Business Briefs

Forms of Business Ownership

One of the early decisions for a person starting a home-based business involves choosing the best form of organization and ownership. The form of organization used depends on the type of business, how many owners or investors are involved, and how tax and liability issues will be handled.

Sole Proprietorship

The sole proprietorship form usually is advantageous to a new business because of ease in organization. The business owner is responsible for all financing, management decisions, and liabilities of the business.

Advantages

  • Owner in direct control (you are the boss).
  • Low start-up (organizational) costs.
  • Least government regulation.
  • Ease of formation and simple structure.
  • No double taxation.
  • Business losses can offset personal income (for tax purposes).
  • Owner receives all profits.
Disadvantages
  • Total (unlimited) personal liability.
  • Limited financial resources (capital).
  • Lack of continuity as a result of disability or death of owner.
  • Owner may have limited managerial expertise.
  • All profit is taxed as personal income.
  • Can expand only with "after-tax dollars."
Most home-based businesses use the sole proprietorship form. It is simple, inexpensive, and requires less complex record keeping methods than the other forms of ownership.

Partnership

A partnership provides the opportunity to pool the capital and management resources of two or more individuals to conduct business. Two types of partnerships are the general and the limited.

A general partnership is fairly easy to establish. A written partnership agreement drawn up by an attorney should be used to clarify business arrangements and to avoid misunderstandings. The partnership agreement should include: a list of the rights and responsibilities of each partner and their heirs; the management and continuity arrangements for the business in the event of death or disability of one of the partners; the profit (and loss) distribution plan; and any special conditions or arrangements that may affect any of the partners through operation of the business. When signed by all partners, the agreement is an enforceable contract.

Advantages

  • Simple organization.
  • Additional personal resources (financial and managerial).
  • The right to select partners.
  • Low start-up (organizational) costs.
  • Limited outside regulation.
  • No double taxation.
Disadvantages
  • Unlimited liability for partnership obligations.
  • Lack of continuity in event of death or disability of one partner.
  • Sharing of profits.
  • All profits are taxed as personal income.
  • Difficult to raise additional capital.
  • Hard to find suitable partners.
  • Divided authority (limited decision making).
The limited partnership permits investor involvement with liability limited to the amount of the investment or the amount agreed to in the limited partnership agreement. The partnership must include at least one general partner who has general liability for the debts of the limited partnership. The general partner usually manages the business. The limited partner usually exercises no control over the business of the partnership but is merely an investor.

Advantages

  • General partner maintains control of the business.
  • Limited partner can invest with a limit on personal liability.
  • Easy way to secure capital.
  • Business not taxed directly.
Disadvantages
  • More complex to organize.
  • Limited partner has no control over the business.
  • General partner has unlimited personal liability for the obligations of the business.
  • Lack of continuity in event of death or disability of the general partner.
Corporation

A "C" corporation is a separate legal entity from its owners, the shareholders. It can enter into contracts, be liable for any obligations, and must pay taxes on income as well as dividends distributed to shareholders. A corporation attracts capital investment funds by selling shares of stock in the company to investors or by trading stock for assets. Generally, stockholders are not liable for claims in excess of the current value of their shares. Corporate officers may be required to personally guarantee bank notes or loans and, therefore, are personally liable for the obligation. Other creditors generally can lay claim only to the assets of the corporation.

Advantages

  • Limited personal liability.
  • Separate legal entity.
  • Specialized management.
  • Transferable ownership.
  • Perpetual life.
  • Easier to raise capital.
Disadvantages
  • Closely regulated.
  • Most expensive to organize.
  • Complex organization and management.
  • Extensive record keeping necessary.
  • Double taxation.
One corporate form home-basers may consider is the "S" corporation (Subchapter S Corporation). The "S" corporate structure should be considered when:

The owners expect operating losses.
Large dividends are anticipated.
The owner's individual tax rates are lower than the corporate tax rates.
There are 35 or fewer stockholders.
The corporation has only one class of stock.

The "S" corporate structure allows a tax burden shift to shareholders. The election is made formally on Form 2553 filed with the Internal Revenue Service. The election can be made at any time during the previous year or up to March 15 of the year of election. By April 15, the "S" corporation also must file an informational return allocating profits or losses to shareholders.

