Business Entities - Notes

Partnership

  • General Partnership:

    • Owners are called partners.
    • Easy to start but should consult with an attorney about the partnership agreement.
    • Unlimited personal liability for partners.
    • Taxed at the owner level (partners report their share of income, losses, expenses on their personal income tax returns).
    • No double taxation.

  • Limited Partnership (LP):

    • Created when a partner doesn't want unlimited personal liability.
    • Requires at least one general partner and one limited partner.
    • A separate legal entity (must provide information to the Secretary of State).
    • The LP takes title to the property, not the individual partners.
    • General partners manage the partnership and have unlimited personal liability.
    • Limited partners have no say in management but have limited personal liability (liability is limited to their investment).
    • Taxed like any partnership (partners report their share of income, expenses, losses on their personal tax returns); no double taxation.
    • If a limited partner dies, it has no effect on the partnership.
    • If a general partner dies, the limited partnership dissolves.

  • Limited Liability Partnership (LLP):

    • For professionals (doctors, lawyers, engineers, accountants).
    • Protects partners from another partner's malpractice.
    • The partner who committed malpractice is still liable, but other partners are protected.
    • Not a separate legal entity.
    • Treated like a general partnership for liability purposes.
    • Individual partners take title to property, not the LLP.

Corporation

  • Owners are called shareholders or stockholders.

  • Managed by a board of directors, who are elected by the shareholders.

  • Officers carry out the functions of the corporation.

  • Shareholders have limited personal liability, limited to their investment if the corporation is treated right.

  • The corporation is a separate legal entity (must get in touch with the relevant authorities).

  • Subject to corporate tax; the corporation earns money, files an income tax return, and pays taxes.

  • If dividends are distributed, they are reported on shareholders’ tax returns and taxed again (double taxation).

  • S Corporation:

    • A corporation can avoid double taxation by making an S election under subchapter s of the Internal Revenue Code (if the corporation meets the requirements of certain and a certain number of shareholders).
    • Taxed like a partnership; owners report their share of income, expenses, and losses on their personal tax returns.
    • Not every corporation qualifies to make the S election.
    • An S election may not be desirable if the corporation intends to roll money back into the business for a long time.
      Corporate tax rates may be lower, resulting in less overall tax if no dividend distributions are made.

  • Downsides to a Corporation:

    • Double taxation (unless S election is made).
    • Requires an operating or shareholder agreement.
    • Must have annual shareholders' and directors' meetings and keep minutes.
    • Failure to meet these requirements can result in the entity being treated as a sole proprietorship or general partnership, which opens up personal liability.

Limited Liability Company (LLC)

  • An attempt to combine the benefits of different entity types.

  • Owners are called members.

  • Can have one or multiple members.

  • Managed either by members (member-managed) or by a manager (manager-managed).

  • The operating agreement specifies whether it is member-managed or manager-managed; otherwise, it defaults to member-managed in most states.

  • Member-Managed LLC:

    • Decisions are made by a majority vote.
    • Any member can bind the LLC in a contract.

  • Manager-Managed LLC:

    • The manager is elected by a majority vote of the members.
    • The manager can be a member or someone outside the LLC.
    • Only the manager can bind the LLC in a contract.

  • Operating Agreement:

    • Important to specify who can sign on behalf of the LLC, especially when borrowing money or entering into contracts.
      Parties doing business with the LLC may want to review the operating agreement.

  • Taxation of LLCs:

    • Can choose to be taxed like a corporation (subject to double taxation) or like a partnership (members report their share of income, expenses, and losses on their personal income tax returns).
    • An LLC might elect to be taxed like a corporation if they plan to pay a lower tax rate at the corporate level.
    • You can't just start doing business and declare yourself as an LLC; there are procedures to follow.