Business Entities

Business Entities

This article will provide an overview of the basic business structures, including non-entity and entity structures of business, and how a business lawyer can help with the decision-making process.

Non-Limited Liability Structures (Not Recommended)

Sole Proprietorship

Even though it is one of the most common types of businesses today, a sole proprietorship is only recommended in limited circumstances. A sole proprietorship is owned and managed by one individual. It is not registered with the Secretary of State, which means that it is “unincorporated.” A sole proprietorship does not have any legal distinction from the individual owner. The owner assumes all obligations of the business and debt risk at a personal level; a sole proprietor does not enjoy any personal liability protection, giving him or her “unlimited liability.” This unlimited liability aspect is why a business attorney does not recommend sole proprietorships.

A sole proprietorship allows the sole proprietor to undergo a single-tax layer obligation, meaning the owner reports and pays business income on his or her personal Federal Income Tax Return. All business income, deductions, and credits are combined with personal Form 1040 income, deductions, and credits. Keeping records of all transactions for the business that will eventually be filed on the personal income is, of course, required. Another reason business attorneys do not recommend this entity is because in the event that the sole proprietor of the business passes away, the business ceases to exist and the assets of the business must be dispersed.

General Partnership

In the State of Washington, the Secretary of State does not require the official incorporation of a general partnership. To create a general partnership, it is enough for the parties to agree to share profit and losses. It does not afford liability protections. Absent a written agreement, partners share profits and losses 50/50.

A general partnership is formed by two or more people and may be “unincorporated.” Business attorneys generally do not recommend general partnerships because similar to sole proprietorships, this structure exposes the partners to unlimited liability, making it the least desirable form of partnership. Not only will the assumption of unlimited liability create risk from the business obligations, but in a general partnership each partner is liable for the other’s debts and liabilities amassed while acting for the business —which can include criminal acts committed by a co-partner during the duration of the partnership.

The general partnership is a “pass through entity” for Federal tax purposes; the partnership files an information return and the partners file the entity’s profits and losses on their personal income tax return.

Partners may exit the partnership without causing the partnership’s termination. The the other partner(s) can decide to continue the business as a corporation or limited partnership. However, the partnership is automatically dissolved if only one partner remains. In this case, for federal tax purposes the entity will be taxed as a sole proprietorship by default.

Not just choosing an Entity, but the Proper Entity

What is a business entity? In terms of businesses, an entity is an association, a partnership or a corporation that has legal standing in terms of laws and taxes. The entity is held accountable for its actions. Business entities can enter into agreements and contracts, assume obligations, acquire and pay debts, and take legal action in their own right.

In order to create a successful business, education about the process can reduce long-term stress for entrepreneurs venturing into the business world. A business entity is chosen based on the types and number of owners, degree of ownership control, profit distribution, main purpose, types of assets, degree of liability protection, and how the business will be capitalized.

Limited Liability Company (LLC)

A Limited Liability Company is widely considered the most flexible entity option and has “select-the-box” tax treatment. Because the member(s) of an LLC can choose which tax treatment they’d prefer, their business can function as if it is a corporation, partnership, or sole proprietorship (see above). A single member LLC is treated like a sole proprietorship or disregarded entity by default and may elect C or S Corporation tax treatment.

An LLC with two or more members is treated as a partnership by default and may also elect to be taxed as a C or S Corporation. An LLC provides its members with limited liability, meaning its members are not exposed to any personal liability for debts or obligations of the entity. An LLC can be a “pass-through entity” for tax purposes, allowing the entity to pass profits and losses to its members’ personal tax returns. Additionally, the LLC can be managed by selected managers, or by its members, either similar to partners, or through electing a board of directors.

From a tax and accounting perspective an LLC can become complex. An LLC’s expenses will increase during conversion into another entity such as a C-Corporation or when creating stock options for employees. Venture capitalists and angel investors (investors who offer capital for a business start-up or entrepreneurs) are not typically attracted to this business entity.

Limited Partnership

A limited partnership is formed by two or more people. A limited partnership must have at least one general partner and at least one limited partner. The general partner acts as a manager and assumes unlimited liability. The other limited partners are passive investors and do not help manage the business. The limited partners assume a risk because if they decide to participate in the business, they might become a general partner and be subject to unlimited liability. The tax structure of the limited partnership is the same as a general partnership. All partners have income and losses passed through to their personal income taxes, however limited partners are not subject to pay self-employment taxes because they are inactive in the business.

In Washington State there are three different types of Limited partnerships that require filing with the secretary of state: Limited Partnership; Limited Liability Partnership; and Limited Liability Limited Partnership. Each is different and provides different levels of liability protection.


A Corporation, oftentimes referred to as a C-Corporation because it is taxed under subchapter C of the Internal Revenue Code, is taxed as if it is a separate person from its shareholders creating two levels of taxation. The Corporation pays tax on its income and the shareholders pay personal income tax on dividends distributed to them. Despite its double taxation, the Corporation offers advantages over “pass-through entities” because of its ability to issue different classes of stock. As a result, Corporations tend to be the entity of choice for investors. Further, the Corporation is a good choice because it can deduct a wide range of fringe benefits to its employees and shareholders as business expenses such as retirement plans, medical coverage, etc. It also allows tax-free reorganizations. The Corporations also maintain easy transferability of ownership.

Making the S-election

Named after “Subchapter S” of the Internal Revenue Code, the S-election is simply a Corporation with a specific tax designation. With an S-election in place the Corporation becomes a pass-through entity, and profits and losses pass through to its shareholders based on their stock holding. However, with the S-election in place a Corporation has limitations on its types and number of shareholders. In order to maintain its pass through status a Corporation cannot have shareholders that are corporations, partnerships, ineligible trusts, or non-US residents. Also, they can only have one class of stock. It is easy to unknowingly violate the S-election requirements, which will destroy the S-election.

Choose the Correct Entity with An Attorney’s Assistance

Choosing the correct entity in the beginning stages of any business can be helpful in the overall success of a business. Specialized knowledge in business law, tax compliance, and estate planning, especially in relation to the long-term planning times of a business, will be pertinent to making strategic financial and organizational decisions for any new business. As each entity is a valid avenue (some more favorable than others) with specific advantages and disadvantages, an attorney can advise the most strategic plan for any beginning business. Furthermore, business, tax, and estate planning lawyers are essential when starting a business in order to avoid making uninformed decisions and creating a present or future problem.

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