The type of business you form will determine how much profit you earn, how much you pay in taxes, how operations decisions are made, how much control you have…and your legal needs and responsibilities.

Let’s review: When starting a new business, you must first decide which legal form of ownership will be best for you and your business. Do you want to be your own boss and operate as a sole proprietorship? Or would you rather share the responsibilities of ownership and create a corporation or partnership? The answer to questions such as these are crucial to ask yourself before setting up your business model.

As we discussed in Part I of this article, no one business model will give you everything on your wish list. Each form of ownership has advantages and disadvantages so you’ll need to determine which offers the features most important to you. You should always consult an attorney before selecting a business model, as each structure consists of unique legal and tax consequences.

In Part I we addressed sole proprietorships, LLCs, and corporations. This time, we’ll look at three additional business structures, as described by the U.S. Small Business Administration, along with formation steps, tax obligations, and the pros and cons of each.


A partnership is a single business where two or more people share ownership. Each partner contributes to all aspects of the business, including money, property, labor, or skill. In return, each partner shares in the profits and losses of the business.

Because partnerships entail more than one person in the decision-making process, it’s important to discuss a wide variety of issues up front and develop a legal partnership agreement. This agreement should document how future business decisions will be made, including how the partners will divide profits, resolve disputes, change ownership (bring in new partners or buy out current partners), and how to dissolve the partnership. Although partnership agreements are not legally required, they are strongly recommended and it is considered extremely risky to operate without one.

Types of Partnerships        

Three general types of partnership arrangements exist:

  • General Partnerships assume that profits, liability, and management duties are divided equally among partners. If you opt for an unequal distribution, the percentages assigned to each partner must be documented in the partnership agreement.
  • Limited Partnerships (also known as a partnership with limited liability) are more complex than general partnerships and allow partners to have limited liability as well as limited input with management decisions. These limits depend on the extent of each partner’s investment percentage. Limited partnerships are attractive to investors of short-term projects.
  • Joint Ventures act as a general partnership, but for only a limited period of time or for a single project. Partners in a joint venture can be recognized as an ongoing partnership if they continue the venture, but they must file as such.

Forming a Partnership                  

To form a partnership, you must register your business with your state, a process generally done through your Secretary of State’s office. You’ll also need to establish your business name. For partnerships, your legal name is the name given in your partnership agreement or the last names of the partners. If you choose to operate under a name different than the officially registered name, you’ll need a DBA.

Once your business is registered, you must obtain business licenses and permits. Regulations vary by industry, state and locality. Refer to the Business License and Permit guide to learn more.

Partnership Taxes                   

Most businesses will need to register with the IRS, register with state and local revenue agencies, and obtain a tax ID number or permit. A partnership must file an “annual information return” to report the income, deductions, gains, and losses from the business’s operations, but the business itself does not pay income tax. Instead, the business “passes through” any profits or losses to its partners. Partners include their respective share of the partnership’s income or loss on their personal tax returns.

The IRS asks that you use this chart to determine which forms you are required to file.


  • Easy and inexpensive: Partnerships are generally an inexpensive and easily formed business structure. Most of the time spent starting a partnership focuses on developing the partnership agreement.
  • Shared financial commitment: In a partnership, each partner is equally invested in the success of the business. Partnerships have the advantage of pooling resources to obtain capital. This could be beneficial in terms of securing credit, or by simply doubling your seed money.
  • Complementary skills: A good partnership should reap the benefits of being able to utilize the strengths, resources, and expertise of each partner.
  • Partnership incentives for employees: Partnerships have an employment advantage over other entities if they offer employees the opportunity to become a partner. Partnership incentives often attract highly-motivated and qualified employees.


  • Joint and individual liability: Like sole proprietorships, partnerships retain full, shared liability among the owners. Partners are not only liable for their own actions, but also for the business debts and decisions made by other partners. In addition, the personal assets of all partners can be used to satisfy the partnership’s debt.
  • Disagreements among partners: With multiple partners, there are bound to be disagreements Partners should consult each other on all decisions, make compromises, and resolve disputes as amicably as possible.
  • Shared profits: Because partnerships are jointly owned, each partner must share the successes and profits of their business with the other partners. An unequal contribution of time, effort, or resources can cause discord among partners.


