Sole Proprietorship

• A sole proprietorship has only one owner, known as the sole proprietor.

  • It operates as an extension of its owner.

  • The sole proprietor has the right to make all management decisions and retains all profits.

  • Assumption of Liability:

  • The sole proprietor is personally liable for all business obligations, which includes debts and contracts signed in the business's name.

  • Creditors can demand payment from the sole proprietor’s personal assets if business assets are insufficient to cover debts.

  • This risk indicates that a sole proprietorship is a high-risk business form.

• Reasons for Choosing Sole Proprietorship:

  • Ease and Inexpensiveness of Formation:

  • No formalities needed; no attorneys are required.

  • Commonality:

  • Many people enter into business without considering other forms, defaulting to this structure.

• Legal Standing of Sole Proprietorship:

  • Lacks a separate legal identity:

  • Cannot sue or be sued in its own name; legal action must be taken against the sole proprietor personally.

  • Must create a new business entity if sold; cannot transfer the proprietorship itself.

• Employment in Sole Proprietorship:

  • A sole proprietor may hire employees, but they remain employees of the sole proprietor.

  • Under the law of agency, proprietors bear responsibility for employees’ contracts and torts.

• Tax Implications:

  • Not a tax-paying entity for federal income tax purposes.

  • All income is reported on the sole proprietor's individual tax return; losses can be deducted without limit.

  • Wealthy taxpayers might utilize sole proprietorships for business investments when expecting losses.

• Trade Names:

  • Many sole proprietorships operate under trade names.

  • Example: Caryl Stanley may operate a bagel shop named Caryl's Bagel Shop.

  • Registration for fictitious business names may be required, and legal actions would identify the proprietor by both their real name and trade name.

Partnership

• A partnership involves two or more owners, referred to as partners, who operate a business with the aim of making a profit.

  • Default rules govern partnership relationships, such as:

  • Joint rights in management decisions.

  • Sharing profits and losses equally unless otherwise agreed.

• Liability in Partnerships:

  • Partners assume personal liability for all business obligations.

  • Partners may have to settle debts using personal assets if the partnership’s assets are inadequate.

• Tax Treatment:

  • Like sole proprietorships, partnerships are not tax-paying entities for federal income tax purposes.

  • All income is reported on individual partners' tax returns, whether or not distributed.

  • Partnerships allow for loss deductions on individual returns without limit.

• Life of Partnership:

  • Continued existence despite changes in partnership; dissolution occurs only under specific conditions.

• Transfer of Interest:

  • A partner's ownership interest is not freely transferable without the agreement of remaining partners.

• Reasons for Forming a Partnership:

  • Requires no formalities; arises by default when two or more persons own a business together.

  • Attractive management rights and loss deductibility features.

Limited Liability Partnership (LLP)

• An LLP offers partners limited liability protection for most obligations of the partnership.

  • Originated to protect professionals like accountants and lawyers from liability related to malpractice by partners.

  • Each partner retains unlimited liability for their own wrongful acts (e.g., malpractice).

• Formation:

  • Requires filing with the state’s secretary of state.

• Taxation Options:

  • LLPs can elect to be taxed as either partnerships or corporations.

Limited Partnership

• A limited partnership consists of at least one general partner and one or more limited partners.

  • General Partners:

  • Manage the business and bear unlimited liability for its debts.

  • Often a corporation is the sole general partner, safeguarding human partners from unlimited liability.

  • Limited Partners:

  • Have no management rights and typically no liability for obligations beyond their capital contributions.

  • Retain limited liability even if they engage in management.

• Taxation:

  • Can be taxed as a partnership (reporting income on individual returns) or corporation.

  • Limited partners can deduct losses only up to the amount of their investment, differing from general partners.

• Existence and Transfer of Ownership:

  • Limited partnerships endure beyond changes in partners unless no general or limited partners remain.

  • Transferability of partnership interests requires agreement from remaining partners.

• Reasons to Organize as a Limited Partnership:

  • Corporate general partnership structure protects individuals from unlimited liability.

  • Enables tax-beneficial arrangements similar to partnerships while attracting significant capital.

Corporation

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

• Separation of Ownership and Management:

  • Ownership and management can exist separately; shareholders do not manage directly.

  • Shareholders, officers, and directors have limited liability.

• Tax Treatment:

  • Corporations are tax-paying entities that pay tax on profits,

  • Double taxation can occur when shareholders pay taxes on dividends received after corporation level taxation.

• Lifespan and Liquidation:

  • Corporations exist independently of shareholders; dissolution doesn’t occur from death or withdrawal of shareholders.

• Reasons for Choosing Corporate Structure:

  • Limited liability attracts investment in risk-prone industries.

  • Ability to raise capital due to transferable shares.

  • S corporations can report income and losses similarly to partnerships, though have restrictions on number of shareholders and share classes.

Professional Corporation

• Definition: A professional corporation allows licensed professionals (e.g., dentists, lawyers) to incorporate their practices.

• Characteristics:

  • Similar structure to a standard corporation but offers unique liability protection to professionals.

  • Professional shareholders face unlimited liability for personal malpractice while shielded from fellow shareholders' malpractice.

• Management Structure:

  • Typically managed by a board of directors, which may not suit small practices.

• Tax Treatment:

  • Professionals can choose between regular corporate taxation or S corporation treatment.

Limited Liability Company (LLC)

• Definition: An LLC merges the beneficial traits of corporations and partnerships, offering limited liability with favorable tax options.

• Ownership and Management:

  • Owned by members who can manage themselves or appoint managers.

• Liability:

  • Members enjoy limited liability, protecting personal assets from business obligations.

• Professional Use:

  • In many states, professionals can also form LLCs, but retain liability for their malpractice.

• Transferability of Ownership:

  • Limited transferability of membership interests without consent, maintaining business continuity despite changes in membership.

Benefit Corporations

• Definition: A benefit corporation focuses on broader public benefits alongside shareholder profit maximization.

• Rationale for Adoption:

  • Responds to the shift in business attitudes towards social responsibility and community impact.

• Certification:

  • Various third-party certifications available (e.g., B Corp Certification) assist businesses in demonstrating their commitment to social and environmental goals. Examples include: Allbirds, Kickstarter, Patagonia.