There are quite a few factors to consider when you’re choosing the legal structure for your company, but the most important is liability. Tax issues come in second place for this decision, followed by the amount of formal paperwork you’re willing to do.
Here’s why liability is the number one thing to consider: If you set up your company as a sole proprietorship or partnership, you are personally 100% financially liable for any and all debts of the business. That means if your business loses a lawsuit, and there’s not enough money in the company bank account, your personal wealth – your house, your car, your emergency savings – is all at risk.
That is even trickier in a general partnership. Each partner is fully liable for 100% of the business debts. So if your partner takes off, dies, or declares personal bankruptcy, you are on the hook for everything. I’m not trying to scare you out of forming a partnership – though I generally do NOT recommend them – but it’s really crucial that you’re aware of the risk potential before choosing that legal structure for your company.
Of course, liability is not the only issue that comes into play when you’re deciding how to set up your company.
The chart below highlights the special features of each business entity, to make it easier for you to figure out which best fits your situation.
| Sole Proprietorship | General Partnership | C Corporation | S Corporation | Limited Liability Company | |
|---|---|---|---|---|---|
| In a Nutshell | Easy to set up and run, single owner has complete control, owner pays the taxes, unlimited personal financial responsibility | Two or more owners, each has unlimited personal financial responsibility, owners pay the taxes, easy to form, tricky to dissolve |
Separate legal entity, set-up fees and paperwork, pays its own taxes, owners’ personal liability limited to their investment, lots of formalities to follow | Separate legal entity, set-up fees and paperwork, taxes flow through to owners, owners’ personal liability limited to their investment, lots of formalities to follow | The combo plate: limits personal liability, owners pay the taxes, set-up paperwork and fees, minimal legal formalities |
| Set-up | Nothing to file except your DBA name | Nothing to file except your DBA name – but I strongly advise creating a formal partnership agreement | File paperwork with the company’s home state; fees vary by state but usually run $300-$1,200 | File paperwork with the company’s home state. Elect S status within 60 days. Fees vary by state but usually run $300-$1,200 | File paperwork with the company’s home state; fees vary by state but typically run $50-$400 |
| Funding Options | Debt | Debt or Equity (add partners) | Debt or Equity (issue/sell shares) | Debt or Equity (issue/sell shares). Limited to 75 shareholders. | Debt or Equity (add members) |
| Personal Liability | Unlimited | Unlimited | Shareholders not liable for business debts | Shareholders not liable for business debts | Members not liable for business debts |
| Taxes | Owner pays | Owner pays | Corporation pays income tax; owners pay tax on dividends received | Corporate income passes through to shareholders | Income passes through to owners unless elect to be treated as a C corporation |
| Tax Reporting | Schedule C in owner’s 1040 | Form 1065 for company, Schedules K-1 for each owner’s share to be reported on her 1040 | Form 1120 for company, W-2 for owner/shareholder salary, 1099-DIV for dividends received | Form 1120S for company, W-2 for owner/shareholder salary, Schedules K-1 for owner share of profits to be reported on the 1040 | Works like sole proprietorship or partnership unless elect to be treated like C corporation for taxes |
| Records & Requirements | Minimal | Minimal | Must hold formal board meetings and shareholder meetings and record the minutes; must file annual reports for the state | Must hold formal board meetings and shareholder meetings and record the minutes; must file annual reports for the state | Must file annual reports for the state |