What's your problem? A brief lesson on the ABCs of LLCs and other legal forms for your new business

Entrepreneur, June, 2002

Q What's the difference between being incorporated and not incorporated?

Name withheld

A Every business needs to take a legal form. If you don't make a choice, a one-person business is, by default, a sole proprietorship. But there are other choices--a partnership, an LLC and incorporating. Each form has its own costs and legal and tax implications.

Incorporating is like wearing a raincoat: It protects business owners against personal liability if the business can't pay its bills or if it becomes liable for monetary damages. While you're not going into business expecting misfortune, some people also incorporate to protect their personal assets.

If you're in business with someone else, there's always more risk--so to protect yourself against liability, you may wish to incorporate rather than do business as a partnership. A less-expensive choice would be to form an LLC, which provides the liability protection of incorporation without the additional taxes incorporation involves.

But if your business is prospering, you might reduce the overall taxes paid from your corporation's earnings by choosing a C corporation until your profits reach six figures. If you're a one-person or husband-and-wife business seeking corporate tax benefits, you, only need to consider a C corporation. The federal tax code also allows S corporations, but these don't offer the same tax advantages. Some states, like California, don't even recognize them.

In addition to cost, there are other disadvantages to incorporating. Corporations are subject to more government regulation than other forms of businesses; documents as well as taxes must be filed regularly. And paperwork must be done right, or the protection a corporation offers can be challenged. To protect yourself, consult a lawyer before making your decision.

Paul and Sarah Edwards' most recent book is Changing Directions Without Losing Your Way. Send them your start-up questions at www.workingfromhome.com or e-mail entmag@entrepreneur.com.