Partnerships, LLCs, and Corporations
The legal form of your business—whether it is a sole proprietorship or partnership, limited liability company (LLC), or corporation—can have a great impact on several key issues faced by business owners. Not only can incorporating your business or forming an LLC provide significant tax benefits, it can also help protect you from personal liability for your business’ debts and obligations.
Partnerships and sole proprietorships are very similar, legally. In both situations, the business is primarily responsible for its own debts. However, if the business’ assets are not enough to satisfy a debt, the proprietor or partners are responsible for paying the remaining amount, and must use their own personal assets, including their bank accounts, cars, and house, to pay the debt. Additionally, if the partnership or sole proprietorship is sued, the plaintiff can sue not only the business, but can also sue the individual business owners personally. If a money judgment is rendered against the business and its owners, the owners are personally liable—meaning they must pay the judgment with their own assets and property.
Corporations and LLCs help to solve the problems of personal liability that accompany sole proprietorships and partnerships. Both create a separate and new legal entity—the corporation or LLC itself—which owns and operates the business. This creates a shield for the owner of the LLC or corporation from the debts and other financial obligations of the LLC or corporation, and also shields the owner of the business from personal liability in lawsuits involving the business. Additionally, use of the LLC or corporation format for your business also provides significant tax benefits. Most attorneys can help you decide which structure would provide the greatest benefits to your business, tax-wise.
The primary differences between corporations and LLCs on a non-tax level relate to the structure of the entity itself and the ease with which the entity can be created. In general, LLCs are considered to be simpler, both in structure and in creation, and this makes them attractive to many small business owners.
Both LLCs and corporations are created by filing an application with the Secretary of State. These applications include certain required information, such as the name of the business, and certain statements regarding the structure and purpose of the business. Corporations must include a statement of the corporation’s purpose, the total number of shares that the corporation may issue to stockholders, and the full name and address of each person incorporating the business. Corporations must also list the location of the corporation’s registered office, and must designate a person to act as agent for the corporation. The agent must accept service of lawsuits and other legal documents on behalf of the corporation. LLC applications require only the name and purpose of the LLC, and the address of the LLC. Like corporation applications, LLC applications must also designate a legal agent for the LLC. Both corporations and LLCs must file an annual report with the Secretary of State which provides current information regarding the business.
The structure of corporations and LLCs differ widely. Corporations are owned by shareholders, who own stock in the corporation. This stock is purchased from the corporation either with money or property. The corporation is managed or run by a board of directors. This board of directors can be as small as one person or as large as the person creating the corporation wishes it to be. The board directs the corporation’s business, so its members should always be chosen with care. Board members and employees of the corporation may be paid a salary by the corporation. Additionally, if the corporation makes a profit, stockholders may receive dividends, which are payments of a share of those profits. This share of the profits is determined by the amount of stock owned by each stockholder.
In contrast, LLCs are owned by “members.” There are no restrictions on the number of LLC members, and a LLC may have only one member. Unlike corporations, unless the LLC specifically designates otherwise, the members also manage the affairs and business of the LLC. These members contribute things of value to the LLC in exchange for their position as a member. These things of value can include cash, property, or services rendered, among other contributions. LLCs also differ from corporations in the way in which profits are distributed. In a corporation, stockholders receive a percentage of the profit based upon the number of shares they own. In a LLC, however, all profits and losses are usually shared equally among all members.
In general, LLCs and corporations have major advantages over sole proprietorships and partnerships. They provide significant tax benefits, and shield business owners from unnecessary personal liability and debt. Speaking with an attorney is the first step to obtaining these advantages for yourself and your business. Your attorney can provide you with more information on this topic, including more complete explanations of the topics presented in this article and help determining whether a LLC or corporation would be better for you.