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Sole Proprietorship. A sole owner controls the business and takes all the profits, which are included in personal income. Any losses can be deducted from the owner’s personal income. No legal formalities are required, and it’s easy to start up or close down the business. However, the owner is responsible for all business debts, so personal assets are at risk. In turn, that risk may limit the ability to raise capital, so expansion may be difficult. Similarly, the owner may not be able to attract key employees who want an ownership stake. Partnership. With two or more owners, more people can invest in the business and share in the profits or use losses to offset other income. Partners are taxed like sole proprietors; except for passive limited partners, each partner is liable for the partnership’s debts. Consequently, partners need to work well together. If one partner dies or leaves the business, the other partners may then have to buy out his share or find a new partner. Limited Liability Company (LLC). Like corporations, LLCs must be set up under state law. LLC owners, referred to as members, are generally shielded from the LLC’s debts and liabilities unless they expressly guarantee or assume them (again, this is similar to the corporate situation). The big difference between LLCs and corporations: Multimember LLCs are treated under the favorable federal income tax rules for partnerships. Single-member LLCs owned by one individual (allowed in all but a few states) can be treated as if they don’t exist for federal tax purposes; in other words, the tax rules for sole proprietorships generally apply. LLCs are attractive because they combine the corporate limited liability advantage with the more favorable (and more flexible) tax rules applying to partnerships and sole proprietorships. Corporation. Most larger businesses incorporate. Then the corporation, not the owners, bears the liability for actions taken by the business. The state must approve the incorporation, and shares of stock must be issued. If a stockholder dies, the corporation remains intact. Because a corporation can sell more stock to raise capital, it has greater growth potential than other types of business organization. Regular “C corporations” are subject to a corporate income tax, with a top rate of 34 percent in most cases. Dividends to employee shareholders are taxed as personal income, but the rate has been reduced to no more than 15 percent for 2003 through 2009. However, many small businesses can qualify as “S corporations,” thus eliminating the corporate income tax. S corporation shareholders enjoy some of the tax benefits of partnerships: They may currently deduct business losses or carry them forward to future years. |
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