Incorporating Business Structures

When you incorporate, you are formally organizing a business structure, however when you are conducting business prior to incorporating, you operate under a default type of business. All of the forms will be examined here and compared to each other, briefly. In the later sections of the incorporation guide, these entities will be dissected for liability protection, taxation, employee issues and other benefits of incorporating your business. This is just an introduction to your choices as far as business incorporation structures with an overview of the benefits and immediate comparisons. Well its time to introduce the options.

Sole Proprietorship
Partnerships
Corporations
Limited Liability Company
Non Incorporated Business Structures
Sole Proprietor

You don't incorporate a sole proprietorship. By default, if you transact business alone, you are a sole proprietor. This is the simplest form of business organization. Pretty much, nothing more than an individual undertaking business activity. This designates a single owner business, not single person business. Sole Proprietors have essentially no liability protection, very few tax advantages and the only benefit is the lack of formalities, just the opposite of incorporating a business. Simple organization and virtually no maintenance. The owner of a sole proprietor is solely responsible for 100% of the debts and obligations of the business and creditors have direct access to the assets of the business owner. This type of business structure suits businesses with no employees, very low income thresholds, no property, no plans for hiring employees and little or no growth expectations. If your plans include any of the above, you should plan to incorporate a business.

There isn't any legal differentiation between the business and the owner for a Sole Proprietor. Therefore the business owner's personal assets are available to satisfy business obligations and cover liability. Taxation is handled at the individual's level since there is no separate legal entity to record income and losses. This simple form of taxation can be acheived by incorporating, more on this later. Sole Proprietors complete a Schedule C with the IRS form 1040 to report business income and losses. This is also the highest audited tax scenario in America. Individuals who report itemized business deductions on their personal income tax returns.

Sole Proprietorships aren't incorporated and lack perpetual duration, the existence of the business ends with the sale of the business, abandonment, death or bankruptcy of the owner. This means that the duration of the entity isn't perpetual, like you find with Corporations and other formal incorporated structures. Selling a Sole Proprietor to another individual essentially results in one business structure ending and a new one beginning. This form of business organization isn't recommended for any business that intends on owning property, such as computer equipment, vehicles and furniture, hiring employees or conducting any business that is high liability, such as working with hazardous materials or contracting and such for businesses that aren't making a lot of money and no plans for growing the business.

Partnerships
There are several forms of partnerships, specifically:

General Partnerships
Limited Partnerships
Limited Liability Partnerships
Limited Liability Limited Partnerships
The LLLP is only currently recognized by some states. These all vary in liability protection and partner contribution, however share close taxation similarities.
A General Partnership is not an incorporated business structure, this does not require any incorporation formalities and offers about as much protection as a sole proprietorship, with even more exposure - to that of your partner's actions, and vice versa. Quite possibly the absolute worst business organizational structure you could choose.

Defined by Section 6(1) of the Uniform Partnership Act as "an association of two or more person to carry on as co-owners a business for profit." Operating a general partnership should include a partnership agreement, which outlines the roles, responsibilities, duties and various rights of each partner. This does not limit any liability or prevent exposure of a partner's assets in an way. Each partner is severally and jointly liable for all business obligations, liability and debts of the partnership. Each partner is also responsible for the actions of another partner on behalf of the business, which leaves room for huge exposure and risk. If your partner were to execute an agreement without your knowledge, you are equally responsible for the obligations of that agreement and the same goes for business debts.

Taxation is still at the individual level, however in this case, each partner will fill out IRS form 1065, a partnership information return. Each partner will complete a Schedule K-1 which establishes each partner's share of the profits and/or losses, which is then used to complete the 1040 individual tax return form.

By not incorporating or even the need for formal organization, there is very little or actually, no operating formalities with a partnership. Even the favorable, pass-through, taxation is afforded to Corporations through the Sub Chapter S of the IRS code and Limited Liability Companies - both of which will be discussed in depth as we progress through the incorporating guide. The existence of a partnership is the same as a Sole Proprietorship, except it takes all of the partners to abandon, sell, die or file bankruptcy to dissolve the business structure.

A Limited Partnership enhances the above concept by adding a different type of partner, a Limited Partner. General partners in a Limited Partnership are identical to those of a general partnership. Still not an incorporated business organization, the LP attempts to bridge a gap between the favorable taxation offered to partnerships and the limited liability afforded to corporate shareholders. The technical definition of a Limited Partnership from Section 1 of the Uniform Limited Partnership Act defines a Limited Partnership as "a partnership formed by two or more persons... having as members one or more general partners and one or more limited partners."

A limited partners can not participate in the business, as soon as they do, they become general partners. Limited partners are generally capital partners who offered money in exchange for shares or interest in the business. These partners cannot be held liable for corporate or business debt obligated by the company. So general partners manage the company and have no protection, limited partners have liability protection, however cannot manage the company. This is not incorporating a business, still an informal business structure, however a bit more robust concept. This form of business does share one similarity to incorporation, being that a recorded document with the state establishes this form of business.

Partnerships had considerable tax advantages over Corporations, however since the inception of the Sub Chapter S Corporation, those were removed, and the Corporation offers many more features and benefits compared to a partnership. One still remaining and distinct advantage a limited partnership has over an S Corporation is that the S Corp is limited in number of shareholders and who/what can be a shareholder - while a limited partnership can have unlimited partners and lack any restriction on who can be a partner.

Limited Liability Partnerships are still not incorporated business structures, you form an LLP, you don't incorporate one. This structure offers general partners a degree of protection from personal liability, how much which will vary from state to state. Some states prohibit professional partnerships from incorporating or forming an LLC, so the LLP is widely used by these types of businesses, accounting firms, law offices, etc.

Limited Liability Limited Partnerships are not recognized by every state. Check with yours before you consider this form of business structure. This is such a new form of business entity that it has yet to be proven for reliability. Corporations have been proven in court cases to protect the shareholders and insulate them from business liability and debt for centuries, an LLLP hasn't.

Next Section: Introducing Incorporated Structures