sole proprietors apply for a business loan, they fill out a form that shows their assets and liabilities. In addition, they're usually required to provide a basic profit and loss statement. Depending on the size of the loan, they may even have to submit a formal business plan stating their goals, objectives, and implementation plans.
Joining Forces: Partnerships
The IRS automatically considers any business started by more than one person a partnership. Each person in the partnership is equally liable for the activities of the business, but because more than one person is involved, a partnership is a slightly more complicated company type than a sole proprietorship. Partners have to sort out the following legal issues:
How they divide profits
How they can sell the business
What happens if one partner becomes sick or dies
How they dissolve the partnership if one of the partners wants out
Because of the number of options, a partnership is the most flexible business structure for a business that involves more than one person. But to avoid future problems that can destroy an otherwise successful business, partners should decide on all these issues before opening their business's doors.
Partnering up on taxes
Partnerships aren't taxable entities, but partners do have to file a “U.S. Return of Partnership Income” using IRS Form 1065. This form, which shows income, deductions, and other tax-related business data, is for information purposes only. It lists each partner's share of taxable income, called a Schedule K-1, “Partner's Share of Income, Credits, Deductions, Etc.” Each individual partner must report that income on their personal tax return.
Meeting reporting requirements
Unless a partnership seeks outside funding, its financial reports don't have to be presented in any special way because the reports don't have to satisfy anyone but the partners. Partnerships do need reports to monitor the success or failure of business operations, but they don't have to be completed to meet GAAP standards (see Chapter 17). Usually, when more than one person is involved, the partners decide among themselves what type of financial reporting is required and who's responsible for preparing those reports.
Seeking Protection with Limited Liability Companies
A partnership or sole proprietorship can limit its liability by using an entity called a limited liability company, or LLC. First established in the U.S. in 1977 in the state of Wyoming, LLCs didn't become popular until the mid-1990s, when most states approved them.
This business form actually falls somewhere between a corporation and a partnership or sole proprietorship in terms of protection by the law. Because LLCs are state entities, any legal protections offered to the owners of an LLC are dependent on the laws of the state where it's established. In most states, LLC owners get the same legal protection from lawsuits as the federal law provides to corporations, but unlike the federal laws, these protections still need to be fully tested in state courts. If you choose to establish an LLC, be sure to discuss with your attorney state court cases related to liability protections to see if there are any red flags in your state.
Reporting requirements for LLCs aren't as strict as they are for a corporation, but many partnerships do decide to have their books audited to satisfy all the partners that the financial information is being kept accurately and within internal control procedures determined by the partners.
Taking stock of taxes
LLCs let sole proprietorships and partnerships have their cake and eat it, too: They get the same legal protection from liability as a corporation but don't have to pay corporate taxes or file all the forms required of a corporation. In fact, the IRS treats LLCs as partnerships or sole proprietorships unless they ask to be taxed as corporations by using Form 8832, “Entity Classification Election.”
Reviewing reporting requirements
The issues of business formation and business reporting are essentially the same for a partnership and a sole proprietorship, whether or not the entity files as an LLC. To shield themselves from liability, many large legal and accounting firms file as LLCs rather than take the more formal route of incorporating. When LLCs seek outside funding, either by selling shares of ownership or by seeking loans, the IRS requires their financial reporting to be more formal. Some partnerships form as LLPs, or limited liability partnerships. In an LLP, one partner is not responsible for the other partner's actions. In some countries, an LLP must have at least one general partner with unlimited liability.
Shielding Your Assets: S and C Corporations
Company owners seeking the greatest level of protection may choose to incorporate their businesses. The courts have clearly determined that corporations are separate legal entities, and their owners are protected from claims filed against the corporation's activities. An owner (shareholder) in a corporation can't get sued or face collections because of actions the corporation takes.
The veil of protection makes a powerful case in favor of incorporating. However, the obligations that come with incorporating are tremendous, and a corporation needs significant resources to pay for the required legal and accounting services. Many businesses don't incorporate and choose instead to stay unincorporated or to organize as an LLC to avoid these additional costs.
Boards can be made up of both corporation owners and nonowners. Any board member who isn't an owner can be paid for their service on the board.
Before incorporating, a company must also divvy up ownership in the form of stock. Most small businesses don't trade their stock on an open exchange. Instead, they sell it privately among friends and investors.
Corporations are separate tax entities, so they must file tax
