Form of Business Entity

Forms of Business Organizations

Generally, Missouri law allows individuals to operate a business under four forms of organizations:

  • Sole Proprietorships
  • Partnerships
  • Corporations
  • Limited Liability Companies

Sole Proprietorship

A sole proprietorship is really not an organization but rather ownership of a business by one individual. Any one person who begins a business without deliberately creating another form of entity ownership automatically begins as a sole proprietorship. Generally, no formal documentation is required or necessary.  However, based upon how a sole proprietor is conducting the business, certain filing requirements may be needed.  For example, if a sole proprietor is doing business under a name other then the individual owner's name, a Registration of Fictitious Name form needs to be filed with the Missouri Secretary of State.

Partnership

A partnership is a combination of individuals, called partners, who operate a business for profit. Although no formal creation is necessary, individuals who wish to form a partnership should enter into a written agreement, called a Partnership Agreement, which sets out all the terms of the relationship. If a written partnership is not entered into, then Missouri law will generally govern the terms of the relationship which may or may not be what the owners want or desire.  Generally, the partners or owners collectively make decisions concerning the partnership.

A limited partnership is a special type of partnership. In a limited partnership, there are two classes of partners, general partners and limited partners.  The limited partners share in the profits, but they cannot participate in the management of the limited partnership.  The general partners manage and control the limited partnership in addition to sharing in the partnership's profits.

A limited partnership can only be formed in Missouri by filing legal documents with the Missouri Secretary of State.  In other words, you cannot have an oral limited partnership. 

Further, if properly created, formed and operated, a Missouri limited partnership permits one partner or group of partners (the limited partners) to be shielded from individual liability for partnership obligations created by another partner's or person's misconduct. A partner's liability is not limited, however, when the misconduct took place under the supervision or control of the limited partner. Only liability arising from the actions or misconduct of other partners or persons is covered by this law; the partnership is not relieved from liability for other partnership obligations and individual partners are liabile for their own misconduct.

Corporation

A corporation is a more complex arrangement allowing for multiple owners but with centralized management. The owners, called stockholders, elect directors, who in turn elect officers to manage the affairs of the corporation. The individuals who wish to form a corporation, called incorporators, must prepare a formal written document called Articles of Incorporation. This document is then submitted to the Secretary of State for approval. Once approved, the Secretary of State issues a Certificate of Incorporation which authorizes the corporation to act. A corporation is then considered to act as a separate person.

For tax purposes, there are two types of special corporations - Subcapter S Corporations and Subchapter C Corporations. Generally, a C Corporation recognizes income and pays tax at the corporate level whereas an S Corporaton flows the income through to the shareholders who are then obligated to pay tax at the individual level.  The Internal Revenue Service has technical and complex rules concerning the tax treatment of Subchapter S Corporations and Subchapter C Corporations.

Missouri also recognizes non-profit corporations. Missouri treats non-profit corporations somewhat differently and the Internal Revenue Service provides for different income tax treatment for non-profit corporations.

Limited Liability Company

A limited liability company is a relatively new form of business organization in Missouri. A limited liability company operates much like a partnership but with some of the advantages of a corporation. A formal written document called Articles of Organization must be prepared and submitted to the Secretary of State for approval. The owners, called members, manage the limited liability company unless the members provide in the Articles of Organization for centralized management by a manager.

Selection of a Business Organization

Although the choice of the type of business organization depends upon many factors, in addition to those previously discussed, most selections are made for three reasons:

  • Liability
  • Income Taxes
  • Funding

Liability

Liability concerns the extent to which an owner is responsible for the debts and charges against the organization. If an owner has "personal liability," he or she is totally responsible, and creditors may reach all personal funds of the owner even if the funds are not invested in or part of the business. If an owner has "limited liability," his or her responsibility is limited to only the funds that he or she has invested in the organization. An evaluation of the risks and possible liabilities to be incurred in the operation of the business may leads to the selection of one type of business entity over another.

A sole proprietor is personally liable for all debts of the business.

Generally, a partner is also personally liable for all the debts of the partnership. However, the liability of a limited partner in a limited partnership is generally limited solely to that person's investment or contribution to the limited partnership.

Unless special circumstances apply, a stockholder's liability is limited solely by the stockholder's investment in the corporation.

Generally, the liability of a member in a limited liability company is limited solely to the member's investment in the limited liability company.

Income Taxes

All income of a sole proprietorship is taxed on the sole proprietor's own personal income tax return at the appropriate individual tax rates.

A partnership must prepare an income tax return but the partnership pays no income taxes itself. The partnership income tax return acts as a conduit of income to the individual partners. The partnership return apportions the income (or loss) among the partners or limited partners. Each partner or limited partner then includes his or her portion of the income (or loss) on his or her personal income tax return.

Since a corporation is considered a separate person, the corporation prepares its own income tax return and pays income tax on its income. Any distribution of income as dividends to the stockholders is also taxed on a stockholder's individual personal income tax return. The income tax rate for the corporation may be very different from the individual personal rate. A Subchapter S Corporation is treated similarly to a partnership for income tax purposes in that income (or loss) is apportioned to the shareholders and reported on their individual income tax return. The income taxation of a non-profit corporation is separate and very complicated.

If a limited liability company complies with technical and complex income tax rules, the income earned by the limited liability company is taxed as the income from a partnership.  However, a limited liability also has the ability to choose to be taxed as another type of business entity.

Funding

When obtaining funds from third parties, a sole proprietorship is generally limited to borrowing money, usually from a bank.

A partnership can seek additional investment from loans or it can solicit additional partners (or limited liability partners) who may contribute additional funds.

A corporation has more opportunities for seeking investment. It can borrow money, seek additional investors to purchase either common or preferred stock or issue other corporate securities such as corporate bonds.

A limited liability company can obtain additional funds similar to a partnership.