There are four basic types of business entities: sole-proprietorships, partnerships, corporations and limited liability companies, each with its own advantages and disadvantages. Consider these factors when you are choosing which is right for your business including tax aspects, legal requirements and the potential for personal liability.
A sole-proprietorship is a business that is owned by a single individual (or by a husband and wife) that is not a corporation or a limited liability company. There are no legal requirements to comply with in order to create and maintain this business structure. The biggest disadvantage is that you, the business owner, are held personally liable for the debts of the business. This means that if someone sues your business and obtains a judgment against it, you will be responsible for paying it even if it exceeds the entire worth of your business. You should evaluate the potential risk of this kind of liability for your type of business to determine whether you should operate as a corporation or limited liability company instead. In addition, a sole-proprietorship cannot provide as favorable retirement or fringe benefits to its owners as a corporation.
A partnership is a business that is owned by more than one individual (not a husband and wife) that is not a corporation or a limited liability company. Nothing is required to establish the business as a partnership, it happens automatically when two or more people own a business that is not a corporation or a limited liability company. However, it is a good idea to have a written partnership agreement which spells out the commitments of the parties, including how much and what they will contribute to the business, how they will draw profits and share losses, and who will have authority and responsibility for making various decisions among other things. Especially important are provisions that provide for a buy out of a partner's interest in the event of a death or a dissolution of the partnership. If the owners of the business do not make a written partnership agreement, state partnership law determines the obligations of the owners.
A corporation can be owned by one or more individuals. Each state’s laws spell out the requirements for setting up a corporation in that state. Generally, establishing a corporation involves the drafting the Articles of Incorporation and By-Laws as well as the issuance of stock.. The Articles of Incorporation are filed with the State and a Certificate of Incorporation is issued to the business. The main advantage of operating a business as a corporation is that the liability of the owners for the debts of the corporation is limited to their investment in the business. The biggest disadvantage is that the business must adhere to the corporate structure by conducting shareholders and directors meetings, which can be cumbersome for small businesses. Also, a shareholders' agreement is essential to provide for a shareholder's death or other buyout event.
Each state’s laws spell out the requirements for operating a business as a limited liability company. The basic structure of an LLC is that it combines the management aspects of a partnership with the liability advantage of a corporation. This makes a very desirable structure for a business. However, like a corporation, there are legal requirements that must be met in order to preserve the status of the business as an LLC. Special care is also required in establishing the LLC to make sure the desired tax status is obtained. You should consult an attorney who practices business law to establish your limited liability company.
What is a limited Liability Company (LLC) and is it a better form for your business than a corporation? LLC’s generally have all the benefits of a corporation when it comes to limiting the business owner’s liability. The advantage of an LLC is the management flexibility it allows, and the potential tax benefits.
LLC’s allow a business to have the limited personal liability of a corporation as provided by state law, while being treated as a partnership for purposes of Federal Tax laws. The downside to an LLC is that you do not get the free transferability of ownership, perpetual existence, and the ability to be totally owned by a single individual that you would get with a corporation. That is the trade off you make to get the Partnership tax status and greater management flexibility.
If the company’s business plan includes raising capital by someday admitting new members or going public, then a Corporation is probably the more desirable form for the business. Limited Liability Companies generally restrict the transfer of ownership interests in the business to make sure the business is classified as a Partnership under federal tax law. An LLC usually has a limited existence in that it will end after a specific umber of years or upon the occurrence of some specified event. This requirement is intended to help the business qualify as a Partnership for purposes of tax law.
Being taxed as a Partnership makes the LLC structure particularly attractive because it gives the owners a great deal of flexibility in allocating profit and loss. Operating as a Limited Liability Company also gives the owners greater flexibility in determining who manages the business and what each owner’s particular duties are in that regard.
Determining whether any particular business would benefit from being structured as a Corporation or a Limited Liability Company is a complex decision. The law firm of Frank W. Daly & Associates, Inc. has organized hundreds of such businesses and can assist you in determining what the possible consequences of each such structure would be for your business.
Not every corporation is a C-Corporation or an S-Corporation. If certain professionals want to operate as a corporation, they must incorporate as a Professional Corporation. Other types of organizations that want to incorporate may qualify to incorporate as a Non-Profit Corporation.
While federal tax law determines how various types of corporations are taxed, it is the various State’s laws that authorize the formation of businesses as corporations. Generally, a corporation may be formed to operate any lawful business. However, professions that carry a risk of professional liability are required to incorporate as Professional Corporations. Doctors, medical professionals, lawyers and accountants are some examples of professionals who would need to incorporate as Professional Corporations. The exact professions will vary from state to state.
Incorporating allows these professionals to limit their personal liability for business debts and for the malpractice liability of their business partners. For example, if two doctors practice together in a partnership, each could end up paying for any malpractice damages awarded against the other. However, if they operate their business as a professional corporation, the doctor who does not commit malpractice will NOT be personally liable for the malpractice of the other doctor. However, the professional corporation law requires that the business carry adequate malpractice insurance. Both doctors will also be protected from personal liability for the actions of employees, as well as for other business debts.
Another alternative form of incorporation is a Non-Profit Corporation. Different state laws will apply to forming a nonprofit corporation. Generally, businesses that have a religious, charitable, literacy, scientific or educational purpose may form as nonprofit corporations. A nonprofit corporation will usually try to qualify as a tax-exempt corporation under the Internal Revenue Code as well. This means that the corporation will not have to pay federal taxes on profits. Act carefully when considering to incorporate as a nonprofit business; once you incorporate as a nonprofit corporation, you will no longer own the business. A nonprofit corporation does not have shareholders. Its profits are to be used only to support its religious, charitable, literary, scientific or educational mission. This does include paying its employees a reasonable salary.
Because each type of corporation has different requirements regarding how the corporation is formed and how it must be operated, you should check with an attorney who practices in the area of these alternative forms of corporation to discuss which is right for your business.