Choosing the right business formation

As many Illinois business owners know, deciding on the legal structure under which a company is formed is an important first step. The structure determines the liability the owners have and the way taxes are paid. Many other operational plans are affected by the choice of legal structure as well.

The simplest type of business is a sole proprietorship. This means there is one owner who is personally responsible for any liabilities the business may incur, which can be a disadvantage. However, it has a simple income tax footprint. It is not recognized as a separate taxable entity by the Internal Revenue Service, and its earnings and losses are passed through to the owner and are reported as income on a regular Form 1040 using Schedule C.

A partnership involves multiple owners and the profits and losses are passed through to the partners. General partnerships are ones where the partners operate and own the business while limited partnerships are ones where some partners are only investors and others are general partners. All partners in a general partnership are personally liable for the entity's obligations, while limited partners do not have that type of risk.

The choice of a corporation is often made during the business formation phase of a start-up company. The distinguishing aspects of both S corporations and C corporations are that both protect owners against liability and the ability the corporations have to raise capital by selling shares. A C corporation is taxed as a separate entity, and its shareholders are taxed on any distributions that they may receive. Conversely, an S corporation does not pay separate tax, and its losses and profits are passed through to the owners.

Choosing the right business format with an eye to the future might benefit from the insight an attorney provides. The circumstances of the owners and the possible need for future capital often dictate the ultimate choice.

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