From Limited Liability Companies (LLC) and Partnerships (LLP) to C and S Corporations, when it comes to creating a legal entity for business or investment purposes there are several options. Firstly, one of the most basic ways of creating a business is through a sole proprietorship, which contrasts starkly with other ways of business ownership or participation. Sole proprietorship is the easiest way for an individual to create and run a small business. Under this structure there is little paperwork, particularly when compared to other forms of incorporation, because the profits or losses generated from a sole proprietorship business are reported directly on the proprietor’s individual tax return. In this sense, sole proprietorships avoid double taxation because their financial performance is considered to be individual income. The main drawbacks of sole proprietorships stem from the fact that they are tied to the individual who operates and is the proprietor of the business. Therefore, businesses in the form of sole proprietorships tend to cease operating when the owner stops working. Furthermore, because sole proprietorships do not create a separate legal entity, the owner is personally liable for any losses or debts incurred by the business.
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Another form of legal incorporation is the General Partnership, which is similar to a sole proprietorship in the sense that the partners do not formally create a new legal entity for their business. Rather, the general partners outline a business agreement in which all partners have equal responsibilities and benefits. Therefore, the profits and losses from general partnerships are passed to the general partners and taxed at the individual level. Likewise, the general partners are all personally liable for any losses or debts incurred by the business.
In an LLC or LLP, the limited partners or investors of the business are only liable for an amount no greater than their respective investments into the business. Unlike general partnerships and sole proprietorships, LLCs and LLPs do create an independent legal entity for the business. Therefore, the limited partners and members of the company are protected from unlimited liability. However, an advantage of these two forms of limited liability businesses is that they allow for flow-through taxation at the individual level, thus avoiding corporate taxation.
Lastly, as a way of managing a business, corporations create separate and independent legal entities. This means that the corporation itself, not its owners or members, is responsible for the debts incurred by the business. Therefore, in the case of default, creditors can only lay claim to assets that are owned by the legal entity that is the corporation. In this regard, corporations offer their shareholders and owners full liability protection. Similarly, because they are independent legal entities, corporations can raise capital by selling shares. Corporations are the most time consuming and complex method to create a business. However, the legal process provides the business with a life of its own and, if profitable, it can be easily sold in the future. This article merely presents a brief overview of legal matters and should not be considered formal legal advice under any circumstance.