There are various types of business organizations: corporations, general partnerships and sole proprietorships. These business organizations have their own legal requirements so they can also be considered as legal entities.
Most small businesses start as a sole proprietorship where there is only one or a few owners with a few employees to help them run the business. Partnerships and corporations have more than one owner but in a corporation the owners have higher investments. Corporations are typically the largest type of business.
Differences between business types
The following are the types of business organizations and their legal considerations:
1. Sole proprietorship
The business and its owner are considered the same entity in legal matters. In terms of tax considerations, the IRS treats the business as a non-taxable entity but it considers the business' assets, liabilities, and income as belonging to the owner of the business thereby making the owner responsible for the debts of the business.
As a result, creditors are legally allowed to go after the owner’s assets and personal bank accounts to make up any difference in debts. In terms of taxes, the income from a sole proprietorship is subject to self-employment taxes.
2. General Partnership
Just like a sole proprietorship, a partnership is not taxable under federal law. However, the income from a partnership is taxed to the partners' individual tax rates. In terms of liabilities, the partners are liable for the debts of the business and the creditors can go after their assets.
3. Regular Corporation
This organization is created by a state filing and is its own legal entity separate from its owners. It is subject to a corporate income tax. In terms of the corporation's debts, the general rule is that individual shareholders are not liable for the corporation's debts. However, there are a few exceptions to this rule.
Other Advantages of a Corporation
Corporations have a continuous life because, unlike a sole proprietorship and partnership, this type of business does not expire upon the death of its owners. It is easier for corporations to raise money for capital as it can sell shares of stock, create new stock types and investors prefer to invest more knowing that they can't be held liable for the debts of the corporation.
It is easier to transfer the ownership interests of a corporation as one can sell his own shares of stock and it will not affect the business’ operations. In a sole proprietorship and partnership, the assets, licenses, and permits should be transferred individually.
Advantages of a Sole Proprietorship and Partnership
Sole proprietorship and partnership businesses cost less to establish compared to the corporation which need to spend for initial formation fees, filing fees and more. There are less formalities in the setting up of a proprietorship and partnership.
Corporations need legal documents filed with the state. The owners in sole proprietorship and partnership businesses are not liable to pay for unemployment insurance as compared to a shareholder-employee of a corporation who needs to pay unemployment insurance taxes on their salary. While there are various advantages and disadvantages of each business type, it is best to consult a startup or business lawyer to seek advice on the decisions that affect the business.
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