A
Comparison of “Business Legal Structures”
The following
descriptions will give you a basic understanding of each entity
listed. For answers to your questions or more detailed analysis
of a particular entity or entities, please call us toll free
at 1-866-249-2472.
There
are six different business legal entity structures, each offering
certain benefits. They are (click to zoom to each):
Sole
Proprietorship
A sole
proprietorship is simply “you doing business.”
No filing requirements and no formal paperwork is necessary
unless you are operating under a fictitious name in which
case you will need to file a d/b/a with the appropriate
government agency.
As a
sole proprietor you report your income on schedule C of
your federal tax return. The main downside of a sole proprietorship
is the unlimited risk of liability that you face as you
and the business are considered one and the same by the
courts. Everything you own is at risk. If your business
goes bankrupt, you will have to file for personal bankruptcy
as well. There are also a number of tax advantages to forming
an entity that are not available to the sole proprietor.
General
Partnership
A general partnership
is formed when two or more individuals or entities agree
to carry on business together for a profit. There may or
may not be a written agreement.
The partnership
itself does not pay taxes, but instead files an informational
return on IRS form 1065 which summarizes the income, expenses
and the profit or loss of the partnership business. All
profits or losses flow through to the partners and are reported
on schedule E of their respective individual income tax
returns. The partnership will send each partner an IRS form
K-1 explaining their share of the profit or loss.
A general partnership
affords no liability protection for the partners, and in
fact, any partner can be held jointly and severally liable
for the tortious acts of the other partners.
Corporation
A corporation
is an entity that exists separate and apart from its shareholders.
To establish a corporation, “articles of incorporation”
must be filed with the appropriate secretary of state, and
the list of officers and all annual fees must be maintained.
The corporation issues stock to the owners/shareholders,
the shareholders elect a board of directors and the directors
appoint the officers of the company.
The major decisions
are made by the board of directors noted through minutes
of meetings and/or resolutions while the day to day operations
are performed by the officers of the company.
In most states
one individual can act in all capacities – director,
president, secretary and treasurer. It is important to disclose
which capacity he/she is acting in when making various decisions
and taking various actions.
C-Corporations
versus S-Corporations
There are two
types of corporations for tax purposes, C-corporations
and S-corporations. All corporations start out as C-corporations.
You must make an election — a choice — on
form 2553 with the IRS to be taxed as an S-corporation.
All large,
publicly traded corporations are C-corporations as well
as many small and family owned businesses. C-corporations
file their own tax return on IRS form 1120, and they pay
their own taxes which can be considerably lower than some
personal rates on the first $50,000 to $100,000 of net
income. If those profits are later paid out to the shareholders,
they are taxed again as dividends. The current tax rate
on dividends has a maximum rate of 15%.
An S-corporation
is a “flow through” entity. It files an informational
return on IRS form 1120-S, and reports the shareholder’s
profit or loss on form K-1. A big advantage to the S-corporation
is the reduction in self employment taxes that can be
taken.
The S-corporation
has some ownership restrictions in that it can only be
owned by US citizens, another S-corporation or a single
member LLC, and it can have no more than 75 shareholders.
Limited
Partnership
A limited partnership
is made up of at least one limited partner and one general
partner. Most states require that a limited partnership
certificate along with the required fees be filed with the
secretary of state in order for the limited partnership
to become effective.
Limited partners
generally have no liability over and above their contributions
to the partnership, and they are not liable for the tortious
acts of the other partners. In exchange for this limited
liability, the limited partners must give up all rights
to participate in the control and management of the partnership.
The general partner
controls and manages the partnership including any disbursement
of cash to the limited partners. The general partner has
unlimited liability to the creditors of the partnership
including wrongful conduct within the partnership business
to third parties.
The limited partnership
does not pay federal income tax, but files an informational
return on IRS form 1065, and issues K-1’s to the limited
partners. The partners must pay federal income tax on their
proportionate share of any income whether or not it is distributed.
Creditors of
individual limited partners cannot replace a limited partner,
but may only receive the partner’s share of distributions,
if any. This benefit to the limited partner is called a
“charging order.” The creditor receives no right
to participate in the management of the partnership.
Limited
Liability Company
Limited liability
Companies (LLCs) are formed by filing “articles of
organization” with the secretary of state. The LLC
is owned by members rather than shareholders, and, like
the shareholders of a corporation, are not liable beyond
their contributions to the LLC. Unlike a limited partner,
members can participate in the management of the company.
The LLC can be
run by its members or by a manager which can be either a
corporation or an individual who may or may not be a member.
When an LLC is “manager-managed” (as apposed
to “member-managed”), it is similar in operation
to a limited partnership. The manager makes all the day
to day decisions and signs for the obligations, but, unlike
a general partner, is not liable for the debts or other
obligations of the company. When the LLC is managed by its
members, all of the members can participate in the management
and control of the company. The members, however, are not
liable for the debts and other obligations of the company.
The decision on how the LLC will be managed should always
be spelled out in the “operating agreement”
– the replacement to the bylaws in a corporation.
LLCs with two
or more members are taxed as a partnership with the LLC
filing an informational return on IRS form 1065. The members
receive a K-1 reflecting their proportionate share of profit
or loss.
The LLC is the
only entity that offers the flexibility of a partnership
with all of the protection of a corporation. The LLC is
an excellent tool for asset protection as it offers ease
of operation, tax savings and maximum protection. The charging
order mentioned under the limited partnership section of
this page is also applicable to the LLC.
An LLC can also
be owned by one member only, providing the protection as
above, but with the simplicity of being a disregarded entity
for tax purposes. The income flows directly to the individual’s
or entity’s tax return with no filing requirements
of its own. The “single member” LLC is also
the only entity that can be used for 1031 real estate transactions
when owned by an individual.
|
