There are five ways you can conduct business. You can operate as a sole proprietor, a partner, a limited partnership, a corporation or a limited liability corporation (LLC). The differences in these structures fall into two categories.
Liability. The state statutes control one’s exposure to liability. Sole Proprietors, partners and general partners in limited partnerships have unlimited personal liability. The company is sued and they can lose their personal assets. The purpose of incorporation is to limit your personal liability to the assets of the corporation. This is accomplished if you work with your attorney and aggressively respect the “corporate veil.” In other words, you must treat the corporation as a separate entity and keep proper books and records. The corporation structure does not protect you if you are sued personally. Someone who successfully sues you personally for your personal actions can attach your assets and included in those assets are the shares of stock that you own in the corporation. About fifteen years ago the states started adopting a second kind of corporation called limited liability corporations (LLC). These are corporations with the same personal liability protections however they have one significant difference—if the owner of shares in an LLC is sued, the creditor can attach his property but cannot attach his shares in an LLC. This protects the company from “backdoor liability.” Remember that all insulation from liability through the corporate structure is predicated upon you respecting the formalities of the corporate form. You must have you shareholders meetings, you must keep your minutes up-to-date, you cannot comingle your personal funds with your corporate funds, you must keep your state filings in order—you must treat the corporation as an entity separate from yourself and you must respect that separation. Monetary liability can be a moot issue—major creditors often require a personal guarantee anyway and in signing that personal guarantee you lose your corporate protection against that debt.
Taxation. Taxation is a separate issue from liability. Taxation is handled by the federal government pursuant to the Internal Revenue Code (IRC). Under the IRC, if you operate as a sole proprietor, partner or general partner, the income or losses of the enterprise are your personal income. If you are a corporation (notice that an LLC is a corporation) then you can elect to file under either sub-chapter S or sub-chapter C of the IRC. If you elect to file under sub-chapter S, then just like a sole proprietor the profit or losses are passed directly to you as your personal income. If you elect to file under sub-chapter C, then the corporation itself files its own tax return. There are advantages and disadvantages to both. Sub-chapter S is very beneficial when the company is losing money. The losses are passed directly to you and can offset other personal income. The disadvantages include the necessity to have a calendar year-end, the inability to take some deductions that sub-chapter C allow, and the problem with “phantom income.” If the company shows a profit, then that is your income whether or not the company disburses cash. You can end up paying income tax at the highest tax scale on money that you don’t even receive. Lazy accountants love to scare people from sub-chapter C with the argument that after the corporation pays its tax if you distribute dividends that money will be taxed again as personal income—double taxation. One must ask, “Who would be so stupid as to do that?” The fact is, the first $50,000 of income in a C corporation is taxed at 15% and most people don’t take out all of the profit from their business anyway. Of course this does require the filing of an additional tax return.
The fact is that there is no right structure for every business. You should consult both your attorney and your accountant to discuss the separate issues of liability and taxation. The weight you put on the advice of one may override the advice of the other. As to taxes, if you think that you are paying too much in tax then you probably are. What is important is that you have an aggressive tax plan in place and constantly review it. As to liability—keep your records straight and your funds separate.
 Note that in Colorado an LLC is taxed as a general partnership.