 Types of Business Entities &
Corporation in the USA
How to Decide What Type of Business Entity is
good for you before you form or incorporate a Company in USA
When a person plans to set up a business, one of the first questions that
crosses one's mind is to determine what business structure is suitable for
the intended business. That is to say what business identity one wants to
adopt for one's business out of the various options available under law.
Taking this decision is necessary for tax purposes and also helps an entrepreneur
to plan for the future business expansion. It is here that the present article
would come handy as far as basic information about available forms of business
organizations are concerned. Try to learn as much as you can before making
a decision. In addition, be sure to consult a lawyer to assist you and to
answer any questions that you may have.
Now about options for business structuring under law.
FORMS OF BUSINESS ENTITIES
While there are many different forms of business entities, there are four
main types in the United States:
1. Sole Proprietorship
2. Partnership
3. Limited Liability Company
4. Business Corporation
1. Sole Proprietorship
Sole proprietorship is the simplest form of business type. It is a business
owned and controlled exclusively by one person. This person is responsible
for the business, including all liability and any profit or loss.
Features:
- Inexpensive to form
- Easy to dissolve
- Generally have no tax aspects
- Virtually no formalities to be observed except basic bookkeeping
- Firm's liabilities are treated as personal liabilities of the owner
- On death of the owner sole proprietorship immediately ceases to exist
Profits and losses of the business are of the owner's personal income and
the proprietorship firm is disregarded for tax purposes. However, since legally
the firm is nothing more than an individual using a trade name, there is
no limit to the owner's liability for the firm's obligations.
2. Partnership
It is an association of two or more persons (persons being people, corporations,
other partnerships, LLC's, trusts or others) to carry on, as co-owners, a
business for profit. These individuals are responsible for the business,
including all liability and any profit or loss.
The persons intending to enter into a partnership make an agreement to share
profits and losses. The partnership is required to file an informational
return to the government to report what the profits and losses of the partnership
were and how these were allocated to the partners. Since the liability of
partners is joint and several, any particular partner can be made to pay
the entire debts of the partnership, regardless of the allocation of profits
and losses, or capital contributions made into the partnership.
Features:
-Relatively inexpensive to form
- Each partner has joint and several liability to the partnership
- Taxation is a bit complex, but the partnership itself pays no taxes
Partnership can be as simple or complex in structure and administration as
the partners want it to be. A partnership ceases to exist when certain criteria
are met, such as the death or bankruptcy of a partner; or if the partners
decide to end the partnership.
There are three kinds of partnerships:
General Partnership:
This is the most basic type. It assumes equal partnership, and therefore
equal ownership. All management and liability is shared between the partners,
unless otherwise specified.
Limited Partnership (a Partnership with Limited Liability):
In limited partnership, one or more general partners manage the business
and are personally liable for partnership debts; and there are one or more
other limited partners who contribute capital and share in profits but who
do not run the business and are not liable for the partnership obligations
beyond contribution.
A general partnership may elect to have limited personal liability for its
general partners by registering this election with the Secretary of State.
In such a case, the partners are responsible to the extent of their investment.
Joint Venture:
This type of partnership is time-based. Two or more individuals may work
together for a particular project or for an extension of time. Upon completion,
the partnership is dissolved. If the individuals would like to continue to
work together after that, they would then register as general partners.
3. Limited Liability Company
This is a rather new classification that is now allowed in most states.
A hybrid of a corporation (with an ability to limit personal liability) and
a partnership (with an ability to assess profits and losses to individuals),
this type of organization provides a flexible structure to achieve these
ends.
LLC's are extremely flexible, and can be used for a very wide range of
businesses. Like partnerships, LLC's can be as simple or complex as the members
desire. Depending on state law, an LLC can have the same limited liability
for members as a corporation, or have some members with limited liability
and some without limited liability (like a limited partnership), or even
have no limited liability for any members (like a general partnership). Unlike
corporations, some States require that their LLC's designate a date in the
future at which the LLC will automatically dissolve. Some States also require
that if a member dies, goes bankrupt or meets some other calamity the remaining
members of the company must either dissolve or vote to continue.
A LLC functions as a limited liability corporation, but is taxed and operated
in a way that is most consistent with a Partnership. However, one must ensure
that a Limited Liability business does not have more than two of the four
qualities that characterize a corporation (limited liability concerning assets;
continuity of life; centralization of management; the ability to transfer
ownership interests). If more than two of these qualities are met, the Limited
Liability becomes a Corporation and is taxed accordingly.
4. Business Corporation
A business corporation is a legal entity established by individual(s) under
the laws of a state to conduct particular types of business or transactions.
Kinds of Corporations
From the functional point of view, there are two kinds of corporations-a
business corporation and a not-for-profit corporation.
A business corporation is formed for the purpose of transacting business
in the broadest sense of the word, and these transactions are conducted to
return a profit.
A not-for-profit corporation is formed for the purpose of advancing a particular
objective of an organization which is not established to make a profit.
Generally, this includes charitable, benevolent and educational organizations.
Business and not-for-profit corporations are either domestic or foreign
corporations. A domestic corporation is the one incorporated under the laws
of one of the states of the United Sttaes. A foreign corporation is the one
that has been incorporated under the laws of another state or country and,
by registering with a different state in United States, may be authorized
to do business within that state.
A business corporation is more complex than a partnership or a sole
proprietorship. In fact, by incorporating, a new legal person is created.
