One of the first things you must decide when starting a new business is what type of business entity form should you choose? This decision has short-term and long-term consequences and requires consideration of both your immediate and future business plans. To determine what corporate form is right for you, consider the following:
Although not exhaustive, below is a brief overview of the most common forms of business entities:
This is essentially no corporate form at all. As a result, the owner is liable for all the business’ debts, obligations, and liabilities. This means that the owner is personally liable for all contractual obligations (such as leases and vendor agreements), or for any injuries or damages caused by the actions, or lack thereof, of the business (such as slip and falls on the business’ premises, defective products sold, or deficient services provided).
Since there is no separate business entity, the owner reports his/her income or losses from the business on his/her personal income tax return and pays separate self-employment taxes.
There is little paperwork involved, as there is no entity being created or partnership terms that need to be defined. However, you will have to make sure to comply with all state and local licensing/registration requirements that may be applicable to your business, and you may want to register a “doing business as” name with the applicable state or local agencies. And if you want to close the business, you simply stop doing business.
A general partnership is basically the equivalent of a sole proprietorship for a business with two or more partners. Like a sole proprietorship, the partners of a general partnership are personally and jointly liable for all for all the business’ debts, obligations, and liabilities.
Even though there is no distinct entity being created, the partners must prepare a partnership agreement that details each partner’s interest and the terms to govern their relationship and the management and control of the business. The partners will also have to make sure to comply with all state and local licensing/registration requirements that may be applicable to the specific type of business, and the partners will likely need to register a “doing business as” name with the applicable state or local agencies.
Although general partnerships file an IRS Form 1065, the partners report their individual percentage of the income or losses on their personal income tax returns and are subject to self-employment taxes.
A limited partnership is the same as a general partnership, with one major exception. In a limited partnership, a “general partner” is designated to control the operations of the business while a “limited partner” contributes capital and receives a percentage of the profits of the business. Under this form, the general partner is personally liable for all the business’ debts, obligations, and liabilities. However, the limited partner’s liability is limited to the total amount of his/her investment in the business.
By providing for the designation of limited partners, this form of business works well for a sole proprietary in need of passive investors
All of the partners report their individual percentage of the income or losses on their personal income tax returns, but only the general partner is subject to self-employment taxes.
An LLC provides for the management and control of partnership with the liability protections of a corporation. In fact, an LLC can have only a single member/shareholder, like a sole proprietorship. In an LLC, the members are protected from personal liability for the debts and liabilities of the LLC, unless they have engaged in some form of unlawful conduct in the carrying out of activities of the LLC. Moreover, if the LLC does not maintain a minimum level of corporate formalities, such as a separate bank account and books, the “corporate veil” of protection may also be pierced by someone pursuing a claim against the LLC and its members.
Like a partnership, the members/shareholders must prepare an operating agreement that details each member’s interest/shares in the LLC and the terms to govern their relationship and the management and control of the LLC. If a single-member LLC should have an operating agreement in case it wants to later add new members, there will already be a framework in place to do so.
LLC’s must be registered with the State of formation and should obtain federal and state tax identification numbers. The LLC should also register with any State in which it intends to conduct business.
For tax purposes, a single-member LLC is generally disregarded as an entity for income taxes, with the member reporting the LLC profits or losses on his/her personal tax return unless it files an IRS Form 8832 and elects to be treated as a corporation. The member also pays self-employment taxes. However, a single-member LLC is treated as a distinct entity for employment and certain excise taxes. An LLC with at least two members is treated as a partnership for federal income taxes unless it files an IRS Form 8832 and elects to be treated as a corporation. Each member who is active in the management of the LLC must also pay self-employment taxes.
There are a few different kinds of corporations, but we won’t be getting into too much detail about each one. A corporation is an entity separate from the owners/shareholders with its own rights. The owners and shareholders are generally protected from personal liability for the debts and liabilities of the corporation
Corporations should have a shareholder’s agreement and bylaws that detail the terms to govern their relationship and the management and control of the corporation. A corporation must also be registered with the State of formation and should obtain federal and state tax identification numbers. A corporation should also register with any State in which it intends to conduct business.
A C corporation is owned by shareholders and taxed as a separate entity. There can be an unlimited number of investors in a C corporation, making it great for a company in need of a lot of capital investment or one that plans to go public.
An S corporation is not so much a corporate form, but rather a tax designation that may be available to an existing corporate entity. For that reason, we will not get into the specifics in this post.
A B corporation is also known as a “benefit” corporation that meets specific criteria to demonstrate it is structure to make a positive impact on society.
A Nonprofit corporation is a tax-exempt entity that must meet specific IRS criteria and be structured to have a purpose other than making a profit.
If you are thinking about forming a business, or if you already have an existing business that’s needs may be better served by a different form, contact Michael Ansell, Esq. at NextGen Counsel to discuss what business form is right for you.
Information contained in this post is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult with Michael H. Ansell, Esq., or other competent legal counsel.
NextGen Counsel is not engaged in the providing of tax advice. NextGen Counsel does not offer, nor profess to provide any information or advice regarding the application or impact of federal, state, or local tax statutes, regulations, ordinances, guidelines, advisory opinions or other requirements or information provided by governmental agencies and authorities. NextGen Counsel strongly recommends that the you consult with your tax professional regarding the applicability and impact of the foregoing.