Choice of Entity

In selecting an appropriate type of business entity, Scott Law Firm recommends thorough discussion of the issues with an attorney and accountant. The primary factors to be considered are:

  • Liability
  • Income taxes
  • Funding


The liability consideration is the extent to which an owner may be personally liable for the debts and other obligations of the business. If a business owner has personal liability, his or her personal assets – even those which are not invested in or part of the business – may be reached by creditors of the business.

On the other hand, if a business owner has limited liability, his or her liability is limited to the money and property he or she has invested in the business, and his or her personal assets are not at risk.

Sole proprietors are personally liable for all debts of the business.

In general, partners in a general partnership also are personally liable for all debts and obligations of the partnership. However, the exceptions are:

  • A limited partner in a limited partnership is generally liable only for those partnership obligations to the extent of his or her investment in the limited partnership.
  • Individual partners in a limited liability partnership are shielded from individual liability for partnership obligations that were caused by another partner’s or employee’s misconduct. However, a partner’s liability is not limited for his or her own misconduct or for misconduct that took place under his or her supervision or control.

Absent rare circumstances, a corporation stockholder’s liability and a limited liability company member’s liability is limited solely to the stockholder’s or member’s investment in the corporation or LLC.

Income taxes

The net income of a sole proprietorship is taxed on the sole proprietor’s personal income tax return at the individual tax rates. Business loss is also reported on the sole proprietor’s personal income tax return.

While a partnership must file a tax return, this is only an informational return, and the partnership itself does not pay income taxes. Rather, the partnership tax return allocates taxable income (or loss) to the partners in accordance with their ownership percentages, which they then report on their individual returns.

Standard corporations, because they are considered separate legal entities, prepare their own income taxes returns and pay income tax on their net income. Distribution of income to stockholders in the form of dividends is taxed on the stockholders’ individual tax returns. The tax rates for corporations are higher than some individual tax rates.

A corporation which elects taxation under Subchapter S of the Internal Revenue Code is treated much like a partnership for tax purposes. No tax is imposed at the corporate level, but the corporation files an informational tax return which allocates taxable income (or loss) to the stockholders based on their percentage ownership of stock. The stockholders then report the taxable income (or loss) allocated to them on their personal income tax returns.

Limited liability companies are taxed the same as partnerships.


Sole proprietorships generally find themselves limited to borrowing money, usually from a bank, to fund their business.

Partnerships can seek funding either through loans or by bringing in additional partners or limited partners who make capital contributions to join the partnership. Existing partners can also be asked to make additional capital contributions.

Corporations have several options for raising money. They can borrow money, seek additional investors to purchase common or preferred stock, and possibly issue other corporate securities such as corporate bonds.

The funding of limited liability companies is similar to that of partnerships.

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