Sole Proprietorship
Partnership 
Limited Liability Corporation (LLC) 
Corporation
S-Corporation
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Part of keeping your home-based business legal involves choosing the legal structure for it: sole proprietorship, partnership, or corporation. Aside from being necessary for government reporting and tax purposes, this can enable your business to operate more efficiently. Since each legal form has its own unique characteristics, your goal is to choose the form that works best for you.  

A business owned by one person, who is entitled to all of its profits and responsible for all of its debts, is considered a sole proprietorship. This legal form is the simplest, providing maximum control and minimum government interference. Currently used by more than 75 percent of all businesses, it is often the suggested way for a new business that does not carry great personal liability threats. The owner simply needs to secure the necessary licenses, tax identification numbers, and certifications in his or her name, and you are now in business!

The main advantages that differentiate the sole proprietorship from the other legal forms are (1) the ease with which it can be started, (2) the owner's freedom to make decisions, and (3) the distribution of profits (owner takes all).  

Still, the sole proprietorship is not without disadvantages, the most serious of which is its unlimited liability. As a sole proprietor, you are responsible for all business debts. Should these exceed the assets of your business, your cred­itors can claim your personal assets--home, automobile, savings account, and investments. Sole proprietorships also tend to have more difficulty obtaining capital and holding on to key employees. This stems from the fact that sole proprietorships generally have fewer resources and offer less opportunity for job advancement. Thus, anyone who chooses the sole proprietorship should be prepared to be a generalist, performing a variety of functions, from accounting to advertising. 

A business owned by two or more people, who agree to share in its profits, is considered a partnership. Like the sole proprietorship, it is easy to start and the red tape involved is usually minimal. The tax structure is the same as proprietorship except in the profits and losses of the partnership are divided by an agreed percentage by the partners. 

The main advantages of the partnership form are that the business can (1) draw on the skills and abilities of each partner, (2) offer employees the opportunity to become partners, and (3) utilize the part­ners' combined financial resources. 

However, for your own protection, it is advisable to have a written partnership agreement that will spell out the specifics of the agreement. This should state (1) each partner's rights and responsibilities, (2) the amount of capital each partner is investing in the business, (3) the distribution of profits, (4) what happens if a partner joins or leaves the business, and (5) how the assets are to be divided if the business is discontinued. Things have a way of changing and people forgetting over time, so it is essential that there be a signed document that all abide by. 

Partnerships also have their share of disadvantages. The unlimited liability that applies to sole proprietorships is even worse for partnerships. As a partner, you are re­sponsible not only for your own business debts, but for those of your partners as well. Should they incur debts or legal judgments against the business, you could be held legally responsible for them. Disputes among partners can be a problem, too. Unless you and your partners see eye to eye on how the business should be run and what it should accomplish, you are in for trouble.  

However, a partnership is generally the least advisable way to go. It requires filing a separate partnership tax return, does not carry liability protection for general partners, and can lead into legal and personal disputes. A corporate form of ownership is generally recognized as preferable over partnership, because it can serve the same purpose while offering a cleaner and better protected structure for the owners. 

A corporation differs from the other legal forms of business in that the law regards it as an artificial being possessing the same rights and responsibilities as a person. This means that, unlike sole proprietorships or partnerships, it has an existence separate from its owners. It has all the legal rights of an individual in regards to conducting commercial activity -- it can sue, be sued, own property, sell property, and sell the rights of ownership in the form of exchanging stock for money. 

As a result, the corporation offers some unique advantages. These include (1) limited liability: owners are not personally responsible for the debts of the business, (2) the ability to raise capital by selling shares of stock, and (3) easy transfer of ownership from one individual to another. Plus, unlike the sole proprietorship and partnership, the corporation has "unlimited life" and thus the potential to outlive its original owners. 

The main disadvantage of the corporate form can be summed up in two words: taxation and complexity. In what amounts to double taxation, you must pay taxes on both the income the corporation earns and the income you earn as an individual. Along with this, corporations are required to pay an annual tax on all outstanding shares of stock. Given its complexity, a corporation is both more difficult and more expensive to start than are the sole proprietor­ship and the partnership. In order to form a corporation, you must be granted a charter by the state in which your home-based business is located. For a small business the cost of incorporating usually ranges from $500 to $1,500. This includes the costs for legal assistance in drawing up your charter, state incorporation fees, and the purchase of record books and stock certificates. And, since corporations are subject to closer regulation by the government, the owners must bear the ongoing cost of preparing and filing state and federal reports. 

If you are interested in forming a corporation, but hesitate to do so because of the double taxation, there is a way to avoid it. You can do this by making your business an S corporation. The Internal Revenue Service permits this type of corporation to be taxed as a partnership rather than a corporation. However, in order to qualify for S status, your business must meet the specific requirements set forth by the IRS. These include limits on (1) the number and type of shareholders in the business, (2) the stock that is issued, (3) the corporation's sources of revenues.  

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