Legal Forms of Businesses - Their benefits and requirements - which is best for your small business?

We continue to see a growth in start-up small businesses throughout the area but especially in smaller communities.  A common concern is forming a legal entity.  Therefore, I will devote two columns to the topic of finding the best solution.  I will pass on some of the work recently completed by one of SCORE’s content partners,  Nellie  Akalp.  She is a passionate entrepreneur, business expert, professional speaker, author, mother of four and CEO of her business  CorpNet.

From agriculture-based organizations to engineering enterprises to handicrafts, rural entrepreneurs start businesses of all types and sizes. But no matter the size or location of the business, the business’s legal structure plays a considerable role in the owner’s legal accountability for the products and actions of the company. To ensure rural small business owners have all the facts regarding business structure, here is a quick guide to what entities are available for your rural business and how each can protect you from future legal nightmares.  This week I will start with Sole Proprietorships, Partnerships, General Partnership (G.P.), and Limited Partnership (L.P.).

Sole Proprietorships

By far the least complex business structure to form—a sole proprietorship is considered a nonentity in the United States. Therefore, it does not need to register formally in its home state.

While sole proprietors are self-employed, it’s wise to run your business under a company name and keep separate bank accounts for personal and business activities; This is especially crucial for small rural enterprises, such as crafts or small farming. Without proper separation, the Internal Revenue Service may consider your activities a hobby instead of an official business. And engaging in a hobby excludes the owner from declaring any business expenses and credits available to business owners.

Suppose a sole proprietor doesn’t register a company name with the state. In that case, the business owner’s first and last name is, by default, the business’s name. Rural entrepreneurs who prefer to run their companies under a different name must file for a “fictitious name” or a “trade name” with the Secretary of State of their states. By filing a DBA or “Doing Business As,” the owner has established a separate professional business identity.

However, a separate business name does not translate into a legal separation between the sole proprietor and the business. In a sole proprietorship, profits and losses are passed through to the owner and filed with the owner’s taxes on a Schedule C (IRS Form 1040) “Profit or Loss from Business.” Although the sole proprietor is not an employee of the business, they are still responsible for paying self-employment taxes such as Social Security and Medicare. Typically, sole proprietors file taxes and business documents with their social security numbers; however, once the sole proprietor hires an employee (or several employees), the owner must obtain a Federal Tax ID number or Employer Identification Number (EIN) from the IRS. (Most banks require you to have an EIN to open a business bank account, so it’s a good idea to get one as soon as possible.)

In a sole proprietorship, the owner is personally liable for the legal and financial debts of the business. So, if the owner fails to pay their bills or gets sued by a customer or vendor, their personal assets (home, car, checking and savings accounts, etc.) are on the line to settle the debts.

Partnerships

Like sole proprietorships, businesses with more than one owner who does not file for another legal entity in their home state are considered partnerships. In a partnership, each partner owns an equal portion of the assets and liabilities by default (and the partners are personally liable for the legal and financial debts of the company). However, the partnership division of assets and liabilities does not have to be equal if the partnership agreement outlines the specifics.

Partnerships may have some state guidelines to follow, depending on the state and how the partnership is structured:

General Partnership (G.P.).

A general partnership is straightforward and doesn’t require you to register with the state. In a G.P., all partners have equal power to make company decisions about financing and contracts. Also, each partner retains equal liability and is held responsible for the company’s debts and legalities. G.P. owners are also not considered company employees and must pay employment taxes on their share of the profits (owner draws).

Limited Partnership (L.P.).

Limited partnerships must register with the state and follow state guidelines, which may require reserving an L.P. business name, allocating partner duties, and periodic reporting obligations. L.P.s typically have one designated general partner and one or more limited partners. Limited partners may invest money and share in company profits and liabilities but not participate in the company’s daily operations.

In my next column, I will end this topic with the C Corporation, Limited Liability Company (LLC), and The Cooperative.

About the Author(s)

Dean Swanson

Dean is a Certified SCORE Mentor and former SCORE Chapter Chair, District Director, and Regional Vice President for the North West Region, and has developed and managed many businesses. The Rochester Post Bulletin publishes his weekly article on a topic geared toward the small business community. The articles here are printed in their entirety.

Certified SCORE Mentor for the Southeast Minnesota Chapter
LLC operation agreement