Lesson 2.2 Business Legal Types

We will now look at some of the most common business types and the advantages and drawbacks of each type.

When you need to decide on a Business Type?

In our first course, you decided on a business area, researched your business name, created a basic business plan and built a basic business website. You can do all of these things before actually starting your business. However, before you actually start a real business you need to take a few important steps in order to keep your local, state and national governments happy.

One of the first steps is decided on what legal type of business you will have. Some of the most common options include sole proprietorship, partnership, limited liability corporation (LLC) or non-profit. With a non-profit, you can either have a tax deductible non-profit also called a 501c3 or a more political but not tax deductible non-profit also called a 501c4. Finally, in Washington State, there is a new type of corporation called a Social Purpose Corporation or SPC which is run like an LLC but which can be organized for purposes other than making a profit – making it somewhat like a non-profit organization but with fewer rules.

Before we explain the legal steps for starting a business, let’s take a look at the advantages and drawbacks of each of these 7 types of businesses – as the exact steps will vary a little bit based on which type you choose.

Sole Proprietorship
This is the most common form of business mainly because you do not need to draw up Articles of Incorporation or register your business with the State Secretary of State. You merely get a free federal Employer Identification Number (EIN) and a state business license (from the State Department of Licensing) and register with the State Department of Revenue if you will have more than $12,000 in sales per year. You also register with your City and get a city business license. You should also get a business only bank account to place all income and expenses in. You are then legally all set to start selling products. You pay state taxes on your sales and profits and federal taxes on your profits along with your personal income tax filing. You can deduct losses and expenses against other income.

However, the drawback of a Sole Proprietorship is that you are personally responsible for any debts incurred by the business including any lawsuit judgments against the business. There is typically almost no cost for setting up a sole proprietorship.

Partnership
This is similar to the Sole Proprietorship except that it is two people who go into business together according to the terms of a written signed agreement between the partners often with one partner supplying most of the funds and the other partner doing most of the work and committing their own time. There is no need to create or file articles of incorporation. But you may need the help of an accountant to sort out the tax liability. A drawback is that both partners are liable for the debts of the partnership.

Limited Liability Corporation (LLC)
The Limited Liability Corporation (LLC) is the most popular legal structure for small businesses wishing to incorporate. The benefit of forming a Limited Liability Corporation is that if the business is sued, it is merely the business that can lose all of its assets rather than the business owner(s) losing all of their assets. Setting up an LLC is a relatively simple process that can usually be done in an hour or less. You need to have three people and write up Articles of Incorporation based on filling in a template. Then get your federal EIN. Then files your Articles of Incorporation with your State Secretary of State. Then file with your State Department of Revenue and get your local business license. Then get your business bank account. Then you are ready. The State will charge you for filing an LLC. This cost typically ranges from $100 to $200.

Social Purpose Corporation (SPC)
This is the newest type of business and currently applies mainly to Washington state – see RCW 23B.03.010. A social purpose organization must be organized in a manner intended to promote positive short-term or long-term effects of, or minimize adverse short-term or long-term effects of, the corporation's activities upon any or all of (1) the corporation's employees, suppliers, or customers; (2) the local, state, national, or world community; or (3) the environment. In plain English, what this means is that an SPC can act like and have the benefits of an LLC without needing to make short term profit its highest priority.

Yet at the same time, unlike a 501c3 or 501c4, a SPC can make a profit as long as making a profit is not its primary purpose. The set up process for an SPC is nearly the same as for an LLC. The State will charge you for filing an SPC. This cost typically ranges from $100 to $200.

Full Corporation
This is the kind of corporation most people are familiar with. It requires having stock holders and holding meetings with strict reporting requirements and strict Articles of Incorporation. You will likely need a lawyer and an accountant to set up this kind of business. Most people start with a simpler business type and then become a full corporation only much later after they are making so much money they do not know what to do with it all. The State will charge you for filing a full corporation. This cost typically ranges from $100 to $200. But the real cost is paying for accountants and attorneys to make sure all of the rules are followed. This cost could be in the thousands of dollars.

501c3 or 501c4 Non-profit
Non-profits are easier to form than a full corporation but harder to form than an LLC or SPC. You not only need your articles of incorporation, you need to supply the IRS with several other documents in order to get their approval. Once approved, the Non-profit is exempt from federal taxation. If the non-profit is a 501c3, they can issue donors with certificates such that donations to the non-profit may also be deducted from federal taxes. The only limitation of a 501c3 is that it may not participate directly in political campaigns. The State will charge you for filing non-profit Articles of Incorporation. This cost typically ranges from $100 to $200. There is also a cost for the IRS review of your Non-profit application. This cost can be several hundred dollars.

Steps to complete after registering your business

After you set up your business bank account, you will need to set up your business accounting system in order to accurately keep track of your business income and expenses for state and federal tax purposes. This is the subject of our next lesson.

Washington Business organization FACTORS Comparison Table