Whether you are starting a new business or considering changing your business structure, the first step is determining what type of business entity is right for you. The needs of every business are different and the type of entity you choose depends upon your business objectives. It is important to seek legal and accounting advice to explore the complicated distinctions among the available business structures and to evaluate which features are most important to you.
Of the many types of business entities to consider, the most common are:
- · Corporations (C-Corps)
- · General Partnerships
- · Limited Partnerships (LPs)
- · Limited Liability Companies (LLCs)
- · Subchapter S Corporations (S-Corps)
The key differences between these structures relate to (i) the extent to which the entity will protect its owners from liability; (ii) the taxation of the business and/or its owners, and (iii) the corporate formalities and filings required by the state. This article serves as an initial overview of the different types of business entities available to you and will introduce you to some of the basic attributes of these entities and the questions to consider in choosing a business structure. However, determining which type of entity to form is a complex undertaking and there are many legal and financial nuances not discussed in this article. The ultimate decision should be made in conjunction with your attorney and tax advisor to ensure that your entity is formed properly and that the structure you choose is well suited to achieve your business goals.
A corporation is formed by filing certain statutorily required documents with the Secretary of State. The main advantage of structuring your business as a corporation is that a corporation is a separate legal structure that protects its owners from being held personally responsible for the liabilities of the company. Corporations can also raise capital for growth more easily through the sale of stock. This structure, however, carries with it strict organizational, record keeping and filing requirements. In addition, C-Corps are subject to “double taxation” because the business is taxed on its profits when earned and the shareholders are taxed when those profits are distributed to them as dividends.
A general partnership is an association of two or more persons to carry on a business for profit. All partners enter into a partnership by either written or oral agreement and the partners have a great deal of control over the management and operation of the business and the distribution of profits among partners. Partnerships are not separately taxed entities like C-Corps and therefore do not have the disadvantage of double taxation. Instead, general partnerships provide their partners with “pass through” taxation where each partner reports his or her share of the partnership profit or loss on his or her individual income tax returns. Unlike corporations, however, general partnerships do not provide liability protection for their partners. Instead, partners are jointly and severally liable for the legal and financial obligations of the partnership and for any wrongful act performed by any partner while acting in the ordinary course of partnership business.
A limited partnership is a partnership formed with one or more general partners and one or more limited partners which provides its partners with pass through taxation like a general partnership. A general partner participates in the management of the partnership and has the same unlimited liability for partnership debts or obligations as does a partner in a general partnership. Limited partners cannot participate in the management of the limited partnership, but have limited liability in that they are not responsible for partnership debts or obligations beyond their individual capital contributions to the partnership. A limited partner can, however, lose this limited liability protection if he or she participates in the management of the limited partnership.
Limited Liability Companies
The Limited Liability Company is one of the most popular business entities because it is a hybrid business organization that provides its owners (also called members) with many of the advantages of corporations and general partnerships. Each member in a limited liability company has liability protection like a shareholder of a corporation and the business itself is not taxed on its profits as is a C-Corp. Instead, LLCs provide members with pass-through taxation like a general partnership where the member reports the limited liability company’s profit and loss on his or her personal tax return and a corporate tax return is not filed. In addition, LLCs are not required to observe many of the formalities and filing requirements of a corporation.
Subchapter S Corporations
The S-Corporation is another frequently utilized business structure, especially among smaller businesses and startup ventures. An S-Corporation is a corporation that receives an S-Corp designation from the Internal Revenue Service. A company must first be formed as a corporation with the Secretary of State before filing a Subchapter S election with the IRS. Although S-Corps and LLCs share many advantages, they also have distinct differences. Like LLCs, S-Corps receive many of the advantages of a C-Corp, including limited liability protection, but eliminate “double taxation” in that profits and losses pass through to the personal tax returns of the owners like in a partnership or limited liability company. Unlike LLCs, however, there are significant restrictions as to the size and composition of businesses seeking an S-Corp designation.
Determining the appropriate type of organizational structure for your business is crucial to its long-term operation and growth. The structure of a business impacts the way it is taxed, the way profits and losses are allocated, its ability to raise capital, and the exposure of its owners with respect to liabilities of the business. In addition, proper formation of your business can help reduce the costs associated with growth and limit your exposure to future liabilities. Please contact us to discuss your objectives and other specific considerations and how we can help identify and implement the appropriate structure for your business.