Sole proprietorships and partnerships can be simple forms of conducting business. The owners make all of the decisions relating to the business and are taxed on business income and loss as individuals, with no taxation at the entity level, as is the case with corporations. However, sole proprietors and individual partners in a partnership are personally responsible for the performance of all contracts and obligations of the business.
This means that sole proprietors and partners risk losing assets belonging to them which have no relation to the business in the event the income from business operations are insufficient to cover the business’ obligations, including obligations arising from lawsuits. By forming a corporation or limited liability company under which to conduct business operations, a business owner can minimize his or her risk of losing personal assets for business obligations. This is true because corporations and limited liability companies offer “limited liability” for their owners.
Essentially, the benefit of “limited liability” means that a business owner is liable only for the obligations of the business to the extent of his or her investment in the company. Absent the business owner’s own wrongdoing or negligence, creditors and those bringing lawsuits against a company may only look to business assets for relief. Conducting business under an entity that offers limited liability essentially means limiting your personal risk for the following types of liability:
- Liability for an employee’s actions within the scope of their work duties;
- Liability for injuries to individuals on an owner’s business premises;
- Liability for environmental contamination;
- Liability for Worker’s Compensation claims;
- Liability for the payment of payroll taxes;
- Liability for the wrongful acts of fellow partners (in the partnership context);
- Liability for breach of contract and warranty claims: and
- Liability for claims by creditors for business obligations.
Because limited liability is such an attractive feature, business owners should strongly consider the formation of such an entity. However, individuals contemplating such action are urged to consult a qualified advisor early in the decision making process.