Corporations are one of the oldest and most traditional business entity forms. The basic premise of a corporation is that the business owners and the business itself are separate legal entities. This business form is attractive because corporations can (a) sell shares to obtain investment capital without giving up managerial control; (b) exist on their own, perpetually (meaning they do not dissolve automatically when major stakeholders die or go bankrupt); and (c) protect the business owners (shareholders) from personal liability beyond their investment in the business.

Corporations must be formed and operated in compliance with state law. This means registering the corporation with the state and making necessary periodic filings and paying fees to the state, not mingling the assets of the corporation and its owners, and complying with other state-specific rules. It's really not as difficult as it sounds, as most states have made it relatively easy to incorporate. Usually it is simply a matter of choosing a name, filling out a form, and paying a filing fee to the Secretary of State. No lawyer is required, nor do you need a license, assuming you will not be doing business in a regulated industry, such as a banking or insurance.

The trick, however, is sticking to the rules. Generally speaking, if a business owner follows proper corporate formalities and adheres to the laws of the state in which the corporation operates, she will not be held personally liable for the monetary and legal claims against the corporation. (Note that the business owner can still be held personally liable for his own misconduct, failing to fund the corporation with enough money to reasonably cover its liabilities, failing to keep the corporation's business separate from the owner's personal business, and a number of other reasons.) This general protection of the business owner from personal liability is one of the major advantages of choosing a corporate form. But as with most good things in life, this protection is taxed.

One of the major drawbacks of choosing the corporate form is the problem of double taxation. Because the corporation and the business owner(s) are separate entities, the corporation pays its own income taxes. When the corporation then distributes money to its owners, the owners then pays taxes on that income. The end result is that every dollar a customer pays is taxed twice before it reaches the business owner(s) hands.

A general partnership is similar to a sole proprietorship in several ways. If two or more people engage is a business endeavor together and take no steps to select another entity form, the business will automatically be deemed to be a general partnership. Though a general partnership may need to obtain licenses and permits to operate the business, no specific state filings or fees are required to form a general partnership.Similar to a sole proprietorship, the owners of a general partnership are not subjected to double taxation (see discussion of corporations below). Any income received by either owner is reported on his or her personal income tax return, and the income made by the general partnership is taxed only once.

Although general partnerships can be created by the default operation of law, they are most often created when business partners sign a partnership agreement that formalizes their arrangement. Partnership agreements typically outline each of the partner's respective powers and responsibilities, how profits and losses will be divided, and how the partnership can be dissolved. If no specific agreement is reached on these issues, the law automatically provides that (a) each partner shares equally in all profits and losses; (b) each partner is an agent of the other partners, and all partners have the power to bind the partnership; (c) a majority vote is necessary to decide on all day to day operational issues, and a unanimous vote is required on all major issues; (d) a partner cannot sell or transfer his or her interest in the partnership without the consent of all the other partners; and (d) the partnership is automatically dissolved by the death, bankruptcy, or withdrawal of any partner.

Like the owner of a sole proprietorship, the partners of a general partnership are personally liable for all of the monetary and legal claims against the business. This means that the partners are also personally liable for each other's business actions. In addition, this liability is unlimited as it relates to the debts of the partnership. So for example, if Partner A binds the partnership to a business venture that ends up losing a million dollars, but Partner A has no personal assets, the partnership's creditors can come after the personal assets of Partner B and C for the money due, even if B and C were not actively involved in the deal. As you can see, general partners must have a lot of faith in each other.

A limited partnership, or "LP", is similar to a general partnership, except that it contains one or more "silent" partners. An unlike a general partnership, forming a limited partnership requires the business owner to proactively choose the business form and register with the state. Generally speaking, an LP is made up of a combination of one or more general partners and one or more limited partners, and is governed by a written partnership agreement. In terms of management rights and responsibilities, the role of a general partner is the same in a limitied partnership as it is in a general partnership. All general partners of an LP have the power to manage the business and bind the partnership in contract. Similarly, they are also personally liable for all of the LP's debts and legal judgments. And like a general partnership, a limited partnership is established, managed, modified, and dissolved according to the terms of the partnership agreement.

The special twist in a limited partnership is the presence of limited partners. Limited partners can essentially be thought of as passive investors, in that they own a stake in the business but do not have a say in how it is run. In exchange for giving up management rights, limited partners receive limited liability. This means that if things go wrong, and the LP loses money or is sued, the limited partner only stands to lose her investment. The one caveat to this is that the rule only protects limited partners who strictly adhere to the LP formalities. In other words, if you enter into an LP as a limited partner, you must always be sure not to participate in any management decisions or otherwise deviate from your partnership agreement, or you will risk losing your limited liability status.

Like all partnerships, the income of an LP is not subject to double taxation. This feature has helped to maintain the popularity of limited partnerships through the years. Often, wealthy individuals will use a limited partnership arrangement as a tax "pass through" for their income from other sources. This means that the wealthy investor will invest in a type of business that gets very favorable tax treatment, anticipating that the business will lose money. When the business does in fact lose money, the limited partner loses his investment, but the large tax loss "passes through" the LP and more than offsets this loss with the tax savings to his other income.

A sole proprietorship is the default business form for an individual business owner, and it is the simplest and most common type of business. Though a sole proprietor may need to obtain licenses or permits for operating a business, there are generally no specific state filings or fees required to form a sole proprietorship. If a person starts running a business and does not pick another form, it will automatically be considered a sole proprietorship.

The benefits of a sole proprietorship include total operational control, avoidance of double taxation (see the discussion of corporations below), and the lack of state filing requirements and corporate formalities. An owner is free to run the business as she pleases, and does not need the approval of investors or other stake holders. There is also no requirement to adhere to strick corporate formalities, such as annual meetings and separate bank accounts. Sole proprietors can also hire employees and contractors without changing the business form, as long as the owner does not try to disclaim responsibility for the actions of the employee. Generally, a solo proprietorship can be established without much time or legal expense, and in reality, they are often established without the owner even realizing it. A business owner just needs to pick a product or service to offer, and begin running the business.

The major drawback of a sole proprietorship is that the business owner is personally liable for all monetary and legal claims against the business. There is no legal barrier between the business and its owner. This means that if the business owes money for any reason, the creditor can come after the personal assets of the owner. Likewise, if the business gets sued for a tort or breach of contract, the business owner's home, savings and other assets can all be attached to the judgement. In addition, because the assets and liabilities of the business are the same as those of the owner, it can be hard for sole proprietorships to find investors, because people do not want to take the risks. Because of the potential personal liability of the owner of a sole proprietorship, with the many other options available to business owners, this option is often avoided in favor of other arrangements.