I see this question a lot, "I'm thinking of starting a business, but I'm not sure what type of business organization it should be." There is no right or wrong answer to this question, each type of business has it's pros and cons. To start let's look at the three main kinds of businesses:
Sole proprietorships are often the easiest to start. They are small businesses with a single owner. For tax purposes they are considered flow-through entities. This means that the company's earnings flow onto your personal tax return. They are not subject to double-taxation (more on this when we talk about corporations below). However sole proprietorships offer no legal protection for their owner. As an owner you are personally responsible for all debts of the company, and if someone sues the company you can be held liable. This is because the owner and company are considered one legal entity (you still have to keep separate financial records for the company).
Partnerships are very similar to sole proprietorships. They are flow-through entities that offer no legal protection for their owners. A partnership however has more than one owner. They are also easy to start, but I do want to offer a small piece of advice if you are starting a partnership. In most cases you do not need a written partnership agreement, but getting one drawn up is often worth the time and money. Most partners have some sort of personal relationship prior to starting the business. Either they're friends, family, or have some sort of outside working relationship. While you may think you are in agreement with the other partner(s) on how you would like the company to function you may find out later your ideas conflict. A good partnership agreement should have at a minimum the ownership percentages, expected financial and time contributions of each partner both at the formation and throughout the life of the business, agreed upon compensation levels for each partner, and the agreed upon processes for dissolving the partnership, bringing in a new partner, or a partner choosing to sell their portion of the company. Ideally this should be drawn up by a lawyer. I have seen good friends end their friendships over hard feelings during the dissolution of a partnership.
Corporations typically come to mind when you think of large publically traded companies. But not all corporations have to be big or publically traded. There are plenty of privately held small corporations. Corporations are considered separate legal entities from their owners. Because of this they provide legal protection for their owners. Owners are not held personally liable for the actions of the company, unless an owner has personally guaranteed a debt or something along that nature. Upper level management can be held legally liable for misrepresented financial information. Corporations are subject to double-taxation. The corporation as an entity pays taxes on their earnings. Then any earnings distributed to the owners of the company are taxed on their personal tax returns. Therefore the earnings are said to be double-taxed, once through the corporation and then again for any earnings distributed to the owners.
Now that we've discussed the three main types of businesses let's talk about a few other types. There are a number of other kinds of companies that provide different levels of legal protection and tax benefits. A few of the most popular include:
Limited Liability Companies
Limited liability companies (LLCs) offer a higher level of owner protection that sole proprietorships and partnerships. They can also be taxed as flow-through entities or corporations in some cases. This makes them a very popular business type.
Limited Liability Partnerships
Limited liability partnerships (LLPs) are similar to LLCs, but are often reserved for companies that offer professional services (doctors, lawyers, etc). They also may have some limitations on who may own them (some may not be owned by a corporation). Their tax benefits are similar to LLCs. Their liability protection may be similar to LLCs or may require an owner to take responsibility for their own actions, but not that of their partners.
A S Corporation is a type of corporation that can have flexible tax benefits while maintaining the legal protection of a C Corporation (what we typically think of as a corporation). Oftentimes there are limits on the number and types of owners for a S Corporation.
This overview is very brief and I strongly suggest seeking legal advice when forming a company to determine the best legal structure for your needs. A lawyer can also help you navigate filing all of the appropriate paperwork for starting a company which varies from area to area. Companies need to be registered with the IRS, state governments, and often local governments. There may also be restrictions and licenses that a company must maintain in order to operate in specific areas or industries. While many small business owners want to reduce their start up costs this is often one area that will save you a headache down the road when done properly.