The definition of a business has changed over the years and it has become increasingly important to have a clear understanding of the different types of business. A business is basically defined as an enterprise or commercial entity engaged in business or commercial activities for profit. Businesses may be either sole proprietorships partnerships, corporations, or other organized forms of business.
A sole proprietorship, also called a partnership, is one in which only one person owns the business. Partnerships may not create any residual or passive income. A sole proprietorship normally focuses on one specific activity, such as manufacturing or selling goods. For example, if you are involved in the manufacture of furniture, you are a sole proprietor and your business will probably focus on the production of your products rather than any secondary activities.
Two other examples of sole proprietorship include corporations and partnerships. Corporations are generally classified as having 100 or more shareholders, and partnerships are businesses that have more than two partners. Examples of corporations include partnerships that produce or construct something together, including builders and suppliers. Examples of partnerships include real estate partnerships and retailers that construct furniture together.
In contrast, a corporation is a separate entity from its owners and usually has no shareholders. A corporation also has voting power and cannot spend its own money. Some businesses have both a corporation and a partnership. For example, many real estate partnerships have a corporation that buys property and then resells it to individuals or sell it to other corporations.
A C corporation is a corporation that has both a capital stock and an operating capital. Because the company is allowed to issue shares of stock and earn dividends, most small businesses are treated as C corporations for tax purposes. If the company makes more than one profit during a year, the company must report only one profit and can avoid being taxed twice. If the company makes no profits during a year, the corporation may be taxed based on the amount of profit it earned instead of on the total profits.
A partnership is a separate entity from its owners, but does not have the same tax advantages as a corporation or sole proprietorship. When you form a partnership, you and your partners agree to treat each other as separate entities for tax purposes. The partnership files its income statement with the IRS and reports the partners’ profits. In some cases, when a partner dies, his or her share of the partnership immediately becomes available to his or her family. In other cases, the distribution of assets is delayed until the death of the last partner, called a terminal partnership.
Many businesses form limited liability partnerships or LVPs. Limited liability partnerships are considered “pass-through” businesses, meaning they are self-employed and do not bear any personal liability for the actions of their partners. LVPs do not have the advantage of having no corporate or partnership tax liability.
Many business owners choose to form corporations. A corporation is not a partnership, so the business owners and partners bear no liability for the actions of their partner. Corporations are able to issue shares of stock and have limited liability. However, although corporations have many advantages over partnerships, they are subjected to double taxation, the income tax that occur if the company is a sole proprietorship, and the corporate tax that occur if the business is incorporated. In order to reduce your corporate tax liability, some small business owners opt to incorporate their businesses as partnerships.
A limited partnership is formed when two or more people combine together to form a company. The general partner is responsible for managing and marketing the partnership’s business. Partnerships are different from general partnerships in that they are not permitted to conduct business using their own funds, but rather use the funds contributed to the partnership.
Limited partnerships are similar to limited liability partnerships, which are also known as “shell” partnerships. With a shell partnership, the business name of the general partner and all of the assets owned and controlled by the general partner are transferred to the new business. There is no need to take out a new business loan to finance the partnership’s growth. With a limited partnership, the general partner’s liability for debts of the partnership is limited to the equity value of the partnership’s capital stock.
Like general partnerships, limited partnerships may be registered for tax purposes as a C corporation or an S corporation. There are similarities between limited and general partnerships, but there are also key differences. Limited partnerships are an excellent choice for most small businesses, but they should be used with caution and due diligence.