One of the first decisions to make in starting a new business is to determine its legal structure. The legal structure of a business determines tax responsibilities, the extent of liability, the formality of operation, as well as ownership and management arrangements. Each form has advantages and disadvantages that should be weighed carefully.
A sole proprietorship is the most common and least complex business structure. Under this form, the owner essentially is the business. The owner controls all business and management decisions and manages cash flows. Profits or losses are reported on the owner's individual tax return, which tend to have lower rates. The chief downside with this business structure is the extent of personal liability. The owner is personally responsible for all debts, taxes, or claims incurred by the business. If the business is unable to meet these obligations the owner's personal assets, including their home, may be at risk. Another disadvantage of sole proprietorships is that ownership is nontransferable.
A partnership is a business with two or more owners. Each person contributes to the business and shares in the profits or losses according to a partnership agreement. While a written agreement is not required, it is highly recommended. The agreement should spell out the terms of the business arrangement including how decisions will be made, who will contribute what resources, how profits and losses will be shared, how to resolve disputes, and terms for the transfer of ownership stakes. In drawing up a partnership agreement consultation with a legal professional is recommended. There are two types of partnerships -- general and limited.
General Partnerships are similar to sole proprietorships in that the law does not distinguish between the business and its owners. Each owner is personally responsible for the obligations of the business as well as the actions of the partners. Limited Partnerships consist of both general and limited partners. Under this structure, the general partner retains unlimited personal liability in exchange for full control of business and management decisions. In exchange for relinquishing a role in the management of the business, the liability of the limited partner is restricted to the amount of their investment. A Limited Liability Partnership (LLP) is a special type of general partnership available to certain businesses that provide professional services such as accountants and attorneys. General partners in an LLP are not subject to personal liability for the malpractice of other partners or for the debts and obligations of the business.
Establishing a limited partnership or limited liability partnership is more complex. In addition to the requirements met by general partnerships these entities must also register with the N.C. Secretary of State's Corporations Division.
A Corporation is a distinct legal entity separate from its owners. As such, the personal liability of its owners, called shareholders, is limited; rather the business itself becomes responsible for all legal and financial obligations. The corporation may also acquire assets, incur debt, enter into contracts, and issue shares of stock as evidence of ownership. Management of a corporation is delegated by its shareholders to an elected board of directors. The board of directors is responsible for setting and managing the overall strategic direction of the business and approving major decisions and transactions. In turn the board of directors elects corporate officers to oversee the day-to-day operations of the business. In small organizations a single person may serve as the sole shareholder, director, and officer. The Articles of Incorporation and By-Laws spell out the rules for how the corporation will conduct its activities. In drawing up the paperwork to form a corporation consultation with a legal professional is recommended.
While corporations offer many advantages they also require compliance with a number of legal requirements including regular shareholder and board of directors meetings, maintaining recorded minutes of these meetings, filing annual corporate income tax returns, and registering with the N.C. Secretary of State. There are two types of corporations -- C corporations and subchapter S corporations.
C corporations, also called regular corporations, must pay corporate income tax on its earnings as well as the dividends it pays to its shareholders. In addition the owners must pay personal income tax on any compensation paid to them as employees of the corporation. The corporate income tax rate on retained earnings is typically less than that of personal income tax rates thus presenting a potential tax advantage. Furthermore, C corporations are eligible for a wide range of retirement and benefit plans unavailable to other business types. A Subchapter S corporation, or S-corporation, is a special option available to smaller corporations, those with less than one hundred shareholders, exempting the business from corporate income tax. Instead, the gains or losses are passed through to the shareholders who report them on their personal tax returns. S corporations must still file an informational tax return.
Establishing a corporation can be an expensive proposition and requires careful planning. For more information about forming a corporation in North Carolina refer to the N.C. Secretary of State's Corporations Division guide, Incorporating Your Business in North Carolina. Once established the corporation must register its business name and obtain theappropriate business licenses.
Limited Liability Company
A Limited Liability Company (LLC) is a business owned by one or more of its members. LLCs combine limited liability characteristics of corporations with the tax advantages and management flexibility of sole proprietorships and partnerships. Like a corporation an LLC is considered a distinct legal entity and as such limits the personal liability of its owners. Like a sole proprietorship or partnership the gains or losses are automatically passed through its members to be reported on individual tax returns.
The management arrangements of LLC's can be tailored to the needs of the business and are specified in its Articles of Organization and operating agreement. The Articles of Organization is the legal document filed with the N.C. Secretary of State establishing the LLC while an operating agreement is a internal statement of each member's financial and management right and duties. LLC's may resemble the shared-decision making of a partnership through an arrangement referred to as member management or the delegated decision-making of a corporation through an arrangement referred to as manager management. Under a member management structure all members participate equally in decision-making. Under a manager management structure certain members are designated to make business decisions. As with all types of business structure consultation with a legal professional is recommended.
Establishing an LLC can be an expensive proposition and requires careful planning. For more information about forming an LLC in North Carolina refer to the N.C. Secretary of State's Corporations Division guide, Organizing Your Limited Liability Company in North Carolina. Once established the LLC must register its business name and obtain the appropriate appropriate business licenses.
How to Register Your Business
Regardless of the business structure you choose you must register the name of your business with the Register of Deeds office in the county or counties where you will do business. Different business structures require different forms.
North Carolina Department of the Secretary of State
Business names for limited partnerships, LLCs, LLPs and corporations are registered with the North Carolina Secretary of State’s office in the Corporations Division.