A cooperative is a business or organization owned by, and operated for the benefit of, those using its services. Profits and earnings generated by the cooperative are distributed among the members, also known as user-owners.

Typically, an elected board of directors and officers run the cooperative while regular members have voting power to control the direction of the cooperative. Members can become part of the cooperative by purchasing shares, though the number of shares they hold does not affect the weight of their vote. Cooperatives are common in the healthcare, retail, agriculture, art, and restaurant industries.

Forming a Cooperative

To start up, a group of potential members must agree on a common need and a strategy on how to meet that need. An organizing committee then conducts exploratory meetings, surveys, and cost and feasibility analyses before every member agrees with the business plan. Not all cooperatives are incorporated, though many choose to do so. If you decide to incorporate your cooperative, you must complete the following steps:

  • File articles of incorporation: The articles of incorporation legitimize your cooperative and include information like the name of the cooperative, business location, purpose, duration of existence, and names of the incorporators, and capital structure. Once the charter members file with your state business entity registration office and the articles are approved, you should create bylaws for your cooperative.
  • Create bylaws: While bylaws are not required by law, they do need to comply with state law and are essential to the success of your cooperative. Bylaws list membership requirements, duties, responsibilities, and other operational procedures that allow your cooperative to run smoothly. According to most state laws, the majority of your members must adopt articles of incorporation and bylaws. Consult your attorney to verify your bylaws comply with state laws.
  • Create a membership application: To recruit members and legally verify that they are part of the cooperative, you must create and issue a membership application. Membership applications include names, signatures from the board of directors, and member rights and benefits.
  • Conduct a charter member meeting and elect directors: During this meeting, charter members discuss and amend the proposed bylaws. By the end of the meeting, all charter members should vote to adopt the bylaws. If the board of directors are not named in the articles of incorporation, they must be designated during the charter meeting.
  • Obtain licenses and permits: You must obtain relevant business licenses and permits. Regulations vary by industry, state, and locality. Refer to our Business License and Permit guide to find a list of federal, state, and local permits, licenses and registrations you’ll need to run a business.

Be sure to consult with an attorney to ensure your cooperative is following the laws established in North Carolina.

Cooperative Taxes

Most businesses must register with the IRS, state, and local revenue agencies, and obtain a tax ID number or permit. A cooperative operates as a corporation and receives a “pass-through” designation from the IRS. More specifically, cooperatives do not pay federal income taxes as a business entity.

Instead, the cooperative’s members pay federal taxes when they file their personal income tax. Members pay federal and state income tax on the margins earned by the cooperative, though the amount of taxation varies slightly by state. Cooperatives must follow the rules and regulations of the IRS’s Subchapter T Cooperatives tax code to receive this type of tax treatment.

To file taxes on income received from cooperatives, please refer to IRS instructions on how to file Form 1099-PATR. More information about taxable distributions received from cooperatives is available at If you create a consumer cooperative for retail sales of goods or services that are generally for personal, living, or family, you will need to file Form 3491 Consumer Cooperative Exemption Application for exemption from Form 1099-PATR.

Some cooperatives, like credit unions and rural utility cooperatives, are exempt from federal and state taxes due to the nature of their operations.


  • Less taxation: Like an LLC, cooperatives that are incorporated normally are not taxed on surplus earnings (or patronage dividends) refunded to members. Therefore, members of a cooperative are only taxed once on their income from the cooperative and not on both the individual and the cooperative level.
  • Funding Opportunities: Depending on the type of cooperative you own or participate in; a variety of government-sponsored grant programs are available to help you start. For example, the USDA Rural Development program offers grants to those establishing and operating new and existing rural development cooperatives.
  • Reduce costs and improve products and services: By leveraging their size, cooperatives can more easily obtain discounts on supplies and other materials and services. Suppliers are more likely to give better products and services because they are working with a customer of more substantial size. Consequently, the members of the cooperative can focus on improving products and services.
  • Perpetual existence: A cooperative structure brings less disruption and more continuity to the business. Unlike other business structures, members in a cooperative can routinely join or leave the business without causing dissolution.
  • Democratic organization:  The democratic structure of a cooperative ensures that it serves its members’ needs. The amount of a member’s monetary investment in the cooperative does not affect the weight of each vote, so no member-owner can dominate the decision-making process. The “one member-one vote” philosophy particularly appeals to smaller investors because they have as much say in the organization as does a larger investor.


