Choosing aBusiness Structure

By Cynthia A. Callaway, P.E., Member ASHRAE, Dua ne Wolf, Associate Member ASH RAE
and Dan !(ramer, P.E., Fellow AS HRAE

ne of the first decisions to make when starting a business is the type of structure to use. The four main types are

0 sole proprietorship, partnership, corporation and limited liability corporation. Each has advantages and dis-
advantages. Sole Proprietorships. A sole proprietorship is the simplest structure because the owner and busi-
ness are the same. It is easy to form (typically requiring only a certificate of doing business and/or business license),
and is not subj ect to many regulatory and/or reporting
requirements. In a sole proprietorshi p the owner has total
numagement control. Also, the business is not a separate entity,
so it does not pay taxes. Income and losses from the business
flow directly through to the owner and are reported on the
individual's tax return. In the early years of a business, when
losses are common, this can afford a significant tax benefit to an
owner who has substantial income from outside the business.
The downside is that the owner is personally liable for the
debts of the business. Another problem is that capital for the
business is limited to the owner's business and personal
resources. Fm1her, since only the owner can act on the business's
behalf, the business tenninates upon death. And fmally, although
sole proptietorships arc allowed to have employees, the owner
carmot be one of them. Consequently, owners arc not entitled to
pati icipate in company-funded employee benefit plans.
Partnerships. A pat1nership is an association of two or more
people who operate the business as co-owners, sharing man-
agement control. While no written pmincrship agreement is
required, it is highly reconm1endecl.
Pat1nerships have many of the same characteristics as sole
proprietorships. For example, they may be formed without
fi ling legal papers. Partnerships are not subject to federa l
income tax, although they must file informational tax returns.
Partnership income and losses flow directly through to the
pati ners who report them on their individual tax retums.
The primary disadvantage of doing business in partnership
form is that partners are personally liable for the debts of the
pati nership. Since partners share management control, f.1r mor~ .
potential for exposure exists in a partnership than in a sole
proprietorship. Another disadvantage of a partnership is that
it terminates upon the death or withdrawal of a partner (except
as otherwise provided by law or in a partnership agreement).
Corporations. Unlike sole proprietorships and pati nerships,
a corporation is a formal legal entity sepa rate and distinct
from its owner(s), who are called shareholders. The day-to-clay
affairs of a corporat ion are managed by officers, who are
answerable to a board of directors, which is elected by the
shareholders. In small corporations, shareholders often serve
as officers and directors.
The main advantage of doing business in corporate form is
that a shareholder is not personally liable for the business
debts of the corporation, which means that his exposure is
limited to what he paid for his stock. Another advantage of
doi ng business in corporate form is continuity of existence.
If a shareholder dies, the corporation still functions.
A big disadvantage to doing business in corporate form is
double taxation. Since a corporation is a separate legal entity,
it pays income tax on its profits. When the COilJoration distrib-
utes its net profits in the form of dividends, the dividends
constitute income to the shareholders. This means that corpo-
rate profits are taxed twice. There are other disadvantages as
well. For example, to fonn a corporation one must comply with
state law, which typically requires the fi ling of a document
called a certificate of incorpora tion, and payment of a fee.
Corporations are subj ect to many regulatory and reporting
requirements. Some states do not allow professionals to
practice in corporate form.
Limited Liability Companies. A limited liability company
(LLC) is a "hybrid" enti ty that combines the best characteris-
tics of partnerships and corporations. The owners of LLCs,
who are called members, can be individuals or entities. Mem-
bers can manage the company themselves, or they can elect or
appoint a manager. Typicall y, members of an LLC enter into an
operati ng agreement, much like a partnership agreement.
The main advantage of doing business in LLC form is that,
like corporate shareholders, LLC members have no personal
liability for the debts of the company. Another ad vantage is
that LLCs are permillcd to exist indefinitely in many states.
Li ke partnerships, LLCs arc not subject to federal income tax,
although they are requi red to file informational returns, and
profits and losses flow directly through to members.e

The ASHRA E Hlsk Group on General Legal Education rec-

omlnends that you consult an allomey and an accountant The info rmation contained in this article represents the
regarding th e type of business organization that will best opinion of the autlwr(s). It is not intended to, and does not,
meet your needs. JJ~ encourage readers to send in ideas f or constitute legal advice, nor does it represent the opinion of
topics for f uture colum11S to legal-issues@ashrae.org. ASHRA E or any of its bodies.

42 Apri l 2 0'0 2 IA S HRA E J o ur n a l