The startup entrepreneur faces many choices and challenges, not the least of which is the decision of what type of business entity to choose. The limited liability company (LLC) and subchapter S corporation (S corp) are two popular forms for small businesses. Each offers different advantages and drawbacks in comparison with the sole proprietorship, which serves as the default business entity for a business owned and managed by one person if no other business form is chosen.
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The Limited Liability Company
The LLC has gained popularity as a relatively simple vehicle for achieving limited liability and flexible tax treatment without the onerous paperwork requirements associated with starting and operating a corporation. As an LLC is a separate legal entity from its owners, who are called members. The torts committed by employees or co-members will not endanger the innocent member's personal assets provided that all requirements have been met and the formalities observed. LLCs are easy to create, with many states offering online forms for the essential documents required for LLC creation. Drawbacks include limited transferability and difficulty in raising capital through the issuance and sale of stock.
Subchapter S Corporation
The S corp is also a popular vehicle for start-up businesses. Like the LLC, it protects the personal assets of its owners, who are called shareholders, in the event of wrongdoing by other shareholders and employees. Also like the LLC, it offers the opportunity for shareholders to avoid double taxation by receiving pass-through tax treatment, where the corporate profits are passed through to the individual shareholders' returns. An S corp isn't a particular type of entity itself, but rather a corporation that has elected tax treatment under Subchapter S of the Internal Revenue code. As a corporation, it requires the appointment of a board of directors and the holding of annual shareholder meetings.
The Sole Proprietorship
If a startup entrepreneur chooses no particular business form, he will operate his business as a sole proprietorship. This is the simplest of all forms and generally requires nothing more than a certificate of assumed name in the event the owner decides to name the company. Sole proprietorships require no articles of organization or corporate charters, no bylaws, no shareholder meetings and no annual filing requirements beyond the owner's own personal tax returns. Sole proprietors receive the same pass-through taxation as LLCs and S corps and can deduct company expenses from their personal returns. Sole proprietorships offer nothing, however, in terms of limited liability. If an employee commits a tort, the owner can be sued personally.
Making a Decision
Deciding on a type of business entity is best accomplished after consultation with an attorney and certified public accountant. A sole proprietorship may be the best choice for the sole-member startup that will have no employees, as members and shareholders are always personally liable for their own torts, limited liability offers no advantage if there is no one else to sue. An LLC makes more sense for a business that may hire employees in the future. An S corporation may provide the best option to a venture that may one day be sold.