  • Obtaining capital through investors: Cooperatives may suffer from slower cash flow since a member’s incentive to contribute depends on how much they use the cooperative’s services and products. While the “one member-one vote” philosophy is appealing to small investors, larger investors may choose to invest their money elsewhere because a larger share investment in the cooperative does not translate to greater decision-making power.
  • Lack of membership and participation: If members do not fully participate and perform their duties, whether it be voting or carrying out daily operations, then the business cannot operate at full capacity. If a lack of participation becomes an ongoing issue for a cooperative, it could risk losing members.

S Corporation

An S corporation (also referred to as an S corp.) is a special type of corporation created through an IRS tax election. An eligible domestic corporation can avoid double taxation (once to the corporation and again to the shareholders) by electing to be treated as an S corporation.

An S corp. is a corporation with the Subchapter S designation from the IRS. What makes the S corp. different from a traditional corporation (or C corp.) is that profits and losses can pass through to your personal tax return. Consequently, the business is not taxed itself. Only the shareholders are taxed. There is an important caveat, however: Any shareholder who works for the company must pay him or herself “reasonable compensation.” Basically, the shareholder must be paid fair market value, or the IRS might reclassify any additional corporate earnings as “wages.”

Forming an S Corporation

To file as an S corporation, you must first file as a corporation. After you are considered a corporation, all shareholders must sign and file Form 2553 to elect your corporation to become an S corporation.

Once your business is registered, you must obtain business licenses and permits. Regulations vary by industry, state, and locality. Refer to the Business License and Permit guide to learn more.

Combining the Benefits of an LLC with an S Corp.

There’s always the possibility of requesting S corp. status for your LLC. Your attorney can advise you on the pros and cons. You’ll have to make a special election with the IRS to have the LLC taxed as an S corp. using Form 2553. And you must file it before the first two months and fifteen days of the beginning of the tax year in which the election is to take effect.

The LLC remains a limited liability company from a legal standpoint, but for tax purposes it’s treated as an S corp. Be sure to contact your state’s income tax agency where you will file the election form to learn about tax requirements.


All states do not tax S corps equally. Most recognize them similarly to the federal government and tax the shareholders accordingly. Your corporation must file the Form 2553 to elect “S” status within two months and 15 days after the beginning of the tax year or any time before the tax year for the status to be in effect.

The IRS asks that you use this chart to determine which forms you are required to file.


  • Tax savings: One of the best features of the S corp. is the tax savings for you and your business. While members of an LLC are subject to employment tax on the entire net income of the business, only the wages of the S corp. shareholder who is an employee are subject to employment tax. The remaining income is paid to the owner as a “distribution,” which is taxed at a lower rate, if at all.
  • Business expense tax credits: Some expenses that shareholder/employees incur can be written off as business expenses. Nevertheless, if such an employee owns 2% or more shares, benefits like health and life insurance are deemed taxable income.
  • Independent life: An S corp. designation also allows a business to have an independent life, separate from its shareholders. If a shareholder leaves the company, or sells his or her shares, the S corp. can continue doing business relatively undisturbed. Maintaining the business as a distinct corporate entity defines clear lines between the shareholders and the business that improve the protection of the shareholders.


  • Stricter operational processes: As a separate structure, S corps require scheduled director and shareholder meetings, minutes from those meetings, adoption and updates to by-laws, stock transfers, and records maintenance.
  • Shareholder compensation requirements: A shareholder must receive reasonable compensation. The IRS takes notice of shareholder red flags like low salary/high distribution combinations, and may reclassify your distributions as wages. You could pay a higher employment tax because of an audit with these results.

Structuring the way in which your business will be run and organized can be a daunting task. Trying to choose between registering as a sole proprietorship, general partnership, corporation, or limited liability company? Let Oliver & Cheek, PLLC guide you in these types of decisions, the creation of job titles and duties, and the mapping of future expansion. For more information, call (252) 633-1930 or visit

(Sources: U.S. Small Business Administration; NC Department of the Secretary of State; Oliver & Cheek, PLLC; Entrepreneur Magazine; Internal Revenue Service; Albuquerque Business Law; Fryar Law Firm P.C.; Fundera, Inc.; and Virginia Tech and the Saylor Foundation.)