Choosing a business structure is a decision that should be made on the basis of a variety of considerations, including the present and future needs of an organization. There are no one-size-fits-all solutions in this area, since all business structures are associated with unique advantages and limitations. It is advisable to compare and contrast the attributes that are important to your organization and to choose accordingly with the knowledge that the decision, while not permanent, may have long-term ramifications.

1. Setting it up
Sole Proprietorship. A sole proprietorship is a business owned and operated by an individual. The individual has total control of the business, receives all profits from it, and is responsible for all taxes and liabilities. The upfront filing and start-up costs involved in setting up a sole proprietorship are limited, though most cities and counties do require sole proprietors to register and pay a minimum tax. Also, if the sole proprietorship operates under a name other than the individual’s name – for example, Brown Bear Bakery – a fictitious business name certificate should be filed in the county where the principal place of business is located. A sole proprietor may also need to obtain local licenses, registrations and permits that are relevant to the operation of the business, such as a zoning permit or alcoholic beverage license.

Limited Liability Company. A limited liability company (LLC) offers liability protection similar to that of a corporation but is taxed differently. To create an LLC, a business owner must file articles of organization with the offices of the Secretary of State. A filing, which requires a fee payable to the state franchise tax board, requires the registrant to provide basic details about the company and to name a registered agent who can receive legal notices on behalf of the corporation. A registrant must also execute an operating agreement among the owners of the LLC to establish shares, rights, responsibilities, and profit arrangements. The operating agreement should also address important issues such as the winding down of an LLC and how the departure of an LLC member should be handled.

Corporation. The corporation is a legal entity that exists separately from its owner and therefore limits the personal liability of its owners. To form a corporation, it is necessary to file articles of incorporation with the offices of the Secretary of State, as well as issue stock to shareholders and create corporate bylaws. In many states, including California, corporate bylaws do not have to be filed with the state but are nevertheless important because they establish the specifics of corporate governance. The existence of the corporation begins upon filing of the articles of incorporation, and the incorporator or incorporators must then hold a meeting for the purpose of adopting bylaws, electing directors and transacting any other business.

2. Personal liability for claims and business debts

Sole Proprietorship. A sole proprietor can be held liable for any claims or business-related obligations, which means that creditors can pursue a sole proprietor’s personal assets to satisfy debts or judgment claims. This is one of the least desirable features of the sole proprietorship and the reason why many business owners opt to incorporate or file for LLC status.

Corporation and LLC. Corporation and LLC owners are limited in liability to the extent they have invested in the business. However, liability may extend to personal assets when the business owner disregards the corporate entity and neglects corporate formalities, such as by commingling corporate and personal assets.

3. Taxation

Sole Proprietorship. Sole proprietorship affords no special tax benefits; business income and losses are simply filed as part of the sole proprietor’s personal taxes. Also, sole proprietors are responsible for filing income taxes and making withholdings, such as contributions to Social Security and Medicare that would ordinarily be filed by an employer. If the sole proprietor hires employees, it will also be necessary to apply for an Employer Identification Number (EIN). EIN registration is free and available online via the Internal Revenue Service website.

LLC. The LLC is considered a “pass-through entity” by the IRS, which means that income simply passes through the business to LLC owners. Co-owned LLCs must file Form 1065 to disclose profits and losses to the IRS each year, but the LLC itself is not liable for taxes. The LLC owners, in turn, report and pay taxes on their share of profits via their personal income tax returns. It will be necessary for the LLC owners to set aside income and make quarterly self-employment tax payments to the IRS. Additionally, many states including California, New York and Delaware (but not Nevada), levy a franchise tax on LLCs, which may be a flat fee or an amount based on certain factors, such as profits, revenue or number of owners.

Corporations. A corporation, as a separate legal entity, must pay taxes on its remaining profits after paying out operating expenses. In addition, the owner of a corporation who also works for the corporation will receive a salary and be taxed on earnings like a regular employee. Corporations must either file Form 1120 with the IRS to report and pay out taxes at a corporate rate, or file Form 2253 with the IRS as an “S corporation” to receive similar tax treatment to an LLC.

4. Management and administration

Sole Proprietorship. A sole proprietor is the simplest of all business organizations to create and maintain. The burden of administration lies primarily in paying income taxes and business debts to avoid personal liability.

LLC. It is advisable to separate personal business from LLC business and to create and adhere to an operating agreement. An LLC is managed either by a manager or team of managers hired specifically to take care of day-to-day business or equally by the group of LLC owners.

Corporation. As compared to other business structures, the corporation is associated with a high level of administrative work. In order to maintain the corporation as a separate legal entity and ensure that the owners are not subject to personal liability, certain corporate formalities must be observed and maintained. Corporate funds must be kept in a separate account and must not be commingled with personal funds. State law will require the corporation to maintain accurate and thorough financial records, as well as keep records of shares and minutes of shareholder, board and executive committee meetings. Board and shareholder meetings will also be required, either annually or as specified in the corporate bylaws. It is worth noting that in a corporation, officers, board members and controlling shareholders are bound as fiduciaries to act for the benefit of the corporation. They may be subject to personal liability if they breach their duties of care and loyalty.

-By Dava Casoni, Annie Lin