Basics of Business Formation in Alabama: What Are the Forms of Business Entities?

What Are the Forms of Business Entities?

Starting a business in Alabama begins with a critical decision: choosing the right legal structure. The form of business entity you select will affect everything from your personal liability and tax obligations to your ability to raise capital and manage operations. In this first installment of our series, we’ll explore the primary types of business entities recognized under Alabama law.

1. Sole Proprietorship

A sole proprietorship is the simplest and most common form of business. It is owned and operated by one individual and there is no legal distinction between the owner and the business. While easy to set up, sole proprietors are personally liable for all business debts and obligations.

Under Alabama law, a sole proprietorship is defined as “a business in which one person owns all the assets, owes all the liabilities, and operates in his or her personal capacity.”[1] “Alabama law makes no distinction between an individual and a sole proprietorship operated by the individual. They are considered the same for legal purposes.”[2]

Key Features:

• No formal registration required with the state
• Owner reports income on personal tax return
• Full personal liability (no liability protection)

2. General Partnership

A general partnership involves two or more individuals who agree to share in the profits and liabilities of a business. Like sole proprietorships, general partnerships do not require formal registration, but a partnership agreement is strongly recommended.

In Alabama, partnerships are governed by the Alabama Partnership Law, Ala. Code § 10A-8A-1.01, et seq. “A partnership is a separate legal entity.”[3] A partnership is created when there is an association of two or more persons “to carry on as co-owners a business for profit” regardless of whether or not the persons intend to form a partnership.[4] A partnership may either be governed by a written partnership agreement or, if none, then by the Alabama Partnership Law.[5] Generally speaking, all partners are jointly and severally liable for all obligations of the partnership.[6]

Key Features:

• No formal registration required with the state
• Shared management and profits
• Joint personal liability (no liability protection)
• Optional partnership agreement

3. Limited Liability Company (LLC)

An LLC is a popular choice for small to medium-sized businesses due to its flexibility and liability protection. Owners (called “members”) are generally not personally liable for business debts, and the entity can choose how it wants to be taxed.

In Alabama, LLCs are covered by the Alabama Limited Liability Company Law, Ala. Code § 10A-5A-1.01, et seq. The LLC is formed by one or more organizers filing a “Certificate of Formation” with the Secretary of State.[7] The LLC typically adopts a “limited liability company agreement” (sometimes called an “operating agreement”) to define the structure and management of the company.[8] The company agreement may be written, oral, or implied.[9] If the company agreement does not provide for a matter, then the LLC Law governs.[10] Generally (see article on limitations here), a member of an LLC is not personally liable for any debts, liabilities, or other obligations of the LLC.[11]

Key Features:

• Limited liability for members
• Flexible management structure
• Pass-through or corporate taxation options
• Requires filing a Certificate of Formation

4. Corporation (C-Corp and S-Corp)

Corporations are more complex entities that are legally separate from their owners (stockholders). They offer strong liability protection and can be ideal for businesses seeking to raise capital through stock issuance.

In Alabama, corporations are covered by the Alabama Business Corporation Law, Ala. Code § 10A-2A-1.01, et seq. The corporation is formed by one or more incorporators filing a “Certificate of Incorporation” with the Secretary of State.[12] The corporation must adopt “bylaws,” a binding contract between the corporation and the stockholders to govern the corporation.[13] The corporation must have a “Board of Directors,” and it is this board that has all corporate powers and authority for management of the corporation.[14] The stockholders have the right to elect the directors and to receive distributions.[15] Generally, “[a] stockholder is not personally liable for any liabilities of the corporation.”[16]

Key Features:

• Limited liability for stockholders
• Formal governance (board of directors, officers)
• Subject to corporate taxation (C-Corp) or pass-through taxation (S-Corp, if elected)
• Requires filing Certificate of Incorporation
• Requires Bylaws

5. Limited Partnership (LP) and Limited Liability Partnership (LLP)

These entities offer variations on the partnership model. In Alabama, limited partnerships are covered by the Alabama Limited Partnership Law, Ala. Code § 10A-9A-1.01, et seq.

An LP includes both general and limited partners, where each general partner has equal governing control of the business,[17] and the limited partners have restricted liability and involvement.[18] Thus, an LP may be a good structure for a business that wants to concentrate control in one person (or small group) yet also have passive investors.

An LLP provides liability protection to all partners, often used by professional service firms. The Alabama Partnership Law includes a provision whereby a general partnership may elect to become a limited liability partnership by completing certain formalities, including filing a statement with the Secretary of State.[19]

Key Features:

• LP: General partners manage; limited partners invest
• LLP: All partners have limited liability
• Requires registration with the state

6. Nonprofit Corporation

Nonprofits are formed for charitable, educational, religious, or similar purposes. They must apply for tax-exempt status with the IRS and follow specific governance rules.

In Alabama, the entity is covered by the Alabama Nonprofit Corporation Law, Ala. Code § 10A-3A-1.01, et seq. The entity is formed by filing a Certificate of Incorporation with the Secretary of State.[20] The entity must adopt Bylaws to set forth the rules for the entity’s management.[21] The entity is managed by a Board of Directors.[22] While the formation of the nonprofit entity is a relatively easy process, the more difficult and unique aspect of formation is seeking tax-exempt status from the IRS.

Key Features:

• No profit distribution to members
• Tax-exempt status (if approved)
• Requires registration with the state
• Requires Certificate of Incorporation and Bylaws
• Requires IRS application and annual IRS reporting

Final Thoughts

Choosing the right business entity is a foundational step in launching your venture. Each structure has its own legal, tax, and operational implications. In other posts, we’ll dive deeper into the formation process, filing requirements, and best practices for each entity type.