No. You can operate most businesses as a sole proprietor or, if you have a partner or partners, you can operate without a formal entity as a joint venture or partnership. However, it may not be wise to operate your business as a simple sole proprietorship or partnership because proceeding in this manner will not provide the individual owners of the business the personal liability shield available through the use of a corporation, limited liability company (LLC), or other formal entity that provides a limited liability shield. So, if you operate your business via a corporation or LLC and you maintain the separateness of the business entity from your personal affairs and accounts, a judgment against your business entity will allow the recipient of that judgment to go after the assets of the business to satisfy that judgment, but not your personal assets, like your car, house, bank accounts, etc.
Business Formation Frequently Asked Questions
The most common types of entities that provide a personal liability shield are the corporation and the limited liability company. In both the corporation and the LLC, the assets of the business should be held by the entity and all business-related contracts should be entered into by the business. Likewise, the business entity will have its own bank account(s), which must be maintained entirely separately from the personal bank accounts of the business owners. Another business entity that provides a liability cap is the limited partnership or limited liability partnership, in which each limited partner is only liable up to the amount of their investment in the venture.
Corporations and LLCs are formed at the state level. In most states, the documentation, filings, and fees necessary to form an entity can be found at the Secretary of State’s website. For example, here is the California Secretary of State’s page providing forms and listing filing fees for most common entity formation, maintenance, and dissolution filings: https://www.sos.ca.gov/business-programs/business-entities/forms.
In most states, in order to form a corporation it is necessary to file Articles of Incorporation (and pay the appropriate fee). In California, soon after filing the Articles of Incorporation, it will be necessary to file a Statement of Information (and pay the appropriate fee). It is advisable to have written Bylaws, which should be voted on and accepted by the shareholders of the corporation at the first meeting. Bylaws are, essentially, the constitution of the entity, laying out the rights, obligations, and prohibitions of the shareholders, among other things. Typically, it will be necessary to secure a FEIN/Tax ID number for the new entity, which is done by visiting the IRS here: https://www.irs.gov/businesses/small-businesses-self-employed/apply-for-an-employer-identification-number-ein-online. With the file-stamped Articles of Incorporation and Tax ID number, you should be able to open a bank account in the name of the entity. There are also ongoing filings with the Secretary of State that are necessary to maintain the good standing status of the corporation.
Forming an LLC is very similar to forming a corporation. First, it will be necessary to file Articles of Organization with the Secretary of State. In California, go here: https://llcbizfile.sos.ca.gov/registration. As with corporations, soon after filing the Articles of Organization it will be necessary to file a Statement of Information (see https://llcbizfile.sos.ca.gov/SI ). The LLC should have a written Operating Agreement (similar to Bylaws in the corporation context), which should be voted on and approved by the LLC members (corporations have “shareholders” whereas LLCs have “members”) at an initial meeting. The LLC will secure a FEIN/Tax ID number in the same manner as corporations by visiting the IRS site (https://www.irs.gov/businesses/small-businesses-self-employed/apply-for-an-employer-identification-number-ein-online). With a file-stamped copy of the LLC’s Articles of Organization and a Tax ID number, you should be able to open a bank account in the name of the LLC. As with corporations, there are ongoing filings with the Secretary of State that are necessary to maintain the good standing status of the LLC.
While both entities provide their shareholders/members with a limited liability shield, in general, there is less formality required to maintain an LLC than there is a corporation. Perhaps the biggest difference between an LLC and a corporation is that the LLC, by default, allows for pass-through tax treatment, whereas the corporation does not. Generally, corporations are taxed both at the corporate level (when the corporation receives income) and at the shareholder level, when distributions are made to shareholders. It is possible to elect to be an S-corporation, which form allows for pass-through tax treatment, but S-corporations, unlike LLCs, allow for only one class of stock and have other ownership restrictions that LLCs do not. Bottom line, the decision whether to be a C-corporation, an S-Corporation, a limited liability company, or any other form of business entity often comes down to the type of business you are pursuing and finding a structure that is most tax efficient and easy to maintain. Accordingly, we strongly recommend that you confer with your attorney and CPA or other tax professional before deciding which type of entity to form.