Selecting appropriate business form an important task for entrepreneurs

Selecting the appropriate business type is important to ensure a budding business gets off on the right foot, but how does an entrepreneur know what the best business form is for his or her needs? Looking at the question generally, there are four basic types of business forms available.

In a sole proprietorship, one owner has sole profit, control and liability for the business. Sole proprietorships involve less paperwork and fewer requirements than other business forms. On the other hand, the owner has sole responsibility for liabilities, and that liability is personal. In addition, sole proprietors have a limited ability to raise capital. In a sole proprietorship, taxes are filed as personal income tax.

Another possible business form is partnership, which involves two or more individuals who share profits, but who also share unlimited personal liability for debts and liabilities, at least in a default partnership arrangement. With partnerships, each partner is personally liable for the debts of other partners. Partnerships can be classified as either general or limited.

In a general partnership, all the owners sign an agreement laying out the terms of the partnership, addressing the contributions of the partners, distribution of profits and losses, terms for dissolution, and other important issues. A limited partnership is formed when there is one or more general partner(s)and also one or more limited partners who have limited liability and limited responsibility for management of the business. Limited partnerships are formed by filing documents with the state.

A further option is a limited liability partnership, which is formed when a general or limited partnership files documents with the state making the appropriate elections indicating that general partners have additional protection from personal liability for the liabilities and debts of the other partners.

The way a partnership, general or limited, reports income depends on whether the business is taxed as a partnership or as a corporation. If taxed as a partnership, each partner reports income separately, while partnerships which elect to be taxed as corporations pay taxes as a business. Sorting out the advantages and disadvantages of each approach is not always straightforward, and it is important to work with an experienced attorney not only to determine the best way to form the business and the proper elections to make, but also to ensure that all applicable legal requirements are met.

In our next post, we’ll continue looking at this topic, particularly at limited liability companies and corporations. 

Source: Pennsylvania Department of Revenue, Starting a Business in Pennsylvania: A Beginner’s Guide,” Accessed April 4, 2017. 

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