Choosing how to organize your business is one of the most important preliminary decisions you can make. Your choice can affect your legal standing, how you are taxed and how you can grow your business in the future. There are two classes of businesses: incorporated and unincorporated. Incorporated businesses are corporations, while unincorporated businesses are sole proprietorships and partnerships. Businesses are regulated at the state level, so there may be some small differences regarding the rights and obligations of each type of business from state to state. However, there are general traits that incorporated and unincorporated businesses share, regardless of where they are located.
Incorporated businesses are independent legal entities, while unincorporated businesses are simply extensions of their owners. One of the chief implications of this legal distinction is that owners of unincorporated businesses are generally personally liable for the business’s liabilities, while owners of an incorporated business are generally not liable for the business’s debts. This means that if an unincorporated business runs out of funds, its owners will have to pay any remaining outstanding debts. On the other hand, if an incorporated business runs out of money, its owners are generally not legally required to pay any of its outstanding debts.
Another implication of the relationship between the owner and a business regards how long the business can last. Since unincorporated businesses are essentially extensions of their owners, these organizations have a finite life; each unincorporated business can only last as long as the owners live. On the other hand, an incorporated business is independent and not tied to the life of any person. As a result, an incorporated business, theoretically, could last forever.
Transferability of Interest
Since unincorporated businesses are extensions of the owners, it is difficult to transfer interest in the business to a third party. While an unincorporated owner may be able to share business assets, he is generally unable to sell his interest in the business because the business is legally an extension of himself. On the other hand, since an incorporated business is legally independent, an owner’s interest in the business can easily be transferred without affecting the business itself.
Since unincorporated businesses are not independent, the owners must report their share of the business’s income and losses on their personal returns. On the other hand, incorporated businesses must pay taxes on any income it earns. Then, if it distributes any income to its owners, the owners must pay tax on any cash they receive. As a result, unincorporated business owners are taxed once while an incorporated business owner is taxed twice.
References & Resources
- Entrepreneur: Sole Proprietorship
- Suffolk University Law School: Selecting a Business Entity for a Small Business: Non-Tax Considerations
- Entrepreneur: Corporation
- Internal Revenue Service: Sole Proprietorships
- Internal Revenue Service: Partnerships
- Internal Revenue Service: Publication 542 - Corporations