Although the law generally doesn't require it, there are good reasons that many business owners choose to create separate entities through which to conduct their businesses. First, creating an entity can ease transfers of ownership, which can be as easy as selling or buying shares of stock. Second, most types of business entities, if created and operated appropriately, will, if the business fails, give the owners a liability shield to protect their personal assets (that is, their property other than the assets they've invested in the business). Finally, the tax laws grant some benefits to legal entities, especially in the employee benefit area, that are not granted to partnerships or sole proprietorships.

A corporation is a legal entity -- an "artificial person" -- created through filing a document called "Articles of Incorporation" with the Kansas Secretary of State's office and taking certain other steps. As a legal entity, a corporation exists separately from its owners and will have its own tax identification number. The owners may be issued stock certificates. One main advantage of a corporation is that it provides its owners with a liability shield (called the "corporate veil") to prevent the corporation's creditors from reaching the owners' personal assets. A corporation's name must clearly identify it as a corporation, so that potential creditors will be warned that they can't count on reaching the personal assets of the owners to pay the business's debts.

Without an affirmative choice properly reported to the IRS (an "'S' corp election"), every corporation is treated as a "C" corporation. A "C" corporation is taxed separately from its owners. Therefore, if the corporation has a profitable year, the corporation will pay income tax; in turn, if the "C" corporation pays a dividend to its owners, the owners will again pay personal tax on that income. This is often called "double taxation." By contrast, for income tax liability purposes, the IRS ignores the "S" corporation and simply treats the corporation's profits as the owners' income. There are limitations on the types of corporations that can qualify to be "S" corporations.

A limited liability company, like a corporation, is a legal entity. It is created through filing a document called "Articles of Organization" with the Kansas Secretary of State's office and taking other steps. The owners may be issued membership certificates. A limited liability company provides the liability shield of a corporation, but (unlike "C" corporations) may yield the tax advantages of a partnership (avoiding the "double taxation" of corporate income and shareholders' dividends, discussed above). So that potential creditors will receive due notice, a business's name must clearly show that it is a limited liability company, such as by including the initials "L.L.C." or "L.C."

A sole proprietorship is simply an individual setting up a business without creating a separate business entity. If two or more people engage together in a business for profit and don't set up a separate business entity, it is referred to as a general partnership. In either case, the business will owe no corporate income taxes; however, if the business fails, business creditors can pursue the personal assets of the business's owners.

Rev. 4/06