Business Entities

Often ancient societies punished with slavery those who lost money for investors in business ventures. Eventually the law allowed for limited liability companies which permitted investors to back a venture and risk a fixed amount of money. This helped fuel the industrial revolution. Even the pilgrims made use of a limited liability company to raise funds to travel to America. Under early English law, the charter of limited liability companies were obtained from the King or Parliament. In the American colonies, often it was obtained from the state legislative branch as a privilege. Now obtaining a corporate charter is a routine clerical matter.

There are now several types of commonly used entities. The choice of entity depends on your objectives and the tax and legal aspects of the entity. All entities except Proprietorship and Partnership require a filing and fee paid to a state. The federal government does not create entities for private businesses (except a few rare exceptions). If you fail to continue to pay the fee and update filings, the entity will be dissolved.

Proprietorship

A proprietorship is the name given for one-owner businesses that are not using another business entity form.

Partnership

A partnership is two or more people in business together. A partnership can be implied in law so it is often a legally risky form of business entity. It usually better to form an entity to define the business relationship.

Limited Partnership

A limited partnership is a partnership consisting of one or more general partners and one or more limited partners. The limited partners and general partners may be entities (e.g. corporations). The general partners run the business and have general liability. The limited partners are only liable to the extent of their promised capital contribution. If limited partners are active in the business, they assume general liability.

The limited partnership was popular before the federal tax code amendments in 1986. Its function has for most purposes been taken over by the limited liability company.

Corporation

The corporation is considered to be a separate legal person under the law. It is run by a board of directors who appoint officers to run the day to day business affairs. It is owed by shareholders. Shareholders are either common or preferred. Preferred shareholders usually have more rights than common shareholders. Preferred shareholder rights are specified by the corporate charter and director's resolution. It is the most common entity used by public companies.

S Corporation

S Corporation is exactly the same entity as a corporation or a "C" corporation. The entity is defined by state law. The "S" and "C" designations are for federal tax law purposes only. An S corporation was the first entity designed to help small business avoid the double tax C corporations are must pay (at the corporate level and then at the shareholder level if dividends are paid). The S corporation election taxes the shareholders for the profits of the corporation even if no dividends are paid. Losses are passed on to the shareholder but can only be deducted to the extent of the amount paid for the stock (called "basis").

Generally S corporations are complicated and , have hidden risks. Limited liability companies are a better choice for most small businesses.

Business Trust

Business trusts are a fairly rare form of business entity which exists under some state laws. For most purposes it is taxed and treated like a C corporation.

Limited Liability Company

The modern form of business entity is the limited liability company. It is taxed like a partnership (at the owner level), is very flexible, and has legal advantages that are not available to corporations (e.g. no 'piercing of the corporate veil'). It requires a good transactional lawyer to set it up properly if there are more than a few owners.