Choosing the proper legal organizational structure for your business is one of the most important decisions you will make. While it may not have much impact on the day-to-day operations of a small business, it can have a huge impact come tax time, when you want to borrow money or attract investors, or in the unfortunate event you get taken to court. While it is possible to change your structure at a later date, it can be a difficult and expensive process. Better to make the right decision in the first place.
In the United States, you are not required to have an attorney prepare and file the paperwork to create any of the structures listed below. In fact, there are numerous books and other products available to help you do the filings yourself, as well as many Internet services that will do them for you. However, depending on the size and complexity of your business, you may want to consult with an attorney, and you almost certainly should consult with your tax advisor regarding which structure is best for your situation. This article can't possibly answer all your questions, but it will help you determine the right ones to ask a qualified professional.
The following are the basic forms of business ownership in the United States. There are variants from state to state, so be sure to check with your state's Secretary of State Office for the exact details in your state.
Sole Proprietorship. The individual owner of an unincorporated business operates the business as an extension of himself. The profits and losses of the business are reported on the tax return of the owner - there is no separate business filing. The owner is personally responsible for any liabilities of the business. If someone sues the business for breach of contract, personal injury, or to collect a debt, the court can directly levy the personal bank account and other property of the owner. The major advantage of sole proprietorship is that it is the simplest and least expensive structure, as there is really nothing to set up and maintain, except perhaps a fictitious business name (aka DBA, or Doing Business As).
General Partnership. Two or more people own the business jointly and share profits and losses of the business as spelled out in the partnership agreement. Each partner is potentially responsible for the full amount of all liabilities of the business, i.e., a creditor can collect the full amount of a debt of the partnership from the partner that is the easiest to collect from. Distribution of profits and losses is determined by the partnership agreement and passes through to the individual partners. It does not have to match the ownership percentages. The partnership itself is not subject to any income or franchise tax. Control of the business is determined by the partnership agreement, but unless stated otherwise, the partners control the business jointly, with each partner having an equal vote. An advantage of partnerships is that, like a sole proprietorship, no state filings are required to create the business entity, nor are there any ongoing reporting requirements.
Limited Partnership. The basic structure and tax implications are the same as for a general partnership, but the limited partnership allows for one or more limited partners, or "silent partners", to own a portion of the business, but not participate in the management of the business. The partnership must also have a general partner who has personal liability for all liabilities of the partnership. This structure allows a partnership to have outside investors without subjecting them to the liabilities of the business.
Limited Liability Partnership (LLP). The LLP is a fairly new structure that appeared as a result from demand from attorney and accounting firms to be able to limit the liability between partners (attorney and accounting firms were at one time not allowed to incorporate, though they are now). An LLP is taxed like a partnership, but limits the liabilities of all partners much like an LLC. However, at this point in time, LLP laws vary significantly from state to state. For example, California and New York only allow this form for attorney and accounting firms. In many other states, partners in an LLP only have a "limited shield", and are not afforded the same protection they would enjoy in an LLC or corporation. These restrictions make the LLP generally only a good choice for attorney and accounting firms, at least in the states with the limited shield law. Check with your Secretary of State for the specifics in your state.
