Sole Proprietor – This is the easiest type of business to form because there are no forms to submit to the Secretary of State’s Office. You may need to complete a “certificate of assumed name” with the County if you do business with a different name other than your own. You will have to pay self-employment taxes with the state.
You are your business. Therefore, your business debts are your personal debts. If your business is sued, you are sued, meaning that a judgment can be recovered out of your personal assets. This is the main reason why this is not the best type of business to form. The paperwork to the Secretary of State’s Office and the IRS is very simple and it is not expensive, so that should not be a deterrent to formalizing your business.
Partnership – This is similar to the sole proprietor except for number of people. You are your business . . . well, you and your partner(s) together are the business. This means that if one of your partners does something wrong, your personal assets may be used to pay the liability. If the wrongdoing partner has sufficient assets to cover the liability, you can sue for contribution and force the wrongdoing partner to pay. Otherwise, you are on the hook personally.
No formation paperwork is required to be filed with the Secretary of State’s Office. The partners individually pay income tax every year (regardless of whether you “pay yourselves” or not . . . partnership income is your income). Finally, you should draft a partnership agreement. This will outline how the partnership is run, how the partners are paid, and the ownership interests of each partner (if not owned equally, which is the default unless otherwise stated).
There can also be a limited partnership, which means that one (or more) of the partners has no management control but is there for investment purposes only. The limited partner is entitled to income from the partnership and enjoys limited liability in the event the partnership is sued. General partners participate in the management of the partnership and are personally liable for partnership debts. A limited partnership must file paperwork with the Secretary of State’s Office.
Limited Liability Partnership - This type of partnership has only general partners, but the partners still enjoy protection from personal liability. This is certainly the way to go when it comes to partnerships. The only thing that is additionally required is registering the LLP with the Secretary of State’s Office.
Corporation – A corporation (“C-Corp”) is the most formal type of business. A corporation has a board of directors, who make management decisions, and shareholders, who invest and receive income back in the form of dividends. In order to form a corporation, Articles of Incorporation must be filed with the Secretary of State’s Office. An EIN must be obtained from the IRS. If securities are offered, federal securities regulations will need to be followed. North Carolina has statutes that govern board meetings and shareholder meetings. By-laws must be created.
The main drawback of a corporation is the double taxation structure. When the corporation makes money, the corporation has to pay income tax. When the shareholders are paid a dividend, they have to pay income tax as well. Because the corporation is its own entity, the shareholders have no personal liability for the corporation’s liabilities.
An “S Corp” is a special type of taxation structure that is not taxed at the corporate level. See below (LLC) for more discussion. An S-corp is not a form of corporate entity created with the NC Secretary of State. It is an IRS designation.
Limited Liability Company (LLC) – This is a popular option because there are not as many formalities as a corporation, but the company/individual is typically only taxed once, and the owners enjoy limited personal liability. The LLC is its own separate entity for debt/liability purposes.
The IRS and NCDOR treat LLCs as partnerships for tax purposes, so there is no separate entity tax unless the LLC elects to be taxed as an S-Corp. If the LLC has just one owner/member, the IRS treats it as a sole proprietorship (again, no separate entity tax), so no election is required; however, the LLC will still have to make the election (partnership vs. S-Corp) with the IRS and NCDOR. If the business makes the S-Corp election, the business profits are taxed on each shareholder’s individual tax return. Any LLC member who works for the company must pay himself “reasonable compensation.” Therefore, many start-ups are not initially taxed as S-Corps.
An LLC must be registered with the Secretary of State’s Office by filing an Articles of Organization and must file annual reports like LLPs and Corporations. If there is more than one owner/member, an operating agreement needs to be drafted governing how the LLC will be run and detailing the ownership interests of each member.
PLLCs also exist for "professionals," such as accountants, attorneys, and doctors, who are licensed by state boards. The LLC requirements are the same, but the professionals should check with the licensing board because the board will likely have additional formation and filing requirements.
This is a very basic outline of the types of business entities in North Carolina. Depending on the type of business and your goals, one might work better than another. For any of the above entities promising limited liability, it is very important that business and personal debts be kept separate. Also, some of these types of business require that the business names be unique and contain words that signify what type of business entity it is. Thus, you should consult an attorney when the time comes to formalize your business!