Business Entities: Flashcards

Learning Objectives

  • Understand the motivational drivers behind entity choice.
  • Familiarize with major legal forms of doing business and how each is taxed.
  • Identify specific types of partnerships and corporations, including Limited Liability Companies (LLCs) and Benefit Corporations (B Corps).

Drivers Behind Entity Choice

  • Limits to Liability: Determines personal liability for business debts.
  • Ease of Formation and Dissolution: The complexity involved in starting or ending a business entity.
  • Taxation: Different entities face different tax implications.
  • Owner Compensation: The means by which owners receive profits from the entity.

Types of Business Entities

  1. Sole Proprietorship

    • No formal organization required, except a fictitious name registration if not using the owner's name.
    • Taxed at the individual level (self-employment tax + income tax).
    • Unlimited liability; all personal assets at risk.
    • Simple formation but high personal liability risks.

  2. Partnership

    • No formal requirement for organizing documents (but beneficial).
    • Joint and several liability applies; partners share liabilities regardless of individual fault.
    • A partnership agreement is essential to outline roles and profit-sharing arrangements.

  3. Limited Partnership (LP)

    • Requires one general partner with unlimited liability and limited partners whose liabilities extend only to their investment.
    • Must file a certificate with the Secretary of State.

  4. Limited Liability Partnership (LLP)

    • Similar to partnerships but limits liabilities for malpractice to the individual (who committed the malpractice).
    • Primarily applicable to professional services, e.g., law and accounting.

  5. Corporation

    • Formed by filing articles of incorporation; requires corporate bylaws.
    • Treated as separate legal entities, offering limited liability protection to owners (shareholders).
    • Taxed at a flat 21% corporate rate post-Tax Cuts and Jobs Act.

  6. S Corporation

    • A special type of corporation that allows pass-through taxation if it has 100 or fewer shareholders.

  7. Limited Liability Company (LLC)

    • Created with a certificate of organization; has required operating agreements known as member operating agreements (MOA).
    • Offers limited liability and flexibility in management and taxation.

  8. Benefit Corporation (B Corp)

    • Can be designated as either a C or S corporation for tax purposes and must have a positive impact on society, not just profit.

Key Concepts for Sole Proprietorship

  • Liability: No limit; personal assets are at risk.
  • Taxation: Taxed at owner's individual tax rates (including self-employment taxes).
  • Formation: Very easy; no substantial filing requirements unless using a fictitious name.

Key Concepts for Partnerships

  • Liability: Joint and several liability; partners are fully liable for debts.
  • Partnership Agreement: Highly recommended to delineate roles, responsibilities, and profit-sharing.

Key Concepts for Corporations and LLCs

  • Separate Legal Entity: Offers limited liability, protecting personal assets from business debts.
  • Taxation: Corporations face double taxation on profits (21% tax on corporate earnings + taxes on dividends to shareholders).
  • Operating Compliance: Must adhere to regulations such as holding annual meetings and maintaining records.

Important Considerations

  • It is essential to have clear agreements in place to protect interests and clarify roles in business partnerships.
  • Awareness of potential tax implications and liabilities associated with each type of entity is crucial when choosing how to structure a business.
  • The nature of the business, the number of owners, and desired liability protection will influence the choice of entity.

Additional Notes on Taxation

  • Tax Cuts and Jobs Act Impact: Reduced corporate tax rates and introduced nuances in taxation for various entity types.
  • Self-Employment Tax: A significant cost factor for sole proprietors and partners; important to consider when evaluating profit.
  • Pass-through Entities: Like partnerships and S corporations, which are taxed at the individual level rather than at the corporate level, avoiding double taxation.