Many small businesses operate as sole proprietorships or general partnerships.  A sole proprietorship arises when an individual begins operating a business under a company name. A general partnership is created when two individuals start up a business venture together. Traditionally, neither form of business requires the filing of official, state forms. Moreover, general partnerships sometimes are operated on handshake agreements with no legal formalities in place.

Although sole proprietorships and general partnerships are easily started, they also have significant drawbacks.  Both business forms expose business owners to personal liability for company debts.  They can also lead to confusion and escalated legal fees when disputes arise between owners.  They can also miss opportunities for tax deductions that are available to duly formed business entities.

By forming a corporation or a Limited Liability Company (LLC) a business owner’s personal wealth can be shielded from business liability.  The owner’s home, savings, vehicles, and other individual assets generally cannot be used to satisfy company debts if the business is maintained and operated as a separate, legal entity. Corporations also call for written documents, such as by-laws, to establish guidelines for owner conduct and business operations.  Likewise, an LLC should have an operating agreement to set a clear framework for the business owners.  This avoids the pitfalls that less formal partnerships often encounter.

Forming and keeping a corporation or LLC in good standing are straightforward tasks. Most official, state websites make corporate and LLC required forms freely available to the general public.  It is also advisable to consult an attorney when forming a corporation or LLC.  Legal counsel can address the ongoing requirements for keeping a company legally valid and tailor written agreements to keep understandings clear along owners.

Knowing the differences between a corporation and LLC can help a business owner make an informed choice when deciding which to use.  A key difference between corporations and LLCs involve the actors that run them.  A corporate board of directors is in charge of major, directional decisions for a corporation.  A corporation can also raise capital by selling shares and may distribute profits though stock dividends.  LLCs are operated by its members rather than a board.   LLC members own the company unlike corporations which are owned by their shareholders.  LLCs also cannot issue stock to raise capital for business operations.

Tax ramifications also should be closely considered when selecting an LLC or corporation.  LLCs are considered “pass through” companies for taxation purposes meaning they are not double taxed against the business and its individual members.

Corporations are divided into two common categories; C corporations and S corporations.  Like an LLC,

S corporations avoid the double taxation that larger C corporations are subjected to.  Smaller C corporations already in existence can make S corporation elections by filing the required forms with the Internal Revenue Service.  Corporations can also be classified as C or S at the time they are created.

Businesses owners should also check individual state requirements to determine if additional filings must be made with state taxing authorities for S corporation recognition.  Relying on a tax expert to keep current with changing tax regulations and to ensure proper filings is advised.