Limited Liability Company (LLC)

A limited liability company (LLC) is a business entity created by statute. It has some characteristics of a partnership and some characteristics of a corporation. A LLC has the tax advantages of a partnership and the limited liability advantages of a corporation. Properly structured it is taxed like a partnership or an "S" corporation. If the LLC is not properly structured, it is taxed like a "C" corporation. Forming a LLC is more complex than forming a partnership, but less complex than forming and operating a corporation. Forming a LLC is a formal process, contact the Mississippi Secretary of State at 601/359-1633. LLC's are a relatively new form of business in Mississippi. Legislation creating this form of business was passed in this state in 1994. It should be noted that the lack of precedent adds some uncertainty to adopting this form of business. However, experts predict the LLC is quickly becoming the form of choice for many small businesses.

Before deciding on a form of business ownership, consult an attorney and a certified public accountant (CPA). Their expertise can help you avoid making costly mistakes. The final decision should be based on what is best for your individual situation and business needs.

Table Comparing the Different Forms of Business
Type of Business SoleProprietorship Partnerships Corporations Limited Liability Company
General Limited C Corp S Corp
Definition A business owned and operated by one person for profit. Two or more people who jointly own or operate a business for profit. One or more partners have limited liability and no rights of management. An organization formed under state or federal law. An artificial entity separate from its owners. An organization structured like a corporation but taxed like a partnership. A business entity created by statute. The owners are called members. It is taxed like a partnership or an s corp. It has limited liability like corporations.
Ease of Formation Easiest form of business to set up. If necessary, acquire licenses and permits, register fictitious name, and obtain taxpayer identification. Easy to set up and operate. A written partnership agreement is highly recommended. Must acquire an Employer ID number. If necessary, register fictitious name. File a Certificate of Limited Partnership with the Secretary of State. Name must show that business is a limited partnership. Must have written agreement, and must keep certain records. File articles of incorporation and other required reports with the Secretary of State. Prepare bylaws and follow corporate formalities. Must meet all criteria to file as an S corporation. Must file timely election with the IRS (within 21/2 months of first taxable year). File articles of organization with the Secretary of State. Adopt operating agreement, and file necessary reports with Secretary of State. The name must show it is limited liability company.
Period of Existence Terminates at will or on the death of the owner. Terminates by agreement, or by death or withdrawal of partner, unless there is a partnership agreement to the contrary. Continues until formal dissolution. Most stable form of business. Not affected by death or disaffiliation of shareholder. May terminate by agreement, or withdrawal of a member, depending upon operating agreement.
Taxes Profits are taxed once. Profit and loss are reported on the owner's individual state and federal income tax returns. Profits are taxed once. Each partner reports his or her share of the profit and loss on his or her individual state and federal income tax returns. Partnership files an information return. Profits are subject to double taxation, once at the corporate level, and again at the shareholder level. Profits are taxed once. Each shareholder reports his or her share of profit and loss on individual income tax returns. S corp does not pay tax, with some exceptions. If the LLC is structured properly, each member reports his or her share of the profit and loss on his or her individual income tax returns. It is taxed like a partnership or an S corp. If the LLC is not structured properly, it is taxed like a C corporation.
Liability The owner's personal assets are at risk. Each partner's personal assets are at risk. General partners' personal assets are at risk. A limited partner is liable only to the extent of his or her investment. Limited to corporate assets, except:

1. Personally guaranteed business debts;

2. Personal negligence or fault; or

3. Corporate form is found to be a sham.

 Similar to rules for corporations.
Dissolution Easiest form of business to dissolve. Pay debts, taxes, and claims against business. Pay debts, taxes, and claims against business. Settle partnership accounts. Pay debts, taxes, and claims against business. Settle partnership accounts. File cancellation of certificate with the Secretary of State. Obtain shareholder approval to dissolve. File statement of intent to dissolve with the Secretary of State. Pay debts, taxes, and claims against business. Distribute corporate assets to shareholders. Pay debts, taxes, and claims against business. Distribute remaining assets to members. File articles of dissolution with the Secretary of State.
Gain on distribution of assets is subject to double taxation. Gain on distribution of assets is taxed once, with some exceptions.

Table prepared by Carol A. Schwab, J.D., LL.M., a Member of the North Carolina State Bar and a Family Resource Management Specialist for the North Carolina Cooperative Extension Service, North Carolina State University, Raleigh, North Carolina.

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