There are many subtitles but potentially important differences between these types of business entities, and exceptions to the general rules governing them, which are not mentioned in this very brief summary. You should not make a decision for your business based on the limited information contained here, which is intended only as background.
A sole proprietorship is a business owned by a single individual. If it goes by a name that has any words in it other than just the owner’s name, for example, Tom’s Auto Repair, it is a good idea to file a Fictitious Business Name Statement for the business in the County Clerk’s Office. This will allow the business to sue or be sued in the name of the business rather than the name of the owner, and it may give some trade name protection against use of that name or a confusingly similar one by competitors. A sole proprietorship does not provide any protection for the assets of the owner of the business against liability for the debts or torts of the business.
A general partnership is a business owned by two or more persons, each of whom is fully liable individually to outsiders for the entire amount of the debts or torts of the business if the other partners(s) are unable to pay their share. The partners may agree among themselves for different contributions of capital and or labor from the individual partners, and different decision-making authority, as well as different percentages of individual liability for the debts and torts of the business. These agreements are enforceable among the partners, but, as stated, do not limit the liability of each individual to the outside world for the partnership obligations. To avoid future misunderstandings, it is essential to have a signed, written Partnership Agreement detailing the different or identical individual partners’ internal contributions and liability. Crippling tort liability can tend to be minimized by insurance. A partnership should take out life insurance on each partner, naming the other partner(s) as beneficiaries, so that the surviving partner(s) can buy out the share of the deceased partner from the partner’s heirs/survivors. This arrangement and its details should be set out in a signed, written Buy-Sell Agreement between the partners. Partnerships terminate on the death of all partners. Unless the partners have made different arrangements among themselves, like a Buy-Sell Agreement supported by adequate insurance money to eliminate the deceased partner’s share of the partnership debt and an indemnification by financially- able remaining partner(s) for the balance of any partnership debt, the estates of the deceased partners are liable for the debts of the partnership.
In a limited partnership, there are two kinds of partners – general partner(s) and limited partner(s). The general partner(s) has (have) all the decision-making authority, and are fully liable individually to outsiders for the entire amount of the debts or torts of the business. The limited partner(s) has (have) no decision-making authority, but have no liability beyond their initial investment for the debts or torts of the partnership.
There are several types of corporations – C corporations, S corporations, Non-Profit Corporations, Religious Corporations, etc.
In most cases, the contract and tort creditors of corporations are limited to enforcing their claims against the assets of the corporation, and cannot reach the assets of the individual owners (shareholders) of the corporations. The corporation comes into existence through the filing of Articles of Incorporation with the California Secretary of State, and the designation of several legally required officers, which may all be the same person, who may also own all the shares of stock of the corporation. Where this is not the case, the corporation is governed by a Board of Directors elected annually by the shareholders at a mandatory Annual Shareholders Meeting, and also by By-Laws adopted at the first meeting of the Board. Annual reports on the identity of the essential officers must be filed with the Secretary of State, and written minutes of the Annual Shareholders Meeting must be kept. A fixed, but sizable, Corporate Franchise Tax must be paid each year to the Franchise Tax Board. Income of the corporation that is not distributed to the shareholders is subject to annual U.S. and California income tax. Corporate income distributed to the shareholders is taxed individually to those shareholders.
Limited Liability Companies
Limited Liability Companies, often called “LLCs,” share many characteristics of corporations. They come into existence through the filing of Articles of Organization with the Secretary of State. They are owned by Members, each of whom owns a designated fractional share of LLC. Unlike a corporation, there are no shares of stock and no meetings are required.. LLCs are governed by an Operating Agreement between the Members, and must have at least one Manager. Like corporations, in most cases, the contract and tort creditors of LLCs are limited to enforcing their claims against the assets of the LLC, and cannot reach the assets of the individual Members. Annual reports on the identity of the Members and Manager(s) must be filed with the Secretary of State. The same fixed, but sizable, Corporate Franchise Tax paid by corporations must be paid each year to the Franchise Tax Board. Income of the LLC that is not distributed to the Members is subject to annual U.S. and California income tax. The Members are taxed individually on distributions of income from the LLC to the Members.