The Five Ways to Set Up Your Business: Their Pros and Cons
SOLE PROPRIETOR GENERAL PARTNERSHIP C CORPORATION SUBCHAPTER-S CORP. LIMITED-LIABILITY COMPANY

Why choose one form of business over another?

 This is the most basic form of doing business. As one tax analyst puts it, "You keep all the profits and accept the entire risk of loss. It is capitalism at its most basic." Best for very small businesses and in early start-up phases when you intend to grow large. You create this structure by an agreement, which can be oral but should be in writing (often with the aid of lawyers to avoid unnecessary troubles). The agreement should, among other things, set forth the respective ownership interests of the partners, the extent of each partner's investment in the business, and other important matters. With the coming of both limited-liability companies and partnerships (see right), general partnerships seem to be growing obsolete. By incorporating your business, you create an entity that is separate and distinct from you as an individual. Special laws and taxes apply to any corporation. A C corporation (the standard type) may not be the best structure for a small business, especially one in start-up phase. The formalities are many, and the tax consequences may leave less money in your pocket. Moreover, liability protection can also be found in a limited-liability company or a subchapter-S corporation. However, if your business is growing large and you want to raise money through the sale of stock, a C corporation may be the way to go. To combine corporate liability protection with the tax aspects of a partnership, consider this popular structure. There are, however, restrictions as to who may participate, which can be problematic when raising capital. For example, in addition to the limited number of shareholders, foreign nationals may not hold subchapter-S stock. This relatively new business structure is currently permitted in 35 states, including Florida, Texas, and New Jersey, but not (as of July 1994) New York, California, or Ohio. A limited -liability company (LLC) has the limited liability of a corporation but the flexibility and tax status of a partnership. That makes it an up-and-comer in business circles. A structure in a few states, such as Utah and Delaware, is the limited-liability partnership (LLP). Within a year or two, all states will permit LLCs and most will permit LLPs.

How complicated is it to create and operate?

 You need to take no formal action, merely start doing business. However, your municipality or state might require various licenses, depending on the nature of the business and where it's being operated. Because so many terms must be plugged into the agreement - including the rights and obligations of each partner, what happens if a partner dies, and so forth - a partnership can be more complicated than it might initially appear. With so much to consider, it's a good idea to have a lawyer advise you on the issues and to prepare and negotiate the agreement. In terms of running the business, note that partners can have differing views of what it should be or the feeling that one person is doing more work than the others. To incorporate, you must file articles of incorporation, create corporate bylaws, and fulfil other state requirements. Stock must be issued, even if you're the sole shareholder. If you commingle personal and corporate assets or otherwise not conduct the corporation as a separate and distinct entity, you may lose your right to limited liability (a primary reason for forming a corporation). Creating a subchapter-S corporation is about as complicated as forming a standard C corporation (see left). A filing must be made with the appropriate state authorities. Usually this consists of the article of organization and the operating agreement. It is important to dot all the "i's" and cross all the "t's" when creating this structure, so you should retain an attorney who understands your state's specific laws.
What tax issues should I consider?

 You report business profits or losses on an individual tax return. On Schedule C you list business income and take deductions for expenses. The net profit is the taxed at personal income tax rates - federally from 15 to 39.6 percent. If you lose money, you cannot deduct losses but can carry them forward to the next tax year. Should you make a profit that next year, you deduct the previous year's (or years') losses from the profit (as long as it doesn't reduce your net business income to less than zero). Although it is not taxed as a single entity, total profit and losses are tallied for the business. Each partner then files an individual tax return (using Schedule K-1) that includes the amount of his respective tax liability and is taxed accordingly. Setting up retirement plans becomes complicated because all partners must agree on the type of plan or no plan might be possible. The business reports income on a corporate tax return, separate form shareholders' returns. Also, regardless of profitability, many states have minimum taxes that are owed by corporations. Shareholders will be taxed for dividends received, and of course any salaries from your corporation will be taxed at individual rates. Corporate tax returns are more complicated than individual ones, which generally means higher fees paid to a tax professional. On the other hand, corporations are usually taxed at a slightly lower rate than individuals - 34 percent maximum versus 39.6 percent. Shareholders are taxed as if they were in a partnership, and file individual rather than corporate tax returns. In fact, tax liability is the same as that of a partnership. The IRS has, for the most part, accepted the LLC, but be sure to ask if the law in your state has been approved.. Your report profits and losses on a personal, rather than corporate, tax return.
Would my assets be at risk if I’m found liable for a problem?

 You are personally liable for every business debt as if you had incurred such liabilities as personal expenses. That means all of your personal and business assets are at risk. Each partner is personally responsible for all of the business liabilities of the partnership and even the individual liabilities incurred by partners during the course of partnership activities. Each partner’s personal assets are potentially at risk. If a bill isn’t paid, you can be made to pay the entire amount if your partners are unable to pay their respective shares. Limited liability for shareholders in a vital benefit. Under normal circumstances, a corporate owner’s liability is limited to funds invested in purchasing stock. Stockholders cannot be held personally liable for corporate actions, and creditors are limited to corporate assets when seeking to collect money owed. As with a C corporation, there is no stockholder liability beyond the assets of the corporation. As the name implies, liability is limited to the assets of the LLC.
How easy is it to raise money?

 Most banks and other lending entities will require personal collateral (home equity or other valuables). Too often, capital is only generated form your personal resources - by borrowing on credit cards or from family. Partners contribute time, money, or property to receive equity interest. These contributions must be tracked and will have ramifications for each partner. Borrowing from banks or other lending sources is as problematic as for sole proprietors; personal collateral is often necessary. Corporations have a method of raising money not available to other types of business structures - selling stock to the public. Furthermore, with a standard C corporation, there are no limits as to who can own stock or to the number of shareholders, thereby maximizing the potential access to capital. A subchapter-S corporation can have up to 35 stockholders. That enhances its ability to raise working capital. However, if you wish to offer shares to investors at large, you will have to form a standard C corporation. The ease of securing capital is the same as that of a general partnership, which means your revenue options are limited because you cannot raise money through shareholders.
What happens to my business if I sell, become disabled, or die?

 You have no separately existing business entity. Thus, if you die or become incapacitated, your business goes with you. Selling is a bit more feasible - but only if you have an established service business or a readily assumed product-based business. All this makes estate planning vital for sole proprietors. Partners can provide for the contingency of another’s death, incapacity, or desire to sell his equity in the partnership agreement or in a buy/sell agreement can say that upon death, the dead partner’s heirs will receive the proceeds of a life insurance policy taken out for that purpose and, in return, lose all rights, title, and interest in the partnership business. Once formed, a corporation continues in existence until formally shut down. Thus, if a key player in the corporation dies, formal actions is not required by the corporation to deal with the problem since the ownership will pass to the heirs. Also, under most circumstances, stockholders can sell their stock whenever and to whomever they please.

 A subchapter-S corporation offers the same flexibility as a C corporation (see left). You will have to engage in succession planning, as you do in a general partnership (see left).