Forming a Business Entity

Forming a business, whether it is web-based or otherwise, is not as simple as it once was.  With the bureaucracy of taxes and legal forms, it is no longer possible to just open up shop and start selling.  Well, it is possible, but the liability that the owner might incur could be devastating. 

Before deciding upon the type of business entity, the individual must take a couple of things into consideration.  The first is cost.  Depending on the state laws, there might be annual fees that the individual has to pay depending on the type of entity for which they wish to file.  The amount of liability that will be needed to maintain a business entity is another thing to take into consideration.  Some entities are better at self-sustaining than others, in terms of amount of record keeping and maintenance.  Tax liability also falls under this category.  Again, more often than not this depends on the state requirements.  Finally, the type of ownership that is desired must be taken in to account.  This becomes an extremely important thing to consider if there is ever a point where the business might become big enough to become a stock holder based business.

There are a few different types of business entities and it is important to understand the difference between them. 

Sole Proprietorship

This type of business entity basically sets the business owner up as indistinguishable from the business.  This is a low cost option, usually involving registering with the state.  This is the equivalent of just opening up shop.  It also does not usually require many recurring fees.  Once the proper license is acquired, it is up to the business owner to advertise, most often locally.  This free flowing type of business does come at a price.  For one, the tax benefits for this type of business are minimal.  The business owner is not able to use the business income tax rates because there is no difference between individual income and business income.  Also, the potential for liability if in conflict with a customer falls completely on the shoulders of the individual, including potential costs. 

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Corporation

There are two types of corporations

            C Corporation

This is the standard state corporation.  It is considered an individual entity and therefore is liable to itself when it comes to taxes and damages.  In this entity, shareholders are protected from any liability.  Although they provide the most protection for the business owners, this is also the most expensive type of entity to maintain.  There are annual fees and a board of directors must be appointed to oversee the activities of the corporation.  Most large corporations fall in this category. 

S Corporation  

This type of entity is very similar to a C Corporation.  One of the differences is that in an S Corporation, the shareholders are able to claim their portion of the corporation’s income as personal income.  However, this will only work with much smaller corporations, as S Corporations are limited to 75 shareholders. 

General Partnership

This entity is formed when two or more independent legal entities come together.  The burden of the partnership is shared by both entities; there is no distinguishing between them after the partnership is formed.  As far as taxes are concerned, all partners file as if they were self-employed.  There is usually little maintenance and expense in forming a partnership, other than the possibility of shouldering the burden of one of the partners. 

Limited Partnership

Operating much like a general partnership, there is a slight difference in a Limited Partnership by distinguishing the type of partner.  In a limited partnership, there are two types of partners.  General partners operate as if in a general partnership.  However, limited partners do not have responsibility of management and are not liable for anything other than individual capital investments.

Limited Liability Company

As the name would imply, this type of entity is a combination of a corporation and a partnership.  It provides the same level of tax and liability benefits that are granted to shareholders in a corporation.  Yet it is managed as a partnership.  There are more restrictions on a Limited Liability Company.  These depend on the state restrictions.  In order to form a Limited Liability Company, the process is about as extensive as forming a corporation and the costs to maintain it are also similar.