Sole Proprietorship

• Definition: A sole proprietorship is a business entity owned by a single individual, referred to as the sole proprietor.

  • The sole proprietor has the authority to make all management decisions of the business.
  • All profits generated by the business belong to the sole proprietor.

• Liabilities:

  • The sole proprietor assumes full personal liability for all obligations and debts of the business.
  • This includes obligations arising from contracts made solely in the business name.
  • If business assets are inadequate to settle debts, the sole proprietor's personal assets (e.g., bank account, home) may be utilized to satisfy creditors.
  • The high risk inherent in a sole proprietorship can lead to significant personal losses in case of business insolvency.

• Reasons for Choosing Sole Proprietorship:

  1. Ease of Formation: The sole proprietorship is simple and inexpensive to establish as it requires no formalities or legal assistance.
  2. Default Business Form: Many individuals beginning a business do not choose a formal structure, and thus automatically create a sole proprietorship.

• Characteristics:

  • It has no legal existence apart from its owner; therefore, its continuity is directly linked to the sole proprietor's existence.
  • While the business can be sold, it cannot be transferred as a legal entity; the new owner must establish a new business entity.
  • As a business entity, a sole proprietorship cannot sue or be sued; claims must be directed at the sole proprietor personally.
  • Employee Relationships: A sole proprietor may hire employees; however, employees are technically employees of the proprietor, who is accountable for their actions under agency law.

• Tax Implications:

  • A sole proprietorship itself is not subject to corporate income tax. The income is reported on the owner’s personal tax return, allowing unlimited deduction of business losses.
  • This feature is beneficial for wealthier taxpayers involved in risky business ventures, as it allows losses to offset personal income taxes.

• Trade Names: Sole proprietorships often operate under registered trade names, which require filing under state laws. E.g., Caryl Stanley operates Caryl's Bagel Shop, and liabilities are attributed to her directly.

Partnership

• Definition: A partnership is a business structure involving two or more owners (partners) who conduct a business for profit.

• Management and Profits:

  • Partners collectively make management decisions, and profits/losses are typically shared equally unless stated otherwise in an agreement.

• Liability:

  • Like sole proprietorships, partners are personally liable for the partnership's obligations.
  • Debts incurred are collective responsibilities, and creditors may pursue individual partners’ assets if business assets are insufficient.
  • Partners must also bear responsibility for torts committed by one another or by employees during the course of business.

• Taxation:

  • Partnerships do not pay federal income tax; income is passed to partners and reported on their individual tax returns, with deductions for losses permitted without limit.

• Life of the Partnership:

  • Partnerships may continue to exist despite a partner's departure or death.
  • A partner's ownership interest is not freely transferable without consent from the other partners.

• Creation of Partnerships: Similar to sole proprietorships, partnerships can be formed informally and automatically arise when individuals conduct business collectively without a formal structure.

Limited Liability Partnership (LLP)

• Definition: An LLP is a partnership where partners have limited liability for the negligence or malpractice of other partners.

• Background: Originated to mitigate personal liability risks faced by professionals like accountants and lawyers.

• Formation:

  • Requires the partners to file with the state’s secretary of state and elect LLP status.

• Liability Protection: LLP partners are not held liable for partnership debts unless they committed a wrongful act themselves.

• Taxation: LLPs can choose how they are taxed—like partnerships or corporations, modifying how income and profits are reported for taxation.

Limited Partnership

• Definition: This consists of one or more general partners who manage the business and have unlimited liability, and one or more limited partners who have limited liability.

• Roles:

  • General partners manage operations and bear full liability for debts, often being corporate entities themselves.
  • Limited partners invest capital and have no managerial rights; their liability is limited to their capital contributions.

• Taxation:

  • Limited partnerships may elect partnership or corporate taxation.
  • General partners can deduct business losses without limits, while limited partners can deduct losses only to the extent of their investment.

• Continuity: The partnership can continue existing despite changes in partners, provided at least one general partner remains.

• Creation: Limited partnerships necessitate compliance with state statutes; they cannot be formed by default.

• Reasons to Choose:

  • Protects individuals from unlimited liability and allows for significant capital attraction, making it suitable for businesses requiring large investments.

Corporation

• Definition: A corporation is owned by shareholders who elect a board of directors for management.

• Management Structure:

  • Ownership and management are separate; shareholders do not manage, and directors/officers need not be shareholders.

• Liability:

  • Shareholders, directors, and officers enjoy limited liability for corporate obligations, with personal separation from corporate debts.

• Taxation:

  • Corporations are tax-paying entities; they pay taxes on profits, and shareholders only report income when profits are distributed or shares are sold, resulting in potential double taxation.

• Life of the Corporation:

  • Corporations have perpetual existence, unaffected by the loss of shareholders or directors; interests may be transferred freely unless restricted by agreements.

• Reasons for Incorporation:

  • Protection from unlimited personal liability, ease of capital raising through shareholding, particularly in high-risk industries.
  • Electing S corporation status allows pass-through taxation while imposing a limit on the number of shareholders.

Professional Corporation

• Definition: A type of corporation for professionals such as lawyers, doctors, and accountants.

• Structure: Similar to a standard corporation, can be managed by a board of directors unless state law dictates otherwise.

• Liability:

  • Shareholders have limited liability for corporate obligations, but retain full liability for their own professional malpractice.

• Shareholder Requirements: Typically, only licensed professionals in the same field can be shareholders. Professional corporations may elect how to be taxed.

• Trends: Many professionals are choosing LLPs over professional corporations for their liability protection and management flexibility.

Limited Liability Company (LLC)

• Definition: A business structure that merges the liability protections of corporations with the tax benefits of partnerships.

• Ownership: Owned by members, who can manage the LLC or appoint managers.

• Liability: Members have limited liability for business debts, similar to that of shareholders in corporations.

• Flexibility: Members can choose to have the LLC taxed as a corporation or as a partnership for favorable tax treatment.

• Transferability: There is limited ability to transfer membership interests, needing either member consent or an LLC agreement adjustment to allow the transferee to become a member.

• Lifecycle: The LLC does not dissolve due to member departure, death, or bankruptcy, ensuring continuity.

Benefit Corporations

• Definition: A recent business form focused on achieving a public benefit along with profit, differing from traditional profit-driven corporations.

• Public Benefit Definition: Operating with a material positive impact on society and the environment is considered a key goal.

• Adoption: Over half of the states have established statutes for benefit corporations to operate under these principles.

• Rationale: This structure allows businesses to look beyond shareholder profit, balancing community and environmental deadlines with business decisions.

• Certifications: Third-party certifications are available to validate a benefit corporation's commitment to public good, though not required by law.

  • Notable certifying organizations include B Lab, which grants certifications based on evaluation across multiple impact factors.

• Examples: Major companies recognized as benefit corporations include Allbirds, Kickstarter, and Patagonia, showcasing effectiveness in corporate social responsibility.