For every small business it is prudent to have a legal structure. Some businesses assume legal structures by default. If you are operating a business alone or jointly with two or more partners and have not formed a separate legal entity, the business is considered a sole proprietorship or partnership. There are no legal formalities involved in forming a sole proprietorship or partnership. A major risk with these legal forms is that your personal liability is unlimited. Any claims or liabilities arising out of your business can affect your personal assets.
You can limit your personal liability from business operations by forming a Limited Liability Company or a Corporation. Members and shareholders have limited personal liability which means that your personal obligation to business debts is limited to a certain amount. To form an LLC or Corporation you have to comply with state laws and regulations. States require the organizer or incorporator to file articles of organization or incorporation and pay a filing fee to register the LLC or Corporation. You are required to draft the LLC operating agreement or Corporation bylaws as an additional condition. By laws or LLC operating agreements examples are freely available on the internet and some states do provide samples on their official web site.
IRS and state taxation formalities for LLC and Corporation are a tad more complex than sole proprietorship or partnership. IRS requires information returns and individual tax returns from these business entities. Corporation tax returns depend on its structure. A C Corp is required to file an individual tax return on its profits and pay taxes directly. This direct taxation of C Corp has a double taxation effect as the shareholders are required to report dividends form a C Corp as personal income and pay tax on it. S Corporation advantage is that the shareholders can report the profits prorated in their personal tax returns and avoid the double taxation.