When deciding to start a business the first step is to decide on the entity to form the business. This decision depends upon two factors namely
* The type of business being created, and
* The extent to which the entity will protect its principals from personal liability
In the US, the most basic and the most common forms of entity formationor ownership are
* Sole Proprietorship
Also known as a sole trader, or simply proprietorship, it is inexpensive to form and easy to dissolve. As the name suggests, it is owned and run by an individual who owns all assets and all debts of the business. In this type of ownership, there is no legal distinction between the owner and the business. This type of business entity is disregarded for tax purposes since profits and losses of the business are simply part of the owners personal income.
It is formed by two or more persons (or any business entity) who make an agreement to share profits and losses. Taxation is more complex, but the partnership itself pays no taxes. It is only required to file an informational return to the government to report what the profits and losses of the partnership were and how these were allocated to the partners. A partnership ceases to exist in the case of the death or bankruptcy of a partner or when they decide to terminate the partnership.
* Limited Liability Companies or LLCs
Such type of entities is highly flexible, and can be used for a various types of nature of business. Depending on state law, an LLC can have the same limited liability for members as a corporation, or have some members with limited liability and some without limited liability or no limited liability for any members. Unlike corporations, some States require that their LLCs designate a date in the future at which the LLC will automatically dissolve. Some States also require that if a member dies, goes bankrupt, or meets some other calamity the remaining members of the company must either dissolve or vote to continue.
Compared to the above, corporations are more complex. Forming a corporation means creation of a new legal entity, which is separate from its owners. Therefore, its life is independent of the life of shareholders. Depending on state law, a corporation can be owned by just one person and have just one director and officer. Corporations are legally required to follow more formalities than any other entities. Taxation of corporations is much more complex.
Since the selection of the proper type of entity formation is important for any business, entrepreneurs should seek the help of service providers to make the right selection.