Business Entities in the U.S.:

• Corporation (C, PSC, and S)
• Partnership (Limited and general)
• Limited liability company (LLC)
• Sole Proprietorship

Limited partnerships (LP, FLP, LLP), limited liability companies (LLC) and corporations are official entities and are created according to state statutes and require registration within each state in which they operate. These entities are governed by formal rules from the corresponding state regarding the entity’s structure and operation, and require some state supervision along with annual taxes or registration fees.

Sole proprietorship is considered an informal business structure; no formalities other than a business license may be required. You have a proprietorship simply by “going into business” with no requirement other than a name.

Why are formal business entities important?  Essentially, there are four major uses of and reasons for forming a formal business entity:

1. Limiting your personal liability from legal problems of the business. This is termed “limited liability and is granted by state statute (or, in some instances, case law). This feature usually prevents debts and liabilities of the business from being collected from the owners and officers personally (although there are some exceptions).
2. To provide a simple method of dividing ownership interests among multiple owners.
3. To provide a centralized management system when there are multiple owners.
4. To take advantage of business tax breaks which are only allowed to legal entities. These breaks include various fringe benefits, health insurance, pension plans and profit distributions which may not be subject to self employment taxes.

Who Needs a New Business Entity?

While sole proprietors and the self-employed do not have multiple owner issues, they don’t have the limited liability and special business tax breaks. Lack of limited liability can often be a major threat to a business owner. There are six entities or groups that businesses death with, and any one of them is a potential threat to sue the business.  These groups are: customers, employees, creditors, sub-contractors or contractors, competitors, and regulatory governmental agencies. If you deal with any combination of these groups as a proprietorship or as self-employed, as a licensed professional or as the general partner of a partnership, you are a candidate for a formal business entity. Your status as a proprietor, self-employed or general partner will provide no limited liability, which could put you in personal jeopardy from business related lawsuits. Also, you may have mismanaged an existing business entity to the extent that your limited liability is in jeopardy or is non-existent. Therefore, the best way to distance yourself from the problems that this mismanagement created may be to become a candidate for a new entity.

Which is Best for Me?

This question can only be answered by the specifics of your situation and is best answered by working with a competent attorney. The tax treatments vary substantially based on the type of entity and must be considered in the formation stage.

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