As anyone who has started a business can attest, there are several choices a business owner must make even before making the first sale. Specifying the structure of the business, both from a liability perspective and a tax perspective, is one of them.
There are four general categories of business entities. While choosing the business designation, it is best to consult with an experienced business law attorney, who will be qualified to give advice which will protect you not only legally, but also will benefit the business’ year end taxes.
1) Unincorporated Associations
Sole proprietorships and general partnerships are both under the umbrella of an unincorporated association. Unlike most companies, however, unincorporated associations are not required to register anything with the Secretary of State in which business is held.
Unincorporated associations, under the law, have no legal separation between the individual owners and the business. In the case of financial hardships, the business owners may find themselves financially liable.
General partnerships fall into the same category of unincorporated associations as sole proprietorships, but a general partnership is an association of two or more persons who are both co-owners in a business. Corporations can be a legal person in this instance, and are entitled to be a partner. This partnership may be formed orally or in writing. The partners are fiduciaries to each other, meaning a partner has the legal duty act with loyalty and utmost good faith. Further, a partner’s actions and decisions may obligate the other partners to the same actions.
An owner of an unincorporated association may try and protect themselves by purchasing liability insurance or by moving their personal assets into trusts.
2) Registered Partnerships
Unlike a general partnership, which is not required to register with the Secretary of State, there are certain types of partnership structures that can register with the Secretary. Limited partnerships (LP), for example, are a statutory business organization. This specific partnership must have one or more general partners who manage the business, and one or more limited partners who do not participate in the management of the business. The limited partner’s liability is limited to the amount of their investment in the business, and may at any point, transfer their interest to a third party. Unlike a general partnership, a limited partnership must file a limited partnership certificate with the Secretary of State, which must be signed by a general member of the partnership. This filing is public record. If not filed, then the partnership is considered a general partnership, and the limited partner does not have the liability restriction described above.
Limited liability partnerships (LLP) are similar to a general partnership, but as long as the LLP status is maintained, the individual partners are not wholly responsible for debts, obligations, or liabilities of the LLP except to the extent in which the liabilities were part of that individual partner’s wrongful acts or errors. As with the limited partnership, the LLP must file a registration statement with the Secretary of State.
3) Limited Liability Companies (LLC)
Yet another statutory business organization, the LLC has similarities to the LP, LLP, and corporation. The owners of an LLC are called members, and an LLC may have one or more members. By default, the member or members manage the LLC, but the members may appoint one or more managers to handle day-to-day operations. This type of business entity is formed by filing a certificate of organization with the Secretary of State,
Similar to an LLP, an LLC designation limits the liability of its members. Other benefits of this election include flexible tax treatment. The LLC generally has the option to be taxed as a pass-through entity (as a disregarded entity if owned by one member, or a partnership if owned by more than one member) or a corporation, depending on the LLC’s tax and financial goals.
4) Corporations
A corporation can be formed by preparing Articles of Incorporation and filing it with the state of incorporation’s Secretary of State office. A corporation is a legal entity separate from its shareholders, meaning the corporation can sue or be sued. Generally, shareholders are not personally liable for corporate debts, and thus, a shareholder’s personal assets are protected from business creditors.
Profits from the corporation can either be reinvested into the corporation or paid out to the shareholders through a dividend. How that dividend is taxed depends on the tax structure of the corporation. To learn more about tax and management structures of corporations, click here.
There are both privately-held and publicly-tradedcorporations. Publicly-tradedcorporations’ shares may be bought by the public on a public exchange (such as the New York Stock Exchange or NASDAQ), but only after a company goes public by registering itsshares with the Securities and Exchange Commission.
Closely held corporations are corporations that have a small number of shareholders, typically among family members.
S-corporations, are an election that a corporation can make with the IRS to change its tax structure by filing Form 2553 with the IRS. The legal structure of the corporation itself remains inherently the same; however, as a “pass-through entity”, the shareholders will only pay tax once on income earned through their individual return. To learn more about S-corporations, click here.
Not-for-profit corporations are a specifically formed for purposes other than operating a profit-seeking business, such as charitable or educational purposes. They are also referred to as 501(c) corporations, named after the non-profit organizations section in the Internal Revenue. Not-for-profit corporations do not have any shareholders, but they are managed by directors.
Professional corporations are corporations with special registration status that allows them to render certain professional services. States may require companies providing professional services (such as medicine, accounting, or legal services) to be registered as a professional corporation in order to provide those services, and those states may place restrictions on who can own such a corporation. For example, all 50 states prohibit non-lawyers to own shares in professional corporations that provide legal services.
Determining which corporate structure to have for your business requires understanding your business and financial goals, and it is best to speak with your attorney and accountant before either starting or changing your organization’s structure.
Matt DeNoncour is the owner of Magis Law Firm, a solo law firm located Boston, MA, where he provides legal services to the healthcare, biotechnology, and business communities. You can reach Matt at magislawfirm.com, by phone at 857-242-6826 or by email at matt@magislawfirm.com. This post is not meant to be legal advice: learn more here.
