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Distinguishing Sole Proprietorships, Partnerships, Corporations And Limited Liability Companies

By: Jim Busch

Within the State of Georgia, business is usually conducted by four principal entities. These four entities are sole proprietorships, partnerships, corporations and limited liability companies. When conducting business within the State of Georgia, it is important to understand the type of entity or entities with whom you are doing business. By understanding the general components of these entities, you will understand their various strengths and weaknesses and protect your business.

A sole proprietorship is a business conducted by an individual or under a business name that has not been legally incorporated. Typically, the owner uses his or her personal bank account(s) to conduct business. Thus, in a sole proprietorship, personal and business finances are one in the same. Although the owner may hire employees and the owner draws compensation from the business by making payment to himself, the business, if not legally incorporated, affords the owner no individual liability protection.

The owner’s net profit or loss is included each year in his or her personal tax return. From a business standpoint, the major legal drawback of a sole proprietorship is that the owner is personally liable to his or her creditors and customers.

A partnership is generally an association of several individuals formed to conduct business. This association is formally outlined in a written partnership agreement. This partnership agreement outlines the various roles and responsibilities of the respective partners as well as the rules governing day to day operations and distribution of profits.

Partnership partners generally have unlimited personal liability to creditors and customers. However, in a limited partnership, all partners but the general or managing partner have no liability to creditors and customers. In a limited partnership, the general or managing partner is personally liable for the debts and liabilities of the Limited Partnership. It is important to also note that unlike a general partnership, a limited partnership must be registered with the Georgia Secretary of State.

Partners generally draw cash compensation without paying withholding taxes. As business is conducted, any remaining cash after paying costs and partners draws may be distributed to the partners according to ownership interest in the partnership. Partners pay income tax on the results of the partnership’s taxable transactions at the individual partners income tax rates.

Partnership agreements, although formally written, are private unless a limited partnership and thus not of public record. This aspect provides the partners greater privacy and significant flexibility.

The best known business entity in the State of Georgia is the corporation. Corporations take two forms: “C” Corporations and “Subchapter S” Corporations.

A “C” Corporation is a legal entity which is created by state laws and is considered separate from its owners. By being a separate legal entity, the owners are not personally liable to creditors or customers. The owners receive cash in the form of salary as well as other benefits. Applicable taxes such as federal, state and FICA taxes must be withheld from salaries paid to owners. Generally, “C” Corporations are large, often publicly held corporations.

“C” Corporations pay income taxes to the extent that sales exceed operation costs. Often “C” Corporations distribute after-tax profits to its owners as dividends which are included in the owners tax return. Thus, “C” Corporations profits are taxed twice; once at the corporate rate and again at the owner’s individual rate assuming dividends have been paid.

The most common “small” corporation is a Subchapter S Corporation. Under Subchapter S corporations, the owners benefit from the limited liability associated with “C” Corporations, but also enjoy the benefit of a single tax. Subchapter S Corporations, however, are severely restricted by the number and type of shareholders. The tax imposed on Subchapter S corporation owners is the individual tax rate of the owner. Subchapter S corporation owners also pay taxes on dividends at their individual tax rate.

The final, newest and least known business entity in Georgia is the Limited Liability Corporation (L.L.C.). A Limited Liability Corporation is a new legal entity that incorporates the same tax treatment of a partnership and the limited liability protection of a corporation. Thus, as with a partnership, the income and expenses are allocated to each Limited Liability Corporation owner. The owners pay income tax on the limited liability corporation taxes consequences in their personal return. Owners of L.L.C’s may actively participate in the business and draws a salary like a partnership, however, there are not the restrictions in number and type as in a Subchapter S Corporation.

As a result, L.L.C.’s provide owners with the liability protection of a corporation while allowing them the flexibility and favorable tax treatment of a partnership.

When choosing a business formation or when conducting business in Georgia, it is important to understand the above characteristics. By understanding the respective characteristics, owners may chose the correct balance of liability exposure and tax consequences. In addition, when doing business in Georgia, understanding the respective liability consequences of your customers can allow you to better protect your business.

Mr. Busch is an attorney specializing in commercial and construction litigation for Busch, Reed, Jones & Leeper, P.C. in Marietta, Georgia

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