There are many important legal factors for an entrepreneur to consider before starting a business. First and foremost is the type of legal entity to be formed. Options include a sole proprietorship, legal partnership or state created legal entity. The types of state created legal entities are limited liability companies and Subchapter S corporations.
The simplest way to start a business is to create a sole proprietorship. If you are not expecting to have any employees this can be the most effective and less costly alternative. If the business is to be operated under a name other than your own a fictitious name should be obtained from the Pennsylvania Department of State. Income and expenses are reported on Schedule C of your tax return, and then carried over to your 1040 federal return. You should carry adequate liability insurance on your business enterprise. Sole proprietors remain personally liable on contracts entered into by the proprietorship and for torts committed by the proprietorship.
In the event you have a partner for your business you will need to have a partnership agreement drafted by a competent attorney. Income and expenses from the partnership are reported on Schedule 1065 and passed through to individual partners on Schedule K-1. Liability insurance is necessary, as partners remain liable under contracts and for torts related to the partnership, although the partnership agreement may provide for indemnification by partners to each other under certain defined circumstances.
State created legal entities, such as Subchapter S corporations and limited liability companies, can potentially protect shareholders or members from personal liability. However, it must be understood that individuals can always be held responsible for their own negligent acts, or for breaches of contract when personal guarantees are imposed by third parties dealing with the legal entity chosen. In Pennsylvania, both Subchapter S corporations and limited liability companies must be established by way of applications filed with the Pennsylvania Department of State. Legal advertising is required for Subchapter S corporations but not for limited liability companies. Shareholder agreements should be prepared for Subchapter S corporations if there are two or more shareholders. An operating agreement should be prepared for one or more members in a limited liability company. Liability insurance should also be obtained, and a tax professional should be retained to prepare and file tax returns.
The foregoing is intended to be a primer on the legal aspects of setting up a business. Before moving forward, I encourage you to discuss all relevant aspects about your business plan with an attorney and a tax professional. My office is more than happy to answer your questions regarding legal aspects. Please consider contacting me, Steven R. Blair, at my Lancaster, Pennsylvania office at (717)390-2030 or by email at firstname.lastname@example.org.