June 23, 2014
By Lindsay A. Getman, Summer Associate
When forming a new business and deciding on the entity type for your business, there are a number of factors to consider. This two-part series will provide information on the benefits and hurdles of the four main types of business entities that New York State business owners might choose. Two of the most important factors are the tax implications of your choice and the level of legal protection your choice would offer you personally. It is also important to consider the administrative costs, both in forming and maintaining the business. Finally, you should take into account your ultimate goals regarding the size and nature of your business. For example, will you seek outside investors? There is no one-size-fits-all entity type for new businesses, but there are advantages to choosing a simpler or more complicated entity structure, depending on the vision you have for the growth of your business.
The sole proprietorship is the simplest type of business entity, where the individual owner owns all the assets of the business. The formation and maintenance costs for this type of business are very low. The profits from the business are reported and taxed through the owner’s personal tax return, and there are no corporate taxes. The business entity dissolves automatically upon the retirement or death of the owner. No paperwork is required unless the business is operating under a name other than the proprietor’s (also called a “doing business as” name or DBA). In that case, the owner would need to file an Assumed Name Certificate with the clerk of the county or counties in which the business is conducted, which generally costs around $50. Instructions for completing the form can be found on the New York Department of State webpage.
One big disadvantage to a sole proprietorship is that the owner is personally liable for all debts of the business. This means that creditors could potentially go after your personal bank account or even your house to settle your debts. Registering a DBA will not shield the owner from liability. In addition, it can be difficult to secure investors with this type of entity, and the owner may be limited to personal funds or consumer loans.
It is important to note, however, that a sole proprietorship may be converted into another type of business entity as the business grows and the owner’s needs change.
In a partnership, two or more people jointly own a business, and agree to the potential associated profits or losses. Like a sole proprietorship, the business itself is not taxed as a separate entity; rather, each partner pays income tax on his share of the business income through his personal income tax return. Federal law also requires the filing of an annual partnership income tax return. Although each partner has full authority to do business for the partnership, each partner is also responsible for the business decisions of others, and is jointly and severally liable for the business’s debts and obligations. Unfortunately this arrangement still allows creditors to reach an individual’s personal assets to absolve the partnership’s debts.
The formation of a partnership requires no formal paperwork. However, even though it is not required, those forming a partnership should consider a legal partnership agreement that sets out each partner’s investment and role in the business, as well as what will happen in the event of a liquidation of the business. Once the partners have reached an agreement, they have the option to file an Assumed Name Certificate with the clerk of the county or counties in which the business is conducted.
There are different types of partnerships such as a limited partnership, an arrangement where there are “general” and “limited” partners. In broad terms, the general partner is at risk for all partnership liabilities and a limited partner is not. There are also registered professional limited liability partnerships for the practice of certain professions.
A partnership terminates on the bankruptcy, withdrawal or death of any of the partners, or at a specific time set out by the partnership agreement.
My next post will provide an overview of limited liability companies and corporations.
About the Author: Lindsay A. Getman, Mackenzie Hughes LLP Summer Associate, is a student at Boston College Law School where she is involved with the Juvenile Rights Advocacy Project and the Environmental Law Society. She is a graduate of Fayetteville-Manlius High School and attended Hamilton College, where she graduated with a B.A., cum laude, in English.