One of the first decisions that you will have to make as a business owner is how your business should be structured. There is no one legal entity that best fits all small businesses. Whether you decide to start as a sole proprietor, partnership, limited liability entity, or nonprofit depends on several factors such as ease of entity management, liability, and taxation. THIS IS NOT A SUBSTITUTE FOR PROFESSIONAL ADVICE
Sole Proprietorship = One Owner
- A sole proprietorship is an extension of you and as such you have unlimited liability in your business and are legally responsible for all debts against the business. Profits from the business flow directly to the owner's personal tax return without taxation at the business level.
- Most small businesses start out as sole proprietorships because this is the simplest type of business structure. To start a sole proprietor, you will need a San Francisco Business Registration Certification from the Tax Collector's Office.
General Partnership = At least 2 Owners
- In a general partnership, two or more people share ownership of a single business. Just like a sole proprietorship, the law does not distinguish between the business and its owner. Each partner is responsible for the debts and obligations of the business. Generally, a formal written partnership agreement is essential to define roles, expectations, future contributions, and involvement in the business, as well as what would happen in case of liquidation. Without an agreement, default partnership laws will apply. California Corporations Code Section 16100 et seq.
- A general partnership has flow-through taxation meaning no taxes are paid at the business level. Instead, the individual partner is taxed on his/her share of the partnership income.
- To start, you will need a San Francisco Business Registration Certification from the Tax Collector's Office.
Limited Partnership (LP) and Partnership with Limited Liability (LLP)
- "Limited" means that most of the partners have limited liability in terms of their investments as well as limited involvement regarding the day-to-day management decisions. This form of ownership is not often used for operating retail or service businesses. In general, LLP's are set up to accommodate investors.
- In California, you must file a Certificate of Limited Partnership with the California Secretary of State (see Step 4 below). The initial fee is $70 with a minimum $800 minimum franchise tax due at the time your LP is filed (based on 2008 figures)
- LLP's are only available for architecture, accounting and legal services in California (Cal. Corp. Code Section 16101(8))
- By law, a corporation is a separate and unique entity from those who own it. While partnership and sole proprietorships are an extension of you, a corporation can be separately taxed, sued, and enter into contractual agreements. The owners are called shareholders, and the shareholders elect a board of directors to oversee the major policies and decisions and appoint officers who carry out the daily operations of the business.
- A properly formed corporation assumes a separate legal and tax life distinct from its shareholders. Profits are subject to two levels of tax - corporation taxed as separate entity and shareholders taxed on dividends paid by corporation.
- The process of incorporation requires more time and money than other forms of organizations. Corporations are monitored by federal, state and local agencies, and as such may have more paperwork to comply with regulations. Formalities include separate bank accounts, scribing meeting minutes, holding regular meetings, and filing requirements.
- $100 fee to California Secretary of State for filing Articles of Incorporation; first year's tax to CA Franchise Tax Board.
- Filing tips from the California Secretary of State
- This entity takes the advantages of the limited liability aspect of a corporation and the pass-through tax treatment of a partnership.
- There is no federal income tax. S-corporation pays the state taxes which are currently 1.5% in 2008.
- Limited to 100 shareholders and limited to 1 class of stock. Shareholders cannot be nonresident aliens (for federal income tax purposes)
- File Articles of Incorporation with Secretary of State. Additional filing requirements with the Internal Revenue Service - IRS Form 2553 and California Franchise Tax Board.
Limited Liability Company (LLC)
- Just like an S-Corp, the LLC provides limited liability features as a corporation and the tax pass-through operations of a partnership. The difference is that the LLC is a relatively new type of business structure. In terms of formation, the LLC is easier to form than a corporation, but more complex to form than a general partnership.
- Owners are called members.
- An LLC is typically taxed as a partnership if it has two or more members for federal income tax purposes. The LLC will not pay federal income tax and must file tax returns as like each individual member.
- In California, LLC cannot engage in banking, insurance, or trust company business.
- $70 filing fee Articles of Organization with the Secretary of State; $800 annual tax due to CA Franchise Tax Board; first year tax of $800 payable within first 3 months of organization; plus subject to an annual fee to CA Franchise Tax board based on LLC's gross income.
- LLC's must maintain separate bank accounts, but no board minutes are required.
Business Entity Comparison Chart (PDF)
Search the SBA Course Listings for Basic Law Workshops to help you decide which business entity tochoose
Example Forms for incorporation and partnerships
Step 2. Develop the Business Plan
Small Business Assistance Center, City Hall, Room 110, 1 Dr. Carlton B. Goodlett Place, San Francisco, CA 94102
Phone: 415-554-6134 Office Hours: M-F, 8 AM - 5 PM