Considering Liability, Ownership and Taxation (LOT), business owners choose the legal form of their business entity. Choices for typical business entities are: Sole Proprietorship, Partnership, Limited Liability Company (LLC), S Corporation, and C Corporation.

Sole Proprietorship

As the name implies sole proprietorships mean one owner. A sole proprietorship requires no legal documentation; setting it up is sweet and simple. The owner reports business revenue and expenses on Federal Income Tax Form Schedule C with all net income being passed to and taxed on the sole proprietor’s personal tax return.

Note that simplicity comes at the cost of shelter from personal liability. The owner receives no protection of personal assets in this form of legal business entity. If a customer of the business decides to sue, they sue the sole proprietor. This puts the owner’s personal assets at risk.

Partnership

Two or more people are the business owners and take an active role in daily management of the business. Each partner may split the profits in equal or unequal shares depending on the partnership agreement. All profits pass through to partners each year. Partners should ensure a legal document exists outlining the details of the partnership.

All partners’ personal assets risk exposure to law suits for the actions of any one or more of the partners. If you want a risky form of business, this is it!

Limited Liability Company (LLC)

The LLC provides small businesses protection for owners’ personal assets while also allowing a simple legal entity. Limited Liability Companies do require legal documentation best drawn up by a lawyer practicing corporate law. Many states require the filing of the LLC documentation, annual meeting minutes and an small annual filing fee.

Profits pass through the LLC to owners of the company and can be in equal or unequal shares, depending on agreement of the owners. Check your states rules for exact terms of an LLC since LLC rules differ by the state in which you operate. The number of owners and the citizenship of owners may change based on your state.

S Corporation

The S Corporation is another favorite legal of entity of small businesses as it also allows for personal asset protection for all owners. S Corporation business form existed much longer than LLCs (relatively new to the legal entity form) but have some advantages for larger small businesses. Not all profits have to be distributed to owners every year.

The documentation and income tax rules for an S Corporation are more complicated but allow for the existence of the business for a short period of time if the owners die. As with Limited Liability Company’s, S Corporations must file annual reports. Use both an experienced attorney and CPA if you choose this business form as the requirements are rather strict.

C Corporation

Publicly traded companies usually take this legal form. Owners and investors receive personal asset protection and the corporation can choose how much if any of the profits to be distributed to owners.

As with LLC’s and S Corporation annual filings and annual meetings are required. Each state determines rules for C Corporations incorporated in their state. A C Corporation may form in any state but is required to have a registered agent (for receiving legal notices) in each state in which they operate.

Regardless of the entity you form, giving those with whom you do business is necessary for asset protection. So if you choose an LLC, S Corporation or C Corporation, make sure your business discloses its legal form and meets all state requirements.

Check with the Professionals

Remember the information presented here should not be taken as legal or tax advice. Check with your attorney and accountant for how these forms of legal entities may affect your business situation.