Sole Proprietorship: a business owned and managed by one person (or, for tax purposes, a husband and wife). For IRS purposes, a sole proprietor and her business are one tax entity.

This means that business profits are reported and taxed on the owner's personal tax return. Once a fictitious name statement (assuming you don't use your own name) has been filed and any required basic tax permits and business licenses obtained, a sole proprietor will be in business. As opposed to the creation of other business entities, a sole proprietorship does not require legal formation documents to be filed with any governmental agency. Under the law, a sole proprietor is personally and directly responsible for all business debts.

This type of business structure is best when:

• Your business is owned and managed by one person - you!
• You want a structure that is simple and inexpensive to create and operate.
• You want to report profit or loss directly on your own taxes.
• You don't want to deal with governmental filings and rules.
• All you want to have to file is your DBA and your personal tax return.
• You are not concerned with raising outside capital or with personal liability for the obligations of your business.

General Partnership: a business owned by two or more people (called partners or general partners). To form a partnership, each partner normally contributes money, valuable property or labor in exchange for a partnership share, which reflects the amount contributed.

Although not legally required, many partners prepare a written partnership agreement to define items such as ownership percentages, how profits and losses will be divided, and what happens if a partner dies or becomes disabled. General partners usually have equal management rights, unless they agree otherwise. 

Like a sole proprietorship, general partnerships are easy to form since no registration is required with any governmental agency to create a partnership (although tax registration, business permits and licenses, filing fictitious name statements and other basic business requirements may still apply).

This is not true if the general partnership owns real estate, in which case certain filings are required. Under the law, general partners are held personally responsible for all business debts. General partnerships themselves do not pay federal or state income taxes; rather, profits are passed through to partners who report and pay income taxes on their personal returns. 

You should consider forming a general partnership when:

• Your business is owned and managed by more than one person.
• All you want to file is your Partnership Agreement in your desk drawer and with local agencies if there is any real estate held by the partnership.
• You want a structure that is simple and inexpensive to create and operate.
• You and your partners want to report profit/loss on your own taxes.
• You and your partners are not concerned with raising outside capital.
• You and your partners are not concerned about personal liability for the obligations of your business.

Considering forming a limited partnership when:

• You and your partners (if any) are raising private money (selling securities) but don't want management involvement from outside investors.
• You want to provide your investors protection from personal liability but don't want the hassle of forming a corporation.
• All you want to have to file is a Limited Partnership Certificate and/or Agreement with appropriate regulatory agencies.
• You and your partners are not concerned about your own personal liability for the obligations of your business.
• You and your partners want to report profit/loss on your own taxes.

Limited Liability Company (LLC): a very popular hybrid type of business entity that is a cross between a sole proprietorship and/or partnership and a corporation. Like a sole proprietorship or partnership, LLC owners (called members) are taxed on business profits each year on their individual tax returns.

Like a corporation, the members are protected from personal liability from debts and claims: only the assets of the LLC are at risk, not the assets of the LLC owner. Forming an LLC requires the creation and filing of Articles of Organization with the Secretary of State (many states have a fill-in-the-blank form which takes only a few minutes to prepare). 

As part of this paperwork, the management structure of the LLC must be defined: whether it is member-managed or manager-managed (in which case one or more owners are designated to take responsibility for running the LLC while the rest sit back and share in profits). Many LLCs also create an operating agreement that defines the rights and responsibilities of LLC owners and managers.

LLCs are operated informally without regular meetings and in most states can also be owned and operated by one person. Security laws can kick in if ownership interests being sold to initial LLC investors meet the definition of a security. LLC owners can elect to be taxed by the IRS like a corporation. Some states charge an LLC a separate LLC entity level tax.

An LLC is ideal for you if:

• All members (even just one except in two states) want protection from personal liability.
• All you want to have to file is a fill-in-the-blank LLC Articles of Organization form with your Secretary of State.
• You don't want to hassle with costly lawyers required to form limited partnerships and corporations.
• You want a simple management structure in which all members manage.
• All you want to prepare is your LLC Operating Agreement.
• Members want the option of reporting profit or loss on their own tax returns OR elect to be taxed like a corporation (after you start making money).

If you are issuing memberships to passive investors who will not be participating in the management of the LLC, you will have to qualify for one of several exemptions available from state and federal securities law.

Limited Liability Partnership (LLP): a type of partnership recognized in a majority of states that protects a partner from personal liability for negligent acts committed by other partners or by employees not under his or her direct control. Many states restrict this type of partnership to professionals, such as lawyers, accountants, architects and healthcare providers.

Consider this type of business entity when:

• You don't want any liability for negligent acts committed by other partners or by employees not under your direct control. 
• You are a professional service provider (lawyer, accountant, architect or healthcare provider).
• You don't mind strict compliance with IRS guidelines (as a partnership).

This kind of entity is a recent hybrid and is not yet available in all states. In states where it does exist, some restrictions apply.

Under state law, formal rules apply to the operation of a corporation. Every corporation must issue stock certificates, maintain a stock ledger, record minutes of all board meetings, hold annual meetings for stockholders, appoint certain kinds of officers (such as a treasurer, secretary, etc.), and have bylaws, a corporate seal, and an organizational board of directors who pass resolutions.

State corporate laws set up a built-in division of rights and responsibilities between owners (shareholders) and managers (directors) of a corporation. Owners must meet legal requirements for stock registration and paperwork. Corporations are created when Articles of Incorporation are filed with appropriate state agencies. For more information on this topic, see How-To Understand Corporations.

Consider forming a corporation when:

• You have a business in which the ability to issue stock or stock options is important.
• Your business has become so profitable that you can save significant income tax dollars by keeping profits retained in the corporation.
• Your business is large enough to benefit from centralized management. (Because you want to attract outside investors, it has now become necessary to set up a management team that is independent at least in part from ownership.)
• You own a family business and want to start planning for the next generation of ownership or want to begin making gifts of ownership to your family.
• Others insist that you incorporate. (Because you are an independent contractor or because your spouse does not want to be liable for any business debts you may occur.
• You offer a professional service in which your personal liability may be great (i.e., you are a doctor or engineer).