A corporation is an entity that is separate from its owners, so that regardless
of what happens to shareholders, the corporation continues until it is legally
dissolved. Depending on state law, a corporation can be owned by just one
person and have just one director and officer. The owner(s) of a corporation
are known as shareholders. The shareholders elect directors to set the policies
of the corporation and represent their interests. The directors appoint the
officers of the corporation to manage day to day operations. Corporations
are legally required to follow more formalities than any of the other entities,
including annual meetings of the shareholders and directors, as well as board
approval of most significant acts by the corporation. A corporation is separate
from its shareholders. It means that a shareholder cannot just take company's
funds for him/herself without documenting the reason and entering a board
resolution into the corporate records.
Taxation of corporations is much more complex than sole proprietorships or
partnerships. Depending on the number of, residency of and type of shareholders,
a corporation can elect to be treated for tax purposes as if it were a
partnership (an S corporation), and therefore not pay taxes itself, or it
can be treated as a taxable entity (a C corporation). An S Corp allows its
shareholders to treat profits as distributions and to pass them through to
their personal tax return.
Features:
- The corporation exists separately from its shareholders, directors and
employees.
- A corporation is a 'person' in the eyes of the law. A corporation functions
in the same manner as a person and has the same rights and responsibilities
as a person. - The corporation may make contracts, assume liabilities, sue
and be sued.
- The corporation and its shareholders and directors have specific duties
and obligations to each other.
- Liability of shareholders is limited to the amount of shares held by them.
- Centralization of Management
- Shareholders can transfer ownership interests
- Continuity until dissolved according to law
CONSIDERATIONS FOR DECIDING THE MOST SUITABLE BUSINESS
ENTITY
1. Sole Proprietorship:
In this situation, one owns the business oneself and can reap whatever financial
benefits come from it. One can make decisions on one's own and guide the
growth of the business without having to consult with any other entity. This
also means that no other employee will ever have the chance to have own stocks.
This may sound pretty good. But be aware that with a sole proprietorship,
there is no distinction between one's business life and one's personal life
as far as taxes and other financial obligations are concerned. As far as
the government is concerned, proprietor and the firm are one and the same.
This could have negative repercussions on the proprietor. Moreover, as a
sole proprietor, one's business will exist only as long as one continues
to own it.
2. Partnership:
In the same way as a sole proprietorship, a partnership draws no financial
distinction between a partner's personal and business finances. There are
also inherent risks in partnerships. It is important to draft a "partnership
agreement" to outline what happens if there is a disagreement among partners,
if one wants to end the partnership, if one of the partners dies, etc.
3. Limited Liability Company
LLC's are extremely flexible, and can be used for a very wide range of
businesses. The members (equivalent to shareholders or partners) can, but
need not, have limited liability; can, but need not have, managers (equivalent
to directors and officers) and can elect to be taxed either as corporations,
or as partners (if they have two or more members) or be disregarded for tax
purposes like a sole proprietorship.
4. Business Corporation
Becoming "incorporated" brings with it many advantages. Your business becomes
a separated entity (from you) and is chartered by the state in which it is
located. This means that your business can enter into contracts, it pays
taxes of its own, it can be sued. The owner becomes a shareholder and has
the option to sell the business if things don't work out for continued ownership.
The negative piece of this option is that it is more expensive than the others
and takes a bit more time. It is subject to much more compliances as compared
to a Sole Proprietorship or Partnership or Limited Liability Company.
Therefore, some issues to consider when deciding include personal protection
from liability, tax liabilities, and business continuity.
CORPORATIONS- FREQUENTLY ASKED QUESTIONS
What is a Corporation?
A corporation is a legal entity established by individual (s) under the laws
of a state to conduct particular types of business or transactions. The
corporation exists separately from its shareholders, directors and employees.
A corporation is a 'person' in the eyes of the law. A corporation functions
in the same manner as a person and has the same rights and responsibilities
as a person. The corporation may make contracts, assume liabilities, sue
and be sued. The corporation and its shareholders and directors have specific
duties and obligations to each other.
What are the advantages and disadvantages of
incorporating?
The answer to this question varies depending on your business and what you
want to gain from incorporating. Some issues to consider when deciding include
personal protection from liability, tax liabilities, and business continuity.
Who can form corporations?
Business and nonprofit corporations may be formed by one or more individuals
or by another corporation.
How is a corporation formed?
When individuals decide that they wish to form a corporation, they must file
articles of incorporation with the Office of the Secretary of State. The
articles of incorporation establish the individuals' intent to form the
corporation and indicate who is forming the corporation.
Any changes or amendments to a corporation's articles of incorporation must
be filed with the Office of the Secretary of State.
What is an annual report?
All corporations must file an annual report with the Office of the Secretary
of State by June 1st of each year in order to retain their good standing
to do business within the State. The annual report is a standard form available
from the Bureau of Corporations, Elections and Commissions, and provides
information on the corporation's current officers, registered agent, and
address etc.
What is a registered agent?
A registered agent (sometimes referred to as the clerk of the corporation)
is the individual or company who serves as the corporation's contact to receive
service of process in legal matters. A corporation must always have a registered
agent on record and any change in the registered agent of a corporation must
be filed with the Office of the Secretary of State within 30 days of the
change.
What is an assumed name?
An assumed name is a name that a business uses to identify itself that is
different from its true corporate name. (For example: Very Good Corporation,
Inc. may also have an assumed name of VGC, Inc.). Any business entity recorded
with the Secretary of State must file for authorization to use an assumed
name unless that name is always used in conjunction with its corporate name.
If the corporation's name is changed in any way from its original filing,
this change must be filed with the Office of the Secretary of State.
What does it mean when a corporation dissolves?
If a corporation decides that it no longer wants to remain in business, it
must file dissolution papers with the Office of the Secretary of State. When
a corporation dissolves it can no longer do business. It must wind up its
affairs and distribute its assets appropriately.
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