As you venture into a new business you must decide the kind of business organization or “entity” that you wish to establish to operate your business. The structure you choose is important in many ways because each kind will have varying tax filing requirements, state and local registration requirements, and varying personal liability for business activities.
Some of the common business structures include the Corporation, Limited Liability Company, Limited Partnership, and Sole Proprietorship. Below you shall find some basic information about these structures
The sole proprietorship is basic and informal that is relatively inexpensive to form. Generally a single person or a married couple owns operates the business. The owner(s) is personally liable for all business debts, can freely transfer all or part of the business, and can report profit or loss on personal income tax returns. There is generally no delineation between the business and its owner(s) in terms of business assets and liabilities.
Limited Liability Company (LLC)
The LLC can be an advantageous structure for a small business because of the limited liability principles that are combined with the tax advantages of a partnership or sole proprietorship. In essence the LLC is its own person. As such the owners are generally shielded from the liabilities of the business, notwithstanding any voluntary assumption of those liabilities such as signing as a guarantor or using the LLC as an alter-ego etc. Profits and losses may be passed through the company to the members or the LLC can choose to be taxed as a corporation. LLCs do not have stock and have fewer formalities than a Corporation when it comes to the operating integrity. Owners are called members, and the LLC is managed by these members or by appointed managers.
LLCs can be either multi-member or single member owned. There is a discussion in the estate and business planning community regarding the use of the LLC in asset protection plans. In essence, there is a trend, (and a very bad one to follow) to try and use the theory that the charging order remedy, which is generally the exclusive remedy of a judgment creditor of a member of an LLC with regard to executing upon that member’s interest in the LLC, will protect the members assets which are in an LLC to protect assets from member creditors.It is imperative that people do not execute these kinds of plans without the advice of experienced legal counsel. In many cases, people are finding that their asset protection plans fail. The primary reason for this failure is because the charging order sole remedy, which is well settled law, was and is not intended to shield the judgment debtor’s assets, but instead, to protect the non debtor partner/co-member’s business interests in the company from the judgment debtor’s personal liabilities and creditors. Therefore, many cases involving single member LLC’s have been ruled on with decisions coming down in favor of the creditors because there are no partner’s interests to protect. See the following cases for example: See Olmstead v. F.T.C., — So.3d —-, 2010 WL 2518106 (Fla. Jun 24, 2010); In Re Albright 291 B.R. 538 (2003); A-Z Electronics, LLC, 350 B.R. 886 (2006); In re Modanlo, 2006 WL 4486537 (D. Md. 2006) (slip copy).
The LLC remains in my opinion an advantageous structure as discussed above for business operation purposes; and with proper planning, purpose, and posture it still has a functional role that will provide incidental asset protection.
Partnerships are easy to form and often difficult to untangle when things do not go as expected. They require an agreement between two or more individuals or entities to jointly own and operate a business. Profit, loss, and managerial duties are shared among the partners, and each partner is personally liable for partnership debts. Partnerships do not pay taxes, but must file an informational return; individual partners report their share of profits and losses on their personal return. Short-term partnerships are also known as joint ventures.
Limited Partnerships are more evolved than the general partnership and are the “older cousin” to the Limited Liability Company. In essence, there is a general partner who operates the business, and a limited partner who is essentially a stakeholder/investor. The Limited Partner’s liability for business liabilities is generally limited to whatever his capital contribution was, while the general partner is generally liable as with a general partnership. There are some registration formalities with a LP, and the limited partner is generally precluded from partaking in the management of the business.
C Corporation (Inc. or Ltd.)
The corporation is probably the most complex business structure with generally more startup costs than many other forms. A corporation is a legal entity separate from its owners, who own shares of stock in the company. Corporations can be created for profit or nonprofit purposes and may be subject to increased licensing fees and government regulation than other structures.
Profits may be taxed both at the corporate level and again when distributed to shareholders.
Shareholders are not personally liable for corporate obligations unless corporate formalities have not been observed; such formalities provide evidence that the corporation is a separate legal entity from its shareholders. Failure to do so may open the shareholders to liability of the corporation’s debts. Corporate formalities include: issuing stock, holding annual meetings, recording the minutes of the meetings, electing directors or ratifying the status of existing directors.
Sub Chapter S Corporation (Inc. or Ltd.)
This is a Corporation that has elected to be taxed as a partnership. If a corporation qualifies for S status with the IRS, it is taxed like a partnership; the corporation is not taxed, but the income flows through to shareholders who report the income on their individual returns.