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Business Formations Breakdown

When starting a business venture, you’ll need to decide how to structure your operation. There are many types of business formations, all with different implications. Before formally incorporating your business, learn more about each type to find the one that would work best. When you decide to incorporate, consider speaking with a lawyer and accountant to make sure you understand the issues regarding tax, liability, management, and formality of operation. Below is an overview of the most common types of business formations.

Sole Proprietorship

This is a business run by one person who has not registered with the state. It does not require any papers to be filed, which makes it popular for small businesses. Check out our explanation of the Pros and Cons of Sole Proprietorships to learn more about this type of business entity and whether it’s the best fit for your venture.

Partnership 

Similar to a sole proprietorship, a partnership is a business owned by two or more people that haven’t filed to become a corporation or a limited liability company. The partners pay taxes on their shares of the business income on their personal tax returns and are jointly liable for the entire amount of any business debts, liabilities, and losses. There are three common types of partnerships – general partnerships, limited partnerships, and joint ventures. Learn more about forming a partnership from the Small Business Administration.

Limited Liability Company

Most commonly referred to as an LLC, this is the most popular structure for small businesses. It provides many of the benefits of a corporation without many of the formalities. Because the business is a separate legal entity under this formation, LLCs shield the owners from the business liabilities. LLCs also enjoy flexibility in the way they are taxed. An LLC with one owner is automatically taxed as a sole proprietorship, while an LLC with more than one owner is automatically taxed as a partnership. However, the owner(s) can change how the LLC is taxed by filing documents with the IRS within 75 days of formation. There is no limit on the number of owners, but the business cannot issue stock. Each state has its own standards of LLC formation, but the Small Business Administration provides a great overview on the general principles of a limited liability corporation.

Corporation

This type of formation, sometimes called a C Corporation, is usually used by very large businesses, as it comes with the most regulations and a less favorable tax structure. However, this is the only entity that can issue an unlimited amount of stock as well as different classes of stock. If you plan to raise money from outside investors or plan to go public, this is the formation you’ll need to use. The rules and implications differ depending on the state in which you incorporate, so consider speaking to a local attorney to make sure your business complies with all applicable laws. Check out the Small Business Administration’s guide to corporations for more information.

S Corporation

This special type of corporation is often used by small businesses. This is a corporation created through an IRS tax election. Under this formation, the owners enjoy limited liability status and are allowed to issue stock, though limited to 100 shareholders. The tax structure is more favorable than a C corporation as it avoids double taxation – once to the corporation and again to its shareholders. Once your corporation is formed, you can elect to be taxed as an S corporation by filing Form 2553 to the IRS.

Nonprofit Corporation

A corporation formed to carry out a charitable, educational, religious, literary, or a scientific purpose can be designated as a not-for-profit or nonprofit organization, and can enjoy favorable tax breaks and qualify to receive funds from government agencies and private foundations. Nonprofit corporations also provide limited liability to its directors, officers, and members. Forming a nonprofit is similar to forming a regular corporation, with an additional application to the IRS for recognition of tax exemption. Check out the overview on applying for tax exempt status on the IRS website.

Cooperative

Also known as a collective or co-op, this type of organization is owned and operated democratically by its members. The formalities relating to cooperatives vary from state to state, so check out your secretary of state’s office for more information if you’re interested in creating a cooperative.
Once you decide which business structure you need, you can start your business by looking at your local requirements for formation and/or consulting an attorney to handle creating your business entity. Good luck!

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