Is an LLC a Sole Proprietorship or Partnership?
One preliminary concern that must be addressed when starting a business is what type of structure it should take. There are several business structures. Sole proprietorships, partnerships and corporations are traditional forms. Limited liability companies (LLCs) are also popular, largely because of their hybrid nature and lax management requirements. An LLC is not a sole proprietorship or a partnership, although it may have certain characteristics of those business structures and could be classified as such for federal tax purposes.
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Sole Proprietorships and Partnerships
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Sole proprietorships and partnerships are default forms of business. In general, the owners do not need to formally create the business entity by filing documents with the secretary of state's office. If one person operates a business for profit, he is a sole proprietor. Essentially, the business is no different from himself -- he remains personally liable for the debts and obligations of the company. The same is true for general partnerships, except that two or more people operate the business. Each partner has an equal say in the operation and management of the company, but each partner also remains personally liable for the debts and obligations of the company.
Hybrid Business Structure
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A limited liability company is a cross between a partnership and a corporation. The owners -- called members -- must file articles of organization with the secretary of state's office to create the business. Unlike a partnership, the members have limited liability. In general, members of an LLC are only liable for the debts and obligations of the business up to the extent of their investment in the company; the company operates like a corporation in this sense. Unlike a corporation, LLC profits are not taxed at the corporate level; instead, the profit passes through the structure and the members report the income on their respective income tax returns (like the partners in a partnership).
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IRS Classifications
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State business laws govern LLCs; the federal government does not recognize this business entity for federal income tax purposes (as of the date of publication). When an owner forms an LLC, he must classify the business as a recognizable entity for the IRS. Single-member LLCs may choose to operate as a sole proprietorship or a corporation. Multi-member LLCs can choose to file as a partnership or corporation. The decision affects the types of tax returns and tax forms the business must use to file its return.
Tax Implications
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Before forming an LLC, consider the tax implications. Multi-member LLCs may be able to classify themselves as an S-corporation, a structure that avoids both the double-taxation of regular corporations and one that may provide relief from other tax liability, such as the self-employment tax (although the members would need to pay an employment tax on declared salaries). Because of the tax liability and legal nature of this business, readers should consider speaking to a professional before proceeding.
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