Forms of Business Organization Made Easy

by Edward Coblens

What form of business should your business be? Should you operate as a sole proprietor, corporation, partnership or LLC? Here are some guidelines to help you understand the differences.

When starting a new business it is important to determine the form of organization, since this will determine many things such as tax effect, liability, sharing of profits or losses and possibly how the business might be sold or expanded.

Generally, the forms of business organization are: Sole Proprietorship, Partnership, S Corporation, C Corporation, and LLC.

Sole Proprietorship: This is the simplest form of organization. If you are a one person business there are no papers to file therefore, no professional fees are incurred. You might want to get an Employer ID number from the IRS, but if you do not have employees and do not plan to be in a business where state sales taxes are required the Employer ID number is not required. There is no fee to get an IRS employer ID number. Go to www.irs.gov and search for IRS form SS4. After answering a few basic questions, the IRS will issue the ID number. If you plan to collect state sales tax, you will be required to contact NYS Sales tax and apply for a sales tax number. You will need your ID number to apply. As to accounting, keep your business income separate from your personal income and expenses. The best way to do this is by having a separate checking account. On the check stubs clearly show the source of deposits, and detail of checks issued. This way it will be easy to assemble the activity for your accountant to prepare the proper schedule on your personal tax return (it is schedule C on your personal tax return, form 1040). It is a good idea to communicate with your tax preparer, or accountant before the tax season rush so that you can have your records assembled in the manner your tax preparer prefers.

Partnership:  If the business is owned by more than one person, the sole proprietorship organization does not apply. You will have to consider the partnership form of organization. Try to keep it simple. Agree among the partners as to the important things, such as original investment, sharing profits and losses, and duties each is responsible for. In many cases, you can just write down what you have agreed to, and hopefully you will never have to look at the agreement. If you decide to use a lawyer to set up a partnership agreement, there will be a fee involved, and you may find that there is a lot of decision making, which may take away from your time and the excitement of starting your business. Things that may come to mind would include, partner life insurance, liability insurance, general partner or limited partner, buy out, distribution of income or loss etc. If you keep it simple, you can get an Employer ID number in the same manner as described under Sole Proprietorship above. The same applies to the sales tax. Accounting can be simple and done with a separate checking account as described under sole proprietorship above. For tax purposes, your tax preparer or accountant will prepare a separate Partnership Tax Return, and distribute taxable income or loss to each of the partners using a schedule K-1 which each partner will use to show income or loss on his/her personal tax return form 1040.

S Corporation: Some people feel they can limit their liability by forming a corporation.  Basically, an S Corporation is similar to a Sole Proprietor or Partnership, in that profit and or losses are passed on to the owners, who are now called stockholders. There are some benefits to the corporate form of organization. Some people feel it sounds more like a real business if the word Corp. or Inc. is shown after the name. As to limited liability, it means that obligations of the corporation are not likely to be obligations of the individual owners. For example, if the corporation signs a lease, the owners would not be liable in case of early termination.  Keep in mind that landlords are aware of this, and often ask for a personal guarantee for a small business lease. The same applies for bank loans.  However, most vendors will sell to corporations without asking for personal guarantees.  While it is possible to use the internet to set up an S Corporation, generally it is best to use a lawyer, to make sure you do it properly. The IRS requires more detailed accounting for a corporation, so it would be best to have an accountant advise you at the very start.
C Corporation:  A C Corporation is a separate entity.  The owners are merely stockholders in the corporation. The corporation files its own tax return and pays taxes based on its income. Distribution to the owners is via salary or dividends. If you feel a C Corporation is best for your purposes, it would be wise to discuss the matter with your accountant and attorney.  Limited liability is similar to S Corporation described above.

LLC: The abbreviation stands for Limited Liability Company. Basically this is giving a Sole Proprietorship or Partnership the same limited liability benefits of an S Corporation.  Income would be distributed in the same manner. While it is possible to set up an LLC using the internet, it probably would be best to use a lawyer. As mentioned under S Corporation, landlords and banks will usually ask for personal guarantees.

Some general comments: There is, or should be excitement about starting a business. You should love it and be anxious to do business. Spending a lot of time in organization and set up will delay doing what you want to do and should do, get customers, provide service etc. Generally it makes good sense to do a business plan to determine if the business will work. Then get started and do business.   This article provides general information about forms of business organization. It is not intended to be step by step instructions of business formation and organization

This article was prepared by Edward Coblens, a CPA who is a member of the Small Business Advisory Committee, a voluntary organization of the Huntington NY Chamber of Commerce. Business advice is available free to everyone. Call 631 423-6100 for an appointment, or e-mail smallbusinessadvicefree@yahoo.com.

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