There are 4 basic types of business entities:

Sole Proprietorship
A sole proprietorship is an unincorporated business owned and managed entirely by the "proprietor," except to the extent that the proprietor may delegate management responsibilities to an employee.

The Limited Partnership
A general partnership is like a sole partnership except that it is owned and managed by more than one owner.

The Limited Liability Company (LLC)
The LLC is a form of business entity which represents a similar attempt (in addition to the "S" corporation) to combine the "limited liability" feature of the corporation with the tax advantages of the partnership.

The Corporation
A corporation is a separate legal entity owned by one or more shareholders, and the shareholders have "limited liability."

SOLE PROPRIETORSHIP

In General, a sole proprietorship is the simplest form of business. A sole proprietorship is not a separate entity itself. Rather, a sole proprietor directly owns the business and is directly responsible for its debts. In a sole proprietorship, the owner is personally liable for the company, thus placing his or her entire personal assets and wealth at risk. If an owner is married, that owner puts the community property at risk as well.

The owner (sole proprietor) has total management and control over the company. Such command makes the owner solely accountable for personal liability incurred through the acts of the owner's agents or employees.

With the exception of complying with applicable business licensing requirements, there are no formalities required of a sole proprietorship. The owner can sell the business as he or she pleases and the business remains in existence for as long as the owner is willing or able to stay in business.

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LIMITED PARTNERSHIP

In a Limited Partnership, one or more "general" partners manage the business while "limited" partners contribute capital and share in the profits - but take no part in running the business. General partners remain personally liable for partnership debts while limited partners incur no liability with respect to partnership obligations beyond their capital contributions. The purpose of this form of business is to encourage investors to invest without risking more than the capital they have contributed.

The formalities of setting up and operating a limited partnership are very similar to that of starting a corporation. Death, disability, or withdrawal of a general partner can dissolve a partnership unless the partnership agreement provides other provisions or if all partners agree, in writing, to substitute a general partner. Note, death or incompetence of a Limited Partner will generally have no effect on the partnership.

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THE LIMITED LIABILITY COMPANY

Many attorneys and CPAs view the Limited Liability Company as the business form of choice for those business owners desiring 1) protection from individual liability for company debts, negligence, and breaches of contract; and 2) flow through taxation.

The Limited Liability Company is a hybrid between the corporation and the limited partnership. The Limited Liability Company protects all members (owners) from individual liability for company debts and misdeeds, much like the corporation. What's more, while a creditor of the corporation can attach corporate stock and gain control of the corporation, a creditor of a Limited Liability Company cannot become a member and control the company. Consequently, the Limited Liability Company combines the best of corporations and partnerships because the Limited Liability Company offers its members protection from individual liability and, like a limited partnership, allows others to become a member only if the other members agree.

The Limited Liability Company is taxed like a partnership or S Corporation. In other words, it is a flow through entity. The Limited Liability Company does not pay income tax, rather income is distributed to the members according to their ownership interests and the members report the income on their individual income tax returns. Non-United States citizens may also wholly or partially own the Limited Liability Company.

Unlike the corporation, the Limited Liability Company is governed by its regulations, called an operating agreement. Importantly, the Limited Liability Company is further distinguished from the corporation in that it is not required to have annual meetings. In order to maintain protection from individual liability, the Limited Liability Company must still keep it's accounting separate from its individual owners and must have and abide by company regulations.

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THE CORPORATION

A corporation is distinguished from a sole-proprietorship or general partnership primarily because the corporation offers its owners (shareholders) protection from individual liability. In other words, the owners of the corporation will not be personally liable for corporate debts, negligence, or breaches of contract.

Further, a corporation is different from other forms of business entities in that it is taxed as a separate entity. The corporation has its own tax ID number and files its own income tax return. Many small business owners find it useful to allow income to build up within a corporation or reinvest corporate income because, often times, the corporate income tax rate is lower than the business owner's individual income tax rate.

In order to maintain the asset protection advantages associated with operating your small business as a corporation, it is important that you observe the formalities of operating a corporation. Specifically, your corporation must have a comprehensive set of bylaws setting out the rules of the corporation. Additionally, the corporation must have an annual meeting of the board of directors to elect officers and conduct other necessary business. Further, the owners must keep separate financial records for the corporation. For example, if the owners use the corporation's checking account like a personal checking account, the courts will look past the corporate veil and find the individual was operating as a sole proprietorship and not a corporation.

The corporation allows individual owners to divide the corporation into shares. These shares are issued using stock certificates. Allowing the ownership of the corporation to be divided among more than one individual is useful for many reasons. First, it allows the corporation to raise capital by selling its shares. Additionally, it allows for the democratic management of the corporation when there are multiple owners.

THE S CORPORATION The S Corporation is distinguished from the traditional C Corporation based on its tax status. The S Corporation is a closely held corporation that has chosen to be taxed as a partnership. Consequently, an S Corporation is called a "flow-through entity." Because it is taxed as a partnership, an S Corporation distributes to its shareholders all of the net income of the corporation each year. Only the shareholders pay federal income tax on the S Corporation's income. The S Corporation avoids "double taxation." Double taxation refers to the fact that the C Corporation pays income tax on corporate income before it makes distributions to the shareholders. The shareholders must then pay income tax on the distributions they receive from the corporation. To receive and maintain the corporation's status as an S Corporation, the corporation must: 1) be a closely held corporation; 2) have only U.S. citizens as shareholders; and 3) not be owned by an irrevocable trust, estate, or partnership. It is permissible for S Corporation stock to be owned by a revocable living trust so long as the revocable living trust has special language. The shareholders of the S Corporation enjoy the same protection from personal liability from corporate debts, torts, and breaches of contract as the shareholders of a C Corporation. It is also very important for the S Corporation to adhere to the corporate formalities.

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