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Corporation/Partnership

Corporation/Partnership Law Overview

Choosing a business form is an important decision. The decision to run your business as a corporation or partnership will affect your personal liability and have tax implications. Every state has its own specific rules about setting up a corporation or partnership ranging from filing procedures to reporting requirements. There are several types of business entities and variations within each type. If you are considering setting up a business, an attorney can help you understand the steps required to establish your business and the best structure for you.

Types of Business Entities:

Sole Proprietorship

This is the simplest business entity because it's just you. A sole proprietorship requires the least amount of work to set up. To create your sole proprietorship, you still must file certain tax information and apply for a business license with the state.

Sole proprietorships usually only have one person in the business, though exceptions are made for husband-wife run businesses in some states. The business entity itself is not taxed, but the individual will be taxed.

A sole proprietorship can also be risky because you as sole proprietor as fully liable for the debts and obligation of your business.

Partnerships

A partnership is formed when two or more people agree to carry on business for profit as co-owners.

The members of the partnership don't require a written agreement because all states have default rules regarding the operation of a partnership, from formation of the partnership to ending it. For example, unless there is an agreement stating otherwise, it is assumed that both partners will share all profits and debts equally. Each partner is personally and individually liable for the debts and obligations of the partnership. Unless otherwise agreed upon, each partner has the authority to bind the partnership in contract as long as it is in the course of partnership business.

Partners also have obligations to the partnership and the other partners. For example, a partner must use his or her best efforts to help the partnership succeed. Therefore, a partner cannot compete against the partnership in a way that it hurts the business.

Like a sole proprietorship, the partners are taxed. Additional paperwork must be filed with tax returns. In addition, the partnership itself must file an informational return with the IRS.

Given the risk that occurs with a general partnership, many partners choose variations of the general partnership such as the limited partnership and the limited liability partnership. As their names suggest, these business entities provide a means for partners to reduce the amount of liability that they may be potentially exposed to. Both the limited partnership and the limited liability partnership require that you file the appropriate paperwork with the appropriate state agency to establish your limited partnership status.

Corporations

A corporation differs from partnerships (and sole proprietorships) in that a corporation is a separate legal entity. A corporation conducts its own business, is liable for its own debts and pays its own taxes. To form a corporation, you must file articles of incorporation with your local secretary of state's office, including the name of the corporation, a registered address, a registered agent for the corporation, by-laws and the number of shares of stock the corporation plans to issue.

Corporations have shareholders. Generally, the more shares of stock a person owns, the more control he or she will have over the corporation; however, shareholders do not typically run the day to day business of a corporation.

Shareholders determine who is elected to the board of directors, which hires officers and managers to run the corporation. The shareholders also vote on major issues that affect the company, including the corporation's by-laws, which set out rules for how certain aspects of the corporation will operate.

When it comes to taxation, a corporation can fall into one of two categories (both named after their respective chapters of the Internal Revenue Code). A "C" Corporation follows the standard corporate tax rules. Certain corporations can elect to be an "S" Corporation, which follow a different set of rules for tax purposes. Though an "S" Corporation is not a partnership, it will essentially be taxed like one-i.e. the corporation isn't taxed, but the shareholders are. There is a newer form of business entity known as a Limited Liability Corporation. An LLC is essentially a hybrid between a corporation and a partnership, providing the individual taxation of a partnership while affording the same protection from liability as a corporation.

Whatever entity you decide to use for your business, it is important to understand the standards, rules, benefits and drawbacks. The laws regarding corporations and partnerships vary from state to state. As previously stated, the type of entity you choose will determine your level of liability and tax responsibilities. It is important that you set up your partnership or corporation correctly. Otherwise, you could expose yourself to unforeseen liability.

An attorney can help you decide which business form is right for you and help you set it up. The decision to run your business as a corporation or partnership will affect your personal liability and have tax implications.