A sole proprietorship does not require formal paperwork to form. The sole proprietor is the sole manager of the business. The sole proprietor is personally responsible for business debt and taxes.
General partnerships can be formed by a verbal or written agreement. This means no formal paperwork is required by the state to form a general partnership. Like a sole proprietorship, there is no legal separation of the partners from their general partnership (they are one and the same). It can be formed by two or more parties that are working towards a common business interest and sharing in the profits and losses of the business. The partners manage the business and their liability exposure is unlimited. The partners are jointly and severally liable for partnership debt. Therefore, a debt collector can sue all partners for the partnership debt or elect to sue a specific partner or partners. Only the partners are taxed, not the general partnership itself.
Limited partnerships are formed through a written agreement. The limited partnership must comply with the state statutory law governing limited partnerships. Limited partners do not participate in the management or control of the limited partnership. Their liability is limited to their capital contribution. The general partners manage the limited partnership and they are personally liable for the business’ debts. For tax purposes, the partners are usually taxed, unless the limited partnership opts to be taxed as a corporation.
A corporation is formed by an agreement and it must comply with the state statute that governs corporations. A board of directors manages the corporation and owner liability is limited to capital contribution. The corporation is double taxed.
An S corporation is formed by an agreement and it must comply with the state statutory law governing corporations. A board of directors manages the S corporation and ownership liability is limited to capital contribution. The owners of the business must formally declare S corp status with the IRS. The S corporation is unique in that the shareholders can elect to have the business taxed like a partnership. The S corporation shareholders are taxed, not the business entity.
A limited liability company is formed by an agreement and it must comply with state statutory law governing limited liability companies. Members generally manage the limited liability company, but they may opt to have a manager run the company instead. Owner liability is limited to capital contribution and members are taxed, unless the business has opted to be taxed as a corporation.
A sole proprietorship is advantageous because it easy to form and the sole proprietor does not have to share control of the business with others. A disadvantage of a sole proprietorship is that the sole proprietor is solely responsible for business debt. Also, the sole proprietorship terminates upon the death of the sole proprietor.
A general partnership is advantageous in that is easily formed (does not require formal paperwork to be filed with the state). The managers also share equal control over the business, unless otherwise agreed to. A general partnership is that it is treated like a disregarded entity for tax purposes, and so income "flows through" to the partners who pay ordinary income tax on the business income. A major disadvantage of a general partnership is that general partners are jointly and severally liable for partnership business debt. Another problem with the general partnership form is that it can be created even if the parties do not consider themselves to be partners. For example, a court can declare that a general partnership exists when the parties have a common interest in a business and they share in the profits and losses in that business.
A limited partnership is advantageous because it offers liability protection for limited partners. Limited partners are not personally liable for the debts of the business; whereas, general partners are personally liable for the debts of the limited partnership. A limited partner is liable only to extent of their investment in the business. A disadvantage of the limited partnership is that limited partners are excluded from controlling the business. Only general partners are allowed to manage the business. In certain circumstances, a limited partner can lose their limited liability status. It is therefore important that limited partners avoid domination over business operations.
The corporate form of business is advantageous because shareholder liability is limited to their capital investment. The corporate form of business also allows for a perpetual existence. A corporation can also continue to exist long after its founders have died. A major disadvantage of the corporate form is that it is subject to double taxation. In addition to state filing requirements, corporations are also subject to extensive government regulation.
The S corporation business form is advantageous in that ownership liability is limited to capital contribution. The shareholders can elect to have the business taxed like a partnership. S corporations are at a disadvantage in they can have no more than 75 shareholders. S corporations are also governed by complicated tax law.
The limited liability company business form is advantageous in that it allows members to choose how they wish to manage the business. All the members can manage the business or they can designate a member or members to manage the business. Also, members are not personally liable for the debts of the business. There are some disadvantages associated with limited liability companies. For one, they are subject to strict state regulations (can only be created by complying with state filing requirements). Furthermore, since they are a separate legal entity from their members, members must take care to interact with LLCs at arm’s length, because the risk of piercing the veil exists with LLCs as much as it does with corporations.
This vocabulary list includes terms that might help you with the review items above and some terms you should be familiar with to be successful in completing the final exam for the course.
Try to think of the reason why each term is included.