Choosing how to form your business is one of the most important business blocks in building your business. The entity you choose will affect many factors of your business including how you name your business, what your personal liability is, how you file taxes, and where and how you secure funding. Spend the time, do your research, consult with professionals, and choose the right business structure in the beginning.
Sole Proprietorship
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The definition of a Sole Proprietorship is “an unincorporated business that is owned by one person who reports business profits on his or her individual tax return and pays personal income tax on profits earned by the business.”
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Sole proprietorships are considered pass-through entities, meaning the profits are passed directly to the owners.
Partnerships
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The definition of a Partnership is “an unincorporated business shared by multiple owners.” Profits are divided among the owners and reported on their personal tax returns.
Types of Partnerships
1--General Partnership
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The most basic and easy to form partnership is the general partnership. This does not require registering or forming an official business entity with the state. Most general partnerships operate from a partnership agreement.
2--Limited Partnership (LPs)
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LPs are official business entities that require registering with the Secretary of State.
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Limited Partnerships are used when a business has silent, or limited, partners. This happens when there is at least one general partner who takes responsibility for the business and one or more limited partners contribute money but do not actively participate in running the business.
3--Limited Liability Partnership (LLPs)
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LLPs operate similarly to general partnerships, establishing a division of labor and responsibilities between partners. Unlike general partnerships, this business structure is considered a legal entity.
Limited Liability Company (LLC)
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A Limited Liability Company, or an LLC, is a formal partnership that requires articles of organization to be filled with the state. It is a hybrid business structure of partnership and corporation. It has the flexibility of a partnership but the protection of a corporation in that the owners are not personally liable for the company’s debts or liabilities.
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Unlike a corporation, an LLC is taxed as a pass-through entity, passing the profits directly through to its owners, also called members. Members can be employees. Their wages classify as operating express and are deducted from the business profits. Losses can be used to offset income, but only up to the amount invested. By default, the IRS sees LLCs as a pass-through entity, though owners can opt to classify as a corporation.
S Corporation
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An S Corporation (S-Corp) has the benefit of incorporation with the taxes of a partnership. S Corporations have one class of stock and a limit of 100 shareholders which can consist of individuals, specific trusts and estates, or certain tax-exempt organizations. Shareholders cannot be a for-profit business, partnership, a nonresident alien, or another corporation.
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Like Sole Proprietorships, Partnerships, and most LLCs, S Corporations are pass-through entities and do not pay federal taxes at the corporate level. The profits and losses are passed directly to the shareholders, or owners, to report on their individual tax returns. Shareholders, or owners, have limited liability. The corporation protects their personal assets.
C Corporation
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Unlike S Corporations, C Corporations are taxed as separate entities from their owners. Profits are taxed at a corporate level. Any dividends paid to owners are paid after profits are taxed. Shareholders, or owners, must also pay taxes on their proceeds, creating a double taxation situation.
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C Corporations limit their shareholder’s liability, protecting personal assets above the shareholder’s initial investment.
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Also, unlike S-Corps, C Corporations have multiple classes of stock and an unlimited number of shareholders. A C-Corp is a great fit for a startup seeking investments, a company looking for rapid growth requiring cash, or if your plans for your business include becoming a publicly-traded company.
If your business is located in Mississippi, here is a list of entities recognized by the Secretary of State:
https://www.sos.ms.gov/
If you have any questions regarding the setup of your business entity I encourage you to speak with an attorney or accountant. Especially when it comes to more complex LLCs and corporations. You can reference a previous blog posting where I talk with local business owner Taariq David about establishing his LLC through the Transactional Law Clinic at The University of Mississippi.
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