This article will focus on different forms of business. There are a number of ways to structure a business — these include sole proprietorships, different types of partnerships, limited liability companies, and corporations. Each form of business organization has advantages and disadvantages and these are largely influenced by the purpose of the enterprise as well as a number of other factors. Each type of organization poses different legal ramifications and income tax considerations. This article will provide an analysis of the different types of business organization as well as a brief discussion of the advantages and disadvantages of each structure.
Keywords Articles of Incorporation; Business Organization; By-Laws; Capital Gains Tax; Corporation; Form 1040; General Partnership; Incorporator; Limited Liability Company; Limited Partnership; Members; Owners; Partnership; Partnership Agreement; Pass-Through; Proxy; Quorum; Resolutions; Shareholders; Sole Proprietorship; Stock Holders; Stock
Law: Types of Business Organizations
There are a number of ways to structure a business, and the factors involved in choosing the appropriate legal structure include: the purpose of the organization; the size of the entity; the costs involved in starting the entity; state, federal and local laws and rules governing the business; and tax considerations. Essentially, there are four types of legal structures for business:
- Sole Proprietorship
- Limited Liability Company
There are advantages and disadvantages to each type of business organization and these are driven by a number of factors. The following is an analysis of the four legal structures.
A sole proprietorship is the most basic business form and is frequently utilized by a single person owning or running a business on his or her own. Such business enterprises are often run from the person's home. Owners pay taxes on the business profits and this is reflected on individual tax returns (Form 1040 and Schedules C and E). In some states, the costs of a business that is being operated from an individual's home may be deducted from income taxes. However, at the same time, certain counties and states may require a sole proprietor to pay property taxes on the value of any office equipment used for the business. In addition to tax liabilities, sole proprietors are also responsible for the debts of the business (Butow 2004).
A partnership is the legal structure for a business enterprise when two or more people start a business. There are different types of partnerships, and these include general partnerships, limited partnerships and limited liability partnerships. In order to set forth how the business will operate, the partners should enter into a partnership agreement. The partnership agreement should specify who the partners are, what their roles and responsibilities are, and most importantly spell out how the profits will be divided between or among the partners.
A general partnership is a business structure where each partner is liable beyond what he or she has invested in the enterprise. Also, each partner can take actions that may bind the entire partnership. A general partnership is not a taxable entity because the income and losses pass to each partner who, in turn, reports the profit and loss on individual tax returns. Because the income and losses pass to each partner, these entities are also referred to as "pass-through" enterprises. In a general partnership, the profits and losses are normally distributed equally between or among the partners. At the same time, each partner is jointly and severably liable for all the obligations of the partnership. That means a person suing the partnership can choose to collect from any partner and does not have to collect an equal amount from each partner. (Rianda, 2011).
On the other hand, a limited partnership is one where two or more partners agree to operate a business jointly. In this structure, each partner is liable only to the extent of the amount each has invested in the business. This entity is also pass-through enterprise. A limited partnership can also include both general and limited partners. In these cases, the general partners usually are responsible for running the operations of the business while the limited partners are essentially investors. Further, each partner shares the profits and losses according to the partnership agreement (Butow 2004).
Another type of partnership is a limited liability partnership or LLP. These structures are normally used by professional organizations such as law firms and accounting companies. An LLP has similar features to a partnership, but the partnership as a business entity is responsible for any debts and the individual partners are shielded from these liabilities.
Limited Liability Companies (LLC)
A limited liability company is a cross between a corporation and a partnership. This type of business organization offers more protection from creditors' claims than a partnership. In this way, it is similar to a corporation, but it is also a pass-through entity so it shares the features of a partnership. However, LLCs have distinct features and requirements. In an LLC, the owners are called members. Members, in turn, can be individuals or corporations. However, unlike a partnership where profits and losses are evenly distributed according to the partnership agreement, there is greater flexibility in this regard for a limited liability company.
Further, in order to establish an LLC, it is necessary to file articles of organization with the secretary of state. Another way that LLCs are similar to partnerships is that a limited liability company is required to have an operating agreement. The operating agreement should specify who the members are, what the role and responsibility of each member will be and how profits will be shared between or among the members. The operating agreement should also contemplate changes in ownership if other members are invited to join the enterprise or if an existing member decides to sell his or her interest. Finally, because this is also a pass-through structure, members report income and losses on personal income tax returns.
A corporation is essentially an entity that exists separate and apart from its owners. Corporations are required to have at least one owner, and owners are called shareholders or stockholders; ownership interests are referred to as stock. Because a corporation exists separate and apart from the owners, the owners are protected from debts and liabilities. The corporation itself assumes liability for the debts and obligations of the business, putting aside the issue of personal guarantees (Rianda, 2011).
A corporation is established when articles of incorporation are filed with the secretary of state. This document establishes the reason for the enterprise and in some states it is referred to as a certificate of incorporation or a company's charter. The articles should clearly state the business purpose, but at the same time that description should also allow the business flexibility to grow and evolve. The basic information that should be stated in the articles includes the business' name and address, the name of the incorporators, the intended duration of the business entity (either perpetual or of limited duration) and the purpose of the business (Arend 1999).
An incorporator is the responsible individual for filing the articles with the secretary of state. In many states, the incorporator cannot be an owner, officer or director of the business entity. A legal agent is a third party who is not affiliated with the business entity who will be responsible for accepting any legal process papers filed against the business. A legal agent can be a law firm, but there are also professional organizations that perform these duties.
Corporations are also required to have written by-laws. This is the governing document of the business and it establishes the operating procedures for the entity. By-laws describe the management structure and what the roles and responsibilities of the officers and directors will be. Generally, directors are senior executives or managers who are responsible for the day-to-day operations of the business while officers are the individuals appointed to implement the policies and procedures established by the directors. Officers report to the directors who are ultimately accountable to the owners, that is, the shareholders. By-laws should also specify the voting procedures, notice requirements, proxy, and the minimum number of people who must be present for a vote to be effective — this is referred to as a quorum.
Corporations are required to have an annual meeting, but meetings can also be held once...
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