Sole Proprietorship
Sole Proprietorship is a type of business entity where there is no legal distinction between the owner and the business. A sole proprietorship can be informal–without filing with the state–or formally registered as a fictitious name with the Pennsylvania Department of State (you may also need to apply for paperwork, licenses, or permits appropriate for your specific type of business).
In a Sole Proprietorship, the business owner will typically be personally responsible for any liabilities or obligations that arise from the business. Business owners’ personal assets may be a fair game for parties trying to recover a judgment from a lawsuit against the business.
For tax purposes, the business owner needs to report the net profit or loss from the business on their personal federal and state tax returns.
In order to register a fictitious name, a sole proprietor should first search the name on Pennsylvania’s company name search tool.
Pennsylvania’s business entity search allows for others to complete a fictitious business name search to see what business name may come up for a certain company.
Partnership
General Partnership means two or more people engage as co-owners in a business without filling any paperwork with the state to form a for-profit business (you may need to apply paperwork for licenses or permits appropriate for your business). All partners can be held personally responsible for any liabilities or obligations that arises from the business.
Typically a partners should have an agreement between them that lists each partner’s contributions, how profits or losses will be distributed, who can commit the partnership to legal obligations, and how the partnership will be dissolved. Without an agreement, the partners will be presumed to be 50/50 and profits and losses will be distributed equally. We talk about the importance of having your agreements be in writing in a prior blog post about avoiding shareholder disputes.
For tax purposes, in a general partnership, the business does not pay taxes. The individual partner includes their share of profit or loss on their personal tax return (This is called Pass-Through Taxations).
Limited Partnership can have two types of partners 1) a general partner who is involved in day-to-day operation and management of the business and (2) a limited partner (also known as a silent partner) who is usually not involved in the day-to-day operation and management of the business.
The general partner is personally responsible for liabilities or obligations arising out of the partnership. Limited partners’ liability is limited to the amount of money they have invested in the company and will usually not be held personally responsible for the actions of the partnership.
For Tax Purposes, a limited partnership is treated the same as a General Partnership with Pass-Through taxation.
Limited Liability Partnership (LLP) means that a general partnership or limited partnership (or a newly formed partnership) files a statement of registration with the state. You can read more information about LLP registration in Pennsylvania here. In LLP all partners enjoy limited liability meaning that the individual partners are not personally responsible for liabilities or obligations of the partnership.
For Tax Purposes, a limited liability partnership is treated the same as a General Partnership with Pass-Through taxation.
Limited Liability Company (LLC)
LLC is a creature of statute, and all 50 states have a statute that gives authority to create LLCs. To form an LLC, you need to file a formation document in Pennsylvania with the secretary of the state. Owners of an LLC are called members. Ideally, the members will have an operating agreement that documents their duties to the LLC and to each other, their roles in the business, and to hopefully avoid any disputes between members. We recently did a video on what happens if there is no agreement in place, the LLC’s agreement defaults to the Pennsylvania Business Corporation Law (“BCL”). In an LLC, members are not personally responsible for any liabilities or obligations that arise from the business. However, there are exceptions in cases of fraud and when an LLC is improperly operated… more on that later.
LLC is more flexible in terms of management style and taxation. Regarding management style, you can set up the LLC either as member-managed (where all or some members manage the day-to-day operation of the business similar to a partnership) or as manager managed (where members delegate day-to-day operation to either officers or the board of directors similar to a corporation).
For tax purposes, depending on various components (that a tax consultant can advise you about or if you don’t have tax consultant you can get more information from the IRS about LLCs, your LLC could either be a Pass-Through entity (S Corp) like a partnership or double tax entity like a corporation (C Corp).
Corporation (C Corp)
The owners of a corporation are called shareholders. Corporations are created by state statute. To form a business you need to incorporate the business in any state of your preference. More than 50% of Corporations are registered in Delaware as it is a business-friendly jurisdiction.
However, Delaware is not the right place for your business then it might be better for your business to be incorporated in the state where the business is being operated. If you incorporate your business in Delaware but operate in a different state (such as Pennsylvania), then you be required to file for a certificate of authority in the state where you operate the business which can mean additional expenses and tax reporting.
Shareholder are usually not held personally responsible for any liabilities or obligations that arise from the corporation (except in situations where the corporate veil is pierced, see here for more information on piercing the corporate veil)
There are numerous formal steps to take in order to incorporate like filing a charter with the state, forming a board, issuing stock certificates, creating bylaws, entering into a shareholders’ agreement, and many more. Contact Kaminsky Law if you need help forming your business.
For tax purposes, there is “double taxation” which means the corporation pays taxes on its profits, then the shareholders pay taxes on the distributions they receive from the Corporation. For this reason, many people elect to have their Corporation be treated as an S-Corp.
What’s next?
This blog was just a snippet of the types of entities you could use to form your business. There can be a lot of moving parts while forming any new entity, including various contracts, and other factors to protect yourself from business disputes.
It would also be helpful to keep in mind that as of June 27, 2023, the U.S. Supreme Court made a significant ruling stating that companies can be sued in states where they are registered to do business, regardless of how much business the company actually does there.
At Kaminsky Law, we can help you form a business and provide you with all the contractual agreements that you might need to operate. Moreover, if you are involved in a business dispute then we can also help as business disputes is one of our main practice areas.
