Business structures, such as sole proprietorships, partnerships and corporations, normally have two goals: to provide some protection from personal liability and to establish a separate legal entity.
While those goals tend to overlap and support each other, each structure has unique characteristics that must be considered. As per Aron Govil it is important for small business owners to understand the pros and cons of each type of business structure so they can make an informed decision about which one best fits their needs.
Here’s the lowdown on Business Structures
A sole proprietorship is an unincorporated business owned by one individual (who also manages its day-to-day affairs); therefore the owner assumes unlimited personal liability for all debts, losses or claims against the business. That means that if a customer slips on a wet floor in your retail store, for example, your personal assets are at risk to help satisfy the claim of an injured customer.
This business structure is relatively easy to establish and use, but many small businesses have little choice but sole proprietorship because they are not aware that other options exist or simply don’t know how to incorporate their one-person venture into a separate legal entity with liability protection.
A general partnership is formed when two or more people equally share management responsibilities and receive all profits of the enterprise. Partnerships do not have “owners;” instead partners co-own the partnership itself through membership interests (which represent percentages of ownership). Each partner shares any liability the other partners may have for the business, including claims made by third parties, such as customers or employees.
This structure is often followed when a venture is started by two or more people that do not want to form a corporation. It does provide some liability protection for its owners because each partner’s personal assets are not normally at risk for claims against the business itself. However, if a lawsuit arises from a personal injury claim it can put your other personal assets at stake and put you in a personally compromising position with respect to your co-owners.
In addition, each partner must file an informational return (Form 1065) with the Internal Revenue Service on an annual basis as well as pay income taxes on their share of the business profits. A partnership is not a separate taxable entity from its partners, so filing can be more complicated than with corporations in some cases, in particular when it comes to tax planning.
A corporation is an independent legal entity established under state law through articles of incorporation filed by the owners (stockholders) of the business with the Secretary of State or other designated agency within the state in which it is being formed.
As such, a corporation has many rights and privileges under state law that is unavailable to unincorporated entities. These include perpetual existence (subject to certain dissolution requirements), limited liability, easy transferability of ownership interests and centralized management through directors elected by stockholders.
The main benefit of forming a corporation is to protect the stockholders from being held personally liable for business debts, claims and other liabilities. This liability shield does not extend to certain acts, such as a breach of a fiduciary duty or a debtor/creditor relationship. The tradeoff is that corporations are more complex to form, have many tax rules that apply only to them and must file formal annual reports with the state in which they are being formed.
In addition, most states impose yearly corporation fees along with taxes on an entity’s net income. In some cases, there may be franchise taxes based upon the value of issued stock, although many states have eliminated these types of fees for newly-formed corporations because of the dramatic decrease in startup costs over recent years.
Discrimination against corporations
According to the Supreme Court, corporations cannot be discriminated against by the government; for example, a state may not prohibit publication of its laws and regulations in corporate-owned newspapers or broadcast outlets. Also, corporations cannot be denied the right of free speech (under the First Amendment) because they are “persons” within the meaning of this clause.
The Fourteenth Amendment’s equal protection guarantee prohibits states from discriminating between individuals under similar circumstances; however it does not specifically refer to discrimination against corporations. Recently there has been controversy surrounding the idea that labor unions have a constitutional right to require all workers they represent to pay union dues as a condition of continued employment.
It is important for small businesses considering incorporation to understand what legal protections will be afforded to them by the state in which they are located, as well as what obligations will be imposed upon them.
Conclusion by Aron Govil
There are a variety of factors to consider when deciding whether to form a corporation and each business should weigh the pros and cons in order to make the best decision for it. However, the main benefit of incorporation is the liability shield it provides for stockholders, which can be essential in protecting their personal assets from risks associated with the business.
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