Business Entities

Key Drivers of Entity Choice

  • Limits to liability: Determines the amount of personal exposure for business debts.

  • Ease of formation/dissolution: Influences how simple or complex it is to start or close the business.

  • Taxation: Different entities are taxed in various ways, affecting overall financial health.

  • Ownership rewards/compensation: Enables proper distribution of profits to owners or shareholders.

Types of Legal Forms of Doing Business

  1. Sole Proprietorship

    • No formal formation documents needed unless using a fictitious name.

    • Taxed at the individual level; subject to self-employment tax plus income tax.

    • Ownership compensation is typically through draws, which are after-tax monies.

  2. Partnership (Subchapter K of the IRC)

    • Types: General, Limited, and Limited Liability Partnerships (LLP).

    • Generally requires a Partnership Agreement.

    • Taxed at the individual level; each partner pays tax on their share of profits.

  3. Corporation (Subchapter C of the IRC)

    • A separate legal entity, limits liability to personal investment.

    • Requires Articles of Incorporation and Corporate Bylaws.

    • Taxed at corporate rates on profits plus dividends taxed at individual rates.

  4. S Corporation (Subchapter S of the IRC)

    • Combines benefits of a corporation with taxation similar to a partnership.

    • Requires Articles of Incorporation plus Federal S Election via Form 2553 and Bylaws.

    • Provides pass-through taxation where profits and losses are passed to shareholders.

  5. Limited Liability Company (LLC)

    • Known as the ‘Burger King of entities’ due to flexibility in taxation and management.

    • Requires Certificate of Organization and a Member Operating Agreement.

  6. Benefit Corporation

    • Can operate as either C or S Corporation but with a focus on public benefit.

    • Taxation depends on classification.

Organizing Documents for Different Entities

  • Sole Proprietorship: No documents required unless using a fictitious name.

  • Partnership: No formal documents, but a Partnership Agreement is crucial.

  • Limited Partnership: Must file a Certificate of Limited Partnership and have a Partnership Agreement.

  • LLP: Requires a Statement of Registration plus a Partnership Agreement.

  • Corporation: Must file Articles of Incorporation and Corporate Bylaws.

  • S Corporation: Articles of Incorporation and Federal S Election via Form 2553 required along with Bylaws.

  • LLC: Needs a Certificate of Organization and a Member Operating Agreement.

Summary of Entity Liability and Taxation

  • Sole Proprietorship:

    • Liability: None

    • Ease: Easy to form

    • Taxed at individual level.

  • General Partnership:

    • Liability: Joint & several liability

    • Ease: Easy to form

    • Tax implications depend on partnership agreement.

  • Corporations:

    • Liability: Limited

    • Ease: Difficult to form

    • Subject to corporate level taxation.

  • Agencies:

    • Definition: Legal arrangements between shareholders, board of directors, and officers.