company (LLC)
A Limited Liability Company (LLC) is composed of one or more “members”, which provides the owner(s) protection of personal assets while allowing the owner(s) to be taxed as if they were either partners or a sole proprietorship. Members invest in an LLC in exchange for a percentage ownership interest. An Operating Agreement states what share of the LLC profits and losses each member will receive and spells out the internal arrangements of the business
The most complex of business organizations, the corporation, acts as a legal entity which exists separately from its owners. While limiting the owners form personal liability, it is creates a “double taxation” on earnings. The corporate also allows capital to be raised through the sale of stocks and bonds and can continue to function as a business even without key individuals. It also enables employees to participate in various types of insurance and profit-sharing plans. Corporations must be registered with the Secretary of State and there are considerable costs associated with creating a corporation.
For additional information regarding the types of legal structures for business visit the Starting a Business section of the Secretary of State’s website at: www.ss.ca.gov/business/resources.htm