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Frequently Asked Questions by our clients in Indiana

Q: I have heard about limited liability companies, corporations, partnerships, and sole proprietorships, but I do not understand exactly what these terms mean and what the differences are between them?

A: There are four main types of business structures: (1) sole proprietorships, (2) partnerships, (3) corporations, and (4) limited liability companies, and of these main types there are any number of various sub-types.

The differences between the business structures are primarily rooted in the areas of protection against personal liability and taxation.  

Protection Against Personal Liability.
Sole proprietorships never provide protection to their owners against personal liability for business debts and partnerships frequently do not.  Whereas, corporations and limited liability companies both provide protection against personal liability. 

How important is protection against personal liability?  Protection from personal liability is extremely important because this is what prevents creditors of your business from being able to go after you personally for the debts of your business.  In other words, if your business is a limited liability company and owes a debt, then the creditor of your business can attempt to collect upon that debt by suing your limited liability company, but that creditor cannot sue you.  However, if your business is a sole proprietorship, then the Courts will draw no distinction between you and your business so that a lawsuit against your business is also a lawsuit against you, which means that your personal assets are in jeopardy.

Taxation.
Sole proprietorships, partnerships, corporations formed under Subchapter S, and some types of limited liability companies are treated as “pass-through entities.”  As opposed to C Corporations, which are not accorded this (generally) favorable tax status.  The income of a “pass-through entity” is not taxed at the entity level.  For example, a partnership will never pay income tax.  Instead this income passes through to the individual business owners, who will then pay tax on that income.   

Compare this with the C Corporation, which suffers from what is frequently referred to as “double taxation.”  This simply means that the business itself must pay tax on the income it produces, and then when that income is distributed in the form of dividends, the shareholders must pay tax again on that same income.  However, this does not mean that the C Corporation is always inappropriate for a small business, and, in fact, in certain instances it is possible that despite the “double tax,” the total tax obligation may be lower with a C Corporation, due to the differences in tax rates.

The critical point of this discussion is that there are significant and oftentimes complex differences between the various types (and sub-types) of business entities, which means that sophisticated counseling in this area is a necessity for small business owners.  Your attorney and your accountant should be able to work together to advise you regarding this foundational issue.  

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